1. Executive Summary

The objective of this book is to introduce the KAPSARC Global Energy Macroeconometric Model (KGEMM) and to conduct a detailed survey of the existing macroeconomic models for Saudi Arabia, discussing their strengths and weaknesses. KGEMM is a policy analysis tool for examining the impacts of domestic policies and changes in global economy including energy markets on the Saudi Arabian economic, energy, and environmental variables at both aggregate and disaggregate levels.

Macroeconometric models inform policymakers about the dynamic relationships among economic indicators, how economies have performed in the past, and how their current and future behaviors might differ. Models are simplifications of actual relationships that provide analytical and empirical frameworks concentrating on important aspects of the relationships. Macroeconometric models can explain, project, and evaluate economic processes. They can be especially useful in helping policymakers to evaluate the impact of alternative policy choices. In this regard, macroeconometric models provide analytical and evidence-based foundations for policy decisions, contributing to the increased likelihood of successful policies.

A macroeconometric model for Saudi Arabia is particularly important for the country’s policymakers. The Kingdom faces numerous economic, demographic, and social changes as it diversifies its economy away from oil toward a greater role for the non-oil private sector and a more efficient public sector with enhanced services. The Kingdom’s economy is as responsive to international energy market dynamics as any other oil exporting economy. The future of the country’s economy is based on a transformation process, outlined in the Kingdom’s strategic roadmap, Saudi Vision 2030 (SV2030). SV2030 involves important initiatives such as an energy price reform to induce more rational use of the Kingdom’s energy resources, fiscal reforms for more effective government spending and increasing non-oil revenues, investment projects for supporting economic growth and diversification. The role that oil exports and revenues play in Saudi Arabia’s fiscal policy and economy will certainly continue during the transition. Projections and assessments by international agencies suggest that global energy markets will see slower oil demand growth. Obviously, renewable transitions and environmental protection policies play a central role in this slowdown. Reforming the Kingdom’s investment environment and legislation attracts more foreign direct and domestic investments. Such institutional and structural reforms could, over time, bring about changes in the country’s fiscal and monetary policies and in financial markets, as highlighted in SV2030 realization programs, such as the Fiscal Sustainability Program, the National Transformation Program, and the Financial Sector Development Program. Labor market reforms are also necessary to absorb the current and coming young male and female Saudis entering the labor force. Expatriate labor’s role in the workforce will change. Quantifying the effects of the above-mentioned domestic and international developments on Saudi Arabia’s economic energy, and environmental dimensions requires well-designed models.

Policymakers need to know how the implementations of the above-mentioned initiatives of SV2030 coupled with global changes could influence the country’s economic, energy, and environmental outlook. Macroeconometric models augmented with energy and environmental representations could provide insights about these. They could also show how the economy could be restructured and how sectoral and macroeconomic indicators should be changed to help achieve SV2030 targets.

No publicly available macroeconometric models can address the points above to the best of our knowledge. The KGEMM research project is an attempt to fill this gap and provide insights into economic-energy-environmental related policy options for the Kingdom’s decision makers.

The model has nine blocks (real, fiscal, monetary, external, domestic prices, labor and wages, energy, CO₂ emissions, population and age cohorts) that interact with each other to represent the Kingdom’s economic (macro and sectoral), energy, and environmental linkages.

KGEMM can address two broad sets of policies and areas of research: domestic economic-energy-environmental relationships and the effects of the rest of the world, particularly global energy markets.

The following characteristics of KGEMM show its contribution to the existing literature on macroeconomic modelling in Saudi Arabia:

It can also contribute to economic (macro and sectoral) modeling for other open economies that are rich in natural resources, as there are similarities among these countries.

KGEMM can be used to analyze the current stance and project the future paths of economic (macro and sectoral) and energy indicators as well as CO₂ emissions. The model can also be used to evaluate the effects of different policy options (e.g., SV2030 initiatives and targets). It can further enhance effective cooperation between modelers, researchers, and practitioners from various government agencies and research institutions as it represents different aspects of the economy, energy, and environment in the Kingdom.

KGEMM has been validated using different validation tests, such as statistical significance and theoretical consistency of the estimated parameters, post-estimation tests for the residuals of the estimated equations, in-sample performance for the approximation of historical data, and out-of-sample performance for policy analysis. In this book, we run the model for an in-sample forecast to approximate the historical time path of the endogenous variables as well as an out-of-sample simulations to assess the impact of Arabian light crude oil’s international price, foreign direct investments inflow, and renewable deployments on Saudi Arabia’s economic, energy, and environmental indicators. In-sample and out-of-sample simulations show that KGEMM has robust predictive and policy analysis capabilities. Indeed, KGEMM has been used extensively in multi-stakeholder projects to assess the macroeconomic and sectoral effects of the Kingdom’s domestic energy price and fiscal reforms, the key initiatives in SV2030’s Fiscal Balance Program since December 2015.

KGEMM is a hybrid model in two senses. First, it incorporates Input-Output Table representations of intermediate, final, and total demand by economic activity sector into a typical macroeconometric modeling framework. Second, it nests the theory-guided modeling approach with the data-driven approach. The KGEMM version presented in this book has a number of developments since its third version presented in Hasanov et al. (2020). The main developments are the representations of the petrochemical sector, disaggregated imports, and CO₂ emissions. The latter one makes KGEMM a type of E3ME model (Energy-Environment-Economy Macro-Econometric model) and being similar to SEEEM (Sectoral Energy-Economic Econometric Model) and PANTA RHEI, the models that cover energy-economic-environmental dimensions.