August 4, 2017

Self-Imposed Barriers to Economic Integration in the GCC

Interior, foreign, and defense ministers of the Gulf Arab states meet during the opening of the Gulf Cooperation Council Joint Meeting in Riyadh, Saudi Arabia, April 27. (Saudi Interior Ministry via AP)

Qatar has lodged a complaint with the World Trade Organization against the United Arab Emirates, Saudi Arabia, and Bahrain for blocking its air traffic and increasing the costs of basic food and medicine imports. Though intra-Gulf state economic relations continue to suffer as a result of the current crisis, there are long-standing barriers to trade and investment flows that deserve consideration. Since the inception of the Gulf Cooperation Council, there have been deep tensions on ceding sovereignty and facilitating the free movement of people, finance, and ideas. While trade flows between the GCC states have been increasing in recent years, some of the most important added value of integration has been in the facilitation of investment flows, the free movement of GCC citizens, and large shared infrastructure investment, such as the Dolphin pipeline between Qatar, the UAE, and Oman.

One can see the glass half empty or half full in terms of the progress of GCC economic integration. In 1983, the GCC launched its Free Trade Agreement, which reduced trade restrictions between member countries and facilitated trade flows. In 2003, the GCC marked another step forward with the establishment of a customs union. The common market, allowing free movement of people and goods, began in 2008. Intra-GCC trade has grown nearly fortyfold since its establishment and reached more than $90 billion in 2013; yet, it is still a small share of total trade volume, at about 8 percent of total trade in 2014.

The general trend of increased intra-GCC trade has been upward in the last decade, as the organization has sought to build institutional efforts to increase trade and human capital flows; consider tighter coordination in monetary policy; promote infrastructure investment in a shared rail network; and build linkages to share electricity and create a common energy market. However, most of these ideas are currently on hold. The GCC, as an institution, has attempted to meets its members’ goals of economic cooperation. The problem isn’t the organization, per se, but rather reticence on the part of members to fully deploy the policy objectives they have devised. It is the member states that continue to get in the way of their own stated economic development goals.

One prime example of a persistent barrier to economic integration is the protection of local agents in the framework of the GCC customs union. Commercial agency is the representation of a foreign principal by a local agent for the purposes of distributing, selling, offering, or providing merchandise or services inside domestic territory for a commission or profit. All six GCC states have commercial agency laws, with varying degrees of restrictions. Some agent protections are exclusive, in that one agent has control over the importation of a single good or brand without competition. The general principle of these laws has been to help nationals develop independent businesses, transfer expertise and technology, and secure benefits of foreign investment to the national population. Typical protections under commercial agency laws include: reserving the business of commercial agency for nationals; a registration system for agents; agent exclusivity granted by law; and protection from termination or nonrenewal. The problem now is that the commercial agency restrictions are in conflict with the 2008 GCC efforts to encourage nationals to invest, work, and buy property in neighboring member states. These restrictions continue to privilege nationals over citizens of other GCC states, while also encouraging monopoly practices in the importation and distribution of goods and services.

The movement (and retention) of human capital in the Gulf is a simmering area of tension, which all GCC members will have to reconcile with their economic integration or isolation policies. Recent efforts in both Qatar and the UAE to create pathways to permanent residency, if not citizenship, are an example of this policy challenge. These efforts to attract highly skilled, and wealthy, migrants is meant to leverage growth in the private sector by attracting technology and investment to grow new businesses that would presumably seek a regional platform. The chilling effect on business and government of deterrents to free movement of GCC citizens within the region, as well as attracting highly skilled migrants, will surely have a measurable impact on economic growth in the near term.

With free movement of human capital comes mobility of financial capital. In the current dispute with Qatar, capital flight is a serious threat to long-term viability within the local bank system. According to research by J.P. Morgan and data published by the Qatar Central Bank, capital outflows through the Qatari banking system may have been as much as $20 billion in June. Nonresident depositors withdrew $3.8 billion from Qatari banks and funding from foreign banks decreased by $11.5 billion in June. Capital flight is more likely to have been from non-GCC banks and investors, as GCC creditors held less than a quarter of Qatari banks’ foreign funding at the end of 2016. There could also be a regional cascade effect in capital flight, as investors and lenders steer clear of potential conflicts.

Despite the platform and agreements the GCC provides to stimulate policy coordination, and the efforts individual state ministries make to promote regional trade, there are large gaps in compliance and shared political will to integrate. There are several other areas of commercial tension that pose barriers to private sector growth and investment, which a more integrated GCC might provide. The implementation of a shared value added tax is one example that could be the next integration hurdle for member states early in 2018. The UAE has recently passed legislation to help administer tax collection and pave the way for broadening the state’s ability to access financial information on firms. Whether the legal framework in one state will encourage integration and information sharing across the GCC looks increasingly unlikely, though each state has its own reasons to move forward with efforts to implement tax collection as a revenue stream.

The GCC states are their own best foreign investment partners, yet the current climate is in some ways a continuation of recurrent institutional and political barriers to economic integration in the region. Economic integration is a symbolic ideal of possibilities of the GCC and meant to be a bridge to more difficult areas of cooperation in defense and security. As Jeff Martini and colleagues at the Rand Corporation have argued, “within the sovereignty-sensitive GCC, economic cooperation was judged as more attainable than ceding decision-making over foreign affairs or merging their military capabilities into a truly integrated collective defense capability.”

The GCC’s efforts at economic diversification and economic integration are now at a tipping point. The shared reform agendas across the region, including efforts to increase private sector productivity and diminish the state’s reliance on hydrocarbon revenue, hang in the balance. The GCC is a network of six countries that manufacture very little and share an unconventional, resource-dependent model of economic development. Diversification from oil and gas dependency has relied on infrastructure and real estate investment, largely in state hands, as well as the growth of financial services and an investment climate. Much of that investment climate has privileged nationals through the commercial agent system that discourages movement and regional expansion. The nature of GCC trade has changed such that the re-export of goods among Gulf states makes up an important part of their trade patterns. In areas where there is opportunity, cooperation is essential for open markets to produce and trade electricity, to grow new financial centers with expertise in niche markets such as Islamic finance, and to grow their own equity trading platforms that support and fund local businesses. The ideas are there and the institutional platform is in place. What is missing now is the political will to move integration, and shared economic growth, onward.

Market Watch is a blog conceived by AGSIW Senior Resident Scholar Karen E. Young seeking to provide insights from the crossroads of Gulf politics and finance.