August 14, 2011

Integrating, Not Integrated

With the eurozone stalling and protectionist tendencies on the rise worldwide, the merits of economic integration, in which several national economies agree to coalesce into a larger single entity, have recently been called into question. But this context unfairly overshadows the substantial economic and strategic benefits that such integration has brought about in many parts of the world including the EU, which has seen the creation of 2.75 million new jobs and 2.2 percent of additional GDP over a 15 year period—a direct result of integration efforts such as standardization of customs and border regulations that facilitated the movement of goods, services, and labor between countries. In addition, the introduction of the euro and a monetary union has contributed to a 5 percent to 10 percent increase in trade. Another benefit comes in joint R&D efforts which has encouraged public and private sector investments and has spurred economic development. Many of these benefits can directly apply to countries within the GCC.

As the GCC approaches its 30th birthday, the economic integration of the six member countries has not progressed as much as had been expected, a new study from Booz & Company reveals.

“The region has shown admirable growth in the past decade, yet that growth represents the efforts of six individual states, rather than a coherent and aligned group operating as an integrated economic entity,” said Richard Shediac, Senior Partner, Booz & Company. “More comprehensive integration has the potential to boost the region’s economy much as it did for the EU. In short, there is an opportunity cost to not integrating further.”

Booz & Company evaluated the region’s level of economic integration based on five core dimensions: the monetary union, customs and borders, intra-regional investment, joint infrastructure and knowledge cooperation. These five criteria were selected to highlight areas that GCC members declared to be priority, and in which action has already been taken, with ratings determined based on the following:

1 = Major setback to the goal or stagnation of process
2 = Minimal progress toward goal since last action
3 = Some indication of effort and progress toward the goal
4 = Substantial momentum generated toward the goal
5 = Accomplishment or near completion of the goal

Monetary Union

With a score of 2.8, there are clear efforts under way in regard to the monetary union. The GCC established a Gulf Monetary Council in early 2010—an important first step toward a regional authority that can set policy for all six members as a single economicentity. All of the GCC member states, with the exception of Kuwait, have pegged their currencies to the US dollar, which will pave the way for a smoother transition to a common currency if and when it is put into place.

However, the 2010 target date to establish a single GCC currency has passed, and the withdrawal of the UAE and Oman from the proposed common currency is a major setback to its creation. It is difficult to imagine a monetary union and currency regime that excludes two of the GCC’s members: Such an effort could ultimately have an adverse effect by creating a two-tiered structure of integration. GCC leaders are leaving the door open for further discussions.

A critical step for GCC nations to achieve monetary union is to establish a robust system of payments and strong links among financial markets, by harmonising legal and regulatory infrastructures. To that end, the GCC countries should invest in compatible statistical institutions at both the national and regional levels, perhaps akin to the Eurostat of the European Union. The ability to gather and analyse macroeconomic data is a key requirement for harmonising regulatory policies and risk management practices—as the Greek debt crisis in the EU shows.

Customs and Borders

Booz & Company ranked this dimension 3.0 based in part on the fact that intra-GCC trade has grown tenfold since the GCC’s founding. After the Customs Union agreement of 2003, for example, intra-GCC non-oil exports between 2004 and 2008 increased by 27 percent annually, compared to only 20 percent for the rest of the world over the same period.

However, intra-GCC trade has never exceeded 10 percent of total trade for the region. By comparison, blocs such as ASEAN and EU-15 generate 23 percent and 57 percent, respectively, of their overall trade from within their regions.

GCC governments are making an effort to ensure that future trade flows more smoothly. “Although disagreements have arisen over issues such as the sharing of tariff revenues and wait times at border crossings, there is willingness among GCC countries to remove these obstacles and news reports indicate a determination to resolve all outstanding customs issues by 2015. Several member countries have already begun to automate their customs procedures, though these efforts must be coordinated to create a single GCC-wide window in which all member states can share trade information and documentation,” stated Hatem A. Samman, Director, Ideation Center.

In terms of labor flow between GCC countries, as of 2007, just 27,000 GCC nationals—a mere 0.2 percent of the estimated labor force of about 15.6 million—were working full-time in other GCC member states. This number is expected to increase, however, given a recent decision to allow GCC companies to open branches in member states, which will likely foster more movement of citizens across borders.

Intra-regional Investment

The GCC has witnessed an unprecedented rise in intra-regional investments over the past eight years, earning this dimension a score of 3.0. In previous decades, FDI flow between GCC countries was minimal—only $3.6 billion between 1990 and 2003, for example, or a mere 2.9 percent of the aggregate regional FDI outflow of $125 billion. However, since the surge in oil prices beginning in 2003, the amount of cross-border investments has increased significantly, especially in the telecom sector. Indeed, GCC M&A activity has been quite robust across sectors, growing to over US$26 billion from between 2000 and 2008.

Yet this increase in regional investment has happened despite a lack of formal coordination, and overall financial integration for the region remains inconsistent. “To further enhance intra-regional investment, the GCC should work to harmonize laws on the investment and ownership of GCC companies in all sectors,” Shediac said. “The GCC should also encourage foreign direct investment, and it should promote and grow the private sector, with a particular emphasis on measures to diversify national economies away from their reliance on hydrocarbon revenue.”

Joint Infrastructure

With a score of 3.6, this dimension is the most integrated of the five. Multi-billion dollar projects in oil and gas, road, railroads, and electricity have been announced, with several significant milestones having been reached. In transportation, Qatar and Bahrain are planning a US$4 billion causeway and high-speed rail link that will connect the two countries, and Oman is planning a super-expressway to connect Muscat with the UAE, planned to open by 2015. As a whole, the GCC is planning a 2,117km railway network at an estimated cost of US$25 billion, to be built by 2017. Bahrain, Kuwait, Qatar and Saudi Arabia are making major additions to their existing airports and all, with the exception of Saudi Arabia, have signed some form of open skies agreement, though the GCC is still waiting for an open skies agreement that will permit fully free movement of people and goods within the region.

Many of the infrastructure projects are extremely ambitious—current infrastructure plans in the region have been valued at more than $1 trillion—at a time when some construction efforts in the region and worldwide have been subject to delays or cancellations. Therefore, the GCC should consider creating an infrastructure monitoring board to evaluate and spur progress on large-scale regional infrastructure projects. The region must also build on the success of interconnection projects, such as expanding the electricity grid to include Oman and the UAE by the end of 2011.

Knowledge Cooperation

This dimension, with a score of 2.3, has the greatest opportunity for improvement. Individually, GCC countries have built impressive new educational institutions and invested heavily in R&D, with facilities in Oman, Saudi Arabia and Qatar developing new healthcare and energy technologies, while the UAE has established new entities such as Masdar and Dubai TechnoPark to spur innovation through R&D.

Yet despite these initiatives, the overall region has fallen short of its vision for an integrated, high-quality education system and R&D cooperation. “There are no common GCC-wide programs for digital education content and services, and despite the establishment of foreign university satellites attracting high education students from across the GCC, competition among regional institutions has hindered their mutual cooperation,” commented Samman. “In R&D, the GCC has not developed a flagship regional institute for joint R&D spending akin to that of the EU, despite the common economic and social interests of member states. The GCC should establish a regional research institution, akin to the European Research Council, to promote, fund, and assess collaborative projects. The region also needs to involve the private sector in R&D projects via incentives that give companies the opportunity to contribute to transnational research and development.”>

Overall GCC Integration

With a score of 2.9 on overall economic integration, the GCC has reaped substantial benefits from closer integration since its establishment. Yet this scorecard of core issues shows that there is much work remaining before the region is truly integrated. A wider economic landscape and a more harmonized financial system will allow the GCC to exploit economies of scale, attract FDI, and negotiate favorable agreements with larger economic counterparts such as the EU. As global economic competition intensifies, GCC countries must strive for broad economic integration, which will enable the six member states to better face future socioeconomic challenges.