By Jannis Koehn
King Abdullah Economic City (KAEC) is the first proper city that we discussed in the course. At least, it might eventually become one. Whether it qualifies as a sustainable city remains to be seen, and I do not want to get bogged down in the question what an economic city is exactly. So far the city developers are stuck with interdependency among sectors none of which yet exists, lack of capital, lack of knowledge and lack of a strategic plan. I want to suggest that a few adjustments may help the Protagonists to solve this Gordian Knot.
First, define strategy and focus. In my understanding, EEC is a publicly listed city developer, not a port developer or a power utility. In that role, EEC can provide seed funding if that is needed to attract further private or public capital; it should not be the primary investor as long as capital is scarce. That means no matter how value-creating and financially attractive the port may be, EEC should not invest more than the absolute minimum needed.
Second, engage expert companies through build-operate-transfer contracts. Allowing foreign construction companies to build new infrastructure at their cost reduces capital expenditures for EEC. Fees for operation can be paid either by users or by the city developer; while the first would free EEC entirely of the cost, the latter would leasing-like smoothen capital outflows. And after a pre-defined period, the asset would be transferred back to the city developer or the state. With lack of capital and expertise, that is the best way to go. The difficulty for greenfield cities like KAEC is guaranteeing sufficient demand should the operator be compensated by user fees. A minimum income guarantee or a Least Present Value model may help.
Third, become more flexible. Zoning shares like 38% for industrial and logistics or 16% for leisure are way too specific at this early stage. Even in a guided economy like Saudi Arabia, no-one knows what the actual demand for different industries, sectors and zones will look like years ahead. Even less so as the industrial focus of KAEC remains unclear (see last paragraph). What if labor-intense IT services turn out to be the dominating sector – would 27% for residential still be enough? These figures reveal a deeper problem: The city has been designed in all detail but not yet strategically planned.
Fourth, rethink the revenue model. It is very difficult to be profitable as the developer of an entire city. I see four sources of revenues:
1) Selling or leasing of property is the most straightforward way to go. I would suggest leasing out property as this reduces barriers to exit and thus increases the likelihood of influx of new citizens and businesses. One might experiment with leasing and selling according to demand. The overall problem: those revenues may not be enough.
2) Imposing taxes and fees is possible in principle; after all, that is what cities do. The problem is that Saudi Arabia is a country where taxes are highly uncommon. And even if not – taxes usually belong to the government, not a private entity. Alternatively, EEC could require a certain percentage of investment volume as a commission. Yet, this would discourage new investments that are urgently needed.
3) Own investment activity in assets and projects is restricted by limited capital and is not, as outlined above, the main objective of a city developer.
4) The only remaining option are government funds. In fact, if the Saudi government asks EEC to develop the city, and given the positive externalities the city is supposed to provide, the government should be willing to pay a development fee to EEC.
These initial steps may help KAEC to flourish. But also the King and his advisors need to act and reduce KAEC’s planning uncertainty. Let’s assume the country has identified a number of growth sectors to strategically transform the Saudi economy. Then some central authority should give guidance on which of the four Economic Cities should focus on which sectors. Otherwise the King may end up with four ports and no manufacturing or several universities but no tourism. For KAEC, for instance, he could define the port and the university as strategic sectors around which to develop the city. Such guidance should be based not only on what industries are needed in the country but also which location bears the best resources (trade routes for ports, beach and water quality for tourism). This bigger-picture view is called industrial policy may conflict with the libertarian idea of resource allocation through free markets. But in a guided economy that wants to develop strategic sectors, it is just good old portfolio management that would certainly help.