Economics

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.

Adam smith developed the labor theories of value to explain the relationship between the value attached to a commodity and the labor required to produce the item. According to Adam Smith, the value of a commodity is directly proportional to the amount of labor required to produce it.  He says that the value of any product is attached to the labor used to make it. Labor refers to the efforts that a person puts in an activity to achieve some specific results.

Adam Smith gave the first definition of value as the exchange price that a consumer gives out to obtain a certain product. The price of any commodity is related to the value. Therefore, the value of labor can be related to the price paid in exchange of the commodity. The price (value) of any item is related to how scarce that item is to obtain. Scarce items have greater value than readily available ones. Adam Smith also defined value in terms of the utility obtained from a product. Utility refers to the satisfaction that a person acquires from consuming a particular commodity. It also refers to the usefulness of a particular product to the consumer.

The nature of the conceptual problem that led Smith to revise his original labor theory of value for an advanced society was the contradiction imposed by the two definitions of value. Under close scrutiny, value has two meanings which are paradoxical the utility (value in use) of an item and the price (value in exchange) of that commodity. The commodities which have the highest value in use have small or no value in exchange. On the other hand, items which have highest value in exchange have small or no value in use. For example, water has the greatest use, but to the contrary, it has little or no exchange value. Gold has scarce value in use, but on the other hand it has the greatest value in exchange.

The second version of defining value of a commodity as postulated by Adam Smith was that the value of any commodity is equivalent to the amount of labor which enables him to buy or command. David Ricardo argued that Smiths second version was unnecessary because the value of any commodity varies with changes in distribution and technology in the labor market.  Ricardo accepted the definition that the value of labor was proportional to the exchange value of that commodity.

According to Adam Smith, the term economic growth refers to increase in the total Gross Domestic Product (GDP) of a country. The rate of change in Gross Domestic Product measures economic development in a country. It is used to refer to the amount of goods and services that a country produces and does not include the methods of production used to make the commodities. Alternatively, Gross National Product (GNP) can be used to measure Gross Domestic Product. GDP is used to estimate the purchasing power of currency in a country. GNP compares the per capita incomes of different countries. Inflation adjustment coefficients are used to compensate for inflation that may affect GDP or GNP.

Economic growth is defined in terms of the long term period. It defines the changes in the standards of living of the citizens of a nation over a certain period of time. Econometrics is a field of economics which measures the outcome of the policies made by economists. Other concepts that lie within the definition of economic growth are the rate of unemployment and inflation.

Economic growth can be classified in terms of how positively or negatively it is contributing to the economy of the country. Economic downturn as well as depression defines the negative economic growth. On the other hand, an increase in the Gross Domestic Product is associated with positive economic growth. Smith defines economic development as the change in the methods of producing goods and services. He explains that positive economic development engages introducing new efficient production technologies.

Mercantilism economic theory suggests that the economic growth and development of a country depends on the amount capital resources that it possesses. The theory suggests that the world market of international trade cannot be changed. The bullion held by a country represents the economic capital and that only a positive balance of trade can increase the bullion. Mercantilism also assumes that the capital as well as monetary resources is the same. This theory proposes that the state ought to encourage exports and discourage imports (protectionism) in order to achieve its economic growth and development goals. These goals can be achieved by the use of tariffs and subsidies. The development of mercantilism was seen to encourage several European wars and increased European imperial systems.

Adam Smith criticized mercantilism theory by suggesting that the use of the bullion system should be replaced by the system of measuring economic growth and development according to the productive capacity of a country. He argued that the tariffs discouraged trade although it contributed to a great extent to the income of the country. Adam Smith criticized mercantilism by saying that prices are directly proportional to the amount of money circulating in the country whereas mercantilism did not relate the two aspects clearly. He also said that the wealth of any nation is produced by the human capital and it is not fixed. Mercantilist never recognized the contribution of comparative as well as absolute advantage to trade. Smith never accepted the fact that balance of trade could remain constant for a long period of time as proposed by mercantilists. This is because as countries exchanged bullion, there would be imbalance in supply and demand of the bullion between the state importing and exporting. This would create instability in the balance of trade. Smith suggested that the mercantilists confused wealth and money and that bullion was just like any other commodity and did not require too much emphasis.

Employment of capital (Smith)
Employment of capital is also called capitalism and involves the control of capital by the private sector. This is an economic and social system that allows the trade of labor, goods and capital in markets. Under this system, there is distribution and investing of the profits generated from the capital assets into developing new technology and industries. Capitalism encourages economic growth due to the increase in the GDP that is realized under this system. Under the system of capitalism, there is reduced government control on the market activities.

The history of capitalism can be traced back to the 16th century in Europe. However, during the ancient times, organizations that were similar to capitalism existed.  A small amount of capitalism was experienced during the late middle ages. After the massive establishment of capitalism in Europe, it continued to extend all over the world in the 19th and 20th centuries and it is said to have contributed a lot to industrialization.

Composition of capital (Ricardo)
Capital is composed of two elements the variable capital and the constant capital. The variable capital represents the value of labor as a factor of production while the constant capital represents the value of the means of production. The variable capital is adjusted in order to decrease costs and increase profits made by the company. However, the constant capital is incurred by the company despite the amount of profits or losses made by the company.

The theory of capital composition was developed in 1830s. This was invented after economists realized that profits are not only dictated by wages, which was considered the major capital element by that time. As technology changed, the composition of capital continued to change. Economic changes also caused changes in the ratio to which capital components are made of. Adjustments must be made when the economy is favorable while during recession, the composition of capital must be reduced proportionately in order to cater for the changes.

Forces of production (Marx)
According to Karl Marx, the forces of production refer to the combination of means of labor with human labor power. The means of labor refer to the tools, machinery, infrastructure and many others. This concept includes the forces that people apply in the process of production. Karl Marx suggested that labor factors can be considered as forces of production if and only if they applied by the living human beings. Capital is considered as a force of production since it is used to buy labor. Production forces are not similar to means of production. According to Karl Marx, there are three components of production human labor, subject of labor and means of labor. The forces of production include the combination of human labor and the means if labor.

A minimum wage is the least wage that is lawfully permitted in an industry, organization and government. The main aim of coming up with minimum wage was to assure those who earn wages a living standard that is above the minimum required standard. The minimum wage has been arrived at by unions of labor through combined bargaining by negotiation, action of the board and by legislation.
The minimum wage was first introduced in New Zealand in the year 1894 through mandatory negotiation. At this moment, the minimum wage has become a fraction of the social legislation in nearly all nations. Even though the United States was the first to carry out laws of federal minimum wage, a fight that was strong conducted by organized labor for enactment terminated in the year 1938 the channel of the fair labor standards act which put .25 per hour as the wage for those who worked in interstate commerce. Industry committees were set up by the Act to calculate rates for each industry. There has been subsequent raise of the wage through the decades.

Economic aspect of minimum wage
The minimum wage tries to protect workers from exploitation. It thus gives them a chance to acquire the fundamental needs of life. The minimum wages differ depending on the country and in some cases it also fluctuates between provinces or states.

The economic aspect of laws for minimum wage is quite simple. Many employers dont pay wages that exceed the value of overtime. A raise in minimum wages results to dismissal of low productivity workers by their employers. Those with least job experience, education and maturity suffer most from this policy. As a consequence the laws for minimum wages are expected to affect teenagers as well as those with less education.

Eradication of laws of minimum wage would lead to reduction in joblessness and raise the effectiveness of markets for labor of low productivity. There are some economists who have been advocating for minimum wages that are higher. Some of them have the common ideological learning.
Economists who have a link with the Institute of Left oriented Economic policy as well as the Clinton administration have linked a normal for increases in minimum wage. As far as this economists are concerned higher wages motivate employees and thus higher work efficiency. Due to this, employees will require a minimum wage once their bosses are forced to make the payments.

If this statement was true then employers could exploit the workers who are less educated and experienced to maximize their profits. They would be willing to pay higher wages without minimum wage legislation. Besides, those economists who came up with this notion claim to have tangible evidence that supports their ideology.

There has been a publication made by economists Alan Krueger and David Card on analysis of the fast food industry. Their study reveals that minimal increases in minimum wage would only lead to minor losses in jobs and might raise employment slightly in some cases. This Krueger and Card studies indicate only that a minor increase in minimum wage might not lead to significant unemployment. The studies also overlook the fact that the present rates of minimum wages are already leading to noteworthy unemployment for many.

The aspect of economy concerning minimum wage increases has been a major concern with the public as well as professional views. A few of economists studying free market like Landsburg have approved that a raise in minimum wages do not affect employment much. Landsburg says that those who criticize laws of minimum wage insist that they lack appropriate impact on teens and blacks. He goes ahead to dismiss these claims because minimum wages have insignificant effect on unemployment. Minimum wages only eradicates fewer jobs. He insists the ancient argument that minimum wages are not good for minimum wage workers cannot be maintained.

Statistics that are real reveal that those who criticize laws for minimum wage were right all along. A part from the fact that minimum wages do not lead to higher levels of unemployment, they have an adverse effect on ethnic minorities and teenagers. As far as Bureau of Labor Statistics is concerned the rate of unemployment for each individual above sixteen years was 5.5 percent in the year 2005. For those who fell in the age bracket of 16-19 years had an unemployment rate of 17.2 percent.

The unemployment rate for those aged 16-17 years was 19.6 percent while it was15.7 percent for those aged between 18 and 19 years. The ethnic minorities are the ones who are affected most by minimum wage as compared to others. The rate of unemployment for white teens in the age bracket of 16-17 years was17.2 percent in the year 2005. While their Hispanic and Black colleagues had unemployment rates of 24.9 percent and 40.8 percent respectively.

These figures of course reduce for older minorities. Blacks who fall in the age bracket of18-19 and 20-24 years had unemployment rates of 25.6 percent and 19.8 percent respectively in the year 2005. The unemployment for Hispanics was a bit lower 17.7 percent for those aged 18-19 and 9.5 percent for those aged between 20 and 24.

Landsburg maintains that a good number of the jobs lost are miserable jobs that teens will not miss.
According to DeLong, laws of minimum wage can assist in reducing poverty. This is because employees who maintain their works at minimum wage benefit a lot and at the same time those who are not employed lose little. The problem associated with this argument is that it comprises negotiable value judgments. As far as the theory of mainstream economy is concerned, economic efficiency is achieved when markets clear because this is how all profits from trade are recognized.
With unemployment of the teens doubling to 40.8 percent, it is clear that some markets of labor are not clearing. If such degrees of unemployment are brought by labor market limitations, economics like Krueger, Delong as well as Card would advocate for governments to get involved and rectify these failures of markets. Yet they consider double teen joblessness comfortable when it emerges as a result of government intervention. This is because they want to utilize policies of this kind to reorganize income.

The theory of mainstream economy lacks any fundamentals for judging the impact of economic reorganization. As far as economics of textbook is concerned, the highest degrees of economic effectiveness are attained when markets clear. At this time, maximum gains for jointly advantageous trade are realized. Other people gain from income transfers at others expense.
There are no scientific techniques used by scientists in doing comparisons between profits and losses that comes as a result of income transfers. At the moment economists deviate from analyzing the effectiveness conditions and embark on talks about redistribution of income, they become forerunners of a political agenda instead of objective scientists.

The unemployment that results due to laws of minimum wage is not considered significant as far as Landsburg or DeLong, are considered. But these losses of jobs are significant to the employers as well as the workers affected by these laws. The ideas of few scrupulous economists should not matter most than the interests of workers and employers because these jobs might be miserable jobs. But other individuals also argue that these jobs are of significance importance as they form the fist step in getting experience on job and familiarizing with adult responsibility.
Another trouble associated with minimum wage is that they also affect older workers. As noted earlier, employees who fall in the age bracket of 20-24 years are likely to be affected by laws of minimum wage. Rates of joblessness in the age bracket of 25-34 years are higher as compared to those for the age bracket of 35-44 years.

The rate of joblessness for Hispanics and blacks aged between 25 and 35 years were 5.7 percent and 11 percent respectively in the year 2005. The rates for whites and Asians in this age group who were unemployed were 4.3 and 3.4 respectively. The unemployment rates in the age bracket of 35-44 years for blacks, Hispanics, whites and Asians were 7.1 percent, 5 percent, 4.3 percent and 2.6 percent respectively.

The black to Asian joblessness is revealing. For this reason, the laws of minimum wage are of little significance to Asian Americans. As a consequence, the Asians can afford to achieve unemployment which falls in the range of 2 to 3 percent. For the Asians with 16 years and above, they had a rate of unemployment which was 3.2 percent in the year 2005.
Those Asians who fall in the age bracket of 20-24 years, had unemployment rate of 5 percent in 2005. These figures only constitute a portion of joblessness experienced by blacks in the same year. The Hispanic white as well as black Americans have no reason of not attaining the 2-3 percent range of unemployment as the Asians.

Minimum wage advocators
Those who support laws of minimum wage do not recognize that the rate of unemployment nationally did not fall beyond 5 percent before the minimum wage laws were implemented. As far as the United States census is concerned, the rates of unemployment nationally were3.2 percent, 3.1 percent, 2.4 percent, 1.3 percent, 2.7 percent,1.6 percent and 3.6 percent in 1927, 1926, 1925, 1923, 1919, 1918, 1907, 1906 and 1902 respectively.

In the present day, there are some states that have low employment rates like 3 percent. For instance, the state of Virginia in the present day has rate of unemployment of 3.1 percent. The state of Wyoming has rate of unemployment of 2.9 percent while Hawaii consist of 2.6 percent unemployment rate.
The rates of unemployment nationally rarely reduce beyond 5 percent because some classes of employees remain within double digit unemployment. Considering these figures, one can argue that laws of minimum wage increases the national rate of unemployment by three percent.

According to economist Okun the gross domestic product falls by 2.6-3 percent for every 1 percent increase in joblessness. If the minimum wage laws can raise the rate of unemployment by three percent, then minimum wage losses are significant. Since the law of Okun is an experimental suggestion, its not real certainly. Elimination of minimum wage might not necessarily improve the GDP contrary to the way this law suggests.

Nonetheless, doing away with laws of minimum wage would have a certain positive impact on the GDP. The data available as well as economic theory show that laws of minimum wage leads to inefficiency in the economy. The living wage implementation would only intensify the losses. There arguments on whether those propose living wage want to witness the rise of rates of unemployment within ethic minorities and teens or not.

Economically, the living wage case is unfounded. The minimum wage of today comes up with high levels of joblessness within low productivity workers. Living wages that are higher would only worsen these problems. The claimed moral case for minimum wage overlooks the fact that increases in living wage have an adverse impact to the individuals who are supposed to be assisted by forerunners of living wage.

If sound policies are to be pursued by politicians, they should bear in mind to retract the laws of minimum wage more so considering the teens. Contrary to this, a good number of politicians consider political expediencies most rather than effective economic policy. Due to this, there will be an increment in minimum wage until the time the opinion of the public will change significantly.

Many economists have criticized the minimum wage due to the fact that it creates a price floor on wages. Dead weight loss in an economy can result from price floors. This implies that there is an existence of inefficiencies. In such cases the companies are forced by minimum wages to employ few workers and therefore increase unemployment.

According to Klein and Dompe, regulations of the minimum wage which were endorsed by the federal government set the minimum levels at which employees may be compensated by those who employed them. For owners of small businesses who employ other individuals, might have difficulties when it comes to compensation. Creative reimbursement packages like performance based reimbursement and others are gaining acceptance at a faster rate and thus changes the manner in which employers pay their workers. In many small businesses, the minimum wage remains an ever-present form of compensation.

Minimum wage changes affect approximately eleven million workers in the United States. 90 percent of the minimum wage workers do their jobs within the privatized sector. Inns and restaurants, retail ventures and private households usually pay the minimum wage. Considering the department of labor, more than one third of those likely to be victims of increase in minimum wage are teens who range between 16 and 19 years and part-time employees.

Protection acts for wage bill and small businesses.
There were two legislation pieces passed within the 90s. The pieces affected the manner in which the owners of small businesses compensate their employees of minimum wage. These two Acts that were enacted simultaneously and jointly were Small Business Job Protection Act (SBJA) passed in the year 1996. These acts impacted a much bigger range of aspects rather than simple wages. And this was misleading. For example, SBJA raised the amount a small business can set aside for purchases of equipment from 17,000 to 24,500 in the year 2003.

The bill also gives companies ample time to evade the problem of wrongly considering a contractor as a worker. It also sets free and simplifies procedures of S corporation and gives ample time to owners of small businesses to avail pension as well as plans of retirement for their workers.
As an owner of a small business, it is vital to come up with budgetary adjustments prior to changes in wage. Being familiar with trends of legislation may assist one in maintaining accounting procedures flexible.

It is obvious that some owners of small businesses will be impacted by alterations of minimum to a degree that is same. Some businesses heavily depend on the work force of minimum wage while others rely on employees who make more as compared to the base wage.

Usually, the most important aspect in determination of the wages paid is the industry in which a business runs. Another factor which can also determine this is the geographical location.
There are some economic analysts who insist that there are many merits associated with paying workers above the minimum wage. Considering a recent survey carried out by National Small Business United on small businesses, structures that pay above the minimum wage have advantages which include

The federal government controlled base wage fluctuations will not affect a business that pays higher than minimum wage as compared to a business that tightly holds to paying a minimum wage.
Higher wages paying employers have good options for new hires. Salaries that are higher imply better people because most people will find open position(s) more attractive.
Salaries that are competitive eradicates turnover. The workers become less tempted by other workers because they earn better salaries as they would anywhere. A work force that is stable leads to higher productivity.

Minimum wage goals
Even though minimum wage goals are accepted widely as proper, there is a big disagreement as to whether these wages are efficient in achieving their goals. Since they were introduced, laws of minimum wage have received minimal support from analysts of economy as compared to the general public. Debates about gains and cost of minimum wage are underway until today despite the economic research that has been conducted in decades.

Stigler, provided the classic clarification of weaknesses of minimum wages in decreasing poverty. According to him, employment may decrease much as compared increase in wage therefore decreasing overall income. As workers from the covered sectors are absorbed by uncovered sectors, the reduction in wages in sectors that are uncovered may surpass wages increase in covered sectors.
There might be a negative effect on family earnings distribution by minimum wage unless the better jobs that are few are given to needy families members rather than to youths from richer families. The laws which state that an employer is not to pay lower than minimum wage are equitable to laws that restrict employees from working in the sectors that are protected unless employed by those willing to pay them the wage.

Direct experimental studies reveal that effects of anti-poverty in the United States would be quite reserved even without effects of unemployment. Limited workers that earn low wages come from poor families. Teenagers and inexperienced adult females who are part time workers are the ones who are affected by minimum wage primarily.

Minimum wage economics
According to Arrigo and Steedman, a study done by mainstream economics on demand and supply indicate that maintaining a price floor above wage that is equilibrium, the laws of minimum wage brings about unemployment. This is so because a good number of employees are more than ready to work at raised wages while few jobs will be available at the raised wage.

Many introductory economics textbooks show a model which suggests that increase in minimum wage leads to decrement jobs for minimum age employees. These books puts across that it a raised minimum wage increases the rates of wage for workers who lack skills, the number of unskilled employees will reduce. The direct outcome of legislation of minimum wage is mixed.
Some employees more so whose initial wages were close to minimum wage will benefit from higher wages. Others especially those who had least prelegislation wage rates will lose their jobs. They will be forced to get in to the ranks of the unemployed or force that is out of labor.

There is an assumption that employees are work for longer periods as long as they are paid higher wages. The cost of a firm depends directly on wage rate. There is an assumption that higher wage rates will make the employers demand few hours with the employee. This is so because increases in wage rates makes it expensive for firms to employ many workers hence few workers are hired or only hired for few hours.

A combination of labor supply and demand curves allows economists to evaluate the minimum wage. The first assumption that is made is that labor supply and demand curves will not alter due to an increase in minimum wage. If there is no minimum wage, employers and employees will not stop to adjust labor quantity that is supplied in accordance to price until the labor quantity demanded equals the labor quantity supplied, thus the demand and supply curves intersecting at the equilibrium price.
The behavior of minimum wage is like that of labor classical price floor. According to standard theory, that if minimum wage is set to be higher than equilibrium price, the workers will be more prepared to give more labor while the employers will not hence creating labor surplus.

In simple terms, basic economics say that increasing the price of a commodity artificially increases its supply and lessens its demand. The outcome is the surplus of the product. When the product is in surplus for example wheat, the government purchases it. Because the government doesnt employ surplus labor, the surplus labor becomes unemployment, which seems to be higher with laws of minimum wage than without the laws.

Therefore, the basic theory puts across that an increase in minimum wage is beneficial to employees whose wages are increased, and harms individuals who lose their jobs or dont get hired. This is because organizations reduce their employees. On the other hand, those who propose minimum wage insist that the condition is more intricate than the fundamental theory can describe.
One intricate aspect is probable monopsony in the market of labor whereby the employer get power through market and can use this power to determine the wages paid. Therefore it is somehow possible theoretically that employment can be boosted by minimum wage. Even though there are possibilities that market power of a single employer in many markets of labor in the sense of customary company town, information that is asymmetric and poor mobility give some level of wage-setting power to most organizations.

Standard criticism theory
The notion that minimum wages reduce jobs is arrived at basing on the typical mold of demand and supply of the labor market. Most economists argue that the model is incoherent logically even with all its speculations. Basing on simulation results, they argue that little of the experimental work done with the model of the textbook comprises of a test that is potentially falsifying and as a consequence, experimental proof rarely exist for the same model.

Graham, argues that considering somewhat on Sraffianism, the augmented market of labor suppleness policy as well as the decrement of minimum wages does not consist an economic theory argument that is intellectually coherent.

According to Fields, who is a labor and economics at lecturer at University of Cornell, the model of standard textbook for analyzing minimum wage has a lot of ambiguity and the standard theoretical speculations wrongly measures a market of one sector only. According to Fields, a market of two sectors where the service workers who are self employed as well as workers of the farm are excluded from the coverage of minimum wage. One sector market with a coverage of minimum wage and another without (and probable mobility within the two) is the backbone of good analysis.
Fields, illustrates through his model that the emblematic theoretical argument is full of ambiguity and puts across that prophecies derived from the model of the textbook explicitly does not consider the two sector markets. Basing on the fact that since a sector that is non-covered exist almost every where, the prophecies of the model of the textbook cannot depended on.

There is another view of labor market which has labor markets that have low wage. These markets are perceived as having monopolistic competition. This is where employersbuyers have market power that is significant as compared to employeessellers. This monopsony could be brought by international collusion among buyers or natural factors like segmented markets, costs of information, poor mobility and the personal aspect of markets of labor.

In such case, demand and supply curves would not derive the labor clearing quantity and wage rate. This is due to the fact that as upward sloping supply would remain constant, other than making use of the downward demand curve monopolistic buyers would make use of the curve that is steeply sloping downwards which corresponds to expenditures that are marginal.
Such cases are forms of market failure that leads to a low pay to workers who get little compared to their marginal value. Regarding monopsonistic speculation, a suitably set minimum wage could raise both wages as well as jobs with the finest level being equitable to the labor marginal productivity. This observation illustrates the work of minimum wages as a policy of market regulation analogous to policies of antitrust.

Another factor why employment in certain organizations may not be affected by minimum wage is that the product produced by employees has a highly elastic demand. For instance, if wages are increased by force the management can set higher prices for commodities on the market so as to meet the high wages that its supposed to pay to the employees. Because the products demand has high elasticity, consumers will carry on with buying of the product at hiked prices and as a result the manager will not be forced to lay off employees.

Krugman, suggested three other probable reasons to show that minimum wages do not affect employment wages that are high may decrease turnover and consequently costs for training increasing minimum wage may reduce the complexity of hiring employees at a wage that is higher as compared to the current employees and employees of minimum wage might correspond to such a small fraction of the cost of a business. He says that he is not sure with the correctness of this and argues that that one can welcome the new experimental findings.

From many studies carried out by economists many have different views concerning the impact of minimum wage on the economy. Even though a few of economic analysts say that increase minimum wage improves the economy, the benefits associated with these are minimal as compared to the negatives that can be brought about by minimum wage increment. Increase in minimum wage results to significant job loss and also the employers will be forced to hire workers for few hours due to this. Therefore the laws of minimum wage should not be encouraged.

The growth or sustainability of a nations economy is highly dependant on the circular flow of income among the different stakeholders of the economy. It is due to the consumers habits of spending that triggers investments as a way of meeting their demand for goods and services. Such investments open new employment opportunities to the people thus increasing the net expenditure capacity of the consumers. Increase in the net expenditure ability of the householders has a linear implication on the growing demand for goods and services thus consequently increasing the investment capacity of the investor. It is the laws of demand and supply which influence the economic growth of any society.

The spending ability by the consumer greatly factors in determining the type, quality and quantity of goods and services that an organization should provide. This cycle of income and expenditure is referred to as the circular flow of economic activity. It is to be clearly noted that for economic prosperity in the society income of the citizens should exceed their related expenditure. In the event that expenditure exceeds income levels, then the economy of the society is said to be on recession.  It is still to be noted that any economic equilibrium is the state where expenditure and income are equal thus implying stagnation of the nations economic. Therefore, it should be in the sole purpose of any government to put in place the necessary measures for ensuring economic prosperity.

This paper is a critical analysis of the concept of the circular flow of economic activity as applied in the field of economics. The author in particular talks a look at how such an economic model is useful in explaining the economic growth of a nations economy. Diagrams are used in support of the authors arguments.

The Concept of Circular Flow of Economic Activity
The economy of any human society must involve the activities of production and consumption. To be noted here is the fact that firms are both producers and consumers in the circular flow chain while the household serves the consumption aspect of our economic chain.  Production can be defined as any act of using available economic resources in the process of creating goods and services which match the needs of the consumers. Consumption on the other side can be defined as the act of purchasing goods and services either for household use or for use in the process of making new goods and services. The later is the reason behind the qualifying of firms as consumers. It is also to be noted that economic activities also include employment and income generation. Employment is the acquisition of human resources for the benefits of realizing the production of goods and services by a firm. Income generation as an economic activity includes all the costs incurred by the organization in the process of producing goods and services. Such could include costs for purchasing raw materials, labor wages and other expenses incurred by the firm during the production process.

Types of circular flow of income models
There are two types of circular flow of income models. The first is the two sector model type of circular flow of income which assumes no changes in the levels of income and expenditure as well as the ultimate output of the economic activity. The model assumes that only the firm and the households are the key players in the economic development of a community. Here, the household spends on goods and services thus giving income to the firms which in return spend the gained income to sustain its production processes. In this model, income, expenditure and output should be equal for economic equilibrium to be realized. This illustrated in figure 1.

SHAPE   MERGEFORMAT                  
Fig 1. An illustration of the two sector model        
 A diagram showing the two sector model   
The other model is the five sector model which takes into consideration the economic development role played by financial institutions, the government and foreign contributions. Financial institutions here are seen as a source of investment capital to the investors as well as an institution for saving the extra income of the consumers. The government sector on the other side involves in the taxation of its citizens in return for the protection it provides to them. It should also be noted that the government is also responsible for spending such revenue collections on development projects such as building of road infrastructures and funding of the health and education sectors of our community. Foreign or oversea sector in the five sector model is quite crucial in enhancing the process of importation and exportation involvements of the economy. It is to be realized here that imports and exports are a crucial factor in any economy. It is such acts which provide for both access to goods and services unavailable in the nations as well as expanding the market for goods and services produced in the nation. It is this sector of the model which converts the nations economy to an open economy. It should be noted that the nations expenditure must not be higher than its income for exports if the economy is to be sustainable. In this model, economic equilibrium is realized when all involved expenditure cancels the incomes realized. This is demonstrated in fig

2.SHAPE   MERGEFORMAT
Fig 2. An illustration of the five sector model
Principles of economics as explained by the circular flow of economic activities
The economic development and sustainability of any society is highly dependent on production and consumption. It is to be noted here that the production process is determined by the availability of economic resources such as physical facilities, lobar and investment capital. Land is the physical resource required for the construction of the factory facilities and agricultural activities. It should also be noted that land is the source of most of the economic resources required by firms in the production process. Such resource as electricity and minerals are found in the soil, making land a crucial factor in the production process.
   
The availability of qualified and reliable lobar force is another basic requirement for sustainable production in any firm. It is the human resource which factors greatly in ensures the efficient operation of any organization. It should also be noted that by providing for employment, the firms are initiating the reciprocal factor of economic activities. With good wages, workers as consumers will increase their purchasing power for goods and services thus increasing the overall income margins for the firms. This will have the end result of increasing investment capacity for firms and thus ensuring a sustainable economic growth in the nation.
   
Any investment requires capital. These are the durable goods and facilities which positively influence the production process. Such include setting up of factories and offices as well as investing in other production supportive requirements. It is to be appreciated that it is investment capital is mainly in form of loans from financial institutions customer gained income through purchase of the companys goods and services or from the investors own savings. It is due to this reason that financial institutions play an important role in the economic growth of any society.
   
The concept of circular flow of economic activities is found in the concept of stocks and flow. The decision making process pertaining the economic position of any investment lies on its stock flow records. As a cycle of economic value reciprocation, it is worth noting that the use of economic resources in the productions process requires demand for a return value to the firms. It is due to this that goods and services are usually purchased at a given marketplace price. Such income gained from the sell of the products will serve to pay wages for workers, rent to the landowners and contribute to the tax kit of the nation. With income, the workers will increase their purchasing power thus consequently increasing the overall economic potential of the firms. The government on the other side will invest on societal development projects thus realizing a sustainable development in the nation. It is this cycle of interaction from production, employment, capital generation and consumption which leads to circular flow of economic activities in the society.
   
It is still to be realized that it is the household which provides most of the economic resources needed by firms in the production process. Households are the owners of the land which they offer at a fee to the investors. Still to note is that the consumers are the source of the labor that serves to oversee the production of goods and services in the company. The investment capital is another thing which proves the reciprocal nature of the economy of any society. It is to be understood that most investments rely on financial institutions for funding of their projects. Still to be appreciated is the fact that the financial institutions a heavily reliant on the consumer savings for their survival. This makes the economic growth of a society thus a circular flow of income among the producers and the consumer.

The concept of equilibrium and adaptation to disequilibrium
Economic equilibrium is defined as an economic state in which both the firm s and the consumers have equally benefits or spends towards the involved economic activity. It is only in such a state that sustainability of the economic can be realized. It is however to be stated here that this is not always the case in the real business world. It is a common practice by many consumers to change their purchasing patterns while seeking to save for their future lives. This leads to decrease in the companys projected market returns. Such decreases in the overall market returns of the company have a result of risking the retrenchment of the employees and closure of some production facilities. All these will have the end result of reducing the household income levels thus further reducing their purchasing power. Failure to rectify such circular flow of economic declines can lead to the ultimate down fall of the nations economic. It is in fact a result of such economic practices that the globe is experience an economic recession.

It is however to be noted that the problem of reduced can be easily by the firms. It is in the knowledge of many investors that consumer only spend part of their income while saving the rest for future use. This has the ultimate result of leading to contraction of the circular flow of the economy. However, this can be easily prevented by the firms if they spend most of their unsold output in increasing their future production capacity. This ensures that the firms spend more capital investments to reduce their investment needs in the future. Such disposal mechanisms will help reduce the immediate production capacity thus matching the household demand thus eliminating the disequilibrium factor in the economic. This aids in the normalization of the circular flow of the economic activities.

Circular flow with government and oversea investors
The inclusion of government and foreign investors in the circular flow of economic activities makes the circular flow more realistic. It is to be noted here that the government is for the people and made of the people. This means that the execution of governments responsibilities must be heavily reliant on the citizens contribution towards the governments upkeep. It is however to be noted that such contributions to the government are a direct reciprocal act owing to the protection that the government offers to its people. Such are also seen to go into the implementation of developments projects in the communities. Still to be noted is the fact that the government acts in encouraging investment through provisions of investment incentives.
   
Involvement in foreign business is another crucial element in the circular flow of economic activities. This is basically in the aspect of imports and exports. It is to be realized here that imports and exports are a crucial factor in any economy. It is such acts which provide for both access to goods and services unavailable in the nations as well as expanding the market for goods and services produced in the nation. It is this sector of the model which converts the nations economy to an open economy. It should be noted that the nations expenditure must not be higher than its income for exports if the economy is to be sustainable. Still evident in oversea sector is the fact that it aids in initiating and nurturing international relationships among nations, a crucial element for the harmonious coexistence of different members of the globe family.
Summary
   
Production and consumption are the most crucial elements in any economic setting. It is by consumption of the produced goods and services that firms get value for their investments. Still, it is by production that consumers can have the desired satisfaction for their needs in life. The production process also involves the purchasing of goods and services for aiding in the production process. It is thus clear here that firms are both producers and consumers in the circular flow chain while the household serves the consumption aspect of our economic chain. It is due to this reason that both the firms and the households are found to be two different but highly complimenting elements in the realization of a sustainable economy in any society.
   
The households are the source of sustainable market for produced goods and services in the community. It is by their purchasing of the products of firms that firms can claim guaranteed return of value for their investment. Such guaranteed market for goods and services lead to increased potential of expansive investments by organizations to meet the increasing consumer demands. It is to be noted here that increased investments come with increased employment opportunities for the people. Still to be realized is the fact that employment opportunities increase the employees income and thus greatly improving their purchasing power. Such will have the end result of having a linearly increasing demand-supply situation in the society. This means that the economy of the community will keep on expanding provided such demand and supply trends are kept.
   
It is however to be noted that demand is not always equal to supply as most a times consumers decide to save part of their income for future use. It is due to this reason that economic disequilibrium is a common thing in our society. The globe recurrent faced with economic threats mainly due to such disequilibrium of demand and supply in the marketplace. It should be noted here that equilibrium is the best state of any sustainable economy. It is due to this that many companies seek to address the problem of disequilibrium by using investment capital structures as a way of disposing their unsold products. Such acts ensure the firms added advantage for meeting any future rise in supply demands while limiting potential losses in the meantime.
   
The circular flow of economic activities, in amore realistic way relies of the government, financial institutions and foreign countries. Financial institutions are seen as a source of investment capital to the investors. It is to be appreciated that such financial institutions are heavily reliant on the consumer savings for their survival. The government sector on the other side involves in the taxation of its citizens in return for the protection it provides to them. The government is also responsible in spending such revenue collections on development projects such as building of road infrastructures and funding of the health and education sectors of our community. Lastly, foreign or oversea countries are quite crucial in enhancing the process of importation and exportation involvements of the economy. It is such acts which provide for both access to goods and services unavailable in the nations as well as expanding the market for goods and services produced in the nation.

In conclusion, it has been evidently established that a market economy is marked with production and consumption as the major key player in ensuring circular flow of economic activities. It is however evidently clear that a sustainable circular flow of economic activities should be thought out using the five sector model of circular flow. It is this model which eliminates the assumptions found in the two sector model of the circular flow. It is clear that the five sector model appreciates the fact that financial institutions, governments and foreign nations are crucial factors if the circular flow of economic activities. It is only with available financial institutions like banks that funding of investment can be assured. Still to be noted is the fact that the government as the custodian of the citizens must be involved in ensuring fair and just flow of economic activities. Involvement in import and export trading ensure the long term sustainability of demand and supply factors of the economy.

Monetary transmission mechanism is a policy and a process where the change in the interest rates affects the levels of inflation. This mechanism generally describes how changes that are induced by policies in the nominal short term interests can have a major impact on several variables such as employment and the output aggregate.  There are particular channels of monetary transmission that work on the premises that monetary policy has effects on interest rates, rates of exchange, prices of the real estates, equities, bank lending and  the balance sheets of firms. This paper will focus on the mechanisms and policies of monetary transmission in relation to the oil industry.

Preview
Monetary transmission mechanism is the channel through which a countrys monetary policy has an impact on the economic variables of that country which include output and employment. Comprehension of this mechanism has been very essential topic of research in macro economics and is central to the analysis of the economic policy.  There are various explanations of the monetary transmission policy to the real economy and they try to capture the total effects. These channels include the Cost of Capital Channel (traditional view), the Credit Channel (which has traditionally been broken down into Bank Lending Channel and Balance Sheet Channel) and the financial accelerator.  Cost of capital channel can be explained in the following way. Companies fund their operations using three ways. These ways include stocks and equities, debt methods and the reinvestment of money earned through previous trading. This means that the weight of capital for a company is weighted upon the sub total of equity and debt while the reinvested capital is charged as the cost of equity because if that money us not reinvested, it is normally returned to the company investors who are the share holders. The cost of debt is also termed as the cost of borrowing money.

In this traditional channel, when the central bank reserves reduce, the demand for deposits by the commercial bank reduces and it the prices get prickly a short term decrease in the monetary holdings in the real economy always leads to real interest rates that are higher than the normal ones and this translates into a contracted interest positive elements of aggregate expenditure. The credit channel approach of transmission postulates that fictions in information in the credit market always worsens during tight money periods and there is a resulting increase in the external finance premium which is seen as the cost variation between internal and external funds. This enhances the effects of the policy on the economic situation of a country and can be seen in the response in the GDP.  In this policy of monetary transmission, a change in the interest rates affects the levels of inflation. This mechanism generally describes how changes that are induced by policies in the nominal short term interests can have a major impact on several variables such as employment and the output aggregate.  There are particular channels of monetary transmission that work on the premises that monetary policy has effects on interest rates, rates of exchange, prices of the real estates, equities, bank lending and the balance sheets of firms. The transmission mechanism has three stages.

Stages of monetary transmission
Monetary transmission channels occur in different stages. The first stage is where a change in the rates of interest that are set by the MPS influence changes on all the other rates. This is where banks and all the other institutions react to an official change in the rates by changing their rates that govern savings and loans. This change will always affect the prices of very many other things like the households assets, security prices, shares and equities, energy and equities. The expectations of individuals and companies will also change to accommodate that change in the interest rates. The confidence about the future financial path begins to wane. The second stage is where the spending patterns of the consumers are affected thus affecting the demand of goods and services.

When the interest rates are high, the level of aggregate demand for goods is usually low because the consumers in the wake of the increased rates and the accompanying effects cut back on their spending meaning that their purchasing power is very low. The effects will also be felt internationally as the volumes of exports and imports are also affected. The third stage is the impact of the monetary transmission mechanism on inflation and the gross domestic product of the nation. These are largely dependent on the total levels of supply and demand underpinned by the fluctuations in the interest rates. However, if there is an AD increase, and enough economic capacity, then the increase in the rates may not cause a noticeable inflation.

Impacts Economic Downturn
In 2008 there was an economic crisis that had a very huge impact on the monetary transmission mechanisms and the energy sector was one of the hardest hit by the economic downturn that started toward the end of 2007. In 2008 petroleum prices went up to unprecedented levels, something that pushed up the interest rates all over the world and had a huge impact on prices of very many commodities around the world since petroleum products are hugely involved to fuel the transport industry that relays different consumer goods through the different levels. The petroleum crisis had an interweaving relationship with the global economic downturn because the shortage of petroleum led to the rapid increase in prices of the petroleum products while the global economic down turn affected the spending power of most consumers meaning that in the long run, the consumption of petroleum products went down because of the low purchasing power.

Impact on oil and Auto Industry
One of the industries that were worst hit by this monetary transmission crisis in the petroleum industry is automotive making industry especially in the US. There was substantial increase in the cost of the fuels that drive automobiles because of the combination of the energy crisis and the economic downtown. Automakers that deal in vehicle that do not have low fuel economy were the hardest hit by the this instance of monetary transmission because the demand for the sports utility vehicles that guzzle fuels and trucks went down visibly This is because of the reduced spending power occasioned by the high interest rates that had been pushed up by the effects of the energy crisis and the economic downturn. The sales for the giant automakers in America, GM Ford and the Chrysler started sliding and they did not have alternative fuel-efficient autos to provide to the customers who were highly watching their pockets. This scenario had a double impact on petroleum companies because to start with, there is a problem with the availability of fuel meaning that they will have to spend more to get the usual amount of fuel, and secondly, even if the fuel is there, the rate of consumption was very low because of the spending habits of most people who were economically conscious because of the credit crunch. Some of the petroleum companies were forced to reduce their operations in various countries.

For example, Caltex pulled out of various African countries including Kenya while Shell sold half of their stations in a number of countries to the emerging oil Libya. It is during this energy crisis coupled with the economic downturn in 2008 that prompted the shell CEO to create a global scenario that he called the scramble and Blue prints that focused on the state of the oil industry and the energy sector in the next five years onwards, forecasting a global crisis should the world opt to follow the scramble option that will see the countries scramble for the available petroleum resources, thus depleting them without having made an alternative form of energy to replace the dwindling oil resources.

Impact on Future of Oil Industry
To make long term strategies, shell has been developing scenarios since the 70s and the latest scenario is the Scramble and Blueprints that illustrates the routes the world will take in the face of the energy crisis that will hit the world as from 2015. The scramble route will be an exciting route with a lot of competition but will grind to a halt with unimaginable consequences. The scramble scenario is a path of less resistance where the nations will make haste while the sun shines meaning that they will run to secure energy resources and there will be losers and winners. However, a time will come when all the fuel energy will be depleted and the race will come to a painful end. This method solves no problem because the supplies will run short leading to high energy prices, political response and volatility. However, the Blueprint option will have a lot of problems at the start and the ride will be bumpy but due to the ingenuity and technical innovation, the excitement will be felt at the end. 

Whichever route is taken, the problem cannot be solved without the addition of other energy sources in the world in order to keep up with the increasing demand occasioned by the population upsurge. However, the Blueprints route will be disorderly at the start but less painful toward the end because positive coalitions will emerge to ensure energy security and enhance more innovation. This scenario will work hand in hand with the environmental sustainability path and there will be growth of number of cars that use alternative energy sources like electricity and hydrogen. This is where the shells scramble and blue prints scenario and the automotive industry relate because the path taken will have an impact on the automotive industry.

According to the shell CEO, this will occasion unprecedented monetary transmission mechanism around the world with prohibitive interest rates and very high prices of assets and products. Once again, the industries that will be heavily affected are the motor and petroleum industries. This is because, auto industry relies on petroleum products and with the dwindling resources it means that there will be an extremely low demand for motor vehicles from a global population that will already being reeling from the effects of an unprecedented credit crunch. The main reason for the increased demand of oil that will outstrip the capacity of the world resources to supply it is the revolutionary growth of economies especially China and India, if the world does not invest in alternative forms of energy like the oil sands or nuclear energy. However, the shell CEO says that if the world chooses to follow the blueprint option, such a monetary transmission crisis may be avoided because the blueprints path will ensure that countries invest in alternative forms of energy in the face of dwindling oil resources. This is a path of creativity and auto makers will not suffer from demand problems because they will have prepared for this eventuality by manufacturing vehicles that use alternative forms of energy and the interest rates will have been cushioned by this preparedness unlike the just ended economic crisis that saw the purchasing power of many household being completely depleted.

Inflation
There are energy advocates who are pushing for a consistent policy of energy because the swings in prices have become wild thus affecting inflation and interest rates and this has crippling effects in many industries. For example, due to the credit crunch, the GM motor company almost collapsed and it was not in a good financial position to obtain credit for it to be able to make an acquisition of Chrysler. The fall of sale and tightening consumer credits was another big impact that almost drove the automaker out of market. The other impact of monetary transmission was the effect on credit worthiness of people. The financial crisis made it hard for the average person to get credit from banks to buy vehicles meaning the rate of vehicle consumption went down thus also pushing down the demand for oil products. Most average people buy cars using loans granted by banks and at that time when the interest rates were at an all time high, most people would shy away from such risky monetary commitments. This is especially because of the instability in the job market.

Cyclical Impact
The monetary transmission especially during the 2007 -2008 period also had an impact on the industrial output of very many industries. This is because the credit crunch affected the buying power of consumers meaning that the demand for industrial products went down. Very few companies were operating at maximum capacity while some of the industries had to close down in the wake of the economic downturn that drove levels of inflation to unprecedented heights. All industries use energy meaning that if the companies were not operating at maximum capacity, then the levels of energy that they were utilizing were very low. This means that the demand for energy due to the low industrial production occasioned by the low demand for industrial good and this had a major effects on major oil companies especially the one that concentrate in industrial supplies like Caltex. The situation here was very cyclical and this manifests how deep the impacts of monetary transmission had gone. The cyclical situation starts from the high oil prices that push up the prices of products because oil is used in various stages of business, for example, industrial production and transportation.

The increase in the prices forces the consumers to cut their spending on different industrial goods including automobiles and the increase in interest rates also reduce their chances of getting credit from monetary institutions. Their reduced spending means that the demand for the industrial products goes down and the industries respond by producing lesser goods and in the process of producing lesser goods, they use lesser amount of energy including oil. These industries are now forced to reduce the amount of labour force, who are industrial consumers meaning that their spending power goes down again pushing the demand for industrial products and energy down. With the low demand of energy including oil, the prices of oil go down thus as the levels of inflation also goes down making the situation to go back to a state of normal equilibrium. That is the cyclical impact of monetary transmission mechanism that in this case is triggered by the rise in the fuel prices and is brought to a halt by the reduction of the same prices, but after a series of events and counter events.

The period 2006 to 2008 is an interesting one in the economic sense. This is because of the way the global economy went full cycle and stunned the world. In the year 2006, the global economy was doing well and generally people were hopeful about their future. Due to this optimism, borrowings from the financial markets to fund huge spending by the public dramatically increased, and as a result the financial market kind of overheated. Then towards the end of 2008, economic experts and the general public were engaged in a heated debate on whether or not the world economy was facing or was actually in a recession. However, there was a wide acceptance that the world was facing a financial crisis of unprecedented scale. Businesses were either losing money or closing down and hundreds of thousands were losing their jobs as a result.
    Hence in a way we can visualize an economic cycle having taken place in the period between 2006 and 2008.Given this position, the objective of this paper will be to decipher how economic changes affect the performance of the retail industry. First, before the financial crisis became apparent, that is between 2006 to 2007, we would like to see how the retail industry performed vis a vis the economy. Then after the financial crisis began to take its toll on the global community, spending patterns definitely changed, and it is important to note how this affected the industry. Lastly, it would be important to try and come up with an economic relationship between economic performance and the performance of the retail industry. The resultant model should be able to be used to forecast the future of the retail industry based on economic projections that are normally put forward by economic and financial experts from time to time.
LITERATURE REVIEW
Retailing is primarily concerned with the sale of finished products to the end users (Rakhi, 2009).It is comprised of both individuals and companies. On the retailing continuum, we can have a family run store on one hand. On the other extreme we have such global behemoths like Wal-Mart, the worlds largest retailers, operating in numerous states. Retailing is considered to be a primary driver of the global economy given the fact it permeates all levels of the society and employs millions across the world. For instance, according to Jones (2009) a massive 15.5 million people worked in the United States Retail Industry in the fourth quarter of the year 2007.
Economic Indicators and Retail Performance
According to Euromonitor International (2009), the performance of the economy as a whole has a great impact on retailing. This is because a retailers profits are closely correlated with the performance of the economy. This way, performance indicators such as price growth and retail turnover will either show favorable or poor prospects depending on the movements of the various economic parameters. Economic growth trends such as  HYPERLINK httpwww.investopedia.comtermsggdp.asp Gross Domestic Product (GDP), HYPERLINK httpwww.investopedia.comtermsiinflation.asp inflation, consumer confidence, personal income and interest rates are extremely important when thinking about the expectations and therefore performance  of  the retail industry(Jones,2009). A drop in interest rates by say 50 basis points for example, might look as a small gain to an individual consumer, but Jones (2009) notes that if considered in terms of an economy as a whole, it has a big effect on spending patterns. Likewise, if incomes of people fall, or they are less confident about their economic future, they are likely to cut back on expenditure, and save so as to take care of the future uncertainty (Euromonitor International, 2009).This drop in spending means that the retail industry takes a beating in terms of low sales. Coincidentally, spending is a function of peoples income levels and their confidence, and this varies with the performance of the economy. In Spain for example, 2008 saw a slow down in economic growth accompanied by increased rates of inflation and unemployment, and as a consequent, retail sales grew by only 2 compared by over 10 in 2007(Euromonitor International ,2009).

The Economy and Different Retail Segments
Economic hardships are likely to limit peoples spending, in view of the fact that most people will have lost jobs and therefore incomes earmarked for purchases would have fallen. Johnson and Scholes (2003) notes that each segment or range of products is affected differently by the economic cycles. The impact of economic cycles on each retail segment therefore tends to vary substantially. According to Jones (2009), this reflects how each group of goods represents a discretionary form of household expenditure. Some segments of the retail industry will therefore record robust sales figures while others will suffer loses. These trends might cancel out each other. As a result, the retail industry might actually record growth, even in difficult economic times. For instance, only 20 of the variation in the volume of food retailing may be attributed to changing economic conditions, compared to around 85 of movements in the hospitality and services sector (Shulha ,2006).This means that in an economic downfall, the food industry is likely to experience modest changes in sales figures while the service sector suffers huge losses.
Employment and Retail Performance
According to Shulha (2006), employment rates within an economy, which is closely linked with the economic strength, also affects the performance of the retail industry. This is particularly because the unemployed tend to exhibit spending patterns different from the employed. Myers (2004) notes that during difficult economic times, there is a tendency towards hidden unemployment whereby more people are willing to take up part time and casual employment which in many cases represents a form of under employment. On the other hand, the increasing incidence of under funded retirees who are unable to maintain previous levels of consumption takes an upward turn. All these groups represents a form of unemployment given the fact that spending is cut, particularly for discretionary items such as clothing, electronic goods and holidays. And this pattern is likely to negatively impact on  retailing. The opposite is true when an economy is experiencing a boom, when people are able to find jobs, are more confident about the future and therefore feel free to maintain high consumption levels.

Income Distribution
Income distribution also impacts significantly upon per capita retail expenditure. This is because of the income elasticity of demand (Johnson and Scholes, 2003).The income elasticity of demand is the extent to which demand for a product changes in response to a change in income. According to Johnson and Scholes (2003), per capita expenditure on clothing, and caf and restaurant meals, increases sharply with household income. This contrasts with spending on food which is relatively more stable across income groups. According to Euromonitor International (2009), these patterns of expenditure have significant implications where changes in household income occur in response a structural change in employment patterns. Considering the period 2006 to 2008, it will be interesting to see how retail industry performed in the face of drastic changes in income patterns, given that millions of people across the world lost their jobs towards the end of 2008.

RESEARCH METHODOLOGY
Information Sources
Given the size, dynamism and complexity of the retail industry, primary methods of data collection might not give a true picture of the happenings in the retail industry. Besides, the sheer volume of work involved in analyzing a representative sample is not only enormous, but also requires a lot of time, which is not available. Consequently, secondary methods will be used to collect data. Information will be sourced from newspaper articles, trade journals and white papers. Data from various government agencies, trade associations, paid databases and credible internet sources will also be considered. Among factors to be considered will include the retail turnover indicators, changes in consumer expenditure patterns, changes in factors driving growth in the industry and the influence of economic performance on retail performance indicators.
Analysis Methods
Given the global economic performance in the period 2006 to 2008, whereby the economy did very well in the beginning (2006) and headed towards a recession (towards the end on 2008) it will be important to find out how economic indicators relate to retail performance. In this regard, Linear Regression Analysis will be employed to determine the existence, if any, of causality between the two parameters. Besides, attempts will be made to come up with a Historical Trend Analysis of the period under review. This will be represented in bar graphs and line graphs. Lastly, Ratio Analysis will be used to analyze performance in the period .This will give us a glimpse of whether the retail industry has the capacity to pose any further growth..

Purchasing power parity is a theory of determining exchange rate and a means of comparing the average costs of goods and services between different countries. This theory operates on the assumption that the actions of both exporters and importers are motivated by cross border countries prices variances, inducing changes in spot exchange rate. In addition, the theory of purchasing power parity also suggests that transactions on a countrys current account, affects the value of the exchange rate on the foreign exchange market.
Purchasing power parity theory states that the exchange rate between one currency and another is in equilibrium when their domestic purchasing powers at exchange rate are equivalent (Joseph, 2002).This means that ther price of goods like a computer in China and United States of America should costs the same taking into account the exchange rate between the two countries.
     According to Sustav Cassel, a Swedish economist, the external value of currency depends on the economic purchasing power of that currency relative to that of another currency (Joseph, 2002).. This means rate of exchange between two inconvertible paper currencies is determined by the equality of their purchasing power or by their relative price levels. The purchasing power parity theory explains   exchange rate determination and its currency fluctuations when different countries are on inconvertible currencies.
The theory of purchasing power parity is best explained using two principles the law of one price and from the Law of One Price (LoOP) to Purchasing Power Parity (PPP).
The Law of One Price (LoOP)
This law states that goods which are identical should be sold for same price in two separate markets when no transportation  costs is incurred and no differential subsidies or  taxes are applied in the two markets. In cases where no transportation cost is incurred on such goods, this opens an opportunity to make profit through trade. Therefore, discrepancies in price of goods is due to transport costs incurred between different countries and taxes applied by different countries  and states on their goods thus leading to variation in prices of goods (Joseph, 2002)..
From Law of One Price (LoOP) to Purchasing Power Parity (PPP).
This theory of purchasing power parity is an aggregate of law of one price with a bit of twist added to it and it says that all identical goods should be sold between countries or in both markets. This law states that if two countries have different inflation rates, then the price of goods in both states will change. Hence, the price of goods is determined by exchange rate through the theory of purchasing power parity. In this case a country with a high inflation rate is believed to have its currency value decreasing.
In conclusion, the theory of purchasing power parity argues that the rate of exchange is usually determined by the ratio of purchasing powers between countries. Therefore, goods and services identical in nature from different countries should cost the same price in different countries. The price differential between different countries is not sustainable in the long run as the market forces (demand and supply) will tend to equalize prices between states or countries and their exchange rates.