A STUDY OF THE ASSOCIATION BETv-EEN ABSORPTIVE CAPACITY AND DEVELOPMENT STPATEGY IN SAUDI ARABIA by SALEH ABDULAZIZ OMAIR, B. of Com., M.A. A DISSERTATION IN ECONOMICS Submitted to the Graduate Faculty of Texas Tech University in Partial Fulfillment of the Requirements for the Degree of DOCTOR OF PHILOSOPHY Approved Accepted Augu>£*, lyVG y^' ^01 T 3 • r, p • 2- TEXAS TECH UNIVERSITY The Graduate School LUBBOCK, TEXAS ABSTRACT OF DISSERTATION for the Degree of DOCTOR OF PHILOSOPHY Author's Full Name: Saleh Abdulaziz Omair Title of Dissertation: A Study of the Association Between Absorptive Capacity and Development Strategy in Saudi Arabia Names of Committee Members: i Dr. John C. Gilliam, Chairman, Dr. Robert L. Rouse, Dr. Roger M. Troub, Dr. Gene C. Uselton, j Dr. Thomas Pogue ' Department: Economics \ Date of Graduation: August, 19 76^ / /- 7 o 1 Signature of Committee Chairman Signature of Graduate Dean This study analyzes the association between absorptive capacity and Saudi Arabian development strategy. It is the aim of this dissertation to identify, in broad terms, some of the major aspects of a strategy by which to pursue economic development in an efficient and effective manner which takes absorptive capacity constraints into account. To accomplish that aim, this study first discusses the unusual aspects of the development problems currently confronting Saudi Arabia. These aspects arise mainly from the large flows of financial capital in a situation of a modest stage of development. Saudi Arabia has financial capital available to an extent that allows it some latitude in the selection among alternative future circumstances and configurations of its society— including the nature of its economic system. Three types of possible future states of the Saudi Arabian society have been identified. The first is called a rentire society; the second a dualistic society, and the third a modern society. On the assumption that Saudi Arabia seeks to become i a modern society, the study identifies a set of allocative ^ I decisions which an appropriate development strategy must \ take into account. These decisions include (1) present . versus future sales of natural resources abroad; (2) » domestic expenditures versus foreign investment; (3) among domestic expenditures, consumption versus investment; and (4) among domestic investment, allocations among various types of investments. The study also discusses the importance and interdependence of three types of capital (physical, organizational, and human) and three types of infrastructure (physical, technological, and institu­ tional) . The study shows that Saudi Arabia faced, and still faces, a complex set of cultuiial, social and institutional relationships that impedes the optimal utilization of existing resources and the development of new resources. The discovery of oil removed one obstacle—the lack of capital, but the social and economic structures did not change fast enough to permit the economy to absorb the capital made available by oil revenues. The performance record was disappointing. Through­ out the period under discussion there was little change in the structure of production. The oil sector remained the most important part of the economy. Gross domestic product has risen steadily during the period under discussion, reflecting the rise in oil output and price. Investment targets have not been realized. The study suggests that some policy measures can be adequately used to relieve some of the specific absorptive capacity constraints, thereby increasing the aggregate absorptive capacity. -i^^'^'wmmi ACKNOWLEDGMENTS A thesis cannot be exlucisvely the product of a single individual's efforts. Therefore, this author wishes to express deep gratitude to the members of his disserta­ tion committee for their constructive criticism and guid­ ance. Special thanks are due to Dr. John Gilliam whose jj I knowledge of the Middle East was crucial in the formation ^ of premises regarding Saudi Arabia, and to Dr. Roger Troub, | who by virtue of his advice and indefatigable editorial ' I I labors, bears more responsibility for what may be good in form and content of this dissertation than a mere acknowl­ edgment of help can convey. Furthermore, special recognition must go to the Institute of Public Administration (the author's immediate employer) in the government of Saudi Arabia for providing most of the data used in this study. 11 TABLE OF CONTENTS Page ACKNOWLEDGMENTS ii LIST OF TABLES viii LIST OF FIGURES x CHAPTER I. THE PROBLEM AND THE SETTING 1 The Setting 1 A Development Challenge with Unusual Aspects 1 Determinants of Appropriate Development Strategy 6 Absorptive Capacity Constraints 10 The Problem 12 Topic Organization 14 II. ABSORPTIVE CAPACITY: CONCEPTS AND ASPECTS RELEVANT TO SAUDI ARABIAN DEVELOPMENT STRATEGY 16 Absorptive Capacity: Fundamental Concepts 17 The General Concept: Ambiguity and Clarification 17 Absorptive Capacity and the Law of Diminishing Returns 19 Sources of Constraints on Absorptive Capacity 20 111 '.IMUJUillUII.- Absorptive Capacity in the Existing Literature 26 The Two-Gap Approach 26 The Capital-Output Approach .... 27 The Marginal Rate of Return Approach 29 The Time Dimension 32 Definition of Investment Projects 32 Absorptive Capacity Limitations . 33 Additional Relevant Concepts i and Considerations 35 \ « Appropriate Technology 35 | The Role of the Public Sector ... 36 [ Balanced vs. Unbalanced Growth . 37 ^ The Macro Allocative Decision Set . 39 } Types of Capital and j Absorptive Capacity 41 Absorptive Capacity and Infrastructure 4 3 Absorptive Capacity Considerations and the Economic Planning Information System 45 Absorptive Capacity and the Investment Sequencing Problem 49 IV Absorptive Capacity Considerations and Appropriate Development Strategy for Saudi Arabia 51 The Problem and Its Setting 51 Aspects of an Appropriate Development Strategy ^ III. BACKGROUND: SOCIAL INSTITUTIONS AND THE STATE OF HUMAN RESOURCES ^^ Cultural and Social Values and Institutions and Their Implications ^° The State of Human Resources 6 5 The Rate of Population Growth, the i Dependency Ratio and their 1 Implications 66 j I Literacy and Educational System ... 71 ^ t The State of Health 75 J The State of Nomads 78 , \ IV. BACKGROUND: THE STRUCTURE OF THE ECONOMY ? AND THE POLICIES OF THE 1950's 87 J The Structure of the Economy 87 Policies of the 1950's 99 The Monetary Reform of 1952 99 The Financial and Monetary Crises of 1956-58 104 The 1958 Reforms 106 V. THE DEVELOPMENT OF FORMAL PLANNING IN SAUDI ARABIA 113 The Role of Planning 113 Approaches to Planning 114 Partial Planning 118 Formal Planning in Saudi Arabia ... 120 The Economic Development Plan (1970/71 - 74/75 125 The Second Development Plan ... 129 VI. THE PERFORMANCE OF DEVELOPMENT PLANNING IN SAUDI ARABIA 133 The National Budget 13 3 Government Expenditures 13 3 Appropriations by Major Sectors . 136 The Performance Record 143 <i 1 Gross Domestic Product 14 3 ) I Agriculture 14 8 i Transport and Communication • Sector 149 * Education 149 Public Health Programs 152 Evidence of the Saudi Economy's Limited Absorptive Capacity 15 3 Actual vs. Planned Expenditures . 153 Sectoral Absorptive Capacity . 157 An Evaluation of Development Planning 159 Increasing Aggregate Absorptive Capacity 169 VII. SUMMARY VI 179 yisr Absorptive Capacity and Development Strategy 181 Social Institutions and Human Resources in Saudi Arabia 182 The Structure of the Saudi Arabian Economy 183 Formal Economic Planning in Saudi Arabia 183 An Analysis of Recent Development Planning in Saudi Arabia 184 SELECTED BIBLIOGRAPHY 186 APPENDIX 192 A. THE "TWO-GAP APPROACH TO DEVELOPMENT ... 193 ^ ii B. GENERAL APPROACH TO PROJECT EVALUATION \ SOCIAL BENEFIT-COST ANALYSIS 204 t C. THE DEVELOPMENT OF THE OIL INDUSTRY [ IN SAUDI ARABIA 224 D. BALANCED VS. UNBALANCED GROWTH 1 STRATEGIES 267 Vll LIST OF TABLES Table Page 1. Number of Students by Sex and as a Per­ centage of the Population for Selected Years, 1958 to 1972 "^2 2. Number of Students by Sex and by Levels of Education (Years 1967 to 1972) 74 3. Number of Hospitals, Hospital Beds, Dis­ pensaries, Health Centers, Physicians, and other Medical Personnel, for Selected Years 1967 to 1972 76 4. Relative Importance of Sources of Revenue ^ for Selected Years 1948 to 1974 91 , I 5. Some Indicators of the Reliance of the ' Saudi Economy on Oil Revenue for ^ Selected Years 1962 to 1974 93 6. Percent Contribution to GDP and Employment j by Type of Economic Activities 97 j f 7. Average Annual Growth Rates of Value i Added by Sector and GDP in Con­ stant Prices -127 8. Distribution of Financial Allocations for the Plan 128 9. Budget Appropriation by Major Sectors, 1960/61 to 1974/75 140 10. Percent Distribution of Budget by Major Sectors, 1960/61 to 1974/75 141 11. GDP by Economic Activities (at Constant Prices of 1969-70) 144 12. Percent Distribution of GDP by Economic Activities 146 Vlll Table Page 13. Student's Enrollents, Riyadh University, by Faculty (Years 1971-1973) 151 14. Actual and Allocated Project Expenditures (Years 1963/64 to 1973/74) 154 15. Gold, Foreign Exchange Reserves, and Invest­ ment Abroad (Years 1964/65 to 1974/75) . 156 16. Ranking Some of the OPEC Members with Respect to: Proved Reserves, Oil Production, Oil Exports, and Production/Reserve Ratio, as of January 1, 1973 236 17. OPEC (Middle East) Terms of Trade, Base Year 1958) 250 18. A Comparison of Government's Share per Barrel after the Tehran and Tripoli Agree­ ments 257 IX «^ i a LIST OF FIGURES Figure 1. Kinked Marginal Efficiency of Capital Schedule 30 2. A Comparison of Expected Rates of Return /' on Capital in More Developed and Less Developed Countries 31 3. The Increase in Absorptive Capacity . 173 4. The Fixed-Coefficient Production Function 196 .1 » * X CHAPTER I THE PROBLEM AND THE SETTING In many respects Saudi Arabia is an underdeveloped country, but because of the large flow of financial resources it began deriving from petroleum resources a few years ago, it finds itself with opportunity for devel­ opment far greater than that of almost all other less developed countries (LDCs).