The Importance of Local Content in GCC
Effective local content policies can create significant benefits for the GCC, as governments seek to encourage higher in country value, the creation of more domestic jobs and economic diversification across the region
GCC countries are investing heavily in infrastructure projects, with a priority to develop local suppliers. In Saudi Arabia, the government is expected to spend USD 1.1 trillion from between 2019 and 2038. During the same years, the UAE should put some USD 350 billion into infrastructure. These large sums will support economic growth, lead to more jobs, and improve overall economic performance. However, these positive effects could be blunted if governments do not avoid deep-seated biases in how they formulate their local-content policies.
To avoid much of this investment going abroad to foreign contractors, GCC governments have local-content policies that seek to steer infrastructure spending toward local providers. In too many cases, however, these efforts do not reach their targets as the approach is marred by conceptual biases among policymakers. GCC policymakers can fix this by identifying and comprehending the nature of these biases. By doing so, they will avoid common shortfalls in local content policies and instead craft schemes that will keep most of the gain from infrastructure spending at home.
Local content policies are critical for the GCC. Such initiatives encourage local companies to maximize in-country value in the provision of goods and services. More importantly, they promote the shift away from dependence on oil exports. Local content programs can foster corporate capabilities among GCC firms, thereby positioning them to become exporters of non-oil products.
“Local content policies are critical for the GCC as they encourage local companies to maximize in-country value in the provision of goods and services.”
The GCC is not alone in its quest to promote local content. At present countries outside of the Organization for Economic Cooperation and Development (OECD) have some 300 local content requirements. In Brazil, the government is gradually upping the local content demand for offshore deepwater oil and gas exploration and development work to 65% from 30%. Similarly, Indonesia stipulates that local suppliers receive 71% of the spending for electrical power infrastructure, and 50% from wireless broadband equipment projects.
The difficulty is that although these requirements make economic sense, the details of policy design and implementation often fall short. In many cases, policymakers are under pressure, both from their own leaders and the public, to demonstrate that infrastructure spending is providing opportunities to local firms and creating local jobs. This can lead to policies that are not grounded in objective analysis and fact. Instead, without knowing it, the most experienced professionals fall victim to unconscious biases in reasoning and evaluation.
Most common are three illusions related to the false aggregation of demand, fixation on familiar objects, and absolutist target-setting.
The first, the false aggregation of demand, involves policymakers believing that there is more opportunity for localization from a certain product category than it actually exists. This mistake occurs because a product category is often more complex and varied than it appears initially. Within any product category there are items with the same description but that are substantially different in terms of size, design, and cost. One example is valves. These can be a lump of plastic costing a few cents or precision, engineered, equipment with price tags of tens of thousands of dollars. Although both are valves, it creates a fictitious market opportunity to place such different objects in the same category.
Second, the fixation on familiar objects, involves policymakers focusing on product categories that they know well rather than on components that add more value to the economy. For example, governments are so keen on local companies assembling solar panels that they levy import duties on the necessary sub-components such as solar cells. Such a policy is counterproductive as it puts local manufacturers of high-value-added sub-components such as solar cells at a disadvantage when compared to cheaper imports. Policymakers therefore need to remember that local content is not about positive headlines, but value creation.
Third, absolutist target-setting, involves policymakers seeking high percentages of local-content without considering how much value they create. This approach is not surprising given the social pressure for more local-content. However, the problem is that local content policies can destroy value if they go beyond a certain level.
“Saudi Arabia is expected to spend USD 1.1 trillion from between 2019 and 2038.”
To combat these biases, policymakers should use behavioral and analytical safeguards. These are mutually reinforcing and complementary.
Analytical safeguards mean a quest for precision. Policymaker must create detailed baselines of such information as local manufacturing capabilities and all procurement spending, including sub-components and raw materials. Governments can thereby quantify the economic value from local content policies. Simple, accurate measures also help governments refine policies by testing the data.
Behavioral safeguards require policymakers to be conscious that, in common with everybody else, they have cognitive biases. This can assist them in locating and discarding ingrained thinking. To do so, they must promote debate and opposing views, particularly from junior employees who see how policies are being implemented. It is important to scrutinize policy recommendations through adversarial debate and external expert reviews. The result should be more rigorous policy formulation and means of promoting local-content that are more robust.
Getting local-content policies right is critical. The wrong decisions can damage an economy over the long-term and erode national competitiveness. A deliberate, bias conscious method for drafting and implementing local content policies will lead to better policies, more effective promotion of local content and broader economic gains.
“Between 2019 and 2038, the UAE has earmarked USD 350 billion for infrastructure investment.”
About the authors:
Dr. Shihab Elborai, Partner, Strategy& Middle East (formerly Booz & Company), part of the PwC network
Dr. Raed Kombargi, Partner, Strategy& Middle East (formerly Booz & Company), part of the PwC network
Dr. Yahya Anouti, Principal, Strategy& Middle East (formerly Booz & Company), part of the PwC network
Anthony Yammine, Manager, Strategy& Middle East (formerly Booz & Company), part of the PwC network