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While the social conflict theory (SCT) suggests that absolute monarchies will not tolerate inclusive economic institutions, the Gulf Cooperation Council (GCC) countries have regularly achieved above global average ratings for property rights protection, entry barriers, disruptive wealth redistribution and corruption. This paper discusses the extent to which GCC states have potential to further improve their institutional quality. We explore whether inclusive economic institutions may emerge in GCC states, such as: (1) regional economic integration and competition which alleviate rulers’ capability to expropriate private property and ease entry barriers to the market, (2) rulers of resource rich economies sustain political power with control of natural resources as opposed to the extraction of private property; and (3) prospect of long-term gain for the ruler incentivizes the adoption of a market-based economy. Strong state involvement in manufacturing and the monopoly of some services, the effect of tribalism in economic affairs and the distribution of resources, as well as a sponsorship system for foreign workers in these states may all impede the development of a truly competitive and free economy.

This paper develops a theoretical model to analyze whether a rentier state can diversify its economy away from the rent revenue and hence sustain the economic development and preserve the status-quo. Considering the decarbonization process of the global economy and rapidly fall in economic value of hydrocarbons in the face of the supply glut, rentier states depending on oil and gas revenues urgently need to diversify their economies to avoid social backlash and political upheaval. There are three intertwining factors that determine an effective economic diversification away from the rent revenue: The profitability of non-rentier sectors, the size of the domestic economy to induce a “Big Push” for industrialization to non-rentier sectors, and the level of economic inclusivity. For an optimal level of economic diversification in a rentier state: (1) Non-rentier sectors should be attractive to private agents without the entry barriers; (2) domestic economy should be large enough to induce investment into non-rentier sectors; (3) the ruler(s) should have sufficient tolerance (inclusivity) for private agents investing into non-rentier sectors. Our findings indicate that a rentier state can achieve an optimal level of economic diversification provided that the conditions above are met even without any political change.

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