Economic Growth in Oil-Rich Countries: A Theoretical Analysis with an Application to Saudi Arabia

The Saudi economy is faced with critical challenges due to excessive dependence on oil and the lack of other sources of income. The present thesis seeks to study the influence of these factors on the Saudi economy and examines the potential implications of introducing consumption and personal income taxes on economic growth. This thesis provides a theoretical analysis of economic growth, where the discrete-time of Barro (1990) model is extended in three chapters (Chapters 4, 5, and 6). Chapter 4 aims to describe the Saudi economy before implementing the proposed fiscal policy reforms by the IMF. Since oil revenues solely finance productive government spending, Chapter 4 studies how the Saudi economy is affected by a negative shock in oil demand. Results of this chapter show that the growth rate of government spending is the growth rate of oil profits, g^2. It also shows that although the level of consumption is growing slowly due to negative shock, it is indeed increased relative to the previous trajectory. This suggests that there is some partially offsetting shift in the level of consumption, which may not be obvious. In Chapter 5, the model presented in Chapter 4 is extended by introducing consumption tax to investigate the effectiveness of these taxes on economic growth. Oil revenues and consumption tax revenues in this chapter feed productive government spending. The results show that there are two types of steady-state, the exogenous and endogenous growth steady-state, which cannot exist for the same set of parameter values. This result demonstrates two main findings. The first is that if the g^2 is sufficiently high (low) for a given value of consumption tax, then the steady-state will be an exogenous (endogenous) growth steady-state. The second finding is that if we set g^2 constant and vary consumption tax, the economy at a certain value of consumption tax could move from one type of steady-state to another. In the latter case, the endogenous growth steady-state would be preferable because it would ensure a higher growth rate. Consequently, our results cast a new light on the possibility of switching regime as we change the policy parameter, and how consumption tax can compensate for any reduction in oil revenues. Chapter 6 studies the possibility of introducing personal income tax in the Saudi economy and how its economic growth can be affected by this type of tax. Two different sources of government revenues finance productive government spending: oil and personal income tax revenues. The finding is like chapter 5, in which the two types of steady-state cannot exist for the same set of parameter values. However, the results of this chapter, contrary to the findings of chapter 5, show that two critical values allow the economy to switch from exogenous growth steady-state to endogenous growth steady-state and vice versa. These two critical values depend on the rate of personal income tax. The results also show that the personal income tax would temporarily reduce the growth rate under certain parameter values, which could be considered as a warning to a policymaker. This result indeed contrasts with the result in chapter 5, where the growth rate will unambiguously be temporarily increased by an increase in consumption tax.