Broad-Based Development in The Kingdom of Saudi Arabia: Creating Linkages Between SMEs and Private-Sector Firms in Industry and Services

Dr. Julia Devlin Ph.D.

Introduction :

Over the last hundred years the Kingdom of Saudi Arabia has made remarkable progress in establishing globally competitive resource-based industries, a vast physical and social infrastructure and the modernization of economic activity in agriculture and trade. Today development priorities are shifting towards deepening the base of productive activity, as exemplified by the Sixth Development Plan (1995–2000), which articulates goals of enhanced participation by the private sector, particularly in the development of human resources.

Traditional policy instruments designed to create a base for modern industry effectively maximized key linkages between the public sector, large private-sector firms and foreign companies. Broadening the base of private-sector activity, on the other hand, requires a different set of policy instruments: in particular, national planning to modernize the service sector, which houses substantial amounts of private-sector activity and expertise, as well as mechanisms to strengthen financial and human capital linkages between large and small firms in local development partnerships. This chapter adopts an institutionalist approach to expanding and deepening the base of the Saudi private sector via the promotion of service sector activity in the aggregate and enhancing linkages between large and small private-sector firms at the microeconomic level.¹

In Part I, a brief history of the Saudi private sector is presented, with special emphasis on the evolution of linkages between public and private sectors and with foreign firms complementary to industrial development. This section also addresses the importance of modernizing the service sector, which incorporates significant amounts of private-sector activity and is complementary to industrial development goals. Part II includes a description of small enterprises in Saudi Arabia today and of the benefits of encouraging increasing numbers of SMEs in industry and services. In Part III, policy recommendations designed to foster the business linkages between large private-sector firms and SMEs are presented in the form of suggestions for subcontracting, franchising and the outward processing trade, with suggested models for pilot programmes. Relevant experience from Egypt and Lebanon regarding the promotion of SMEs through business linkages between large and small firms is also discussed.

I. A. The evolution of the Saudi public–private partnership and institutional linkages Unlike Western conceptions of an industrial bourgeoisie, the Saudi formal private sector represents educated, urban groups bound by strong kinship ties who are largely operating in trade and commerce.2 Traditionally dominated by merchants, this sector formed a close relationship with the state during the oil-boom years by providing labour and imported equipment to facilitate the construction of massive infrastructure projects. From its traditional roots in the Hejaz, the Saudi private sector subsequently expanded to include a larger representation of political and business interests from the Nejd during the oil-boom years, as well as forging extensive links with foreign private-sector firms.³

In the 1950s and 1960s, for example, interaction between public and private sectors resembled a partnership based on consultative ties between the state and the traditional Hejazi merchant elite. Local chambers of commerce representing private-sector interests effectively monitored the registration of commercial and contracting firms, as well as the allocation of state subsidies and tariff legislation. The collection and provision of information regarding private-sector activity was a key component of the symbiotic relationship between the Saudi public and private sectors at this time.

By the 1970s, the core of private-sector activity had expanded to include the rise of Nejdi entrepreneurs with strong links to the state bureaucracy. Commensurate with this institutional shift was a domestic development strategy targeting wider segments of the local population, continued efforts to consolidate the national market and long-standing support for a laissez-faire economic philosophy. Public–private sector relations became redefined to incorporate an increasing emphasis on direct sectoral development by the Saudi State through interest-free loans and production subsidies administered by specialized funds in the agriculture, real estate, and other sectors.

Unlike other developing countries, where access to the domestic market is restricted, in Saudi Arabia most private-sector firms have been able to serve as intermediaries between the government and foreign interests, acting as independent contractors and entrepreneurs. Many large private-sector firms effectively supplied knowledge of local market conditions, while others acquired contracts, permits, and labour licences for foreign companies. In effect, the private sector played a critical role in mobilizing domestic resources for national development and expansion of the domestic market.

Industrial growth and development in the Kingdom since 1970 has been virtually unprecedented (see Table 13.1). Average annual growth in GDP from 1970 to 1980 was more than 10 per cent, in contrast with countries with roughly similar levels of per capita income and population, such as Chile, where GDP growth averaged less than 2 per cent for the same period. Labour-force growth in the Kingdom was also higher than average in relation to countries in Latin America and Asia, reflecting dramatic improvements in social infrastructure, economic activity and overall standards of living.

Table 13.1. Regional Development Perspectives

Country	GNP per capita US$ (1997)	Population in Millions	Avg. Annual GDP growth 1970–80	Avg. Annual Growth in Industry 1970–80	Avg. Annual Growth in Services 1970–80	Labour Force Growth 1970–80
Chile	5,020	15	1.8%	0.2%	2.8%	2.4%
Korea	10,550	46	9.6%	15.2%	9.6%	2.6%
S. Arabia	6,790	20	10.1%	10.2%	10.3%	5.5%
Venezuela	3,450	23	3.5%	0.5%	6.3%	4.8%

Source: World Bank.

In summary, the nature of the public–private and foreign enterprise relationship in Saudi Arabia in the post-oil period has evolved in conjunction with the Kingdom’s vast development needs. During the course of modern development, the Saudi State formed important linkages with local private-sector interests on the basis of information exchange and access to local networks of labour and capital, largely operating in the service sector. Joint ventures with foreign firms served primarily as a means towards the human capital and technology transfer required by the massive industrialization effort. Today, the demands of a modernizing economy require greater emphasis on promoting the service sector, which hosts significant private-sector activity, is complementary to industrial development objectives and has the potential to accommodate rapid labour-force growth within the Kingdom.

I. B. The need to modernize services

It is imperative that national planning in the Kingdom begin formally to incorporate development of a modern service sector. According to development economists, the service sector is widely acknowledged as maintaining well-defined complementarities and linkages with the general level of economic activity and development.⁴ It has the potential to create additional and higher-grade jobs, and to contribute to the enhanced efficiency, productivity and international competitiveness of the manufacturing and primary goods sectors, as well as to generate additional sources of foreign-exchange earnings and promote the health, education and social welfare of the general population.

Recent studies of service-sector activity in the industrial countries demonstrate significant employment potential. From 1985 to 1992, for example, business services as a group contributed virtually one in five of net additional jobs in the European Union, and for the longer period from 1960 to 1993, the average share of services in total employment increased from 42 per cent to 65 per cent for all industrial countries. In addition, the development of business services such as legal and accounting activities, consultancy and related professional activities is frequently correlated with an increasing complexity and sophistication of product lines through targeted marketing, shorter life cycles of products, widening of product lines and product differentiation. Service inputs represent roughly one- half of the sales price of manufactured goods in most industrialized countries. Increasing the component of services in goods assembly also translates into higher efficiency and productivity, particularly in the area of information technology.⁵

In Saudi Arabia today, services constitute the second most important source of economic activity behind industry (including oil), contributing roughly 18 per cent of GDP, although these figures also tend to reflect the importance of public administration and services. Private-sector activity in services has been relatively concentrated in trade, tourism and some financial services; but there is clearly demand for a broader array of service industries. On a global scale, Saudi Arabia’s service imports are roughly US$ 22 billion relative to US$ 3.5 billion exports in 1996, and the country ranks 17th in the world as a service-sector importer. Service imports are concentrated in communications, computer information services (89 per cent of total service imports in 1996) and transport services (9.5 per cent of total service imports in 1996).⁶

Enlargement of the service sector, particularly in the area of business services, would contribute to a more diversified productive base and broaden the economic participation of the private sector, as well as providing additional jobs and improving the competitiveness of the industrial sector. Saudi private-sector firms have long-standing expertise in service-sector activities through their knowledge of local market conditions. This clearly enhances the prospects of developing local service industries and the potential for co-operation with foreign service suppliers in adapting service products to the local markets, particularly in the area of business services.

At the macroeconomic level, broadening the base of the private sector requires a national policy applied to the service sector, complementary with policies and regulations concerning industrialization, investment, technology transfer, and licensing requirements, as well as national policies concerned with human capital development, transport and communications and telecommunications systems. The streamlining of regulatory frameworks to enforce business laws and contracts is needed, as well as more rapid progress on privatization, the harmonization of tax codes to avoid confusion, lack of understanding and inconsistencies within the tax system, and the gradual elimination of government pricing and government control of critical inputs. From the vantage point of foreign investment, local content requirements according to which multinational and regional firms purchase set quotas from the local markets should be reconsidered, since they tend to raise overall costs, by forcing companies to rely exclusively on local inputs, which can be more costly, resulting in the need for reimbursement by the government through tax holidays. Financial constraints could be eliminated by allowing increased participation by foreign and regional investors, and by the development of venture capital funds. Protection of intellectual property rights, the streamlining of labour legislation and a form of training of nationals that incorporates computer and customer service training are all needed to encourage the private sector to expand activities in domestic services. At the level of the microeconomy, local service activities can be encouraged through fostering business linkages between large and small firms built up through forging local development partnerships based on subcontracting, franchising and outward processing trade.

II. A. SMEs in the Kingdom of Saudi Arabia

Development planners in the Kingdom are clearly carving out a larger role for the private sector in the context of macroeconomic and structural reform initiatives such as fiscal retrenchment and financial and labour-market liberalization. With private-sector growth averaging roughly 7.1 per cent per year since 1967, and the sector’s contribution to GDP increasing from 11.8 per cent of GDP in 1974–5 to 45.3 per cent in 1993–4, the potential role of the private sector as an important engine of growth in the next century is promising.⁷ A microeconomic approach to broadening the base of private-sector activity consists of promoting business linkages between large and small private-sector firms to foster the growth of SMEs, which are relatively labour-intensive and encourage innovation and entrepreneurship In Saudi Arabia today, small and medium enterprises are playing an increasing role in generating productive output in industry and services as well as employment. According to local surveys, over 90 per cent of business establishments in Saudi Arabia have less than 20 employees, indicating a substantial number of small and medium-sized firms. Small firms in Saudi Arabia contribute significantly to social services and industrial development, representing more than 60 per cent of the total number of firms in sectors such as clothing, textiles and leather goods, wood products construction, glass, machinery and mineral products (see Table 13.2).

Table 13.2. A Sample of Small Firms in the Kingdom of Saudi Arabia, 1992

Sector	Total Number Small Firms	Small Firms in Sector As % Total Firms in Sector	Small Firms In Sector As % Total Small Firms
Food, Beverages	160	50.2	13.6
Clothing, Textiles, etc.	43	61.4	3.7
Wood Products	57