The Impact of Capital Formation on Economic Diversification in GCC Countries—Empirical Analysis Based on the PVAR Model

Abstract

Economic diversification has been a cornerstone of the policy agenda of resource-rich countries, such as Gulf Cooperation Council (GCC) countries, seeking sustainable economic development to avoid reliance on hydrocarbon revenues that cause significant vulnerabilities and economic, social, and political instability in the long term. GCC governments invest the proceeds from rich hydrocarbon exports to build a diverse local economy. However, it is unclear whether increased capital formation through public investments helps these economies diversify away from hydrocarbons. The main objective of this study was to determine whether GCC countries’ capital formation has appreciable impulse effects on response–economic diversification in the short or long term. A panel vector autoregression method describing the cause and effect or the dynamic relation between capital formation and economic diversification was used to attest to the success of economic diversification policies in resource-rich countries. The results show that a shock to real gross capital formation has a limited impact on economic diversification (the non-resource rent share) in the GCC economies. This could be attributed to these countries’ oil/gas-focused fixed investment build-up. Furthermore, an evaluation of the recursive relationship shows that the impact of growing non-hydrocarbon sectors on gross capital formation is limited.