The most unmanageable risk facing American interests in the Persian Gulf is neither Saddam Hussein nor Iranian expansionism. Rather, it is the slow but sure decay of the economic and political structures of the United States' key regional allies. They are the Gulf Cooperation Council (GCC) states: Saudi Arabia, Kuwait, Bahrain, Qatar, Oman, and the United Arab Emirates (UAE). Washington's obsession with external threats to friendly governments and direct risks to the continued flow of oil has blinded it to the end of these countries' 20-year holiday from politics and economics.

The holiday from economics was characterized by, among other syndromes, the lack of binding budgetary constraints, which reduced and sometimes even eliminated the need to set spending priorities and allocate scarce economic resources. Furthermore, the financial pie was so large that even with a highly skewed income distribution all sectors of society saw some measure of improvement in their standard of living. Unemployment was unimaginable as governments showed a seemingly infinite capacity to hire both citizens and foreigners in public jobs.

These economic circumstances led the way to a parallel escape from politics, in which the ruling elites rarely faced the need to share power, renew their legitimacy and credibility, or tolerate any meaningful public debate over major economic, social, or political issues such as oil and budgetary policy. The resulting system had neither taxation nor representation. These symptoms were mild in Oman, more serious in Qatar and Bahrain, and severe in Saudi Arabia, Kuwait, and the UAE.

The oil boom of the 1970s made the holiday possible. As the average price of crude oil rose from less than $2.80 a barrel in 1972 to more than $34 in 1981, the aggregate annual merchandise export earnings of the GCC states soared from less than $10 billion to more than $163 billion. Although imports rose dramatically as well--from about $3.5 billion in 1972 to more than $52 billion in 1982--the group managed to record a sizable current account surplus exceeding $66 billion in 1982. However, neither the oil prices nor the export earnings were sustainable for long, and by 1986 both had come tumbling down. The price of crude oil averaged less than $14 a barrel, and the aggregate merchandise export earnings of the GCC were down to about $45 billion. Although both oil prices and the region's financial conditions improved somewhat from their 1986 trough, the carefree era technically came to an end that year.

But governments in the region prolonged the holiday with chronic deficit spending. During the last ten years government deficits in the GCC have averaged well in excess of 5 percent of GDP, reaching 15 percent in Saudi Arabia. Budget shortfalls were almost entirely reflected in the external accounts, leading to large current account deficits. External and domestic deficits were initially financed by drawing down the substantial foreign assets accumulated during the 1970s and early 1980s. With the exception of the UAE, most gulf countries depleted their assets and turned to borrowing, which for the first time exposed their economies and economic policies to serious international scrutiny.

This deficit spending is the main reason cost-cutting has become the operative word in budgeting exercises. The most celebrated of the attempts to reduce spending was the 20 percent budget cut that King Fahd of Saudi Arabia announced last year. But the holiday cannot be ended by cost cuts alone, necessary as they are in the short run to stabilize the budget and current account deficits. Cost cuts are no substitute for comprehensive structural economic reform. Indeed, recent budget reduction measures have concentrated on capital spending rather than wasteful consumption, jeopardizing future growth.

The gulf syndrome of the 1970s was made possible by an economic order based on unearned income. The economic link between production and consumption was severed, while free-spending rulers assumed the role of providers, establishing an elaborate welfare state and securing their rule. The rise in fortunes was so vast that few objected, and the oil boom froze in time the process of social and political maturation. While the transformation of the physical landscape of the gulf progressed at an incredible speed--with the building of industrial infrastructure, hospitals, universities, housing, and utilities--the social and political structures were fixed and secured.

As long as money was available to grease its wheels, the system worked smoothly for over two decades. But without the constant flow of funds through the elaborate income distribution networks, much of the status quo is unsustainable. It is no longer possible to cover up structural weaknesses and policy inconsistencies. All major interest groups, including governments, ruling families, merchant families, and the population at large, are under pressure to earn not only their privileges but their keep.

THE SHIFTING SANDS

Now that the economic order based on unearned income is no longer affordable, a new social contract must be forged. The task entails getting rid of the unaffordable components of the old system and building on the transferable achievements of the past 20 years. The former is by far the more difficult because it requires changing entrenched attitudes toward work, consumption, government, and the most basic economic norms. Further complicating this task are demographic and socioeconomic trends such as the rapid rates of population growth and urbanization and the emergence of a massive public sector as employer of first and last resort. These trends are not easily reversible and have become entrenched in social relationships.

The internal forces transforming individual countries of the gulf are particularly formidable because they coincide with changes at the global and regional levels. The end of the Cold War and the systematic dismantling of the Soviet Union destroyed a global context within which the governments of the gulf had grown accustomed to viewing their interests. Increasing demands for transparency in domestic economic and political affairs limit the freedom gulf governments once enjoyed in dealing with strictly internal matters. To hide the host of inconsistencies in the domestic status quo from the world community is no longer acceptable. This change has created not only new pressures for the governments, but considerable confusion over how to reorder priorities and articulate policy objectives.

The unprecedented financial and economic dislocations in the gulf states coincided with growing global competition for markets and pressure from the industrialized countries to continue large military and industrial purchases. The gulf states in turn have suffered heightened anxiety about national defense, given the post--Cold War potential for, and indeed reality of, increased interstate conflict. Saudi Arabia's recent multibillion-dollar commitments to buy new civilian and military hardware from the West, coming only a few months after its celebrated budget cut announcements, are a good example of both the pressure and the anxiety.

Western complacency about this state of affairs has many causes: the reflexive avoidance of embarrassing discussions about and with friendly governments, an uninformed impatience with the internal political and economic forces in developing countries, and the temptation to assume conditions in the gulf will change as little in the next ten years as they are perceived to have changed in the past ten. The key players and systems of government seem to have survived the military, political, and financial repercussions of the Persian Gulf War. Furthermore, a byproduct of the advancing peace process between the Palestine Liberation Organization and Israel has been a perceived reduction in the chances for radical change. Finally, the shifts currently under way in the gulf are so subtle and slow that they are not easy to detect. Because they challenge the roots of the old system, on the surface their impact is not immediately apparent, but that is also why they are significant.

REFORM OR DIE

None of the conventional economic remedies and policy options will even begin to become relevant for the oil-producing countries of the Middle East unless governments there recognize the need to redefine their role. But it is not easy to end the holiday, not only for the governments but also, and often more important, for other socioeconomic interest groups. Almost every oil exporting government in the Middle East is trapped in a vicious circle of failures. It usually starts with the failure to deliver on the economy, which eventually leads to vocal political opposition. Mounting complaints expose the many structural weaknesses of the system. The governments, under increasing pressure, become more rigid in political and economic decision-making. Serious policy paralysis results, which prevents much-needed economic reforms and leads to further deterioration of economic conditions.

This model, with minor adjustments, can be applied to most GCC states. In virtually every gulf country vulnerable governments and the main economic interest groups, including the ruling and large merchant families, have tended to retreat to defense of their traditional privileges. This process can best be understood by considering how governments, the private sector, and the people at large have hobbled themselves with what might be called chosen dilemmas. For governments, the dilemma consists of the futility of trying, through budget cuts, to abdicate responsibility for the provision of economic well-being while maintaining unquestioned authority without accountability. Equally futile is the bid by private-sector monopolies to inherit, under the guise of economic liberalization and privatization, the productive assets of the public sector without assuming any of the social burden. The people of the gulf states are beginning to demand political participation and inclusion while striving to maintain the old economic order; this, too, is impossible.

These chosen dilemmas, reflecting an enormous reluctance to end the holiday, contain unrealistic and internally contradictory objectives. They inhibit the needed cooperation between governments, the private sector, and the population and encourage the emergence of extremist ideology, which causes further distractions for and limits on the latitude of decision-makers.

Today, despite the investments of the last two decades, almost every economy in the group faces more serious structural problems than before the oil boom of the 1970s. Furthermore, the political will to deal with such problems is less than it was before 1973. Still, the economic problems are by no means unmanageable. The GCC countries sustain high per capita income, debt is not at a crisis level for any of the governments, and oil remains an extremely valuable long-term resource. But even oil, which was responsible for inaugurating the holiday, cannot be the answer now. A significant and lasting increase in the price of oil is unlikely in the next few years, and even if one were to occur, it would not solve the fundamental economic problems.

The challenge facing the governments of the region is not to find the means to prolong the holiday with higher oil prices; rather, it is to introduce greater public accountability coupled with an elimination of bureaucratic and regulatory obstacles to competitive, private-sector economic activity, including regulation or elimination of the large monopolies that plague most gulf economies. Also important is a commitment to raise the quality of education and give people greater inclusion in national politics. Political inclusion should be more meaningful than ruler-appointed consultative assemblies. Kuwait and Oman have made progress on these issues, thanks largely to relatively open public debate. Most other GCC states, however, seem to be more preoccupied with denying the existence of the problem than finding solutions to it.

The conventional wisdom (interestingly, in both the Middle East and the West) is that to prevent a disruptive change in the gulf states the status quo must be preserved and buttressed. If the current system fails, the argument goes, some type of radical ideology will sweep the region, turning back the clock several centuries. The villain of choice is political Islam, which some Middle Eastern governments wave in front of their Western protectors to explain and justify their excesses and inadequacies. But gulf societies need not face only the two equally untenable choices of stasis or chaos.

BEYOND CHAOS

A guided process of change rather than a disruptive one remains possible if the region's governments and private sectors enter into rational partnerships and set in motion an evolutionary reform. This can be achieved only through the initiative of social and political elements that can transcend their parochial interests and demonstrate faith in their country's long-term survival and prosperity. Only then can a meaningful vision of the future be formulated. Setting the priorities for reform is critical. For example, many of the economic liberalization and privatization policies that are being contemplated and in some cases implemented in the gulf are premature. They will simply concentrate wealth further in the private-sector (or ruling family) monopolies. Most private-sector monopolies have either a direct or indirect presence in various ministries, enabling them virtually to guarantee that no competition enters the market. Only after the establishment of a competitive private sector can privatization be meaningful and productive. In this context, strong antitrust laws must replace the current protection of large private monopolies, as with the agency laws of most countries, which give exclusive rights of distribution of foreign goods to local merchants.

To encourage broad-based, competitive private sectors further, governments must move away from conceiving and implementing non-infrastructural projects, such as aluminum and steel plants, hotels, and certain agricultural projects. Instead they should see to it that their countries show macroeconomic promise within a rational, fair, transparent, and predictable legal environment. In order to stimulate investment, governments must establish a rule of law that assures businessmen fair judgments and impartial enforcement.

The biggest challenge is broadening political and economic participation. The people of every gulf state are willing and able to participate meaningfully in political and economic affairs but are generally excluded from both. Governments must create the conditions for public debate on key issues, including the budget and oil policy. To facilitate a gradual scaling back of the welfare state, businesses must show a greater willingness to hire national rather than foreign workers. Citizens must pay realistic prices for services that they receive from the government and ultimately even pay taxes.

In this scenario, while the current regimes in the gulf would be replaced, the ruling families would stay, but without the exclusive control over their countries they now have. These ruling families have been in control for much longer than the regimes they set up during the holiday. To remain important political and economic players, however, they will have to demonstrate the finely honed survival instinct that led them to bend with the demands of the times over the past century, when many of them evolved from tribal chiefs to desert warlords, to colonial protectorates, to state builders, and now possibly to nation builders and eventually constitutional monarchs.

A relatively orderly, if monumental, process of change requires a little help from the West. The United States, as the ultimate guarantor of security in the gulf, has a particular interest in seeing that the gulf states make a nondisruptive transition to a more manageable socioeconomic order. At a minimum, Washington needs to cast aside the denial syndrome associated with clientitis and recognize officially that its hitherto unshakable gulf allies face a potential crisis. Moreover, the transition in the gulf makes it imperative that Washington broaden its base of relationships, reflecting the realities of the whole region and not only the particular sensitivities of any one country. Perhaps much more important, Washington should establish contact with most political movements of the region, including those opposing the regimes currently in power. Finally, the transition requires more direct and even supportive recognition of positive trends, such as the reestablishment of an elected parliament in Kuwait. With regard to the gulf, Washington's holiday is over too.

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