Learning from East Asia: Why the Saudi Government Ought to Intervene to Influence Banking Policy
by Waroud Aldossari
As one of the oil-richest nations in the world, Saudi Arabia finds itself in an enviable position in comparison to many of its economic competitors, but the recognition that oil is a finite resource makes clear the task of diversifying the economy in order to ensure ongoing success. In particular, to the extent that banks have an important role to play in fostering the more balanced economy on which the country’s long-term maintenance of its performance and standing relies, it must be noted that hitherto they have largely abdicated this responsibility. By failing to invest adequately in manufacturing industries capable of adding to the country’s GDP, they have ignored the lessons of recent East Asian history. Japan, Korea, Taiwan and China all owe their economic success to their strict observance of a three-stage sequence of development, which at first prioritises land reform designed to produce high-yield household farming, then turns to manufacturing – increasing exports – and only later places emphasis on the provision of services. Instead, Saudi banks have encouraged a pattern of behaviour associated with less successful South-East Asian countries, like Thailand and the Philippines, where troubles have arisen as a result of their attempting to skip the manufacturing stage.
Drilling down more deeply into the contrast between the financial arrangements made by successful East Asian countries and those of their less successful South-East Asian neighbours, we discover that the key issue is that of regulation. Financial systems in Japan, Taiwan, Korea and China were kept under close supervision, and controls on international capital flows were maintained until an advanced stage of development. The main mechanism to ensure finance supported state policy objectives was bank lending, which forced export discipline on manufacturers by offering credit only to companies capable of showing export orders. On the other hand, South-East Asian states typically chose, on the basis of bad advice from richer countries, to deregulate banking and remove capital controls. As a result, family-business-controlled banks began to proliferate, and, at liberty to direct funds where they pleased, they tended to favour companies of two kinds: either non-manufacturing, or, if engaged in manufacturing, only concerned with selling products domestically. Interestingly, the hazardous nature of this financial policy, visible to all comers in retrospect, was noticed at the time by the Japanese economist Yoshihara Kunio. In the 1980s, he could already see the dangers with which South-East Asian countries were flirting, pointing out that their success in attracting investment, which enabled an immediate embrace of services, carried the risk, if investment funds dried up, of rendering them ‘technology-less’ developing nations, as subsequent events duly demonstrated.
Importantly, the difference between countries in the two regions has little to do with the relative inventiveness and intelligence of their respective entrepreneurs, but turns rather on the question of the business environment created by governmental legislation. In East Asia, by tying subsidies to export performance, governments stimulated speedy technical upgrading in manufacturing, and accelerated the pace of industrialisation to unprecedented levels. In South-East Asian countries, by contrast, although leading entrepreneurs were no less capable, governmental policy failed to bind them to manufacturing or to impose export restrictions on them. Instead, there were government-funded industrial ventures, but, with minimal competition among enterprises and no compulsion to export, returns on all types of industrial-policy investments were extremely low.
A clear and alarming sign that Saudi may be on the verge of pursuing the South-East Asian route, rather than the East-Asian one, is provided by statistics from the years 1985–89. During that period, funding from banks for various enterprises went up from 3% to 12.5%, but the share of the industrial sector in credit decreased from about 10% to 6%, with the unmistakable implication that the money was going to the wrong places. Indeed, over the last half century, far from sponsoring industry, Saudi banks have focussed on three areas – the trade sector, real estate, and personal consumption – which make a minimal contribution to GDP. In 1969, these three sectors accounted for 70% of the credit granted by banks, and, whilst that figure dropped in the 1990s, it has risen again more recently, reaching 68% in 2019.
For the time being, the effects of this policy on the economy are masked by the country’s ongoing oil wealth, but, as mentioned at the outset, this state of affairs will not persist indefinitely. A day of reckoning is in store, and, unless the banks change their approach decisively in the interim, Saudi Arabia faces a distinctly uncertain future. If loans promoting GDP growth continue at their present level – 59%, as compared to 109% for developed countries – it seems highly unlikely that the goals outlined in Vision 2030, among which a diverse export portfolio features prominently, will be realised.
Although the banks may seem, by this token, to be the villains of the piece, it would in fact be inappropriate to lay blame at their door. Their primary responsibility is to turn healthy profits for their shareholders, and in this they have been highly successful: their annual average net profit margin in the period from 2005 to 2018 was 40%, as compared to 12% for banks in developed countries. Rather, the problem lies with the government, which has failed to exercise control over their activities. Instead of leaving the banks to their own devices (as South-East Asian countries did to their cost), our legislators must force their hand (in the manner of East-Asian states), obliging them to direct credit to sectors with added value in keeping with the Kingdom’s development plans.
A bright future awaits Saudi Arabia but only if the government, alert to the danger of neglecting the industrial stage in the country’s development, uses protection and subsidies as mechanisms to direct entrepreneurial talent towards manufacturing rather than services, and particularly towards large-scale manufacturing with the weight to compete globally. Only in this way can national development and commercial interests be brought into proper alignment.