Economic diversification is one of the most important goals sought by oil countries, as it achieves economic stability and sustainable development, reduces dependence on oil, and reduces the volatility of economic growth. Economic diversification is one of the most important goals of previous development plans since the 1970s, which unfortunately did not achieve as hoped. Despite the efforts made, successive plans, and initiatives at the sectoral level, the goal of diversification was difficult to achieve in oil countries that did not adopt sufficient macroeconomic policies to neutralize the fluctuations of oil revenues on the local economy. Given the importance of economic diversification, it is one of the most important goals of the Kingdom’s “Vision 2030” to shift the source of economic growth from government spending to private investment and address the imbalance that the local economy suffers from.

The economies of oil countries suffer from economic instability, as a result of the oil sector shocks to the economy, which raises the level of risks and leads to an imbalance in the relationship between exportable productive sectors and non-exportable sectors such as the real estate sector and the imbalance in real exchange rates, although the nominal exchange rate is fixed with the dollar, as is the case in the Kingdom. Government spending is affected by oil revenues, whether they rise or fall, which constitutes shocks to the economy that lead to instability of the national economy and poses risks to long-term private investment.

During the phase of rising oil revenues, spending increases beyond the economy’s absorptive capacity, which raises inflation and wages. Real estate prices also rise, which raises economic costs for producers in the productive sectors, weakens the competitiveness of the local economy, and reduces the economy’s attractiveness for investment in long-term development projects, which are the most important source of sustainable development and employment. The contracting and services sector also becomes more attractive to investments and talents due to its association with government contracts with higher returns in the economy, through which investors can reduce the risks they may face. The low risks and high returns compared to other productive sectors that target exports and local demand contributed to directing bank loans to sectors associated with government projects and reduced its contribution to other sectors.

In contrast, during periods of low oil prices, oil-producing governments resort to one of two policies: the first is to reduce spending as much as possible, and the development sectors, such as health and education, which are essential for achieving sustainable development, suffer the most. The second is to focus on non-oil revenues by raising taxes and fees to maintain the high level of government spending, which has been inflated by oil revenues. This policy inevitably leads to raising the cost of business for the private sector, weakens the purchasing power of individuals’ income, and reduces real wages, which in turn reduces productivity, or the private sector is forced to raise nominal wages to maintain purchasing power. In a country like the Kingdom, more than 50 percent of the workforce is non-Saudi, so it is expected that higher wages will be required to accept work in the Kingdom, which raises the wage bill and weakens the competitiveness of the private sector. As an economic result of the increase in non-oil revenues, aggregate demand will decline and the costs of doing business will rise, so the economy begins to search for a new equilibrium point.

To achieve stability and avoid oil sector shocks on the economy, the economy needs to neutralize the fluctuations of the oil sector on the economy through macroeconomic policies, institutional building and governance, which limit the impact of oil sector shocks on economic sectors. Among the most important of these tools, which have been simplified and written about in economic literature, and proposed by international organizations, such as the International Monetary Fund, are the financial rules for fiscal policy, the most important features of which are determining the oil pricing mechanism for budget purposes, based on the average historical and future oil prices for a number of years, and directing part of the financial surpluses to a budget balance fund, in addition to an external (long-term) generations investment fund and a local development fund, in addition to determining the percentage of spending for local income and setting ceilings for revenues, as well as for public debt. In addition, determining tax rates in a stable manner during different periods of oil price fluctuations, with the possibility of changing them slightly for fiscal policy purposes.