Corruption: “A form of dishonest or unethical conduct by a person entrusted with a position of authority, often to acquire a personal benefit. Activities of corruption can include bribery, and embezzlement. “
The move was long over due, too long have Saudi been plagued with corrupt public leaders that aimed to benefit themselves and their relatives at the expense of society. The costs of corruption is high, especially in shaping people’s incentives and expectations. It reduces the trust people have in the political and economic systems they inhabit. This leads to a loss of faith in the institutions and leaders they follow. Which creates the wrong incentive for people, one that is not aligned with prosperity and sustained economic growth.
Figure 1 is from the Journal of Economic Perspectives; the paper is called “Eight Questions about Corruption” by Jakob Svensson. The figure depicts a regression line of corruption on per capita income. There is a strong negative connection between the relationship between the well being of countries and corruption. Even though measuring corruption can be difficult, its impact can spread to other factors other than just income.
Corruption can also cause large wealth inequalities and labor market failures. The case can be particularly strong in Saudi. I just do not have the data to test this. Essentially, Saudi Arabia’s labor market decisions is predominantly influenced by connections rather than qualifications. If you know the right person in Saudi, you are most likely going to be hired. This reality is seen by many of us, and it causes the wrong incentive. If people are getting hired based on their connections rather than their qualifications, this can be an indication that education, experience, and training does not matter as much as it should at determining wage levels and job-skill matchmaking. Which could send all kinds of wrong labor market signals.
On an international level the move is welcomed and feared. The corruption crackdown is believed to have effected oil markets. Oil prices hit a two-year high on Monday.
Figure 3 below depicts the Saudi Riyal exchange against the US Dollar. The announcement of the arrests was on the news on November 4th. We can clearly see signs of fear against the currency that persisted for more than a day.
As Saudi approaches its vision in 2030, and Aramco’s IPO in 2018. It is going to need to signal to investors that corruption is not welcomed. Investors need assurance that their property rights and investments are going to be protected from any entity. No matter how big the family name is or how deep their pockets go, corruption does not have a place in the new Saudi Arabia.
Most economists agree that Oil is considered to be a normal good, by normal we mean that as your income goes up you would buy more of that good, that is a basic definition. As oil prices fall you would expect that oil consumption would increase, however in the short-run that is not the case. Oil in fact is inelastic in the short run, inelastic means that its consumption is not sensitive to price. Companies still need to operate at the same rate to satisfy their operations and people still need to drive to get to work. It takes time for markets to adjust and people to change their way of living. The long run is a different topic by itself and is out of the scope of this post. You are not going to buy a 8 cylinder pick up after you hear oil fell this month are you?
We can then agree that oil consumption would not change in the short run. Now we can check the graph that I have made to illustrate a theoretical approach of what consumers are going through at this point of time.
Lets say that you pay $500 rent a month for 5 years. Suddenly rent became $300, means you have $200 more to spend on other things other than rent or you could decide to save it. So in simple terms lower oil prices has caused income to increase, which means people can consume or save more than they previously could.
The Vertical Axis labeled “A.O.G”(All Other Goods)- In terms of Quantity. (The farther up means more)
The Horizontal Axis labeled “Oil”.- In terms of Quantity (Further right is more)
The red line depicts a budget. Where “I” is the starting point. The Horizontal intercept of the Budget at I & I*, to be known as (Income/Price of Oil). The Vertical Intercept is unchanged since their prices are presumed to be constant,Ceteris Paribus.
The green dotted line is Hicksion line, a line parallel to the new Budget line and tangent to the old Indifference curve.
A decrease in the price of oil would shift the Horizontal-intercept on the Oil axis to the right, meaning that “Income has risen”, as indicated I —> I*, where I*>I. Using the Hicksion method we find that initial change for the substitution effect, for as Income goes up we would have to consume more, for the normal good condition. Moving oil Consumption from X*—>X and shown on the original indifference curve Point (A) to point (C). Since we have established that oil is inelastic in the short run, so that would mean that consumption levels of Oil would go back to its initial starting level X* but on the new Indifference curve on the new budget line resulting in tangency of Point (B), which satisfies the inelastic condition, where consumption for oil does not change. However that results in A.O.G consumption increase from Y —> Y1. Which satisfies that a drop in oil prices in the short run leads consumers to spend more on other goods, Ceteris Paribus.