Dubai… again…

And now… for the final denouement…

What was glaringly obvious to few of us some years ago, is now slowly being grasped by not many.

Just as it is impossible to permanently shift from a productive economy to an economy that is overwhelmingly service based, it is not possible to build a country starting with a service based economy.

Economies must follow a logical progression that must undeniably start with basic skills and industries. Service based economies are necessarily dependent on credit. Credit is a characteristic of inflation.

By trying to short circuit the natural evolution of the economy, Dubai borrowed heavily in an attempt to start with a service based economy. In the process, wittingly or not, they disregarded the importance and utility of basic industries and skills that contribute intrinsic value in favor of outlandish real estate projects. That’s it.

With a stated desire to become the “Wow destination of the world”, Dubai borrowed heavily to build impressive real estate structures thinking that it would be sufficient to attract companies to set up shop in the Emirate. But Dubai was not aiming to attract just any company. Dubai was aiming high. Dubai along with cats, dogs and sundry in the Middle East-Indian Ocean region, wished to become an IT hub. That’s right. Dubai, like Jordan, Egypt, Turkey, the Seychelles and dozens other countries aimed to become an IT hub for the region… thus going head to head with India for example.

What in the mind of the ruler could have possibly made him think that a country of a few hundred thousand (very few) barely literate, negligibly competent and generally ineffective inhabitants could have allowed him to intellectually challenge India in the IT sphere we will never know.

But Dubai also aimed to become the financial center not only for the region but the entire Asian expanse. They wanted to become the oil trading hub of the world. They wanted to become the stock exchange hub of the world… they wanted to become the center of the arts of the… world… they wanted to become something that has taken London, Tokyo, New York and Singapore many centuries and many decades of endogenous intellectual and physical work to achieve… and they wanted to do Bit in 25 years by skipping the basics. All they needed, he thought, was money.

And if you don’t have money? Why! Then, borrow it.

But beyond being mesmerized by the slow motion implosion of what was clearly a wreck waiting to happen, what is happening in Dubai is important to the extent that we have to find out who is holding the credit default swaps on the debt that has been extended to them. Dubai may only be in debt to the tune of 80Billion Dollars but what matters is the extent of the pyramid of derivatives that has built upon this debt that may well be in the hundreds of billions if not a few trillion Dollars. The pressing question is who are the counter parties to the swaps and how much they are on the hook for. It is a foregone conclusion that the major global banks are involved; but which ones and for how much? This is the type of event that nobody is looking at and that may very well trigger a cascade of defaults.

So far, although Abu Dhabi is playing hard ball, it is likely they will still come to the rescue scooping up Dubai’s assets at a few cents on the Dollar. But what if Abu Dhabi genuinely has no interest in rescuing Dubai?

The following is a note I wrote on Facebook circa September 2008 in response to a press article that put forward the possibility that the Emirate’s economy might implode.

Here is the quick and dirty: how could it not!?

I’ve already written so much about this that I am just quickly going to sum up all the reasons I think the Gulf economies can go supernova. And when they do, it’ll be a doozie.

There are myriad reasons why the Emirates’ economic experiment is a ticking bomb. I suppose that Emirati malls are an appropriate parallel to describe the country: for all the extravagance, UAE malls leak like sieves. That’s right. During a thunder storm, the floors of most malls are dotted with buckets placed under leaks seeping in from every corner of the roof. And that, in a nutshell, is the UAE. The proverbial triumph of style over substance.

For those of you that keep pointing out that “people are making money” in the UAE as an argument for the viability of the state, you have to get it through your skulls that there are fundamental differences between the viability of a state and the success of individual entrepreneurs. Hopefully, you will see why by the time I am done with this note.

For starters. The lines between the ruling family and the state are blurred.

There are no independent civil institutions that have any power to act independently on critical matters. For example, there is an appearance of secular law complete with lawyers and courts of law that functions well enough for every day mundane matters. However, for matters perceived to be important to the state or pertaining to morals or the image of the ruler, the secular courts of law are of no use. Whatever the man says is law. If he says yes it is yes, if he says no it is no, regardless of what laws may be in force in the country. More worryingly, there isn’t a mechanism in place, for example, that would ensure continuity and transition should the main man pass away. It is generally hoped that things transition smoothly but it is not a guarantee.

Then there are the demographics. They are horrible. Emiratis are, what, half a million souls? And here they are embarking on infrastructure projects suitable for a country of 20/30M. Also, on the whole, they are marginally literate and largely idle.

Emiratis pay no or low taxes and their maintenance cost is dis-proportionally high for the state.

In light of state expenditure, they are not giving the nationality to nearly the amount of people they need to in order to ensure a steady and sufficient revenue for the state

It is unclear what sort of state revenue is generated by the economy as the state budget is not available for study and, at any rate, the vast majority of large companies who’s contribution could be of consequence at state level are already owned or part owned by the ruling family.

The UAE’s economy is what I term an “I want” economy more akin to a state planned economy than an economy that grows through the creativity, the needs and requirements of society and its external relations. The latest case in point is Abu Dhabi’s wish to establish a Louvre museum. Now think about that for a moment. Museums are exceptionally costly endeavors and even in the heart of Europe museums can barely generate enough interest to earn sufficient revenue to keep the lights on. Collections, curators, alarm systems, suitable infrastructure, custodians, researchers, publications and overhead expenses come at a fairly high price. How do you think Abu Dhabi can ever hope to generate enough traffic for this institution to be self sustaining is a mystery. But beyond any other consideration, the UAE’s economy lacks diversity, depth, texture and above all, it lacks logic.

Along the same lines, and by their own admission, the Emirates want to build a “wow” destination. This is a great idea in principle but in actuality, if your objective is to be a wow destination you are forever doomed to outdo yourself year in year out. Wow projects are such because they are economically unsound. If they weren’t, then everyone would be embarking on wow projects and they would no longer be such. Therefore, a wow project is inherently uneconomical. If one wow project is uneconomical, more of the same is… is…. well, it’s just horrendously uneconomic. Wow projects are not only costly to build but they are costly to run and maintain. But most importantly, the replacement cost of wow projects is prohibitive because wow projects often make use of gizmos and materials that are one off items specially designed and manufactured for the project. Not exactly the sort of stuff you find readily available off the shelf at the local Homebase. This being the case, wow projects are bound to run into the law of diminishing returns at a speed that is the square to the degree of wow-ness. I admit this is not a scientific statement but you get the drift.

So, putting it all together, it is clear to me that the UAE is an economy that is on life support. In this case, the UAE exists due to an exogenous revenue stream that is not dependent on their own talent, creativity or productivity. For as long as the revenue stream persists and for as long as the credit cycle is on an expansionary cycle, the UAE can sustain the “economy”. The question is whether what they have built can be self sustainable in the event that the exogenous revenue stream should diminish or disappear and/or that the credit cycle and inherent leverage should reverse its upward trend.

Finally, as the theory of Peak Oil gains momentum and as empirical evidence so far buttresses the theory, it is likely that the UAE’s exogenous revenue stream may indeed be waning… of course, once again, scientific studies are lacking and what there is is not for public scrutiny. There is therefore a large degree of conjecture in assessing the state of oil reserves in the UAE as in the entire region especially Saudi Arabia.

Nonetheless, a credit cycle that is on a downward trajectory will, in and of itself, have a significant impact on continued development in the UAE.

The UAE could alleviate the likely bust if, for example, they started expanding their population base by handing out the nationality to large swathes of people in an attempt to both widen the tax base and give depth and diversity to the economy.

All my 2c worth of course…”


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5 Responses to “Dubai… again…”

  1. David W. Lincoln Says:

    The repercussions of Dubai are hardly felt only in the immediate. There is this:

    • guidoamm Says:

      That’s a good article. Thanks.
      I am a bit rushed these days and don’t have much connection time. I had put together a bunch of articles of interest and then lost the whole thing in a freak power outage. Anyway. The New York Times article highlights a number of issues that I have tried to highlight for the past ten years. Notably, the fact that in Dubai it is difficult to differentiate government from the ruling family business as, indeed, the fact that the rule of law is not really guaranteed by independent civic institutions – in the particular case of property law, it is not at all clear or established what the rights and obligations of the state may be and how they may be applied. As a resident in the region, I have been to Dubai on a number of occasions and have shared my feelings with anyone that asked my opinion on investments there. Some significant excerpts from the NY Times article (highlight added)

      A default would also pose a major new test for Dubai’s courts, which have never handled a major bankruptcy of one of the government’s own companies, lawyers and bankers said.

      Unlike its neighbors, Dubai has kept its judiciary system separate from the United Arab Emirates Federal Judiciary Authority. The decisions of the Dubai courts, which are controlled by the emirate’s ruling family, can be fickle, say lawyers in the region.

      For example, in order to bring a court case against a government-owned or government-run entity, a corporation or individual needs to get permission — from the government. In the prospectus for Nakheel bonds, investors are warned that “judicial precedents in Dubai have no binding effect on subsequent decisions,” and that court decisions in Dubai are “generally not recorded.

      Under Dubai law, it added, no debt owed by the ruler or government can be recovered by taking possession of the government’s assets.

      There you have it. Nobody but the government has any rights at all. But the government is also a company. Thus any partnership involving Dubai World or Dubai Ports or any other subsidiary of DW or DP and sundry cannot be forced to do anything under local laws. They are the law.

  2. David W. Lincoln Says:

    Guido, have you come across, “The Lost Crusade: America in Vietnam” by Chester L. Cooper? Towards the beginning of the book, some pages are devoted to what Franklin Delano Roosevelt thought was the best avenue for Vietnam, namely a preparatory regime to show the locals how government is supposed to function, and to do it for a long enough period of time, so that eventually they would be ready to govern themselves.

    This ties in with the view of people like David Lloyd-George, who thought that at the end of the First World War, India wasn’t ready to govern itself.

    What Natan Sharansky wrote, towards the end of “The Case for Democracy”, about an interim Palestinian Authority is along the same lines, but on an accelerated timeline (in my observation).

    So, the UAE, like so much of Asia, Africa & South America are ripe for this approach.

    The thought police enforcers, aka the Politically Correct crowd, won’t like their ox being gored, but their way hasn’t delivered.

  3. David W. Lincoln Says:

    The Emirates giving citizenship to landed immigrants, or people who have been there long enough, if they were in other countries, is as likely as a leopard changing its spots.

    Japan does not grant citizenship to those who have no ancestral ties to Nippon, and the rationale is much the same as to why the Emirates do not
    grant citizenship.

    • guidoamm Says:

      That is correct. However, it is misplaced to compare what Dubai does not intend to do with what Japan is not doing. Although Japanese society displays many of the characteristics of Arab society in that they both hold “family honor” as an overarching priority both are racist and both are fairly closed for example, Japanese society differs hugely in that they are on a permanent quest for intellectual advancement and have a developed sense of aesthetics and desire for improvements in quality and efficiency. Thus Japanese need no exogenous intellectual assistance to conceptualize and realize projects at the economic, social, scientific or cultural level. There is no remotely similar intellectual resonance in Dubai or the UAE for that matter. All they have is money; either borrowed or from oil.

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