The Gulf economic visions seek to create vibrant private sectors free from dependence on income from hydrocarbons. During the transition, however, some governments are playing the role of lead venture capitalists in strategically important sectors such as renewable energy and civil aviation.
China’s experience suggests that this increasingly popular model of state capitalism has flaws that policymakers should be aware of as they restructure their economies.
When an entrepreneur establishes a new business, no matter how brilliant the idea, at some point they will need external investment for their company to grow and realise its potential. This capital often comes from private sources, as in the case of the billion-dollar venture capital and private equity funds that exist in California.
Alternatively, startups can look to the government for funding, either through direct capital injections, or indirectly via sovereign wealth funds.
During the 1980s and 1990s, economists were highly sceptical about governments being able to make judicious investment decisions. Arab and Latin-American countries had experimented with state-led economies, yielding weak results. Most suffered from: low rates of economic growth, large budget deficits, spiralling government debt and perennial exchange rate crises became the norm.
The government’s ineffectiveness as the economy’s driving force was attributed to two key factors.
First, many government officials lacked the competence to steer these gigantic economies. This was not due to a lack of cognitive skills; rather, it was a reflection of the complexities of modern economies, and the need for private entrepreneurs on the frontline – who possess unique, nuanced knowledge, and who are motivated by profit – to be at the heart of decisions about where scarce capital needs to be directed.
The second was the threat of crony-capitalism, whereby sometimes officials were susceptible to corrupt decisions about how to allocate capital. Inefficient businesses that were politically connected managed to secure government support, resulting in stagnating economies and deteriorating state finances.
This “Washington Consensus” – referring to the notion the International Monetary Fund and World Bank used to hold, that the government should take a backseat – did not last long. The 2008 global financial crisis strongly pushed the pendulum back towards a belief in state-led capitalism as a sort of middle ground.
Those concerned about the government’s ability to steer the ship came to see it as the lesser of two evils, as globally the private sector’s rampant irresponsibility had almost brought the global financial system to collapse. The strong, positive contribution that China’s government had made to its own stellar growth also helped rehabilitate state-led capitalism.
It was at this point that the Gulf countries began to scribe their own economic visions. Inspired by the recent Chinese experience, and the historical experiences of countries such as Japan and South Korea, some governments sought to forge commercial ecosystems where the state would play the role of strategic venture capitalist.
The private sector’s business acumen was a welcome complement. However, some private fund managers suffer from flaws that make them ill-suited to lead the way in emerging sectors such as renewable energies and military manufacturing. The most salient is that often these investors are conditioned to favour projects that yield returns that will materialise within a maximum of five years, yet many of the benefits of technologies such as solar power take literally decades to arrive.
Moreover, sectors such as defence manufacturing require co-ordination between many related sectors, and usually it is only the government that possesses the authority and patience needed to get everyone pulling in the same direction.
The Covid-19 pandemic reinforced this mindset, as the Gulf governments gained confidence in their ability to manage systemic crises, and to guide the economy into the right sectors.
Yet a recent paper by Dr Emanuele Colonnelli (University of Chicago), Dr Bo Li (Peking University) and Dr Ernest Liu (Princeton University) suggests that some policymakers may wish to reassess their approach.
Dr Colonnelli and his co-authors used advanced experimental and surveying techniques to understand the pros and cons of government involvement in investment decisions. By speaking to private investment funds and the businesses that seek capital, they arrived at two important conclusions.
First, the average Chinese business is wary of investors with government ties. Second, the companies that were most wary happened to be the best-performing private businesses – the ones that are most likely to create jobs and contribute to the growth of the economy.
Further analysis revealed reasoning that harked back to the Washington Consensus: political interference in decision-making – meaning civil servants instructing companies to make what could sometimes be commercially unwise decisions due to extraneous political considerations – is the leading reason why government capital is unattractive to private firms.
Moreover, according to the findings from Dr Colonnelli and his colleagues, private businesses lamented the lack of professionalisation of some civil servants attached to these investment funds, especially in cutting-edge sectors such as technology, where the consequences of ill-informed but overly confident functionaries interfering could be disastrous.
This is a clear warning that the government’s role as a strategic venture capitalist may need to be modulated. As the private sectors in these countries improve their capabilities, and they start to flourish in new sectors such as biotechnology and AI, there is a risk that the government will transition from being a nurturing parent to a suffocating in-law.
There are several indications that China’s government is not realising this quickly enough, and is being slow in reforming its approach. But by virtue of their small populations and young national histories, the Gulf governments exhibit high levels of agility, and so are better placed than any to adapt the role that the state plays in the economy in accordance with the evolving needs of the private sector.
At the heart is the ability to keep abreast of the latest research in economic development, and to rapidly absorb the lessons presented by scholars such as Dr Colonnelli and his colleagues.
Regional governments will do well to be cognisant of the fact that the answer to the question, “how involved should the government be in the economy”, is neither definitive nor stable.
