From Oil Dependence to Diversified Prosperity: The Unconventional Journey of the United Arab Emirates

UAE Skyline

What is the "resource curse"? How has the United Arab Emirates been able to avoid it? In this blog, I will present the measures implemented to overcome oil dependency as a primary source of income for the country. To do this, I will describe briefly the main macroeconomic policies and the measures taken to implement these policies, such as good governance, stability, and corruption control.

The "resource curse" is a phenomenon in which nations with abundant natural resource endowments experience slower growth than those with few. It has been a topic of debate in the literature for many years. Some investigations showed that resource-rich nations expand slower than resource-poor countries, hence the term "natural resource curse"(Gelb, 1988; Auty, 1990; Sachs, and Warner, 1995; and Gylfason, 2001). However, there have been studies indicating that the occurrence of a natural resource curse relies on variable conditions. For instance, Limi (2007) discovered that the quality of governance impacts the negative effects of the natural resource curse on the country's economic growth. Manzano and Rigobon (2001) found that the natural resource curse depends on debt overhang and typically ignores elements connected with primary exports. Gylfason and Gylfi, (2006) stated that enhancing the quality of institutions can alleviate capital market flaws caused by natural resources and thereby minimize the natural resource curse. Good governance, accountability, high government effectiveness, appropriate regulations, and anti-corruption policies can help turn natural resources into a benefit for sustained economic growth (Elwerfelli and Benhin, 2018). These factors have linked natural resources with high sustained economic growth and turned the resource from a curse into a benefit for UAE.

The UAE is the Middle East's second-largest oil producer, with significant oil and natural gas reserves, which have fueled its economy. Prior to the discovery of oil, the country's economy was based mostly on agriculture and other subsistence activities. Following the rise in oil prices in 1973, the UAE established official structures that coincided with a significant increase in oil production and exports, leading to economic prosperity in the early 1970s. The country's economy has significantly grown over the past 20 years, and its proven oil reserves account for nearly 10% of the world's total. Moreover, the UAE's dependency on oil revenues has decreased dramatically. The share of oil revenue in GDP dropped from 60% in 1979 to 11.5% in 2020 (World Bank, 2020), which represents significant progress in economic diversification.

Literature suggests that countries with abundant natural resources should adopt sound macroeconomic policies, including avoiding large debts, both foreign and domestic, maintaining budget surpluses, controlling inflation, and keeping competitive exchange rates (Usui, 1997; Mikesell, 1997; Sarraf and Jiwanji, 2001). UAE has identified these issues and adopted such policies to decrease the dependency of its economy on oil. In the first four years of the third millennium, the UAE saw rapid expansion, and it is seen as a stable economy in the Middle East.

Its pegged currency, UAE Dirham (AED), serves to stabilize the currency, but it could also suggest the risk that a decrease in the USD would diminish its purchasing power to imported products on which the country is so reliant. In contrast to other nations that have adopted a different strategy for floating exchange rates, fixed exchange rates were not particularly effective in most nations. However, the UAE instance was completely different. Since the last three decades, the inflation rate there has been exceptionally low compared to other Gulf countries and even OECD countries. This aided the UAE in minimizing the detrimental impact of oil price shocks.

To stimulate Foreign Direct Investment, the UAE government has established and lately enlarged the number of free trade zones, in tandem with the signing of bilateral investment treaties. According to the Trade Policy Review, the UAE now has 23 free trade zones, which are distinguished by 100 percent foreign ownership and no income taxes. The restrictions to international investment and local competition that were identified in the WTO Secretariat evaluation report do not exist in free trade zones. For example, there are no restrictions on foreign ownership involvement, no requirements for foreign company branches to hire a local agent, and no exclusive import and distribution services for national agents. Furthermore, enterprises are not subject to the Emiratization policy of (minimum) quota employment of UAE nationals.

The UAE government makes use of the country's strategic position, which has 15 seaports from which commodities and raw materials are exported and imported. Furthermore, the UAE has made it easier to start a business, ranking 16th out of 190 nations in 2019 and first in the Gulf area (World Bank, 2019). Some of the most frequent business incentives are a 10-year golden visa for business owners, 0% tax on personal income, and an immobile exchange rate, as well as good governance, stability, and corruption control. Due to such policies, FDI inflows have quadrupled to more than 19 billion dollars in the last ten years.

Moreover, the service sector has played a significant role. The economy has been diversifying and transitioning away from its reliance on the oil and gas sector, and the service sector has been a key driver of this growth. The service sector in the UAE encompasses a range of industries including finance, tourism, real estate, transportation, and telecommunications. The sector has grown rapidly in recent years and has become a major contributor to the country's GDP. Tourism is a particularly important part of the service sector, with Dubai, UAE's most populated city, repeatedly selected as the world's second most attractive tourist destination (O’Hare, 2022). The government has invested heavily in building world-class hotels, theme parks, and attractions. Elwerfelli and Benhin (2018) estimated that in the last three decades, UAE has spent 7 billion dollars in industrial development and infrastructure to boost its economy. Tourism accounts for 11.9% of the GDP (Ministry of Economy UAE, 2022), which suggests that enormous efforts have been made by the government to transform a desert into a tourist hub and generate significant revenue from it.

Good governance has played a critical role in helping UAE escape the resource curse. A strong and effective government, coupled with a predictable and transparent regulatory framework helped to create a stable investment climate and attract foreign investment, which is critical for the country's continued growth and development. Additionally, a strong rule of law aided in reducing corruption, promoting economic competition and protecting property rights, all of which are essential for a thriving economy. The UAE has made significant progress in recent years, as reflected in its scores on various governance indicators. For instance, its scores for government effectiveness, political stability and absence of terrorism, regulatory quality, and the rule of law are all over 80, demonstrating a high level of political stability, regulatory efficiency, and legal certainty in the country (World Bank, 2021).

Control of corruption is vital for creating a transparent and predictable business environment, reducing the cost of doing business, and promoting investment. A corruption-free environment builds trust between businesses and the government, which is essential for encouraging entrepreneurship and innovation. In resource-rich countries like the UAE, control of corruption is critical in preventing the diversion of resources and ensuring that the country's wealth is used for the benefit of its citizens (EIA, 2019). Moreover, control of corruption helps to enhance the effectiveness and efficiency of government institutions as it reduces the impact of rent-seeking and rent-seeking behaviors. A transparent and accountable government helps to reduce the scope for corruption, leading to a more level playing field for businesses, improved service delivery, and enhanced economic growth (IMF, 2017). Control of corruption has been a crucial factor in helping the UAE escape the resource curse and ensuring long-term sustainable economic growth. According to Transparency International's Corruption Perceptions Index (CPI) 2022, the UAE scores 67 out of 100 globally, putting it among the countries with a relatively low perception of corruption (Transparency International, 2022). This is a remarkable accomplishment for the UAE, as it is the best-ranked country in Asia in terms of CPI.

In conclusion, the UAE has managed to avoid the "resource curse" by implementing sound macroeconomic policies, promoting good governance, and diversifying its economy beyond natural resources. In the progress of diversification, it has been focusing on the service sector and investing heavily in infrastructure and free trade zones, and the country has attracted significant foreign direct investment, leading to sustained economic growth. The UAE's results can serve as a positive case for the above-mentioned literature discussing conditions on avoiding "resource curse", it offers an example of how good governance, regulatory frameworks, and strategic planning can help nations with abundant natural resources to leverage these resources to drive long-term economic prosperity.

Cover photo courtesy of Khaleej Times

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Maisam Amiry

About the author

Maisam Amiry, a first-year student at the Willy Brandt School of Public Policy, specializing in Global Public Policies and Social Economic Development.

~ The views represented in this blog post do not necessarily represent those of the Brandt School. ~