Draft 09 The Secret of Dubai's Long-Run Economic Success Counter Intuition

Tuesday, August 04, 2009 DRAFT 09
The Secret of Dubai’s

Long-Run Economic Success:
COUNTERINTUITION
Ohan S. Balian, Ph.D.
Dubai
June 2009
To my mother
2
Acknowledgments
3
Preface
4
Table of Contents
Acknowledgments...................................................................................3
Preface.....................................................................................................4
Introduction.............................................................................................6
Counterintuition and Super-Competitiveness.......................................16
Dutch Disease...................................................................................16
Super-Competitiveness and Productivity..........................................21
Capital Inflows and Investment............................................................33
Real Estate.........................................................................................33
Tourism.............................................................................................43
Finance..............................................................................................53
Economic Policy vs. Commercial Policy .............................................58
Economic Policy Effectiveness.........................................................58
Commercial Policy and Market Structure.........................................66
Governance and First-Best Solutions....................................................72
Governance Indicators......................................................................72
The ‘Luxury’ of Choosing First-Best Solutions................................79
Dubai Strategic Plan (2015) and Sustainability....................................83
Building-Blocks of DSP (2015) .......................................................83
The Rising Cost-of-Living................................................................89
Some Labor Issues ...........................................................................94
Bibliography..........................................................................................98
5
Introduction
A ski resort in the desert, a ‘palm tree’ on the sea, a hotel under
the sea, the tallest building in the world, and the list goes on and on, all
examples of counterintuition defined as intuition that is counter to
common expectations. When Stephen Hawking, a world renowned
physicist disabled by a crippling disease was asked why he was so fam-
ous even in the eyes of the general public, he replied: “People simply
did not expect to see me on a wheelchair”. But to achieve these coun-
terintuitive outcomes, one has to be super-competitive because these
achievements must be beyond expectations.
This book reveals the secret of Dubai’s remarkable economic
success by showing that its governance structure, institutional setting,
market structure, and economic policies have all been highly supportive
of powerful market forces, beyond the control of any government,
which have channeled investments into the most profitable sectors. Al-
though the emirate of Dubai, one of the seven emirates of the United
Arab Emirates (UAE), does not contain much oil, it has experienced
large inflows of capital. The book is written in simple non-technical
language and is not an exposition of the latest theories and practices in
public policy making. It also does not contain extensive descriptive
data on the performance of the Dubai economy which can be easily
found in hundreds of newspaper articles and from the recently launched
portal of the Dubai Statistics Center (www.dsc.gov.ae). The book
simply places what Dubai has achieved so far in the ‘right’ perspective
in the sense that all of its actions and policies are based on fundamental
6
economic principles. It also argues that counterintuitive ideas, in both

industry and government, are key to the economic success of Dubai
with scarce natural resources and a small native population. Although
there is a huge literature on the competitive advantage of nations in the
form of resource abundance, low labor costs, and good governance,
very little has been said on the ability of nations to create this competit-
ive advantage; what is termed as super-competitiveness in the form of
achieving improvements in the many factors that affect overall eco-
nomic performance.
The secret of Dubai’s economic success has been the govern-
ment’s ability to recognize and identify the flow of resources into spe-
cific sectors and devise original and innovative policies to take maxim-
um advantage of these flows. Perhaps one of the best examples of a
counterintuitive outcome is the so-called Dutch Disease. When Nether-
lands in the early 1970’s discovered natural gas, the common expecta-
tion was that the resulting export earnings would lead to rapid econom-
ic growth. But contrary to this expectation, Netherlands experienced
high rates of unemployment and inflation. The explanation of this
counterintuitive outcome was that large inflows of capital, which are
unrelated to the productive capacity of the economy, caused an increase
in wages. As wages (a cost) began to increase, producers increased their
prices (a revenue) to maintain their pre-existing levels of profit. Produ-
cers in the non-tradable sector (services such as banking, tourism, and
real estate) were able to increase prices but they could not do so in the
tradable sector (mainly manufacturing) because prices of manufactured
goods are determined in international markets. Since profits in the non-
7
tradable service sector were greater than profits in the tradable manu-
facturing sector, resources (both labor and capital) began moving from
the tradable manufacturing sector to the non-tradable service sector.
This process of Dutch Disease, also known as de-industrialization,
caused unemployment - because labor was moving out of the manufac-
turing sector and it takes time to train these workers to work in the non-
tradable service sector - and inflation - because the prices of non-trad-
able services increased.
A similar process has been happening in Dubai with one major
difference – no unemployment. As capital inflows in Dubai have in-
creased, the returns on resources (labor and capital) have increased in
the non-tradable service sector which is evidenced by the booming real
estate and tourism sectors. There has been no surge in unemployment
because Dubai has started from a relatively low manufacturing base
and all the labor and capital that has moved into the non-tradable ser-
vice sector is new and did not come from the tradable manufacturing
sector. This phenomenon is reflected in higher prices in the real estate
sector, and many other non-tradable services, as evidenced by the rising
cost-of-living in Dubai. The secret of Dubai’s economic success is its
ability to reinforce the flow of resources into the non-tradable service
sector such as real estate, tourism, and financial services. Most Dubai
government policies, initiatives, and investments can be traced to the
higher returns in these non-tradable service sectors, the biggest sector
being the real estate sector.
But just as capital inflows have increased the profitability of
non-tradable sectors such as real estate and banking, the current global
8
financial crisis has considerably reduced capital inflows into Dubai, in

turn lowering the profitability of these sectors as reflected in falling
property and stock prices. The more interesting question is where has
all the money gone? The answer is that it is ‘trapped’ in banks because
of their unwillingness to lend at current low rates of interest; and,
‘trapped’ with the public because of their unwillingness to invest since
they expect property and stock prices to fall further. This situation,
known as a ‘liquidity trap’, has severe policy implications since the rate
of interest is so low that no one is willing to lend and everyone is hold-
ing money in idle balances earning very low interest. In such a situ-
ation, even if the government injects liquidity into the financial system,
banks are not willing to lend because of very low interest rates. In other
words, the traditional policy prescription of using an expansionary
monetary policy to increase the availability of loanable funds does not
work in a ‘liquidity trap’ situation. A more effective solution to escape
this trap is for the government to bypass banks and, among other ac-
tions, lend directly to the public. This direct policy intervention is cur-
rently being adopted by the US government. For this reason, the recent
liquidity injection of about $30 billion by the UAE Central Bank may
not immediately ease the credit shortage faced by consumers if banks
are not somehow ‘forced’ to lend at low interest rates, and if the gov-
ernment does not find alternative channels of lending directly to con-
sumers. The ultimate cost of a ‘liquidity trap’ is that weak banks will
fail unless they merge with stronger banks because weak banks will not
be able to make profits at low interest rates.
9
To be counterintuitive, one has to be highly competitive and

productive. ‘Normal’ competitiveness will enable one to achieve nor-
mal outcomes. To achieve outcomes counter to common expectations,
one has to be super-competitive which is defined as being productive in
the ‘other’ factors that affect economic growth. To better understand
this definition, when economic commentators speak of productivity
they do not specify the productivity of which input. Usually, productiv-
ity implies labor productivity – or output per-man hour – and higher
labor productivity generates higher rates of growth. But there are many
‘other’ factors which affect economic growth such as physical capital
(machinery and equipment), human capital (education), knowledge
transfer (especially the embedded technology in imported goods), insti-
tutions, and much more. A more accurate description of the productiv-
ity of an economy would be total factor productivity which takes into
account the ‘mix’, with labor, of all these ‘other’ factors which affect
economic growth. In other words, how much a worker produces de-
pends on how much capital he or she has, on his level of education, on
his health, on the available technology, on institutions, on governance,
and on much more – what Robert Solow appropriately called a meas-
ure of our ignorance. Super-competitiveness, in addition to the normal
competitive factors, takes into account these ‘other’ factors to improve
our measure of ignorance. The secret of Dubai’s economic success, to a
large extent, is explained by the strengthening of these ‘other’ factors
through strong leadership, improved governance, knowledge transfer,
and much more, and in the achievement of successful, yet counterintu-
itive outcomes.
10
Economic success also depends on the effectiveness of econom-

ic policies. However, in most emerging economies, there is some mis-
understanding of economic policy as developed countries know it.
When economists talk about economic policy, they usually mean fiscal,
monetary, trade, and labor policies at the country level which are con-
ducted through changes in taxes, the money supply, import tariffs, and
the like. In most emerging economies, economic policy is regarded
more as ‘commercial’ policy which can be conducted through rules and
regulations. This interpretation of economic policy is especially blurred
in the United Arab Emirates primarily because each emirate can formu-
late its own rules and regulations at the emirate level. Economic policy
deals with macroeconomic issues such as unemployment, inflation,
budget and trade deficits, and is not directly concerned with influencing
market structures. The indirect effects on industry are more of a by-
product of these policies. Commercial policy, on the other hand, affects
market structure directly through rules and regulations on free zones,
establishment of enterprises, and competitive practices which are nor-
mally enacted by local specialized government agencies. One of
Dubai’s biggest successes has been the recognition of this difference
between economic policy and commercial policy in the design of
policies to attract foreign investment and increase domestic competi-
tion.
The secret of Dubai’s economic success is its ability to achieve
a more accurate measure of our ignorance through the use of indicators
for improvements in government performance – the ‘other’ super-com-
petitive factors which affect overall economic performance. As Albert
11
Einstein famously noted, “Not everything that can be counted counts,

and not everything that counts can be counted”, Dubai has been highly
successful in choosing indicators that measure government perform-
ance more accurately. These indicators have sometimes been adopted
by looking at best practices in other countries, especially in the emer-
ging economies of Asia, and have been modified to capture the specific
characteristics of local government agencies. Dubai has also been suc-
cessful in avoiding the ‘moral hazard’ problem - a situation in which
firms and institutions perceive that the government will bail them out if
they fail or under-perform - by rewarding successful enterprises and de-
moting unsuccessful ones through its various excellence programs.
Dubai has also been able to achieve remarkable economic suc-
cess because of its governance structure which has enabled the choice
of first-best or optimum solutions to pressing problems. In most de-
veloped countries, policy decisions and the enactment of laws and regu-
lations require considerable time and debate prior to implementation.
Although these policies are usually based on intuitive research and
policy debates, the relationship between policy research and policy
making in the real world is very weak. Several studies have shown that
the relationship between policy analysis and policy making is not very
strong because of the influence of special interest groups, and because
of differences in the objectives of policy researchers and policy makers.
These differences have been very often responsible for choosing
second-best solutions to urgent economic problems in developed coun-
tries. This is another example of a counterintuitive outcome in the sense
that although common sense tells us to base our decisions on ‘scientif-
12
ic’ research for optimum outcomes, there are so many complexities in

the real world that we cannot measure policy variables accurately, espe-
cially those ‘other’ factors of a productive economy which explain a
sizable portion of overall economic productivity. For this reason, ini-
tially counterintuitive policies may yield first-best optimum outcomes.
To sustain this rapid economic growth, the Dubai government in
2005 began to formulate a 10 year strategic plan known as the Dubai
Strategic Plan DSP(2015). Although the DSP(2015) covered economic,
social, infrastructure, and security issues, the economic development
component was based on 6 building blocks to generate an annual aver-
age rate of growth of 11% with the help of 880,000 additional workers
over this 10 year period. DSP(2015) contains hundreds of action plans
and initiatives which are currently being implemented by the govern-
ment. Unlike standard 5 or 10 year development plans formulated by
many developing countries, the DSP(2015) is a ‘live’ document taking
into account changing regional and global economic conditions. The
DSP(2015) also makes sure that its recommendations and many initiat-
ives are based on fundamental economic principles tested in developed
economies, and has been modified to take into account the specificities
of the Dubai economy such as market structure, immigration, labor is-
sues, and the expected rise in the cost-of-living.
The rising cost-of-living in Dubai is an expected outcome be-
cause it is caused by the high rate of government spending (as it builds
the infrastructure of a rapidly growing economy), and a high rate of
capital inflows (as it attracts foreign direct investment). The increase in
the general level of prices is also fuelled by the increase in the prices of
13
non-tradable services as the demand for such services has increased due
to Dutch Disease effects noted earlier. The rising cost-of-living is also
due to the fixed-exchange rate regime with the US currency which has
fallen considerably in recent years causing an increase in the relative
price of Dubai imports, especially imports from euro zone countries.
This has been reflected in the high price of intermediate inputs such as
cement and steel which are heavily used in the real estate sector. But
the recent increase in the value of the US dollar has somewhat reduced
inflationary pressures, and the slowdown in capital inflows caused by
the global financial crisis has also lowered prices of non-tradables as
evidenced by the decline in property and stock prices. However, regard-
less of the underlying causes of inflation in Dubai, the government has
not been able to adopt ‘standard’ economic policy tools, such as in-
creasing the rate of interest or decreasing the money supply, because its
fixed exchange rate regime with the US dollar has tied the movement
of its domestic interest rate with movements in the US rate. Moreover,
even if Dubai desires to control its rate of inflation through contraction-
ary monetary policies, it has few degrees of freedom because the
money supply is controlled by the UAE Central Bank at the federal
level. Alternatively, the Dubai government has adopted counterintuitive
policies in controlling inflation using various price and rent controls.
The rising cost-of-living has also eroded the purchasing power
of unskilled workers. Although it is becoming increasingly more diffi-
cult to retain skilled workers due to the rising cost-of-living in Dubai,
nominal wages of skilled workers have actually increased due to Dutch
Disease effects. There is no doubt that wages of unskilled workers have
14
eroded in recent years but that is primarily due to the fall in the US dol-
lar. This erosion of purchasing power has been somewhat rectified due
to the recent appreciation of the US dollar. Moreover, both the Dubai
local government and the UAE federal government have achieved con-
siderable progress in improving labor conditions of unskilled workers,
much more than the improvements achieved by the governments of
their home countries. This book illustrates the many examples in which
Dubai has adopted counterintuitive policies to generate rapid rates of
growth. But the adoption of counterintuitive policies requires super-
competitiveness to identify and measure the ‘other’ factors that affect
overall productivity such as leadership, innovation, technological
change, and institutional performance. The secret of Dubai’s economic
success has been its ability to identify, in Einstein’s words, ‘what
counts’, and formulate appropriate policies, very often counterintuitive,
to achieve first-best optimum outcomes.
15
Counterintuition and Super-Competitiveness

Dutch Disease
Perhaps the best example of a counterintuitive outcome is the
so-called Dutch Disease or de-industrialization caused by a large in-
flow of capital which is unrelated to the domestic productive capacity
of the economy. Although the original model by Corden and Neary
(1982) looks at the effects of a natural resource discovery (natural gas),
they were well aware that the same effects could be generated by large
capital inflows caused by Foreign Direct Investment (FDI), remit-
tances, foreign aid, or the discovery of precious metals such as gold.
Corden and Neary group the goods and services produced by an eco-
nomy into three groups: natural resources (oil), tradable goods (manu-
facturing), and non-tradable goods (services)1. By definition, tradable
goods are subject to international competition; hence, their prices are
determined by international demand and supply, and it is assumed that
the country is small enough so as not to be able to influence these
prices. Services, since they are non-tradable, are not subject to interna-
tional competition and therefore their prices are determined by domest-
ic demand and supply2.
1
The building & construction sector is also regarded as a non-tradable sector because
you cannot physically ‘import’ or ‘export’ a building. Perhaps the earliest example of
this awareness was when foreigners in the early 70’s were purchasing buildings in the
UAE and residents became very worried and complained to His Highness Sheikh Za-
yed Al Nahyan, the late President and founding father of the UAE. His wise reply was
that as long as they were not tying ropes around buildings and pulling them to their
home countries, he was not really worried.
2
Tradable sectors are defined as sectors that produce goods for both domestic con-
sumption and exports (imports). Non-tradables are sectors that produce goods and
16
The Dutch Disease model distinguishes between a resource

movement effect and a spending effect. A rise in the price of oil in-
creases the demand for labor and capital in the oil sector which leads to
higher wages and a higher return on capital in that sector. If factors are
mobile and can move between different sectors, then this will induce
labor and capital to move from the manufacturing and services sectors,
to the oil sector. Output and employment in the oil sector will thus in-
crease while output and employment in manufacturing and services will
decline. While the price of manufactured goods does not change (be-
cause it is determined internationally), the decline in services output
leads to excess demand for services and therefore to an increase in the
price of services3. Resources (both labor and capital) would move into
the production of services to meet the excess demand. This is known as
the resource movement effect. The spending effect occurs when some
fraction of the increase in income generated by the booming oil sector
is spent on both the tradable and non-tradable sectors. This higher in-
come would push-up the price of non-tradables. But since prices of
tradables are fixed (since they are determined in international markets),
then an excess demand for tradables can only be eliminated by an in-
crease in imports. At the same time, the price of services relative to the
price of manufactured goods also increases causing an appreciation of
the real exchange rate – i.e. a unit of foreign currency now buys fewer
services only for domestic consumption.

3
It is explicitly assumed that the market for non-tradable goods (domestically pro-
duced) always clears through the price system – i.e. an excess demand causes domest-
ic prices to increase and an excess supply causes domestic prices to decrease. In the
tradable sector, excess demand and excess supply are eliminated through increases in
imports and exports respectively.
17
goods in the domestic economy as it did before. This real appreciation

weakens the competitiveness of a country’s manufacturing exports, and
causes de-industrialization. Both of these changes take place because of
the spending effect.4
Combining the spending and resource movement effects, the
Dutch Disease hypothesis generates four predictions. First, since the re-
lative price of services increases, the real exchange rate appreciates.
Second, there is an unambiguous decline in manufacturing output and
employment. Third, the combined effects on output and employment in
the oil sector and the service sector are ambiguous because the spend-
ing and resource movement effects pull in opposite directions.
However, if the oil sector employs relatively few workers or if labor
mobility is low, then it is expected that the spending effect will domin-
ate the resource movement effect in which case we would also expect
to see an increase in service sector output and employment. Fourth, if
4
Appreciation of the real exchange rate will occur regardless of whether the nominal
exchange rate is fixed or flexible. Under a fixed nominal exchange rate, such as in the
UAE and in all the GCC countries except in Kuwait, the conversion of the foreign
currency into local currency would increase the country’s money supply, and pressure
from domestic demand would push up domestic prices. This is why under a fixed ex-
change rate system this real appreciation will lead to higher inflation, the case in most
GCC countries. This would amount to an appreciation of the real exchange rate be-
cause a unit of a foreign currency now buys fewer ‘real’ goods and services in the do-
mestic economy than it did before. If the exchange rate is flexible, the increased sup-
ply of foreign currency would drive up the value of the domestic currency which also
implies an appreciation of the real exchange rate, in this case through a rise in the
nominal exchange rate rather in domestic prices. In both cases, real exchange rate ap-
preciation weakens the competitiveness of the country’s manufactured exports and
causes deindustrialization.
18
labor is mobile, then the overall economy-wide wage level will in-
crease.5
The above analysis is more relevant for resource rich countries
with an abundance of oil or other natural resources. For an emirate such
as Dubai with scarce endowments of natural resources and a small nat-
ive population, the source of Dutch Disease has been the large inflow
of Foreign Direct Investment (FDI)6 caused by the creation of a busi-
ness friendly environment, especially after 2001. We thus look at FDI,
as opposed to oil revenues, as the major source of capital inflows
which, again, is not related to the internal productive capacity of the
Dubai economy. This approach leaves us with two sectors: a tradable
manufacturing sector and a non-tradable service sector. The increase in
FDI causes similarly an appreciation of the real exchange rate which re-
duces the competitiveness of the tradable manufacturing sector and
leads to deindustrialization7. As the return on capital and wages begin
to increase because of the spending effect, resources begin to move
from the tradable manufacturing sector into the non-tradable service
sector since producers in the tradable sector cannot increase their prices
because prices of manufactured goods are set internationally especially
in a small open economy such as Dubai which is a price taker and can-
not influence world prices. This resource movement effect in Dubai has
5
For an excellent discussion of Dutch Disease and its practical applications to the real
world, see Migara, K. and O. De Silva (1994).
6
A survey conducted by the Dubai Statistics Center in 2007 showed that FDI was
$11.6 billion in 2006, or an increase of 13.4% compared to 2005.
7
One explanation for why deindustrialization is perceived to be ‘bad’ is because there
is more scope for technological progress in manufacturing than in services except in
information technology and financial services, areas in which Dubai has achieved
substantial progress.
19
been evidenced by the dramatic growth of the real estate, tourism, and
financial sectors. Moreover, since Dubai has started from a low indus-
trial manufacturing base, most of the labor and capital in the non-trad-
able service sector is coming from abroad as evidenced by the increase
in the expatriate population. The Dubai government, recognizing this
phenomenon, has formulated appropriate policies to reinforce these re-
source movement effects into the highly profitable service sectors such
as tourism, finance, and real estate.
The recent global financial crisis has considerably reduced cap-
ital inflows into Dubai with ‘reverse’ Dutch Disease effects. In other
words, as the inflow of capital has slowed down, the upward pressure
on wages has somewhat subsided. This slower rate of growth of the
wage rate has caused a reversal of resource movements out of the non-
tradable service sector as evidenced by layoffs in the real estate and fin-
ancial sectors in recent months. Profitability, especially in the real es-
tate sector, has also been reduced to ‘normal’ levels with lower expecta-
tions. This is a good sign since property prices were getting out of con-
trol and it was becoming increasingly difficult to attract and retain
skilled workers. The slowdown in the rate of growth of wages has also
been helpful in controlling inflation caused by the increase in aggregate
demand through the spending effect. As capital inflows have decreased
due to the global financial crisis, these reverse Dutch Disease effects
have been very helpful to slow the rate of growth of the economy, espe-
cially in non-tradable service sectors. This lower spending by con-
sumers has been to some extent offset by increased government spend-
ing as Dubai builds its modern infrastructure.
20
Super-Competitiveness and Productivity

The competitiveness of a country is a highly ambiguous concept
since it incorporates many variables and indicators on the performance
of the economy. Strictly speaking, there are two meanings of competit-
iveness: ‘business’ competitiveness as elaborated in various competit-
iveness reports, and ‘economic’ competitiveness which depends on
factor endowments and productivity. Business competitiveness is best
illustrated by the annual reports published by the World Economic For-
um (WEF) and the International Institute for Management Develop-
ment (IMD)8. Neither IMD’s nor WEF’s rankings are comparable
through time due to changes in data, methodology, and countries
covered. IMD’s World Competitiveness Index (WCI) has continued in
the spirit of the original indices and has been mostly moderate in its re-
visions, and its methodology was considerably revised in 2001. WEF
introduced a completely new measure, the Current Competitiveness In-
dex (CCI), and relabeled the World Competitiveness Index (WCI) as the
Growth Competitiveness Index (GCI).9
8
WEF is an independent non-profit organization based in Geneva, Switzerland. It
promotes economic growth and social progress worldwide and has NGO consultative
status with the United Nation’s Economic and Social Council. Its activities are funded
by multinational corporations. IMD is an independent non-profit foundation and a
premier business education institution located in Lausanne, Switzerland. It educates
business executives at every stage of their careers.
9
WCI measures and compares how countries are doing in providing firms with an en-
vironment that sustains the domestic and global competitiveness of the firms operat-
ing within their borders. Similarly, CCI evaluates the underlying conditions defining
the current level of productivity. GCI is considerably different from the two and it
aims to measure the capacity of the national economy to achieve sustained economic
growth over the medium term, controlling for the current level of economic develop-
ment.
21
There is no readily available economic theory that could be ap-

plied to the construction of these indices. Growth literature provides
some guidance in selecting the appropriate variables and their relative
weights but, beyond that, index crafters must rely on expert judgments
and ad hoc empirical analysis10. All the indices combine ‘hard’ data
(statistical indicators such as wage rates, inflation rates, interest rates,
etc) and ‘soft’ data (indicators based on survey responses such as in-
tensity of research collaboration, implementation of new technology,
ease of doing business, etc)11. According to both IMD and WEF, current
competitiveness is the same as having an attractive environment for a
firm’s business activities. This is somewhat different from typical
definitions of competitiveness which emphasizes a country’s ability to
offer a high and rising standard of living to its citizens or the ability of
a nation state to continuously attract high value-added activities in such
a way that all factors of production are employed and earn high returns.
Economic competitiveness, on the other hand, looks at resource
endowments and how these resources are used most efficiently in the
production process at both the micro and macro levels. Some countries
are competitive in the production of certain products simply because
they are abundantly endowed with natural resources. For example,
Saudi Arabia is economically competitive in the production of oil
10
Porter’s (1990) work on competitiveness has influenced WCI and his diamond
model is highly visible in CCI. GCI is influenced by Barro (1991) and subsequent
works.
11
The indices have several shortcomings, the most serious critique relating to the Ex-
ecutive Opinion Surveys, namely, that opinions of fewer than 20 business managers
do not provide solid foundations for economic analysis.
22
simply because its vast oil deposits are very cost effective to extract.
Economic competitiveness at the macro level has to do with the eco-
nomy-wide production function which is a technical relationship
between output (GDP) and the various inputs that go into the produc-
tion of that output. The functional relationship between total output and
the various inputs is always positive but the degree of the effect on out-
put depends on factor intensities and on the ‘mix’ of the different in-
puts. At the micro level, economic competitiveness has to do with mar-
ket structures at the industry level such as perfect competition, mono-
poly, duopoly, or monopolistic competition. Countries usually have
little control over economy-wide competitiveness in the short-run, but
can affect market structures through various competition rules and reg-
ulations.
Nonetheless, competitiveness, whether ‘business’ or
‘economic’, is important because it lowers costs and forces the factors
of production to be more productive – that is, the same unit of input
produces more output than before. But when economic commentators
talk about productivity, they normally do not specify the productivity of
which input. The common measure of productivity, at least in the US, is
labor productivity – output per man-hour. But the productivity of an
economy depends on much more than the productivity of its labor 12. It
also depends on the ‘mix’ or efficiency with which the ‘other’ inputs in
the production process are combined with labor – what is known as
Total Factor Productivity (TFP)13. In other words, the amount of output
12
Productivity is important because it affects per capita GDP which in turn determines
the rate of growth of the economy.
13
Also known as Multi Factor Productivity (MFP).
23
that a unit of labor can produce depends on the amount of capital that
the worker has, on his level of education, on his health, on his training,
on institutions, on governance, and so on – what Robert Solow called a
measure of our ignorance14. In effect, we are saying that an increase in
TFP means that more output is obtained without increasing the quantity
of inputs. This distinction between labor productivity and TFP is im-
portant because labor productivity might be increasing not because
workers are working harder, but simply because they have more capital
to work with. Since this capital is costly, it will ultimately reduce over-
all economic productivity. The same argument can also be made for all
the ‘other’ inputs that affect overall economic productivity such as hu-
man capital, technology transfer, institutions, and so on. The important
point for policy purposes is that overall economic productivity will be
overstated if the measure is labor productivity because we are not tak-
ing into account the costs of capital, education, healthcare, technology,
institutions, and so on15. TFP takes into account these costs and will
therefore exhibit lower rates of overall productivity growth.
Intuition tells us that interest rates will be low during periods of
economic slowdown as governments push down rates to generate eco-
nomic growth. The interest rate can be looked upon as the cost of capit-
al since investors need to borrow to make investments. But given that
the economy is in a ‘liquidity trap’, banks are not willing to lend at low
levels of interest and will only be willing to do so at higher rates, thus
14
This does not imply that we do not know what these ‘other’ inputs are. It simply
means that they are difficult to measure.
15
For this reason, the Organization for Economic Cooperation and Development
(OECD) looks at Total Factor Productivity especially for cross-country comparisons
of productivity growth. See OECD (2001).
24
pushing up the cost of capital. In other words, although market rates are
very low, actual rates - rates at which banks would be willing to lend -
are much higher. This higher cost of capital will be reflected in lower
productivity growth which will eventually lead to slower economic
growth. The current economic reality in Dubai is very similar to this
situation which is evidenced by the fact that if one goes to the bank to
borrow money, banks are only willing to lend at about 7-8%, even to
their high net-worth customers. Again, a highly counterintuitive out-
come in the sense that higher investment will lead to lower productivity
growth, in turn, leading to lower economic growth.
These ‘other’ inputs that affect productivity growth can be
grouped under three main headings: knowledge; factor supplies; and in-
stitutions16. By knowledge we mean the creation, transmission, and ab-
sorption of knowledge. Since knowledge cannot be directly measured,
it is often proxied by R&D and by the number of patents. There is very
strong evidence to suggest that increases in knowledge positively affect
productivity growth, and increases in the stock of knowledge are
caused by investments in education and R&D. Knowledge can also be
imported in the form of FDI (where technologically advanced foreign
firms invest in the domestic economy) and/or in the form of technically
advanced imported products (such as computers, advanced machinery,
high-tech equipment, etc). Generally, more open economies tend to be
better positioned to import knowledge from abroad although the effect-
iveness of this advanced knowledge may be limited by the absorptive
capacity of the economy. For example, an educated and healthy popula-
16
For a comprehensive literature survey of these ‘other’ inputs, their determinants,
and effects, see Isaksson (2007).
25
tion will be in a better position to absorb and learn from imported

knowledge. The creation of knowledge through innovations has also
been shown to be an important determinant of productivity growth
where innovation can be defined as a network of institutions (universit-
ies, public and private research centers and think-tanks), rules, and pro-
cedures that influence the way by which a country acquires, creates,
disseminates, and uses knowledge.
Factor supplies mean the supply of human capital17 (healthcare
and education), infrastructure, and the supply of savings (financial sys-
tem). A better educated and healthier workforce is much better posi-
tioned to absorb and use the latest techniques in both the manufacturing
and service sectors, the latter in the form of better managerial tech-
niques and processes. A good infrastructure reduces transaction costs of
doing business as the transportation of both goods and people becomes
more efficient, and an efficient financial system allocates savings to in-
vestments in such a way that returns on capital are maximized. With
respect to institutions, there are generally 3 main issues that policy
makers need to consider to increase productivity: enforcement of prop-
erty rights (encourages investment); constraints on the actions of
powerful groups (reduces the risk of expropriation); and equal oppor-
tunity for all (ensures equitable distribution of income). Better and
stronger institutions result in higher savings and investment which in
turn cause faster productivity growth rates. Institutions are also import-
17
It is implicitly assumed that capital (machinery, plant and equipment) can be meas-
ured and is always used by labor. For this reason, it is not usually included in the ‘oth-
er’ factors which influence productivity growth.
26
ant in improving the process of innovation because it is regarded as a

public good and cannot be left to the market alone18.
The term institution can be interpreted either as a political entity
or an economic one. In the former context, institution means the system
of political structure such as democracy or autocracy. As an economic
entity, institution implies the rule of law and property rights. There is
very strong evidence that institutions play an important role in generat-
ing higher rates of productivity growth19. But the more interesting ques-
tion is whether there are certain institutions that secure, for example,
property rights better than others, and hence, generate faster productiv-
ity and growth rates. In a democracy, factors of production are allocated
according to market forces given that citizens are well informed and
that the state establishes a sound set of laws, rules, and rights20. But for
these rules and rights to be effective, the state must be highly commit-
ted which is not always possible in an autocratic system because cit-
izens cannot force autocrats to do so. But this does not mean that demo-
cracy works better than autocracy because threats to property rights in a
democracy can originate from powerful groups such as organized labor
or special interest groups. An ideal political system would be “a system
where the state is effective in what it does while being insulated from
what it does not want to do”. (Rodrik 1992).
18
Innovations cannot be totally left to markets because the market outcome might be
sub-optimal.
19
See Acemoglu, D. (2003).
20
Are citizens really well informed? Do they have access to accurate sources of in-
formation? These are highly restrictive assumptions, and once dropped, the whole
concept of ‘the market’ as an efficient allocator of resources becomes ambiguous.
27
The secret of Dubai’s economic success can be explained by its

ability to be super-competitive by focusing on these ‘other’ factors
which affect total factor productivity21. In terms of the creation, absorp-
tion, and transmission of knowledge, Dubai has been creating various
‘knowledge centers’ such as Dubai Knowledge Village, Dubai Academ-
ic City, Dubai Internet City, and Dubai Silicon Oasis. Dubai Know-
ledge Village (DKV), launched in 2003, places the Middle East on the
map as a destination for learning excellence and provides a ready envir-
onment for a variety of knowledge-based entities including training
centres and learning support entities. This thriving knowledge com-
munity was founded as part of a long-term economic strategy to devel-
op the region’s talent pool and accelerate its move into a knowledge-
based economy. Benefits for DKV partners include 100% foreign own-
ership, 100% freedom from taxes, 100% repatriation of assets and
profits, and effortless visa issuance procedures. DKV also offers first-
rate facilities for the use of its knowledge partners and their students in-
cluding serene landscapes, food courts, and sports grounds. Its partners
include diverse nationalities such as Australians, Indians, Pakistanis, Ir-
anians, Russians, Belgians, English and Irish. DKV has over 350 part-
ners which include training centres, professional centres and HR com-
panies. DKV also enjoys the distinction of being the world’s only free
zone totally focused on professional training and learning support ser-
vices.
21
This may be one explanation for the relatively low levels of productivity figures in
Dubai because these ‘other’ factors which affect total productivity are costly and re-
duce overall economic efficiency in the short-run.
28
Dubai Academic City (DAC) is the world’s only free zone ded-
icated to higher education. A regional base for premier international
higher educational institutions, DAC is the world’s first dedicated ter-
tiary cluster development. Spread across an area of 25 million square
feet, the DAC campus provides an intellectually inspiring environment
for students and faculty. Benefits for DAC partners include 100% for-
eign ownership, 100% tax free, and 100% repatriation of profits. There
are currently 32 international universities of higher learning from di-
verse regions including USA, Australia, India, Pakistan, Iran, Russia,
Belgium, UK, and France, operating out of DAC and catering to the
needs of over 12,000 students. These include Michigan State Uni-
versity, The University of Wollongong in Dubai, Middlesex University
Dubai, and S.P Jain Centre of Management Dubai, among many others.
These institutions offer programs that range in duration from one year
to four years. Major academic programs on offer include engineering,
computer science, media studies, environmental studies, child develop-
ment, quality management, and business management programs.
Dubai Internet City (DIC) provides a strategic and cost effective
platform for ICT companies targeting emerging markets in a vast re-
gion extending from the Middle East to the Indian subcontinent, and
from Africa to Central Asia. Launched in the year 2000, DIC now fea-
tures a dynamic international community of ICT companies including
global giants like Microsoft, Cisco Systems, IBM, HP, Dell, Siemens,
Sun Microsystems, Computer Associates, PeopleSoft and Sony Eric-
sson. Many small and medium businesses and promising entrepreneuri-
al ventures are also part of the community. The cluster comprises com-
29
panies from a variety of sectors - software development, business ser-

vices, web based and e-Commerce, consultancy, sales and marketing,
and back offices. DIC provides an environment that attracts all the ele-
ments of the ICT value chain, and has developed several programs that
can be leveraged by the community to explore and expand development
opportunities. Companies are privy to an advanced Ethernet broadband
infrastructure and a range of business-enabling services including gov-
ernment transactions. DIC also has the world’s largest commercial IP
telephony network and offers both 100% tax exemption and 100%
business ownership.
Dubai Silicon Oasis (DSO) was established by the Government
of Dubai in 2005 with the objective of developing an integrated
technology park highlighting industries built around the production of
information and communications technologies using semiconductors.
Its vision is to make DSO one of the world’s leading centers of
advanced electronic innovation design and development, and to create a
universally recognized state-of-the-art ‘technology oasis’ by facilitating
and promoting technology-based industries, research and development
within a fully integrated community. It is spread over a 7.2 square
kilometer area providing a highly conducive environment for
manufacturing companies, warehousing, and regional offices. It is
rapidly becoming a thriving urban community with a core technology
zone surrounded by a master-planned residential environment
consisting of villas, technologically advanced commercial and
residential buildings, and offering 100% foreign ownership, zero
30
personal taxation, zero corporate taxation, and a state-of-the-art IT

infrastructure.
Dubai has benefited immensely from its openness by acquiring
knowledge through its imported intermediate and final goods and ser-
vices, especially modern managerial techniques and construction tech-
nology. Dubai is also paying very close attention to upgrade its health-
care and education systems by establishing Healthcare City and con-
ducting a comprehensive reform of its education system to be more
compatible with the needs and requirements of a knowledge-based eco-
nomy. The Dubai Health Authority (DHA) was created in 2007 with a
clear mandate to upgrade health standards and improve the health of
everyone living and working in Dubai. Since then, DHA has been re-
sponsible for promoting international accreditation of all healthcare ser-
vices, and has actively promoted numerous partnerships between public
and private healthcare providers. The Knowledge and Human Devel-
opment Authority (KHDA), established in 2006, has the task of devel-
oping all knowledge and human resource sectors in the emirate of
Dubai. KHDA aims to develop the education and human resource sec-
tors and bring them on par with international standards and prevalent
best practices while keeping in mind the requirements of the job mar-
ket. Keeping in line with the economic and social growth in Dubai, the
KHDA was established to ensure the continuous development of the
education sector and to improve the quality and outcomes of education
on all fronts and at all stages22. Moreover, huge infrastructure projects
22
The first ever official study into local education conducted by the Dubai School In-
spection Bureau found that 9 out of ten schools in Dubai were found to be providing
education that was ‘acceptable’. See Annual Report 2009, Dubai School Inspection
31
from the Dubai Metro to the construction of new roads and bridges will
ultimately lead to reductions in transaction costs and increase total
factor productivity. Dubai has also established a modern financial cen-
ter such as the Dubai International Financial Center (DIFC), encour-
aged Islamic finance, and developed various financial markets which
will ultimately maximize the returns on capital. But perhaps the biggest
advantage that Dubai has over other emerging economies is its focus on
institutional performance23 by honoring property rights and a zero toler-
ance against corruption, especially in the booming real estate sector. In
the political dimension, Dubai’s governance is very close to the ‘ideal’,
as envisaged by Rodrik (1992) – “a system where the state is effective
in what it does while being insulated from what it does not want to do”
- a highly counterintuitive approach compared to most governance
structures in emerging economies.
Bureau.
23
Institutional performance is discussed in detail in the section on Governance Indic-
ators.
32
Capital Inflows and Investment

Real Estate
The fastest growing sector in Dubai has undoubtedly been the
real estate sector where the booming domestic economy has caused a
large increase in the demand for both commercial and residential space.
The surge in tourism has also increased the demand for hotels, hotel
apartments, and various types of resorts to cater for the needs of differ-
ent types of tourists. Moreover, the expansion of existing industrial
areas in duty free zones and the construction of new ones have substan-
tially increased the demand for housing for different income groups.
This dramatic growth in the real estate sector has posed three related
questions: What are the main causes of this growth? What are the un-
derlying economic fundamentals of the Dubai real estate market? And,
are there any signs of bubble trouble?
The current boom in real estate traces its roots back to 1997
with the creation of the publicly quoted Emaar and Nakheel properties
which have spawned developments such as Dubai Marina, Burj Dubai,
The Palm Jumeirah, The Palm Jebel Ali, The World, and The Uni-
verse24. Until 2002, only Gulf Cooperation Council (GCC) nationals
were allowed to hold property in Dubai while non-GCC expatriates liv-
ing in the UAE were only permitted to rent or own property on a feder-
ally approved 99-year leasehold basis. In 2002, the Dubai government
allowed the ownership of freehold property to all foreigners triggering
24
This list is by no means exhaustive. Many projects and developments are in the
pipeline which will be completed during the 2008-2015 period, and beyond.
33
a chain of events which quickly began changing the face of the real es-
tate sector. The 2002 announcement coincided with another decree al-
lowing foreigners to purchase and own freehold property in selected
areas of the city known as ‘New Dubai’. It then took until March 2006
for the publication of the new law legalizing foreign ownership of prop-
erties in designated areas. As a further move to boost investor confid-
ence in the real estate market, the Real Estate Regulatory Authority
(RERA) was established in July 2007. The main responsibility of
RERA is to formulate, regulate, and manage various real estate activit-
ies in Dubai. In 2009, RERA was affiliated with six global real estate
associations and organizations to improve property laws and protect the
rights of both developers and consumers according to global best prac-
tices.
The second major cause of the growth in the real estate sector is
the movement of resources into this sector because of its higher profit-
ability compared to the profitability in other sectors. As capital inflows
into Dubai have increased, especially after 2001, the economy-wide
wage rate has also increased25. Producers, to make-up for the loss in
their profits, have been forced to increase their prices. They were able
to increase their prices in the non-tradable service sectors (the most
prominent being real estate) but they were not able to do so in the trad-
able manufacturing sector because prices of manufactured goods are
determined in world markets. This difference between the higher profit-
ability in the real estate sector and the lower profitability in the manu-
facturing sector has attracted developers into the real estate sector as
25
Wages have increased because of greater spending caused by the increase in the
money supply as a result of large capital inflows.
34
evidenced by the increase in construction and related activities. The

Dubai government has been able to reinforce these resource movement
effects into the real estate sector by improving property laws and creat-
ing a highly conducive business environment for real estate developers.
At the same time, the Dubai government has not neglected the lagging
manufacturing sector which is evidenced by the establishment of vari-
ous industrial parks such as Dubai Investment Park and Dubai Industri-
al City, to name just two.
Whenever the word ‘market’ comes across, one tends to think of
the concepts of ‘demand’, ‘supply’ and ‘price’. The real estate market is
no different in the determination of the ‘price’ of real estate which is ul-
timately determined by economic fundamentals such as demand and
supply. However, the standard analysis of this market is based on static
instantaneous changes in market forces such as an overnight increase in
the supply of housing. But as we know very well, an increase in the
supply of housing does not happen instantaneously and one needs time
to build new houses, structures, and buildings. Hence, in the real world,
a more dynamic approach is required for real estate price determina-
tion. A second caveat is that the simplistic view of demand and supply
is based on the assumption of perfect information (for both buyers and
sellers of property) and does not take into account speculative motives
which more than often have driven property prices, and which tend to
be influenced by expectations rather than by pure economic fundament-
als. For these two reasons, the analysis of the real estate market is not
as straightforward as the analysis of other markets. For a more accurate
determination of the price of real estate, and for more effective policy
35
intervention, one has to take into consideration these shortcomings and

be able to isolate the speculative factors from pure demand and supply
fundamentals.
Most economic commentators on the real estate market in
Dubai have attributed the increase in the price of property, housing, and
rents, to a supply shortage caused by the high rates of economic
growth. Some have argued that this surge will be eliminated as new
units are completed and released to the general public by 2010 26 thus
dampening the upward pressure on prices, while others have predicted
that the increase in population and tourism will result in further in-
creases in the demand for residential and commercial space and will
more than make-up for the increase in supply, thus sustaining the high
prices in the real estate market27. Another factor which has been putting
upward pressure on prices is explained by the actions of both individual
and institutional speculators who purchase and hold property for short
periods of time, and thus create an ‘artificial shortage’, eventually
selling their properties at higher prices28.
Having realized this rapid pace of price increases in the real es-
tate market, the Dubai government has adopted various policies, with
varying degrees of success, to control this price increase. Perhaps the
most counterintuitive policy has been the use of rent controls for both
26
By some estimates, about 180,000 new units will be delivered by 500 registered de-
velopers in 2010. However, due to the recent slowdown in the real estate market, only
about 60% of these units are expected to be delivered on schedule.
27
The population of Dubai is expected to increase from 1.4 million in 2007 to 1.7 mil-
lion in 2010, and tourism is planned to increase to 15 million by 2015.
28
This practice is commonly known as ‘flipping’. Some speculators also purchase
property ‘off-plan’ (on the map) by paying 5-10% of its value and sell them at higher
prices after a few months.
36
residential and commercial properties. The government in 2006 im-

posed a 15% cap on rental price increases which have been progress-
ively lowered to 7% in 2007, and most recently to 5% in 2008 for ten-
ants who have occupied their apartments for 2 years. This policy has
been counterintuitive since no country has been successful in holding
prices down using such controls29. The main argument against such
controls is that they discourage developers and divert investment to
more profitable sectors30. Rent controls also create black markets and
are difficult to administer since they need to be enforced on a case-by-
case basis and have many loopholes. Moreover, country experiences
have shown that once these controls are lifted, prices tend to overshoot
as landlords attempt to make-up for their ‘losses’. To control specula-
tion, the Dubai government has recently enacted new rules and regula-
tions administered by RERA to prevent property flipping by forcing
property buyers to hold their properties for relatively longer periods of
time, and by making it more difficult to purchase off-plan. Recent high-
profile corruption scandals by well known property developers have
also strengthened the government’s resolve against corruption by de-
claring a zero tolerance policy. All of these policies have been designed
to maintain the traditionally high levels of confidence in the Dubai real
estate market.
As capital inflows into Dubai have decreased because of the
global financial crisis, the rate of growth of wages has also decreased.
29
Except Canada which also simultaneously controlled wages and incomes.
30
This is the reason for the transformation of the South Bronx area in New York City
into a slum in the early 1970s as landlords began to cut down on maintenance, land-
scaping, and other expenses.
37
However, profitability in the non-tradable sector, especially in real es-

tate, is still greater than profitability in tradable sectors such as in man-
ufacturing because producers in the manufacturing sector cannot in-
crease their prices to make-up for their ‘losses’ 31. Developers in the
real estate sector will still be able to raise their prices but not by as
much as before the decrease in capital inflows. Given this relatively
lower profitability in the real estate sector, investors will be inclined to
move their capital to more profitable sectors but since real estate invest-
ments entail ‘sunk-costs’, capital is not as mobile as one would ex-
pect32. Hence, the rate of return on capital will be lower as evidenced
by the fall in property prices in recent months. Some analysts have re-
cently predicted property prices to fall by as much as 80% in the com-
ing few months but such a large drop is highly unlikely because the
Dubai government has considerably increased its expenditure to trans-
form the Dubai economy from a supply-driven economy (where the
government builds a business friendly environment to attract producers
and suppliers of goods and services) into a demand-driven economy
(where economic activity will be determined by aggregate demand).
The real estate market has also been affected by lower spending as a
result of reductions in capital inflows. This lower spending by con-
sumers and investors has pushed down property prices further to more
‘normal’ levels. This ‘reverse’ Dutch Disease effect has not been as
31
Producers in the manufacturing sector cannot increase their prices because prices of
manufactured goods are set in international markets. This is why they are also known
as ‘tradables’ – i.e. manufactured goods can be exported and imported.
32
‘Sunk-costs’ are investments that cannot be easily relocated elsewhere because of
the physical nature of the investments. In other words, once a building is built, the
capital (cement, steel, etc) used-up in the process cannot be ‘taken-out’.
38
powerful as standard Dutch Disease effects demonstrated earlier be-

cause capital in the real estate market is less mobile than in other sec-
tors such as in the financial service sector where one can easily with-
draw capital. For this reason, the adverse direct effects of reductions in
capital inflows on the real estate market will not be as severe as the ad-
verse effects on banking, tourism, finance, and other non-tradable ser-
vice sectors33.
Nevertheless, both the general public and various analysts are
deeply concerned about the effects of a real estate market ‘correction’.
So are there any signs of bubble trouble in the Dubai real estate
market? A simplistic view would be to say that if we can somehow sep-
arate the increase in the price of real estate into its fundamental (de-
mand and supply) and speculative components, then if, say, 70% of the
increase in prices is caused by fundamentals and 30% is caused by
speculation, it automatically follows that the ‘correction’ would result
in at least a 30% price fall. But just like a stock, a house has also a
price-earning ratio, where earning is interpreted as rent34. When we
buy a stock (an asset) we are effectively buying an earning stream. The
price we pay for the stock should reflect current earnings and reason-
able expectations about future earnings. A bubble is created when these
get disconnected. The price of a house follows a similar logic – namely,
33
However, there may be indirect effects on the real estate sector because of liquidity
shortages in the financial sector caused by ‘capital flight’. For example, as currency
traders (primarily from GCC countries) were expecting a re-valuation of the UAE
Dirham against the US dollar, they amassed large Dirham deposits at UAE banks. But
as the de-pegging with the US dollar did not materialize, there was a huge ‘capital
flight’ which reinforced the adverse effects of resource movements out of the real es-
tate sector.
34
This section follows closely Leamer (2002).
39
the price paid for a house should reflect the present value of future
rents that the buyer expects to receive. The buyer must ask how much
the house could currently be rented for on an annual basis, and then di-
vide the seller’s asking price by this rental number. That’s the price-
rent ratio. If a $200,000 house generates $10,000 rent annually, then the
price-rent ratio is 20. A high price-rent ratio can be justified if the
house is in an area that can be expected to experience high growth rates
and thus rapid appreciation in rents, just like a technology stock can
have a higher price-rent ratio than a car manufacturer. But one is com-
pletely mistaken if he or she thinks that there can be a long-run discon-
nect between a house price and its potential rental stream. If such a dis-
connect exists, then there is definitely bubble trouble.
Going back to the analogy with the price of a stock, when a cor-
poration experiences a rise in earnings, stockholders may bid up the
price of the stock by a percentage that is higher than the increase in
earnings, and thus increase the price-earning ratio. This new higher
price-earning ratio could be based on the idea that these higher earn-
ings are a permanent event. Similarly, if people think that there is a
‘momentum’ in rents with high appreciation supporting further in-
creases in rents caused by expectations of population growth, increased
tourism, and ‘shortages’, then the price-rent ratio of housing might also
be set at a higher level. In other words, this higher price-rent ratio is
based on the expectation of home buyers that rents will continue to rise,
thus justifying higher prices for houses. A lot depends on the validity of
these higher expectations which are in turn justified by so-called ‘short-
ages’ in housing. But a freely functioning market cannot have ‘short-
40
ages’. A market system has high prices for some goods and low prices
for others. A ‘shortage’ is created when the price mechanism is not al-
lowed to work. There can be a ‘shortage’ of umbrellas in a storm be-
cause sellers choose not to increase the price to equate supply and de-
mand. Then the sellers run out of umbrellas and people go without one
even though they would have been willing to pay a higher price. A
shortage can cause a rise in price if the fundamental demand and supply
conditions that caused the price increase in the first place persist, and if
the market is allowed to clear. But both the market for rentals and the
market for houses are highly evolved and do not suffer from the fixed
price pathologies that cause shortages. There are high rents, or low
rents, but no ‘shortages’. There is no ‘shortage’ of houses anymore than
there is a ‘shortage’ of cars, or diamonds, or shirts. Limitations on new
housing can cause rents to increase at an abnormally high rate for a
period of time but the higher rate of growth of rents should be quickly
‘capitalized’ in the price of a house once the market realizes the impact
of supply restrictions on future rents. That means a one-time jump in
price, and, thereafter, price changes like every other product – up some-
times, and down sometimes. In other words, since higher rents have
been capitalized in the price of houses, then there is no guarantee that
prices will always move higher.
The global financial crisis and the concomitant fall in Dubai
real estate prices have considerably reduced the willingness of banks to
lend, especially for housing loans. Some banks have recently doubled
the minimum salary requirement to qualify for a loan to consumers be-
low a certain threshold, putting extra pressure on consumers’ ability to
41
make timely mortgage payments. The recent fall in real estate prices
has also reduced the ‘perceived wealth’ of many homeowners in vari-
ous segments of the market. This wealth effect has reduced consumer
expenditure, one of the largest components of aggregate demand35, put-
ting added downward pressure on property prices. Property developers
in Dubai have also announced ‘delays’ and some cancelations of real
estate projects which will reduce future supplies. The ‘net’ effect on
property prices will depend on the magnitude of these two market
forces. If the fall in demand caused by the unwillingness of banks to
lend is much larger than the fall in supply, then property prices will
surely fall. On the other hand, if the fall in demand is less than the fall
in supply, then the fall in prices will be moderate. Given that the UAE
Central Bank has injected more than $30 billion into the banking sys-
tem in recent months, and given that banks are currently more willing
to lend, albeit at more stringent terms and conditions, the fall in Dubai
property prices should not be very severe36.
35
Aggregate demand is the total demand for goods and services in the economy which
is composed of 4 components: Consumer expenditure (C); Investment expenditure (I);
Government expenditure (G); and net exports (exports – imports). In most developed
countries, consumer expenditure accounts for up to 80% of aggregate demand.
36
The ‘net’ effect is beyond the scope of this book. For a more rigorous analysis, one
needs to identify and measure the many factors that determine both demand and sup-
ply such as population growth, income, tastes, and many other factors.
42
Tourism
Another unexpected outcome has been the dramatic growth in
the tourism sector. This outcome has been unexpected because Dubai
had to compete with established tourist destinations in other parts of the
world, especially under the political instability of the Middle East.
Dubai has long been considered as the connecting link between Europe
and Asia with a long history of acting as the ‘middleman’ in the facilita-
tion of trade. Oil does not play a major role in its economy (about 3%
of GDP) and tourism has contributed over 20% to its GDP attracting 6
million tourists in 2007 alone. The growth of the tourism sector can be
explained by the higher profitability in this non-tradable service sector
caused by Dutch Disease effects noted earlier. This higher profitability
has encouraged both public and private foreign investment in the devel-
opment of shopping malls, hotels, restaurants, entertainment and leisure
activities, and many other related services. The driving force behind the
development of the tourism sector has been the Department of Tourism
and Commerce Marketing (DTCM) with the specific objective of trans-
forming Dubai into a regional tourism hub.
The current global financial crisis will undoubtedly have an ad-
verse effect on the Dubai tourism sector. Tourism, by definition, is very
sensitive to changes in income. For a more accurate assessment of this
adverse effect, one has to distinguish between different types of tourism
such as ‘business’ and ‘leisure’ tourism. Over the last few years, Dubai
has been very successful in attracting a large number of ‘business’ tour-
ists through its many international meetings, conventions, and exhibi-
43
tions. Whereas ‘leisure’ tourism is regarded as non-essential expendit-

ure and can be easily cancelled or postponed during economic hard-
ships, business type tourism is not as sensitive to economic downturns.
Unlike in most other emerging economies, the Dubai tourism sector is
highly diversified catering to the needs of different types of tourists. In
other words, the adverse effects of the financial crisis on the tourism
sector in Dubai will be less severe than in other cities because the fall
in tourism will be somewhat cushioned by the smaller fall in ‘business’
tourism due to the highly diversified nature of the Dubai tourism sector.
The indirect effect of the financial crisis on tourism is that as tourism
income falls, the profitability of this sector will also fall, forcing hospit-
ality ‘guest’ workers to move out of this sector. To the extent that these
‘guest’ workers are willing and able to return back to their home coun-
tries, there will not be a large pool of unemployed workers that the gov-
ernment has to provide for through social and other programs.
Having realized the movement of resources into this non-trad-
able service sector, the Dubai government has initiated many projects
to reinforce these resource movement effects. The Dubai Shopping
Festival (DSF) and the Dubai Summer Surprises (DSS) are only two
notable examples in catering to the needs of international shoppers and
vacationing families. DSF was first started in February 1996 by the
Dubai government aimed at promoting trade in Dubai. Since then, it
has become an annual shopping, entertainment, and cultural extravag-
anza that continues to promote tourism in Dubai and draws people from
around the world each year. On February 15, 1996, the travel industry
in the Middle East heralded the beginning of a new dawn - the birth of
44
the most impressive shopping cum entertainment mega event. An en-

tirely new concept, it succeeded brilliantly in showcasing what cooper-
ation between private sector and public sector could do to create a
mind-boggling achievement. Initially, the DSF was conceived as a pure
retail event, the primary aim of which was to revitalize the retail trade
in Dubai. It was later developed into a comprehensive tourism product
in line with Dubai's far-sighted vision to set global standards in every
field. DSF is basically a shopper’s paradise. Although Dubai is known
around the world as such a paradise throughout the year, the red carpet
is really laid out during shopping festival month with over 2,300 parti-
cipating retail outlets that offer everything imaginable from gold, per-
fume, haute couture, cars, and electronics, to handicrafts and textiles.
As months of preparations went into creating DSF, the shopping festiv-
al matured into a major retailing cum entertainment extravaganza.
Today, one of the biggest beneficiaries of the event is the tour-
ism sector. Hotels, travel agents and tour operators contribute to the
selling of the event worldwide and run at peak levels of operation dur-
ing the event. Every year, DSF lives up to its promise of staging the
most exciting activities for the whole family inspired by the theme
“One World, One Family, One Festival”. As universal brotherhood,
happiness, excitement, joy and adventure became the signature trade-
marks of DSF, the Festival itself became a tribute to the inherent ambi-
tion and strength of the people of Dubai. Local and multinational
brands acknowledged their faith in the event, and brands like Visa, Pep-
si, and Emirates Airlines became partners to DSF's growth. Most hotels
and apartments also get involved offering special discounts and offers
45
during the period. Even the world famous Burj Al Arab is included in
the hotels. With all these special discounts available, many would feel
that would suffice. But Dubai goes quite a few steps further. There are
scores of raffles that offer very attractive prices, and Emirates Airlines
and most other airlines flying out of Dubai offer discounted airfares and
much needed excess baggage allowances during the festival. There are
other events as well including international fashion shows, children's
events, street-side performances, nightly fireworks, film festivals, and
many other cultural events that reflect the emirate's cosmopolitan char-
acter. One of the biggest events of them all, the Dubai World Cup, also
takes place during the festival with a staggering US$ 12 million purse
that makes it the richest horse race in the world.
The Department of Tourism and Commerce Marketing (DTCM)
has also focused on the worldwide promotion of Dubai as an ideal tour-
ist destination and a thriving commercial and business centre, very at-
tractive for Dubai property investors. This has involved setting up
DTCM representative offices in many countries as well as participation
in numerous international tourism fairs. In addition, DTCM has
launched highly successful campaigns worldwide and has organised
tourism related exhibitions. Dubai is also developing its medical tour-
ism industry by establishing Healthcare City in partnership with Har-
vard Medical School to create a ‘centre of excellence’ for clinical and
wellness services, and medical education and research aimed at com-
peting with low-cost healthcare providing countries in Asia, especially
Singapore and Thailand. This is another example of super-competitive-
46
ness because Dubai is successfully competing with countries which

have a well-established history of offering medical tourism37.
In the leisure and entertainment sector, Dubailand 38 is the
world’s most ambitious project catering to the needs of the entire fam-
ily. This unique 3 billion square feet development has been designed to
catapult Dubai onto the global map, reinforcing its ambition of emer-
ging as an international hub of family tourism appealing to tourist seg-
ments across genders, age groups, world regions, and activity prefer-
ences. Dubailand is projected to attract millions of tourists annually
from around the world once fully operational. A number of Dubailand
projects are currently up and running including Al Sahara Resort,
Dubai Sports City, and Dubai Autodrome, with a host of other projects
currently in their final stages to be completed by 2010. The diverse pro-
jects under Dubailand include theme parks, eco-tourism projects, shop-
ping malls, restaurants, and residential units. The project is estimated at
$85 billion with a total of 45 mega projects and expects 40,000 daily
visitors which will significantly contribute towards attracting 15 mil-
lion tourists by 2015 as outlined in the Dubai Strategic Plan. It will also
have a minimum of 55 hotels within its geographical location and pro-
37
Thailand, which received 1.2 million medical tourists in 2006, has gained an inter-
national reputation for offering the best of both worlds – inexpensive surgery com-
bined with a 5 star beach holiday. Singapore, whose healthcare system has been
ranked 6th in the world by the World Health Organization in 2006, consistently earns
high marks in international surveys of medical tourists. It is aiming to attract one mil-
lion foreign patients a year by 2012.
38
For a detailed description of Dubailand and its many theme parks and projects, see
www.dubailand.ae
47
jects a population of 2.5 million people which includes workers, resid-

ents, and different types of tourists once it is fully operational.
Dubai's exciting new tourism destination started off as a huge
cultural entertainment center to cater to the need for a central meeting
point where different countries could showcase myriad cultures. Over
the years it has grown into a star attraction among UAE nationals,
resident expatriates from over 160 different countries, and visitors from
across the world. Today, this major crowd-puller has been transformed
into a unique international destination for tourism, entertainment,
leisure and culture. As a world-class tourism destination, Global
Village brings together diverse customs and cultures covering a broad
spectrum of activities including music, dance, art, handicrafts, theatre,
costumes, and cuisines of different countries. In addition to hosting the
colorful activities that are organised by countries from the different
continents of the world, Global Village also offers a range of top
quality facilities and services including restaurants, shuttle transport
services, and a huge parking area that can accommodate thousands of
vehicles.
Dubai has also developed numerous other touristic attractions
over a relatively short period of time. The Burj Al Arab hotel has be-
come an iconic symbol of Dubai. It is one of the region’s most famous
tourist landmarks, and as a hotel it has set new standards for excellence
in Arabian hospitality. The hotel, which was inaugurated in 1999, estab-
lished its presence with its futuristic and magnificent exterior. The
World, an archipelago of 300 man-made islands off the coast of Dubai,
has been created from sand dredged from the sea. The World is a land-
48
mark for future eco-tourism projects worldwide and is one of several

tourist and commerce related projects off the coast of Dubai which can
be seen from space. Dubai Marina, set to be the world’s largest man-
made marina, located close to the heart of ‘New Dubai’ and linked with
Jebel Ali Port, Dubai Internet City, and Dubai Media City. Mall of Ara-
bia, set to be the largest shopping mall in the world, will have a final
gross leasable area of 10 million square feet. Dubai Sports City, an en-
tire sports city currently under construction in the entertainment com-
plex of Dubailand, featuring apartment buildings as well as state-of-
the-art stadiums and facilities. Dubai Sports City will be the envy of
venues around the world. Its centre-piece, a 60,000 seat, multi-purpose
outdoor stadium, will play host to football, rugby, and athletic matches.
Business Bay, a central business district located in Downtown Dubai, is
designed primarily for international trade purposes and will have up-
wards of 230 buildings for both commercial and residential purposes.
Burj Dubai, opening in 2009, is a super-tall skyscraper set to be
the tallest building in the world. In a breathtaking design, which en-
compasses the makings of a small city in its interior, Burj Dubai will be
the centerpiece of Dubai’s new Dubaitown District. Palm Trilogy, con-
sisting of three man-made islands in the shape of palm trees, has been
created to help solve Dubai's beach shortage. Atlantis is a 1,539 room,
ocean-themed destination resort located at the centre of the crescent of
the man-made Palm Jumeirah in Dubai. This US$1.5 billion joint ven-
ture project was developed with the Dubai government and was opened
in September 2008. The resort utilizes a 46 hectare site with 17 hectares
of water park amusement, further marine and entertainment attractions
49
and a collection of some of the most renowned world-class chefs in-

cluding Nobu, Giorgio Locatelli, Santi Santamaria and Michel Rostang.
Atlantis offers an unprecedented entertainment centre, an impressive
collection of luxury boutiques and shops, and extensive meeting and
convention facilities. It is home to one of the largest open-air marine
habitats in the world with some 65,000 marine animals in lagoons, and
displays including The Lost Chambers, a maze of underwater corridors
and passageways providing a journey through ancient Atlantis.
Culture Village, situated on the Dubai creek, will offer a plat-
form where all the components of a higher lifestyle can take place, sat-
isfying the intellectual as well as the practical needs of residents and
visitors. Visual arts, performing arts, and literary facilities will contrib-
ute to the higher standard style of living. Culture Village proposes a
wide variety in styles and in content of art galleries, museums, theatres,
public exhibition spaces, fashion activities, institutes specializing in
different disciplines, gardens, and many other activities pertaining to
the promotion of the arts in society and in the community in general.
Restaurants and specialty stores will offer a mix that contributes to the
eclectic and creative mood of the location. Bawadi will be the world's
largest hospitality and entertainment development boasting from end-
to-end a spectrum of amusement centres, shopping malls, theatres, res-
taurants, convention centres, and hotels. Occupants at any of Bawadi’s
60,000 rooms in over 51 hotels will have their own incredible experi-
ence to bring back home. From the fabulous Desert Gate Hotels and
Towers that mark the entrance and exit to Bawadi to the 6,500-room
centerpiece Asia-Asia hotel, an 1,800-seat theatre, family and extreme
50
sports parks, a themed shopping mall as well as a 20,000 seat multipur-

pose arena, Bawadi may stay unrivalled by any other development in
the world for a long time. Bawadi will also be home to the world’s
largest shopping area, literally promising a shop-till-you-drop experi-
ence, and providing over 40 million square feet of gross leasable area
for retail outlets. Featuring malls, boutique malls, street shopping and
an underground shopping area connecting all of Bawadi’s elements, the
stage is set for Dubai to roll-out the longest shopping boulevard in the
world.
Besides its retail attractions including the Middle East debut of
several global, high-profile brands such as Waitrose and Hamleys, The
Dubai Mall has varied lifestyle and leisure offerings including a
sprawling Gold Souk, an Olympic-sized Dubai Ice Rink, and the multi-
media-rich Fashion Catwalk atrium. The Dubai Aquarium & Discovery
Centre is already in the global spotlight having clinched the Guinness
World Record for the ‘World’s Largest Acrylic Panel.’ The Dubai Mall
will have a total of over 14,000 spaces for parking across three car
parks, with valet services and a car locator ticketing system. Sprawling
over 12 million square feet - equivalent in size to more than 50 soccer
pitches – with an internal floor area of 5.9 million square feet and a
gross leasable area of 3.77 million square feet, The Dubai Mall is the
flagship development of Emaar Malls Group, the shopping malls subsi-
diary of global property developer Emaar Properties. When fully opera-
tional, The Dubai Mall will have over 1,200 stores of which nearly 165
retailers – equaling 1.1 million square feet or 30% of the total gross
leasable area of the mall, are either new to the region or opening stand-
51
alone or flagship stores for the very first time in Dubai. The retail mix
includes two anchor department stores, Gallery Lafayette and Bloom-
ingdale’s (both opening their first stores in the Middle East), two hun-
dred and twenty gold and jewelry outlets, one hundred and sixty food
and beverage outlets including Dubai’s largest food court with 40 out-
lets, a super-supermarket, and an organic food mart.
A major challenge facing the tourism sector is the current slow-
down in the global economy, which would adversely affect the tourism
sector because of its income sensitivity. However, given the high rates
of growth in GCC countries and the difficulties associated with out-
bound travel to Europe and the US, especially after September 2001,
Dubai has been focusing on attracting high-income tourists from Arab
and GCC counties in both the leisure and business tourism sectors.
Dubai is the regional hub for meetings, incentives, conferences, and
events (MICE) with over 100 international exhibitions and countless
events held annually ranging from CityScape in real estate development
to GITEX in information technology. On the other hand, Dubai is facing
growing strains in its hotel capacity and infrastructure, and is working
round the clock to broaden the range of its tourist services and upgrade
its infrastructure to meet the shopping and travel needs of its visitors.
The ultimate objective is to position Dubai as a global travel industry
hub which is evidenced by building the largest airport in the world, a
state-of-the-art Metro system, and various leisure and entertainment
projects to attract 15 million tourists by 2015.
52
Finance
Dubai has also reinforced the flow of capital into the financial
service sector through the establishment of ‘financial centers’ such as
the Dubai International Financial Center (DIFC). The future of these
centers as modern international financial centers will depend on main-
taining a strong and transparent regulatory framework, continuing in-
novation, and making improvements in human capital, the business en-
vironment, and market access. DIFC was established in 2004 to serve
as a gateway for the flow of capital to and from the region, and was
spurred by the sharp increase in economic activity and the subsequent
need for substantial financial intermediation.39 DIFC offers its parti-
cipants a highly attractive investment environment such as 100% for-
eign ownership, zero taxation, and no restrictions on profit repatriation.
It is regulated by the Dubai Financial Services Authority (DFSA), an
independent regulator staffed by an impressive list of international pro-
fessionals with a regulatory mandate covering asset management, bank-
ing and credit services, securities, collective investment funds, custody
and trust services, commodities futures trading, an international equit-
ies exchange, an international commodities derivatives exchange, insur-
ance, and Islamic finance. DIFC has registered over 320 companies,
and the Dubai International Financial Exchange (DIFX) located at
DIFC and regulated by DFSA, has a market capitalization of about $40
billion. It provides a dollar-denominated trading platform for interna-
39
See IMF (2008).
53
tional issuers to raise capital and debt through conventional and Islamic
instruments.
These financial centers have fostered a vibrant market for Is-
lamic financial products.40 DIFC has already established a strong pres-
ence in this market with about $16 billion listed in DIFX, and interna-
tional investors are flocking to Dubai’s first Sukuk issuances and initial
public offerings. Several Islamic finance learning centers have also
been launched in Dubai which offer a range of Islamic financial, bank-
ing, and training programs to help meet the significant demand for hu-
man capital development. These learning centers are also aiming to at-
tract practitioners from countries with large Moslem populations such
as the US, UK, Germany, and France. The rapid pace of economic
growth is also boosting the demand for insurance products with Dubai
commanding approximately 50% of the UAE share. Life insurance is
also increasing while the non-life segment of the market such as acci-
dent and liability insurance accounted for 60% of total premiums col-
lected, followed by the fire, marine, and aviation segments. The bank-
ing sector in Dubai is also positioning itself to become ‘the’ regional
banking hub driven by the very strong performance of the sector in re-
cent years. There are currently 52 local and foreign banks in Dubai and
the sector is seriously considering consolidating given the turmoil in
global financial markets.41 This would considerably strengthen the abil-
ity of the banking sector to face global challenges by pooling resources
40
Islamic finance refers to a system that is consistent with Fiqh al-Muamalat (Islamic
rules on monetary transactions). For example, since ‘interest’ is prohibited under Is-
lamic law, instead of giving the borrower a loan, the bank purchases the item and re-
sells it to the consumer at a mark-up. For an excellent discussion of Islamic finance,
see Rahali (2008).
54
and sharing risks. There is also very high potential in the retail banking
sector with strong consumer spending and negative real interest rates.
Dubai has also announced plans to establish a Financial Arbitration
Center to quickly resolve disputes between businesses and different
types of financial institutions.
In its assessment of financial service sectors, the IMF and the
World Bank jointly conducted a Financial System Stability Assessment
(FSSA) in the summer of 2007 and concluded that the banking sector,
which dominates financial intermediation, has enabled rapid credit ex-
pansion to households, corporations, and public and semi-public enter-
prises. Major construction projects for hotels, apartments, commercial
and entertainment properties, and infrastructure have dominated the
landscape in Dubai. Demand for credit has also been driven by rapid
population growth and interest rates in the domestic currency that are
negative in real terms. The assessment also demonstrated that the bank-
ing sector, as a whole, showed comfortable levels of profit having be-
nefitted from the rapid expansion of the economy. In this favorable en-
vironment, the authorities have begun to open-up the banking sector to
greater competition, and several stress tests conducted by the IMF and
the World Bank joint team revealed that the banking system would ad-
apt very well to a variety of shocks. Specifically, banks have absorbed
the recent decline in stock prices with little effect on their balance
sheets, and the rapid increase in overall lending has helped offset a drop
in fees and commissions. The FSSA also concluded that the authorities
41
In 2007, Emirates Bank and National Bank of Dubai merged into a single entity,
Emirates NBD. Such consolidations will ultimately create a few large banks with
greater ability to withstand any external shocks caused by future crises.
55
have made good progress in strengthening financial supervision by the

approval of several key laws and the issuing of a new Code of Corpor-
ate Governance (May 2007) that is expected to enhance the governance
and disclosure practices of listed financial companies.
Nevertheless, the current global financial crisis has created a
situation in which people do not expect high returns on physical and
financial investments, preferring to keep their assets in short-term ‘safe’
bank deposits rather than make long-term investments – a ‘liquidity
trap’ situation. In such a situation, banks are unwilling to lend at these
low interest rates and consequently, any increase in liquidity by the
Central Bank is ‘trapped’ with unwilling lenders. The current situation
in global financial markets, and to some extent in Dubai, can be de-
scribed as a ‘liquidity trap’ situation42 in which the nominal interest rate
is so low that no one is willing to lend at the market rate of interest.
Since banks base their lending decisions on real (taking into account
the rate of inflation) rather than on nominal interest rates, they will not
lend unless they can charge an interest rate which is at least equal to the
rate of inflation during the period of the loan. In such a situation, the
monetary authorities cannot stimulate the economy by lowering interest
rates further. The alternative is to increase the money supply directly by
injecting liquidity into the financial system as the UAE Central Bank
has recently done. However, there is the real fear that most of this new
liquidity, about $30 billion, will be ‘trapped’ with banks because of the
low rate of interest. An alternative explanation of the recent economic
slowdown is that the economy has suffered from the recession portion
42
This ‘liquidity trap’ situation was also prevalent during the Great Depression in
1929, and during the Japanese recession in the late 1990’s.
56
of the business cycle brought on by high rates of inflation in Dubai

which can only be ‘corrected’ by allowing the recession to liquidate the
‘wrong’ investments during the boom 43. In such a situation, govern-
ment intervention of any kind will worsen the recession or even delay a
much bigger one.
The financial sector in Dubai has also attracted highly skilled
professionals in the wake of the current global financial crisis. Interna-
tional branches of investment banks have set-up shop to cater for the
needs of high net-worth customers in the Gulf region by providing spe-
cialized ‘boutique’ services and acting as suppliers of capital to other
sectors, especially to the real estate sector. The current upgrading of the
financial infrastructure of Dubai will considerably increase overall
factor productivity as businesses will be able to raise capital and benefit
from more diversified financial products. To reinforce the confidence in
the financial sector and to reassure investors, the Dubai government re-
cently injected $20 billion into the banking system to ease credit con-
cerns and provide liquidity. The recent global financial crisis has also
provided the opportunity for Dubai to boost its position as ‘the’ region-
al financial hub by providing a highly conducive business environment
to enable the financial sector to innovate new products tailored to the
specific needs of high net-worth Gulf investors.
43
This is also sometimes known as the Austrian explanation.
57
Economic Policy vs. Commercial Policy

Economic Policy Effectiveness
When economic commentators speak of economic policy, they
usually speak in very general terms such as the establishment of new
companies, increases in investment, changes in consumer spending, in-
creases in exports and imports, and the like. Even policies at the firm
level are considered as economic policy. For an economist, economic
policy tries to influence underlying macroeconomic variables using the
tools of economic policy to steer the economy to desired growth paths.
Given limited tools and instruments in a market economy, policy
makers must usually choose between different macroeconomic priorit-
ies and do not have the luxury of choosing optimum policy tools due to
trade-offs. For example, if policy makers target lower inflation, it will
be at the expense of higher unemployment. If they wish to increase
consumer spending, it will be at the expense of higher budget deficits,
and so on. But all policy makers strive to achieve macroeconomic sta-
bility44 using ‘standard’ economic policy tools, knowingly and some-
times unknowingly, such as monetary policy, fiscal policy, trade policy,
and labor policy. Monetary policy deals with controlling the money
44
Macroeconomic stability exists when key economic relationships are in balance—
for example, between domestic demand and output, the balance of payments, fiscal
revenues and expenditure, and savings and investment. These relationships, however,
need not necessarily be in exact balance. Imbalances such as fiscal and current ac-
count deficits or surpluses are perfectly compatible with economic stability provided
that they can be financed in a sustainable manner.
58
supply through changes in the interest rate. Fiscal policy has to do with
government expenditure and revenue. Trade policy tries to affect the
terms-of-trade with its trading partners by changing (or fixing) ex-
change rates; and labor policy tries to affect underlying labor market
forces to influence the wage rate (the price of labor).
The effectiveness of economic policy, as demonstrated in many
financial and economic crises, is not as certain as policy makers would
like to perceive45. There are simply too many variables in the real
world, and too many psychological reasons (‘expectations’) for policy
tools to have a full impact on economic aggregates (such as on GDP,
inflation, unemployment). But even under ‘ideal’ circumstances, the ef-
fectiveness of economic policy is based on behavioral assumptions. For
example, if the responsiveness of consumers to changes in taxes is not
very strong, then a given decrease in taxes will not have much effect on
economic growth. Similarly, if a change in the money supply is not re-
sponsive to changes in the interest rate, then a decrease in the rate of in-
terest will not increase liquidity. There are many such examples in eco-
nomic policy where its effectiveness depends on the validity or ‘robust-
ness’ of underlying assumptions. The effectiveness of economic policy
in Dubai is further complicated by the fact that economic policy (mon-
etary, fiscal, trade, and labor) is conducted by the federal ministries at
the country level. The money supply is controlled by the Central Bank
of the UAE; fiscal policy is determined by the federal government;
trade policy is determined by trading relationships with the UAE; and
45
For an extensive discussion on the effectiveness of economic policies and the reas-
ons as to why policy makers cannot always choose ‘optimum’ solutions, see the sec-
tion on ‘The Luxury of Choosing First-Best Solutions’.
59
labor policy is determined by the UAE Ministry of Labor. This unique

situation has somewhat reduced Dubai’s degrees of freedom in con-
ducting independent economic policies as we know it.
Nevertheless, Dubai has been successful in conducting its own
economic policies, sometimes in coordination with other emirates, to
achieve desired outcomes46. The ineffectiveness of monetary policy, for
example, is due to the fixed exchange rate with the US dollar which
forces the UAE interest rate to move in the same direction of the US
rate of interest. The increase in the money supply, on the other hand, is
influenced more at the domestic level through changes in banking regu-
lations, and by increasing the confidence in local banks, institutions,
and financial markets. But even under these constraints, the Dubai gov-
ernment was recently successful in issuing government bonds to fin-
ance its economic growth47. Trade policies have focused on increasing
trade through bilateral agreements, the expansion of existing ports and
the construction of new ones, and by positioning Dubai as a trading hub
for multinational companies. Fiscal policies have tended to be on the
expansionary side given the rapid development of the Dubai economy
and the continuous upgrading of its infrastructure. In June 2009, the
government announced a further expansionary stimulus by announcing
a 30 percent reduction in most of its fees to further boost economic
activity. And finally, labor policy has been conducted by wage agree-
ments with labor exporting countries (primarily with Southeast Asian
46
Note that ‘commercial policy’- those to do with rules and regulations to affect mar-
ket structures at the industry and sectoral levels - is extensively discussed in the next
section.
47
In early 2009, the Dubai government issued $20 billion worth of bonds which were
subsequently purchased by the Abu Dhabi government with an annual yield of 4%.
60
countries) and by enforcing labor substantially improving working con-

ditions, especially for the unskilled segment of the labor force.
But perhaps the two most important policy issues that have been
the focus of much attention in recent months are the GCC currency uni-
fication and the introduction of a value added tax (VAT). The main ar-
gument for the introduction of a common currency in GCC countries is
that it will reduce foreign exchange costs of intraregional transactions 48.
A unified currency will eliminate foreign exchange commissions paid
by firms and households when exchanging regional currencies. A uni-
fied currency will also eliminate uncertainty about bilateral exchange
rates. The ultimate benefit of eliminating these costs and uncertainties
is that it will increase intraregional trade and investment, and will con-
tribute to advance the region’s economic integration. In addition, since
trade between GCC countries is mostly in non-oil goods, the elimina-
tion of these costs will enhance non-oil sectors which are important
strategic objectives of GCC countries. But the benefits of a currency
union will be relatively small because of the relatively small size of in-
traregional trade between GCC countries49. Moreover, current exchange
rates between GCC countries are already virtually fixed because of
their fixed exchange rate systems with the US dollar (except in
Kuwait). Nevertheless, when the benefits of a currency union are evalu-
ated in terms of the contribution to the non-oil sector, the benefits are
48
In May 2009, the UAE exhibited ‘reservations’ in joining the currency union due to
disagreements on the location of the GCC Central Bank. Although the UAE was the
first country to propose the establishment of the GCC Central Bank on its soil, other
GCC members chose Saudi Arabia (Riyadh) as its location.
49
The value of intraregional exports represented less than 10% of the total value of all
GCC exports compared to over 50% in the European Union. See Jadresic (2002).
61
significant. When both crude and refined oil exports are excluded from
intraregional trade data, total exports among GCC countries increases
to over 40%, and for some countries such as Kuwait and Qatar, this fig-
ure is as high as 60%50.
One major disadvantage of a currency union is that countries
have to give up the option of unilaterally changing their exchange rates.
This is considered a disadvantage because there is always the possibil-
ity that a country might face a large current account deficit and will not
be willing to bear the full adjustment costs of lower nominal wages and
lower prices in a currency union. Another cost of a regional currency
union is that countries will lose the independence and control of their
domestic monetary policies. Although one could argue that the effect-
iveness of monetary policy is already very limited under the current
fixed exchange rate system with the US dollar, countries can still influ-
ence domestic liquidity by printing their individual currencies,
something that would not be possible in a currency union. But perhaps
one of the greatest fears of joining a currency union is that countries
that face no fundamental economic problems of their own may end-up
suffering negative monetary spillovers from macroeconomic imbal-
ances of other countries. In other words, the monetary union may be
forced to modify existing monetary and exchange rate arrangements for
the ‘common good’ despite the objections of an individual country
which may ultimately experience the adverse effects of the changes in
50
Rose (1999) has found that after controlling for variables such as geographic prox-
imity, existence of established trade agreements, language, common cultures and his-
tories, two countries that share the same currency trade 3 times as much as they would
with separate currencies.
62
these arrangements. However, given that all GCC countries are oil
and/or gas exporters, an external shock will affect all countries such
that their interests will eventually converge. Moreover, they may al-
ways jointly decide on changing the peg for the common currency in
the face of common external shocks.
A second policy issue which has gained much attention in re-
cent months is the introduction of a value added tax (VAT). The general
concern is that this tax will ultimately lead to higher prices and add ex-
tra pressure to already rising rates of inflation. A VAT is a tax on all
sales of goods and services at every stage of the production process. Its
defining feature is that it credits taxes paid by firms on their inputs
against taxes they charge on their sales – i.e. the government collects
revenue on “value added” throughout the production process. Its distin-
guishing feature is that it does not affect the prices firms pay for inputs
because the tax is ultimately passed-on to the final consumer. Since it
does not affect input prices, it does not cause any production distortions
and does not create “cascading”51.
Perhaps the biggest advantage of the VAT is that it is very prac-
tical to implement since it is collected at every stage of the production
process. As a simple example, suppose firm X sells its output to firm Y
for a price of $100, which in turn sells its output to the final consumer
for $300. Assume now that there is 10% VAT. Firm X will now charge
firm Y $110, remitting $10 to the government in tax. Firm Y will
charge consumers $330, remitting tax of only $20 (output tax of 30$
minus a credit for the $10 of tax charged on its inputs purchased from
51
Cascading is a “tax on tax” when a tax is levied on both the output and on the final
inputs used in the production of that output.
63
firm X). The total revenue of the government is therefore $30. Al-
though this is equivalent to a 10% tax on final sales of $300, this meth-
od of collection secures the revenue more effectively. In other words, if
firm X, for some reason, were to omit charging tax to firm Y, the gov-
ernment would still collect $30 from firm Y. If firm Y were to omit
charging the tax, the government would at least collect the $10 from
firm X. The advantage of VAT over a standard sales tax on final con-
sumption is that if the final retailer (firm Y) somehow were able to
avoid paying tax, then the government would still collect $10 from firm
X. With a sales tax, the government would receive nothing52.
Despite the problems faced by economic policy makers in gen-
eral, and problems associated with the definition of economic policy as
economists understand it, Dubai has been highly successful in formu-
lating effective economic policies53. This is primarily because policy
implementation in Dubai is taken very seriously with strict timelines
and monitoring mechanisms. The effectiveness of economic policies in
most emerging economies is hampered by poor enforcement and
‘loose’ implementation due to bureaucratic red-tape and the lack of
qualified professionals. Even in developed economies, the effectiveness
of economic policy is hampered by special interest groups with their
52
The ultimate payer of the tax is the consumer. Thus, there is some justification
about the concern on rising costs-of-living. For a detailed yet very simple discussion
on VAT, see Liam E. et al (2002).
53
The effectiveness of economic policy can be measured either in a partial equilibri-
um model or a general equilibrium model. In the former, the modeler looks at the ef-
fect of the policy on a single market in isolation from the rest of the economy. Such
models are common in the analysis of the impact of a policy on a specific industry. In
a general equilibrium model, the analyst looks at the effect of the policy on the whole
economy by modeling inter-industry transactions and linkages between different eco-
nomic agents such as firms, households, the government, and the rest of the world.
64
own objectives, and by the fact that governments may be ‘voted out’
and will not have the required time to implement a given policy.
Moreover, any economic policy will have ex-post undesirable outcomes
affecting economic groups disproportionately and which cannot be de-
termined until the policy is fully implemented ‘on the ground’. The
secret of Dubai’s success in increasing its economic policy effective-
ness is that these undesirable outcomes are quickly rectified through the
establishment of specialized task-forces, working-groups, committees,
and other specialized agencies. Perhaps a good example of the effect-
iveness of economic policies in Dubai is the current implementation of
the Dubai Strategic Plan (2015) which contains hundreds of initiatives
and action plans to triple Dubai’s GDP to over $100 billion by 2015.
The DSP(2015) is having some undesirable, yet expected impacts such
as a rising cost-of-living and falling real wages which are being recti-
fied by a special task-force on inflation and the signing of agreements
with labor exporting countries to increase wages.
65
Commercial Policy and Market Structure

Notwithstanding the limitations of economic policy in the tradi-
tional sense, Dubai has adopted commercial policies in the form of
laws, rules, regulations, and projects to attract foreign investment and
affect market structures. Perhaps the most important of these commer-
cial policies has been the establishment of Free Zone Areas as interna-
tional business hubs in a wide range of sectors and services such as
Dubai Airport Free Zone, Dubai Healthcare City, Dubai Knowledge
Village, Dubai Industrial Park, and much more54. Dubai is well placed
midway between Europe, Asia, and Africa and provides its clients with
a huge customer base of over 2 billion people. An outstanding logistics
infrastructure is one of the free zones’ key strengths. Dubai has also the
world’s 7th largest seaport and the upcoming Al Maktoum International
Airport will be the world’s largest cargo airport. Free zones also
provide a range of facilities which include pre-built modern warehouses
ready for lease, office space in various sizes, and plots of land from
small and large scale operations such as manufacturing and extensive
warehousing. Free zones enjoy a wide range of commercial incentives,
from a 100% foreign ownership, zero corporate and income taxes for a
period of 50 years, to exemptions from local labor restrictions, full re-
patriation of profits and capital, and no foreign currency restrictions -
attributes seldom found in other parts of the world.
The two commercial policies which have had the greatest im-
pact on Dubai’s economic growth are the Trade Agency Law and the
54
For a comprehensive list of all free zones in Dubai see eyeofdubai.com
66
Company Law55. The Trade Agency Law grants special privileges to

UAE nationals to import specific goods. The law has been criticized on
various grounds for restricting competition. Recently, the government
has been considering the enactment of a Competition Law to limit the
goods that UAE nationals can import, and some items, especially food
items, have been exempted from this law to increase the availability
and choice of these products due to the rising cost-of -living. The Com-
pany Law restricts foreign ownership of companies to 49% of total cap-
ital except in Free Zone Areas. Some sectors, especially the service sec-
tor such as education, healthcare, and technology, have been exempted
from this requirement on the grounds that such restrictions have held
back human capital development by discouraging highly skilled profes-
sionals to start their own businesses in areas other than in the free
zones. Despite the many advantages that these laws provide to foreign
companies, both the Trade Agency Law and the Company Law have
been unfairly criticized by international organizations, especially the
World Trade Organization, on the grounds that they discriminate
against foreigners and distort resource allocation56.
Many other commercial policies, initiatives, and projects are
also formulated and implemented by the various Dubai government de-
partments and agencies such as the Department of Economic Develop-
ment (DED), Dubai Chamber of Commerce and Industry (DCCI),
Dubai Ports, Customs and Free Zone Corporation, and Dubai Municip-
55
See UAE Federal eGovernment Portal http://www.government.ae/gov/en/biz/start/incorp.jsp
56
See World Trade Organization (2006).
67
ality, to name just a few57. The Department of Economic Development

was established with a mission to contribute to economic planning and
business sector regulation by recommending policies and preparing de-
velopment programs and projects. Its most important goal is to create a
competitive investment environment to attract local and foreign invest-
ment, and to organize the business sector according to best practices. To
achieve this goal, DED has been instrumental in conducting specialized
studies on different economic sectors, recommending policies and pro-
cesses to attract investments, performing regular reviews of its rules,
regulations and procedures, and becoming close partners with the
private sector. DED has also several projects to enhance competitive-
ness and human capital. ‘Intilaq’ (which means ‘take-off’ in Arabic) is
a project initiated back in 1999 to encourage all UAE citizens residing
in Dubai to start their own home-based businesses within the frame-
work of certain regulations and professions to preserve the residential
character of neighborhoods while permitting certain limited commer-
cial activities such as fashion design, educational services, and broker-
age services. DED has also launched a ‘Human Development Initiative’
which includes a number of projects and awards that aim at upgrading
and developing human resources.
The Dubai Chamber of Commerce and Industry (DCCI) started
its activities in 1965 with only 450 members, and by the end of 2007
had over 100,000 registered members representing all economic sec-
tors. DCCI has been continuously streamlining its processes to simplify
57
For a comprehensive list of all Dubai government departments and agencies and
links to their respective websites, go to www.dubai.ae
68
and expedite the setting-up of businesses in Dubai by acting as an in-

formation and research center by providing business documentation, of-
fering legal services, facilitating business networking opportunities, and
providing effective business solutions to the business community. The
Dubai Ports, Customs and Free Zone Corporation encompasses Dubai
Ports World (DP World), Dubai Customs (DC), Jebel Ali Free Zone Au-
thority (JAFZA), and Dubai Multi Commodities Center (DMCC). Ter-
minals in Dubai are among DP World’s flagship facilities and are
ranked as the 7th top container port in the world handling 11 million
TEU of cargo in 2007. Dubai Customs facilitates free trade and helps
secure the integrity of Dubai’s borders. Its major duties are the collec-
tion of customs revenue and the administration of trade measures. It has
also implemented information networks to minimize customer hassle
and manage risk efficiently. Jebel Ali Free Zone Authority (JAFZA) is
spread over an area of 50 square kilometers and ranks among the
world’s largest and fastest growing free zones. Since 2000, JAFZA has
grown by over 3 times its original size and is situated between Jebel Ali
Port and the upcoming Al Maktoum International Airport. It is the only
free zone in the world located between these two major logistic ena-
blers, and with a six lane highway, JAFZA will facilitate the transporta-
tion of goods from sea to air in just 20 minutes. The Dubai Multi Com-
modities Center (DMCC) was created to establish a commodity market-
place in Dubai and provide a full range of facilities for gold, precious
metals, diamonds, colored stones, energy, and other commodities. Its
objective, among others, is to facilitate the integration of the entire
value-chain of its key segments by providing a highly supportive busi-
69
ness environment. DMCC is a Free Zone Area offering participants

100% ownership, a 50 year tax exemption, and a one stop shop facility
for processing all documentation including immigration, registration,
and licensing.
The highly supportive role of the government through these
commercial policies has attracted a large number of firms into the ser-
vice sector58, especially in the retail, hospitality, finance, and real estate
sectors, creating a very healthy competitive market structure59. These
markets in Dubai are characterized by fierce competition, primarily
through marketing and advertisement campaigns, to differentiate their
products in terms of quality, taste, preferences, and other attributes res-
ulting in the provision of a wide variety of goods and services catering
to the distinct needs of various income groups especially in the retail
and hospitality service sectors. On the other hand, the market structure
in the telecommunications sector can be described as an oligopolistic
structure in which there are only 2 service providers, Etisalat and du,
which, unlike oligopolies in the traditional sense, do not collude but
compete to improve their services. Some service sectors, such as utilit-
ies, are ‘natural’ monopolies because of strategic reasons but do not act
58
The relative growth of the manufacturing sector has been slow because of Dutch
Disease effects through an appreciation of the real exchange rate – i.e. a unit of the
foreign currency now buys less domestically manufactured goods. This has reduced
the competitiveness of the manufacturing sector.
59
Market structure refers to ‘the degree of competition’ in a specific market which
ranges from perfect competition to monopoly. In a perfectly competitive market, there
are many buyers and sellers dealing with a single homogeneous product. In a mono-
poly, there is a single producer. In the real world, however, market structures fall
somewhere between these two extremes such as monopolistic competition where there
are many buyers and sellers but a differentiated product, and oligopoly in which few
firms (2 to 10 depending on the size of the existing market) dominate the market.
70
as typical monopolies in the sense that they do not restrict output to

charge higher prices. This is especially true of the Dubai Electricity and
Water Authority (DEWA) which has relatively low tariff rates, espe-
cially if one takes into account the scarcity of water resources in the re-
gion. Moreover, the price of gasoline is much lower than prices in other
countries because these prices are heavily subsidized by the govern-
ment. Most ‘outsiders’ incorrectly think that Dubai is rich in oil just be-
cause it is in the Gulf. On the contrary, Dubai has very limited oil re-
sources and purchases most of its oil needs at international prices.
71
Governance and First-Best Solutions

Governance Indicators
The secret of Dubai’s economic success is also explained by the
intimate involvement of the Dubai government in the provision of
goods and services to consumers and businesses alike. Governments,
by definition, are inefficient because they do not allocate their re-
sources using the price mechanism. In a market economy, the price sys-
tem acts as a powerful signaling mechanism ‘telling’ producers what
and how much to produce. In other words, in a market economy, de-
mand creates supply. If a typical government wishes to supply a
product or a service to the public, its ‘price’ is not determined by de-
mand and supply factors. This misallocates resources by producing
goods and services that are not demanded by the public, or by under-
producing and creating shortages. For this reason, the Classical school
of thought holds the view that the role of the government should only
be a regulatory role such as policing and judiciary, and should not inter-
fere in the market system. On the other hand, the Keynesian school of
thought advocates government intervention in the market system
through fiscal policies (taxes and government expenditure) to help
achieve desired economic outcomes60. Although in the real world there
60
Prior to the start of the Great Depression in 1929, the Classical (or laisez faire)
school of thought was the dominant school arguing that any market inequalities will
be automatically corrected by the ‘invisible hand’ through the forces of demand and
supply, and there is no need for government intervention. However, the high and per-
sistent levels of unemployment during the Great Depression were not eliminated
through automatic market corrections and the government had to interfere extensively
through its use of Keynesian expansionary fiscal policies by reducing taxes and in-
72
is always some form of government intervention, the recent collapse of

the global financial system and the subsequent intervention of govern-
ments to bail-out these financial institutions demonstrate the dominance
of Keynesian government intervention over the classical ‘hands-off’ ap-
proach. The secret of Dubai’s economic success has been the govern-
ment’s deep involvement in the market and its genuine desire to im-
prove its performance; again, a highly counterintuitive approach com-
pared to the role of many other governments in emerging economies.
Governance is defined as ‘the manner in which public officials
and institutions acquire and exercise the authority to shape public
policy and provide goods and services’. 61 The difficulty in measuring
government performance is that unlike the output of commercial entit-
ies, the ‘output’ of the government is a highly subjective concept influ-
enced by the views and opinions of individuals, firms, and experts. As
Einstein’s quote reminds us, “not everything that can be counted
counts, and not everything that counts can be counted”, Dubai has been
highly successful in choosing those indicators that matter most. In prin-
ciple, all governance indicators fall into two groups: rules-based and
outcome- based indicators62. In the former, we determine the existence
(or non-existence) of a rule, and in the latter we look at the implement-
ation of the rule ‘on the ground’. For example, in a rules-based indicat-
creasing government expenditure.

61
Although there are many definitions of governance depending on the level of devel-
opment and the political structure of a country, most definitions agree on the import-
ance of a capable state operating under the rule of law. For an extensive and practical
discussion on governance and its many indicators, see World Bank (2007).
62
For a detailed discussion and list of rules-based and outcome-based indicators, see
Kaufman and Kraay (2007).
73
or we determine if there are rules ‘on the book’ on, say, compulsory
education, and we ‘map’ this rule to outcomes ‘on the ground’ by ask-
ing the public through opinion surveys if it perceives the country to
have a good education system 63.
Dubai has been very innovative in the use of governance indic-
ators to measure and evaluate government performance through various
programs and initiatives64 such as the Dubai Government Excellence
Program (DGEP), the Dubai Government Performance Measurement
System, the Mohammed bin Rashid Program for Leadership Develop-
ment (MBRPLD), and many innovations in e-Government to improve
performance and delivery of public services. Most of these programs
and initiatives are outcome-based governance indicators. The most not-
able of these programs is the Dubai Government Excellence Program
(DGEP) which was initiated at the Department of Economic Develop-
ment (DED) in 199965. Its main objective, among many others, is to es-
tablish a guiding reference and benchmarks to measure the progress in
effecting change and evaluate the performance of public agencies ac-
cording to established criteria in different categories divided into ad-
63
The most frequent criticism of such indicators is that it is impossible to trace back a
specific outcome ‘on the ground’ to a specific rule ‘on the books’ because there are
many other variables that can influence the outcome. Moreover, there is no clear de-
marcation line between rules-based and outcome-based indicators, and both types of
indicators are highly subjective and are based on value-judgments.
64
For an excellent discussion on the Dubai experience in governance, see Al Yousuf
(2005).
65
The original name of the program was the Sheikh Mohammed bin Rashid Govern-
ment Excellence Award which was conceived as an innovative impetus to speed up
the pace of change and drive all administrations towards improvements, increased ef-
ficiency and effectiveness.
74
ministrative excellence and employee excellence 66. In 2002, the ‘mys-

tery shopper’ was introduced to the evaluation process, and in 2003 the
concepts of employee satisfaction and departmental social responsibil-
ity for the community were added. Also in 2003, a category called ‘Ex-
cellence in Departmental e-Government’ was added with the aim of
achieving a paperless public administration. In 2004, the original mod-
el67 was changed to the European Business Excellence model which en-
hances innovation, learning, and transparency. Today, in a highly publi-
cized ceremony broadcasted nationwide, winners are granted promo-
tions and substantial monetary rewards for their achievements. After
seven years of its launching, DGEP commissioned the services of a
team of experts from Cranfield School of Management in the UK to
measure the impact of the excellence models on public administration
and users of public services. Their study concluded that DGEP is cred-
ited as being the ‘key driving force’ behind the remarkable performance
of the public sector. To ensure a more professional approach to the col-
lection, analysis, assessment and monitoring of performance results, the
government has recently installed a state-of-the-art performance man-
agement software to assist departments in the preparation and submis-
sion of their applications for evaluation.
The government has also achieved remarkable progress in the
application of electronic on-line tools in the provision of a wide range
of services to the general public. The Dubai e-Government initiative
was launched in 1999 and currently handles 90% of about 2000 public
66
For an in-depth discussion of the inception of this program and its subsequent
modifications, see Makharita, R. (2005).
67
The original model was an adaptation of the US Malcolm Baldrige model.
75
services provided by the government. For example, Government e-Ser-

vices Statistics (GeSS) measures the levels of e-Enablement from over-
the-counter services to e-Services by government departments; the e-
Complain service allows all customers to electronically record and
track their complaints against government entities which are then for-
warded to the respective departments to improve customer satisfaction;
e-GovCards is a convenient, flexible, and highly secure alternative to
carrying cash, and has all the advantages of a standard payment card in
addition to unique government-related features; and mPay enables one
to make payments using the mobile phone. All of these electronic ser-
vices have considerably reduced transaction costs and increased com-
petitiveness with the ultimate objective of increasing overall economic
productivity. According to the United Nations international classifica-
tion, Dubai has reached the fifth and final stage in the project lifecycle
of e-Governance by offering fully integrated services through a single
portal, namely, www.dubai.ae
To sustain the development of the Dubai economy and further
improve governance, the government has also been supportive of creat-
ing ‘future leaders’ to achieve the ambitious targets of the Dubai Stra-
tegic Plan (2015), and beyond. The Mohammed bin Rashid Program
for Leadership Development (MBRPLD) is a highly innovative pro-
gram comprising of four categories – Young Leaders, Promising Lead-
ers, Government Leaders, and the Director-General Majlis. The overall
aim of this program is to foster leadership skills in UAE nationals to
ensure local sustainable development in partnership with leading insti-
tutes such as INSEAD, Harvard, Duke Corporate Education, and the
76
like. The program was launched in 2003 and has produced over 150
graduates who are employed in government and semi-government or-
ganizations. Some graduates have also been employed in the private
sector and a number of them are currently leading new projects and es-
tablishments. The distinguishing feature of MBRPLD is that it tries to
achieve balanced growth in various fields of leadership by providing
the opportunity to all UAE nationals to develop their ‘hidden’ leader-
ship abilities in their specific areas of interest. In this way, each future
leader is given a chance to distinguish himself or herself in their chosen
field of expertise. The program is regularly updated to take into account
regional and international developments such as the recent launching of
a training program on Business and Finance Fundamentals in response
to the current global financial crisis.
It is also important to note that the deep involvement of the
Dubai government in the economy does not imply that the government
will always act as a lender of last resort to bail out under-performing
establishments. The raison d’être of the government’s interference in
the economy of Dubai is to increase competition by creating a healthy
competitive environment for all, both private and public establish-
ments, so that they can compete on a level playing field. The ‘moral
hazard’ problem – a situation in which large establishments perceive
that the government will always bail them out – was clearly demon-
strated in the bail-out of US and other financial institutions.68 The risk
68
The argument for bailing-out large establishments is that their collapse will have
ripple-effects throughout the rest of the economy and cause irreparable damage. This
argument is misleading since the financing of the bail-out is harmful by itself since it
is paid for by the public in higher taxes.
77
of bailing out inefficient establishments, whether private or public, is

that this would breed more inefficiency and ultimately decrease overall
productivity. Perhaps the best example of the absence of the ‘moral
hazard’ problem in Dubai is the recent fall in the price of Emaar stocks,
a partially government owned real estate developer, in which the gov-
ernment has not interfered to boost its stock price. This has forced
Emaar to cut labor costs by laying-off hundreds of workers and restruc-
ture to increase profitability. In other words, under-performing estab-
lishments, even public ones, do not get special treatment in the highly
competitive Dubai market. Again, a highly counterintuitive approach
compared to the support granted to inefficient ‘natural’ monopolies in
most other emerging economies.
78
The ‘Luxury’ of Choosing First-Best Solutions

The secret of Dubai’s economic success can also be explained by
the government’s ability to choose first-best optimum solutions to pressing
economic problems. In most advanced economies, first-best solutions are
determined by social science researchers using a wide range of sophistic-
ated ‘models’ to replicate the effects of a specific policy which ‘theoretic-
ally’ enables them to choose the ‘optimum’ policy among many alternat-
ives. But models are nothing but rough representations of the workings of
a real complex economy with a countless number of unpredictable vari-
ables which can influence the outcome of a given policy69. Even if model-
ers were able to accurately capture these real world variables in their
policy analyses, there are certain aspects of the real world policy making
process that are incompatible with the utilization of research. For example,
research requires a clear definition of the problem and the variables to be
measured which is not always possible because governments tend to have
loosely defined and multiple, even contradictory, objectives. Moreover, the
need for research often becomes apparent too late because of other more
urgent priorities. It is also important to realize that in the real world, espe-
cially in Western societies, policy decisions are arrived at through a bar-
gaining process to satisfy the political needs of the ‘opposition’ or some
special interest group. For all these reasons, accuracy and specificity are
sacrificed at the expense of ‘broad statements of principles’ declared by
69
This does not mean that models are not important. On the contrary, models simplify the
real world by focusing on variables that matter most, especially in determining the direc-
tion and magnitude of a specific policy change. In other words, just like travelling from
one city to another, we do not need to know every single landmark on the way. The direc-
tion and distance of the route will get us there.
79
governments that are not easily amenable to rigorous research and analys-
is.
Another important aspect of the policy making process is that the
objectives of researchers and government policy makers are not always the
same70. Policy makers in government are more interested in distributional
issues such as ‘winners’ and ‘losers’, whereas policy researchers are con-
cerned with efficiency issues such as the efficient allocation of scarce re-
sources. Moreover, most policy makers in government tend to have back-
grounds in law and thus favor legislative instruments as opposed to using
incentives to affect economic behavior. University research is also not very
suitable for policy makers because it takes much longer to produce re-
search results at academic institutions than a policy maker in government
with a short deadline can tolerate71. Nevertheless, there are three condi-
tions under which first-best solutions are most likely to be adopted by gov-
ernments72. The first of these conditions is when research is concerned
with critical future outcomes such as forecasting population growth rates
or rates of growth of the economy. The second condition is when there are
powerful competitive pressures and incentives to innovate. And the third
condition is when government departments are highly accountable and
must somehow justify the policy decisions they take. Bearing in mind that
first-best solutions can be adopted by governments under these conditions,
it is indeed encouraging to see that Dubai satisfies all three conditions.
70
See Glover, D. (1991).
71
This does not mean that university research is not important. It simply implies that uni-
versity research is ‘research for knowledge’ as opposed to ‘research for action’ which the
policy maker in government requires in a relatively short period of time especially when
the economy is in a recession.
72
See Faulhaber and Baumol (1988).
80
With respect to the first condition, a big chunk of policy research

in Dubai has been concerned with forecasting critical future outcomes for
planning purposes. For example, the Dubai Strategic Plan (2015), cur-
rently being implemented by the government, is based on several assump-
tions on the rate of growth of population, on the number of incoming tour-
ists, on the cost-of-living, on the supply of housing, and many other de-
terminants of the successful implementation of the DSP(2015). We also
need to bear in mind that the Dubai economy is currently a ‘supply-driven’
economy where the government is building both the soft and hard infra-
structures of the economy to attract investors, tourists, and different types
of labor. The objective of the DSP(2015) in the long-run is to transform
Dubai into a ‘demand-driven’ economy in which production of both goods
and services will be determined by tastes, preferences, consumer behavior,
and expectations. For policy purposes, it is much easier to forecast future
critical outcomes in a ‘supply-driven’ than in a ‘demand-driven’ economy
because there are fewer uncertainties in a ‘supply-driven’ economy. For
this reason, the Dubai government has been able to choose first-best op-
timum solutions from many alternatives. Moreover, critical future out-
comes, especially in the short-run, are much more relevant in a rapidly
changing economy because the DSP(2015) can be modified, especially
during the initial stages of its implementation, to achieve its highly ambi-
tious objectives73.
The Dubai economy is also a highly competitive economy and
there are numerous incentive structures in place to encourage innovation
in both government and industry. The fulfillment of this second condition
73
In May 2009, the government announced that the targets and assumptions of the Dubai
Strategic Plan (2015) were to be revised and adjusted to current global market conditions.
81
is self-explanatory since the very definition of ‘competition’ necessitates

the choice of first-best solutions to achieve optimum outcomes in a com-
petitive environment. These powerful competitive forces have been re-
peatedly demonstrated throughout the book either in the form of market
forces beyond the control of the government (Dutch Disease effects) or in
the form of incentive structures such as the various excellence programs
and awards to encourage innovation in governance and the establishment
of ‘technology’ clusters to encourage innovation in industry. And finally,
the third condition of accountability of government departments was ex-
tensively discussed in the previous section. The fulfillment of all three
conditions, by no means an easy and ‘luxurious’ task, has enabled the
Dubai government to choose first-best optimum solutions.
82
Dubai Strategic Plan (2015) and Sustainability

Building-Blocks of DSP (2015) 74
Dubai’s economic growth has been truly remarkable with double-
digit real GDP growth rates and a relatively high per capita income despite
negligible dependence on oil. The driving force behind Dubai’s economic
performance has been the government through investments and other initi-
atives supported by the private sector. Economic performance at the sec-
toral level has also been impressive and has been led by the trade, con-
struction and real estate sectors with good signs of successful diversifica-
tion. In particular, since 2000, real GDP has been growing at a compoun-
ded annual growth rate of 13%, by far exceeding that of its GCC counter-
parts. The Dubai economy has also been growing faster than the emerging
economies of China and India, and the developed economies of Ireland,
Singapore, and the US.
Much of Dubai’s current success has been a result of its bold and
visionary leadership and innovative human resources, mainly driven by
government policies aimed at improving the business and investment en-
vironment, in addition to initiatives to establish specialized zones and
megaprojects such as Internet City, Media City, Healthcare City, the Palm,
Dubailand, and much more. These developments ensured a leading role
for Dubai and help attract excess regional liquidity in the form of foreign
direct investment. Economic growth has also been fueled by private sector
participation in developing sectors for which the government has set the
74
This section follows closely The Executive Office (2006). Highlights: Dubai Strategic
Plan (2015), Dubai… where the future begins. Dubai, United Arab Emirates.
83
stage by establishing a conducive business environment, coupled in many

instances with heavy initial investments to boost private sector confidence.
Other supporting factors are supply-side factors such as availability of
labor and land for major real estate projects, the existence of efficient gov-
ernment services, a solid institutional framework and good mechanisms
for service delivery, strong laws and regulations, excellent infrastructure, a
strategic location coinciding with the rapid rise in global trade especially
in China and India, and openness to other cultures giving Dubai a reputa-
tion as a safe and comfortable place to live and do business. These factors
have put Dubai’s real per capita GDP at $31,104 in 2005 with an annual
average growth rate exceeding 6% over the 2000 - 2005 period75.
Economic performance at the sectoral level has also been impress-
ive. The non-oil sector has played a more prominent role since 2005 with a
95% contribution to GDP, as compared to 90% in 2000, and 46% in 1975.
This was mainly the result of the reduced dependence on oil as well as a
deliberate policy of diversifying the economy in favor of non-oil sectors in
which both the overall business environment and sector-specific programs
have played vital roles. The service sector has been the key driver of eco-
nomic growth with an annual growth rate of 21% since 2000, constituting
$27.6 billion or 74% of Dubai’s current GDP. In particular, the trade sector
has experienced the highest increase in the share of GDP. Although the
contribution of the manufacturing and oil & gas sectors has decreased, the
manufacturing sector has grown by an average of 12% since 2000. The
75
Dubai’s per capita income today compares very favorably to that of many developed
countries such as Singapore’s ($26,836) and Hong Kong’s ($25,493), countries which re-
quired a much longer period of time to reach their current high levels of GDP.
84
construction and real estate sectors have also exhibited share gains primar-
ily due to the availability of land, labor, domestic and foreign capital, and
changes in regulations.
Dubai’s current GDP mix is very favorable as its strongest sectors
by international standards happen to be highly conducive to future global
growth. These sectors are tourism, transportation, construction, and finan-
cial services, and are well-placed to constitute the focal point of Dubai’s
future growth path within the economic development sector plan. Building
on Dubai’s remarkable economic performance and future trends, economic
targets for 2015 have been set and are classified into the following cat-
egories: (1) Economic growth: sustain a real GDP growth rate of 11% per
annum for the next 10 years and increase real GDP per capita to $44,000
in 2015; and (2) Enhanced labor productivity and sector development: in-
crease productivity by 4% per annum, move existing sectors of strength to
new frontiers (both domestically and internationally), create new sectors
of strength with sustainable competitive advantage, and promote innova-
tion to develop new sectors and increase productivity.
The recommended future strategic growth path is based on 6 com-
binations of sectors, or vertical building blocks, including, among others,
sectors such as tourism, trade, transportation, and financial services76.
These sectors were identified based on their current status, international
competitiveness, Dubai’s capacity to develop them, and local availability
of required factor conditions. However, targeting these building blocks
will not yield rapid and sustainable growth unless 7 horizontal enablers
for growth are addressed in parallel, namely, human capital, productivity,
76
These are strong sectors by international standards which are highly conducive to fu-
ture growth.
85
innovation, cost-of-living and doing business, quality of life, economic

policy and institutional framework, and laws and regulations.
The strategic thrusts supporting the achievement of economic de-
velopment targets are described as: (1) Sector focus and development:
moving Dubai to a new growth path, coupled with further diversification
while maintaining focus on high-value added sectors that can boost overall
economic growth. (2) Productivity growth: transforming Dubai into a hub
of business excellence by raising the productivity of economic sectors and
maintaining high production quality standards. (3) Human capital excel-
lence: preparing Dubai’s workforce for the high-value, knowledge-driven
economy, which requires attracting and retaining highly skilled employers,
improving nationals’ qualifications, and increasing their motivation. (4)
Science, technology, and innovation capacity building: turning Dubai into
a vibrant science and technology hub in targeted sectors by supporting the
development of existing sectors and establishing the right environment for
nurturing the post 2015 economy. (5) Cost of living and doing business
management: ensuring and maintaining Dubai’s competitiveness by man-
aging the rising cost-of-living. (6) Quality of life improvement: establish-
ing Dubai as a preferred home for current and future residents by improv-
ing the well-being of citizens and residents and helping them live healthier
lives enriched with opportunities and choices. (7) Policy and institutional
framework excellence: striving for excellence in economic policy-making
and deployment through coordination with the federal government, provi-
sioning of adequate data, and strengthening the institutional framework
and capabilities. (8) Laws and regulations alignment: aligning Dubai’s
economic laws and regulations with international best practices and stand-
86
ards. The pursuit of the proposed strategic growth path will promote GDP
growth to $108 billion by 2015. This approach would strengthen Dubai’s
healthy sector mix by ensuring focus on key sectors while further promot-
ing diversification and ensuring reduced vulnerability to external shocks,
and a systematic integration into the regional and global economy. To
achieve these economic growth targets, it is estimated that 882,000 addi-
tional workers are required to join the workforce by 2015, bringing total
employment to 1.73 million with a significant move towards higher skilled
employment.
Perhaps one of the most important attributes of the DSP(2015) is
that it is a ‘live’ document constantly being updated and modified to chan-
ging regional and international conditions. During its formulation in 2005,
the major thrusts of its growth path were also based on current and expec-
ted developments in the rest of the world. Moreover, the DSP(2015) is
based on macroeconomic principles to ensure that priorities do not clash
and market forces are reinforced. The positive aspect of the DSP(2015) are
double digit economic growth, a carefully thought out strategy of diversi-
fication, a substantial increase in the share of Arabs in the labor force,
deeper integration of the economy both regionally and globally, and
strengthening of the ability of the economy to absorb and cushion the ef-
fects of external shocks through improved policy making and institutional
strengthening. On the other hand, the DSP(2015) faces many challenges
such as a declining share of nationals in the labor force, major human cap-
ital development challenges, continued reliance on imported unskilled
labor from South Asia, and the ability to attract and retain skilled workers
87
given the expected rise in the cost-of-living which is primarily caused by a

sharp increase in government spending to achieve its targets by 2015.
88
The Rising Cost-of-Living

The sustainability of the Dubai Strategic Plan (2015) depends
on, among other things, maintaining a stable level of prices to prevent
the erosion of purchasing power and attract high-skilled workers. The
rising cost-of-living in Dubai is an expected outcome because it is
primarily caused by the rapid pace of government spending as it builds
both the hard and soft infrastructures of a rapidly growing economy.
The rising cost-of-living is also fuelled by large capital inflows in the
form of foreign direct investment which has contributed significantly
towards the increase in the money supply which, in turn, has resulted in
an increase in consumer spending on both durable and non-durable
goods. The fixed-exchange rate system with the US dollar has also
caused an increase in the relative price of imports, especially the price
of imported products from euro zone countries, as the value of the US
dollar has fallen in recent years. But apart from these standard tradi-
tional causes of increases in the cost-of-living, prices have also in-
creased due to Dutch Disease effects noted earlier as resources have
shifted from tradable manufacturing sectors to non-tradable service sec-
tors which is evidenced by the dramatic boom in the real estate, tour-
ism, and financial sectors.
The standard policy prescription in most countries facing infla-
tionary pressures is to adopt contractionary monetary and fiscal policies
to decrease both the money supply and consumer spending. Contrac-
tionary monetary policies work by increasing the rate of interest to in-
crease the cost of borrowing and thus reduce business investment and
89
consumer spending. However, due to the fixed exchange rate system

with the US dollar, domestic interest rates closely follow US rates
which are currently at historically low levels. Moreover, monetary
policy is conducted at the federal level by the Central Bank of the UAE
which considerably reduces the degrees of freedom available to Dubai
in controlling the money supply. Dubai has also limited instruments in
its fiscal policy toolkit to reduce aggregate spending due to the absence
of all forms of taxation. One of its few fiscal policy instruments is to re-
duce government spending but this would ultimately work against the
achievement of the ambitious growth targets of the Dubai Strategic
Plan (2015).
Dubai has adopted price controls, a highly controversial yet
counterintuitive policy, to control the rising cost-of-living especially in
the control of rents and prices of basic food items and intermediate in-
puts. In 2006, the government imposed a 15% cap on rental price in-
creases which has been progressively lowered to 7% in 2007, and more
recently to 5% in 2008 for tenants who have occupied their premises
for 2 years. The Ministry of Economy has also recently fixed the price
of cement at $4.35 per 50kg sack and began monitoring the price of ba-
sic food items imposing penalties on producers who ‘unfairly’ increase
prices. The biggest drawback of such price controls is that they discour-
age developers and producers to invest in these markets because of
their lower profitability as a result of fixing the price below the market
price. Price controls have been tried in many countries with disastrous
outcomes such as in the South Bronx in New York where landlords
could not afford to maintain their buildings which ultimately led to the
90
creation of urban slums. Price controls also encourage the creation of

‘black markets’ since they create an artificial shortage at the lower con-
trolled price77. Moreover, country experiences have shown that since
price controls are perceived to be a temporary measure, once they are
lifted, prices tend to ‘overshoot’ as landlords and producers try to
make-up for their previous ‘losses’. Nevertheless, this highly contro-
versial yet counterintuitive policy has been partially successful in
Dubai because of strict enforcement, and because tenants are provided
greater choices as the supply of housing expands in the medium term.
Price controls have been only partially successful because of major
loopholes such as the possibility of landlords evicting ‘old’ tenants on
the pretext that they will be renovating their premises, and due to the
large volume of complaints which cannot be always handled by the
courts on a timely basis.
Against this background on the rising cost-of-living in Dubai,
the government has considered several other options to control prices.
One option would be to fix the exchange rate to a basket of currencies
with different weights according to its different trade volumes with the
rest of the world. For example, given the relatively large share of im-
ports from euro zone countries, a greater weight would be attached to
the Euro compared to the US dollar. This would cushion the inflation-
ary effects of a fall in the US dollar as the relative price of imports from
euro zone countries will not be affected by as much as under the current
fixed exchange rate system. For a more direct and policy oriented solu-
tion, the government could adopt inflation targeting which is character-
77
For example, after the imposition of the $4.35 cap on the price of cement, most pro-
ducers began selling it at $6 on the black market.
91
ized by an announced numerical inflation target, an implementation of

monetary policy that gives a major role to an inflation forecast, and a
high degree of transparency and accountability78.
The recent global financial crisis has considerably reduced the
cost-of-living in Dubai. A government report on month-by-month eco-
nomic data shows the lowest rate of inflation in nearly a decade. Since
the beginning of 2009, the rate of inflation has slowed to just 1.9%
(from 7.2%) as reported by the UAE Ministry of Economy. This fall in
the rate of inflation is explained by the fall in housing and utility costs
(which make up 40% of the basket of goods an services used in the cal-
culation of the Consumer Price Index), and decreases in the price of in-
termediate inputs such as steel and cement. The price of steel has fallen
by almost 70%, and cement prices have fallen by an average of 22% in
2009. Moreover, the Ministry of Economy has signed several Memor-
anda of Understanding with large retailers and cooperative societies to
fix the price of basic food items. Annual inflation in January of 2009
stood at 7.2%, slowing to 6.2% in February, 4.5% in March, and 1.9%
in April according to the latest figures published by the Ministry of
Economy. In 2008, the average rate of inflation was 12.3%, peaking at
13.5% in the second quarter of the same year. Due to this fall in the
price level, some economists are predicting a deflation which could
have severe negative repercussions on the domestic economy79.
78
See Blum and Durlauf (2007) for a more detailed definition of inflation targeting.
79
The main problem with deflation is that people in debt (a large number of people
during a recession) will be worse-off. When someone has borrowed $1,000 from a
bank, a 10% annual deflation rate will increase the burden of the loan by 10% - i.e.
the borrower has to pay back $1,100 in a year’s time. Conversely, when the rate of in-
flation is 10% annually, then the burden of the loan will be only $900 since the pur-
92
However, given the expansionary fiscal policies in the form increased

government expenditure to finance the rapid development of the Dubai
economy, it is highly unlikely that the Dubai economy will fall in a de-
flationary trap.
chasing power of the dollar has decreased by 10%.
93
Some Labor Issues

As outlined in the Dubai Strategic Plan (2015), to achieve its
ambitious targets of generating an annual average GDP growth rate of
11%, Dubai requires an additional 880,000 workers by 2015. The bulk
of these workers, about 70%, will be in the construction and related ser-
vice sectors which would add to existing labor problems especially in
the unskilled segment of the labor force. Currently, there are approxim-
ately 500,000 unskilled workers in Dubai, mainly from Southeast Asian
countries (India and Pakistan) which constitute close to 50% of the
labor force80. These workers earn a net monthly income of between
$150 and $250 and live in labor accommodations in designated areas.
Recent labor unrests and disputes have increased the profile of these
workers, and the government has taken serious steps to improve their
working conditions. These labor protests have been primarily caused by
the fall in workers’ real wages due to the fall in the US dollar and rising
rates of inflation which have reduced their purchasing power and their
ability to remit a large chunk of their incomes to their families in their
home countries. Another source of tension has been caused by the illeg-
al actions of labor recruiting agencies which charge unskilled workers
for work visas and related costs, a practice illegal under UAE labor
laws. Non-payment of wages on a timely basis by construction com-
panies has also been a major source of tension in recent months.
Having realized these problems, the government has begun to
take serious steps to improve working conditions and act as an enforcer
80
Statistical Yearbook – Emirate of Dubai (2007). See Table 03-02, pp 91-92.
94
of existing labor laws and regulations. Tens of thousands of unskilled

workers have taken advantage of a summer-long amnesty in 2007 for
illegal workers agreeing to either legalize their residence status or leave
the country. In recent interviews, officials at the ministries of economy
and labor have said that there is no sign of an impending labor short-
age. Plenty of workers are eager to enter the country to take the place of
leaving workers. In addition, regulators have enforced midday sun
breaks, improved health benefits, upgraded living conditions, and
cracked down on employers bold enough to stop paying workers at all.
To this end, the Ministry of Labor has just launched a Salary Protection
System to ensure that workers receive their wages on time by requiring
all companies in to transfer worker salaries to personal bank accounts.
In a break with past practices, the Ministry of Labor has been backing
the demand of the workers. In cases where companies are not able to
pay wages, the Ministry has tapped company bank guarantees to pay
back wages. It has also barred some companies from hiring additional
workers which has led them to close their Dubai operations, and has
helped existing workers find new jobs. At the GITEX 2008 exhibition
recently, a mobile-phone service was launched to meet the financial
needs of low-income workers. The service, called “Alo”, is a pay-as-
you-go mobile service which has been designed to suit the needs of un-
skilled workers. Workers will not have to pay subscription fees but only
a monthly installment fee of less than $2. The service, apart from the
normal mobile package, will inform workers about changes in labor
laws, provide labor news and other labor related information, and will
enable easy communication between workers and the government.
95
Moreover, in a highly innovative initiative, Etisalat, the local telecom-

munications company, will soon enable laborers to send remittances to
their home countries through their mobile phones using a system called
mPay. This will greatly ease the burden of unskilled workers by avoid-
ing the high transfer fees paid to traditional money remittance compan-
ies and exchanges.
Other initiatives include the proposed establishment of an
agency directly under government supervision to stop the practice of
labor agencies to charge illegal work visa fees. Currently, most labor
agencies recruiting workers from Southeast Asia openly charge the men
and women they bring to the country the ‘cost’ of their visas which is
illegal under UAE labor laws. Due to this practice, many workers have
to take out loans of more than $2,000, often at high interest rates. As a
consequence of this practice, a construction worker uses a chunk of his
monthly wages towards the repayment of the loan, forcing him into a
cycle of debt. Since this illegal practice emanates in the workers’ home
countries prior to the worker’s arrival in Dubai, the government has
signed several agreements with labor exporting countries to prevent
such practices and set minimum wages and standards which has consid-
erably improved working conditions and wages. Moreover, the relat-
ively low wages that these unskilled workers receive in their home
countries is still a big incentive for them to migrate to Dubai even un-
der the assumption that Southeast Asian economies, especially India
and Pakistan, have experienced recent economic boom. This is because
most of the new jobs created in these countries are more suited for
skilled and semi-skilled workers. The government has also been con-
96
sidering shutting down the labor agencies that recruit construction

workers and build ‘worker cities’ to replace about 170 labor agencies
currently licensed by the Ministry of Labor.
The government realizes the importance of labor issues and has
taken many concrete steps, as outlined above, to improve their working
conditions. In the words of one official, “a happy worker is a more pro-
ductive worker”. This is especially true of unskilled workers in the con-
struction sector who are building the infrastructure of a rapidly growing
economy to meet the ambitious targets of the Dubai Strategic Plan
(2015). However, the boom in the real estate market will gradually
slow down in the coming few years as many projects have been
delayed or put on-hold, in turn reducing the profitability of the real es-
tate sector to ‘normal’ levels. Nevertheless, given the speed at which
real estate projects are completed in Dubai and the slowdown in the
global economy, there will always be labor disputes to tackle, just as in
any other market type economy.
97
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Tuesday, August 04, 2009 DRAFT 09

The Secret of Dubai’s

Ohan S. Balian, Ph.D.

economic principles. It also argues that counterintuitive ideas, in both

financial crisis has considerably reduced capital inflows into Dubai, in

To be counterintuitive, one has to be highly competitive and

Economic success also depends on the effectiveness of econom-

Einstein famously noted, “Not everything that can be counted counts,

ic’ research for optimum outcomes, there are so many complexities in

Counterintuition and Super-Competitiveness

The Dutch Disease model distinguishes between a resource

services only for domestic consumption.

goods in the domestic economy as it did before. This real appreciation

Super-Competitiveness and Productivity

There is no readily available economic theory that could be ap-

tion will be in a better position to absorb and learn from imported

ant in improving the process of innovation because it is regarded as a

The secret of Dubai’s economic success can be explained by its

panies from a variety of sectors - software development, business ser-

personal taxation, zero corporate taxation, and a state-of-the-art IT

Capital Inflows and Investment

evidenced by the increase in construction and related activities. The

intervention, one has to take into consideration these shortcomings and

residential and commercial properties. The government in 2006 im-

However, profitability in the non-tradable sector, especially in real es-

powerful as standard Dutch Disease effects demonstrated earlier be-

tions. Whereas ‘leisure’ tourism is regarded as non-essential expendit-

the most impressive shopping cum entertainment mega event. An en-

ness because Dubai is successfully competing with countries which

jects a population of 2.5 million people which includes workers, resid-

mark for future eco-tourism projects worldwide and is one of several

and a collection of some of the most renowned world-class chefs in-

sports parks, a themed shopping mall as well as a 20,000 seat multipur-

have made good progress in strengthening financial supervision by the

of the business cycle brought on by high rates of inflation in Dubai

Economic Policy vs. Commercial Policy

labor policy is determined by the UAE Ministry of Labor. This unique

countries) and by enforcing labor substantially improving working con-

Commercial Policy and Market Structure

Company Law55. The Trade Agency Law grants special privileges to

ality, to name just a few57. The Department of Economic Development

and expedite the setting-up of businesses in Dubai by acting as an in-

ness environment. DMCC is a Free Zone Area offering participants

as typical monopolies in the sense that they do not restrict output to

Governance and First-Best Solutions

is always some form of government intervention, the recent collapse of

creasing government expenditure.

ministrative excellence and employee excellence 66. In 2002, the ‘mys-

services provided by the government. For example, Government e-Ser-

of bailing out inefficient establishments, whether private or public, is

The ‘Luxury’ of Choosing First-Best Solutions

With respect to the first condition, a big chunk of policy research

is self-explanatory since the very definition of ‘competition’ necessitates

Dubai Strategic Plan (2015) and Sustainability

stage by establishing a conducive business environment, coupled in many

innovation, cost-of-living and doing business, quality of life, economic

given the expected rise in the cost-of-living which is primarily caused by a

The Rising Cost-of-Living

consumer spending. However, due to the fixed exchange rate system

creation of urban slums. Price controls also encourage the creation of

ized by an announced numerical inflation target, an implementation of

However, given the expansionary fiscal policies in the form increased

chasing power of the dollar has decreased by 10%.