from Follow the Money

The cranes of Dubai. Are they the answer to Edward Hugh’s question?

February 25, 2007

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I think anyone who visits Dubai right now is bound to be dumbstruck by the sheer scale of the construction.  It, quite honestly, puts anything I saw in China in early 2005 to shame.   To the naked eye Dubai looks to be building more office space than exists in lower Manhattan -- and Wall Street, despite a bit of competition from the City and Hong Kong, still attracts far more IPOs than Dubai’s new international financial centerStephen Roach found the actual data -- and it turns out that Dubai is putting up the equivalent of down downtown Minneapolis in 2007, and downtown San Franscisco in 2008.

Based on industry sources, 26.8 million square feet of office space is expected to come on line in Dubai in 2007, alone -- more than six times the peak rate of completions in Pudong in 1999 and nearly equal to the total stock of 30 million square feet of office space in downtown Minneapolis.  Based on current projections, another 42 million square feet should come on line in Dubai in 2008 -- the equivalent of adding the office space of a downtown San Francisco.  There is one obvious and critically important difference between these two urban development projects: Pudong has an indigenous support base of 1.3 billion Chinese citizens.  Dubai’s current population is 1.3 million.  Throw in the entire native population of the UAE and the support base is still only around 4 million domestic citizens.  That's right, a region with less than 0.5% the population of China is out-building the biggest construction boom in modern Chinese history.

The amount of residential construction is equally staggering.  If you build it, the theory goes, they will come.  The amazing thing: even with so much prospective new supply, rents and property prices are -- last I checked -- still going up.

I consequently fully agree with Stephen Roach's key point: the stereotype of the economically stagnant Gulf is now very, very dated.   Almost as dated as the argument that China doesn’t really have a trade surplus.  The Gulf is not just flush with money – it is now filled with the bustle of loads of new activity.

I don’t buy all the hype coming out of the Gulf though: the arguments about diversification seem a bit overdone.   The Gulf has diversified from pumping oil to pumping oil, refining more of the oil locally and using more of the region's gas to support a petrochemical business.  All that makes a lot of sense, but it is still derivative of the core hydrocarbon business.   And I am not sure that spending oil dollars on construction is real diversification.   If the oil money dries up, so does the construction.

The common argument that the current boom in the Gulf is different than past boomds because it isn't just based on a surge in government spending also strikes me as somewhat over-stated.    Tis no doubt true that less is being spent on classic welfare spending this time around.   But big government sponsored (and in some cases government financed) real estate projects are manna from heaven  for construction contractor.  A cynic might call the current construction boom welfare for the Gulf's business elite, which tends to be found in, guess what, the construction business. The line between spending (building a palace) and investment (building a hotel that doubles as a palace … ) can be a thin.    

Moreover, massively negative real interest rates (Dubai's inflation is around 20%-- per Serhan Cevik of Morgan Stanley -- while nominal interest rates are around 5% due to the dollar peg) encourage lots of private investment.   Some of that may not yield a positive economic return once financial conditions return to normal.  

On the other hand, I am not so sure that diversification is quite as necessary as is often argued.   It kind of depends if oil is going to stay around $60 or fall back to $20.  If oil is around $60, some Gulf states have enough oil and gas relative to their native population that they really don’t need to diversify – not for a long time.   Qatar and Abu Dhabi can live quite well, frankly, by paying others to pump their oil and gas, importing low-wage help from India and Pakistan and, perhaps, learning how to manage more of their own oil wealth rather than outsourcing the management of their money.  The Saudis have a few too many people to live comfortably off their existing oil – their 2006 oil and gas revenue works out to about $40,000 per Saudi family (assuming that the Saudis’ 20 million native born population equates to about 5 million families).  That's good, but not Qatar good.  Qatar's per capita GDP is now estimated at $65,000.  

The real challenge facing a lot of the Gulf states is that oil by its nature tends to generate a lot more revenue than jobs – so employment has to come from distributing and spending the oil rents, not generating the oil.  

That brings up my last point.    The current account surpluses of most oil exporters didn’t rise much in 2006, even though oil prices were substantially higher in 2006 than in 2005.    Why?  Clearly, spending (and investment, especially in real estate) stepped up.    This is a consistent pattern.  Russia’s 2006 surplus was only a bit above its 2005 surplus.  Ditto Saudi Arabia.  Ditto Venezuela.    

We don’t (yet) have data from the UAE (effectively Dubai plus Abu Dhabi) but the sheer scale of the construction suggests that imports are way, way up.   Imported building materials.   Imported food to feed the imported labor force.   Imported luxury goods for Dubai’s own version of Florida’s condo flippers – along with playboy sheiks, Iranian expats and Western bankers.    Dubai itself must be running a current account deficit – as its investment in real estate is huge and its oil revenues small.  That deficit, though, presumably is still easily offset by the surplus of Abu Dhabi, which really has a ton of oil relative to its population as well as plenty of investment income from its huge assets.  But I wouldn't be totally surprised if the current account surplus of the Emirates as whole actually fell in 2006.   

The aggregate current account surplus of the oil exporters clearly went up in 2006 – though I would bet that when the final data comes in, it will have increased by far, far less than initially forecast.    Oil states opened the spending and investment spigots, that pushed inflation up, and rising inflation and fixed nominal interest rates turned real rates negative, encouraging private investment at precisely the moment spending and state investment was rising …   

In q4 – when oil prices turned down – the oil states collectively became a major source of support for global demand.   We don’t yet have the data, but my guess is that sales to Russia and the Gulf are one reason why German, Japanese and Chinese exports have all done well recently (See Edward Hugh for data on Germany and Japan, I have blogged extensively on the recent acceleration in Chinese export growth).   

No one in Dubai seems to drive a US made car. 

The Chinese now make -- as well as use -- a lot of construction cranes.

Moreover, with oil prices heading down (q4 06) or stable (q1 07), the world’s other big spender – the US – maybe wasn’t feeling quite as pinched.     

In 2004 and 2005, the oil states saved most of the incremental increase in their oil revenues.   In 2006, they spent – I would bet – almost all of the increase.   In 2007, they likely will start spending some of what they previously saved.   The combined imports of the emerging oil states should rise from something equal to the revenue of $35 a barrel oil to something equivalent to $40 a barrel oil, if not higher.

So why don’t I see more rebalancing?  Look at the list of countries benefiting from the oil spending and investment boom.  Germany.  Japan.  China.   All already have big current account surpluses.  

Right now, I say the odds are that existing surpluses will get bigger, not that the US deficit will get smaller.  We will see.

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