The Spice of Life
And of Economic Sustainability
In a recent video by the Wall Street Journal, Bahrain is described as being the “most diversified economy in the region”, highlighting the percentage contributions of different sectors towards Gross Domestic Product (GDP). Under this measure, economic activity in Bahrain appears well-distributed with hydrocarbons comprising around 20% — a share that is especially apparent when compared to the rest of the GCC.
This is certainly a good thing. Bahrain does have large financial services and aluminum industries, both of which are significant contributors towards our economy.
And yet, this lens provides a limited view, since the concept of “economic diversification” tends to remain vaguely defined or mischaracterized. You can find yourself in a bit of a rabbit hole if you stop and ask yourself — what is actually being measured here? And why is that a good thing?
Some Definitions
Taking a step back, the modern concept of Gross Domestic Product (GDP) was introduced in the 1930’s as the market value of all final goods and services produced and sold in a country in a specific time period. There are multiple ways to calculate GDP, but its basic accounting identity is GDP = C + I + G + (X-M), or the sum of Consumption, business Investment, Government expenditure and Exports minus Imports.
Essentially, it boils down to anything that is domestically produced and then sold (locally or via exports).
GDP is usually taken as shorthand for the size of an economy, but has multiple documented shortfalls (overlooks non-market activity, ignores degradation of natural assets etc.), nor does it necessarily provide an accurate indication of the well-being of citizens (here’s a Freakonomics episode on critiques and alternatives).
Sectoral GDP as Diversification
A balanced distribution of sectors in GDP is important in that it represents multiple opportunities for employment — an economy concentrated on a single industry can only produce so many jobs. It also increases overall resilience against sector-specific risks; think how tourism collapsed during the COVID-19 pandemic. As new industries are developed, they are also likely to experience higher initial growth rates compared to existing mature sectors.
Financial services, for example, are an important part of the Bahraini economy. This is the case even though approximately one-third of the sector is comprised of offshore institutions — even though profits may remain outside the local economy, there are still spillover benefits in terms of employment and workforce training, real estate occupancy, ancillary services (business travel, legal services) etc.
However, what the GDP view misses — and this is a big miss — is dependencies and flows between industries. This is especially relevant for GCC countries who are resource rich and have social contracts between their governments and citizens. For instance, oil production is recorded under oil and gas GDP, but those revenues are transferred to the government, which pays public sector wages (government services GDP), subsidies for household utilities (electricity and water GDP) and debt interest costs (financial services GDP). The sector breakdown is accurate, but fails to capture the relative importance of certain segments.
A simple example might help illustrate the point.
A Simple Example
Take a hypothetical economy with three sectors — oil, government and cars. The country extracts, refines and exports $100 of oil, with the funds transferred to the government. The government then pays $100 in salaries, ostensibly for the provision of public services. Those employees then use their $100 for buying cars, which were imported for $80. Total GDP is therefore $220 ($100 oil + $ 100 government + $20 cars), and the non-oil sectors make up the majority of economy activity at 55%.
Going one step further — if the government were to borrow $100 to pay bonuses for public sector employees, who buy bigger and newer cars, total GDP becomes $340 and the non-oil share jumps to 70%. Deficit spending is therefore one way to bypass the hydrocarbon sector to “grow” the rest of the economy. It adds up, but seems off.
(I will note that Bahrain’s debt-to-GDP is over 120% whereas Kuwait’s is 7%, so you can see some of the parallels here.)
Another quirk occurs when looking at real GDP over time, particularly during times of rapidly rising oil prices, such as in 2021–22. Because real rates exclude price movements, hydrocarbon sector growth can appear flat, even though the government in reality makes bank. As this money is spent elsewhere, it drives growth across all other industries, giving them a larger share of the overall real economy. Again, this technically adds up but can paint a pretty skewed picture of diversification.
Other Measures
A crucial aspect here, then, is not only how GDP is distributed, but the primary sources of income and value creation. The GCC is known for its reliance on imports for critical supplies, including food, pharmaceuticals, high-tech electronics and building materials. Those imports are purchased with foreign currency, which must be earned by selling goods and services abroad. One way then to look at long-term economic sustainability is through diversification of exports.
I’m missing Q4'22 figures for oil and gas, but even with a conservative estimate, we see that our dependence on oil and gas remains much higher than GDP would suggest. In addition, the remaining third of exports is also concentrated along the lower end of the value chain (unwrought aluminum and iron ore are the two biggest non-oil exports).
It is worth noting noting that we also generate foreign currency via service exports (e.g. finance, insurance, tourism) reflected in the Balance of Payments, but there is no sector breakdown for those figures as far as I know.
One final measure is by looking at government revenues. Over the past four years, the percentage share from oil and gas decreased from 83% in 2018 to 69% in 2021, although the reduction is partially a function of higher non-oil income streams (hello VAT) and partially because gas sales and oil revenues from the Bahrain field have both fallen by 50% — I’m not sure why.
The importance of a well-diversified and equitably-funded revenue base is to build a public sector that is resilient to external shocks and is able to engage in timely fiscal policy; as noted, Bahrain’s government debt levels are staggeringly high, with interest payments over BD 700 million annually. These should only be expected to rise, as the global monetary regime now is much tighter than it was during the past decade.
Anyway, this is a contested and evolving policy space, especially in light of the Fiscal Balance Program’s 2024 goal. We’ll see how things develop on this front, although a higher VAT rate and possible introduction of corporate tax are not implausible outcomes over the next few years.
Fin
In summary, we may be the most diversified economy in the region — in a given sense — but an overemphasis on GDP still misses fundamental truths about the structure of our economy, which we can’t afford to ignore.
