Is the rise of Dubai and Abu Dhabi sustainable?

The economic success that the cities of Dubai and Abu Dhabi have achieved over the past two decades has undoubtedly been impressive – not least in recent months, when economic activity has continued to accelerate in spite of weak oil prices. Despite the diversification that has helped boost both cities’ economic recovery, however, the question of whether they now have the fundamentals for sustainability in place to weather another economic crisis requires a more thoughtful response.

Looking ahead, it seems fair to project that the next decade will be characterized by instability in the region, oil price fluctuations and revitalized competitive cycles of innovation in the East and West, which are transforming our way of life at a rapid pace. These forces will all provide a healthy test for Dubai and Abu Dhabi’s economic resilience.

In a report recently published by the World Economic Forum, Dubai featured among a small group of globally competitive cities that can lay decent claim to setting an example for best practice. The incredible speed of this development and the ambition of Dubai’s vision have amazed the world, spurring other cities in the region to greater ambitions and, if not to copy the model, than to differentiate themselves by referring to it.

Both Dubai and Abu Dhabi have achieved this success through smart, and often long-term, strategic thinking. This has seen them match and in some cases supercede the requirements of  globally competitive cities along the main pillars of competitiveness, namely institutions, policies and regulations of the business environment, and hard and soft connectivity which have in turn helped attract vast amounts of foreign investment.

Such measures provide a bedrock upon which future competitiveness can be built. However, challenges remain. Dubai in particular faces risks caused by several factors, such as the pace of growth, a possible real estate bubble and dependence on Gulf oil-based economies.

This is, of course, what happened in the past. As the pace of growth accelerated after the year 2000, many institutions were formed and bold moves were made in the space of 10 years. The 2009 crash in over-inflated real estate prices brought declines of around 50% and triggered a corporate debt crisis that sent shockwaves of concern across the international investment community.

Dubai has recovered from that situation, but sharp price rises are making the International Monetary Fund nervous about the speed at which recovery is happening. Because Dubai’s debt has continued to rise, it might have difficulty coping with fresh instability, while the risk of a real estate bubble remains real. The IMF estimates that about $64 billion of debt held by Dubai and government-affiliated enterprises will come due between 2014 and 2016. The heated situation in the Middle East region may be the source of indirect risks on the UAE, as oil prices may fluctuate and markets in the region may become unstable due to these conflicts. These risks are beyond the control of Dubai or Abu Dhabi as cities; however, mitigating them by reducing other risks is what matters.

Away from macroeconomics, the two cities have no doubt positioned themselves as the seat of global companies and local ones who want to become global. However, the race for this position has limited the opportunity for homegrown innovation that is commensurate with the global status of the two cities. While both cities have adopted innovation enthusiastically themselves,  and large companies have been able to efficiently operate from that base, small companies (who usually fuel innovation and are a key determinant of future competitiveness) still find it hard and expensive to establish themselves and grow.

Unlike large organizations, administrative complexities and costs may be a barrier for small innovative companies, especially those operating in the e-commerce space. Venture-capital and exit potential for start-ups is also limited, as financial risks and banking regulations may prove to be strenuous for small business start-ups.

This may be one of the most critical challenges facing innovation, and it is a challenge that authorities appear to be taking seriously, with a recently announced innovation strategy for Dubai aiming to, among several things, address this issue.

There are other signs, too, that the UAE of the future will benefit from a more liberal approach to market competitiveness, with a higher degree of independence for regulators and efficient, private-sector-owned infrastructure such as telecommunications, transportation and power. The recent appointment of a world-class regulator from Singapore to oversee Abu Dhabi’s development as a financial centre serves as a reminder that the direction of travel is a good one.

The positions of Dubai and Abu Dhabi as regional (and even global) hubs is not going away. Both will face competition from other cities in the region and around the globe, as well as from the continual economic headwinds that will buffet their many industries. But Dubai has built a remarkably resilient economic diversity in a short period of time, and one detects a bit of envy in both the admirers and critics of its and its neighbour’s models of growth.

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Author: Ghassan Hasbani is author of Oasis Economies, The Middle East in 2030, and a member of the Global Agenda Council on Competitiveness.

Image: An aerial view of Atlantis hotel is seen with The Palm Jumeirah in Dubai December 21, 2009. REUTERS/Matthias Seifert