Economics

The debate on the appropriateness of the effect created on economic growth by financial structures is one to reckon with especially with most of the modern economies. Financial structures determine how far an existing business is financed or in other words it is the credit side of a companys statement of financial position. A closer look at this topic will be geared at the use of extensive and robust research methods in defining the various economic growth and development measures and the financial structures adopted by most of the financial institutions of these economies. The main focus of financial institutions is banks and their corresponding policies with regard to finance issues and how effectively they are able to manage or mitigate risk as much as possible. We therefore use test statistics and hypothesis formulation to create a distinct comparison of financial systems and market based systems.


Financial Structure and Economic Growth.
Chapter1. Introduction
One of the biggest and most heated debates in recent financial times especially with the prevailing effects of globalization and market instability has been the impact of financial structures on economic growth.

However, varying conclusions have been made on a theoretical point of view. It is quite evident that it is very difficult to hold other factors affecting economic growth constant and assess only financial structure.  This is one evident challenge that is quite clear that the indirect effect of financial structures can be identified through the various economic growth measures.

This paper is geared at assessing three different issues as regards the topic of economic growth and financial structures namely the overall change of financial structures as economies grow, assessment of presence of financial sources and financial structure changes.

In the global world having businesses have extensively invested in portfolio analysis of the most economical yet sustainable financial structures. In this regard, they have used methods such as the Gordons model of cost of capital analysis and other measures to determine the most cost effective capital combination in making investment decisions. The impact created by these investments on economic growth is the major focus in this paper while taking direct focus on their overall sustainability.

A proposition by Mansfield (2003) and Benton (2005) is that provision of finance creates an environment that businesses are able to thrive in. A detailed analysis of this has shown that most businesses especially in the developing countries fail due to lack of access of enough capital resources, Mansfield (2003) puts it across that capital availability is the one of the most important factor of production. This just makes it clear that the essence of the presence of enough capital justifies that businesses are able to gain the rewards of capital as a factor of production.

The reward of capital as a factor of production is profit. This profit that is generated by businesses contributes to the gross domestic products when this businesses pay tax. In this analysis a detailed analysis of gross domestic product from different countries of the world extracted from word bank and International Monetary Fund will be included in this survey.

The perspective adopted by Hermann (2000) is that of a heuristic approach to the underlying concept of different forms of financial structure. Different organizations have different financial structures or capital mix. The major question in this topic is what is the influence of these different financial structures on economic growth

To demystify the different financial structures we look at the different abilities of organizations to be able to meet their capital requirements under both the financial system and the market system. To do this a detailed analysis of the characteristics, merits and demerits of these two systems is necessary.


Economic Growth
The term economic growth is used to refer to an increase in the measure of aggregate income or gross domestic product with relevance to the quantity of goods and services produced only and is usually measured as the rate of change in GDP. For the sake of comparing the per capita income for different countries, the statistics are given or quoted in a single currency depending on the prevailing purchasing power parity or exchange rates. Economic growth is either positive or negative.
 Financial structures contribute to this disparity. Economic recession and depression is normally associated with negative economic growth. To compensate for inflation or deflation, the gross domestic product is given in terms of the nominal or current figure, which is usually inflation adjusted as opposed to the actual money figure.

Measuring of economic growth is done using the real gross domestic product, real in that the effects of inflation have been adjusted. The three ways to measure growth of real GDP are the annual average growth rate, the year-over-year growth rate and the quarterly growth at an annual rate.
Financial structures define the frameworks of the various ways a firm uses to get and maintain or support resources necessary for its operations.  These entails the elements listed on the right-hand of the firms balance sheet and may include loan capital, equity capital, overdrafts and trade credit among others.   It is how these resources are utilized that leads to the assessment of economic growth.
In this analysis we try to assess how much the financial structures adopted in different countries is able to affect the gross domestic product in one way or another. The quarterly growth at an annual rate gives the change in real GDP from one quarter to the next compounded to an annual rate.

The year-over-year growth rate compares the level of GDP in one quarter to the level of GDP in the same quarter in the previous year. This method is less volatile as compared to the quarterly growth at an annual rate since it is not compounded. The average of year-over-year percent changes for a given year yields the annual average growth rate.

Financial Structure.
Capital projects undertaken by businesses in any given economy depend on the funds available to finance these investments. For example a decision by a firm to acquire a new plant that will aid in more efficient production implies specific way of financing that project. The major question in place is that of the best capital mix to apply in financing that project. Should a firm apply debt or equity or both What are the implications of the debt equity mix on the operations of the firm What are the implications of this capital structure on economic growth

Managerial economics has tried to elaborate on the various economic advantages that accrue when firms are economically and adequately financed. In this debate the system to be applied is what determines how well these firms are financed.

The various ways applied by businesses to finance their operations are known as the financial structure of the firm and this is represented on the left side of the balance sheet of a firm.
The management of a company seeks to answer many questions in regard to financial structure and some of them include how should the investment project be financed economically Of what economic use is the project to the firm Can the optimum capital mix be determined in practice for a company and what implications will the project have on economic growth and development of a given country.

Despite the quest of achievement of economic growth by the firm there are two underlying issues that the firm tries to address which include risk and return of the investment. The return is the expected growth in cash flows of a firm as result of investing in a given project where as the risk is the uncertainty created as result of undertaking the investment. The two concepts (risk and return) affect the cost of capital and the market value of a firm.

The market value of a firm is what leads us to the debate if a firm is able to generate economic growth as a result of good financial structure. The creation of a high market value means that the firm is able to contribute to the economy in terms of taxes and other government deductions which are used in assessing the gross domestic product of a country. A high gross domestic product means that there is economic growth and this creates an integration of how financial structure relates to economic growth.

Financial Structure and Financial Development.
Raymond W. Goldsmiths (1969) in his book, Financial Structure and Development insists that for economies to grow financial systems must also grow. He defines a financial structure as the overall composition of financial instruments markets and other financial institutions operating in a given economy.

Financial development on the other hand entails the growth in efficiency, effectiveness and sustainability of financial systems in a given economy. In his book Goldsmith explores the evolution of financial systems and the success and failures they have experienced in various countries.

The reason why the debate of how different financial structures affect economic growth is that financial development in the different markets is the variable behind economic growth and development. Therefore assessment of the correlation between financial development and economic growth is very important for the advancement of this debate.

Goldsmith however faced challenges in establishing this relationship between financial development and economic growth. In fact the inter firm and inter industries analysis of this had very limited success. Goldsmith however was successive enough to document a clear positive correlation between financial development and economic development across different countries.

 Financial development as one of the factors influencing financial structure is a key consideration in the adoption of financing schemes. This is because the level of accessibility and cost effectiveness of capital is determined by how financial systems are effective and efficient.

A country like England has very efficient and well developed financial structures. In fact very many scholars are of the view that one of the factors that led to high industrialization in England is the level of financial development. Walter (1873) argues that efficient financial structures ignited by the high level of financial development facilitated the mobilization of the various capital resources for very big investments.

Robinson (1952) says that finance follows enterprise in developed financial systems. According to this proposition, economic development through efficient financial structures spurs the need for different financial arrangements among different entrepreneurs.

This is to show that financial systems are able to respond automatically to the demand for capital. This demand and efficient utilization of capital leads to economic growth. However, some economists still oppose this proposition of the relationship between financial development and economic growth.
Lucas (1988 p.6) asserts that economics badly over stress the role of financial structures in economic growth. In fact Chandavakar (1992) explains that no role is played by financial systems in economic growth of any given country. Other scholars such as Seers (1984) and Nicholas (1989) in fact ignore this topic in their discussion of the level of economic growth in different countries yet they are Nobel Prize winners in the field of economics.

Beck, Demirg-Kunt, and Levine (2000), conclude that although definite conclusions must be made and with very distinctive and clear qualifications, the overall actual response from a theoretical point of view and corresponding empirical evidence suggest a very high relationship between financial development and overall economic growth.

In general it is quite evident that economies grow out of the availability of funds. Efficient and sufficient circulation of funds in the economy creates favorable conditions for businesses to thrive. In this regard the development of financial systems is very vital for economic growth to be achieved. The next chapter aims at explaining the various types of financial structures and how they have contributed to economic growth in different countries such as Japan and Germany.


Chapter 2 Financial Structures
Market system

A system can be defined as a unit that contains severally subparts that are unilaterally integrated and   are interrelated. In economics, the operation of various economic processes does not occur single handedly but depends on the integration of various processes so as to form a working system. The study of micro economics develops some of the key concepts involved in the operation of the economic process in a market system.

According to Heilbroner (1970) every macroeconomic process has its microeconomic base. It is quite evident that a market system involves large scale economic processes and yet these large scale economic processes derive their necessity from the behavior patterns from individuals and firms.
The market is a system based on macroeconomic processes and is obvious not a bazaar. The adoption of the market system to finance operations of a given economy depends on how well the market is adapted to meet the various needs of the economy as a whole. The major issue of concern in this topic is how the market exerts its controlling as well as impelling force on shoppers, job seekers, prices and firms.

According to Heilbroner (1970) the buying and selling that we see each and every day are not just merely casual activities that repeat themselves each and every day but are part of the system as a whole.

The market system is geared towards solving some of the basic economic problems such as what to produce How to produce  What goods to give to whom These are the problems that mobilize men to give an effort so as to produce some output. This output contributes to economic growth as a whole.
According to Levin (2003) the market system is not politically feasible and that it has a high potential for adverse externalities. In the development of this argument Levin that the externalities and transaction costs involved in this system are as a result of the high interdependence of the individuals or households and firms. In this the assumption that the economy operates in a two sector economy as exemplified by the circular flow of income which forms as a major basis for the development of the market system is not valid.

There are many more other external factors involved in this and therefore in this regard a market system fails to provide a reasonable basis for the development of the concept of the relationship of market system and economic growth.

Levin (2003) insists that for a market system to be eligible it must be complete in its general form of application. A market system will only be complete if the prevailing externalities are completely eliminated and when subsequent transaction costs are reduced to the bare minimum.

However according to Heilbroner (1970) the market system is very efficient as it acts a self correcting mechanism. In this debate Heilbroner (1970) continues to argue that the market for goods operates as a dynamic constantly altering and yet self-adjusting mechanism. This can be elicited in the interaction of the demand and supply curves in normal markets.

Many developing countries such as countries in Africa and Asia have a high prevalence and dependence on the market system. The main task involved in these countries has been that of how to allocate production efficiently in the economy to achieve economic growth.

The Bank Based system
The theory of the bank system is base lined upon the sole utilization of banks and other financial institutions to support economic growth and development. Though it is not the most efficient system of finance according to Mansfield (2003) it tries to exhibit most of its strong points in relation to the shortcomings envisaged in the market based system.

This debate tries to explain which of the two systems can efficiently finance firms in developing countries and the same time is in the best position to spur economic growth as much as possible.
This argument is based upon the principles of market efficiency and optimization. Fully utilized or efficient markets are markets that are able to exploit all resources or factors of production and are able to gain optimum rewards from these factors of production.

Are banks so necessary for the survival of firms Are the stock markets on the other hand just necessary for the firms Gerschenkron (1962) argues that economically backward or undeveloped countries cannot trust capital markets as the only source of finance. The argument in this is that banks can finance development of the economy as a whole more effectively than decentralized stock market.

The extent to which this theory according to Alexander Gerschenkron, in his analysis of Japan in the early 1950s is true has been upheld by many scholars. In the analysis of Japan Gerschenkron, noted that there were different market failures which could be overcome by the fact that banks were in a position to utilize deposits and savings to avert this kind of failure.

Despite the strong argument that bank based system are more suitable for economically backward countries there are still many scholars especially in the finance sector who do not believe so and argue that the whole issue is misguided because of the existence of the agency theory and the existence of perfect information in these financial markets.

One evident transition that has even supported this conclusion is that of Europe whereby finance ministers have insisted on financial markets more than banks as a source of capital for firms and there has been so much economic growth that has been experienced. This transition has changed various economies to an extent that scholars have come to believe that existence of perfect information and presence of agency theory with minimal conflict is just enough to create perfect market systems.
In this analysis a closer look at two different countries which are not in the same level of development is very vital. In this regard a good analysis is one that analyses an economy that grew out of the market system and one that has achieved economic growth out of the normal bank system.
According to Boyd and Prescott (1986), one shortcoming of the market system is lack of perfect information as compared to the banking system whereby information symmetry is one of the characteristics. In fact in Germany the continued interaction between banks and investors and investors spurred much more economic growth than the general market system.

The existence of perfect information means that the interaction between firms, individuals or households and the financial institutions which in this case are banks is based on past, present and future information. This means that this information is readily available through the different communication facilities available such as the media.

This information helps firms and individuals make sound financial decisions such as the amount of capital to invest in different projects, selection of the most viable projects to invest in and in selection of the optimum capital structure to operate with.

The combination of the above decisions spurs economic growth since firms will be in a position to contribute to the gross domestic of the country through the returns generated from these investments. The subsequent lack of this perfect information leads to subsequent inefficiencies.

Another major advantage of the bank system is that monitoring of finances is highly enhanced. Through this elimination of moral hazard is efficiently met. The reason why there is monitoring is that most financial institutions issue finances with collaterals in place. This forms a basis for providing reasonable assurance that the firm will do everything to make sure it is able to meet its obligations.

The whole system of banking is set up in manner that there is adequate controlled that integrate business policies and strategies in such a manner that the whole financial process is properly managed. This is through the enhancement of corporate governance. Corporate governance is concerned with the whole issue of the policies, laws, rules and processes adopted by organization in their day to day to day organization.

In this regard firms which are able to apply good corporate governance practices are in a better position to spur economic growth more than those which are not concerned with it. Firms in the market system as evidenced by Japan lack this due to lack of market efficiency.
There is much more cross cutting evidence that developing countries are in a higher position to adopt the bank based system rather than the market system because of the presence of very high market inefficiencies in these countries.

On the other hand it is vice verse for developed countries such as the likes of United States and United Kingdom whereby the market competition and stock exchanges could finance firms and thereby economic growth was highly experienced. This was especially due to the high rates of industrial revolution experienced in these countries. Since industrial revolution was slow in developing countries market systems could not be relied upon as the only source of finance necessary and enough to spur economic growth.

Macroeconomic Policies in bank based systems
A major player in determining the structure, behavior, performance and activity of an economy is banking and finance. Depositing and lending of funds from banks is subject to the management of these funds (finance) in a particular economy.

Government relays on the success of macroeconomic policies to achieve its objectives of establishing a stable and growing economy. The success of these policies, reliant on banking which is in turn subject to finance determines the level of economic growth.

On the international front therefore, macroeconomic policies dictate international banking and finance. This means that macroeconomic policies (fiscal policy and monetary policy), being independent of individual governments regulations on banking, are used to determine the structure, decision making, performance and behavior of the global economy. Macroeconomic policies therefore surpass regional and national boundaries without conflicting specific government regulations to influence the global economy.

According to Cawley, John  Tomas Philipson. (1999), macroeconomic policies also affect the activity of the economy through control of government spending in addition to setting interest rates which has a direct implication on international banking. This means that these policies have implications on other financial issues relating to financial institutions other than banks.

Since macroeconomic policies, specifically the fiscal policy, determines the activity of the entire economy, operations of companies and corporations involved in financial activities will also be subject to alterations in these policies.

The expansionary stance implies governments monetary authority increasing the supply of money by reducing the interest rates in an attempt to curb unemployment in the event of a recession. The monetary policy is based on the relationship between the total supply of money and price of borrowing and lending money, that is, the rates of interest.

It uses a variety of tools in order to administer control on the two in an attempt to influence outcomes of exchange rates with foreign currencies, economic growth rate, inflation and unemployment.
If issuance of currency is under a monopoly or in the case of a regulated system of issuing currency where all the banks are tied to a central bank, the monetary authority is able to alter money supply thus able to influence interest rates and thus the goals of the monetary policy is achieved.

 The monetary policy can also be termed expressed in various ways accommodative if the interest rates set by the monetary authority are aimed at creating growth in the economy, neutral if the interest rates are neither aimed at controlling inflation nor creating growth in the economy and tight if the set interest rates are aimed at reducing inflation in the economy.

Financial Structure and Bank Profitability
Financial structures also have an independent impact on the performance of banks. The overall impact on banks of these financial structures also has an effect on economic growth because banks also contribute to the gross domestic product of a country just like any other business.

The distinction that is necessary at this juncture is just to determine how financial structure affects the profitability of banks in less developed countries and in developed countries. In less developed countries there are no well developed financial systems. One of the effects of the quest to try and improve efficient bank systems is a decrease in the bank margins and profits.

Different countries differ in the extent to which their financial systems are either bank based or market based. The extent to which a financial system is said to be bank based is dependent on the overall reliance in mobilizing savings and allocation of capital by the banks in existence.

In developing countries it is quite evident that financial systems are also not developed. In this regard bank profits and margins are also in these countries. However one cross cutting feature is that most of these countries adopt the bank based system as the market based system cannot be efficient enough to handle economic growth.

Developed countries have efficient systems and their banking systems are well developed and therefore banks contribute significantly to the economic growth of these countries. However if these financially developed countries have efficiently working stock markets, the overall effect is a reduction in bank profits and bank margins.

One of the points to note is that apart from financial structure there are other factors that affect the overall profitability of banks and therefore it should not be taken as the only factor that affects the profitability and bank margins.

As developing countries develop, banks also develop. The development and growth of these banks leads to increased competition and thereby creating a long run effect of reduced bank profits and margins. However the consumers of the services provided by banks stand a chance to benefit as they are able to access capital at very low rates due to this competition.

     A detailed analysis of the topic of financial structure and banks profits can be approached in two ways. The first way is to consider the effect of financial development on bank profits. From this is it easy to develop an assessment on the impact of these profits on economic growth. The second way to approach this topic is considering the effect of financial structure on the performance of banks when financial development is controlled.

There are two measures of banks performance. One of these measures is bank profitability which can be assessed as the profits generated by the bank divided by the assets. The other most important measure of the performance of banks is the bank interest margins which is calculated as the net interest generated divided by the assets of the bank.

The inefficiency or the efficiency of banks can be measured by these two measures (bank profitability and bank interest margins). This is because these two measures act as a connector or a link between savers and borrowers.

The adoption of bank finance by the various stakeholders for investment leads to business for banks. The variables mentioned above affect the cost of bank finance and thereby firms engage in investment profits which are profitable so as to meet these costs and hence economic growth.
In general the overall performance of banks is different in both the market system and the bank system. Therefore to bridge this gap financial development should be enhanced in the economy. If financial development is achieved there is a very high possibility that bank profits and interest margins will be achieved significantly.   

The use of mathematical techniques to assess how financial development is significant in assessment of the profitability of banks has shown that there exists high correlation between the two. When financial development is achieved at the highest level regression analysis has shown that both the bank system and the market system lead to high profitability in banks. This profitability in turn leads to economic growth.

Commercial indicators of high competition in the banking industry are the reduced profitability and low interest rates in banks. The stock market on the other hand complements banks in areas of low level of financial development since there is not much competition in them. The only factor to consider in stock markets is their level of development.

             Development of stock markets is very vital in that it provides perfect information for banks in which they are able to base their decisions on. Sound financial decisions by these banks lead to improved bank performance which on the other hand impacts greatly on economic growth.

Another reason why the development of stock markets is important is that through the existence of an efficient legal framework it is easy to improve the overall banking environment in terms of business processes and contract enforcement.

FIRMS FINANCING CHOICES IN MARKET BASED AND BANK BASED SYSTEM
    The difference between market based and bank based systems is that in market based systems, firms obtain finances from the capital markets in the form of equity and bonds while in the case of bank based systems, banks, by offering credit, are the main financiers of the economy according to Schmukler and Vesperoni (2004).

Lenders in both market based and bank based system are however faced by the expenses of evaluating the performance of firms and their management. Schmukler and Vesperoni continue to argue that commanding control over the debtors and financial instruments liquidity are the major two factors that lenders have to weigh between.

Corporate bonds can be traded in markets which are liquid considering that they do not provide for inside monitoring and thus save on expenses to administer control over management since (Bhide, 1993). As opposed to these, banks, in offering unsecured loans for businesses, have to undergo the expense of acquiring inside information from borrowers in order to exercise control over them.
The two systems therefore are well suited to finance different kinds of firms. Banks are a better fit in financing organizations at their infancy while public markets would do better in funding already established firms with assets that are tangible. Inside monitoring which apparently applies more to banks holds a potential advantage in that it creates an extended relationship between the firm as the borrower and the bank as the lender (Schmukler and Vesperoni, 2004).

In order to obtain financing, a firm may opt for stage financing, which is offered in banks based systems and market based systems. This for example implies that a bank may offer short term contracts in place of long term loans. This therefore means that the bank will be able to access a firms credibility through its various stages in projects investment. Stage financing may be more effective in that, if a borrower pays their debts in time, there would be no need of trying to determine the true value of their assets and thus saving on the resources allocated to inside monitoring of the firm (Stulz, 1998).

    The results of global financial crises affect firms from the different financing sectors in different magnitudes. For example, in the event of a crisis, bank based systems may tend to be more immune to global financial crisis since the long-term relationship between the bank and its borrowers enables the bank to collect enough information regarding the firms performance.

This means that the bank, from its inside information, will continue to lend to financially sound firms and therefore, firms in the bank based system end up being less affected by the events of a financial crisis. Contrary to this, global financial crisis effects on the economy causes public markets to become illiquid leading to a reduction in prices for all firms.

This is bound to make it difficult for investors to distinguish between potentially profitable firms and those that are not potentially profitable. However this still implies that if the banking sector was to be subject to financial crisis then firms in the bank based systems would be hard hit while those in the market based economies would remain unaffected.

In order to describe firms financing choices in market based and bank based economies, Schmukler and Vesperoni use data on firms from Argentina and Indonesia as bank based economies and Brazil, Mexico, Malaysia, South Korea and Thailand as market based economies (Schmukler and Vesperoni, 2000).  The choice of these countries is based on the fact that they have been through financial liberalization, repression and crisis. Schmukler and Vesperoni test for the difference between financial choices for firms in bank based and market based economies by classifying countries depending on the attributes of their financial sector (Demirgut-Kunt and Levine, 1999).
They also study three attributes of the financial structure of a firm which are the firms choices between financing of equity and debt, external and internal financing and debts maturity structure. These attributes are built upon estimate models of dependent variables.

These variables are debt-equity, short term debt over equity, long-term debt over equity, short-term debt over total debt and retained earnings over total debt. Explanatory variables are grouped into effects of the country, macroeconomic factors, firms international capital market access, and attributes specific to a firm (Schmukler and Vesperoni, 2000).

According to Schmukler and Vesperoni (2000), there are factors or ratios that determine financing choices of firms. One of these ratios gives the fraction of short-term debt over total debt and the average debt-equity ratios for market based and bank based systems separately. From this ratio, two deductions can be identified.

One is that, for market based systems, debt-equity ratios are always higher contrasting the general expectation that as compared to debt, equity values in market based economies are higher. Second, though market based systems are best suited to funding firms with typically tangible assets, that is, liquid financial instruments and bank based systems are a better fit for long-term lending relationship, this does not always imply that greater liquidity results to short-term financial instruments.

Market based economies may also avail long-term financial assets liquidity. In essence, the second deduction from this ratio is that debt maturity structure is the same for both market and bank based economies as described in the foregoing explanation. These may also be explained by stage financing whereby short-term liabilities are not a preserve of market based economies and long-term liabilities a preserve of bank based economies.

Firms are affected differently by the effects of international capital markets access and financial liberalization depending on the firms financial structure, that is, bank or market based economy. This therefore means that there are two types of regression, regression for market based economies and regression for bank based economies.

A difference in market based and bank based systems implies a difference in the effects of integration with international financial markets, more significantly in market based systems. This will be so because variables that show international markets access are particularly expected to change significantly with changes in international financial markets integration. Resultant changes in variable that measure participation of firms in global equity and bond markets obtained in this case depicts the difference in effects across the two systems.

As Schmukler and Vesperoni (2000) continue to argue, a small difference between market based and bank based systems compared to the difference between developed and emerging economies implies that the effects of international capital markets access is also small.

Financial liberalization among other factors denotes deregulation in the local financial sector a period in which economies are in financial intermediation depending on the incentives of the market.
Financial liberalization does not necessarily imply effects on market based systems but can lead to a competent banking sector thus it is not certain that the variable depicting financial liberalization will change specifically in either of the systems according to Demirguc-Kunt and Levine (1999). Effects of the variable denoting financial liberalization are dependent on the aftermath of financial liberalization.

Specific attributes of a firm are bound to affect the financial structure in either bank based or market based economies. For both, market based and bank based economies, the extent of the debt maturity structure increases with increase in size of the firm.
 For bank based systems, increase in size of the firm will result to increase in ratios of debt-equity and long-term debt. Long-term debt and short-term debt changes depending on the size of the firm in market based systems but short-term debt effects are not very pronounced.

In market based systems, larger firms result to a reduction in risk security assuming that large firms refer to firms that are more established. These larger firms are able to reduce their short term debt and increase their long term debt by moving their maturity structure from short to long term.
 For bank based systems, in the case of stage financing, banks will not necessarily have to monitor the activities of a firm as it grows and gets sufficiently established in the market. From the foregoing, increase in size of a firm can be related to ratios of long-term debt and debt-equity.

On the choice of firms financing with regard to tangible assets, there exists insignificant difference in the case of bank based and market based systems with reference to the leverage ratios. Firms with more tangible assets achieve a greater level of internal financing and their debt maturity structure is long in the case of market based systems.

For both financial systems, there is no difference in profits over assets effects. With reference to firms attributes, the only difference between market based and bank based economies is that tradable producers are able to achieve more internal financing in market based economies. This is because tradable producers shift their maturity structure more to the short term.
Financial Services.

Bruce (2005) argues that the overall provision of a full range of financial services is necessary for economic growth achievement in developing countries. In this regard insurance companies, banks consumer finance organizations, government sponsored enterprises, stock brokerage firms and banks are all involved at the same time as sources of finance.

In this regard the financial structure consists of different capital providers at the same time. A detailed analysis of this shows that, the capital mix will be out of different sources. This is very advantageous as even the cost of capital is likely to go down due to the increased supply of capital. In this regard businesses and other firms are able to access capital needed to run their operations.
When businesses are able to access capital to run their operations they are able to contribute to the gross domestic product of the country in a very significant way. This in return spurs economic growth to a greater extent.

A country like the United States relies on financial services to finance 20 of its business operations. Major economic debates about this kind of system reveal that it is efficient in developed countries whereby financial services providers are well advanced.

Though not much criticism has been advanced about the use of financial services it has one major drawback in the rates of default. In this regard it is important to note that with very much default these financial institutions are likely to collapse and thereby will not be in a position to provide capital any further.

In any capital market the presence of financial services depicts a trend that allows for capital consumption in the most efficient way. However, the provision of financial services in developing countries has not been all that effective due to lack of awareness and information about the various sources of finance. In this regard due to the fact that these services are not fully utilized and thereby full blast economic growth is not achieved as would be expected.

In the provision of financial services on fact to behold is that the main emphasis is not the where the finance will be sourced but the emphasis is on the enactment of a conducive environment that provides efficient interaction of capital providers and capital consumers.

The provision of financial services primarily aims at the overall creation of market systems and financial institutions are able to efficiently and effectively finance operations in an economy.
The theory of financial systems aims at driving out the point that both the bank systems and market systems are both necessary for economic growth to be achieved in the best way possible. This is because the bank based system is not sufficient while the market based system is not efficient and thus a mixture of the two is very vital.

According to Levine (2001) different components of the financial system incur different costs depending on the area of coverage. The essence of their operations is just how to meet these costs such as transaction and information costs.

Risk management is also another pertinent issue relating to the financial services sector. This is because the risk associated with default is very high and in this regard a detailed analysis shows that most of these financial services providers try as much as possible to insure their interests so as to avert this risk.

Consequently the need to meet global market needs in terms of imperfections in demand and supply interactions of the market and bank systems contribute to the adoption of both systems so as to bridge this gap between the supply and demand of capital. Different structures adopted by different companies rely on the savings mobilization that financial services provide.

The essence that arises out of the need to tie capital is just enough for government economies to predict the level of change in terms of Gross domestic product and other economic growth measures.

Supply of wages is also dependent on the availability of capital and therefore the level of labor that will be provided to a firm just depends on the financial resources necessary to reward labor as a factor of production.

Any financial arrangement in this setting should therefore engage expert financial and corporate control so as to enhance and meet the desired level of liquidity. In real sense the factor that counts most in either the bank based system or the market system is how much the capital requirements of firms will be meet and what are the opportunity costs involved if these sources of capital are adopted.
The opportunity cost of not adopting a given set of system may be too high such that instead of promoting economic growth it degrades the level of the economy. In this regard careful and thorough market analysis is vital in creation of a financial system that is not only going to spur economic growth and development but one that is also able to sustain this growth.

Levin (2002) argues that The financial services view places the analytical spotlight on how to create better functioning markets and banks, and relegates the  bank based versus the market based system debate to the shadows(p. 401).

Despite the fact that emphasis is laid on the bank based system and market based system, there is much need to identify other systems that function in to integration with these systems. One of the systems involved here is the legal system.

There is no business setting without conflict as put across by James (2000). Provision of financial services is very sensitive and therefore different legal measures and procedures must be put in place in order to make sure that these systems run smoothly.

There exists legal rights relating to finance which must be safeguarded at the same time and the reasonable assurance that they can be safeguarded is only provided by the legal system in place.
The reason for the emphasis of legal procedures in this topic is that unfair competition and engaging in illegal financial activities could have a negative impact on economies. In this regard it is vital that the procedures followed in both the bank based system and the financial system should be legal.
Better protection of the financial rights of market players such as financial institutions maintains higher levels of economic growth. Market laws and regulation provide favorable conditions for businesses to be conducted.

However in a contrasting view of the two systems there is a disparity in terms of legal systems. According to Rajan and Zingales (1998) it is quite clear those economies which uphold low levels of legal institutions and with very poor legal systems experience more benefit in terms of economic growth as compared to those that use the market system.

In this theory Rajan and Zingales (1998) also suggests that for the market system to produce high levels of economic growth, very efficient and strict legal systems should be put in place. This is because the market system deals with very many industrial players and lack of their regulation will lead to collapse of business.

Economic development and growth will only be achieved if there crosscutting analysis of the different financial systems and their inherent systems and comparing them with the level of development of the economy at hand and the corresponding legal system adopted.


Measures of Activities of Financial Intermediaries.
This debate would be incomplete if total disregard of financial intermediaries was upheld. Financial intermediaries are found both on the private sector and public sector and are a key determining factor of financial structures adopted by firms.

The size of these financial intermediaries in any given economy is very important as it determines the extent to which they are able to finance investments. There are two key size indicators of financial indicators according to Goldsmith (2009) which include private credit by deposit money banks to GDP and private credit by deposit money banks and other financial institutions to GDP.
The definition of the first measure of financial is based on two variables which are claims on the private sector by deposit money banks and the gross domestic product of a country. To get the real measure the claims on the private sector by deposit money banks is divided by the gross domestic product.

The definition of the other measure is given by the valuation of claims by both deposit money banks and other financial institutions .the general method applied in both measures is the complete isolation of the private and public sectors.

In conclusion it is quite evident that the market system involves large scale economic processes whereas the bank based system is based on the provision of financial services. The market based system is mostly adopted by developed nations like the United States whereas the bank based system is adopted by developing countries such as countries in Africa and Asia. The next chapter aims at analyzing the existing empirical evidence and formulation of economic models that will further this discussion.

Chapter 3 Existing Empirical Evidence
The discussion of the bank based and the market system would be incomplete without empirical examples of countries that have adopted such kind of systems. There would be even no reasonable basis of justifying the success of any of this system in the quest for economic growth and development.

In this analysis, the countries to look at as empirical evidences of how the discussion of these systems holds are the United States and United Kingdom and Germany and Japan for the market and bank system respectively.

One of the major characteristics of any market system of finance is that there exists a lot of freedom in the market as regards factors of production and their regards. The United States and the United Kingdom are some of the countries that have been able to adopt this kind of financial structure.
The major characteristic of the market economy in the United States is that government intervention is very minimal and in this regard the forces of demand and supply determine the level of production and consumption.

A detailed analysis of the United States economy reveals that the factors of production are fully and efficiently utilized by elimination of agency problems and risk control. The economy is founded on the basis of a legal system with sound legal policies which are a further evidence of the existence of a market based system that is so successful.

In this kind of system it is quite evident that labor mobility and efficiency is very high. A detailed view of this system of finance shows that for it to hold the labor market must be very efficient for maximum production or output to be achieved.

Market demand in this type of this system revolves around the interaction of the firms and households. The circular flow of income is what determines what is right for the economy to grow. The circular flow of income is a model that shows the interactions of firms and households in an open economy.

The operation of the circular flow in real sense acts as equilibrium in which both firms and households depend on each other. Equilibrium in the circular flow of income will only occur if the injections created are equal to the corresponding leakages as depicted in the following equation
Savings  Taxes  Imports  Investment  Government Spending  Exports

The reason for the selection of Japan as a good example of the bank based is because Japan experienced a very fast economic growth due to its bank centered economy. In the 20th century banks were major financiers of operations in Japanese industries and thereby the reliance placed on them by theses industries was on the higher side. It was quite clear that those industries which had preferential access to financial services such as loans were able to grow at higher rate than those that did not rely on these services.

Though this debate remains strong in the minds of many scholars still some of them believe that the height of growth of the Japanese economy was as a result of strict government control and regulation of corporate finance.

Gerschenkron and modern theorists believe that argument which proposes Japanese growth was as a result of the presence of banks is flawed and lacks some sense of truth in it. They believed that the existence of banking institutions that gave firms access to loans and other kinds of debt did not really give these firms and advantage over others in terms of better investment and financial well being.
Perhaps a force to reckon with in this debate was the existence of the Zaibatsu group. This was one of the most powerful financial cliques of the late 1990s and early 2000s. It was believed that banks at the time which financed industrial and financial operations were under the direct control of Zaibatsu in a very significant way. This forms one of the reasons why Gerschenkron and modern theorists believed that banking systems were not involved in the economic growth of Japan.

Gerschenkron believed that the banks provided the necessary finance but it was the government that was responsible for the guidance and direction of these financial resources in order to spur economic growth.

Most of the affiliate banks under Zaibatsu were also involved but it was through the direction and focus provided by the government that sustainable economic growth was achieved. In this regard inefficiencies in financial markets were eliminated through government regulations according to Gerschenkron and his fans.

Though Gerschenkron viewed the Japanese system as one that was not contributed to by banks he reached to a point of controversy with William Lock wood one of the scholars who proposed that the Japanese system was purely run by the zaibatsu financial conglomerate.

In this regard Gerschenkron explained the economic growth of Japan as one that grew reasonably fast not because of Zaibatsu but because of the avoidance it insisted on the decentralized market system.
The German system on the other hand is one that grew out of the presence of decentralized intermediaries like Japan. Germany developed at the height of the world wars and the economy had even at one time dampened as a result of a recession.

Through the existence of market systems that were quick to generate revenues from economic facilities such as banks, Germany had no option apart from empowering them. The reason for the fast economic growth was because Germany had experienced very successful industrialization.
The intermediaries system was highly heightened during the Hitler era (1933-1945) whereby financial institutions were given high government support through the use of subsidies to the sectors that were likely to spur economic growth. Though this was a move by Hitler in order to give Germany military as well as economic power, it enabled the creation of efficient sources of finance.
The advantages stipulated under the bank based system existed also in Germany. In fact the Germans proudly label their economy as a social market economy or soziale Marktwirtschaft, In this regard control of financial structures was independent unlike in earlier times whereby it was dominated by government intervention and control.

The major privilege that this intermediaries system enjoyed then was the fact that the existing markets at the time of industrial revolution in Germany was able to diversify and manage risks very efficiently. In fact the car industry then was able to survive through effective risk management practices.

Germany also experienced very high technological advances and the best source of finance at this time was the bank system as compared on to the market system which required the presence of superior information and high government regulation.

The issue at hand during the time of Nazi power was the fact that there existed so much diversity in opinion among the stakeholders. Also there was no much perfect information present during that time. According to (Allen and Gale 1999, 2000) where there is scarcity of information and very diverse opinions, the bank oriented system comes in handy than the market based system in promoting long run economic growth.

The major concern in the Germany economy which also turned out to work very well with the bank system was the legal system that existed in the country at that time. This in turn ensured that business processes such as contracts were run smoothly and whenever there was conflict the legal system in place was able to handle them in the best way possible.

Long run economic growth is just not easy especially when financial structures come in place. The general economic situation should be one that fosters an economic condition which is suitable for   adoption of any of the above system. The analysis of the countries, Japan and Germany just shows how the conditions present at the moment were able to spur economic growth and development in the long run in these two countries.

The fact that finance is a necessary condition for economic growth and development is necessitated by the investment opportunities present. (Allen and Gale 1999, 2000) stipulates that countries do not grow fast if there is an inadequate finance to finance business operation.

However this debate has been criticized over time by most literatures and they try to explain that financial structure is not important for economic growth. Therefore the general effect of financial structures on economic growth must be taken cautiously.

Conclusions from technical surveys suggest that there is just sufficient evidence that financial structures cannot be relied upon as the only measure of explaining why different countries have different growth rates.

The explanation advanced in light of this disparity is that the access of finance in either of the two systems is not something that is just so easy and therefore the existence of different countries with similar growth rates but with different financial systems.
In light of this the most important factor according to (Allen and Gale 1999, 2000), is the existence of a very strong legal system that is able to ensure that the rights of investors are properly safeguarded and that contracts are enforced in the best way possible.

The advantage of this is that financial markets are developed efficiently and that fair play is enhanced. Intermediaries in the market sector also get a chance to develop efficient systems which in turn improve their operations.

Chapter 4 Specification and Econometric Methods
The general analysis of the production function can be done on the basis of determination of the level of output of a given economy. In this regard we assume that the economy upholds two main factors of production which are labor and capital.

The optimum combination of the two factors of production is what yields the level of production in a given economy. This optimum combination where by the producer is indifferent is depicted by the use of a contour line called the isoquant. This is where the production process is based.

The production function specifies the output of a given economy or industry. Though seen as a subject based or derived from micro economics, it is quite evident that most of the macroeconomic principles are based on the production function.

This is to show that there exists a mathematical relationship between the output derived in a given economy and the input of the two factors of production mentioned earlier. The main issue of concern in the components of the production function is determination of the most optimal combination of these factors of production.

It is also quite evident that sometimes one of the factors of production is fixed while the other one is variable in the short run. However, the production function is not influenced by this and in real sense it remains constant.

Production theory basics are not interested in monetary factors such as costs and price but are rather interested in physical units of output in an economy. This kind of function completely ignores the business processes and therefore fixed and variable costs determination is not necessary for the advancement of this debate.

The main issue of concern in this debate is how the financial structure can be incorporated in the production function and has an impact on the economic growth of a given country. This will be in the determination of the most efficient input allocation to derive maximum input.
This specific analysis involves the application of a generalized production function of the following form
Q  f(X1, X2, X3...Xn)
Where
Q represents the quantity of physical units produced,
  X1, X2, X3...Xn   represents the various factors of production such as capital, land, labor and entrepreneurship
However, in our debate due the fact that we are not interested in joint production as would be yielded by the above equation we take a general form of the Coub- Douglass production function. Being a multiplicative production function it is represented as follows
QF (K, L)
Where
Q quantity of physical units produced
K capital   
L labor 
To advance this debate let X1 represent labor and X2 represent capital. Since the Coub-Douglass function is a multiplicative model it will take the form

Where a, b, and c are parameters which have been empirically determined.
To simplify the equation we simply add logs and the function will be as follows
Log (QX2) a  b  c log(X1X2) a
To relate this equation to the financial structure we introduce a variable that is the percentage of the overall market capitalization over bank lending. The coefficient of this function is represented by W as follows
Log (QX2) a  b  c log(X1X2) a d log (W) a

A high value of W means that the economy is more of a market based economy rather than a bank based economy since bank lending is low. On the other hand a low value of W means that bank lending is high and so the market is more of a bank based system.

With this econometric relation in place it is quite clear that it is easy to establish a relationship between the level of production and the financial structure involved in the course of the production.
The various data available only accounts for per capita output rather than data on labor because time series on labor force does not exists and if it does it is not sufficient. The parameter in place especially d determines the level of impact financial structure creates on economic growth. In this regard the more significant it is, the bigger the effect it creates on economic growth and the less the significance the lower the effect it creates on economic growth.

CHAPTER 5 DATA ANALYSIS

The data provide in the table shows very important information on economic growth in terms of the share of gross domestic product and the corresponding market exchange rates. One very clear observation in the table is that United States has one of the highest shares of gross domestic product in the world as compared to other countries such as Germany and Japan.

Major evidence available is that United States has one of the highest market exchange rate indexes. This supports the adoption of the market based system as a source of finance for the different firms and industries in the United States. This shows that the market system is efficient enough to generate a market index that is very high.

Comparison with other developing countries shows that their share of gross domestic product is quite low as compared to the United States. Their market index is also very low as compared to that of the United States. One of the contributing factors to this is the adoption of a bank based system.

The data in this table takes into analysis various parameters in the United States. In the first instance it is quite clear that the United States operates a market based financial system. The data ranges from the year 1960 to the year 1980 when industrial revolution n in the United States was still a factor to reckon with. It is quite clear that the FINANCIAL SYSTEM DEPOSITS  GDP ratio has been on the rise since 1960 signifying significant level of economic growth. Market capitalization is also on the rise according to the data given.

A careful analysis of this data shows that more and more economic growth is achieved as years go by and there is increase in bank credits in the US. This suggests that however the debate of the adoption of a pure market based system in the US may hold. There is a significant adoption of finance from banking institutions.

The data provided also gives a clear relation that economies grow as a result of market efficiencies. In this regard as market growth is enhanced by the presence of adequate finance for the corresponding industries. This is evidence by the growth of liquid liabilities by industries from 1582626.00 in 1960 to 3650927.00 in 1980 in the United States.

The graph of growth in  liquid liabilities sin the united states clearly shows this. In this regard it is quite evident that growth in the gross domestic product has also been contributed by the growth in liabilities over the years. This means that the different sectors are able to access funds.

This is an analysis of Japan and Germany which adopted the bank based system in their economic growth measures. BANK CREDIT  BANK DEPOSITS show a rising trend. A high correlation exists between the level of deposits and borrowings as years go by. In this regard these countries exhibit a high reliance on the bank system.

One of the features evidencing this is the rise in gross domestic levels as evidenced in the increase of the BANK DEPOSITS  GDP ratio over the years. For example the table shows that Germany had a BANK DEPOSITS  GDP ratio of 0.32 in the year 1960 while in the year 1980 there was a significant increase of this ratio to 0.53 meaning that there was significant increase in the gross domestic product thereby economic growth.

The overall growth in money deposits in the banks created over the years just shows by how much Japan relied on finance from banks. BANK DEPOSITS  GDP are a measure of by how much the bank deposits contribute to the economic growth in terms of the growth in domestic product.
The graph of the growth in BANK DEPOSITS  GDP over the years shows this.

Attached too are excel file which show different aspects of financial structures and their relevance to economic growth in different countries. This analysis draws its data form low income countries, medium income countries and high income countries of the world.

Some of the aspects contained in  the excel files are world bank income group of the country which shows whether a country is in which group of income according to world bank statistics and deposit money bank assets  (deposit money  central) bank assets . The three countries involved in this analysis are Gabon which happens to be an upper middle income country, Indonesia which is a lower middle income country and France which is a high income country.

The three countries analyzed show different parameters as regards deposit money bank assets  (deposit money  central) bank assets, liquid liabilities  GDP, central bank assets GDP, deposit money bank assets  GDP, other financial institutions assets  GDP, private credit by deposit money banks  GDP, bank deposits  GDP, bank credit  bank deposits, financial system deposits  GDP, and private bond market capitalization  GDP over different years.


Chapter 6 Conclusion
This paper was geared to focus on the effects of financial structure and economic growth and a brief literature on the same has been put across. The link that exists between the financial structures put in place by different countries and the growth rate they experience has also been explained.
 A detailed analysis on how different financial structures are deficient or efficient has also been put forward. In this it is prudent to conclude that there is diversity of opinion and views that the suitability of any financial structure on any country cannot just be measured in real terms but is affected by many other factors.

The various theoretical and technical approaches advanced against the market based system derive their negativity from the advantages of the bank based system. On the other hand the disadvantages of the bank based system are derived from the various advantages of the market based system.
The disparity in the views advanced by various scholars implies that economic growth is not only dependent fully on the financial structures adopted by the various countries. This debate is contributed by the fact that different economies have different financial structures but experience nearly the same growth rate.

It is has also been evident that legal institutions and the general concept are key issues to consider in the adoption of any of these systems. This is because legal institutions determine the protection of investors rights and the also determine the extent to which contracts are enforceable. Finance is also vital especially in the bank based system since it helps in evaluation of financial decisions.
Another major area of concern has been how different financial structures impact on economic growth of different countries. It has been quite clear that most of the developing countries prefer the bank based system rather than the market system.

Developed countries like the United States have adopted the market based system and are therefore able to support their economies as a result of stable financial markets. They also have a definite well balanced circular flow of income whereby there is efficient interaction of both demand and supply.
It is also quite clear that through the different literature that is available from various scholars, that the bank based system, financial services and the law and finance views have more theoretical support than the market based system. This is due to the prevailing strict conditions that are available under the market based system.

One feature to note in modern economies is that both the market system and bank based systems complement each other. The issue at hand in the market system is how far the government should regulate the different aspects of the economy so as to maintain market demand and availability of funds at the optimum. Through this regulation, it is inevitable to employ the services of intermediaries. The whole process ends up being a mixed financial structure since it has aspects of both the bank based system and the market system.

As advanced throughout the development of this paper it is quite evident that the two different financial structures have their corresponding advantages and disadvantages depending on the different economic scenarios.   The choice of what system to adopt depends on the suitability it poses on the countrys economic growth and development.

The bank based system or the use of intermediaries is better suited for financing firms that engage in economically viable projects where by the possibility of existence of a moral hazard such as default is highly mitigated. For example financial institutions such as banks will finance capital investment with the likely hood of yielding higher returns as opposed to those that do not yield return
On the other hand the market system is well suited for financing developed economies whereby there is existence of a continuous advancement in technologies. It is also very efficient in countries where by firms are able to function with minimum government intervention in the provision of financial aid.
Different countries differ in the extent to which their financial systems are either bank based or market based. The extent to which a financial system is said to be bank based is dependent on the overall reliance in mobilizing savings and allocation of capital by the banks in existence.

The most ideal economy that would be in existence would be the economy that upholds the two financial structures at par. This is because adoption of any of the systems has its shortcomings that are derived from the strong points of the other. For example one of the shortcomings of the use of intermediaries such as banks is the risk of default. However if there was existence of a well developed financial market this risk could be minimized as there exists financial markets which can be used as an alternative source of finance.

The United Arab Emirates (UAE) is one of those Middle East countries that showed high levels of economic and social development in recent decades. The main source of its export income remains oil exports that constitute 37 percent of earnings in foreign exchange and 60 percent of public sector revenue (Abed and Hellyer, 2001). The acceleration of FDI funding in oil sector in 1970s was among the main reasons of UAE ranking high places in the UN Human Development Index (Oxford Business Group, 2007).

Notwithstanding the rapid pace of economic growth the UAE has not avoided the problem of resource curse widely addressed in the research literature. The concept of resource curse negates the assumption that export revenues generation, based predominantly on natural resources brings sustainable development and social welfare (Stevens, 2003). Moreover, the specific form of resource dependence reflected in oil curse is widely addressed in the literature as the one of the most challenging barriers to stable economic growth and development (Ross, 1999). Apart from negative economic implications for economy, resource curse and specifically oil curse is widely considered to be the main source of political conflict and authoritarianism, social disintegration, international political and economic dependence, ethnic conflicts in developing countries (Panchok-Berry, 2005).
Constant fluctuations in oil prices, reflected in oil booms and shocks, as well as nonrenewable nature of oil resources pose a substantial threat to future economic stability of the UAE. At the same time, while oil revenues may generate large investments and spending on infrastructure, real estate and finance sector, these sectors may become particularly vulnerable to global financial and economic conjuncture.

The aim of the study is three-fold investigate the economic structure of UAE, analyze UAE government policies towards the non-oil sector, and evaluate performance of government policies for economic diversification in UAE. The researcher is guided by several questions. Some of These questions are as follows

1- How dependant is the UAE on Oil2- Why does the UAE want to diversify its economy3-What is the policy for economic diversification in UAE4-How effective has the UAE government policy of diversification been

To achieve the goal of the study, this literature chapter will cover the following aspects

a. The formation of resource abundance concept, resource dependence concept and oil curse theory is studied in historical perspective and from the viewpoint of their applicability to the situation in developing countries. Based on the analysis of related literature the distinction between resource abundance and resource dependence is established. It is argued that resource abundance does not necessarily result in resource dependence as suggested by historical cases of the United States, Canada and other developed countries abundant in resource. In contrast, resource dependence should be described as complex political-economical conjuncture between state, civil society and economy. In this view, resource dependence implications are addressed at two basic levels macroeconomic impact and extraeconomic social, political and institutional consequences of research dependence

Furthermore, the specific situation of oil curse is addressed focusing on its negative consequences in developing countries, including the UAE. Moreover, the concept of oil curse is integrated into the framework of Dutch decease paradigm that proved to be effective in explaining negative implications of limited export nomenclature on balance of trade, payments, fiscal and monetary stability in the developing countries. Finally, in this section the concept of Rentiers and Rentier states is covered. Rentier state is described as direct politico-economic consequence of resource dependent economy, reflected in the dominance of external rent and revenues, low level of domestic economic ties development, poor accountability of rentier states to domestic civil society, limited fiscal and development policies. In other words, the primary sources of state revenues are rents (such as those derived from permitting oil companies access to the resources) rather than form a surplus generated by productive activity or commerce. The concept of Rentier state has a particular relevance to developing countries of Middle East that served as case-studies for its application in research (Beblawi, 1990).

b. Due to the fact that UAE as a federation is a collection of seven city states a major section of the literature review will provide an extensive treatment of the economic development of city states. Based on case-studies of Singapore and Hong Kong, as well as island city-states, such issues as city-states economic development, the need of hinterland are to be discussed. The section specifically addresses the barriers to economic growth, met by city-states and possible ways for their overcoming. This section also provides the discussion of economic base theory that emerged from a series of frameworks that aimed to understand regional economics and how this can affect an economic base.   This is to say that an economy, according to this theory, cannot be self-sustaining even if a particular locality is concentrated on the production of certain products and services.

c. Diversification will be examined in this part of the literature review, in light of the justification of why the UAE want to diversify its economy, and how the diversification into Non-Oil Sector will achieve sustainable development. This section provides the discussion of several basic concepts of diversification including Norths stage concept (1955), developmental diversification approach (Petit and Barghouti, 1992), portfolio variance approach etc. Based on the analysis of these concepts, it is argued that successful economic diversification includes conscious governmental policies, aimed at developing secondary - manufacturing and tertiary  service sectors. One of the most crucial insights of diversification theory is that it should be balanced and complex to avoid crises in basic sectors and general economic instability, resulting from the shrinkage of other sectors revenues. Further on, this section addresses the examples of diversification from oil base. The case of Kuwait suggests that the main barriers to diversification lie in overvaluation of currency, lack of private business initiative in new sectors etc (Looney, 1991). Successful diversification in Middle East region was predominantly based on developing of financial markets, investment funds, stabilization funds, gold reserves, as well as establishing new non-oil industries, such as fertilizers, metals etc.

d. Tourism, as a means of diversification will be addressed, focusing on its positive implications for growth and economic development. Focusing on the experience of developing countries it will be showed that successful tourism diversification is premised on comprehensive development frameworks, aimed at spreading benefits from tourism to other sectors of economy, creating synergies between tourism and modernization and avoiding localization and temporal limitations of tourist activities. All these basic steps correspond to the Sustainable Tourism approach.

e. Finally, based on the analysis of the above described aspects, present review of related literature provides the general conceptual framework of research on diversification in the UAE, focusing on tourist sector. The conceptual framework synthesizes all basic concepts, analyzed in literature review.


1. Resource Abundance, Oil Curse Theory, Concept of Rentiers

The genesis of research abundance and research curse theories.

Research abundance and resource curse concepts became wide-spread in the mid-70s, as a response of scholars, economic planners and experts to 1973 oil embargo and subsequent crisis, organized by Organization of Arab Petroleum Exporting Countries (OAPEC) (Hammes and Douglas, 2005). Their decision was a reaction to the U.S. support for Israeli military in Yom Kippur war. The rising importance of oil in the international politics and economics was understood as the threat to market economy and cooperation and, hence, many scholars drew their attention to correlation between resource economies and stability, conflict, democracy, economic development and growth.
However, far from being a political outcry against the monopoly of Arab world over black gold and its political instrumentalization, research abundance paradigm was an attempt to account of far-ranging economic and developmental implications natural resources prevalence in the formation of national GDP (Auty, 1993).

The consensus was achieved concerning the negative correlation between natural resource dependence and economic growth and economic development, empirically supported in a path-breaking study of Sachs and Warner (2001). Wide-spread utilization of resource abundance and resource curse concepts may be attributed to the fact that unlike neoclassical models, they embraced and synthesized different spheres of society, not reducible to economy.

This gave resource abundance concept a status of interdisciplinary paradigm, based on developmental, institutional economics, political science, sociology and classical economics. The implications of natural resources dependence were assessed not only for economic growth, but institutional development, democracy and even security (Collier, 2003 Le Billon, 2005). Based on these assumptions, the analysis of resource abundance and research curse literature is subdivided in two main parts studies on macroeconomic implications of resources dependence discussion of extra-economic social, political and institutional consequences of research dependence.
Resource Abundance Paradigm Basic premises and assumptions.

Generally speaking, resource abundance concept contends that countries with abundant natural resources experience slower rates of economic growth, than those where productive base and tertiary service sector predominate. This occurs due to the fact that resources belong to the category of primary goods that give less surplus and added value, than produced goods. Resource dependence hinders investment in productive sectors of economy, results in slow pace of innovation and negatively affects competition, as the precondition of economic development.

These negative implications, which are only the part of multiple effects of resource abundance, are developed in a number of studies, including Auty (2001), Ross (1999), Gelb (1988), Lai and Myint (1996). Resource abundance concept may be best expressed in the metaphor of the paradox of plenty, developed by Karl (1997). Paradox of plenty shows that however oil booms are associated with dramatic export revenues, they are just the illusion of development and prosperity and often result in the destabilization of resource dependent regime and weakening states capacity to comprehensively manage economical development.

While the majority of studies focus on structural analysis of resource abundance conditions, Sachs and Warner (2001), made an attempt to present main conclusions of resource curse concept in econometric terms. They define resource scarcity in terms of primary exports proportion to GDP. As a result of cross-sectional analysis of 87 countries, they found out that mentioned variable is negatively associated with economic growth in per capita incomes. Multivariate models, used in this study, include traditional economic factors as GDP, inflation, and institutional factors, such as openness etc, (Sachs and Warner, 2001).

Following Sachs and Warners contribution, but adding new dimension of human capital, Bravo-Ortega and De Gregorio (2005) also validate the hypothesis of negative correlation between growth and resource abundance. Hence, Bravo-Ortega and De Gregorio (2005) demonstrated that resource abundance does not only negatively affect economic growth, understood in traditional macroeconomic terms, but hinders human development.

The described model of resource abundance was harshly criticized by Ding and Field (2004) for the narrow focus on exports as the basic reflection of resource abundance, while neglecting general economic and technological structure. This methodological position leads Sachs and Warner to confusing resource abundance with resource dependence.

As Ding and Field (2004) suggest,
As a measure of resource abundance, primary exports as a proportion of GNP is a misleading index. It registers primarily the sectoral importance of primary industries, in the economy and in terms of exports. A country heavily dependent on primary industries would be regarded as a resource-rich country by this variable. But the resource dependence of the economy and resource endowment are different things. It is possible for a resource-abundant country to have a small primary sector (the United States is a leading example), and on the other hand, for a resource-poor country, nevertheless, to have an economy that is heavily dependent on primary sectors (several good examples are in Tanzania and Burundi) (Ding and Field, p. 497). Such valuable observation by Ding and Field clearly demonstrates that resource dependence is based on disproportional correlation between resource exports and manufacturing and service exports. If primary exports dominate a country abundant in resources becomes resource dependent.  Correspondingly, resource abundance is itself not the main cause of resource curse. Abundance in natural resources may be equally accompanied by highly developed productive, service and technological sectors, as in the case with the United States, Canada, China etc. Hence, the causes of resource curse should be traced in general social and economic structures, making natural resources the barriers to growth and development. To reflect upon this contradictive reality Ding and Field (2004) propose to distinguish between Resource Dependence and Resource Endowment with the former negatively affecting economic growth, while the latter positively associated with it.

The abovementioned distinction is particularly fruitful in terms of locating primary and secondary causes of resource curse in oil-dependent countries and the possible avenues towards diversification.
In the same vein, Stijns (2001) and Lederman and Maloney (2003) provide the distinction between resource abundance and resource dependence. Stijns (2001), while using Sachs and Warners model, replaces their measurement with data on natural resources reserves, concluding that natural resources stocks have not significant impact on economic growth.

The analyzed debate between two main strands in resource abundance debate vividly demonstrates that natural resources are not neutral vis--vis economic and political structures, existing in a given society. Under certain conditions natural resources make culminate in resource dependence, which is associated with empirically validated economic and institutional deficiencies difficult to overcome.

Negative effects of resource dependence in the developing countries Causes and implications of resource curse.

Taken these facts into consideration, it may be argued that the greatest problem of underdeveloped countries is not resource abundance, but resource dependence. It has multiple negative effects for their economies. Auty defines mineral economies as those developing countries which generate at least 8 per cent of their GDP and 40 per cent of their export earnings from the mineral sector (Auty, p. 3). As Auty (1993) argues, counter-intuitively resource dependent countries have significant problems in taking the path of industrialization due to mining sectors production function (i.e. ratio of capital to labour), domestic linkages and deployment of mineral rents. Unlike most (but not all) developing country primary product exports, mineral production is strongly capital intensive and employs a very small fraction of the total national workforce with large inputs of capital from foreign sources (Auty, p. 3). 
In this situation resource dependent economies are characterized by entrenched enclave tendencies and low level of production linkages, which is the corner stone of forming national market of produced goods. In its turn, revenues from mineral resources export revenues are not reinvested, but instead, fuel national debt and conspicuous consumption of local elites.

The degradation of economic linkages is partly explained by the fact that mines in developing countries tended to function as economic enclaves. They transmitted a strong growth stimulus to distant metropolitan regions but their local economic impact was only modest (Auty,  1993, p.13). So, as Hirschman (1977) suggests, mineral production provide positive effects for economy only through external rent, not taxes of domestic economic agents. Such situation is connected with underdevelopedness of domestic industries and correspondingly, low levels of tax borrowing by state. In its turn, fiscal deficits prohibit state from realization of effective socio-economic policies and infrastructural projects. External rent means that state receives the bulk of its profits from foreign economic agent that are interested in investing predominantly in resource sectors.

Unlike Auty, Girvan (1971) provides structural explanation of resource dependent countries slow pace of economic development and reform. He attributes negative economic impact to transnational corporations, whose vertical structure, oligopolistic market and integrated production results in small revenues for developing countries in which they operate. Moreover, TNCs tend to offshore processing from developing countries, limiting tax incomes. Evans (1975) takes the same critical stance on TNCs negative impact on Brazilian industrialization in mining sectors. However the described negative impact of corporations often takes place it can not explain multiple examples of rentier states, which hold state control over mineral resources. Its detrimental role to economic growth and development that is to be described further far outweighs the negative effects of TNCs in the developing countries.

Another negative implication of resource dependence, addressed in literature, is resource dependent countries vulnerability to volatility in international mineral markets. Whereas each country may be affected by international conjuncture, countries with underdeveloped domestic market, weak import-substitution industries and small nomenclature of exports are the most likely candidatures for default and economic crisis. As Wheeler (1984) suggests, in the case of mining exports the implications may be the most damaging, because of the increased vulnerability of oil exports to international price volatility, monopoly price and production regulation by major OPEC producers etc.

There were substantial research related to correlation between poor economic management and the false feeling of security and stability, originating from immense resource revenues (Gylfason, 2000). Indeed, governments that fill their budgets from natural resources feel it easy without innovative and infrastructural projects, aimed at modernization. Such situation aggravates their inability to react on non-standard situations during economic crises. The lack of innovative and infrastructural projects is connected with the existence of relatively stable and easy resource revenues that create fiscal stability in the country. Capital intensive nature of resource sector and its rent character reduces government policies to attracting new foreign direct investment into development of new mines. Economic transition towards technological economy is often regarded as ineffective enterprise, because it requires wide-ranging investments and its fruits can not be seen in the short term period. Such short-sided policies are particularly detrimental during economic crises during which resources demand decreases together with export revenues for resource dependent countries.

Another negative impact of resource curse is excessive borrowings by governments. The rationale behind borrowing by governments that gain enormous profits from exporting mineral resources is that due to appreciation of national rate the interest payments for debt become cheaper. For instance, such countries as Nigeria and Venezuela significantly expanded their borrowing during oil boom of 70s, but encountered severe problems with paying interest rates during oil downfall later (Auty, 1993). Such tendency is vividly shown by Mansoorian (1991), focusing on resource discovery implications for labour and asset holders.

According to this scholar, asset holders debt increases as a result of resource discovery and aggregate expenditures should be smaller, than before discovery.  The overdebtedness of resource dependent countries is also discussed in length by Manzano and Rigabon (2003). Inextricably linked with overdebtedness is the unstable nature of consumption in resource dependent economies, described Rodriguez and Sachs (1999).

Resource dependence also negatively affects trade balance and balance of payments. Balance of payments is characterized by unstable structure due to excessive external borrowings, disproportional character between foreign direct investment and countrys own investments in other countries. Trade balance gravitates towards dependence on limited export nomenclature. In crises periods the imbalance between imports and exports becomes severe due to falling export revenues. In these periods national currency overvaluation changes for inflationary tendencies. Short-sided economic management and innovation often result in the lack of sustainability and stability of economic development with wide-ranging consequences for social welfare and human development.

To sum it up, resource dependence is associated with negative macroeconomic implications for fiscal policies, economic planning and management, trade balance and balance of payments, national debt, stability and sustainability, which are crucial for economic growth and development in the developing countries. However, the nature of resource dependence makes it threatening for political and institutional spheres of society as well.

Negative extra-economic impacts of resource dependence.

Negative extra-economic impacts of resource dependence are also widely discussed in the  literature. For instance, Gylfason (2000) argues that rent-seeking behavior, often present resource dependent economies, results in corruption, nepotism and money-laundering natural-resource-rich economies seem especially prone to socially damaging rent-seeking behavior on the part of producers. For instance, the government may be tempted to offer tariff protection to domestic producers, among other privileges. Rent-seeking may also breed corruption, thereby distorting the allocation of resources (Gylfason, p. 2).  Linking resource dependence with poor system of education, Gylfason rightly suggests that resource dependence is directly linked with low levels of human capital development (Gylfason, p. 3).

Indeed, it goes without saying that degradation of economic linkages, underdevelopedness of productive, innovative and service sectors results in low demand on qualified cadres and science. In this way, economic stagnation in resource-dependent countries is often accompanied with degradation of education and technological development.

Among others Bardhan (1997) empirically showed that import protection and corruption are among basic impediments of economic growth. The corruption is often fostered by the existence of offshore tax havens, used by corrupted elites and their cronies for money-laundering and theft.

The neglect of education in resource dependent countries is empirically shown by Gylfason (2000). For instance, as his research suggests, the OPEC countries send 57 percent of their youngsters to secondary schools, compared with 64 percent for the world as a whole, and they spend less than 4 percent of their GNP on education on average, compared with almost 5 percent for the world as a whole (Gylfason, p. 10). Such situation goes in sharp contrast with policies pursued in such states as Singapore, South Korea, or Taiwan, where investment in technological change, education and science became the major engine of economic development and modernization.

Resource Curse Impact on Democracy

Corruption and nepotism, bred by resource dependent economy is regarded by many scholars as direct threat to democracy. Developed civil society and liberal freedoms contradict clandestine practices of money-laundering and corruption. Non-accountability to citizens is the basic principles of elites, capitalizing on national resources. Strengthening authoritarian regimes with large repressive apparatuses in such conditions is the most effective tool for elites to protect their economic interests. The correlation between authoritarianism and resource dependence is empirically studied by Wantchekon (2004), Ross (2001), and Panchok-Berry (2005) among others.

For instance, Wantchekon, using data from PolityIII, and studying resource dependent regimes in Africa found out direct correlation between resource dependence and authoritarian tendencies (2004). The majority of resource dependent countries are qualified by annual Freedom House review of adherence to democratic values, titled Freedom in the World as Not Free.

Ross (2001) comes to the same conclusion, based on his study of Nigeria, Chile, DRC, Botswana and other oil-dependent countries and total of 113 countries all over the world during the period between 1971-1997. The result of the study show that Persian Gulf states, being the most dependent on oil, are among the most authoritarian regimes in the world.

Lack of democracy and political corruption in resource dependent countries is one of the main cause of bad governance and economic mismanagement (Asongu, 2009). In the absence of internal stimulus for innovative thinking, resource dependent states expertise and information gathering practices are limited. They do not have sufficient knowledge of existing economical problems in the country and possible exit strategies. State departments and agencies oriented at social sphere and human development are among the most marginalized in resource dependent countries state machinery.


Dutch Disease

Resource dependence may take a specific form of Dutch decease. It manifests itself in economic crisis due to negative international conjuncture for natural resources and agriculture. It is often accompanied by underdevelopedness of manufacture sector, currency appreciation and its high volatility due to instability of export revenues. 

The term was coined in 1977 in The Economist to interpret the decline of manufacturing sector in  the Netherlands as a result of discovery of vest natural gas fields in this country in 1959, which negatively influenced Netherlands currency, balance of payments and domestic market. The discovery of gas in the Netherlands resulted in the establishment of influential company Exxon Mobil. In this way, Dutch decease is not a phenomenon specific for developing countries, since it can paralyze economy of modernized countries. For instance, a renowned economist Paul Krugman argues that exchange rate appreciations, which are the symptom of Dutch decease, result in losing competitive advantages on international market, which is difficult to restore (Krugman, 1987).
Dutch decease in resource dependent countries often takes a form of oil curse. As Gelb (1988) showed in his analysis of six oil-exporting states during 1974-8 and 1979-1979-81, oil booms may be as harmful for economy, as oil downfalls. It happens due to structural inability to reinvest export revenues in new productive sectors and due to difficulty to restore economic growth after oil downfalls period (Gelb, 1988).  The negative role of recurrent booms and downfalls in exchange rate volatility is also stressed by Gylfason (2000). Nowadays, during global financial and economic crisis such situation may be seen in Russia, one of the major world exporters of oil and gas. Due to the decreased demand on hydrocarbons it had to significantly reduce expenditures on its national development projects and social services.

In the same vein, Cordon and Neary (1982) showed that shrinkage of export revenues as a result of falling demand on mineral commodities is the main negative influence of Dutch decease on developing countries. Cordons and Nearys model of Dutch decease is described as the most successful attempt to understand its implications. The model includes non-traded goods sectors (including services) and 2 traded good sectors lagging and booming sectors. Booming sector includes the extraction of gas and oil, but it may be expanded to any mining industry, including copper, gold, diamonds or agriculture. In these conditions manufacturing is described as the lagging sector. A resource boom affects economy in two distinct ways. First of all, it increases demand on labor force, attracting it from lagging to booming sector. As a result, the economy experiences so-called direct de-industrialization. The effects of such de-industrialization vary between different mining industries.
The labor movements results in the increased demand for non-traded goods and hence, the growth of their price. However, in the conditions when natural resources prices are set internationally such situation may often result in the increase of a real exchange rate (Cordon and Neary, 1982). In a situation of Dutch decease the traditional macroeconomic concept of comparative advantage does not work. Theoretical assumption that a country, specializing on the extraction of natural resource would have comparative advantages does not account of detrimental affect of the shift away from the manufacturing industries. In the case of downturn in commodity prices, the competitiveness of manufacturing industries would not be restored in the short run. This is connected with the slow down of technological growth in manufacturing sectors due to the lack of investment funds.
The discrepancy between import costs and export revenues as a result of Dutch decease were also vividly demonstrated by Wheeler (1984) in his econometric study of several sub-Saharan African countries.

Dutch decease may be tackled in two distinct ways by slowing down the appreciation of exchange rate and promoting competitiveness of the manufacturing sector. A path to the first strategy may be found in stimulating of the re-investment of export revenues abroad or in domestic economy to avoid spending. Such decision may be effective in providing a country with stable revenues inflow, not tied with export revenues. Moreover, appreciation may be hindered by creating stabilization funds and programs, directing at the development of innovation and infrastructure projects, a step made in Russia and some Arab oil-producing countries. Moreover, developing states may resort to creating new infrastructural projects and welfare programs, aimed at stimulating domestic market and increasing domestic consumption. The intensified economic and spending activities may stimulate internal credit and consumption through mobilizing more financial resources. In its turn, the intensified economic exchanges would increase the share of saving in economy, bringing stability to national currency.

Dutch decease and resource dependence may also be tackled through diversification from resource base, a policy recently promoted in a number of oil-producing countries. In Gulf States, such as UAE, Saudi Arabia etc. such attempts proved to be partially successful  the share of oil revenues in GDP has been steadily reduced through the development of tourism, real estate sector, infrastructure projects and service sectors. These attempts and the diversification strategies, underlying them would be handled in the following sections.

Oil Curse

Oil curse concept should be regarded as direct application of resource abundancedependence theory in situations, where oil exports dominate. The main founders of resource curse theory, such as Auty (1993) and Ross (1999) consistently argued that oil and gas curses are the most detrimental for developing countries due to vast sums of revenues they generate, their rent-seeking nature and weak linkage with other sectors of economy. Oil curse is often connected with changing waves of growth and downfalls at the time of general stability and growth. For instance, the worsening of all major petro-states performance was characteristic of the 90s period (Karl, 1997, 1999).

Most of scholars agree that oil-exporting countries are more than others operate in conditions of domestic internal and external conflict, due to never ending war for rentier status (Kaldor, Karl, and Said 2007 Klare 2002).  Rentier status is linked with states control over non-renewable oil resources that are often located in foreign countries. The access to them often presupposes armed conflicts and warfare. Hence, international and interstate warfare often takes place in regions, dominated by oil-dependent countries (Ross, 2002). In such conditions authoritarian regime is the most likely political form in oil dependent countries (Ross 2001). It happens because of colossal sizes of state apparatus and repressive machinery of oil rentier state, which is necessary to suppress all kinds of protest and opposition.

Recently the attempts were made to understand the underlying causes of warfare and conflict, caused by oil dependence. Such economists as Collier and Hoeffler contend that greed, understood in terms of economic opportunities of new rents is the basic explanation of conflicts during 1960 and 1999  opportunities are more important in explaining conflict than are motives (Collier and Hoeffler, 2001, p. 2).

Behrends and Reyna (2008) enlist 5 basic explanation of oil curse, existing in literature including  (1) a resource curse, (2) the Dutch Disease, or (3) Collier and Hoefflers greed hypothesis or, according to political scientists, that it is caused by (4) rent-seekinginstitutional or (5) patrimonial theories.  (Behrends and Reyna, p. 9).As the previous analysis showed, such explanations are not exclusive, but complementary in many important respects. They presuppose complex political economical approach to the problem of oil curse.

Alan Gelb (1988), one of the major contributors to the concept, vividly shows the paradox of oil curse using the concept of Oil Windfalls  dramatic rises of expert revenues as a result of favorable international conjuncture. The paradox is that such windfalls often play a destabilizing role for economy and hence, can not be beneficial. The lack of structural preconditions for industrialization, modernization and development result in a situation, when immense inflows of money are used for repaying vast borrowings and indulging conspicuous consumption by elites.

The examples of Ecuador, Indonesia, Algeria, Ecuador etc., discussed by Gelb, demonstrate that if oil export revenues are concentrated as private hands, it results in further deterioration of public good (Gelb, 1988). In this way, immense oil revenues result in further concentration of wealth in elites hands and further degradation of public sphere.

In the same vein, Ahmad Khan in his book Nigeria The Political Economy of Oil postulates the non-taxable features of oil revenues, which make rentier-states independent and un-accountable of citizenry.  Perala (2003) argues that oil resources are more negatively connected with growth, than agricultural or tourist endowments. In a similar vein, Murshed (2004) contends that diffuse mineral economies are more likely to be effective, than economies where one resource, such as oil predominates.

Moreover, negative implications of oil curse are particularly evident in human development sector. For instance, Ross (2001) in his analysis of oil dependence development outcomes shows that oil dependence is associated with deficiencies in the spheres of child mortality, nutrition, literacy, human rights etc.

To sum it up, oil dependence may be described as the worst possible type of resource dependence due to the fact black gold is among the most expansive natural resources. Oil curse is not just economic dependence as such, but state and elite dependence on easy incomes and wealth generation. Therefore, combating oil dependence is not just the issue of an alternative economic strategy, but the formation of democratic institutions and decision-making in the developing countries. Oil-dependent states lack of accountability to the citizenry has deeply entrenched economic origins, including external sources of fiscal revenues, poor public-private cooperation, and underdeveloped domestic market and manufacturing sector. These factors often result in states authoritarian trends. Building up military and security forces is considered by state officials as more effective way for bringing social stability and control over societal processes. State apparatus, hence, serves the interests of those, who receive oil revenues, but not of citizenry as such.

Oil Curse and Developing Countries

There exists growing literature on specific examples of oil curse in developing countries. The particular interest of scholars is drawn to Middle East, Africa, Central Asia and Latin America. Case-study is the most wide-spread method of research, helping to analyze multiple negative effects of oil dependence in these countries.

Asongu (2006), based on empirical facts, argues that oil wealth has failed to generate stable development and growth in Equatorial Guinea and other oil-producing countries in Africa, such as Nigeria, Cameroon, Gabon and Angola Contrary to what one might expect, this revenue has not wiped off the scourge of poverty hat has bedeviled the masses in these resource-rich nations (Asongu, p. 8). The author explains such situation by structural deficiency of oil-producing states, which engage in rent-seeking behavior While oil production has increased since 1996, the production of  agricultural products has dropped, and most people in the country make a living  through agriculture. With poor development performance, entrenched  authoritarianism, and political instability, Equatorial Guinea is basically  replicating the experiences of other countries with an abundance of natural (Asongu, p. 10)

In the same vein, McSherry (2006) argues that Equotorial Guineas experience replicates traditional patterns of oil curse in developing world, including high levels of corruption, lack of economic linkages and innovations. Such scholars as Wood (2004) argue that oil curse in Equatorial Guinea is accompanied by criminal nature of government.

Among other scholars Amuzegar (2008) studies the implications of oil dependence for Iran, based on the logic of rentier state relationship with the citizenry and its impact on economy.

Amuzegar notes that oil dependence immediately results in degradation of market economy With larger resources  at the governments disposal, the size of the public sector automatically increases, and  the free-market private sector is correspondingly reduced (Amuzegar, p. 53).  Simultaneously, external nature of rent results in that the necessity of exacting funds from the public in the form of taxes and levies correspondingly  diminishes, the states discretionary and often arbitrary power increases (Amuzegar, p. 53).

The same patterns of oil dependence effect on democracy, economy and public sphere are shown by Ross based on his study of 113 countries all over the world including oil-producing ones, such as Botswana, DRC, Nigeria, Chile etc. between 1971-1997. Several scholars, such as Shaxson (2007) came to the conclusion that oil dependence went so far in certain countries, so it is extremely difficult to diversify their economies without inflicting colossal damage on  entire economy.

This is particularly true of such countries as Angola, Equatorial Guinea and Nigeria, in which, oil and gas now account for between  95 and 99 per cent of exports (in Angola, oil and diamonds now account for over 99.5 per cent of exports, according to IMF data). (Shaxson, p. 1124). Another valuable observation, made by the author is that the majority of sub-Saharan oil-producing countries are at the bottom of all international ratings of corruption and democracy, including Transparency Internationals Corruption Perceptions Index (CPI).

It should be noted that oil and gas dependence often paralyzes economies of countries with a developed technological and productive base. This is particularly the case of Russia that inherited highly developed Soviet industry, space and weapons technologies. However, due to it increased dependence on oil and gas, as the basic sources of revenue it experienced tremendous de-industrialization during last 15 years. Peter Rutland in his study of oil boom in Putins Russia argues that Russia is currently suffering  Dutch decease  due to significant appreciation of ruble (by 80) since 1999.

According to Rutland, such tendency   makes Russian manufacturing and farming uncompetitive unable to nd export markets, and unable to compete with foreign imports  (Rutland, p. 1163). The implications of oil-based Dutch decease are evident not only in exchange rate, but in domestic pressures on non-oil industries, which suffer the lack of investment due to higher returns in oil sector. In Russian case we see all basic symptoms of Dutch decease. Apart from this, Russian case vividly demonstrates that even countries with high industrial and technological potential may be the hostage of oil curse.

Carneiro (2007) provides the study of temporal relationship between real government spending, oil revenues and real output during oil cycle in Angola. The econometric analysis proves the validity of tax-spend hypothesis and oil curse in Angola. The proposed changes include economic diversification and more accurate fiscal regulation in order to avoid budget imbalances.

Extensive research on oil curse in developing countries touch upon complex interrelationship between oil dependence, civil conflicts and good governance. Guenther (2008) shows such connection, focusing on Democratic Republic of Congo. Guenthers framework includes analysis of international actors role in stimulating oil dependence.

So (2009), focusing on case of Cambodia shows that, however, oil may bring huge revenues for budget, weak democracy, political institutions and corruption often result in unequal distribution (So,124). Such situation may be associated with the main feature of oil rent, discussed by Beblawi elite character of oil rent distribution and its external origin. Zounmenou (2008) argues that possibility of overcoming resource curse in Ghana is strengthening its weak democracy and institutions.

Unless effective institutional reforms are made, the problems of poverty and conflicts are likely to perpetuate. Poverty is often connected with economic implications of oil dependence in developing countries. Oil dependence takes the form of enclave economy, producing no strong economic linkages and domestic market. Oil sectors are capital-intensive and hence, their use of labor forces is limited in scope. It is limited in geographical terms, as well only those workers, who are located in immediate proximity to oil fields, have privileged access to permanent employment. In situation, when the bulk of revenues are received from oil, other economic sectors have no incentives for development they lack of investment. Correspondingly, employment opportunities for the majority of labor forces are absent, resulting in mass unemployment. In its turn, mass unemployment results in the formation of informal economy, criminal activities and social instability. No social web of services or employment opportunities is usually proposed by state due to underdeveloped character of public sector and its one-sided direction on security, military build-up and receiving of oil revenues. Oil dependence, hence, is one the main barriers to industrialization, modernization, which are the cornerstones of mass employment and formation of skilled labour force.

In the same vein, Gary and Karl (2003) contend that oil curse may be diverted if oil-revenue management would be based on accountability, transparency and fairness. Another proposal was that oil revenues be initially distributed to citizens and then taxed by government in order to prevent mismanagement and corruption (Salai-Martin and Subramanian, 2003).

Mentioned strategies, however, seem to be unaware of structural causes of oil dependence. The forces, extracting rent from natural resources, would not be prone to change the rules of the game. So, if the proposed reforms are possible they may be made only through wide participation of masses and protagonist democracy. Any reforms, realized by rent-seeking elites would be either formal or palliative.

The literature on oil dependence in developing countries pays much attention to application of rentier state concept in the analysis of special case studies. For instance, Sandbakken engages in critical debate with certain aspects of rentier theory, such the link between taxation and representations In none of the cases does the link between taxation and representation appear to be a signicant determinant of regime type. Although the study conrms that oil wealth is associated with autocracy, the causal mechanisms of rentier state theory could benet from being rened  (Sandbakken, p. 1).
Much research on oil dependence also focuses on interdisciplinary analysis of interrelation between conflict, instability, international pressure and oil curse. For instance, Robert Looney applies such framework in his analysis of post-war Iraq oil policies (2006).

To sum it up, the existing literature on oil curse in developing countries predominantly focuses on economic and institutional implications of oil dependence, the issues of democracy and transparency, rent-seeking behavior and complex interconnection between oil and conflict, either civil or inter-state.


Rentier states

The concept of rent and rentier was very influential in political economy of Ricardo and Marx. Ricardo defined rent as a gift of nature, which gives profit for its holder, while requiring virtually nothing in terms of investment. Ricardo noted, that Mines, as well as land, generally pay rent to their owners and this rent  ...  is the effect and never the cause of the high value of  their produce.(Ricardo, p. 590) From critical positions, Marx defined rentiers as a group within capitalist class, who receive profit in non-productive and parasitic way. In both cases rent is understood as extraeconomic gift of nature, appropriated by property owners and used by them as a source of surplus value. Rentiers in classical political economy are usually subdivided into two groups land rentiers and financial rentiers. The first usually belonged to landed aristocracy, renting its land to new class of agricultural farmers and businessmen. Land aristocracy had virtually no incentives for investing into agricultural technique development all expenditures were taken by businessmen. Financial rentiers are usually described as members of financial capital, whose profits are generated by financial operations of lending.

Such classical understanding of rent and rentiers found its direct application in modern concepts of rentier state and rentier economy. The concept of rentier and rentier state is very helpful in terms of understanding of political economy of resource dependent states. The term was coined by Hussein Mahdavy in relation to pre-Pehlevi Iran  and all countries that receive on a regular basis substantial amounts of  external economic  rent(Yates, p. 11). Such tendency develops due to governments control over natural rent, such as oil or gas and the absence of developed productive economy as a source of tax income for government.  Rent states are the most wide-spread among oil and gas producing countries, such as Iran, Nigeria, Saudi Arabia, UAE and where governments receive the bulk of income from hydrocarbon exports.

Beblawi and  Luciani (1987) argue that rentier state concept neglects wider implications of rent-seeking behavior for society and, hence, prefer using the term rentier economy, describing a condition in which rent is external to economy and is the main source of state income. Beblawi (1990) outlines four main characteristics that should be in place in order to classify a state as rentier. 1. Rent situation dominates 2. External origin of the rent (it should come from foreign sources). 3. Elite character of rent generation (the majority of society is not involved in the creation of wealth). The situation is different for tourism and other types of diversified rent, an activity, in which many economic agents may participate. 4. Authoritarian tendencies arising from state monopoly on natural rent (Beblawi 1990).

In the same vein, Luciani places more emphasis on interrelation between rentier state and economy. According to this scholar the key characteristic of rentier states is that externally received rent liberates a state from the need to get income from domestic economy (Luciani, p. 53).  In rentier economies governments expenditures comprise a great share of GDP due to the fact that GDP is mainly made through external rate. Such situation results in states tightening control over economy and civil society.                                

Panchok-Berry (2005) clearly postulates that rentier state due to structural conditions is unlikely to foster social welfare and democracy

A unique characteristic of the resource in Rentier states is its labor-free profit base. The state is unconstrained by labor forces in making decisions. Resources such as oil are not labor intensive and therefore no collective bargaining will form to make the state accountable to the public. Governments that have this non-labor resource are non-responsive to the collective bargaining of the citizenry and therefore usually have a small minority of people in control of the government. The state does not worry about potential strikes and therefore, no public goods are distributed to please the labor force (Panchok, p. 8).

In the same vein, Ross (1999) defines three direct effects of rentier state for society 1.Rentier state effect 2. Repression effect. 3. Modernization effect. The first effect results in decreasing accountability of a state through the use of patronage and low taxes for cronies. The second explains a state tendency to spend much money on repressive apparatus in order to repress opposition and subaltern masses. Finally, the third shows a states lack of ambition to promote modernization through infrastructural, educational and social welfare projects (Ross, 1999).

If general characteristics of resource curse paradigm and rentier stateseconomy are compared, it seems that rentier state economy are direct consequence of resource curse. All basic negative implications of resource curse, such as de-industrialization, underdevelopedness of productive industries and service sector, poor human and social capital, as well as authoritarian tendencies are common in rentier states. This concept may be helpful in terms of projecting economic consequences of resource dependence on power and social relations in a given society.

2. City State concept and Economic Base Theory.

A city-state, which may be defined as independent states with a territory consisting of city, played a crucial historical role. For instance, Greek city-states (polis), such as Thebes, Athens, Corinth were traditionally the centers of arts, philosophy and science development. Small size of these states encouraged democratic tendencies and progress. (Rhodes, 2007),

Middle Ages city-states in Italy, such as Genoa, Florence, Venice and Siena were the birth place of market economy and banking. They managed to develop complex social and economic structures through trade and finance. Small Italian city-states due to their pragmatic management and innovativeness became the places where the most sophisticated goods were produced and traded. Sea was often the main source of city-states profit  it was the premise of their trading activities in all world regions. Additionally it made it possible to oppose large hordes of foreign powers (Rhodes, 2007).

City states emerged in different parts of the world and in most cases their economic performance and wealth creation was effective in comparison with vast empires and countries. Taken this history of city states in consideration, it may be argued that the concept of city-state is extremely important in terms of understanding possible strategies for overcoming oil curse in such countries as UAE through diversification. Indeed, city-states managed to achieve great economic performance through developing high surplus industries and technologies, diversified economy, banking sector and institutions, which are crucial for developing of modern economy.

The type of modernization they promote may be either democratic, as in the case of such historical examples as Croatian Dubrovnik or authoritarian as in the contemporary example of Singapore (Chiu, Ho and Tai-lok, 1998). For instance, local authorities in Singapores districts have no legislative and executive autonomy from national government.

The economic base theory is very informative in terms of analysis of economies, comparable with city-states. It may be described as application of economic knowledge to the analysis of local economy in terms of it growth capabilities, interrelation with national economy and regional positioning. Economic base theory also analyzes the potential resources  both material and knowledge-of countrys growth and development. Economic base theory is crucial for government management of social policies and human capital.

As Klosterman suggests, Information about an areas future population is incomplete without a parallel understanding of the local economy that largely shapes its future. (Klosterman, p. 113). As Klosterman notes concerning economic base technique is the oldest, simplest and most widely used technique for regional economic analysis. (p. 113).

Following the main premises of economic base theory, economists usually divide local or regional economy in two sectors basic (non-local) sector 2) non-basic sector. Basic sectors have national and global significance, because they produce goods, consumed by foreign importers and are not usually consumed by local households and firms. It should be noted that basic sectors usually include local mining and resource oriented firms and manufacturing. Proceeding from this fact, the discussed resource-dependent economies have the dominance of basic sector in their economic base. In contrast, non-basic sector includes firms, oriented at local consumers. The examples of such activities include restaurant business, supermarkets, drug stores etc.

Basic sector is defined in the majority of studies on economic base theory as the engine of local economy. This is particularly true of modern city-states, such as Hong Kong and Singapore The economic base technique is based on a simple causal model that assumes that the basic sector is the prime cause of local economic growth, that it is the economic base of the local economy. (Klosterman, p. 115). Basic sector in the case of Hong Kong and Singapore is, however, diversified and technologically developed.

In other cases, as economic base theory contends, economy entirely dependent on basic sectors would suffer significant problems during economic crises due to the lack of diversification. Such conceptualization shows that economic base theory uses assumptions similar with the discussed resource curse concept. In economic base theory the impact of basic sector on entire economy is estimated through base multiplier, showing how many non-basic jobs are create by one base job.
Moreover, various economic base techniques are used for analysis of local economys specializations, diversity, strengths and weaknesses. Assumption techniques is utilized for estimating employment in local basic sector through using basic economic assumption concerning local economy.

Location Quotient Technique estimates the levels of employment in basic sector through comparing local economy with larger geographical units. Minimum requirement technique is based on comparing local economy with similar units. The discussed basics of economic base theory show that it is extremely applicable to the analysis of regional and city-state economies. Utilization of economic base theory is a means for understanding the current economic situation, problems, existing economic linkages and possible exit strategies for diversification.

Hinterland and development
The importance of hinterlands is stressed in modern concept of city-state and urban economics in general. For instance, Barrell argues that, Whatever its first function  city state, sea port, market-town, imperial capital  an urban centre always needs a hinterland to support it. Cities on every continent have disappeared into desert or jungle because the lands that surrounded them were lost, stolen or worn out (Barrell, 189). The importance of hinterlands has several important dimensions strategic, economic and recovery. Strategic importance is connected with security issues. Economic significance of hinterlands is directly tied with the issues of developing a competitive economic base. Hinterlands are used as the proxy directions of export, as possible markets for cheaper labor and diversification of local production base. Hinterlands are especially important as place were local differences may be used a source of profitable exchange in tourism and trade (Medovi, 2005, p. 172)
The importance of hinterlands for urban development is also stressed by Harvey (1973), who argues that global cities urban system is build on appropriation and redistribution of surpluses. The relationship between urban core and its hinterland (or periphery are unequal) and hence, hinterland is needed for city to accumulate wealth and redistribute produced goods.

In these conditions, the absence of a hinterland may prove to be a crucial problem for city-states in terms of development. As Wee (1995, p. 68) argues, This presents a unique situation of the absence of a  traditionally  termed  hinterland,  that  is,  the  land beyond  or  the  region  within  the  same  political boundaries  from  which  a  central  place  draws  its resources  and  over which  it  distributes  goods  and services. (Wee, p. 68).

However, the notion of hinterland may be widened for island-city-states as Singapore as their sphere of influence in immediate vicinity (the case of Indonesian territories used by Singapore as a hinterland), The question  is  then whether a city  can  sustain  itself  in  the  long-run  without  a  hinterland  that  is  administered  by  a  regional  or  national government of which  the  city  is  a political  entity (Wee, p.69).

The capitalization of city-states opportunities and overcoming of structural deficiencies, such as absence of hinterland, developing balanced approach to economic base is the basic ways for fostering economic growth, exemplified by Singapore and Hong Kong.

Hinterlands absence is among the basic impediments to economic exchanges between city-states and outside world. Hinterlands provide regional economies with additional sources of labor force, trade and investment, however, for the majority of city-states the only possible solution is construction of artificial hinterlands and regional integration. Another option is developing comparative advantages, based on advantageous geo-economical position.

For instance, Wee argues that Singapores economy managed to achieve such remarkable progress through playing the role of gateway and middleman in relations with other influential regions, such as Japan, China, Malaysia and Indonesia. Partly, the economic success was achieved through integration into ASEAN, which allowed Singapores products and services be exported in this vast regional union. (Regnier, 1991).  Singapore also played important role as a port, through which goods from all over the world were distributed to enormous Asian markets.

The creation of growth triangle linking Singapore to Malaysian state Johor and Indonesias Riau Island was a tremendous achievement of Singapores promoted integration.

The possibility of such sub-regional cooperation was caused by Singapores city-states status. As Wee argues,  Three  key  elements required  to  establish  a  sub-regional  economic  cooperation  have  been  identified  first,  a  highly developed  city  that  has  run  out  of land  and  labor  second, a surrounding area plentiful in both of these sectors and last but not  least,  the political will  to  eliminate visible  and  invisible barriers dividing city  from hinterland (Wee, 72).

Hence, Singapore having no administrative hinterland managed to use its strong economic potential to create artificial hinterland, servicing the development interests of this city-states. This example vividly shows that through attracting other regions to cooperation and economic development the problem of hinterland for city-states may be resolved. 

Singapores economic potential is reflected in multiple employment opportunities in perspective industrial and technological sectors that are proposed for labor force in such countries as Indonesia. Opening its labor market for Indonesian labor force, located in immediate proximity to Singapore, this city-state managed to resolve the problem of labor force scarcity and hinterland absence (Wee, 72). Such cooperation, however, proved also to be effective in terms of resolving unemployment problems in certain Indonesian regions, and, hence may be regarded as mutually advantageous cooperation.

Such role of middleman, vividly demonstrated by Wee (1995),  allowed Singapore city-state to become the influential agent of manufactured goods distribution, the center for financial and banking services, air traffic and sea traffic hub. The strategy chosen by Singapore may be modeled by city-states with no direct control over hinterland For such  a  city,  which  has  no  political  control  over  its hinterland, its prosperity has to be achieved  through  cooperation and its middleman role, not domination or conquest, characteristics of the surplus-extracting core  in  hinterland  literature (Wee, p. 72). City-states may use proxy states and regions as economic, rather than political hinterland, which will bring prosperity and stability.

Many scholars argue that hinterland is central to the development of small island territories, such as Singapore and Hong Kong. For instance, Baldacchino (2006) contends that a small territory is especially obliged to use extra-territorial resources as its hinterland for economic success. Such resources extend over a whole range of goods and services and include access to investment, welfare, security, stable currency, international relations, specialized labour power, transfers, markets and higher education (p. 45). As Baldacchino (2006) argues, the absence of a natural domestic endowment is an intervening variable in the development of a territory (p. 46).

Such observations were also provided by Hintjens in relation to Frances colonies in the Indian Ocean. These islands were marginalized because of the lack of hinterland to exchange with and they conserved their underdevelopedness virtually no physical or cultural hinterland to retreat to (Hintjens, 1991, p. 38). Caldwell, Harrison and Quiggin suggest that island microstates had a more tendency towards westernization reflected in intensified immigration ties with former metropolies and its language. (Caldwel et al., 1980, p. 953).

In the same vein, Paul Streeten (1993) contends that local rural hinterland has a crucial significance for economic development. However, the absence of hinterland was the main engine for such city-states as Singapore, Bermuda, Hong Kong or Malta to promote modernization and globalization of their economies industrialisation or tertiarisation have been the inevitable growth poles, obliging a quick shift of mind-frame towards export pro- motion and the penetration of export markets (p. 47).
Another positive implication of hinterlands absence is noted by Baldacchino. He suggests, the absence of a hinterland has a negative implications in terms of develoloping local land-owning farmers and plantocracy, who lobby import protection and high cost of food items to consumers (p. 47). The absence of hinterland in small island territories is also recognized as a significant problem by such influential organization as the UN (Grifth and Inniss, 1992). Many scholars suggest that sustainable development is impossible in small islands  speaking of sustainable development is a contradiction in-terms  (Connell, 1988 Bertram, 1993 Baldacchino, 2004, p. 6).

This occurs due to the fact insular territories can not survive without hinterland resources and exchange practices. Moreover, they are dependent on external conjuncture, fuelling their economic base. However, such model may be faulty as in the case with Briguglio, who contends that such states survive only through  articial props  (Briguglio, 1995, p. 1622). Such analysis ignores cases of city-states, such as Singapore and Hong Kong, that managed to achieve high levels of development and growth through diversification and using their comparative advantage.

Such scholars as Bertram (1993, p. 248) argue that sustainable development is impossible because of the lack of productive activity within island city-state territory. However, mentioned  thesis also contradicts Singapores example. Indeed, many island states are underdeveloped, however, it is connected not with their geographical position, but structural economical, political and social problems. More pragmatic view point concerning city-states development is expressed by another claim that integration, openness, free market, innovation etc. are crucial factors for development of these territories.  (Bertram and Watters, 1986, p.52 Baldacchino, 2000). 

It should be noted that in city-states, such as Hong-Kong or Singapore where resources are often scarce  real estate has an important role in the functioning of the whole economy (Haila, p.2241).  Transnational real estate firms bring significant benefits for governments revenues, economic growth and individual well-being. Real estate may play a key role in diversifying the economic base of city-states dependent upon natural resources.

Contemporary city-states are predominantly situated in Asia. They significantly vary in area, population, its density, GNP and birth rate. The following city-states are present in contemporary international system Kuwait, Qatar, Bahrain, UAE (made up from seven independent states Abu Dhabi, Dubai, Sharjah, Ajman, Ras al-Khaimah, Fujairah and Umm
al-Qaiwan)., Singapore, Honk Kong, Macau, Goa, Pondicherry.

It should be noted that the majority of listed city-states may be described as resource dependent. The notable exclusions are Hong Kong, Singapore and Macau, being the most successful in terms of economic performance among all city-states.

Cited in Parker (2004, p. 222)
As the table above suggests,  Hong Kong, Goa, Pondicherry and Macau have no sovereignty. All except Goa and Pondicherry are specializing on trade. Only Singapore and Hong Kong have significant role of manufacturing in their economic base. Democratic regime is present only in Goa and Singapore.

Based on the analysis of these structural characteristics of city-states Parker comes to the conclusion that these city-states represent more than just some kind of geopolitical residue left over from the fall of the empires in the late twentieth century. It suggests that they are a part of the wider phenomenon of globalization They are phenomena that in their economic and trading patterns, and in some cases at least, in their cultural diversity, transcend their immediate geographical environment (p. 224).

Example of Singapore and Hong Kong
The majority of city-states have similarities in terms of challenges they meet in global economy and economic base development. This is particularly true of Hong Kong and Singapore, both island city-states having similar colonial heritage and development patterns.

Chiu, Ho and Tai-Loc (1997) argue that these highly developed city-states had significant challenges of cost increases, competition from low labour-cost neighbors and the necessity of effectively using their economic base at global markets.

However, these challenges were differently addressed by Hong Kong and Singapore. Hong Kong preferred Offshoring its production to low-wage regions of China, while Singapore focused its efforts on technological upgrading, developing new high-tech production lines. In this way, Singapore made all necessary to strengthen its production base by diversifying the source of export revenues and increasing the number of industries with high added-value. Such route may prove to be effective for resource-dependent city states.

Unlike Hong Kong, Singapore had managed to maintain its manufacturing base and combine it with highly developed financial and banking services. In contrast Hong Kongs manufacturing base was not upgraded at needed level.

As Chiu, Ho and Tai-Lok (1997), suggest such success was based on states role in strengthening internal economic linkages and developing industries with the highest returns on investment. As far as Singapore has no vast natural resources, a state rejected rent-seeking behavior and played the role of strategic planner and major investor into development.

City-states development is significantly affected by their economic and institutional relationship with neighboring states or as in the case with Hong Kong  hinterland of inland China after Hong Kong became its part in 1997. For Singapore and Hong Kong their economic ties with corresponding hinterlands of Guandong and growth triangle are very intensive. Guandong is the intensively development region of South China with the highest levels of productive activity. The same may be said about growth triangle. Singapore particularly benefits from the availability of  relatively cheap land and labour in the Malaysian state of Johor and, more markedly, on the Riau islands (chief among them Batam and Bintan) of Indonesia (Bunnell, Muzaini and Sidaway, p. 2).

Hong Kongs hinterland particularly influences its economy through family ties many Hong Kong firms are owned by Chinese families, who have connections with firms in inland China. It stimulates the development of economic base through joint enterprises. Some scholars, such Khan argue that productive base in city-states should be also diversified by agricultural sectors due to their non-monetary advantages in the future. Moreover, in a long run agricultural diversification may be crucial in terms of import-substitution strategies (Khan, 1988).

The analyzed concept of city-states and economic base theory suggest that notwithstanding structural barriers to growth and development in city-states, they may be overcome by means of diversification, productive utilization of base sectors, fostering regional integration and technological change. The absence of hinterland is among the basic problems, hindering economic growth in city-states, particularly as far as small island territories are concerned.

Hinterlands, as literature suggests, are crucial for the development of economic exchange between citys core and periphery. However, as the case of Singapore suggests, such problem may be overcome by regional integration and developing of artificial hinterlands in proxy countries. Another conclusion, derived from economic base theory, is that too much emphasis on base sector may negatively affect economic stability and result in Dutch decease. Basic sectors have to be either technologically developed industries or diversified set of sectors, interconnected with strong economic linkages. Diversification may be the most effective option for balancing the correlation between basic and non-basic sectors.

As the previous analysis suggests, city-states may tackle their structural problems in different ways. In the conditions of globalized economy the problem of labour force scarcity and expensiveness may be resolved by Offshoring. Moreover, economic cooperation with outside world may be promoted through joint ventures and investment opportunities for foreign business. If a city-state borders with a developing economy with significant unemployment, this city-state may effectively develop through attracting foreign labor force, and, hence resolving the problem of its scarcity. At the same time, such policies would stimulate artificial hinterland development. Another option is development of capital-intensive high-tech industries with high added value, as suggested by Singapore case. Such approach would generate profits and investment needed for resolving domestic social problems.

The discussed strategies and case-studies may be applicable to the analysis of diversification strategies in UAE seven city-states. However UAE are comparatively developed in terms of GDP per capita and human capital both regionally and globally, the prevalence of oil exports may be detrimental to the sustainability of economy. Recently, many efforts were made by Dubai and Abu-Dhabi to diversify their economies through integration, real estate projects, attraction of sport events and competition, tourism. Tourism along with real estate has recently became the main diversification strategy in UAE and particularly in Dubai that has managed to become one of the main centers of tourism in Middle East and Asia. The analysis of effectiveness of this strategy should be based on careful examination of diversification paradigm.


3. Economic Diversification
The theory of diversification breaks with the dogmatically understood concept of comparative advantage, which often led to limited focus on monoculture exports and resource dependence. Comparative advantage is often narrowly interpreted as the imperative of concentrating economic efforts on developing a limited number of industries and businesses at the expense of others. While such approach obviously contradicts recent developmental economics, which appeal to social welfare and development, it is also at odds with neoliberal paradigm, focusing on growth. The latter argues that economic growth results in development through the effect of wealth diffusion.

Diversification focuses on balanced approach to development, aimed at reducing risks of Dutch decease. As it was noted above, Dutch decease originated from the dependence on a limited nomenclature of goods. Its implications include de-industrialization, manufacturing underdevelopedness and currency overvaluation.

Contrary to common sense judgments diversification does not imply reducing trade in old goods or commodities it is rather centered on decreasing their percentage share in exports through focusing on new goods and services. It is based on new correlation between basic and non-basic sectors, in which the inequality between them is reduced. Balanced approach to diversification requires gradual equalizing of these sectors to the favor of economic stability and social development.  In this way, diversification helps avoid negative implications of international conjuncture, break offs in supply and production etc.

The concept of diversification by no means contradicts the idea of specialization. Specialization may also be detrimental, if it is fostered at expense of economic sustainability and differentiation. However, it should be noted that diversification has to be clearly balanced against specialization and comparative advantage, which bring the bulk of export and budget revenues. For instance, as De Rosa (1992, pp. 590-91) argues, efficiency considerations will . . . continue to place important bounds on diversification, especially in respect to the expected factor content of the countrys trade. In other words, the initial factor endowment of primary factors of production . . . will continue to dictate the efficient possibilities for diversification of production and exports . . . (pp. 590-591).
The discussed literature on rentier states vividly demonstrated that rentier-seeking behavior through promoting of oil dependence has far-ranging negative consequences for developing countries economy. Economic sustainability and development are impossible in one sector economy. Economically sustainability is based on ability to diversify budget revenues through developing of import-substitution industries and diversified source of export revenue.

If governments budget is built on oil-based rent and revenues, the economy becomes particularly vulnerable to fluctuations of international prices and conjuncture. As Gelb showed sharp oil windfalls generated by international oil circles make it difficult to stabilize economic management for developing countries. Oil revenues during oil booms do not offset vast losses during oil crises, resulting in inflation, underemployment, lack of economic activities and investment (Gelb, 1988).
Moreover, economic sustainability can not be achieved due to structural deficiencies of rentier states, discussed in Ross model (Ross, 1999). Modernization is usually difficult to promote, because of elites perpetuating rent-seeking behavior and the bubble of public sector.  Shortage of investment funds and their use in resource sector is one of the main reasons of slow modernization of resource dependent economies. The economic history vividly demonstrates that modernization was primarily state-promoted development through public investment into new industries and infrastructural projects. In rentier economies, however, state has no incentives to invest into innovation and modernization due to easy resource revenues.

Economic linkages and innovative sector of economy are usually the main hostages of rentier economies. In these conditions, diversification should be considered to be the only effective strategy of overcoming resource curse in the developing countries. Resource dependence is often accompanied by poor economic specialization. Increased economic specialization is usually regarded as a result of modernization and innovation, when economic linkages develop between new industries, specializing on the production of certain goods and services, consumed by other economic agents. Such situation results in the development of wide productive cycles and chains, stimulating credit activities and new investments. In resource economies, due to their enclave nature, economic specialization and linkages are hard to achieve. As a result, domestic market of goods and labor is underdeveloped and non-competitive.

Rentier economies tend to conserve the dominant economic structure, because it coincides with their political interests. The challenge against oil-dependence for them is simultaneously a challenge against their monopoly over natural rent. However, even in such conditions permanent crises caused by oil dependence and rising economic interests of middles classes often move rentier elites towards diversification as a means of stabilizing economy and hence, social relations.

The movement towards diversification is often affected by shrinking revenues as a result of a crisis. In the current conditions of global financial and economic crisis, rentier-states are likely to feel international and internal pressure to diversify and create effective domestic market to stabilize employment and social polarization.


Concept of economic diversification
The concept of diversity and diversification are widely used in several disciplines and theories, including economic base theory, industrial organization theory, economic development theory, regional and location economics theories, trade theory, portfolio theory etc (Siegel, Johnson and Alwang, 1995). Our main interest should be focused on diversification meaning in economic base theory and economic development theories, which address the analyzed national policies of diversification.

Economic diversification is widely addressed in economic literature. Two basic units of economic diversification theories analysis are individual firm and the entire economy. The corporate diversification is widely discussed in Lamont (1985), Amit and Livnat (1988). They argue that for an enterprise to be effective its goods nomenclature should be as wide as possible to prevent profit shrinkage due to decreased demand on certain goods and services.

The founder of institutional economics D. North (1955) argues that diversification is inevitably linked with modernization and industrialization of economy. According to Norths sector theory of economic growth diversification passes through gradual states. The first one is self-sufficient agricultural economy. The second stage includes commercialization and trade, which affect the diversification in the direction of manufacturing and industrial base. Finally, the development of highly qualified personnel and cadres stimulates diversification towards banking and service sectors (Thompson and Lanier, p. 77).

Whereas this stage theory of diversification may prove to be effective in describing the path of developed economies, it fails to account of former colonial countries, including the majority of city-states. Their path of economic development differed from that of the core of Western world. Capitalism developed in these societies as a result of colonial rule and its deficiencies and irregularities resulted in unequal exchange and development, as well as resource-dependent patterns of growth. Hence, evolutionary theories of diversification are impossible to utilize due to the fact that diversification in developing countries should be based on subjective strategies and governments involvement in the process. The majority of resource-dependent societies have implemented only limited patterns of modernization, primarily linked with oil sector. However, the rest of economy is characterized by the dominance of pre-capitalist patterns of production. Those societies have uneven development within sectors of economy and regions. Evolutionary pattern of diversification, hence, can not be applied in their case, because it failed as a result of economys structural deficiencies. Moreover, one should point to international context of these societies, including their participation in certain patterns of global specialization, debt obligations and other structural barriers to any evolutionary processes.

The importance of diversification is celebrated because of its alleged link with stability. For instance, Killian and Hady (1988) argue that, diversity is expected to increase the stability of local economies and enhance their potential for growth. (p. 45). Akpadock (1996) advocates the same position in relation to community policies  diversify their economic base so that they could survive any future structural  changes in the national economy.(p.64). Diversity is addressed by Killian and Hady (1988), as well as Akpadock (1996) as a necessary precondition for economic growth, development and stability. Stability is guaranteed by diverse sources of export revenues, which is particularly useful during economic crises and shocks on the international arena. Moreover, it creates enhanced specialization, which is the cornerstone of sound and developed domestic market of goods, services and labor force. Specialization, based on diversity, also creates strong economic linkages within the economy and, hence, is the main prerequisite for the formation of effective civil society.

However, as Wagner and Deller(1998) suggest growth and stability are not contradictory in short- and long-run. Short-term diversification is more growth-oriented, because it commonly focuses on growth perspective sectors and industries. However, such approach may have negative consequences in terms of abandoning sustainable projects in long-term perspective. If target industries are not supported after diversification was boosted, the economic implications may be worse, than before these policies were implemented.  Hence, it may be summarized that short-term diversification policies are oriented at growth, while long-term diversification is oriented as growth and stability.

Key and Lockard, unlike North, stress on the necessity of governments intervention and strategic planning in promoting effective diversification. According to these authors, diversification would not occur as a natural process, but should be promoted through infrastructural projects, investment etc. One of the major debates in the literature on economic diversification is mixing diversity and diversification. As Malizia and Ke (1991) suggest some researchers do not make distinction between diversity and diversification, as if these terms were interchangeable (p. 7). Hence, Diversity is an objective condition of a given economy, while diversification is a policy directed at making economy diverse. As it was noted above, diversification as a governmental policy, should be regarded as the only effective stimuli towards diversity.

The concept of diversification is wide-spread in developmental economics. Schuh and Barghouti (1988), Petit and Barghouti (1992) regard it as a process of structural transformation from resource dependence to secondary manufacturing or tertiary service sector. Syrquin (1988) acknowledges that the process of structural transformation bears on objective traits, being connected with industrial and technological revolution.

Another current in diversification literature, presented by Harris (1989) and Scitovsky (1989) considers that development and diversification are based on effective correlation between growing and declining sector. Diversification should not be promoted at the expense of growing basic sector, since it would inevitably result in economic instability. The most effective balance should be found in order to guarantee stable fiscal policies and export revenues in short and long run.  Public investment in diversification should not also divert funds from crucial social programs and services. This would secure that diversification programs do not result in social conflict and instability.

Mentioned correlation between diversification and instability is widely addressed in the existing literature (Wundt, 1992 Brewer and Moomaw, 1985). According to these studies, diversity quotients help predict economic sustainability in the long run. The formation of such predictions should be based on sufficient knowledge and expertise by government institutions. Every decision concerning diversification should be clearly calculated in terms of possible gains and losses.

Economic base theory views diversification as being determined by development of basicexport sectors as the most effective drivers of economy. (Miller and Blair, 1985). In these conditions diversification should be premised on preservation of the central role of exports in GNP creation. Localization coefficients are used to define the basic vs. non-basic role of a given sector in a regional economy. Diversification measures are taken based on these findings and general assessment of economic linkages and specializations. As Isard (1976, p.252) suggests, For a regional analyst seeking to implement the policy of diversification, a series of localization coefficients could be useful. It could provide the basic for preliminary and tentative judgment about the industries to seek and encourageIndustries with low coefficients are relatively non-concentrated regionally, and are thus presumably amenable to location in a region, seeking industrial diversification (p. 252). (nothing is missing   means that the following part is irrelevant)

Such position is criticized by Siegel, Johnson and Alwang (1995) for equaling low quotient with irrelevance of a given sector. The thing is, as they rightly claim, that one should understand the causes of a low coefficient, which can be either the absence of competitive advantage or missed opportunities. This observation is particularly relevant in the case of resource dependent countries, where underdevelopedness of certain sectors is connected with missed opportunities and rent-seeking behavior, rather than the lack of competitive advantage.

Due to corruption and ineffectiveness of government agencies, responsible for non-oil sectors of economy, the latter lack state subsidies, stimulation of investment and adequate public-private cooperation. The combination of public and private ineffectiveness result in underdevelopedness, which is, however, may be handled.

In terms of portfolio variance approach economic diversification refers to process of reducing economic instability and lack of sustainability by varying the share and value of different sectors (Schoening and Sweeney, 1992). Comparing various combinations of sectoral activity and output is the procedure needed for the creation of the optimal diversification portfolio. However, since the balance of growth and stability is not considered, such approach to diversification is unlikely to objectively assess all extra-economic implications of diversification.

Location and regional economic approach to diversification focuses on economic linkages as the basic mechanism of securing stability during diversification (Hoover and Giarratani, 1985). This approach contends that diversification is likely to be effective in agglomerations with developed economic linkages, which may offset possible negative impact of instability. The case is that in the absence of strong economic linkages diversification may result in short-term instability as a result of changing patterns of policies. However, if strong economic linkages are present, the implications of instability and revenues loss may be less evident.

Diversification of economic activities in these conditions is likely to be a positive exit strategy. It should be noted that mentioned approach is extremely relevant in terms of city-states analysis, because they have no hinterland in a strict sense of the word. Hence, their diversification initiatives are unlikely to be hindered by hierarchical relations between Core (city) and periphery (hinterland) (Harvey, 1973).  In the context of development economics, diversification is affected by the change of production patterns (Petit and Barghouti, 1992). Economic diversification may be accompanied by unbalanced growth, having negative consequences for economy in general and hence, the most genuine strategy is government planning, adjusting diversification to specific economic and social goals. Such approach is extremely important, because it acknowledges the critical role of state institutions in diversification. This is particularly relevant for developing countries, where diversification can not be developed as a natural process, because of structural barriers and where conscious intervention of state is needed. In all success cases of diversification, including UAE and Botswana, government planning was crucial for stimulating private initiative and providing favorable investment climate.

Hirschman (1989) connects the process of diversification with input-output matrix, in which virtually all cells are empty in resource dependent economy and full in economy with developed productive and technological base and strong economic linkages between industries and firms.  Input-output matrix characterizes the level of economic activities concentration in different industries. The larger is the number of sectors of a given economy the stronger are economic linkages, specialization and diversification.

In this way, economic diversification should be directed at sectors, which may benefit the largest number of households and local communities. Tourism may be viewed as one the most effective sectors in this respect. It helps filling empty cells by linking more and more industries and business to provision of necessary goods, communication and infrastructure.

Wagner and Deller (1993) also establish their assessment of diversification strategies based on intersectoral linkages through the use of input-output matrix.  Such approach may be helpful for testing economic stability in a given set of diversification initiatives.

Diversification in resource dependent rentier states, as the research suggests, is accompanied by intrinsic problems and difficulties. While rentier states have enough export revenues and resource to foster investment and diversification of domestic economies, it does not will to do so due to structural causes.  Several structural problems of diversification in rentier economies may be outlined.
First of all, since manufacturing industries are in crisis, imports become more and more monopolized by import-oriented  businesses, which have direct interest in perpetuating underdevelopedness of domestic market. Import lobby may be difficult to struggle with, because of corrupted governmental agencies, nepotism etc.  Moreover, it is difficult to achieve balance between basic sector and target sector. Reallocation of resources to other sectors is difficult, because the entire economy is structurally dependent on resource revenues, which are not linked with other sectors of economy. Such decision may be very difficult in terms of short-term problems.

Secondly, resource rents breed corrupted and strong institutions, which protect their benefits from resource rent distribution and sharing. Their feedback to initiativess from civil society and private initiatives is very feeble and prejudiced.  Such inability is structurally determined by rentier economies structure, which includes 1. resource sector 2. corporate parts of resource sector (for instance government employment), financed from rents. 3. and informal semi-chaotic economy. Informal sector fills the hollow niche, created by the absence of domestic manufacturing and organized economic linkages. The deficit of certain goods, unregulated small and medium business, and corruption make it difficult to develop effective tax relations between government and domestic business. These two factors are one of the most detrimental to successful diversification strategy.
Proceeding from this reality, Hirschman (1989) offers linkage approach, providing understanding of types of economic linkages in a given economy. The first one is consumption linkage, which fuels domestic production of goods. It is rather weak in resource dependent economies, because the majority of goods are imported.  The second is a productive linkage, which is the most crucial for the purpose of economic diversification. It includes developing private initiative and securing the efficiency of public investments. Thirdly, fiscal linkage creating the source of domestic development and public-private cooperation. Productive and fiscal linkages are also underdeveloped in resource dependent economies. As it was noted above, rentier states domestic fiscal policies and tax link are very weak due to the fact that rent has an external character. The bulk of revenues is received from the foreign states and corporations, while domestic business functions in informal sector.

The absence of tax relations between state and domestic business makes it difficult the formation of common internal market and perspective domestic projects. Moreover, as it was noted above, the absence of tax link is the main cause of authoritarian trends in resource dependent countries. Hence, the absence of political will to develop domestic non-oil industries is often caused by structural factors.

To sum it up, the discussed approaches to diversification, stress on policy difficulties of it realization. To be effective diversification should promote both growth and balance. It requires professional expertise and knowledge, as well as developed prognostic techniques. However, in any case, diversification is connected with short-term risks of instability that are difficult to avoid.
   

Types of diversification
 As Hirschmans classification of economic linkages suggests there can be several distinct approaches to diversification. The first one fosters the development of productive base through investment, subsidies, educational programs, attracting of foreign direct investment and multinational corporations. The premise behind such type of diversification is strengthening economic linkages and creating well-developed domestic market, which can diversify budget revenues. Stimulating manufacturing simultaneously result in the re-activation of banking credit and small and medium businesses.

The second approach is focused on attracting private initiative of small and medium businesses and households in the creation and sharing of non-oil rent. As it was noted above, a type of rent generated by tourism is more democratic, because it gives benefit to a vast group of citizens, unlike elite controlled oil rent. Tourism, being a growth industry, may be also an effective strategy in terms of promoting economic growth. Moreover, tourism intensifies international business, educational and cultural exchanges, which are often central to comprehensive development of human capital.
Another type of diversification is diversification in services, including financial tourism and gambling. Financial services may be viewed as important contribution into financial stability of a country. They are crucial in attracting domestic and foreign investment, and may be using for preventing risks. Developed financial services are crucial for stimulating economic activity through credit. This is especially true of small and medium businesses. Based on the possible diversification opportunities they may be classified in three distinct categories 1. diversification of production base 2. diversification of service sector 3. rent diversification
In what follows we analyze different case of diversification in oil-dependent countries, reflected in the existing literature on topic.

Diversification from oil base
The issues of diversification of oil-dependent economies are extensively analyzed in the literature on diversification. For instance Looney studies the prospects of diversification in oil-dependent Kuwaits economy (1991). Looney argues that Kuwaits economy was negatively affected by several Dutch decease symptoms, such as exchange rate overvaluation and sectoral inflation, and war with Iraq. Diversification in Kuwait, according to Looney, should be based on currency devaluation and expansion of industrial output through stimulating manufacturing and real estate project.
In the same vein, Eltony argues that diversification in Kuwait should be premised on developing non-oil economic sectors In the case of Kuwait diversification means reducing heavy dependence on the oil sector by developing the non-oil sectors of the economy. It also implicitly includes the reducing the direct role of public sector, while increasing private-sector activities, and hence, its size and role in the economy.(pp. 197-198). Moreover, as Eltony suggests economic diversification in Kuwait requires the increase of non-oil exports and labour participation in various sectors of economy.

Flejtersky and Kolenda (2008) link the need to diversify with unbalanced nature of oil-revenues, affected by international conjuncture, which is difficult to predict. One of possible avenues of diversification according to these authors is service-oriented diversification, focusing on the development of banking sector, investment and other services. Service diversification is needed, because service sector is one of the most booming and bringing the largest surpluses.
Moreover, it may be used as a source of new investment in non-oil sectors and for hedging the risks of oil dependence in the future. The examples of Abu Dhabi and Dubai vividly demonstrates that oil-producing states may be successful in accumulating wealth through investment funds, stabilization funds, gold reserves and investing money in profitable treasuries and national bank obligations. Saudi Arabia and UAE were so successful in developing their financial sectors that the United States asked them to give loans to restore American economy, suffering from mortgage financial crisis. UAE may be characterized as an example of re-investment of oil revenues into infrastructural projects and real estate.

The issue of economic diversification in Gulf region is extensively studied by Baroudi (2002). The author argues that notwithstanding unsteady character of diversification, certain success was achieved in establishing non-oil industries, such as fertilizers, metals and petrochemicals, agriculture and manufacturing (with the help of heavy subsidies) and services, such as tourism and financial institutions. The steady fall of oil sector contribution in GDP may in comparison with 1981-1985 period may be observed during 1996-98 in certain countries, such as Kuwait and Oman (from 60 to 40), from 40 to 35 in UAE and Saudi Arabia. To intensify diversification, according to Baroudi, the privatization, liberalization of financial markets, reduction of subsidies, enhanced integration and market-based education should be promoted in Persian Gulf countries.

Diversification efforts in Saudi Arabia are studied at length by Abdel-Rahman (2002). Saudi Arabia used planning approach as the corner-stone of its diversification initiatives. Five year plans were created to move from oil-dependent economy. According to Abel-Rahman, such efforts resulted in growing of non-oil GDP at the rate of 5.6  annually with simultaneous growth of oil sector at only 0,7. As of 2002 non-oil sector in Saudi Arabia accounted for about 62, 4 percent compared with 72.0 in 1984.  Abdel-Rahman also shows that diversification had positive consequences for attracting of FDI investment through partial devaluation of national currency. In order to fully diversify its economy Saudi Arabia should pay more attention to such sectors as tourism and manufacturing.
The discussed studies vividly demonstrate that diversification efforts may be realized in oil-dependent countries. Their successful realization should be based on liberalization of private sphere, effective governmental planning and support of target industries and developing human capital needed for new industries through education and training.

Conceptual Synthesis
Based on analyzed literature on economic diversification, it may be argued that it is the most effective tool for overcoming oil dependence. Different approaches and strategies to diversification are present in literature. The main debate between these approaches may be formulated as follows should diversification promote prima facie economic growth or social stability.
In our view, the balance should be found to secure the development of new sectors of economy, while maintaining stability in the economy and society as a whole. Effective diversification approach, as portfolio theory suggests, should be based on the assessment of economic linkages and synergies, arising from different configuration of diversification initiatives. It should be also noted that diversification planners should be well aware of the difference between the absence of comparative advantage and missed opportunity.

This is particularly true of oil-dependent rentier states, where sectoral development of certain industries and services were not due the lack of comparative advantage, but due to structural inability of rentier states to diversify their economic base. One should also point at the crucial role of professional expertise in determining the most perspective sectors to be diversified. Moreover, the balance between short-term growth priorities and long-terms sustainability should be created. The case-study of planning efforts, realized by Saudi Arabian in the form of 5 year plans, may be illustrative in terms of an approach needed to prevent palliative diversification.

Once diversification efforts were made, government managers should not forget the interests of emerging firms and industries, but in contrast should monitor their performance. Moreover, diversification strategies should not neglect countrys comparative advantages, which constitute its economic base. Diversification should be primarily focused on economic activities, which would guarantee vast high income employment, development of economic linkages and domestic market. In this view development of tourism, manufacturing may be the most effective.

However, one should remember that in a globalized economy, based on credit and investment, the formation of strong and healthy financial institutions is also urgently needed. Free financial resources, formed from export revenues may create various funds, designed for stimulating private initiative and innovation. Such approach may foster the increased activities of small and medium businesses. The discussed attempts of diversification in oil-producing countries show that such efforts may be successful if public-private cooperation is in place and if government programs subsidy and investment the sphere which promises the development of economic linkages and non-oil sectors.
The majority of Persian Gulf countries managed to diversify, focusing on real estate, tourism and financial services. UAE, Bahrain, Saudi Arabia were particularly effective in rising the standard of living, per capita GDP, foreign direct investment inflow and regional integration. These successes could not be achieved without vast oil resources, which helped them collect immense investment funds for diversification.

This fact vividly demonstrates the effectiveness of the discussed diversification paradigm. In what follows we discuss the positive and negative aspects of tourism as a means of diversification, focusing on case-studies of different resource dependent countries.


4. Tourism as a means of diversification.

The usefulness of tourism in diversifying economy and promoting economic development was for a long time recognized by development scholars and institutions, such as UN. The influence of international tourism on development was acknowledged already in 40s. (Mihalic, 2002). Starting from 60s the in-depth research was made on the developmental function of tourism (Diamond, 1977, Gray 1982). In the period of modernization paradigm dominance (1950s-70s) tourism was regarded as growth pole effective in stimulating growth through employment, developing economic linkages, diffusing development through less developed sectors and finally, eliminating regional disparities in a given country (Opperman, 1993). Tourism diversification became particularly relevant for developing societies with great natural potential. The inflow of Western tourists in newly formed independent countries boosted the development of various tourist services, hotels, restaurant sector, and food and beverage industries. In its turn, such developments stimulated the formation of new employment in the country, while resolving some of the most burning problems of poverty and social marginalization. In many developing countries tourism was among those sectors, which stimulated economic growth and development through increased quantity of foreign investment and foreign currency inflow with tourists.

Tourism was important as an international development agenda in the context of sustainable development framework. Employment benefits of tourism diversification were as well addressed in the study of Farver (1984). Tourism contribution into bringing stability to the balance of payments was also discussed by Baretje (1982). The author argued that tourism is a crucial tool in bridging the gap between imports and exports. Tourism could stimulate supplementary earnings through stimulating domestic and foreign investment, as well tourist consumption patterns. In this way, it was instrumental in strengthening economic linkages.

Sinclair (1998) regards tourism to be a catalyser of development in rural areas, in urban centers, dominated by tertiary sector services etc. Rural areas may capitalize on their natural wealth, reflected in rivers, leisure places, fresh air, local national traditions and holidays. Tourism may be an additional source of income for farmers, local artisans and art masters. Moreover, tourism diversification in rural areas may be an effective tool for maintaining national customs and promoting local culture at the global level. In highly developed urban areas tourism may be very helpful in terms of stimulating consumption, cultural and educational exchange. Moreover, tourism in urban areas may be a positive factor in the development of recreation areas, such as parks, museums, cultural centers etc.

Although tourism fosters foreign direct investment, employment and revenues it does not explain why it is often preferred to other types of economic activities. Brown (1998, p. 59) argues that such emphasis on tourism in developing countries is connected with the absence of real alternatives, because of lack of financial resources, productive industries and technological resources. Notwithstanding this reality, several reason for tourism being used as a diversification strategy are often referred to in literature on the topic.

Tourism brings economic growth. The growth rate of tourism was dramatic since 1950s for which the industry grew at about 7 annually. The trend is predicted to maintain due to continuing globalization and liberalization of borders and enhanced interpersonal exchanges between nations.  The immense growth of tourism may be explained by the important role of traveling and cultural exchange in peoples life. Recreation, being a part of life styles, intensively developed with the rise of modern civilization, associated with heavy pressures on individual at work, university and elsewhere. The development of traffic and communication made it possible for people to travel in different parts of the world, which were earlier inaccessible. Moreover, the increased role of migration and transnational business were among the central factors, affecting the economic growth, as a result of implementing tourism diversification.

Redistributive function of tourism. WTO and many developmental economists consider tourism to be an important factor in redistributing wealth between developed and developing countries. Widening gap between them is difficult to bridge however, tourism industry seems to be one of the most effective in terms of generating the inflow of private and corporate money into developing economies. However, on should mention that international tourism is regionalized and polarized with developed countries attracting 70 of tourists, while many countries of South are not ready for mass tourist attraction due to lack of infrastructure, instability and conflict (Shaw and Williams, 1994). Polarization is also explained by effective policies of the developed states, directed at the preservation of cultural and historical heritage and their organization in museums, exhibitions etc. Moreover, tourism in the developed world is often stimulated by frequent festivals, tournaments, sport competitions, film and music awards, which attract tourism from all parts of the world. The absence of structural capacities in the developing countries to organize such events is the basic cause of tourism poor development.

Absence of trade barriers for tourism. Among other services tourism is relatively from trade limitations. As Jenkins suggests, tourism in most of countries is an export opportunity free of usual trade limitations (Jenkins, 1991, 84). However, as it was noted above, export opportunities are often polarized by unequal distribution of tourism resources and power relations among countries and regions.

Economic linkages. It is argued that tourism requires the development of additional products and services, which generate intensive economic ties in a domestic economy.

As Telfer (1996) suggests, tourism may foster the development of direct linkages  for instance, farmers may supply food for tourist hotels and restaurants, or indirect linkages through cooperation in construction industry. However, it should be noted, as Sharpley (2002) contends, that not all destinations may be able to take advantages of these opportunities, the diversity and maturity of local economy, the availability of investment funds or the typescale of tourism development being amongst the factors may limit an extent to which backward linkages occur (p.224). Therefore, structural factors and free financial resources often play a critical role in government-promoted diversification.
Rent origin of tourism resources makes them free, because they are not to be created and built. Their value is already created by nature and local resources (Jenkins, 1991). In this view, the main advantage of tourism is its low start-up costs, which make it attractable both to domestic and international investors. Here, however, also exists differentiation between countries in terms of the richness of their recreation resources, such as sea, rivers, forests etc. However, as the facts show even in the absence of exotic landscapes and nature, a country may be successful in attracting tourists to its territory.

The discussed factors contribute to the fact that tourism is one of the most effective diversification options, because of its continuous growth, ability to generate economic linkages, low start-up costs, rent character, attraction of investment and involvement of vast number of small and medium businesses. 

The importance of tourism in generating growth in the developing world was also acknowledged by World Tourism Organizations Manila Declaration on World Tourism in 1980, which argued that, World Tourism Organizations Manila Declaration on World Tourism asserted that world tourism can ... ensure the steady acceleration of economic and social development and progress, in particular in developing countries (WTO, 1980, p. 1). The discussed positive aspects of tourism are suffice to make it one of the most perspective options for diversification.

Critique of Tourism as Diversification Strategy

Recently, a number of studies showed critical attitudes towards tourism as a means of diversification for developing economies. For instance, Sharpley (2009), based on the examples of Gambia shows that, tourism is not immune to the factors that determine a countys LDC status but that, although claims of tourisms developmental role should be treated with caution, the economic contribution of tourism may be enhanced in a number of ways (p. 337).

The majority of developing countries did not manage to begin the path of growth and development through tourism, since it did not boost socio-economic development and modernization. Tourisms inability to dissolve structural handicaps for development in the South was soon acknowledged by many scholars. However, one should point to notable examples of countries, where tourism contributed to growth Egypt, Mexico and Thailand (Clancy, 1999).

In these countries, however, the growth was mainly generated by investment and infrastructural projects, attracted from domestic and external sources. Moreover in the case of Egypt the success was partly achieved, because of proximity to Europe and former Soviet Union. In other developing countries tourism was not associated with comprehensive development framework, generating local economic linkages. Tourism development was reduced to certain regional clusters and remained a partial phenomenon in the majority of African and Asian countries.

Tourism diversification in developing countries is prevented by structural challenges and traps, including colonial history, dependence status in global political economy, number of internal challenges, including poverty, population growth, lack of economic growth, dependence on food imports, limited technological and scientific resource, authoritarian trends.  (de Rivero, 2001, pp. 118131).

For instance, as Sharpley (2008) argues Between 2000 and 2005, international tourist arrivals in The Gambia increased by an annual average of 7.5 over the same period, however, per capita GDP in the country declined from US320 to US290 (World BankUN, 2006, p. 72) whereas, following a trend established in the 1990s, poverty continued to become more widespread (Sharpley, 2008). Such examples vividly demonstrates that tourism diversification does not directly affect growth and development if not accompanied by deep structural transformations. The poverty reduction and creating basic infrastructure and institutions should be regarded as sin qua non of tourist diversification. This initial stage is critical to any form of diversification in the developing economies.

In the same vein, Mowforth and Munt (2003) argue that particular political, socio-cultural and economic characteristics may negatively affect opportunities of development, generated by tourism diversification. The following factors, limiting the impact of tourism diversification are outlined by Sharpley (2009)

Geographical factors remoteness, smallness, land-lockedness, which limit the tourism access, foreign investment and infrastructure development. However such difficulties often have place in the developed countries, they are resolved because of higher levels of technological development.

Vulnerability to internal and external shocks, such as natural disasters and political and economic conjunctures. International sanctions, trade barriers and embargoes, non-accession to influential economic organizations and forums may indirectly affect tourism diversification in the developing countries.

Structural deficiencies, including the lack of accommodation and transport facilities poor telecommunications, reduced access to global systems of distribution weakness of human resources, professional cadres and inter-sectoral linkages.

Ineffective political and institutional structures, preventing developing countries from creating favorable investment climate for foreign investment in tourism. The absence of national capabilities for planning and managing national tourism development projects and plans (Sharply, 2009, p.342).
The outlined aspects, however comprehensive, may be supplemented by another two factors. The first one is vulnerability to internal political instability, including civil conflicts, terrorism, coup detats. The lack of security for foreign tourists is among the basic challenges for developing tourism in many regions of the world. The second factor may be characterized as structural polarization between developed and developing countries. Developed countries possess more resources to market their tourism industry through internet, global communication, investment etc. Their infrastructure is already developed and has a long history of tourism, cultural heritage in arts, music etc., which makes it attractable to tourists from all parts of the world.

Moreover, tourist activity in the West is often accompanied by business relations, educational and cultural exchanges, which multiply the positive effects from tourism industry. In contrast, the majority of developing countries are regarded as exotic places by the majority of tourists. In this way, it is difficult to develop multi-faceted tourist activities, which would generate development in other sectors of economy. Tourism in the developing countries does rarely diffuse development to other economic sectors. The incomes are either consumed or accumulated, but not reinvested in economic activity.

Some scholars, such as Brown (1998) and Lea (1988) argue that positive results of tourist diversification are hindered by the fact that in many cases it is a strategy of last resort, used when all other strategies for development do not work. Cronin (1990) and Telfer (2005) point out that tourism as a single economic sector can not be used as a means for development. It can produce economic growth in the form of revenues for the narrow group of hotel owners.

Moreover, as Ascher (1984) contends, the dependence on tourism presents the potential barrier for long-term development of tourism. Indeed, tourism development is based on a wider economic and institutional progress, attainable only in the case of establishment of the comprehensive framework for overcoming the problems of poverty, poor communications and infrastructure.

The environmental policies of multinational corporations and the pressure of foreign governments may also be the factors, negatively affecting the development of tourism in a given country. For instance, as Sharpley (2009) argues, the 1994 military coup itself in The Gambia had little impact on tourism however, the response of the British government had a major impact (p.343).

Growing number of literature specifically criticizes tourisms contribution to development, including   Brohman, (1996), Mowforth and Munt (2003), Sharpley (2009).

As Sharpley suggests, based on the case of Gambia, the increased number of tourist arrivals is not always accompanied by the increase of per capita incomes and economic growth (2009). As Brohman (1996) argues, tourism may also function as enclave sector, located in limited coast areas. While its increase brings new employment and economic activities in these areas, the development is not always diffused to other regions, often underdeveloped, due to the absence of effective governmental policies, designed to include tourism into development agenda in general. Tourism often has seasonal character and hence, these areas are faced with unstable and temporal character of revenues inflows and resulting fluctuations in employment and development. Such situation often occurs as a result of limited number of tourist services proposed for foreign tourists.

The critique of tourism diversification is also based on the expanded notions of development including human capital, growth and empowerment. As Telfer (2005, p.190) suggests, in dominant neoliberal literature tourism was often praised due to its potential of generating economic growth, however, the latter does not necessarily lead to development, if certain structural and political transformations are not realized.

This is particularly true of the discussed oil-dependent countries, where economic growth was not accompanied by the development of human capital and social welfare. In many African oil-producing countries, such as Angola, the tremendous oil revenues did not result in eradication of poverty, decreasing of the rates of child mortality and combating HIVAIDS. Such changes were difficult to make because of continuing curse of colonial heritage, natural resources, rent-seeking behavior of local elites and unfavorable international conjuncture.  This suggests that in many cases economic growth is not the main factor for boosting development in the developing countries. In contrast, more comprehensive framework should be created to channel economic growth in the right direction. In a more sustainable framework of development tourism is balanced as a profit-driven and resource consuming activity with wider development goals, environmental and communal approaches (Telfer, 2005).

Poor ecology and recreation zones contamination, as a result of mining activities, may become a severe problem for tourism diversification. Many developing countries experienced these challenges. One of the most resonance cases is Niger delta contamination by multinational oil-producing corporations, such as Exxon Mobile. To minimize negative implications of oil industry for recreation resources, developing countries governments should actively regulate the activities of international corporations and local companies.

As Sharpley (2009) suggests, limited regional nature of tourism industry in developing countries makes its contribution to development at least modest. For instance, in Gambia tourism is spatially limited to small coastal strip, which limits employment opportunities and revenues to other regions of the country. In this way, the internal polarization and inequalities are generated and perpetuated (p. 344). The organizational part of tourism development lacks coherence with no sufficient investment in cultural sites, infrastructure, tourist guides, supporting literature, excursions etc. The tourist sector does not generate profit for Gambian citizens and households tourist businesses use low-skilled and low-paid labor force. Tourism sector is often informal, which implies that taxes do not go to national or local budgets and do not support development projects.

Another factor, contributing to insufficient effect of tourism on development is its seasonal character. In developing countries this means that employment is also seasonal with many hotels and restaurants firing their staff, when the tourists inflow is low. As Sharpley (2009) suggests, seasonal nature of tourist also makes it difficult to develop supply chains with agricultural sector, suffering immense losses. The vast numbers of products, needed for servicing tourism industry, are imported, which means that tourism does not provide any stimulus for the development of domestic economic linkages.

Tourism diversification is also deteriorated by poor governance and governmental involvement.  Tourism is exploited by developing governments as the source of easy income, however, they do not re-invest money in the development of this industry or any connected social and human capital projects. Any improvements in such societies are based on international aid.

It should be noted, that domestic investment in the tourism sector is often hindered by high levels of taxation, while international involvement is difficult because of poorly regulated property relations and unfavorable investment climate. In the same vein, the attraction of local small and medium business to developing of tourism is often hindered by the high interest rates in developing countries. In the oil dependent countries the comprehensive development of tourism is often hindered by the absence of available investment funds the bulk of funds is used in profitable and high returning oil sector, thus perpetuating dependence and oil curse. Hotels, restaurants and other components of tourist industry pay immense taxes and fees for using water, electricity etc. which are sometimes very scarce in developing countries.

Moreover, the development of tourist industry is often prevented by the lack of knowledge and information. This makes it difficult for governments and tourist businesses to be aware of existing problems, possible opportunities and priorities. Planners and tourist businesses do not understand tourists behavior, interests and needs. As a result, policy decisions are taken based not on evidence, but false intuition.

To sum it up, positive role of tourism diversification is based on its contribution to economic growth, strengthening economic linkages etc. However, tourist diversifications positive influence on development is conditioned upon comprehensive strategies of developing infrastructure, investing into traffic and global communications, improving governments planning and stimulating private initiative.

In many cases tourism diversification is hindered by the lack of professional governmental expertise, environmental problems of recreational zones, caused by transnational corporations, international sanctions, internal instability and conflict. Lack of security for tourists also contributes to the degradation of tourism industry. Moreover, poor governance prevents the developing countries from effectively organizing tourism diversification through establishment of cultural exchange programs, tourist organizations, councils, institutions for preservation of historical and cultural heritage. Among objective factors negatively affecting tourism diversification in the developing countries one should point at international polarization between developed and developing countries, which makes the former more attractable for international tourists. The critics of tourist diversification rightly contend that it does not necessarily bring positive changes, unless deep structural problems and handicaps are addressed by all stakeholders in the process.

5. Chapter Summary and Beginning of Conceptual Framework.

The discussed research on resource abundance, oil curse, rentier state, economic base theory, city state concept, tourist diversification allows us to begin constructing general conceptual framework for the analysis of UAE diversification from oil base through tourism.
The conceptual framework proceeds from the reality of research abundance and resource curse that are described in literature as one of the main sources of economic and social degradation of many developing countries. Empirical proofs of poor correlation between resource dependent and economic growth were presented by Sachs and Warner (2001), Auty (2001), Gelb (1988) and in a number of other studies. Resource curse and resource abundance concepts seem to be particularly applicable to the case of UAE diversification, because UAE economies are characterized by considerable resource dependence on oil. Some of them, such as Abu Dhabi and Dubai have managed to launch effective diversification strategies in financial, entertainment, real estate and tourism sectors, however, the relative value of each diversification strategy has not been yet measured. Present research framework using sustainable diversification approach, argues that tourism diversification should be regarded as the crucial precondition for transforming resource dependent rentier states from enclave-type production to effective development of economic linkages, fiscal gatherings and general GDP growth. In this framework we distinguish between resource abundance and resource dependence, arguing that in the case of successful diversification resource abundance may prove to be an important factor in promoting change through state-directed investment, interventions, target programs and subsidies. As Ding and Field (2004) suggest, that richness in resources should not be regarded as the barrier to growth and development. Instead, one should look at structural dimension of economy and the role of resources in exports, budget revenues and power relations in society. Some rich natural resources countries, such as the USA, Canada, China etc. managed to develop manufacturing industries, finance and services and limit the role of mineral exports in their GDP. In this way, natural resources themselves should not be regarded as the obstacle to development resource curse is created through structural inability of states to boost development of non-resource sectors and strengthen domestic market.

Thus defined, resource dependence may become the most effective conceptual framework for understanding recent resource curse debate. Negative implications of resource dependence are the main factors, which inform theoretical and practical efforts of scholars. The consensus is formed that the resource curse has structural features, preventing modernization and industrialization of economy. Auty (1993) defines this structural obstacle as mining industry production function (ratio of capital to labor). Mining industries have capital intensive and enclave-like nature, which hinders the development of non-resource sectors, such as manufacturing and services. Moreover, resource dependent economies hinder the development of economic linkages through economy, which are the primary precondition for the formation of domestic market, developing education and professional labor force. The entire economic structure of resource dependent countries is polarized between highly productive mining sector and underdeveloped agriculture, manufacturing, banking and services sectors.

As literature overview showed, many scholars link resource dependence with a number of macroeconomic problems. Wheeler (1984) argues that resource dependent countries are particularly vulnerable to volatility of international prices on natural resources and general conjuncture, because the sources of budget revenues are limited. Such vulnerability is accompanied by false feeling of security and control during favorable periods of growth.

Another imminent negative implication of resource dependence is enormous borrowing by developing governments during cycle growth of resource revenues. Due to appreciation of exchange rate, local banks and government institutions feel it safe to borrow vast credit sums, however during downfalls they are unable to repay them. Overdebtedness in resource dependent countries, widely discussed by Manzano and Rigabon (2001, 2003), is among the basic factors, contributing to social instability and poor social standards in resource dependent countries.

Moreover, negative impact of resource dependence is not reduced to macroeconomic sphere. As the discussed literature suggests, development can not be reduced to economic growth, but is directly linked with institutions, human capital and stability. Among others, Gylfason (2000) points at structural problems of education, corruption, authoritarianism, poor governance in resource dependent countries.

Many scholars also point at the resource dependent society propensity to domestic and international conflicts and political instability. The correlation between authoritarianism and resource dependence is empirically studied by Wantchekon (2004), Ross (2001), and Panchok-Berry (2005). There is no denying the importance of the fact that such negative trends result from undemocratic nature of resource industry in general. The tendency towards conflict, instability, terrorism, criminality are among the basic factors negatively affecting tourist arrivals in the developing countries.

The inability to provide security for foreign tourists makes them dangerous destinations for many potential consumers from the developed countries. Moreover, authoritarian trends, corruption, poor legislative regulation of property rights and investment relations is the primary reason for international pressures and weak cooperation, which preclude intensified commercial, cultural and tourist exchange between developed and developing countries.

Negative impact of resource dependence also found its reflection in the concept of Dutch decease, becoming influential in recent literature on the topic. Dutch decease may be described as the dependence on the export of a limited set of goods and recourses, which results in the underdevelopedness of manufacture sector, currency appreciation and instability of export revenues.  Currency appreciation, according to Krugman, results in losing comparative advantages, which are difficult to restore in short-term (1987). Dutch decease makes a country dependent on international conjuncture, locks economic growth to several export sectors and prevents developing secondary and tertiary sectors of economy. Dutch decease may paralyze economies of any country, including developed ones. Recent case of Russia suggests that oil dependence may result in Dutch decease even in countries, which inherited highly developed productive and technological base.

There exist two possible avenues from resource dependence and its specific case oil curse, evident in the UAE case. The first one is efficient economic diversification, resulting in the creation of sustainable economy and the second one is inefficient economic diversification, resulting in unsustainable economy. These two dimensions of diversification efforts  evaluation are presented in the following diagram, which is the cornerstone of the present conceptual framework.
EfficientSustainableEconomicEconomy


DiversificationResourceAbundance

InefficientUnsustainableEconomic EconomyDiversification

The effectiveness or ineffectiveness of economic diversification depends on several crucial factors, addressed in the research framework.  The first factor is the state of resource dependence at the moment of launching diversification efforts. Understanding this factor requires analysis of the UAE economic structure, the role and value of resource sector in forming national GDP and export revenues, characteristics of economic and social development, the role of rentier state etc.

It goes without saying that economic structure of the UAE may be characterized as limited economic base, paralyzed by oil curse or oil dependence.  Oil dependence bears on all significant traits of resource dependence, however, is more intensive due to marked enclave nature of oil industry and high revenues it brings. Moreover, oil rent acquisition is more elite-like and undemocratic, than in other resource sectors, which makes the political outcome of rentier state more likely. Moreover, many scholars, such as Kaldor, Karl and Said (2007) and Klare (2002) focus on the higher propensity of oil-dependent states towards conflict and international warfare. One should mention the example of Iraq invasion in Kuwait to understand the reasonable nature of such claims.  Moreover, as Gelb argues, there exists deep structural problem in oil dependent countries, reflected in their inability to offset enormous economic losses during downfalls even by huge export revenues, generated by oil booms. The instability caused by this may be detrimental to structural reforms in these countries. The most effective attempt of classifying the underlying causes of oil curses is in our view made by Behrends and Reyna (2008), who enlist 5 basic interpretations, existing in literature, including   (1) a resource curse, (2) the Dutch Disease, or (3) Collier and Hoefflers greed hypothesis or, according to political scientists, that it is caused by (4) rent-seekinginstitutional or (5) patrimonial theories.  (Behrends and Reyna, p. 9). Oil curse theory is particularly effective, when applied to the analysis of developing countries. A number of studies show that oil failed to generate growth and development in the majority of oil-producing African countries, including Equatorial Guinea, Nigeria, Gabon, Angola and Cameroon (Asongu, 2006). Based on the analysis of Iran, Amuzegar (2008) shows that oil-dependence negatively affects market economy, dramatically increases the size of public sector and reducing private initiative. The empirical findings vividly demonstrate deep connection between oil dependent and nepotism, corruption and authoritarian trends.

Some scholars argue that democracy and modernization are based on states ability to extract taxes from domestic businesses thereby strengthening public-private partnership in a society. Such possibility is often absent in oil-dependent countries with underdeveloped internal market.
The same economic implications of oil dependence may be found elsewhere  in Latin America, South-East Asia, Central Asia etc. For instance, in his comprehensive study of 113 countries in all regions, Ross demonstrates the negative impact of oil dependence on economy and public sphere. Shaxson (2007), among others argues that negative implications of oil dependence are difficult to divert, because they bring deep structural deficiencies to economy.

Once oil-dependence became the corner-stone of economy, it is very difficult to diversify and modernize it without tremendous social and economic shocks. Oil dependence may prove to be detrimental for economies with the long history of technological and industrial change. This is particularly true of Russia that inherited highly modernized economy from Soviet Union, however, due to increased oil and gas dependence during 90-s experienced de-industrialization and Dutch decease. Among other conclusions, which may be drawn from literature, one should point at oil dependence negative impact on accountability and equality in the developing countries.

The applicability of oil curse concept to understanding the starting conditions of the UAE diversification, hence, seems quite justifiable. First of all, it application is based on empirical facts, which suggest that the UAE economy is unbalanced in terms of excessive dependence on oil in formation of fiscal and economic policies. Automatically UAE become vulnerable to international markets and financial volatility. The difficulty of overcoming oil resource dependence due to its entrenched implications for public policies and economic linkages should also be kept in focus to understand the effectiveness and sustainability of present tourism diversification strategy.
The second starting condition of diversification is closely linked with oil dependence in the UAE. It seems justifiable to say that UAE bear on all significant traits of rentier state. There, of course, differences between emirates in terms of their rentier character, however, general trend towards rentier-seeking behavior in the UAE is visible. The concept of rentier state, discussed in the present literature overview, may be regarded as the synthesis of political economical, sociological and political critique of oil dependence. The concept of rentier state or rentier economy reflects the fruitful utilization of the notion of rentier and rent to the analysis of resource dependent economies. The nature of rentier states lies in its dependence on external rent from natural resources, which limits states accountability to citizenry and prevents the development of domestic economy. The majority of oil-dependent countries in the developing world, including Ghana, Iran, Saudi Arabia etc. may be classified as rentier states due to explicit expression of the mentioned tendencies. 

Concrete characteristics of rentier states are present in literature. For instance, Beblawi (1990) outlines 4 basic characteristics 1. Rent situation dominates 2. External origin of the rent (it should come from foreign sources). 3. Elite character of rent generation (the majority of society is not involved in the creation of wealth). Oil and gas rents, however, have little in common with tourist rent that is also based on utilization of free resources of nature. In contrast to oil rent, tourism creates rent, which is more equally distributed among the citizenry and creates preconditions for developing free market, private initiative and strong economic linkages between various sectors of economy.  The democratic nature of tourist rent should be emphasized in any diversification strategy, focusing on sustainable development and growth.

Negative effects of rentier state on democracy, governance and corruption are also widely addressed in the literature. As far as the tax linkage between state and citizenry is absent, state institutions are unlikely to foster democracy and accountability, but instead prefer to develop repressive apparatus, used for suppressing opposition and grassroots movements. Notwithstanding multiple negative trends, rentier states have a capacity to accumulate a vast number of financial resources to create developmental and stabilization funds, which may be used for crisis management as in the case of some Gulf states during current financial crisis.

Moreover, accumulated financial resources may be directed at diversification of economy, if political will and effective strategies are established. Liberalization of rentier state may become a trigger for future development and diversification through investing into new sectors and business activities. However, until recently such developments were exclusion, rather than a rule. Among exemplary cases of rentier state diversification one should point to recent policies of tourist diversification in UAE, which are to be discussed later.

The difficulties of diversification in the situation of rentier economy, addressed in the literature, should be specifically tackled in the conceptual framework of the present study. The existing research on the topic shows that rentier state may be regarded simultaneously as a barrier and precondition for successful diversification from oil base. First of all, rentier state may be quite content with limited economic development, based on oil revenues and external rent, because such situation maintains stable source of income and political power of oil-exporting elite. However, in the situation of global economic crisis and oil under-consumption rentier state may prove to be eager to liberalize and move in the direction of successful diversification strategies, as the case of some Middle East oil-exporting countries had demonstrated. Moreover, rentier states often collect vast stabilization funds and currency reserves that may be used for effective investment in diversification projects and infrastructure.

Finally, the third starting condition of diversification strategies in the UAE is its city-state status, which is crucial for understanding possible avenues for diversification and economic growth.
The historical and modern examples of city-states may be helpful for understanding of the possible exit strategies for diversifying oil-dependent economies. Historically, many city-states managed to use their gateway status, trade and mediation, banking services, as their comparative advantage. In the absence of administrative hinterlands and natural resources, they often achieved intensive economic performance, becoming communication, finance and trading hubs.  The absence of natural rent made local private initiative, innovation and technological change the main drivers of development. The modern examples of Singapore and Hong Kong vividly demonstrate that even in the absence of administrative hinterland and rich mineral resources city-states are capable of projecting economic influence and power in other countries. Several city-states with rich natural resources, including Abu Dhabi and Dubai, managed to modernize and globalize their economies, while maintaining the dominant role of hydrocarbon exports in the economies.

Economic base theory is particularly relevant in terms of studying city-states and regional economies. Two economic spheres are generally marked basic and non-basic. Basic sector generates profits through export, while non-basic sector is predominantly oriented at local needs. However, basic sector is often defined as the locomotive of development, the discussed cases of oil-dependent countries show that basic sector should be properly balanced against domestic non-basic sector to avoid Dutch decease and negative macroeconomic consequences of currency appreciation. Economies with overgrown basic sector are likely to suffer from volatility due to the lack of diversification.

The analysis of Singapore and Hong Kong cases showed that these city states managed to avoid the decease of basic sector through outsourcing, diversification towards finance sector and investment funds, active technological change and innovation. Moreover, Singapore managed to create its artificial hinterlands in Indonesia and Malaysia, capitalize on ASEAN cooperation, while maintaining its traditional status as communication and transit hub of South Eastern Asia. For Singapore the absence of hinterland means impossibility of capitalizing on unequal exchange between core and periphery (Harvey, 1973). The substitution of this strategy is engaging in regional cooperation, diversification and modernization of economy. The case of Singapore and Hong King suggests that a city-state can sustain itself without administrative hinterland. Hence, economic notion of hinterland seems the most appropriate in explaining the relationship between city-states and their economic partners in proxy countries. However, the case Singapore does not cancel the reality that the absence of hinterland may be viewed as the barrier to development in small island territories, especially those, which are located far enough from the continent and trade routes (Baldacchino, 2006).

In these conditions, those city-states that are more open to globalization, free trade and modernization are likely to succeed in unfriendly geographical environment. The majority of modern city-states are oil-dependent territories, being either the part of federation as UAE states Abu Dhabi, Dubai, Sharjah, Ajman, Ras al-Khaimah, Fujairah and Umm al-Qaiwan or unitary city-states, such Kuwait, Qatar, Bahrain etc. Oil dependence in these states is aggravated by the mentioned deficiencies of city-states.

If oil dependence is accompanied by specific deficiencies of city states the only exit strategy is economic diversification. This led us to the analysis of diversification concept and different approaches to diversification, addressed in the literature. The analysis oil curse literature suggests that, however oil revenues may generate economic growth it does not result in human and economic development and modernization due to structural characteristics of rentier state.  Such situation explains two possible paths of economic diversification in the UAE. The first one is efficient economic diversification and the second one is inefficient economic diversification.

Efficient economic diversification is based on sustainable approach focusing on generating wide economic linkages between industries, new employment possibilities, liquidation of enclave-type capital-intensive dependencies, creating favorable investment climate for foreign and sovereign direct investments in target sectors. Moreover, sustainable diversification approach focuses on general modernization of national economic and social sphere, including infrastructural projects, investments in education and science. In general, in contrast to inefficient economic diversification, efficient and sustainable economic diversification has to be based on comprehensive public and private approach, directed at stimulating vast economic perspectives and activities not confined to certain diversification sectors.  For understanding of the effectiveness of the UAE tourist diversification present conceptual framework utilizes several approaches, existing in research and practice in terms of studying their applicability in UAE case. They are predominantly developmental, regional and economic base approaches. Moreover, present conceptual framework focuses on policy-oriented approach to diversification, which proceeds from the view of the states crucial role in creating viable and sustainable diversification framework.

The main debate in diversification literature is among those who advocate evolutionary approach to diversification and those who advocate policy approach. North (1955), a founder of institutional economics, contends that diversification passes through gradual stages agricultural economy, manufacturing and industrial base economy and tertiary( service sector) economy.

Such evolutionary approach was widely criticized for its Eurocentrism in treating economic development. For the majority of countries with former colonial heritages, complex pass to capitalism and peripheral, dependent status in global economy, such approach proves to be ineffective. Present research promoted policy-oriented approach to diversification, focusing on conscious planning and management of diversification involving public-private cooperation. It proved to be successful in such city-states as Singapore, Hong Kong and recently Dubai, Fujairah and Abu Dhabi.
Another fruitful approach to diversification strategy is premised on the assumption that it should be based on effective correlation between growing and declining sectors. The analysis of possible effects of diversification on economic instability may also prove to be effective in determining diversification package.  In this view, localization coefficient calculation is used for finding out the correlation between basic and non-basic sectors of economy.

However, low localization coefficient should not be equaled with the absence of a given sectors lack of comparative advantages. As the cases of oil dependent economies suggest, underdevelopedness of a given sector may be also connected with missed opportunities and miscalculations in public policies. Long-standing neglect of certain industries by rentier states was characteristic of many rentier states in Africa, Latin America and Asia. Rentier states for a long time neglected regional development in rural areas, the construction of infrastructure and communication needed for organization of domestic markets, establishment of financial institutions and FMCG (fast moving consumer goods) enterprises and other import-substitution industries. The development of infrastructure was limited to the regions of oil or gas production.

Among other approaches, used for designing of an effective diversification strategy one should point at portfolio variance approach. It is premised on calculating the most viable combination of basic and non-basic sectors and correspondingly developing of diversification package, suitable for set combination. Such approach helps find the optimal correlation between growing and declining sectors and avoid economic and social shocks as a result of new policies.

The same may be said about location and regional economic approach, which focuses on the analysis of interconnection between regional and national economic environment in terms of economic linkages, dependencies and partnership. Such approach seeks to minimize the loss of economic linkages, supply chains, individual and corporate ties as a result of diversification strategy.
Developmental approach is of particular importance in the future analysis of UAE diversification policies. It acknowledges the primary role of governments planning of diversification initiatives and emphasizes the role of education, human capital, professionalization and institutional modernization in fostering stable and growth-oriented development. The cases of Dubais diversification suggest that substantial gains were achieved due to effective expertise, planning, marketing and institutional formation, which are praised in the developmental approach.

The discussed diversification approaches are regarded in the conceptual framework as sin qua non of efficient economic diversification strategies, leading to sustainable economy. Their relevance is then studied based on the analysis of tourism as diversification strategy. It is argued that tourist diversification does not directly result in effective and sustainable economy, if it is not a part of comprehensive approach, taking economic and social sphere as totality.As the critique of tourism as an effective means for diversification suggests, the development of tourism does not always result in the creation of strong economic linkages within developing countries. Finally, tourisms rent nature allows attracting more household and businesses to participation in tourist projects, while capitalizing on the free goods provided by nature, such as mountains, sea, rivers, forests etc.

Critical attitude towards the tourism as a diversification strategy contends that tourism does not always bring development. This is particularly true of countries, where tourism exists in enclave clusters, has seasonal nature and hence, does not provide with strong impulses towards economic cooperation and strengthening industrial linkages. In the majority of the developing countries channeling tourism revenues towards development is hindered by structural problems, such as colonial history, population, and growth, limits of technological development, infrastructure and communication. 

Sharpley gave a classification of factors, negatively influencing tourist diversification, including geographical land-lockedness. 2. Vulnerability to natural disasters, internal and external shocks. 3. lack of transport facilities, telecommunications, global distribution system, human resources etc. 4. ineffective policies and decision-making. The last factor is inextricably linked with the lack of knowledge and information on current situation in tourism, which hinders professional expertise and understanding of foreign tourist needs and interests. Moreover, many governments in the developing country do not provide tourist industry with effective tax and investment climate, thus de-motivating investments and development. As the discussed case of Gambia suggests, tourist industry does not always help labor force to come out of poverty its earnings are very small and it is used on the seasonal basis.

One should specifically point to such negative factor as continuous instability and lack of security for tourists, associated with terrorism, civil conflict, which prevents many developing countries from developing their tourist potential and generating growth. Moreover, tourism development is hindered by international economic, political and diplomatic pressure and international sanctions.

In such situation, tourism fails to become the autonomous source of developments and remains locked in certain geographical areas, having no effective impact on economic growth across the country. Ecological problems, caused by the activities of transnational corporations and domestic mining industries are also frequently among factors  detrimental to the development of tourism. Developing governments are not always active in regulating the activities of multinational corporations, allowing them to contaminate recreational zones.

Therefore, a limited interpretation of tourism as the engine of economic growth dominant in neoliberal literature should be reconsidered to address difficulties of tourism diversification implementation. Tourism diversification should be a part of comprehensive development strategy addressing root causes of resource dependence, underdevelopedness of the secondary and tertiary sector, poverty, increased mortality, conflict and authoritarian trends.  Tourism diversification in the developing countries should be accompanied by diversification from oil base in other sectors and macroeconomic policies, oriented towards decreasing of dependence on exports, currency devaluation, establishing market economy and favorable investment climate.

Based on understanding of tourism diversification as the mechanism, requiring complex approach, present conceptual framework proposes methods of assessing the success of tourism diversification in the UAE. First of all, the focus is put on governmental efforts, including creating responsible bodies and institutions, projects, investment funds for tourism and legislative changes, directed at attracting foreign direct investment in this sector. Secondly, the scientific and methodological provision of tourist diversification in the UAE is assessed focusing on governmental analysis of tourism statistics, coordination between different governmental institutions and officials. Furthermore, private business efforts concerning the creation of new tourist infrastructure, such as hotels and leisure places, are studied, focusing on governmental policies directed at stimulating of investment climate, favorable tax regime for national and international businesses. In sum, the analysis of these structural changes and their implications make up the answer, whether tourism diversification in the UAE is compatible with the goal of creating sustainable economy.

Tourism diversification in UAE.
The discussed concepts, theories and ideas make it possible to start up the discussion of tourist diversification strategies in UAE. However, general introduction to the current situation in tourism industry in the Middle East and UAE specifically may be instrumental.

Notwithstanding significantly developed cultural and historical heritage, as well as natural wealth, Middle East was not a major destination for tourism until recently. In 1999 it contributed only to 2 of the world tourism (Sharpley, 2002). Notwithstanding the fact that the region experienced modest growth in tourist arrivals starting from 50s, tourism relative share was still very low. The polarization between countries in terms of tourism development is also obvious in the region. For instance, as Sharpley (2002) suggests, in 2000 Egypt accounted for more than 20 of total arrivals in the region. Egypt has the largest share of tourism in its GDP and it is the best known tourism destination among Arab countries.

As Sharpley (2002) argues, tourism is the most important industry for Jordan, where it accounts for 26 of GDP. It is, however, less significant in Saudi Arabia, Yemen, Syria and other countries of the region (p.225). In Saudi Arabia the largest share of arrivals is achieved through religious pilgrimage and business trips. Interestingly, except Egypt, none of the countries in the region, that could capitalize on  their culture, history, architecture and traditions, including Yemen, Saudi Arabia, Libya etc. did manage to develop successful tourism industry.

As the analyzed barriers to tourism diversification suggest, such inability was caused by political, religious and social conditions. The majority of mentioned countries are closed authoritarian regimes with the dominance of religion in secular life, dress code limitations for women, various barriers for foreigners, difficult political relations with Western powers. All these contribute to the weak relations with the outside world and poor tourist and cultural exchange.

Among Persian Gulf city-states the most successful example of tourism diversification was Dubai that managed to make a fourfold increase in tourist arrivals since 1980s due to conscious diversification strategies. However, tourism development was not uniform in UAE due to regional differences and the absence of effective federal policies, programs and projects. Sharjah was the first emirate to embark on tourism diversification policies in 80s. The ban on alcoholic beverages was the main barrier to tourist activities, however, Sharjah managed to attract budget-conscious tourists from Eastern Europe and former Soviet Union and hence, establish a competitive tourist industry (Sharpley, 2002, p. 227).

Among other emirates Umm al-Qaiwan, Ras al-Khaimah and Ajman do not have air connections, hotel facilities and shopping capacities, hence, they are unlikely to develop a thriving tourist industry. Hence, the main priorities in tourism diversification are located in three perspective emirates of Fujairah, Abu Dhabi and Dubai. Fujairahs main competitive advantage is access to Indian coast line, which offers beaches, recreation for divers and beach tourists.

However, until recently the emirate experienced the lack of hotel rooms with less than 500 available. Recently, as a result of cooperation with international tourist operators Fujairah embarked on the project of building new hotels and apartments to attract more tourists. Dubai was the most successful among emirates in diversifying its oil dependent economy through tourism.

Its economic openness, cultural diversity and relative freedom were the major factors, attracting tourists and foreign direct investment in the emirate. Moreover, Dubai authorities realized the importance of planning and organization of tourism diversification creating Dubai Commerce and Tourism Promotion Board (DCTPB) in 1989. Nowadays, Dubai offers the largest number of hotels in the region, attracting beach tourists and businessmen (Sharpley, 2002). Moreover, Dubai tourist diversification was successful due to intensified economic exchange with Western countries, including annual shopping festivals, sport competitions (Formula 1) and other events, visited by foreign residents.

Moreover, in 1997 Dubai established governmental Department of Tourism and Commerce Marketing (DTCM) with offices in more than 10 countries. As it is evident, Dubai efforts on tourism diversification may be characterized as well-organized and planned. Dubai authorities realize the role of professional expertise and planning, praised by the abovementioned developmental economists.
Dubai is the most developed tourist destination in UAE and it is the only Emirate, providing annual statistics on tourism to WTO. In this way, tourism in UAE is mainly associated with Dubai. There is no denying the importance of the fact, that the overview of Dubais tourism diversification policies suggests that Dubais authorities implemented developmental and marketing frameworks of diversification discussed earlier.

In comparison with Dubai, tourist diversification achievements in Abu Dhabi are rather modest. It was assessed that a number of leisure visitors to Abu Dhabi comprises the number of 75000-100000 people annually, which is rather small proportion to Dubais visitors. Abu Dhabi business visits from Europe (especially Germany and England) far outweigh the annual leisure visits. It should be noted that unlike Dubai, visits to Abu Dhabi during hot summer months falls to 25, whereas in Dubai it remains stable at around 55 of hotel occupancy (Sharpley, 2002, p.229). This happens, because Dubai leisure and shopping infrastructure are more attractable to tourists. Moreover, during hot seasons Dubais businesses often announce the season of discounts on luxury goods.

To sum it up, success cases of diversification in UAE, such as Dubai certify to the viability of developmental diversification framework, focusing on the creation of comprehensive package stimulating foreign direct investment, business and cultural arrivals to the country. Tourism in Dubai is the part of a wider economy and it not locked to certain areas. Its role is central in strengthening Dubais integration into global economy with its booming commercial and interpersonal relations.
Tourism development in Dubai is accompanied by the creation of modern infrastructure, communications, real estate business and financial services. Moreover, Dubai capitalizes on the approbated strategies of Western countries, such as marketing. Dubai offers conditions for international business forums, sport competitions, cultural events and festivals. Such framework is extremely important in comprehensive tourism diversification, focusing simultaneously on growth and development.