January 21, 2016

What Would Russia Do? Why Saudi Arabia’s Break with Iran Makes Bad Economic Sense

The decision to break diplomatic ties with Iran will have some important economic consequences for Saudi Arabia. While it is true that historically Saudi Arabia and Iran have not shared strong trade links, there is reason to believe that the few economic engines of the region in the coming years will necessarily include Iran. Meeting in Davos this week, economists and business leaders are addressing pockets of economic opportunity, possibilities for economic reforms, and job creation targeting youth in the region, where growth is expected to be low, at three percent or less in 2016.  HSBC economists suggest that if Brent oil prices remain at $30 per barrel, GCC oil earnings will be down more than half a trillion dollars from their peak in the last decade.

The opening of Iranian markets represents a silver lining of the dark cloud over regional markets right now. To bar companies and individuals from those opportunities runs counter to Saudi Arabia’s goals of economic diversification and empowerment of the private sector, especially those firms with the kinds of expertise in the industries that Iran needs most: oil and gas services, infrastructure (including solar power generation), and construction. The political goal of isolating or punishing Iran is now moot, with the lifting of international sanctions and implementation of the Joint Comprehensive Plan of Action. The travel ban for Saudis interested in studying or visiting Iran punishes citizens who are intrepid and open-minded enough to engage with Iranians, as well as singling out Saudis who might visit Iran on religious pilgrimage.

Russia’s calculus on Iran could be instructive to Saudi Arabia right now. Iran hopes to attract as much as $50 billion in foreign direct investment this year. Russia is a willing trade and investment partner, despite a history of lukewarm political relations and a lackluster trade relationship. In 2014, bilateral trade between Russia and Iran was limited to about $1.7 billion. According to Nikolay Kozhanov at the Carnegie Moscow Center, there is not a lot that Russia can offer Iran in terms of trade with the exception of construction of nuclear power units, ferrous metals, wood, and petrochemical products. In 2000, the export of Russian military equipment to Iran stalled, at an estimated loss of $3 billion to Russia.

Nonetheless, there is a mutual political calculation that both sides can benefit from economic relations, and that the level of investment and trade can only go up. Iran’s ambassador to Moscow, Mehdi Sanaei, has emphasized that the two countries can increase their interactions now without “hindrance” from the West, including increased ties in tourism and banking, as well as more traditional avenues of cooperation in military sales and nuclear expertise. Both states are focused on what they have in common: a will to counter Western (or more specifically, American) hegemony in the region, an effort to weather a prolonged period of low oil prices, and an interest in promoting trade. It is somewhat ironic that the defenders of economic liberalism in the Middle East are now Russia and Iran.

The promise of economic growth in Iran crosses many sectors: industry, infrastructure, manufacturing, retail, and professional services. There is not another country in the region as poised to capture this variety of opportunity. With a population of nearly 80 million people, young and well-educated (by regional comparison), Iran will act as a test case for the ability of regional governments to create jobs and attract foreign investment. The chief of staff to the Iranian president, Mohammad Nahavandian, told a Davos audience that he expected eight percent annual growth for the next five years in Iran. That is perhaps wishful thinking, but it certainly beats the projections for the rest of the region. The interest of European trade ministers is well known. German news organization DW estimates that bilateral trade will triple up to seven billion euros in 2016, up from 2.7 billion last year. French auto-manufacturer Renault is eager to re-enter the market and to produce inside Iran, and with four percent of the Iranian workforce in the auto industry, the gains will be mutual.

Russia is as much a rival of Iran as is Saudi Arabia. All three are oil or gas producers. All three are in need of infrastructure investment and job creation. All three wish to influence a regional security architecture. Iran and Saudi Arabia have more in common. Saudi Arabia can offer expertise in domestic energy production in renewables. Saudi Arabia has better technology and experienced firms in oil and gas production and field services. Saudi Arabia is actively engaged in an economic transformation that targets a youth population and a bloated public sector. The economic consequences of travel bans and trade embargos, especially if they are bilateral, are substantial. Saudi Arabia risks missing out on a regional economic success story, and may find it difficult to enforce its political stance among fellow GCC members.

Karen E. Young is a senior resident scholar at the Arab Gulf States Institute in Washington.