The Middle East looks like a paradox: On the one hand the high oil prices boost the regional economies, financiers are running out of investment projects, Gulf stock markets are recovering from the 2006 slump and one of the last “closed economies,” Syria, is opening. However, all this economic development occurs in the shadow of a whole number of political Damocles’ swords. External threats – an American war with Iran, which would affect the Gulf, and an Israeli-Syrian conflict that could draw in Lebanon — and domestic quandaries — ranging from out-of-control population growth to sluggish bureaucracies and the Islamist challenges to ruling elites — could all spoil the current growth.

The twin forces of oil money and attractive economic policies have boosted the region’s economic outlook and general confidence. Mega-scale infrastructure, tourism, and real-estate projects — like the Abdallah Economic City near Jeddah and the Dubai Metro — are springing up, not just in the Gulf, but also beyond the boundaries of big oil-producers. In Damascus we find the Eighth Gate and in Amman there are the Abdali projects.

It’s easy to see from whence this bullishness came. In 2006, MENA oil revenues stood at a staggering $510 billion, $75 billion more than the previous year. With the barrel of oil hitting $75, oil producing nations are swimming in a cash surplus, while remittances and foreign direct investment (FDI) to resource-poor countries have also risen to historic levels.

A time to boom

The current high oil price was caused, mainly, by expectations of continuing strong demand, especially from the fast growing economies of China and India, fears of supply disruption in a number of hotspots such as Iraq, Nigeria and possibly Iran, concerns about the reliability of major oil/gas supplies in Russia and Venezuela, as well as general capacity constraints on the hydrocarbon sector’s infrastructure.

OPEC even estimates that, because of increased demand (reaching 95.8 million barrels per day), falling supply in mature areas such as the North Sea and Mexico, and delays in new projects such as Russia’s Far East, there will be an oil supply “crunch” five years from now, leading to even higher oil prices. The same is forecast for the gas sector.

Buoyed by this dramatic rise in hydrocarbon revenues the MENA region’s real GDP growth stands at 6.3%, up from 4.3% during the first half of the decade, and an even lower 3.6% during the 1990s. In 2006, remittances, flowing from oil- to labor-exporting countries in the region, have reached $19.3 billion for MENA recipient countries, while the tourism sector saw solid growth of 14.5% compared to a 12.6% rate in 2005.

High oil revenues have also spurred FDI, which reached more than $24 billion in 2006, triple the 2004 level. The main recipients are Egypt, Lebanon, Morocco, Tunisia Jordan and the UAE. This intraregional flow of FDI is not stopping any time soon as it finds homes in energy, infrastructure, real estate, and tourism sectors.

Most of the region’s countries have managed to expand their fiscal surplus or, in case of state deficits, significantly reduce debt. In 2006, MENA current account surplus rose to 23% of GDP or $280 billion. This has had positive effects on the labor market, pushing the unemployment rate from 14.3% in 2000 to under 10% in 2006.

The World Bank, in a study released in June 2007, predicts that “prospects for MENA are potentially favorable for the period through 2009.” While an easing oil price might slow down growth among the producing countries, the non-producers are expected to compensate with stronger growth with the region holding steady at over 5%.

Investment data shows that the countries in the region are aggressively pursuing exploration for oil and gas deposits. The Maghreb countries are prospecting new blocks, Egypt is searching on its northern coast and southern border, Jordan — perilously dependent on external supplies — is investigating to exploit oil shale deposits, and even Lebanon has drawn up plans to develop offshore gas reserves.

Much of the surplus wealth is re-invested in the region. By 2010, the GCC countries plan to have spent $700 billion in the MENA oil and gas sector, infrastructure, and real estate projects. Parallel to the oil price hike, the region has also undergone a phase of economic liberalization, partially owing to the demands of globalization and partially owing to the realization even by such nomenklatura states as Syria and Libya that clinging to the old ways would spell certain economic (and with it political) demise.

But wait

Yes indeed, the region is enjoying an economic prosperity last seen in the heydays of the 1970s oil boom. Everywhere one travels, from hyper-rich Dubai to “If-Egypt-is-3rd-World-then-this-must-be-6th” Khartoum, construction sites are buzzing, consumer goods are in demand, and confidence is high. Yet, there are clouds on the horizon. Politics — both global and domestic — could spoil the party and throw spanners into the spinning wheels of the economic boom.

This summer, hints by the advisors to George W. Bush that the U.S. government would like to “solve” the question of Iranian nuclear facilities (read: Iran’s attempts to produce nuclear weapons) before the administration leaves the White House in early 2009, were answered by Iran’s Supreme Leader, Ayatollah Ali Khamenei, with an ominous warning that in the event of a US/Israeli attack, the Islamic Republic would close the Strait of Hormuz, highlighting, yet again, the vulnerability of the Gulf’s main oil and gas export route. The body of water, at its narrowest point barely 34km (21 miles) wide, is the gateway for one-fifth of the world’s oil supply, which in 2006 amounted to 17 million barrel per day (bpd).

This particular threat — coupled, for good measure, with that of retaliatory attacks against US military bases in GCC countries — is certainly the darkest case scenario. Iran will no doubt think long and hard before it decides to jeopardize its good relations with the UAE and Qatar and the oil-hungry economic powerhouses of East Asia. Nevertheless, the chance that Tehran, if it feels cornered, may resort to such an act of despair, or that in the event of a military confrontation, elements within the Iranian army or Revolutionary Guard may take unilateral action, cannot be dismissed as the stakes are too high. In fact no one is taking any chances.

Securing alternatives

Pipelines that bypass the straits already exist while others are on the drawing boards. Because of already existing political upheaval and discord, however a number of already existing pipelines — like the Trans-Arabian Pipeline going from the Saudi Gulf coast through Jordan and Syria to Lebanon’s Mediterranean coast or a number of pipelines running through Iraq — are unusable.

Saudi Arabia’s East-West Pipeline, running from the Abqaiq oil complex on the Gulf across the peninsula to Yanbu on the Red Sea, is currently underutilized, as the shipments via Yanbu add up to five days to the travel time to the Asian customers, but could easily be brought to its full capacity of 5 million bpd.

In the UAE, Abu Dhabi’s state-owned oil investment company has just tendered the engineering and design contract for the Abu Dhabi Crude Oil Pipeline (ADCOP), which will carry 1.5 million bpd — over half of Emirates’ production — to the oil terminal in Fujairah on the UAE’s eastern coast, thereby circumventing the Strait of Hormuz. Another project, at this point only in the pre-planning stage, is the Trans-Gulf Strategic Pipeline (TGSP), which would run along the southern Gulf coast all the way to the Indian Ocean, connecting the “inner” GCC countries Kuwait, KSA and UAE with the “outer” member state Oman, eventually even including Iraq and Yemen and stretching up to 1,500 km. This Strait-of-Hormuz-Bypass is envisioned to carry as much as 5 million bpd.

Eventually, when the two new conduits are constructed in many years to come, those three pipelines could take two-thirds of the oil currently carried by tankers, thus cutting shipping costs, reducing traffic in the narrow straits and busy oil terminals and — by offering a safe route — ensure continuity of oil and gas exports.

But in the meantime all eyes are on the deployment plans of the American aircraft carriers and the training exercises of the Iranian navy.

Heating up

Further west, in the Levant, the external threat is not so much from a direct US intervention — with almost all ground troops busy in Afghanistan and Iraq, the Americans have only capacity for air-strikes and thus the cup of regime change has passed by the Syrian government — but for the time being the frontlines of the Arab-Israeli conflict could easily heat up.

We have already seen what a “heating up” can do in Lebanon, where in the summer of 2006 the economy was brought to its knees within a month and projected growth of 6% was cut down to zero. The Cedar Republic remains in the throes of internal quarrels and external interference.

In a way, Damascus in summer 2007 resembles Beirut 2006 before the Summer War: bullish about its economic future, with drastic upsurge in consumption, real estate developments and other FDI-fuelled projects springing up, yet all linked to the “IF no war breaks out” caveat. Investors, even those who like to take a punt with their diversified portfolios, don’t like war.

However, that might not be Syria’s biggest problem. Following the, albeit slow, economic opening, this infitah policy is not a sure bet. Out of an estimated 20 million people living in Syria today (including up to 1.5 million Iraqis), 1 million are now doing better than under the old socialist economy — but for the other 19 million the situation is remaining stagnant or getting worse in relative as well as absolute terms. Today’s conspicuous consumption — almost unheard of a decade ago — is not only a sign of the country’s economic prosperity but, in a society still officially cherishing social equality and solidarity, also breeds resentment among the have-nots. It remains to be seen if the Syrian government will be able to contain the social tensions in the way Egypt and other socialist-gone-capitalist countries of the region have, or if economic stratification will accomplish what secular and Islamist opposition never could: break the regime.

The other domestic challenge that Syria, together with a whole number of countries in the region, faces is that of rapid demographic growth not matched by a similar rate of job creation. Major oil producers like Saudi Arabia and Libya have the money to absorb job seekers into the state bureaucracies and pay them meaningful wages. Less affluent economies also provide university graduates with public sector employment, but at salaries that force many bureaucrats and teachers to take second jobs to make ends meet. Egypt is a prime, and through its film industry a well-known, example.

However, economic disaffection is brewing in all but the super-rich GCC countries. So far, many of the region’s regimes have benefited from a tight policing of their population and fear of the alternative — as cited in Iraq — has prevented the social upheavals predicted by political pundits at least every six months from breaking out. But the social problems — growing populations and rapid urbanization — will not just go away and can only be addressed by solid economic growth across all social strata.

Dealing with demography

In the Gulf countries, particularly Saudi Arabia, policies of “nationalization of the work force” are seen as a way out of the dependency on foreign labor and expertise and prepare the countries for the time “after the oil” when their economies will have to generate revenues from other sources. The smaller Gulf nations have minute populations relative to their GDP, whereas Saudi Arabia, with a current population of 22 million nationals (plus 5.6 million foreigners) and a 3+% population growth rate is facing a true conundrum. The strong rise in oil revenues has alleviated the pressure for the time being, but contrary to its brothers in the GCC, in terms of demographic challenge it belongs more in the “Egypt, Iran, Syria, Yemen” camp.

Across North Africa, the story is similar: demographic growth unmatched by creation of jobs that pay livable wages breeds discontent within the political system, regardless whether it is monarchist, republican, or whatever. Libya is the 18th-largest oil producer in the world with a small population of just 5.6 million. After it had “come in from the cold” and rapidly developed economic ties with the West — the UK signed a $900 million oil and gas exploration deal — domestic challenges replaced foreign politics as the No. 1 threat to the stability of Qaddafi’s regime with criticism about government policies and social disparities increasingly based on an Islamist worldview.

Indeed, throughout the region, variations on the Islamist theme of politics have become the most pervasive ideology. “New veiling” and the surge of “Islamic finance” alike are markers of this development. This political phenomenon is by no means homogeneous — ranging from the Islamic capitalists of Kayseri (Turkey), whose “If you are successful, God loves you” outlook mirrors the Protestant work ethic, to the anti-business extremists of the Taliban. However, regardless of the specific flavor, it is the followers of political Islam who challenge the status quo across the region and in countries as diverse as Morocco, Egypt, and Saudi Arabia.

It remains to be seen whether the powers that be can successfully accommodate or even integrate these Islamist currents. Turkey is a good example that business-friendly Islamists in power can actually be beneficial to economic prosperity in contrast to overly state-focused secular and military elites, whereas Khomeinist Iran proves that dirigiste Islamist regimes could cause the exact opposite — an ossification of the economic sectors. Of course, then there are the hard-line ideologists who oppose and attack anyone who doesn’t follow their own model. With these, dialogue is impossible and it is they who pose the greatest threat to prosperity, since they do not care about the economic, and thus social, repercussions of their actions, exemplified by the terror attacks against tourists in Egypt and the 2006 summer war in Lebanon. Both — one extremist group and one mainstream parliamentary party — carried out actions that had negative impacts on the local economies of their respective countries.

As all countries in the region, including Gulf states, are enlarging the percentage of tourism revenues within their GDPs, they become more and more reliant on their image as “safe” locations. Whereas the infrastructure can be quickly repaired after war or a terrorist attack, convincing tourists and businessmen that it is again safe to visit is a much harder task. Just look at Lebanon this summer. The place should be full of tourists but they chose to stay away.

Hard to predict

There is no inevitability of disaster. Indeed, warding off those threats doesn’t need magic and the region’s governments and business leaders have all the means at their disposal to shield their countries against outside perils and solve domestic problems.

Prudent allocation of the last years’ high revenues, such as strong debt-reduction and a build-up of financial reserves, give the region’s economies — and their political establishments — good positions to absorb unforeseen shocks and ward off possible threats. Apart from Iraq, Lebanon, and the Palestinian Territories, racked by long periods of political instability and war, most of the countries in the region should be able to weather even a worst-case scenario, on the condition that it is short-lived and followed by an almost immediate recovery.

However, they are not (yet) geared to withstand any major long-term instability.

As long as the current situation prevails — even with Iraq mired in occupation and fratricide, Iran playing with the nuclear option, the Arab-Israeli conflict nowhere near a solution, etc. — the region’s economies will continue to prosper. In fact, countries in the region have a vested interest to maintain a certain “balance of risk” — they profit from a political situation volatile enough to keep the price of oil at the current high but not too unstable to (1) threaten continuity of prosperity and (2) push consumers to look for alternatives to the Gulf’s (and North Africa’s) oil and gas.

The oil producers are keen to keep the price within a band of $50-80 per barrel (pb). If it drops lower, they will face significant financial problems for two reasons. The first is the break-even factor. Qatar, with a break-even price of $47 pb, would be the first to suffer. Oil economies Algeria, Saudi Arabia, UAE and Kuwait have more leeway, since their break-even price is between with $38.80 (KSA) and $22.40 (Kuwait). However, for the countries whose economies are essentially oil-based, any decline in the oil price automatically translates into a significant drop in GDP. Thus, a 10% decline in world oil prices would cut Saudi Arabia’s current account as percentage of GDP by 5.2%, and Qatar’s by 5.1%.

Non-producers, while having to foot larger energy bills, will profit overall from high oil and gas prices, since the vast amounts of petro-dollars that are flowing into their economies in the shape of FDI and remittances outweigh rising energy costs.

Furthermore, cautionary tales like those of Iraq and Lebanon, and incidents of Islamist terror serve the region’s political and economic establishments — often one and the same and in all other cases symbiotically connected — to curb domestic dissent and prevent it from gaining mass appeal. However, the only way to ensure that the current calm, after a decade of trouble in the 1990s, isn’t just a temporary lull before the next storms is if the region’s leaders rapidly create and maintain the frameworks for a self-sustained continuous economic growth. In order to achieve that, they have to significantly decrease reliance on the essentially unpredictable price of natural resources and put less emphasis on the state as the main driver and provider of social prosperity.

It remains to be seen if the balance of risk can be maintained.