The Elusive Costs And Benefits Of Saudization

Saudi Arabia plans to spend $4bn per year on efforts to increase the proportion of Saudi nationals in the country’s workforce. Riyadh faces many challenges in its attempts to implement this ‘Saudization’ policy.

By Ali Aissaoui*

In early August, the Saudi Ministry of Labor (MoL) released its statistical report for 20131. More than just a collection of statistics, this 145-page document analyzes the progress made in implementing Saudization – the nationalization of the workforce. However, what grabbed the media headlines was the report’s indication that the government will have to spend nearly $4bn annually to implement its employment strategy. The strategy, which is the tool path for reforming the labor market and preparing the Saudi workforce for the competitive global economy, identifies three long-term objectives: achieving full employment; supporting a sustainable development of the national human resources; and promoting Saudi labor productivity.

As tentatively shown in this commentary, this $4bn price-tag actually comes on top of a multitude of largely hidden costs, while the benefits beyond those accruing to the targeted beneficiaries remain mostly intangible.

This commentary is in three parts. The first and second parts draw on the MoL Report to outline the current structure of the Saudi labor market, employment quota policies, and achievements so far. The third part looks beyond the report to try and gain a better understanding of the costs and benefits involved.

SAUDI LABOR MARKET STRUCTURE

We begin this discussion by outlining some data issues related to population and employment. The latest statistical releases by the Saudi Central Department of Statistics and Information (CDSI, August 2014) puts Saudi Arabia’s total residents at 30 million at the end of 2013, 20.3 million of whom are Saudi citizens. These numbers indicate an expat community of 9.7 million, a figure far below that which could be inferred from MoL data on non-Saudi workers. This inconsistency, which is explained in footnote 2, can confuse Saudi socio-economic policy-making2. However, it does not invalidate our analysis.

The population of Saudi citizens aged 15 and older reached 13.2 million at the end of 2013; 65.2% of the CDSI-estimated Saudi population. Of these, 4.7 million are employed, 0.6 million registered as unemployed (and seeking work) and 7.9 million are outside of the labor force altogether. The employment rate (employment-to 15-plus population ratio) and unemployment rate (proportion of the labor force that is unemployed and seeking a job) are 35.7% and 11.7% respectively.

Of the 7.9 million outside the labor market, 0.8 million are seniors (older than 65 years) and 2.7 million are in education. This still leaves 4.4 million working age Saudi citizens whom are neither in work, seeking work, nor in education; in other words they are not playing a productive part in the employment market. The resulting “relaxed” unemployment rate of 94.3%, which is gender-skewed, gives a better idea of the huge labor potential and future challenges. Meanwhile, policymakers have to contend with a legacy of heavy reliance on a predominantly low-skilled imported labor force. Currently, expatriate workers represent 68% of total employment, a proportion below the GCC average of 78% and far below those of Qatar and the UAE, each hovering around 90%. However, in absolute terms the expat workforce is the largest in Saudi Arabia, totaling 10.2 million. Of this, 8.1 million are employed in the private corporate sector, 1.8 million in the private household sector, and 0.3 million in the public sector (government and quasi-government). In contrast, nearly two-thirds of the 4.7 million Saudi workers are employed in the public sector.

THE SAUDI LABOUR MARKET

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LABOR MARKET POLICIES, NITAQAT

To shift the burden of employment to the private corporate sector, where expat workers represent 85% of the workforce, a mandatory quota program was deemed necessary. As a matter of fact, Saudi Arabia has been experiencing with quota-based labor policies for decades. However, except in the petroleum and banking joint-ventures, which were keen to promote local employment as part of their corporate social responsibilities, the results proved disappointing.

In recent years, the sudden deterioration of the region’s social and political fabric has increased pressure on the government to devise a more potent employment strategy. A broader and more rigorous quota program came into effect in late 2011. Nitaqat (bands), as it is labeled, requires private companies to meet strict Saudization ratios, differentiated by the size and sector of the enterprise. Companies are color-coded according to their degree of compliance. With the exception of a white band encompassing companies with less than 10 employees (who are required to employ at least one Saudi worker), the bands range from red (non-compliant) to platinum. Incentives or disincentives hinge on the process of obtaining work permits. Companies in the red band, for instance, find it extremely difficult to stay in business due to the enforcement of the new rules regulating the issuance and renewal of expat work visas.

Nitaqat dovetails with several other initiatives to promote employment opportunities for Saudi citizens. They have been supported by the Human Resources Development Fund, a long-standing institution tasked with job placement, training schemes and the offsetting of the cost of new hires. Tangible benefits have mostly accrued to the targeted beneficiaries. Current evidence suggests that under Nitaqat a little more than 0.7 million Saudi citizens have been added to private corporate employment during 2012 and 2013, bringing the Saudization ratio to 15.2%. As a result, the men’s unemployment rate fell from 7.4% to 6.1% and, because starting from a low base, that of women fell more impressively from 35.7% to 33.2%. Accordingly, the combined rate of unemployment decreased from 12.1% to 11.7%.

Nitaqat provides for a minimum wage of SR3,000 ($800) per month. However, implementation has been postponed until its economic impact assessment is completed. But the salary-linked formula for determining companies’ Saudization ratios makes it a de facto minimum wage. Indeed, as a further Saudization incentive, only Saudi workers receiving a salary of more than SR3,000 are fully counted. Those receiving less than SR1,500 ($400) do not qualify. In between they count for a fraction, which varies linearly between zero and one, depending on their wage levels3.

Not unexpectedly, employment of Saudi nationals has increased in all but the low-pay segments of the labor market. The large wage gap in low-skilled occupations makes many job positions hard to fill by would-be Saudi workers. This is symptomatic of a more general pattern highlighted by Steffen Hertog, a political scientist at the London School of Economics, who observes a nonlinear positive correlation between Saudization ratios and wage ratios. The wider the wage gap, the lower is the Saudization ratio, and vice versa4. Clearly, generous public sector employment terms, low-wage competition and low-mobility of expat workers across sectors (sponsorship rules have yet to be fully relaxed) have combined to greatly constrain Saudi employment in the private corporate sector.

To close the wage gap, it was initially envisaged that a differential expat levy on private companies would equalize the cost of hiring an expat worker with that of hiring a Saudi worker. The levy has been set uniformly at SR200 ($53)/month for each expat worker in excess of parity staffing. Based on 2013 employment statistics, we have estimated the amount to be collected at some $4.2bn annually. This is more than sufficient to cover the announced cost of implementing government employment strategy. Otherwise, apart from this levy, the MoL Report hardly throws any light upon the full cost burden to the private sector.

As a matter of fact, despite the far-reaching economic impact of Nitaqat, very few researchers have addressed its costs and benefits. Those to have done so include KFUPM public finance economist Mohamed Ramady who explored with some evidence the potential impact of the minimum wage on growth and productivity5. A more empirical perspective was provided by Jennifer Peck, an economist at the Massachusetts Institute of Technology in Boston, who applied a regression kink approach to estimate the causal effect of the program. Using a large dataset provided by MoL, she confirmed that the program had succeeded in increasing Saudi employment, but noted that it comes “at significant costs to firm growth and survival.”6 In reducing the growth of the expat workforce and decreasing overall private employment, Nitaqat has caused many companies to fold. The construction and manufacturing sectors, which are key drivers of non-oil growth and diversification, have borne the highest costs. To our knowledge, however, none of the published studies have investigated the opportunity costs stemming from the restructuring of a workforce whose productivity is expected to deteriorate before potentially improving.

It is probably to avoid the latter costs that some private companies have resorted to dubious employment practices such as paying new Saudi recruits the minimum wage to stay at home. For MoL the cost of dealing with such unscrupulous corporate behavior is certainly not trivial even if it only accounts for a tiny portion of the cost of implementing government strategy. Much more significant is the cost of investing further in human capital to reduce gender imbalance in the workplace, enhance productivity (both skill-based and work ethic-based) of the workforce and sustain the efficiency of labor policies and institutions. Due to the dynamic nature of Nitaqat, many factors make all such costs as well as the benefits of Saudization elusive. Perhaps even more so when considering developing new employment policies that fit with the government’s proclaimed aspiration to develop a knowledge-based society and economy.

CONCLUSIONS

Regional turmoil has put great pressure on governments to implement effective strategies to cope with fast-growing unemployment. Saudi Arabia has proceeded resolutely with the most widescale labor market reform to address low Saudi participation in the private sector. Nitaqat, the quota program which embodies current policies has been instrumental in significantly increasing employment. However, the effects of the program go far beyond its immediate benefits in terms of job openings and hiring.

The cost burden to companies has yet to be fully acknowledged, while critical reviews have to ask whether the benefits of Saudization, as an enabler for inclusive and sustainable socio-economic development, will outweigh its wider costs to productivity and growth.

*Ali Aissaoui is Senior Consultant at the Arab Petroleum Investments Corporation (APICORP). The original and full version of this paper has been published in APICORP’s Economic Commentary dated September 20147. The opinions expressed are the author’s own. Comments and feedback may be sent to: [email protected]

1. Saudi Ministry of Labor, Annual Statistical Report 2013 (Arabic, 2014)

2. CDSI 2013 statistics put non-Saudi residents (expat workers and their families) at 9.7 million, while MoL’s put Expat workers at 10.2 million. Discounting family members from the latter would result in a total resident population of 30.5 million, which is not a big variation from CDSI’s 30.0 million. However, if we assume that 15% of the Expat workers (our estimate of the professional staff from MoL statistics) are allowed to bring in their families and that the average household size is four, the resulting 4.5 million people unaccounted for would raise Saudi Arabia’s total resident population to some 35 million; a significant statistical discrepancy!

3. The exact ratio formula is determining by: r = [(wage – 1,500)/3,000) + 0.5] if 1,500 ≤ wage < 3,000; r = 0 if wage < 1,500; and r = 1 if wage ≥ 3,000.

4. Hertog, Steffen (2014) Arab Gulf States: An Assessment of Nationalization Policies, Research Paper No. 1/2014, GLMM, http://gulfmigration.eu

5. Ramady, Mohamed (2013), “Gulf unemployment and government policies: prospects for the Saudi labour quota or Nitaqat system”, International Journal of Economics and Business Research, Vol. 5, No.4, pp. 476 – 498.

6. Peck, Jennifer R. (2014), “Can Hiring Quotas Work? The Effect of the Nitaqat Program on the Saudi Private Sector”, MIT, Working Paper, April.

7.http://www.apicorp-arabia.com/Research/Commentaries/2014/Commentary_V09_N09_2014.pdf