Construction activity in the Middle East continues to expand at rates more commonly associated with rapidly developing economies such as China. It has not always been so. Indeed, the economic history of the region has been marked by violence and poor governance by well-entrenched rulers with access to huge oil wealth. A failure to diversify national economies led to a heavy reliance on oil revenues. This dependency upon oil for fiscal revenues and foreign exchange earnings lead to patterns of pro-cyclical fiscal spending and boom-bust growth. Additionally, the region has been held back by an unattractive business climate, an opaque legal and regulatory system, and a tendency for chronic capital flight. Chart 1 suggests the historical linkage between oil revenues and economic growth and illustrates the boom-bust cycle.
So, is the cycle about to repeat itself? There are suggestions that investment activity is outpacing demand, particularly in the area of residential construction. Nevertheless, there are compelling reasons to believe that the expansion has considerable room to run. First, due to supply constraints high oil prices have proven more sustainable than previously thought possible. Global demand for oil remains strong as the US economy proves resilient in the face of a housing bust, while rapid development in China and India, among other countries, continues to expand market demand. Global Insight expects that oil prices will retreat from their current highs, but we believe that they will remain above US$70 per barrel through 2012, a prolonged period of above average oil prices. Even if oil prices were to retreat more significantly than expected, the accumulation of substantial financial assets from the current cycle will cushion any impact.
Meanwhile, economic policies in the Middle East have become more prudent and oil revenue spending less wasteful. Most oil producing nations are now investing their oil wealth in campaigns to diversify their economies, preparing for the day when diminishing oil reserves will require other growth engines, such as technology or services. Furthermore, political developments continue to surprise on the upside. Despite rising political pressure from the bottom, governments are less insecure than in the past, the threat of Islamic extremism seems to be receding, and the risk of a major Arab-Israeli war is relatively low. Our conclusion is that the current investment spending boom has more staying power than previous ones. As Chart 2 indicates, fixed investment spending will slow with time, but growth volatility has virtually disappeared from the outlook. Indeed, our view of the long term growth potential for regional real GDP has been increased a full percentage point over the past four years, an extremely rare and significant re-assessment of the area’s economic potential.
The region’s promise has not gone unnoticed. Foreign direct investment (FDI) to the region has quadrupled since 2002 according to the International Monetary Fund (IMF) and is expected to top $80bn in 2007. This pool of investment funds exists on top of the current account surpluses accumulated from energy revenues and suggests that the region’s international reserves will be almost $790bn by the end of the year.
So, how is the region spending its capital? Chart 3 indicates the distribution of construction spending across the major structure types. The largest share is earmarked for infrastructure projects, which are composed of transportation (highways, bridges, airports, etc.), energy (primary distribution systems such as pipelines) and water and sewer systems. Spending on infrastructure, particularly roads and sewer/water systems, has lagged over the past decade as the region suffered through a cyclical trough. The need to overcome deferred spending, combined with population growth and compounded by the development of mega-projects has created pent-up demand for new and upgraded infrastructure. In the Gulf Cooperation Council (GCC) alone, over $1trn has been announced in new projects, with roughly half of them currently underway. These projects have long development horizons, which again points to the likelihood of the construction boom continuing.
The oil producing countries are also earmarking billions to expand their production and refining capacity. The bulk of this activity is accounted for in the industrial structures category. Indeed, for all the region’s plans to diversify, the industrial sector will remain dependent upon energy for the foreseeable future. Development of other manufacturing industries is not as large a priority as the establishment of a service economy, and while some industrial diversification is on the cards, much of this involves the development of other energy resources, such as natural gas. For example, of the $33bn that Abu Dhabi has planned for industrial development, two thirds, or $22bn, is intended for oil and gas projects.
Residential construction comprises a perhaps surprisingly large share of the region’s construction activity. While the region has a relatively low rate of ‘native’ population growth, it is a tremendous importer of labour from the Philippines, India, Pakistan and other countries. Despite efforts among most GCC countries to substitute nationals for foreign labor by increasing the share of national workers in the private sector, the reverse has been true. The reason is twofold: first, most nationals prefer jobs with the government to those in the private sector because of the higher wages paid in the public sector. Also, foreign labour is relatively cheap; in the case of Bahrain, the average monthly wage paid to foreigners was less than half the salary paid to nationals working in the same sector. Of course, the sheer volume of work in certain industries, such as construction, requires the importation of labour as the national economy simply lacks sufficient skilled workers for the scale of ongoing projects. Whatever the cause, the housing needs of the region are growing at a greater rate than the national population growth rates alone would require. Additionally, the region’s wealth has significantly boosted per capita incomes, and it is an economic certainty that increased income leads to the demand for better goods and services, especially housing. The combination of an expanding adult population base, combined with the demand for better housing, suggests that residential construction will consume a significant share of the construction pie for the next several years. However, most of the population changes are in the rear view mirror, and residential will not be growing at the same rate as other structure types. As such, its share will decline modestly going forward.
Chart 3 should be viewed in the context of chart 4, which indicates how construction growth by building type has fared over the past five years and how it is projected to perform for the next five. In general, the pace of construction is expected to slow as was suggested by the fixed investment view above. Nevertheless, the Middle East remains one of the world’s fastest growing regions, and the nature of its construction suggests that it will remain an even better market for cranes.
Going forward, the strongest growth is expected in the commercial and office sectors. Global Insight defines the commercial sector as retail, lodging and non-industrial warehousing. The institutional sector includes education, health care and government buildings.
Perhaps no Middle Eastern economy illustrates the diversification trend better than the United Arab Emirates. Dubai, in particular, is attempting to re-invent its economy practically overnight. The Dubai International Finance Centre has ambitions to rival the traditional financial powerhouses of New York, London and Hong Kong. Bahrain also has designs on being a regional financial powerhouse as an offshore banking centre. Dubai, however, will sweeten the deal as its financial centre will be serviced by Dubai World Central, which would include an international airport also designed to rival established world transit centres such as Heathrow. Indeed, Dubai has already established itself as a hub connecting East and West, servicing some 30m passengers in 2006. Dramatically expanded air facilities are intended to handle more than 200m passengers by 2015. Tourism is also a critical component of Dubai’s plans with world-class hotels already in place and more expected. Tourism, of course, also inspires a robust retail sector, and the emirate is becoming home to the globe’s established luxury retailers.
While the UAE garners the world headlines, mega-projects are almost commonplace in the region. Even Saudi Arabia, not traditionally an office or commercial player, has launched the King Abdullah Economic City, a $26.6bn mixed-use mega-project. When completed, the project will consume 55m square meters of land and boast a shoreline more than 20 miles long. At build-out, this economic zone alone will employ 500,000 workers.
Qatar is ‘home’ to one of the world’s largest natural gas fields and is investing in infrastructure to triple its LNG production.
Iran remains a question mark for construction in the region. For the moment, it remains a strong market, fuelled by strong oil revenues and aggressive infrastructure spending on the
The next ten years will see a tremendous shift in construction resources from North America and Western Europe emerging markets including the Middle East. It also favours cranes with infrastructure and tower block projects.