Acton Commentary

Wealth Grows in the Desert


With the credit crunch and oil prices continuing to shake economies across the globe, the world's more prominent financial centers, most notably Wall Street and the City of London, have lost much of their luster.

From Geneva to Hong Kong, thousands working in financial industries have lost their jobs. Banks, hedge funds, and private equity groups continue to downgrade their profit forecasts and write off massive losses. Such is the price of poor investment decisions, loose monetary policy by central banks, and a casual attitude toward debt by consumers, businesses, and governments alike in North America and Western Europe.

Amidst the gloom, however, a dim light is beginning to shine in an unexpected place. Most people associate places such as Dubai, Qatar, Abu Dhabi, and Bahrain with oil. Rather fewer think of these locations -- in the very heart of the Arabic and Islamic worlds -- as emerging financial centers.

And yet these are precisely the industries beginning to appear in a part of the world that has long been overly reliant on oil production and often struggled to invest petrol-dollars in entrepreneurial, wealth-creating ways.

The reasons for the emergence of places such as the Dubai International Financial Centre are several. One is geography. As globalization continues to lift millions of Indians and Chinese out of poverty, the Gulf States increasingly constitute a vital East-West transit point for people, ideas, and capital.

The second reason is the sheer amount of capital surging through the region. A McKinsey Global Institute January 2008 report states, "At an oil price of $70 a barrel, the six nations of the GCC [Gulf Cooperation Council] would earn a cumulative $6.2 trillion by 2020, or more than triple the amount they earned from 1993 through 2006." The report further comments: "In 2006, the GCC states together had net capital outflows of $202 billion, joining China to become the world's largest sources of surplus capital."

By any standard, this is serious money. It also reflects a shift in the world's liquidity from North America and Western Europe towards East Asia.

This is not the first time large amounts of capital have flowed into the Middle East. Unfortunately, much was squandered in the past, partly because of corruption, but also because of many post-war Middle-Eastern governments' adoption of socialist economic policies. As the late Peter Mansfield observed long ago in his magnum opus, The Arabs (1992), the result was not wealth, but rather large bureaucracies intent upon maintaining the status quo.

Once a city or country decides it wants to be a player in global capital markets, however, highly centralized, state-orientated economic policies become less and less plausible.

If an international financial center is to be successful, it must (a) allow its domestic and foreign participants the freedom to invest as they see fit and (b) be willing to allow free capital flows. Should a financial center decide to unduly limit either of these liberties, its days as a significant capital market are numbered.

In this sense, the emergence of functioning financial centers in the Gulf represents a step toward the economic liberalization needed so badly throughout the Arabic and Islamic worlds. The very existence of these centers reduces the chances that billions of petrol-dollars will be poured into yet another grandiose, failed state-development scheme. Instead, market signals will guide at least some investment.

The key elements for successful financial centers in today's competitive global capital markets are transparency, minimal regulation, low taxation, rule of law, and private property rights. The spread of these practices and institutions throughout the Middle East will do more to create wealth for all and undermine corrupt governments than any amount of foreign aid or activism by foreign NGOs.

Not surprisingly, some of these financial centers, such as Bahrain's, specialize in Islamic finance. This is big business in a region where many take Islam's strictures about interest very seriously.

But other industries -- bonds, insurance, wealth management, and private equity -- occupy increasing proportions of these new centers' activities. In embracing these businesses, the Gulf's financial hubs accelerate the region's integration into the global economy -- a shift likely to augment the chances for peace in the Middle East.

Of course, much work remains to be done. A September 2007 Economist report on the world's financial centers, for example, mentioned initial concerns about "government meddling" in Dubai. Old habits, it seems, die hard.

Still, the appearance of modern globally-focused financial centers throughout the Gulf represents tangible progress for a region that has struggled to cope with the opportunities and challenges created by oil-generated wealth.

Perhaps, one day, the desert will bloom.