Rentierism and Rivalry Between Riyadh and Tehran

1280px-Riyadh_Skyline_showing_the_King_Abdullah_Financial_District_(KAFD)_and_the_famous_Kingdom_Tower_

by Esfandyar Batmanghelidj

In response to the rivalry between Saudi Arabia and Iran, the United States has long pursued a strategy of counterbalancing, extending its security umbrella to cover the kingdom and the GCC states. But as promises of security fade in the face of decreasing belief in the American commitment, infighting in the GCC, and the advent of Saudi military adventurism, security is no longer a sufficient paradigm for policy that seeks to temper an intensifying regional rivalry.

In Saudi Arabia, a young Crown Prince, Mohammad bin Salman (MbS), is poised to rule a country that—on its current trajectory—faces a sustained economic decline as oil revenues shrink and the population grows. By contrast, having demonstrated considerable economic resilience under sanctions and significantly reduced its dependence on oil rents, Iran may finally be poised to achieve sustained growth.

This divergence in fortunes is at the heart of the regional conflict. Should MbS wish to prevent Iranian domination of the region, he will need to secure Saudi Arabia’s economic future and redefine the contribution of economic rents to state power—a puzzle of political economy. In the absence of any robust solution, he will resort, as most rulers do, to externalizing the political instability that will no doubt threaten him within the kingdom’s borders (see Vladimir Putin). The cynical war in Yemen gives an early indication of how such weakness may tragically precipitate further regional conflict.

The power differential between Saudi Arabia and Iran reflects the degree to which the kingdom remains a rentier state and the degree to which the Islamic Republic does not. In the assessment of political scientist Michael Herb, between 1972-1999, the “degree of rentierism” in Saudi Arabia was 80% while in Iran it was just 55%. To the extent that rentierism is understood as a fundamental liability in a country’s long-term political and economic stability, any intervention to temper the rivalry between Saudi Arabia and Iran will need to contend with the fundamental configuration of Saudi political economy, enabling moderation through strength.

Blurry Vision

MbS’s dramatic move to arrest scores of Saudi elites, including Minister of the National Guard Prince Mutaib bin Abdallah and the billionaire chairman of Kingdom Holdings Prince Alwaleed bin Talal, has been widely described as a “purge” or “soft coup.”

But as executive director of the Arabia Foundation Ali Shihabi has argued, the arrests had little impact on MbS’s political fortunes. He writes, “In actuality, Saudi Arabia completed its political transition last June when King Salman replaced MbN with MbS as heir to the throne.” To this end, it is “wrong to interpret last weekend’s arrests as an action that materially increases the political risk to the monarchy.” Rather, Shihabi suggests that MbS intended to send a message “to political and economic elites that their entitlement to extreme wealth and privilege, and their impunity, is coming to an end.”

The economic consequences of the arrests could be significant. According to a statement on the arrests from the Saudi attorney general, “at least USD $100 billion has been misused through systematic corruption and embezzlement over several decades.” Shihabi believes that MbS will seek the “recovery of substantial ill-gotten assets from many members of the elite” as part of his effort to correct for perceived abuses.

It is tempting to think, in accordance with MbS’s deliberate self-marketing as an earnest reformer, that the move against corruption is an expression of political strength. This may be true within the internal dynamics of the Saudi Royal family—no doubt his moves against family members were bold. But when viewed within the wider economic context, the need to vilify quasi-state appropriation of wealth in the kingdom speaks to a brewing economic crisis and an acute sense of weakness.

In July, the IMF revised down projections for Saudi GDP growth in 2017 to just 0.1%, with growth for 2018 projected at a paltry 1.1%. In the face of low oil prices and general underperformance, the Saudi economy is teetering on the edge of a recession for the first time since 2010. The overall value of the economy has fallen by over $100 billion in just three years.

Saudi Arabia remains a rich country. But a dwindling cash pile (down nearly $300 billion from the 2014 high) and the first indications of oil’s impending decline as a source of rents have triggered a timebomb for MbS. The county’s population is ballooning, with the working age population set to grow by 6 million in a country with just 41% workforce participation. MbS is poised to be the first king in Saudi history for whom oil rents will not meet the country’s economic needs or help consolidate his absolute rule.

The much touted Vision 2030 plan is an attempt to defuse this timebomb through an expansive set of economic and social reforms. In the near term, MbS is aiming to introduce an additional $100 billion annually from non-oil revenue by 2020. As described in a fawning profile in Bloomberg Businessweek, MbS “has already reduced massive subsidies for gasoline, electricity, and water. He may impose a value-added tax and levies on luxury goods and sugary drinks.”

But taxing soda is not going to replace declining oil revenues, and the likely impact of the proposed reforms are being oversold. At a more fundamental level, there are no plans to introduce an income tax, and in order to stave unrest from the least fortunate Saudis, cash handouts are still planned. As though to burnish his populist chops, MbS told Bloomberg, “We don’t want to exert any pressure on [the poor]. We want to exert pressure on wealthy people.”

The prince’s turn to populism may be a novel chapter in the House of Saud’s playbook for regime survival, but it reflects a confused approach to reformation of a broken political economy. By failing to consider the importance of taxation, MbS seems unwilling to renege on what historian Toby Craig Jones calls the “devil’s bargain” of Saudi political economy, where “no taxation without representation” is perverted to “no representation without taxation.”

To date, the essential challenge of Saudi political economy remains unaddressed. So long as the country’s rulers depend on a dwindling natural resource or the fickle commitment of international investors to drive economic growth, the state will remain weak.

Lessons From Iran

Across the Persian Gulf, Iran’s leaders have made their own Faustian bargains concerning political economy, but the 1979 revolution provided a hard reset that addressed the central liability currently facing their Saudi rivals. The revolution served to give the government more levers by which to grapple with the chief risk that plagues rentier economies—income inequality. Iran’s present level of income inequality, as measured by the GINI coefficient, is just below 0.4. At the time of the Islamic Revolution, the level was 0.5.

According to a growing body of evidence, Iran’s combination of resource rents distribution with a progressive income tax has been fundamental to the country’s ability to mitigate inequality, especially given that Iran’s large population renders resource rents alone an insufficient source of government revenue for this purpose. In 2015, for the first time in over 50 years, tax revenues surpassed oil revenues as the primary source of government income.

A recent study by economists Mohammad Reza Farzanegan and Mohammad Mahdi Habibpour of resource rents distribution in Iran concludes that “any transfer policy that uses oil and gas rents which are publicly-owned and managed in Iran will decrease income inequality and poverty.” However, the authors find that “resource dividend” (RD) policies that combine the distribution of oil rents with income tax have the greatest effect at reducing income inequality. In a sample of 140,000 households, the so-called RD policies saw the GINI coefficient fall from 0.44 to 0.32 in rural areas, and 0.39 to 0.33 in urban areas—reductions in line with the overall improvements in Iranian income inequality since the Islamic Revolution.

President Hassan Rouhani continues to battle stubborn inequality, and the perception of misappropriation of rents through government corruption is a major source of political contention. In this sense, Rouhani’s own campaign of arrests, largely targeting elites connected to Iran’s Revolutionary Guard, mirrors the moves by MbS. But there is a crucial difference. Rouhani is trying to address corruption because he needs to better distribute rents, half of which originate from taxation, in lockstep with economic expansion. MbS is namechecking corruption because he needs to consolidate rents as he faces a economic stagnation—a position of relative weakness.

A Common Aim  

In a lengthy interview with the influential Iranian foreign affairs magazine Diplomacy, former Iranian ambassador to Riyadh Hossein Sadeqi makes an emphatic case that MbS will avoid repeating the “Pahlavi scenario,” largely because of a deliberate effort to seek advice from “intellectual centers” including think tanks and consultancies. Sadeqi acknowledged that “Saudi Arabia has a single-product economy in which corruption exists,” but he also puts faith in the country’s capacity for reform, highlighting early progress instituting the Vision 2030 reforms, particularly in a social context.

This measured and hopeful assessment points to an important consideration for American policymakers. Shifting the emphasis in regional balancing away from military parity towards economic parity opens the door for a less confrontational dialogue between Saudi Arabia and Iran. The Iranian government has strong interests in Saudi Arabia’s economic stability. The international community should seek to ensure that a concerted program of training and technical assistance, rather than arms transfers to meet security demands, is made available to support MbS’s reform program.

Moreover, any program that seeks to address the residual challenges of rentierism could be a rare opportunity to bring senior Saudi and Iranian stakeholders around the same table to discuss how best to address destabilizing inequality and preserve standards of living in the post-oil world. The Iranian experience would be hugely instructive if Saudi leaders could be convinced to accept some well-intentioned advice.

Photo: Riyadh skyline

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Esfandyar Batmanghelidj

Esfandyar has spent the last 5 years working on projects related to "business diplomacy" between the West and Iran. He is the founder of the Europe-Iran Forum, the leading annual gathering for business, government and civil society leaders committed to Iran's economic development, and the executive editor Bourse & Bazaar, a digital business publication with a focus on Iran. He is a graduate of Columbia University.

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