Policy makers worldwide need to consider the global and domestic consequences of enormous capital investments from the oil-rich GCC.
With crude oil prices soaring, Gulf exporters have emerged as major players on the global financial stage, snapping up stakes in prominent Western retailers, stock markets and investment banks. But the coming oil windfall will dwarf anything we've seen yet, possibly boosting their earnings to three or four times the amount reaped in past years. This fortune portends both promise and risk for economies and capital markets in the Gulf and beyond, presenting several complex challenges for policymakers.
New research by the McKinsey Global Institute (MGI) shows for the first time the potential scale of this windfall. The oil revenues of the six states of the Gulf Cooperation Council (GCC)—Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates—will collect up to $6.2 trillion in profits over the next 14 years if crude prices are $70 per barrel. That's more than triple the amount they earned over the last 14 years.
This staggering figure is more than twice the size of the British economy today or four times the total profits of the Global Fortune 500 companies combined.
Changing Investment Trends
How the Gulf States deploy this wealth will have global repercussions for decades, and the world at large has an interest in how these funds will be used. Their foreign investment choices will affect interest rates, liquidity, and financial markets around the world. Their domestic investments will determine which of their local industries and cities thrive, whether the region's economies diversify beyond oil, and whether they generate enough jobs to employ their young people.
The new generation of Gulf leaders already has announced plans to pump more capital into their own economies. Since 1993, GCC domestic investment rates have averaged 20% of gross domestic product—almost one–quarter lower than the 24% average investment rate of China, India, Brazil, and Russian combined. (That compares with an internal reinvestment rate of 19% in the US over the same period.) The GCC states now have begun to invest more in new industries, infrastructure, health care, education, and other areas to catch up to their so–called BRIC peers. The funds that are not used for domestic purposes will flow into new investments in global capital markets. MGI calculates that with oil prices at $70 per barrel, this could amount to $3.5 trillion over the next 14 years.
But the funds that flow into global markets will be invested differently in the future than in the past. Gulf investors are a diverse group, including not just the sovereign wealth funds that have attracted the world's attention, but also wealthy private individuals and companies. Although they most likely will continue to hold the bulk of their existing wealth in US and European assets, a growing share of new investment will flow into emerging markets—particularly in the rest of the Middle East, North Africa, and Asia. While GCC sovereign investors in the past preferred passive investments made through external asset managers, they plan to employ more active, direct investment strategies in the future.
These trends present opportunities and challenges, both financial and political, for global capital markets and the world economy. Policymakers in the Gulf and elsewhere will have to grapple with four key questions:
- How will they ensure the additional liquidity flowing into global financial markets does not unduly and unsustainably inflate asset prices? Price–to–earnings ratios have risen sharply in several emerging markets. In developed economies, there are signs of bubbles in some illiquid assets, such as real estate.
- How will they create enough well-paying jobs for the Gulf's fast-growing population of young people? Widespread unemployment would pose risks to the stability of the region. To keep up with growing populations, we calculate the Gulf states will need to create more than 4 million new jobs for its citizens over the next decade—a tall order for a region in which just 4.8 million citizens are employed today. And though the government has been the primary employer of Gulf nationals, the private sector will need to become the chief job creator.
- How will they ensure the Gulf States' investment decisions do not shake global financial markets? Sovereign investors, not only from the GCC but also from Asia and other regions, have now become so big that their actions have ripple effects for markets around the world. So far, sovereign wealth funds have been prudent, sophisticated investors. But as Gulf funds shift from being passive investors to a more active approach—a trend we are already seeing—anxieties about their actions are likely to intensify. As world–scale players, they have a responsibility to recognize the concerns of others.
- How will they allay geopolitical concerns about government–controlled investment funds? Many Western policymakers worry that sovereign investment funds in the Middle East, Russia, China, and elsewhere might use their huge wealth for political purposes. Those fears are likely to intensify as Gulf funds become more active investors. Many Western policymakers have called for the creation of disclosure standards for government investors. But a key factor in assuring greater transparency will be the parties' willingness to negotiate in a spirit of reciprocity. If sovereign wealth funds commit to greater disclosure about their size and strategies, for instance, then Western regulators must ensure that governments' policy responses will be based on an objective appraisal of the facts, not on emotions stirred by the shift of financial power to new players.
The coming oil windfall also may yield many benefits. These include increased liquidity in global financial markets, the possibility of providing greater stimulus to emerging markets, and the opportunity to diversify Gulf economies. If used well, this fortune could lift living standards for millions of people around the world. Policymakers in the GCC and beyond should work together to achieve this goal.
Diana Farrell is the director of the McKinsey Global Institute, McKinsey's economics research arm.
This article originally ran in Businessweek.
