This post is part of an AGSIW series on Saudi Vision 2030, a sweeping set of programs and reforms adopted by the Saudi government to be implemented by 2030.

Economic liberalization tends to bring with it social, if not always political, openings. By definition, liberalization challenges existing orders; more specifically, liberalization tries to deny the state a dominating role in the economy. State-led capitalism, as practiced in the Gulf states over the last 40 years, has invited foreign investment and migrant human capital, but it has always privileged the state and protected opportunity for citizens, most visibly via commercial agency laws and the kafala system.

This is a critical moment in the history of Arab state governance of the economy, and of Arab governance more broadly. The current disorder in the Middle East has many causes, but resolving these conflicts will require new regional and national answers to the central question of the appropriate role of the state in both society and economy. Efforts to impose political settlements to civil wars, ways of introducing aid and postconflict reconstruction, and policies meant to open economies and provide opportunity for citizens all must define a shared expectation of the state.

In the Cold War, Arab states straddled lines between socialist nationalism and the lure of capitalism. The current international political economy offers little inspiration in economic ideology. From Brexit to U.S. President Donald J. Trump’s threats to trade partners of North Korea, the order promised by the postwar Bretton Woods system is undermined by resurgent economic nationalism and nascent trade wars. Globally, financial flows are still regrouping from the 2008-09 financial crisis. The international economic system is less defined than it was a decade ago, making policy options for reform and reconstruction more open to new actors and less reliant on existing norms and patterns.

New Financial Flows Enable Gulf Economic Statecraft

According to a new study by the McKinsey Global Institute, gross cross-border capital flows – annual flows of foreign direct investment, purchases of bonds and equities, and lending and other investment – have shrunk by 65 percent in absolute terms, returning to the level of global flows as a share of gross domestic product seen at the beginning of the 2000s. The retreat in finance has occurred mostly from developed economies, which in turn, has created some opportunity for the amplification of ties between developing countries and new financial centers. Eurozone banks have made a severe retreat in cross-border lending, with total foreign loans and other claims down by $7.3 trillion, or 45 percent, since 2007. In 2005, the United States was the primary net receiver of global capital, absorbing 67 percent of the total; by 2016, that share had fallen by half. Developing countries have become net recipients of global capital for the first time in a decade.

Capital is less interested in political order and is flowing as much from the developing world and its new financial centers as from traditional centers of economic and political power. This financial disruption is but one indication of larger global forces affecting regional political and economic disorder of the Middle East. Instead of reliance on traditional donors and lenders like the International Monetary Fund, World Bank, and Development Assistance Community, and even private capital, countries in the Middle East are as likely to look to neighboring states for assistance. Stepping into the void are the Gulf states, led by Saudi Arabia and the United Arab Emirates. Both states are experimenting with new models of financial governance and a new style of political governance by a younger generation of leaders.

Regional Order at Stake, Not Just a GCC Crisis

At the same moment that the Middle East as a region is looking inward for aid and investment, the providers of this new source of finance are in a profound period of economic transformation. So while Gulf aid and investment is vital to the political and financial health of the region, a cohesive vision of good governance in an economy and a political system remains somewhat undefined, or at least, a work in progress. In the Gulf, questions of economic reform and competing models of governance are intertwined in issues like the embargo of Qatar and the financial backing of Egypt. These questions are about how best to devise systems of governance that will allow growth while preserving (or reinventing) political authority.

For Saudi Arabia and the UAE, the preservation of the state requires some comfort with a period of economic reinvention. This shared effort at building (and exporting) a cohesive vision of the right policy mix is as experimental as it is ambitious. The accommodation of new entrants and competitors to state interests within Gulf economies may be the first test of the resilience of this emerging order.

The simultaneous forces of economic change bearing down on the region are both endogenous and external in nature. Demographic pressures of a youthful and socially active population situated alongside a migrant worker class have reached a critical juncture. The state is no longer able to provide sufficient employment while also spurring productivity in the economy. Low price oil, driven by new supply sources in the West and diminishing demand in the East, has necessitated the activation of diversification plans long overdue. Without both growth and mobility, an entire region risks continued unrest and the rise of alternative authorities, those who often use religion to mask predatory, Mafioso economic policies, as those deployed in the war economies in Syria and Yemen.

The changes underway might be easier to implement as a shock, much like some of the more drastic economic liberalizations of Eastern Europe in the early 1990s. The reason why shock therapy is less likely in the Gulf is because of the persistence of state links in national economies. That is, the persistent intransigence of the state and its interests within the economy. In the postsocialist experiments with economic liberalization, shock therapy was possible because the state acknowledged the old system of political governance had failed. For postsocialist Europe, both new ideologies and new ways of governing were possible. In the Gulf, the state is attempting to transform while also holding onto existing authority.

Saudi Vision 2030, More Talk Therapy than Shock Therapy

The news that Saudi Arabia would revise its National Transformation Program in order to make it more consistent with its larger, sister Vision 2030 plan has been presented by the government as an effort to align policy documents as an administrative procedure. However, the acknowledgment that the reform agenda needs retooling is also an indication of the difficulty of implementing, sequencing, and strategically communicating to markets how reforms will proceed. A reported delay in the Aramco initial public offering is likewise a reflection of the deep discomfort with the need to expose the state to the scrutiny of open markets.

While it is fair to say that Saudi Arabia never intended to go about overnight change (hence the 2030 target), the very nature of its proposed reforms promise a rupture with the status quo that might more easily be accomplished by shock policy implementation. The reason why the aims of Vision 2030 are unlikely to be achieved in their entirety and will continue to be revised over the next decade is because the state will consistently find ways to reinsert itself into the economy and refuse to relinquish its hold.

To shock the Saudi economy, private firms would need the ability to compete across industries the state currently dominates. It is no small act of dissent to challenge the monopoly of state-linked contractors in bidding for major infrastructure projects. To own and operate the “commanding heights” of the Saudi economy, from a stake in Aramco to a public-private partnership of a railway or a power or water utility, an investor will need to at least know the state’s intentions in the market, and how investor rights measure up to citizen demands.

Mixed Messages on Economic Reforms in Saudi Arabia

Saudi economic liberalization, at the moment, is a little confusing. The state’s intentions in the market seem to be: Preserve domestic stability, and reserve access to the upside of privatization for the state, while at the same time lessening the state’s responsibility or liability for service delivery.

The economic cost of stability has been high. As research from HSBC shows, the drawdown on Saudi reserve assets has helped maintain spending in key areas. The June reversal of a decision from late 2016 to cut public sector salaries and benefits cost the state 5-6 billion Saudi Arabian riyals ($1.33-1.6 billion) in reinstatement and back pay. According to research by J.P. Morgan, a deficit of 46.5 billion Saudi Arabian riyals ($12.4 billion) in the second quarter of 2017 was financed from reserves (15 billion Saudi Arabian riyals or $4 billion) and an international Islamic bond sale (33.75 billion Saudi Arabian riyals or $9 billion), Saudi Arabia’s first of this kind. The preference for debt finance, in both international debt issuance and in the use of domestic Islamic bonds or sukuk, has helped cushion the impact of reduced subsidies and new taxes on schools, unused land, properties in economic zones, and the coming value added tax in 2018.

Before 2030, there will be moments of reckoning, especially in debt management. There will be mounting pressure to deliver results (measured specifically in non-oil GDP growth and increased foreign investment that creates jobs for nationals) in the Saudi economy within the next three years, as the first major bonds reach maturity. This is not to suggest that Saudi Arabia is in imminent risk of a debt crisis, but rather that its strategy of debt management to meet government expenditure on a quarterly basis will require the quick generation of alternative sources of revenue and/or diminished spending. In the case of increasing taxes and fees and lower spending on public services like health and education, there will be less room for accommodative funding like the reversal in public sector salary cuts of this summer.

The introduction of taxes and fees in Saudi Arabia, and across the Gulf Cooperation Council states, sets an institutional precedent. Once accomplished, governments will be wary to dismantle these revenue streams. However, governments will also be under increasing scrutiny from citizens to deliver public goods. This is where the pace and sequencing of reform execution become challenging. (Follow changes in tax, subsidies, debt issuance, and labor policy on the Gulf Economic Barometer.)

While Saudi Arabia is eager to sell off state assets in order to increase short-term government revenue, it is also intent on capitalizing on the success of its privatizations. For example, in a recent article in the Saudi Gazette, Chairman of the Economic and Energy Committee of the Shura Council Abdul Rahman Al-Rashid explained the government’s circular vision of privatization:

The new privatization law allows the government to participate in the ownership of some assets like other investors through its financial institutions. It has actually started purchasing shares of institutions that have been targeted for privatization.

Saudi Arabia recently allowed full foreign ownership of engineering firms, as well as firms providing services in education (including K-12 schools) and health care. The state is reserving the right to invest in these firms, and to encourage them to seek private investment through listing on the local stock exchange. This leaves some important questions then on the priorities of the state. Is the state mainly interested in companies that provide health care and education most efficiently and profitably, or only those with the highest standards of care for citizens? Does the investor then define and enforce the regulations of care? Who guards the guardians?

We have had some precedent for this investor-state dual identity in early state investments in technology and transportation ventures in Saudi Arabia. While women face significant barriers to employment, including the ability to drive to work, the government has encouraged ride-sharing companies to provide services to citizens on the open market. The government has also invested in these firms, ostensibly profiting from the exclusion of transportation rights to some citizens.

Reform Timeline is Critical, with Competing Demands on Governance

By acknowledging, very publicly, the need for economic reform, states are taking a step into the unknown. The reconfiguration of state ownership and management of public goods like education, energy, and health care is a statement of confidence in citizens and markets. But the more the state hovers over new opportunities, the more difficult it will be for organic growth to begin.

New models of economic governance in the Gulf states will center on provisions that protect citizens. This is the institutional legacy of rentier capitalism. To transform those traditions, citizens and their firms will need to demand to compete in markets where the state is regulator, not competitor or deep-pocketed investor. The state will need to ask what its core role in the economy should be. What services should it provide, and at what cost?

If a shock realignment is not in the works, then the trajectory of reforms should be as speedy and transparent as possible, and not subject to reversals that will erode investor confidence and public support. What is at stake is the transformation of the Gulf economies to a post-oil dependent era. Perhaps more important, however, is the transformation of the Gulf states as arbiters and exporters of new models of economic governance to the wider Middle East. The failure of the Gulf states to redefine or curb the state’s role in the economy will only serve to strengthen inefficient and predatory governance practices across the region. Moreover, without a concerted move to diversify and open markets to competition, the Gulf states could risk weakening their own financial means of regional intervention.