The Gulf states are acknowledging a difficult truth: the oil and gas–powered, state-led economic development model that lifted them from isolation and poverty less than a century ago must change. Times, and Gulf societies, have changed. A new Saudi push for economic reform is an admission that the state can no longer provide everything for citizens, who must find ways to take care of themselves.

In April, Riyadh launched a new economic reform agenda, Vision 2030, with an accompanying National Transformation Plan. Vision 2030 is a strategy to diversify away from oil dependency, driven by the realization that the economy is not increasing in productivity or generating wealth through entrepreneurial initiative. Somewhat ironically, this is a state plan to diminish the presence of the state within the economy by increasing state spending in investments in the private sector, funded by the sale of state assets—most notably a share offering for a small portion of Saudi Aramco, the state oil company, as well as a number of other privatizations and partnerships in major industry and utilities. The National Transformation Plan establishes roadmaps and shorter-term targets for this transformation between now and 2020.

Deputy Crown Prince Mohammed bin Salman is both the architect of these reforms and their public spokesman. Since assuming the throne in January 2015, King Salman bin Abdulaziz Al Saud has increased the portfolio of his 31-year-old son, giving him oversight of defense policy (including the war in Yemen), economic policy, and the delicate mission of social reform, which involves scaling back the power of the religious police. The reform process is still in its early stages, but it calls for a guided shift in Saudi state identity. Some see it as modernization or revolution disguised as economic reform, but others see an empty promise.

All six Gulf Cooperation Council (GCC) members now operate in fiscal deficit, and even with Saudi Arabia’s significant reserve assets, the spending trajectory cannot be sustained indefinitely, or perhaps even for a decade. Many analysts find the spending untenable even if oil prices were to rise back to the $100 per barrel range. As a result, Gulf states are seeking external sources of capital, including the issuance of international and local debt. Saudi Arabia sold $17.5 billion in bonds in October, raising more capital than anticipated thanks to high demand.

The neighboring United Arab Emirates has been vocal in its support for Vision 2030, partly out of a calculation that failure of the Saudi reforms could call into question the viability of the Gulf model, featuring open economies but tightly controlled political systems managed by hereditary tribal leaders. The UAE fears that the entire Gulf will collapse into chaos and war if Saudi Arabia fails. In the view of these regimes, the implicit ruling bargain common to the region, which forbids dissent in exchange for sharing the wealth via patronage, must be salvaged, or better, transformed to last another fifty years or more.

This is not Saudi Arabia’s first reform effort, nor is it the only hydrocarbon exporter seeking economic diversification and new ways to generate state revenue, attract foreign investment, and create jobs for citizens. Economic diversification has long been a policy priority of all six members of the GCC—Saudi Arabia, Kuwait, Bahrain, Oman, Qatar, and the United Arab Emirates. State development plans in five-to-ten-year phases have proliferated across the Gulf in the past twenty years, generating fees for consulting firms that offer advice on economic liberalization and strategies to end oil dependence and build knowledge economies. Saudi Arabia’s first central planning efforts, developed with guidance from the International Monetary Fund and the Ford Foundation, date back to the early 1960s.

Historically, Gulf economies have been treated as objects under state supervision and control, rather than organic markets that might need a little regulation or state investment. That is the nature of Gulf capitalism: it is a child of the state. But now it may be time to cut the cord.

Boom to Bust?

Even as early as the 1970s, Gulf states began planning for a post-oil economy. Their first priority was always national human development. Saudi Arabia and the Gulf states have achieved some remarkable success in reducing mortality and improving health care and education, as reflected in gains since 1990 in the UN Human Development Index. Saudi Arabia faces greater challenges than the other GCC states, partly because of its large population and landmass, as well as its subjugation of women. It has struggled more than its neighbors to improve maternal health and access to education. Yet it has seen the steepest improvement curve on the Human Development Index of all GCC states since the 1990s.

The Saudi engine of growth has long been oil revenues. The steep decline in global oil and gas prices since late 2014 ended more than a decade of unprecedented wealth creation for Gulf energy exporters. The period from 2003 to 2014 (with a small dip during the 2008–9 global financial crisis) was an anomaly: it was a decade of infrastructure spending, of growth in the population of both nationals and foreign laborers, and of the expansion of state institutions and services in education, health care, and military capacity. Gulf states capitalized on this windfall in different ways, but all six GCC members heavily invested in their domestic economies, from construction and real estate ventures to the banking sectors. Saudi Arabia also amassed a war chest of reserve assets in foreign currency and in equities of leading global companies.

According to Jadwa Investment, a Saudi firm, official foreign reserve assets rose as a percentage of gross domestic product from 34.5 percent in 2004 to 97.2 percent by 2014. While the decline in oil prices has led to a drain on these assets, Riyadh remains capable of directing state funds toward reform efforts, especially plans to invest and share risk with partners in infrastructure projects such as electricity plants and ports. Fiscal policy will have to prioritize spending needs, and public sector jobs are not a good return on investment.

About 70 percent of working Saudis are employed in the public sector. According to Jadwa Investment, the working-age population is expected to increase to nearly 18 million by 2025, meaning 226,000 Saudis will enter the labor force each year. The public sector simply cannot absorb all of them. Meanwhile, the declining productivity of both the public and private sectors means jobs must be transformed, not just created.

Saudi Arabia, like other Gulf economies, is prone to blurred lines between state ownership and the financial interests of the ruling family, such that corporations and banks often have board and ownership rosters that mirror those in government ministries. In effect, the Gulf states boast very profitable state-run economies that have generated private wealth. But that run may have come to an end. The overlapping interests of the state and its stakes in industry, infrastructure, and services are only sustainable when oil and gas revenues stay at very high levels.

The Gulf states have essentially committed to do too much. The problem is that their citizens have come to expect substantial rewards from the state in the form of employment; access to, and often financing of, housing; and generous provisions for health and education.

Growing Pains

Even if oil prices rebound over the next decade, as some expect, the current level of Saudi fiscal outlays per capita is not sustainable. The problem is that the state has not created an institutional framework that allows citizens (not to mention foreign laborers and foreign investors) to create new organizations, whether for profit or for service, that might fill the gaps. The gaps are most evident in the Saudi government’s new trade and investment model, in which society and the rule of law would become the foundation for growth.

The new model relies on two important reforms. The first is a revised institutional framework that is business-friendly, supportive of entrepreneurs and workers who need training in new skills. The second involves a shift to new modes of revenue generation for the state. It is expected that domestic private-sector growth will drive employment and economic activity, which the state can draw on for revenue.

The starting point is a legal framework that would protect investor rights. There are currently no comprehensive bankruptcy laws in the Gulf states, whether for personal or corporate cases. Only free zones and their separate Western-style court systems have been able to accommodate complex corporate restructurings. The UAE is the first state in the region to attempt enacting a bankruptcy framework.

The success of the new Saudi approach depends on investments in human capital and the development of a research and development culture. That amounts to a textbook liberal economic strategy, but in Saudi Arabia, the distance from the current reality to fulfilling that aspiration is substantial. It will amount to a drastic upheaval in the Saudi political economy, where the state generates revenue and funnels it through the banking sector and large contracts to build infrastructure and fuel job growth, albeit mostly in low-wage positions for foreigners.

According to demographer Françoise de Bel Air of the Gulf Labor Markets and Migration Project, as of mid-2013 foreign workers, mostly from South Asia, made up 32 percent of the kingdom’s population. They accounted for 56.6 percent of the employed population and nearly 90 percent of the private-sector workforce. The new political-economy model will have to answer to a population that is a third noncitizen. It will also have to answer to a private sector that has little reason to trust the government’s ability to fairly oversee bidding for assets that are being privatized, and to allow non-state-related (and foreign) firms to compete on an even playing field.

Saudi reform efforts in the 1990s, following a previous oil glut that led to a price collapse, were inadequate. The government simply cut back while making no effort to save or restructure companies that might have brought stability to the private sector job market. It also did not reform the labor market to make training for Saudi nationals more appealing in a coming upturn. The difference between the current downturn and the last one is that the government is now more entrenched as a dominating force in the private sector. When the GCC states last faced declining oil revenue and economic downturns, their fiscal commitments were much lower, their populations were smaller, and they were not as integrated with the regional and global economies.

In a new study by the International Monetary Fund, researchers point to the last downturn, which began with the collapse of oil prices in 1986 and lasted through the early 1990s, as the region’s “greatest depression.” Per capita consumption fell by nearly 20 percent and did not recover until the late 2000s, during the most recent oil boom. In fact, the relative income of GCC countries has fallen in the past 30 years, as low productivity has dampened growth potential. GDP per worker (in purchasing parity dollars) has dropped. Total factor productivity declined in all six GCC countries over the three decades through 2010.

Citizens’ Needs

The evidence suggests that although the Gulf states have become wealthy, and grown in population, it has gotten harder for their citizens to make a living. People’s lives have improved in terms of educational attainment and access to social services, yet efforts to generate wealth and productivity are limited. It will be difficult to keep growing, especially given that trends in the global economy indicate growth will remain low for the next few years.

While citizens, and Saudi society at large, benefited from state-directed investments during the oil boom, their future development needs are very different. Citizens need employment. More importantly, they need employment that is productive, that generates wealth and helps launch new businesses and services. A government paycheck has been a useful way to distribute oil rents, but it does not encourage workers to improve their performance and knowledge base, or to apply their skills to new ventures.

The reform agenda leaves Saudi citizens caught in the middle. They are expected to create and sustain new kinds of growth, but they do not have the institutional support—in training, bankruptcy protection, or access to business loans—that might encourage them to take risks.

The National Transformation Plan includes a number of “localization initiatives” that push government entities to develop and then create links to local manufacturing and service providers. To spur growth in the private sector and create the companies that will be on the receiving end of these contracts, the government has promised to create a new $4 billion venture capital fund to focus on small and medium-sized enterprises (SMEs).

These government giants have been asked to go out and find small companies to employ; in effect, to decentralize their functions by dividing work among a series of subcontractors. The subcontractors just don’t exist yet. The task, in other words, will be to provide funding for SMEs to create new businesses for which contracts already await.

Shifting jobs from the public to the private sector will be problematic for many citizens, even when the government promises to fund their new companies. A labor force initiative announced in late September 2016 aims to “second” government workers to businesses. These secondments require private-sector firms to use preferential hiring practices that favor nationals over expatriates. The government is basically asking the private sector to hire public employees as paid interns, possibly train them, and hopefully hire them permanently in the future.

Historically, Saudi reform efforts in the social sphere have not always coincided with economic reforms. Social reforms are more often attributed to the personal politics of the ruler. In recent decades, they have also tended to cluster in times of economic plenty. While Vision 2030 is not a framework for social reform, it clearly seeks to expand public spaces (with provisions for development of the entertainment sector), and it emphasizes bringing transparency to government bureaucracy. For Saudi Arabia, this mounts to massive social change.

Financial Flaws

The target beneficiaries of the economic reforms are ordinary Saudi citizens. But the reform process is also likely to benefit some well connected “early winners” through privatizations and partnerships that seek to spread risk and profit in the construction of power plants and the delivery of energy, and in the sale of state assets in the oil and mining sectors. There is already evidence that the tender processes privilege domestic firms, especially those with close ties to the state and its ruling family.

Economic transformation will require a regulatory environment for financial services that curtails the dominating role of the state in the economy. Some reforms were implemented during the last oil boom, spurred by the demand for financial services as capital flows surged in the region. But Saudi Arabia and other GCC states took the 2008–9 financial crisis as a cautionary lesson for their nascent financial-services industries, implementing bank regulations that are very strict by international standards in an effort to safeguard their economies from similar crises in the future.

The banking sector in the GCC is not well developed. Few banks hold securities or complex instruments like derivatives, mainly because many of these products are seen as out of line with Islamic law. Bank ownership is also restricted in most GCC states, so that foreigners are not able to set up banks independently. (Bahrain is an exception; all other GCC states limit foreign stakes in local banks to less than 49 percent.) Government ownership and large ruling-family holdings are common across the board in the GCC. In Saudi Arabia, government stakes in the banks are as high as 35 percent.

Because Gulf political economies are prone to investment patterns driven by oil price cycles, banks are often restricted in their lending, in order to diminish exposure to certain prominent sectors like construction and real estate. Yet these sectors are also highly sensitive to downturns. The IMF has warned for some time that the Saudi banking sector is highly exposed in its credit lines to lenders within the GCC and the broader Middle East, further concentrating risk.

After the 2008–9 financial crisis, Saudi Arabia made efforts to conform to the Basel international banking standards, for example by offering deposit guarantees and additional support to the banks through policies governing long-term government deposits. These deposits and liquidity injections have been less frequent since mid-2016 since government spending is more constrained.

Saudi Arabia has had a Commercial Court since 1930 and a bankruptcy preventive settlement law since 1996 (perhaps the most important regulatory change after the last recession), but both are seen as inadequate for complex debt arrangements, particularly between the government and its related entities and foreign investors or partners. One problem is that most of the largest firms in the GCC are not publicly listed companies, which hinders risk measurement and transparency.

Shock Therapy

The challenge of all structural economic reforms is timing. How much change can a government enact? How quickly will the population respond, and in what way? How long will it take to see some benefit from the policy change? Too much reform through shock therapy, as in the 1990s economic reforms in the postsocialist states of Eastern Europe, can cause adverse reactions. Cuts to public salaries and fuel, electricity, and water subsidies can lead to unemployment and all the effects of overburdened family-support networks, in which women and children bear the brunt of poverty. Reforms can also trigger defaults on loans, and, in extreme cases, produce hyperinflation and bank crises.

Economic liberals in many states, such as Bulgaria, were quickly voted out of office in favor of reconstituted socialist parties when the pace of economic reforms seemed too extreme and the positive results too meager. Policy reversals can entrench resistance to reform for decades. In Saudi Arabia, it will not be a democratic election that tests the commitment to reform, but rather the calibration of policy in response to public perceptions.

The government needs to time the use of its diminishing reserves to jumpstart the private sector and prepare its citizens for a different kind of employment, while at the same time selling off enough assets to interest foreign investors in taking part in the transformation. It is an extremely difficult balancing act, one that no liberal economy in transition has managed particularly well. The worst-case scenario is Russian-style privatization, in which elites consolidate power and political liberalization stalls, while a handful of people profit from the sell-off of state industries.

The best-case Saudi scenario would follow the model of Dubai or Singapore, in which the ruling bargain is sustained while liberalization proceeds with heavy guidance from the state. But citizens are not always the primary beneficiaries of economic reforms, particularly in privatization processes that privilege outsiders and large investors rather than citizen-shareholders. Saudi Arabia must place its citizens firmly in the center of its transformation, so that employment, productivity, and local demand determine the direction of the economy.

Riyadh faces a tremendous challenge: the state is leading the reformation of its own presence in both the economy and society. The process is highly centralized, in that it is not only state-led but personally directed by a powerful prince. To achieve real reform, citizens will have to find a role helping to bring change from within, not just from above.

This article was originally published by Current History.