The economics of building big in the Middle East

We’ve all heard about “The Line,” a 170-kilometer desert city to be built by the Saudi Arabian government at a cost of $1 trillion. We all admire Dubai’s Burj Khalifa, the world’s tallest building, which cost the Emirati government $4.1 billion to build. We envy the eight stadiums built simultaneously by Qatar for $6.5 billion, to be used for the forthcoming FIFA Games.

Not to be overlooked is Dubai’s $12-billion Palm Islands, Abu Dhabi’s $3-billion Emirates Palace, and Doha’s $12-billion Sharq Crossing, just to name a few.

One wonders — why do Middle Eastern states build such expensive prestige projects?

There are two simplistic reasons. The first is that Gulf states, which are governed by monarchies, are so wealthy that they indulge in ostentatious projects to bring prestige to both the royal families and their kingdoms. The second reason relates to oil and gas. As petroleum reserves run out, Middle Eastern states are pivoting to tourism to drive their economies. These lavish engineering projects are meant to match the allure of Europe’s cultural sights and Asia’s breathtaking natural wonders.

While both answers are correct, they only tell half the story. Let us not forget that flamboyant prestige projects are financially inefficient. Not only do they take decades to realize their return on investment, they also carry high risks. It only takes one recession to wipe-out occupancies in expensive office towers, dry-up the flow of tourists, and choke luxury spending.

Yet, defying good business sense, the United Arab Emirates (UAE), Qatar, Bahrain and Saudi Arabia have all doubled-down on mega-projects. Why is that?

To understand the motives of Middle Eastern governments, we must first understand how being rich in oil and gas carries serious economic consequences.

Before the discovery of oil, most Middle Eastern states were made up of nomadic tribes that eked out a living through non-industrial fishing, cottage industries, and pilgrimage tourism. The successive discovery of oil and gas from 1938 to 1972 changed their fate. They became very wealthy, very fast.

As Gulf states grew in petro-wealth, local industries began to perish one by one. See, investments in oil and gas are far more lucrative than investing in a manufacturing facility. Naturally, the bulk of state and private sector investments were channeled towards energy-related businesses.

The small populations of Middle Eastern states also contributed to their reliance on oil and gas. The small workforce naturally gravitated to energy-related businesses as they offered greater stability and better pay. There was simply not enough talent left to develop the manufacturing and services sectors.

The value of the currency is another factor. The value of the Rial, Diram, and Dinar appreciated quickly as countries all over the world stockpiled them to purchase oil and gas. The strong currency made importations cheaper and locally manufactured goods more expensive. Goods and services made in the Middle East could not compete with their counterparts from Asia, thus, disincentivizing the development of the manufacturing sector.

These converging factors made oil and gas the only viable industry in Gulf states. They became single-commodity economies — and this made them vulnerable. Not only were they left at the mercy of their finite supply of oil and gas, their economies were also exposed to the whims of world commodity prices.

Oil rich countries who cash-in on their wealth by providing generous subsidies to their population (for politically motivated reasons) instead of investing in new sectors, eventually become economic failures. Venezuela is an example. Venezuela is the poster child of what could happen if an oil rich country fails to diversify.

Middle Eastern economies have done better. With immense wealth generated from oil and gas, sovereign wealth funds were established to strategically invest their petro profits. The sovereign funds of Saudi Arabia and each of the emirates amount to trillions of dollars.

Interest and dividends derived from the funds are what is used to finance various development projects. These include social projects like state-of-the-art universities, hospitals, and mass housing; infrastructure projects like highways and airports; prestige projects like the Burj Khalifa, and a national airline that connects their capital cities to the world.

Middle Eastern airlines serve strategic purposes. They provide distinction, which is important for any up-and-coming tourism powerhouse. They provide a steady flow of short-staying tourists. And, more importantly, they help internationalize the country. All these conspire to help Gulf states wean themselves away from oil and gas to become diversified economies.

So, we go back to the question — why do Middle Eastern states build prestige projects?

Tourists are not the primary targets of prestige projects — businesses and entrepreneurs are.

When a mega-project like “the Line” are undertaken, they require an army of architects, engineers, designers, contractors, service providers, management staff, blue- and white-collar workers, etc. The sheer size of the projects attracts foreign companies to set up offices in the host country if only to get a piece of the multi-billion project.

Prestige projects infuse capital, talent, and new productive capacities to the host country, thereby enabling them to diversify. From only oil and gas, middle eastern economies leverage upon expensive engineering projects to become specialists in a varied range of products and services. Attracting foreign businesses also helps build a population of young, talented, high earning immigrants who help fire-up consumer demand.

But Middle Eastern states must provide reason for these foreign companies and their employees to stay. This is why one mega-project is followed by another. The idea is that in time, their economies become centers for business and commerce. This is the point of it all and the economics behind building big.