Meeting Bahrain's challenges - An interview with Crown Prince

Salman bin Hamad Al-Khalifa

Sheikh Salman discusses the current economic and political reforms in Bahrain
as the country moves toward a future beyond oil.

Kito de Boer and Jaap B. Kalkman

Web exclusive, January 2007

His Highness Sheikh Salman bin Hamad Al-Khalifa has been a leading political figure in Bahrain since being named
crown prince in 1999. Yet Sheikh Salman is arguably best known internationally as chairman of the country’s
Economic Development Board, the government agency responsible for formulating and overseeing economic strategy
and attracting inward investment.

During the past six years the Western-educated Prince Salman has been at the heart of an ambitious program of
economic and political reform—a series of initiatives that has helped spur diversification and growth, eased
communal tensions, and enabled the island nation to respond to growing competition from its resource-rich
neighbors. Whereas Bahrain was the first state on the Arab side of the Gulf to exploit its hydrocarbon resources, in
the early 1930s, its fast-dwindling reserves now mean it will be the first member of the Gulf Cooperation Council
(GCC)—Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates (UAE)—to run out of oil.

Landmarks of economic liberalization thus far have included the deregulation of the telecommunications industry,
fundamental reform of the labor market, the privatization of key industries, and the negotiation of bilateral and
multilateral trade agreements with nations in the Middle East and beyond. Employment growth remains the most
urgent objective: one in eight Bahrainis is out of work, and the labor pool is expected to increase 60 percent as more
Bahrainis enter the job market during the next decade. Currently, two out of every three new jobs are going to
expatriates (mostly from the Asian subcontinent).

Bahrain’s longer-term aspirations are to regain its status as the preferred location for investment in the region,
double or even triple its per capita income by 2015, and achieve a more equitable distribution of wealth. At the very
least, the current pace of activity suggests that progress toward these targets will be carefully watched elsewhere in
the Gulf.

In this conversation with Kito de Boer, a director in McKinsey’s Dubai office, and Jaap Kalkman, a principal in the
Bahrain office, Sheikh Salman discusses the challenges of the reform process; recent changes in labor, education,
and health; and the growing sense of a national identity.

The Quarterly: The chairman of Bahrain’s National Competitiveness Council recently called for a plan, or “vision,” of
the country’s economic future. What is your personal vision?

Sheikh Salman: Bahrain is in the midst of a transition from an oil-based economy to a country in which future
growth will be driven by increasing its productivity. My vision is to guide Bahrain to accelerate the pace of reform and
to ensure that all the levers and institutions are in place so that the transition occurs in a sustainable manner. We
aim to make the private sector the engine of growth for the future. We want to join the wider global economic
community, and we want to do so on our own terms and in a transparent way.

In a nutshell we want to replace unearned income with earned income. Our biggest challenge is the demographic
one—a rapidly rising population—and our overdependence on oil. We must confront these and become more
prosperous in the post-oil age.
The Quarterly: Can you tell us about the main pillars of the reform process?

Sheikh Salman: When we launched the political-liberalization program, under the leadership of His Majesty King
Hamad, the national charter led to a new constitution and the setting up of a bicameral house [parliament]. Other
projects included municipal councils, the abolition of the state security laws, new press freedoms, the creation of
political societies, and the enfranchisement of women. Despite our relatively small size, we now have the second-
largest electorate in the Gulf.

Along with the political program we started a series of economic reforms to deliver a more sustainable future for the
people of Bahrain. The economic reforms are focused around three main pillars. The first is about enabling the
private sector to become the engine of growth for the economy. We work at this in two ways: first, we have a series
of initiatives to remove obstacles that private enterprise may face when doing business in Bahrain. These initiatives
include providing access to capital for SMEs,1 simplifying business start-up procedures, and also planning and zoning
all of Bahrain—what we call “access to land”—to give investors the confidence they need. The availability of this
information increases transparency and cuts red tape. Another aspect of this pillar is to stimulate business toward
higher-value investments in those sectors where Bahrain has a competitive advantage.

The second pillar is about government and how we move it from being the main driver of the economy to playing a
supporting role for the private sector. The efforts in this field include focusing government work on the development
of policy and regulation and privatizing the “machinery” of the economy. We have already undertaken a significant
amount of work, but there is more to do.

The final and most important pillar is about investing in the people of Bahrain. I often ask, “Whom should
development serve?” The answer first and foremost is that it must serve the people of Bahrain. We are investing
heavily in training and education to empower our people with the skills they need to become more productive
members of society.
The Quarterly: The labor reforms seem to have been the most difficult change so far. Why is that?

Sheikh Salman: Yes, this will be a significant change, and change is always a challenge. For the private sector to be
the main engine of growth we had to do something about it. In the late 1960s we created a sponsorship system,
whereby foreign workers were tied to an individual employer and had very few rights. The result, particularly in
SMEs, was to suppress wages, create working conditions that were in many cases abominable, and make foreign
workers much more competitive than Bahraini nationals. Sixty percent of private-sector jobs are now held by guest
workers.

Governments in the region, including Bahrain’s, have introduced nationalization programs that require employers to
hire a certain percentage of nationals. But of course this does nothing for productivity or wage growth—the systems
are abused, and locals end up just making up the numbers.

So what we have done is eliminate the sponsorship system: we have gotten rid of government control over the
supply of labor and instituted a levy on every foreign-worker permit issued by the state. That levy will be flexible
over time: the greater the number of people coming into the country the more we will be able to increase the levy,
though if the economy is stagnating I imagine we could reduce it to stimulate growth. The second aspect is that
there will be a unified labor market, with rights for those who did not have them before. Third, and probably most
important, the money from the levy will be put into a labor fund where it will be used as an investment in the people
of Bahrain—for example, to improve the skills of Bahraini workers and the productivity of companies in the private
sector, ensuring access to both capital and technology. It is a very exciting initiative, and my prediction is that this
model will be followed by the rest of the Gulf.

The Quarterly: There has been some vocal criticism from local companies. Aren’t foreign investors going to see this
as an additional tax burden too?

Sheikh Salman: Not really. We did a survey of foreign investors recently, and on the list of their priorities labor costs
came out as number 14—a very low priority. The top concern was access to land and utilities. Many told us that the
levy was something they were prepared to trade for a more functional society. Foreign investors are much more
concerned that the skills they require will be available in the market, without additional impediments from the state.

The Quarterly: That brings us to education, where your plans are also ambitious, aren’t they?

Sheikh Salman: As I mentioned, investing in people is very important to the future of Bahrain. So we have started a
series of initiatives that aims to raise the output of the educational system to better meet the demands of the
economy. The initiatives include the establishment of a proper teacher-training college that emphasizes the practical
as well as the theoretical, better compensation for teachers, more flexibility between the private- and public-
education sectors, and class sizes that match the best student-teacher ratios elsewhere in the world. We want to
make teaching a more noble profession that will attract the best and brightest. Another initiative is the establishment
of a quality assurance agency that will raise accreditation standards and inspections for the education system as a
whole and will rank the performance of the system through regular national exams. These are only a few of the
initiatives we are working on.
 We also need to provide for students who want to learn vocational skills, such as an apprenticeship, rather than an
academic qualification—so that, say, 50 percent of their time can be spent working with local businesses. The whole
point of educating somebody, after all, is that once they finish their education they have a future in the economy.
Getting rid of our polytechnic college was, in my view, a mistake. Not only should we take care of the students who
we know will go on to higher education, we also need to create an educational stream around the development of
practical skills.

The Quarterly: To complete the reform picture, can you say something about what’s going on in health care?

Sheikh Salman: We think private health care has a lot of potential for
‘Democracy is an evolutionary growth here in Bahrain and will create high-value jobs. We have focused so
process that we firmly believe in; at far on making sure our state-run system can become more efficient—
times debate prolongs the process, but demographics suggest we need more capacity—and we are establishing an
it ensures the inclusion of everyone in independent monitoring agency to ensure that both public and private
society’ hospitals adhere to certain standards and rules, based on international best
practices. We are seeing a lot of investment, with several clinics and fully
fledged hospitals having opened in the past five years. The goal is to supply the international market, but I’m not
going to claim that this is happening yet.

The Quarterly: Reform in Bahrain has at times involved a difficult debate within its society. What wider lessons would
you draw from this?

Sheikh Salman: Democracy is an evolutionary process that we firmly believe in. At times debate prolongs the
process, but it ensures the inclusion of everyone in society. Gone are the days when you simply decree something
and then expect it to happen. What we have to do is reach out to the community, argue the merits of certain policy
ideas, accept the challenges that come back at us, and respond in a manner that brings more people on board.

The feedback we got from the public [on labor reform] was constructive because it made us think of things we had
not thought of in the initial design. It also helped us refocus on where the money [from the levy] should go. Looking
back, if we did it again we would probably bring in a wider cross-section of the population from the beginning.

We have had to compromise, work hard, and lobby. And we had to hold our breath a couple of times as the measure
was going through parliament. Change is not easy and usually takes longer than you expect. But you should never
be discouraged, as it is worthwhile in the long run.

The Quarterly: A lot of companies in Bahrain are still controlled by the government. How and when will that change?

Sheikh Salman: Privatization will be gradual, but over this decade I would see the state retaining less and less
control. So far we have turned the previously state-owned telecommunications company into a corporate entity as
part of a liberalization process that has encouraged competition from private-sector businesses. Another landmark
was the privatization of electricity generation: the largest government-owned power plant was sold to an external
investor, and our first privately owned greenfield power plant will come on line in late 2006, while our port is now
operated by Maersk. We have privatized a lot of public health care services and are looking to privatize or sell off
part of the government’s stake in the aluminum smelter. The list goes on. Privatization is all about execution and
creating value at the end of the day; you can have good ones like British Airways and bad ones like the railways in
Britain. Privatization for privatization’s sake is not wise. In turn, the government in Bahrain will focus much more on
its role as a regulator to create a favorable business environment.

The Quarterly: Moving to the flagship financial sector, how do you feel about competition from the likes of Dubai and
Qatar?

Sheikh Salman: Competition is healthy and should make us better. I welcome it. We have a very good track record
that we can be proud of, and we are now moving into more specialized areas of the financial world. Offshore
banking, for example—a 1980s model—is dead. We aim to build a strong financial center based on private banking,
Islamic banking, capital markets expertise, and all the things that are important to the secure functioning of a
financial system. But the main thing we need to do is to invest in our people, so that they continue to be the best
bankers, and to improve the field they play on.

The Quarterly: Do you see each financial center in the Gulf specializing in different areas?
Sheikh Salman: I see the Gulf moving from a single-hub model to a multihub model. We shouldn’t be afraid of that.
There are legitimate reasons for banks to have representative offices in all the countries of the Gulf. The question
nevertheless becomes, “Where does the work get done? Where is the intellectual hub?” It is our goal to make sure it
stays in Bahrain. I see great opportunities in real estate, tourism, health care, and manufacturing, but the flagship
financial sector is the one that is really growing.

The Quarterly: Bahrain is the first GCC country to have a Free Trade Agreement with the United States. What has its
impact been?

Sheikh Salman: The agreement only came into force in August 2006, and it is still being implemented. But there has
been a tremendous amount of interest from local businesses anxious to explore the opportunities. And the US
embassy phones have apparently been buzzing. From the US side it guarantees access to manufactured goods and
services. I think the agreement is seen by the United States as a module in a larger plan to generate more free-
trade relationships with other countries in the region. We will slot into those. Hopefully, we will also benefit from
increased trade with countries that already have an FTA—for example, Jordan, or perhaps the UAE and Oman in the
future. I am encouraged because the volume of trade in Jordan went from tens of millions to hundreds of millions of
dollars in the three to four years after that country signed its FTA. We are hoping to replicate that kind of economic
stimulus.

The Quarterly: With a single currency planned for 2010, how do you think the GCC countries will develop as an
economic unit?

Sheikh Salman: Although there is political will for this to happen, I have my doubts that the 2010 target will be met
because of a number of technical issues that need negotiation before the launch of a single currency. Among these
issues are agreeing to the convergence criteria for inflation, public debt, and the setting of interest rates, for
example. A single currency requires governments in the region to start moving toward greater transparency in the
government budgetary process. Moreover, much of the potential success will depend on establishing a strong and
independent central bank to determine monetary policy.

The Quarterly: How do you assess the impact of the new political freedoms? How is the relationship with the new
parliament?

Sheikh Salman: I think it’s working very well. His Majesty the King knew that a population that had a stake in the
system would be a much more productive one, and we have seen the impact on the economy immediately. There are
problems, as in the creation of any new system, but they are not insurmountable ones. I think people feel
empowered by the new process, but it will be a constant process of evolution.

The Quarterly: Are you concerned that there are still too many parties outside the formal political system? Should
the Shia be better represented?

‘From personal experience
I would say that economic
growth is a natural
prerequisite for political
reform; it makes the latter
much easier and more
stable’
Sheikh Salman: With democracy there are freedoms, and there will always be those
who disagree. People all over the world can be dissatisfied with any system, and if I
watch CNN or Sky News, for example, there is much more criticism of their own
governments than external ones. Thank God there is a mechanism here for people
to put those ideas into practice if they have a majority view, and at the very least
express them peacefully. On the Shia, I beg to differ. Even with the boycott in the
last elections, we still had a very significant turnout, with 54 percent of the total
electorate—people forget that. And with the participation of all parties this time
[November 2006], the turnout will be more representative. You get out what you
put in.

What we need to focus on is the building of a national identity. We need to move away from the Sunni-Shia divide. It
was not there in the past and has been exacerbated by the political situation of our neighbors. The age-old power
struggle between Persia and the Arab world is reaching a frenzy, as you can see in Iraq. It’s a situation that is not
helping us, but it is something I will continue to fight. We are all Bahrainis here; we are all citizens and should not
differentiate between Sunnis and Shia. I don’t think we should allow this to dominate our political discourse. We
should focus on policy, not on religion.

The Quarterly: And as for policy, which is more important—economic reform or political reform?
Sheikh Salman: I certainly think that economic reform and growth ensure the success of political reform. I’ve heard
people talk about delaying political reform because economic reform is not yet sufficiently in place. It’s a fine
balance, but if I was forced to choose, from personal experience I would say that economic growth is a natural
prerequisite for political reform. It makes the latter much easier and more stable. But if you are willing to work hard,
then starting with political reform will yield the same results.

The Quarterly: What are the major challenges over the next five to ten years?

Sheikh Salman: The great challenge we will have in the future is defining the role of the state in this region—whether
it will remain a welfare state or a state more similar to that of a modern economy. I think this will color a lot of the
public debate, namely how much influence, control, and patronage the state will have versus how much
independence, empowerment, and influence the private sector should have. When civil society, the free market, or
the capitalist system clashes with the oil state, you will see tensions. A high price of oil exacerbates those tensions.
The minute the price of oil drops, however, the choice no longer exists. We are proud that even in an era of high oil
prices, we have been able to drive through significant reforms in Bahrain.

There is a new generation of leaders here and elsewhere in the region who want to see the prosperity they have
enjoyed continue into future generations.

About the Authors

Kito de Boer is a director in McKinsey’s Dubai office, and Jaap Kalkman is a principal in the Bahrain office.

Notes

1
Small and medium-size enterprises.