SAUDI ARABIA BEYOND OIL: THE INVESTMENT AND PRODUCTIVITY TRANSFORMATION DECEMBER 2015 In the 25 years since its founding, the McKinsey Global Institute (MGI) has sought to develop a deeper understanding of the evolving global economy. As the business and economics research arm of McKinsey & Company, MGI aims to provide leaders in the commercial, public, and social sectors with the facts and insights on which to base management and policy decisions. MGI research combines the disciplines of economics and management, employing the analytical tools of economics with the insights of business leaders. Our “micro-to-macro” methodology examines microeconomic industry trends to better understand the broad macroeconomic forces affecting business strategy and public policy. MGI’s in-depth reports have covered more than 20 countries and 30 industries. 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All our work is underpinned by our deep local roots, our firm’s global reach, and our unrivaled investment in creating and developing knowledge. Copyright © McKinsey & Company 2015 SAUDI ARABIA BEYOND OIL: THE INVESTMENT AND PRODUCTIVITY TRANSFORMATION DECEMBER 2015 Gassan Al-Kibsi | Riyadh Jonathan Woetzel | Shanghai Tom Isherwood | Dubai Jawad Khan | Dubai Jan Mischke | Zurich Hassan Noura | Dubai PREFACE Global investors and business leaders are focusing on the Kingdom of Saudi Arabia as oil prices decline from their high levels of the past decade and the country enters a new era under the leadership of King Salman bin Abdulaziz Al Saud. For the past year, the McKinsey Global Institute (MGI), together with McKinsey & Company’s Middle East office, has conducted in-depth research into the Kingdom’s economic situation, examining in detail its strong performance over the past decade and the challenges and opportunities it faces over the next 15 years. When this research started in late 2014, King Abdullah bin Abdulaziz Al Saud was leading Saudi Arabia and oil had already fallen below $100 per barrel. Since then, King Salman has come to rule the Kingdom with a significant change in the government composition, while oil prices have declined further to below $50 per barrel at the time this report went to press. Our analysis, set out in this report, suggests that the Kingdom could once again double its GDP and create as many as six million jobs by 2030, enough to employ the sizable cohort of young Saudi men and women entering the labor force over the next 15 years. This is an ambitious goal, and it will require the Kingdom to embrace significant change to its economic growth model. In this report, we identify eight non-oil sectors of the economy that could become motors of growth, productivity, and employment in the future. We also detail the transformations in labor, fiscal, and economic spheres that would be required to enable that growth. For our analysis and conclusions we have focused purely on economic factors, and for the purposes of this report we have not taken into account the security or the politics of the region. The research was led by Gassan Al-Kibsi, managing director of McKinsey in Saudi Arabia, and Jonathan Woetzel, a director of MGI based in Shanghai. Tom Isherwood, a partner in our Middle East office; Jawad Khan, an associate principal in our Middle East office; and Jan Mischke, an MGI senior fellow based in Zurich, directed the research. Tarek Elmasry, managing director of McKinsey’s Middle East office, and Eric Labaye, MGI chairman, along with Viktor Hediger, Amadeo Di Lodovico, Scott Nyquist, Jorg Schubert, and Hans-Martin Stockmeier, provided overall strategic direction and support. The project team was led by Hassan Noura, an engagement manager in the Middle East office, and comprised Hanan Alawadi, Salman Aldukheil, Joelle Awwad, Shady El Azab, Shafiq Dharani, Jhonny Jha, Plamen Kovachev, Maximilian Mahringer, Tim McEvoy, Angelos Platanias, and Magda Davila Vicente. Three former McKinsey colleagues, Amer Afiouni, Tari Ellis, and Fraser Thompson, led and managed the first phase of the project. Thanks go to Peter Gumbel and Janet Bush for editorial support and to other members of the MGI communications and operations team—Tim Beacom, Marisa Carder, Matt Cooke, Rana Hamadeh, Deadra Henderson, Jason Leder, Julie Philpot, Mary Reddy, Margo Shimasaki, and Patrick White—for their contributions. We are grateful for the advice and input of many current and former MGI and McKinsey colleagues, including Suhas Anand, Rima Assi, Kapil Bhatia, Urs Binggeli, Martin Checinski, Bushra Al Daoud, Tasneem Dargahwala, Nicklas Garemo, Nalin Garg, Zekeriyya Gemici, Panco Georgiev, Andrew Goodman, Solveigh Hieronimus, Ibrahim El-Husseini, Paul Jacobson, Astyanax Kanakakis, Najla El Khatib, David Kovara, Marc Krawitz, Mourad Limam, Jeffrey Lorch, Rachid Maalouli, Rachid Majiti, Tarek Mansour, Chadi Moujaes, Loay Al Mujadidi, Imraan Munshi, Hasan Muzaffar, Muneerah AlQassem, Sangeeth Ram, Alex Sawaya, Dirk Schmautzer, Ziad Soufan, Julia Sperling, Maha Talaat, Ahmed Youssef, Marco Ziegler, and Yassir Zouaoui. We are grateful to the academic advisers who helped shape this research and provided challenge, insights and guidance: Martin N. Baily, Bernard L. Schwartz Chair in Economic Policy Development and senior fellow and director of the Business and Public Policy Initiative at the Brookings Institution, and Richard N. Cooper, Maurits C. Boas Professor of International Economics at Harvard University. We are also grateful to a number of individuals from the private and public sectors in Saudi Arabia for offering their opinions and insights in private discussions. This report contributes to MGI’s mission to help business and policy leaders understand the forces transforming the global economy, identify strategic locations, and prepare for the next wave of growth. While grateful for all the input we have received, the report is ours, including any errors. As with all MGI research, this work is independent and has not been commissioned or sponsored in any way by any business, government, or other institution. We welcome your comments on the research at [email protected]. Richard Dobbs Director, McKinsey Global Institute London James Manyika Director, McKinsey Global Institute San Francisco Jonathan Woetzel Director, McKinsey Global Institute Shanghai December 2015 For Saudis, the 2003–13 oil boom was a decade of prosperity and change © Desert Publisher CONTENTS HIGHLIGHTS In brief Executive summary Page 1 22 Saudi Arabia’s opportunity to transform its economy and double GDP by 2030 1. The oil boom and beyond Page 19 After a decade of prosperity and change, the Kingdom faces new challenges. Saudi household income rose during the decade 2. The $4 trillion investment opportunity Page 45 Eight sectors of the economy could drive growth and employment over the next 15 years. 32 3. Transformations Page 85 Reforms will be needed in labor, business, and fiscal management. 4. Implementation: Three journeys Page 117 More women are working Government delivery will be key, but Saudi businesses and individuals will also need to in retail drive change. Technical appendix Page 127 54 Bibliography Page 139 Saudi Arabia is a global competitor in petrochemicals 117 A new role for government IN BRIEF SAUDI ARABIA BEYOND OIL: THE INVESTMENT AND PRODUCTIVITY TRANSFORMATION MGI is publishing this report on Saudi Arabia at a time of change in the Kingdom. After a surge in prosperity over the past decade, the economy is at a transition point. We see a real opportunity for the Kingdom to inject new dynamism into the economy through a productivity- and investment-led transformation that could help ensure future growth, employment, and prosperity for all Saudis. ƒ An oil price boom from 2003 to 2013 fueled rising prosperity in Saudi Arabia, which became the world’s 19th-largest economy. GDP doubled, household income rose by 75 percent, and 1.7 million jobs were created for Saudis, including for a growing number of Saudi women. The government invested heavily in education, health, and infrastructure and built up reserves amounting to almost 100 percent of GDP in 2014. ƒ The Kingdom can no longer grow based on oil revenue and public spending, in the face of a changing global energy market and a demographic transition that will lead to a bulge in the number of working-age Saudis by 2030. Current labor participation is 41 percent, and productivity growth of 0.8 percent from 2003 to 2013 lagged behind that of many emerging economies. Foreign workers on temporary contracts who are paid considerably less than Saudi nationals today constitute more than half the labor force. ƒ We have developed a model that integrates Saudi Arabia’s economic, labor market, and fiscal perspectives. It shows that even if the Kingdom introduces reactive policy changes such as a budget freeze or immigration curbs in the face of these challenging conditions, unemployment will rise rapidly, household income will fall, and the fiscal position of the national government will deteriorate sharply. ƒ However, a productivity-led transformation of the economy could enable Saudi Arabia to again double its GDP and create as many as six million new Saudi jobs by 2030. We estimate this would require about $4 trillion in investment. Eight sectors—mining and metals, petrochemicals, manufacturing, retail and wholesale trade, tourism and hospitality, health care, finance, and construction—have the potential to generate more than 60 percent of this growth opportunity. ƒ To enable this transformation, Saudi Arabia will need to accelerate the shift from its current government-led economic model to a more market-based approach. In the labor market, greater workforce participation by Saudi men and women is essential to achieve higher household income. The proportion and number of foreign workers may decline but they would likely benefit from higher wages and better conditions. Faster productivity growth requires better business regulation and more openness to competition, trade, and investment. Improved efficiency of spending and new revenue sources, possibly including taxes and higher domestic energy prices, can help ensure fiscal sustainability. ƒ All stakeholders, including the private sector, foreign investors, and households, will need to be involved in this transformation. The state will have to embrace a new delivery philosophy while businesses adapt to a more competitive environment and the individual Saudi citizen takes more personal accountability. The transition will be challenging, but the new era of economic growth and employment it could usher in would be more sustainable than the oil booms of the past. Saudi Arabia A productivity-led transformation After a decade of sustained oil-based growth, Saud Arabia is at a transition point. Over the next 15 years, the Kingdom will face heightened competition in the energy market and a growing number of working-age Saudis. To prevent economic difficulties, Saudi Arabia needs to realize the potential of the non-oil economy. A productivity-led transformation, if successfully implemented, could usher in a new cycle of prosperity. Realizing Saudi Arabia’s full potential by 2030 2 GDP could double again 4 $4 trillion to be invested in the non-oil economy, primarily 2/4/6 from private sources 6 6 million additional Saudi nationals in the workforce 60% $800 billion increase in Saudi household income GDP increase Eight sectors that will generate growth and jobs Mining and Retail and Petrochemicals Manufacturing metals wholesale trade Tourism and Finance Construction Health care hospitality These sectors could contribute more than 60% of the growth needed to double GDP by 2030 Three pillars to transform Saudi Arabia A more productive Economic Sustainable fiscal workforce reform management Increased employment and More competition and greater An overhaul of the existing model participation of Saudi men and openness to foreign investment based on oil revenue and public women in the labor force and trade spending Eliminating the mismatch Simpler, speedier processes to More efficient spending and a between skills and the needs of remove hurdles to private-sector new focus on value for money the labor market growth More than half the Kingdom’s population is younger than 25 © Desert Publisher viii McKinsey Global Institute