The Myth of the Middle Eastern Economy

The nine-month-long war between Israel and Hamas in the Gaza Strip has devastated the Palestinian economy. According to the World Bank, Gaza’s GDP in the last quarter of 2023—reflecting only the damage wrought by the war’s beginning—was 86 percent lower than it had been in the last quarter of 2022, and food insecurity now affects 95 percent of the strip’s inhabitants. In the West Bank, unemployment surged from 13 percent in the third quarter of 2023 to 32 percent by the end of that year, the highest recorded rate. The ruling Palestinian Authority has been pushed to the brink of outright financial collapse; a June analysis by the International Crisis Group found that its debt to commercial banks and its arrears to its own pension fund has mounted to as much as $11 billion.

When the war began, some analysts predicted that these negative economic effects would ripple throughout the region, driving sharp increases in energy prices and declines in revenue from tourism. But this has not happened. The war has yet to seriously disrupt energy markets, the usual barometer of instability in the Middle East. The ability of the region’s economies to access debt has not widely deteriorated, either: bond issuances in the Middle East and North Africa reached $73 billion in the first half of 2024, an increase of 59 percent from the same period in 2023. Not surprisingly, Saudi Arabia accounted for 49 percent of those bond proceeds, followed by the United Arab Emirates (UAE), with 29 percent, and Qatar, with ten percent.

This stability should not have come as a surprise. The reason it did is that for decades, Washington has mistakenly interpreted the Middle East’s economy as cohesive, fueled by the Gulf’s oil and gas. This view often led U.S. officials to relegate economic diplomacy to the back burner. As the Gulf economies grew, the officials anticipated that the region’s economic health would hinge on local bailouts and investments—an expectation that to some degree bore out after the Arab Spring, when Gulf states vied to rescue Egypt.

But Middle Eastern countries have long boasted starkly different economic capacities, and the regional economy has been divided between energy exporters and importers. Even that dichotomy has now become much more complex. Since the Arab Spring, the Gulf states’ advantages have far outstripped the market and technology access sought by their energy asset-rich but poorly governed neighbors such as Algeria, Iran, Iraq, and Libya. Moreover, since 2016, the wealthier Gulf states (Qatar, Saudi Arabia, and the UAE) have been less inclined to provide aid, investment, and trading opportunities to their neighbors as they seek to invest domestically and prepare for their own post-carbon future.

U.S. economic policy initiatives toward the region have not caught up with this reality. They have typically focused on establishing new westward trade corridors, making arms deals, incentivizing governments to join U.S. energy security investments (including in critical minerals in Africa), and promoting technology and energy access in Israel and the eastern Mediterranean. But the United States must acknowledge that the region’s energy exporters’ customers and future demand lies in China, India, and Japan. Promoting the idea of new westward trade routes and partnerships is a diplomatic pleasantry, but it will do little to actually change the region’s economic direction.

Expecting the promise of normalization and trade links to change the course of the war in Gaza is a mistake, too. Too often, Washington’s entire foreign policy toward the Middle East has promised widespread economic benefits in exchange for peace. These initiatives are complicated by the fact that the United States’ fundamental position toward Iran remains unresolved since former President Donald Trump’s withdrawal from the 2015 Iran nuclear deal. This strategic ambivalence encourages Iran to continue to support regional terrorist groups and threaten both governance and growth in Iraq, Lebanon, and Syria. 

Iran has not yet prevented the Gulf states from growing economically, but the specter of terror and the disruption of transit routes by Iran-backed groups remains an ongoing threat. If the United States worked harder to disable Iran’s malign regional activities, that would not alter the Gulf states’ increasing eastward orientation. But it would be the best way, in the near term, for Washington to benefit the Middle East as a whole—and would be more effective than the current, misguided attempts to lump the region’s diverse economies together and direct their growth westward.

BUSINESS AS USUAL

Devastating as it has been to Palestinian livelihoods, the Israel-Hamas war has revealed the Middle East’s existing economic trajectory more than it has changed that trajectory. The economic effects of the past year’s battles in Gaza have remained relatively contained, despite direct conflict between Israel and Iran and widespread Arab outrage at Israel’s military operations. But Gaza was already isolated before October 7. Its economic collapse has not proved contagious, although a full-fledged refugee crisis would wreak immediate economic and political havoc on Egypt.

The war in Gaza has certainly affected the Israeli economy. Employment has been disrupted by reserve-duty call-ups. Government spending surged by more than 88 percent in the last quarter of 2023, and the country’s economy is increasingly relying on debt, which over time could lead to a weakened currency and inflationary pressure. Outside Israel and Gaza, shipping through the Red Sea has been most affected. Revenue from the Suez Canal dropped nearly a quarter between July 2023 and June 2024. But with a generous $8 billion International Monetary Fund loan agreement as well as European Union loans and $35 billion in revenue from land sales to the UAE, Egypt has avoided dire financial crisis.

Outside Israel and the Palestinian territories, the region as a whole is still muddling along. Only a direct effort by Iran to defend Hamas and Hezbollah and to attack oil infrastructure or transit lanes would shake Middle Eastern oil markets. The oil trade has experienced no physical disruption at the most vulnerable chokepoint, the Strait of Hormuz; roughly 15 million barrels of crude and oil products still flowed through this waterway every day during the first quarter of 2024, while about 20 percent of the world’s liquid natural gas exports passed unhindered from Qatar through the strait. Analysts at Energy Intelligence, a data and analytics firm, believe that the risk to oil markets has largely already been priced in at a premium of $3–$5 per barrel. An abundance of non-OPEC supply, notably from the United States, has kept oil prices from spiking.

Because OPEC Plus producers—led by Russia and Saudi Arabia—have extended production cuts into 2025, global demand for oil is likely to continue to just exceed supply, strengthening prices to the $85 per barrel range by the end of year. Although the United States continues to levy sanctions on Iran, American leaders do not wish to provoke direct conflict or wholly impede Iran’s ability to export oil, which keeps oil markets stable and prices lower. Even when U.S. President Joe Biden decided in April to ramp up U.S. sanctions on Iranian oil routed to China through secondary exporters—namely Malaysia and the UAE—oil prices hardly budged. U.S. Treasury officials have had a hard time discouraging the rebranding of Iranian oil products as products from other countries; Iran still evades the United States’ sanctions scheme relatively easily and continues to bring its oil products to market.

SPLIT SCREEN

More broadly, U.S. policymakers have failed to recognize that the region’s wealthiest economies are focused on strengthening their trade partnerships with Asia, not with the West, and with competing with one another. In practice, the Middle East is becoming a set of “flyover” states that are either mired in conflict (Iraq, Lebanon, Libya, Syria, and Yemen) or stagnating (Egypt, Iran, and Jordan) as their growth and linkages to global markets shrink. In April 2024, the World Bank found that on average, the Middle East and North Africa region has a nearly a 90 percent debt-to-GDP ratio. Ten years ago, this average ratio was more like 75 percent. With the exception of the members of the Gulf Cooperation Council and perhaps Morocco, most of the region’s states are dealing with the double burden of conflict and high debt, expected low growth rates, and inflationary pressure from weakening currencies and are struggling to balance their dollar-denominated debt burdens with social spending needs.

Meanwhile, other states such as Oman, Qatar, Saudi Arabia, and the UAE are progressing in their ability to generate non-oil growth and diversify their economies. These energy exporters are also borrowing heavily, now averaging a 30 percent debt-to-GDP ratio compared with ten percent a decade ago. But this borrowing is paying off: the Gulf national oil companies are now more likely than the big U.S. oil companies to boast major renewable-energy projects and investments. These countries’ economic opportunities are secure because of the Asian markets they are now accessing, not because of their ties within the Middle East or Europe. The International Energy Agency has projected that between 2022 and 2028, 90 percent of the growth in oil demand globally will come from the Asia-Pacific region, which will also drive increased demand for liquefied natural gas as its countries pivot away from coal.

Strong hydrocarbon sales have helped these relatively flourishing Middle Eastern states begin to convert the power sources for existing manufacturing industries such as steel and ammonia manufacturing from oil to low- or zero-carbon energy sources, making these exports more appealing to customers aiming for green transitions. The Arab oil giants are also pursuing new shared investments with China in solar manufacturing and power plant development. The Chinese companies TZE, Sungrow, and JinkoSolar, for example, are all expanding exports and their manufacturing capacity in the Middle East, most notably in Oman, Saudi Arabia, and the UAE. The links between Asia and the Middle East are hardly confined to oil. According to data from the International Trade Centre, a multilateral agency established to help developing countries access global markets, Gulf exports of plastics, chemicals, rubber, and precious metals to Asia totaled around $56 billion last year and have the potential to increase by another $50 billion by 2030. Saudi Arabia now hosts over 1,300 plastic factories and has become a leading exporter of plastic and rubber products to China.

Most important, Asian countries—particularly India and China—have focused on expanding free-trade and economic cooperation agreements with the Gulf rather than imposing new trade restrictions. In May, an HSBC analysis projected that cumulative foreign direct investment flows between Asia and the Middle East, particularly the Gulf states, will total over $270 billion over the next ten years, up from less than $140 billion over the past decade. A Comprehensive Economic Partnership Agreement between India and the UAE, for instance, which has been in force since May of 2022, has proved crucial to boosting the UAE’s non-oil industries, driving aerospace exports from the UAE to India from $40 million in 2022 to $2 billion in 2023.

TRADE ACCEPTANCE

Yet the way U.S. policymakers continue to view the region as a coherent whole tends to anchor its interventions narrowly on Israel and on stabilizing energy prices, rather than proceeding from an acknowledgment of how diverse states are positioning themselves differently to achieve economic security. The United States’ efforts to push a cease-fire deal in Gaza have incorporated proposals for Middle Eastern economic integration, including the normalization of diplomatic ties between Israel and Saudi Arabia, which would help Saudi Arabia gain the security guarantees and nuclear technology access it craves. But it would do little to spur investment in either country or to settle the disputes between Israel and the Palestinian Authority. In cease-fire negotiations, the United States has also pushed for the creation of new trade corridors connecting the Gulf to Europe, including the much-vaunted India–Middle East–Europe Economic Corridor. A rapid deepening of the region’s economic ties would have been a long shot before October 7. But Hamas’s attack, Israel’s subsequent military operations, and the Gulf states’ eastward turn have made it even less likely.

When U.S. policymakers have considered trade and investment opportunities across the Middle East, Israel has typically been an attractive stopover partner to access Israeli technology and a foothold in the eastern Mediterranean gas fields. The three top foreign direct investment destinations in the Middle East, in terms of number of new projects and investment allocations, are Israel, Saudi Arabia, and the UAE. These states may be willing to invest in one another, and they share an interest in the continued stability of the Egyptian economy and ease of shipping through the Suez Canal. But they do not see a shared development project across the Middle East.

The United States’ strategic priorities with respect to the Middle East are actually quite simple: compete with China and limit Iran’s influence. But economically speaking, the United States cannot challenge Chinese dominance in the Middle East by building a new, competing Silk Road. U.S. economic policy toward the region must accept that China will remain a key trade and investment partner. China is now shifting its own supply chains by seeking Gulf-based co-investors in Chinese oil refineries; in the Gulf, it is establishing joint ventures in new energy industries such as solar-panel and electric-vehicle production. Because China has never competed with the United States to supply any Middle Eastern country with defense and aerospace capabilities, Washington may choose to focus more narrowly on its defense pacts, especially those with the Gulf states and Israel. Although defense-focused partnerships also constitute important trade relationships, for the United States, they cannot constitute a winning long-term economic or diplomatic strategy in the Middle East.

It is a mistake to believe that a two-state solution could make the whole Middle East flourish.

In the longer term, however, Washington must also recognize that even if the Gulf powerhouses and Israel pursue greater integration they will continue to prioritize their own growth trajectories and preferred partnerships. Many U.S. officials have put great emphasis on Israeli-Saudi normalization, both to help advance a cease-fire in Gaza and to deliver a blow to Chinese and Russian influence in the region by creating a circle of influence around key chokepoints in the Strait of Hormuz and Red Sea corridor. Ultimately, however, normalization between Israel and Saudi Arabia will not accelerate investment and a blossoming of trade across the Middle East. And thus dangling the prospect of greater regional economic integration does not constitute the carrot the United States hopes it might.

Ending the war in Gaza is a strategic priority that the United States and most Middle Eastern countries share. But it is mistaken to believe that a cease-fire or even a two-state solution could hasten economic integration and make the whole region flourish. The Middle Eastern countries experiencing strong economic growth must secure stable and safe eastward trade routes and connectivity to emerging markets in Asia and Africa. The United States must also come to terms with the reality of the geoeconomics of energy. Synergies in renewable energy manufacturing as well as the importance of fossil fuels to easing the transition to greener energy will continue to link the Gulf to Asia. The United States should get clear on what it can, in fact, do: it can put a price on the stability it provides in key transit corridors to the parties that benefit, both inside and outside the Middle East, including​ China. And it can act with more force to disable Iran’s terrorist web to create possibilities for better governance and growth.