The difficulty of economic diversification in oil-producing countries and the need for financial rules

​​Economic diversification is considered one of the most important goals pursued by oil-producing countries, because it achieves economic stability and sustainable development, reduces dependence on oil, and reduces the fluctuation of economic growth. Economic diversification is one of the most important goals of previous development plans since the 1970s, which unfortunately was not achieved, as was hoped for. Despite the efforts made, successive plans, and initiatives at the sector level, the goal of diversification was difficult to achieve in oil-producing countries that did not adopt sufficient macroeconomic policies to neutralize fluctuations in oil revenues on the local economy. Due to the importance of economic diversification, it is one of the most important goals of the Kingdom’s “Vision 2030” to shift the source of economic growth from government spending to private investment and address the imbalance that the local economy suffers from.

The economies of the oil-producing countries suffer from economic instability, as a result of shocks from the oil sector to the economy, which raises the level of risks, and leads to an imbalance in the relationship between the exportable productive sectors and the non-exportable sector, such as the real estate sector, and an imbalance in the real exchange rates, even though the nominal exchange rate is fixed with the dollar. , as is the case in the Kingdom. Government spending is affected by the rise and fall of oil revenues, which constitute shocks to the economy that lead to instability of the national economy, and pose risks to long-term private investment.

During the period of rising oil revenues, spending rises greater than the absorptive capacity of the economy, which raises inflation and wages. Real estate sector prices also rise, which raises economic costs for producers in the productive sectors, weakens the competitiveness of the local economy, and reduces the attractiveness of the economy to invest in long-term development projects, which It is the most important source of sustainable development and employment. The contracting and services sector is also becoming more attractive to investments and attracting talents because it is linked to government contracts with the highest returns in the economy, through which investors can reduce the risks they may face. The low risk and high return compared to other productive sectors targeting export and local demand contributed to directing bank loans to sectors related to government projects and reduced its contribution to other sectors.

On the other hand, during a period of low oil prices, oil governments resort to one of two policies. The first is to reduce spending as much as possible, and the development sectors suffer the most, such as the health and education sectors, which are necessary to achieve sustainable development. The second is to focus on non-oil revenues by raising taxes and fees to maintain the government’s high level of spending, which has been inflated by oil revenues. This policy inevitably leads to raising the cost of doing business for the private sector. It also weakens the purchasing power of individuals’ income and reduces the real wage, which consequently decreases productivity, or the private sector is forced to raise nominal wages to maintain purchasing power. In a country like the Kingdom, more than 50 percent One hundred percent of the workers are non-Saudis. It is expected that higher wages will be required to accept work in the Kingdom, and this raises the wage bill and weakens the competitiveness of the private sector. As an economic result of increased non-oil revenues, aggregate demand will decrease and the costs of doing business will rise, and the economy begins to search for a new equilibrium point.

In order to achieve stability and avoid oil sector shocks on the economy, the economy needs to neutralize the oil sector fluctuations on the economy through macroeconomic policies, institutional building, and governance that limit the impact of oil sector shocks on the economic sectors. Among the most important of these tools, which have been expanded and written about in the economic literature, and proposed by international organizations, such as the International Monetary Fund, are the financial rules for fiscal policy, and one of its most important features is determining the oil pricing mechanism for budgetary purposes, relying on average historical and future oil prices for a number of years, and directing Part of the financial surpluses of the Tawazanat Budget Fund, in addition to an external (long-term) investment fund for generations and a local development fund, in addition to determining the ratio of spending to local income and setting ceilings for revenues, as well as for public debt. In addition, tax rates are determined stably during different periods of oil price fluctuations, with the possibility of changing them slightly for fiscal policy purposes.​​