Explaining growth in an oil-dependent economy: the case of the United Arab Emirates

Discovering oil in the United Arab Emirates (UAE) in the late 1950s has transformed the economy from one of subsistence to a modern high-income economy. This paper looks at the determinants of growth in the UAE and makes policy recommendations for enhancing faster growth in the future.

Fluctuating oil prices and revenues have led the UAE, as of the mid 1980s, to embark on economic diversification. This in turn has led to sustained investment in manufacturing and other sectors dominated by private capital. The paper finds that as a result of this investment, non-oil exports have exceeded oil revenues. Diversification - though still limited - can be attributed to four key factors:

• substantial government investment in physical and social infrastructure which helped boost private investment
• stable macroeconomic environment resulting in low inflation rates and semi-fixed exchange rate
• capital abundance and high degree of mobility facilitating growth in foreign trade
• availability of relatively cheap labor

The paper notes that the UAE performed better than most of the other oil-dependent countries given its relatively high growth rates and generally stable economy. It also finds that labor is the key contributor to GDP, followed by capital, while total factor productivity (TFP) shows a negative average contribution. It is argued that the negative TFP growth is a result of high public investment and low yielding productivity projects in the services and residential sectors.

Increased domestic investment rates and investment in human development have had strong positive effects on economic growth in the UAE. Although low inflation rates and exchange rate stability seem to have no direct effect on growth, they stimulate growth indirectly by helping to create a stable macroeconomic environment and reduce uncertainty.

The paper develops a set of policy recommendations aimed at invigorating sustained growth in the UAE which suggest:

• reforming labor market distortions such as over supply of labor in the public sector and high demand for low-paid, low-educated labor in the private sector, where reversing the situation will enable the UAE to engage more in capital-intensive industries
• encouraging further private investment and expanding output markets regionally and internationally which will increase economic diversification
• developing a financial system in general and equity markets in particular to accommodate the increasing real domestic investment
• adjusting fiscal policy shifting the focus from financing to structural adjustment that includes widening the non-oil revenue base, privatization of public enterprises, rationalizing government expenditure, and reassessing subsidies and incentivesprograms