Fiscal tightening forces Kuwait to consider welfare reform

Fiscal tightening forces Kuwait to consider welfare reform

As Kuwait undergoes fiscal tightening, the government must begin to consider welfare reform as part of its efforts to tackle debt.

Back in mid-October, Finance Minister Sheikh Salem Adbulaziz al-Sabah suggested that Kuwait should review its subsidies system. At the end of the month, Prime Minister Sheikh Jaber Al-Mubarak Al-Hamad Al-Sabah called the welfare system “unsustainable” in a programme sent to lawmakers ahead of the opening of parliament. Then, last weekend, the Kuwaiti government announced plans to review $16 billion in annual subsidies at the same time that IMF chief Christine Lagarde visited the country, highlighting the need for long-term structural reforms to the economy. The real question is: will the government actually do anything about it?

Maybe. There are big problems that come with any attempt to shake up the system. The huge social welfare programmes and subsidies that have been key to raising Kuwait’s per capita GDP to over US$40,000 are increasingly seen as essential to the social contract. Generous spending programmes have been cited as an important reason that the region’s monarchies were left relatively unscathed by the Arab Spring protests. As citizens, especially the younger generation, come to see handouts as entitlements rather than perks, the government is increasingly wary of changes they know could prove unpopular. Just a year ago, Kuwait was seen as the most likely candidate within the GCC for the type of political changes the rest of the region had undergone.

The government will also face strong opposition from parliament. While the ruling al-Sabah family holds key government posts and the emir has the final say, the elected parliament is capable of blocking legislation and putting pressure on cabinet ministers and has used this power in the past. They are unlikely to take kindly to plans to restrict the subsidies, which many of them promised to expand during their campaigns. Instead, many MPs feel the government should focus on streamlining a woefully inefficient bureaucracy and curbing corruption.

Despite these political uncertainties, the economic answer is more clear: they really, really should. This might seem strange, given the current state of the Kuwaiti economy. The country has a 25% fiscal surplus. Non-oil growth is recovering from the global economic downturn and is expected to reach 4.5% in 2014. Last year saw the largest foreign investments ever, and oil revenues set an all-time record high.

A lot of this good news depends on the price of oil. Giyas Gokkent, chief economist at the National Bank of Abu Dhabi, has predicted that the average price of crude oil will stay at or slightly above $100 until 2015, well above Kuwait’s breakeven oil price of $70 a barrel (the price needed to balance the budget at current expenditure levels).

However, significant external downside risks exist if global economic conditions worsen, especially if we see a slowdown in key emerging markets, as this would translate to lower oil demand and prices. Fiscal buffers are large enough to ride out a sudden downturn, but given current expenditures, the IMF predicts that expenditure will exceed oil revenues by 2017/18, and the government could be running a deficit by 2021.

There is of course significant uncertainty in predicting long-term oil prices, and Saudi Arabia acts as an important swing producer, curtailing output should prices weaken sharply. But there is no denying that government welfare spending has mushroomed over the last half decade. Thirteen years of budget surpluses, thanks to high oil prices, has led to a tripling of spending over the last 7 years, from around $23 billion to over $70 billion, mostly on wages, subsidies and grants.

If the Kuwaiti government wants to keep their balance sheet out of the red, they will have to undertake fairly significant economic reform. The IMF released a report at the end of September that enumerated many of the long-term challenges the country faces and the policy responses needed, such as human capital development, improving the efficiency of public administration, and removing impediments to the development of physical, legal, and business infrastructure.

Behind these rather generic policy prescriptions lies an economic model that is deeply flawed. Failure to diversify the economy away from oil and the snail-pace of privatization are major problems. Kuwait also lags its GCC neighbours on measures of economic competitiveness. Most important, however, are its labour policies. Over 80% of Kuwaiti nationals are employed in the public sector and balk at taking private sector jobs, which pay less and require longer hours. Equally, the private sector dislikes employing Kuwaitis, often citing their lack of workplace skills and poor work ethic.

Instead, these positions are filled by importing foreign labour, often low-wage workers from developing countries. This practice is coming under increased pressure. Kuwaitis dislike the high number of foreign workers in the country, and claim they are a drain on public finances (much of public expenditure goes towards subsidies, which benefit Kuwaitis and non-Kuwaitis alike). The government released plans last spring to reduce the number of foreign workers by 100,000 a year over the next ten years. But there is a strong feeling that if these workers leave, Kuwaiti nationals will not be willing to take on the positions left open. This could prove to be a major drain on the growth of the non-oil sector, crippling government plans to move to a post-oil economy.

For the short and most likely the medium term, Kuwait is on safe footing. It is likely to continue seeing significant oil revenues, even if the price of oil drops. But its current trajectory is unsustainable, and it will have to undertake either major changes to its economic model, or major changes to its welfare system, or both, to survive. And that process itself could prove too tumultuous for the emir to ride out safely. But while doing something is dangerous, doing nothing could be disastrous.

About Author