The collapse of Dubai World has called into question the failure of the Dubai economic model and even undermined confidence in the economic future of the Gulf. Much of these sentiments are misplaced as was the loss of confidence in the "Asian Model" in the late 1990s. In fact, both are quite similar since Dubai largely copied Singapore and the other Southeast Asian tigers. Structurally, both had three essential features:
- An efficient and effective state planned and built world class infrastructure to attract private businesses. Of course, the seedy side of this was the use of virtually indentured labor from South Asia (in the case of Southeast Asia it was the Philippines and Indonesia).
- Business investment was encouraged and actually established directly by the state to provide services to a globalized market place (i.e. tourism, business services, media, telecom, cargo handling and even additions to the global production chain)
- Regional gaps and shortages created by restrictions and blockages in trade and finance in specific countries (for Dubai these target markets were Iran, Saudi Arabia, India, Pakistan and the FSU) were filled and alleviated.
Two additional features facilitated and ensured the development of the economic space:
- A heavy reliance on debt financing, which in the specific case of Dubai also exploited the innovations of Islamic finance seen in the last decade
- The creation of commercially run government companies that had the implicit guarantee of the sovereign. In Dubai's case there was an additional implicit guarantee from Abu Dhabi. These mobilized capital and created core sectors which then led to the in-gathering of other private sector businesses
Both the Asia Model and its Gulf clone had a big weakness - over reliance on debt. This was partly a function of the government guarantees and in this case, Abu Dhabi's back stop role. The success of Dubai in promoting itself also played a major role in the financial overstretch as local, regional and international lenders indulged the Emirate. Given the enormous amounts of excess liquidity in the Gulf and worldwide, prior to the financial crisis, it was almost inevitable that Dubai borrowed excessively, just as the Southeast Asian had in the run up to the crash in 1997-1998.
Despite this proclivity towards over borrowing, the fundamentals of the Dubai model are still sound. The infrastructure has been built and is still very useful. The underlying business logic of Dubai Inc - i.e. globalization of services and meeting regional finance and trade needs -- is still very viable even if demand for these services is somewhat more muted due to the problems of the world economy, financial instability and reversals in globalization. Moreover, this will put more pressure on the Dubai Executive to tighten up on regulations and improve governance, including financial management, which should improve the ability of Dubai to weather future storms. Ironically, one of the consequences of the financial bust, a sharp reduction in asset prices, will enhance the Emirate's competitiveness.
What appears not to be sound is the political issue which underpins the Dubai model (see separate forthcoming MIS memo). To get back on track, ruling families of the UAE will have to appear united and work on putting Dubai back on a more sustainable footing. Once this is done, there are few reasons for Dubai not to grow at a steady sustainable rate over the long term.
Another important factor that will help the long term growth of Dubai is that the rest of the Gulf's economies are resilient and their growth models (adaptations of Dubai and the Asian Model) are sound. Saudi Arabia is embarking on a huge capital investment program financed not by debt but by government cash reserves and a determination to keep prices above the Kingdom's threshold price of $55/b. Foreign and domestic private investment in petrochemicals and other downstream industries will also prolong the strong growth prospects in the Kingdom.
Similarly, Abu Dhabi is trying to develop its economy again from its vast foreign exchange reserves. While Abu Dhabi's development could be competition to Dubai, it most likely will complement its neighbor because many of the services it requires could be more economically purchased next door. The overall Gulf's growth will certainly help Dubai - Iraq's reconstruction is still on the horizon and could be another fillip to regional growth prospects.
The ultimate threat to the wellbeing of the region in the medium term is a sustained fall in the price of oil. There the prospects overall look fairly favorable despite a few dark clouds on the horizon. Most excess capacity is in the hands of the Saudis who are loath to do anything to destabilize the price. Other potential competitors to the Saudis and overall OPEC - the BRINK countries - potential output surges are not expected for a few years and there is still a high degree of expectation that they will absorbed without being disruptive to prices. Overall, the fundamentals and the economic policies of the Gulf, including Dubai, are sound and we will likely see this episode fade into the past --just as the Asian crisis did after the late 1990s.