The ongoing turmoil around the Strait of Hormuz is jeopardizing the economic diversification of the Gulf Cooperation Council (GCC) states and could potentially reverse their progress in gaining a more prominent position within the global economic system.
For over four decades, the GCC nations have emerged as the primary economic growth engine in the Middle East and a new regional hub in international trade and investment. The achievements in industrial diversification and economic development in places like Dubai are widely recognized. However, the outbreak of conflict between the US and Iran on February 28th has shaken the two fundamental pillars underpinning the stable operation of the GCC economies: security and freedom of navigation. This war risks interrupting or even reversing the process of industrial diversification and the rising international economic status of the GCC countries.
The Middle East economy already suffers from the critical weakness of a singular industrial structure and high volatility. If it were to lose the GCC as its growth engine, the capital accumulated through industries like oil and gas exports would likely flow out of the region, as it did before the rise of places like Dubai, rather than being reinvested locally to support industrial diversification and economic growth. This would further hinder the inflow of non-oil and gas industrial investment from outside the region.
Progress in GCC Industrial Diversification
Over the past decade or so, GCC nations have made considerable strides in industrial diversification, with the United Arab Emirates and Qatar, in particular, rising to become significant international trade and investment hubs.
The 1973 oil crisis and subsequent price surge initiated an explosive expansion of Middle Eastern petrodollars. This growth was so significant that the International Monetary Fund included the Iranian rial and the Saudi riyal in the Special Drawing Rights currency basket in July 1978. For a considerable period, however, the rapidly accumulating petrodollars found few suitable local investment opportunities, leading to massive inflows into Western industrialized nations, where they were invested in bonds and blue-chip stocks. This flow supported the US dollar's core position in the international monetary system and aided Western industrial development.
For decades, GCC countries have diligently worked to advance industrial upgrading and transformation. A trend has emerged where industrial upgrading and de-radicalization are progressing in tandem, accompanied by substantial growth in foreign direct investment (FDI) inflows, outward FDI, and re-export trade. The sustained, large-scale growth of inbound FDI is a crucial indicator of diversification progress, signaling that these nations have moved beyond merely attracting investors with natural resources. They are now creating favorable business environments that attract investment, logistics, and human capital from other countries.
This progress is partly attributable to the widespread nationalization of the oil and gas industry, particularly exploration and development, across Middle Eastern countries decades ago. Consequently, a significant portion of FDI has been concentrated in non-oil and gas sectors.
GCC Five's FDI Surge Overtakes Israel
The progress of GCC industrial diversification is best illustrated by the five high-income nations: the UAE, Qatar, Kuwait, Saudi Arabia, and Bahrain (excluding Oman, which has a notably lower income). A comparison with Israel reveals shifts in their relative economic competitiveness.
Compared to the resource-rich GCC states, Israel, which is poor in natural resources, has consistently prioritized both domestic and foreign investment. Its domestic investment rate (gross capital formation as a percentage of GDP) and the share of foreign capital in its capital formation (FDI inflows as a percentage of gross capital formation) have long been significantly higher than those of the GCC nations. This characteristic was especially pronounced during the 1970s when most developing countries, including those in the Middle East, were aggressively pursuing the nationalization of foreign enterprises and resources.
Regarding FDI inflows, data from the UNCTAD World Investment Reports shows that Israel maintained a net FDI inflow throughout the 1970s and 1980s. The annual average inflow was $77 million from 1980-1985, followed by $167 million, $256 million, $214 million, $166 million, and $129 million from 1986 to 1990, respectively.
In contrast, almost all GCC countries experienced net FDI outflows in multiple years during the same period. Even the UAE, now the region's largest FDI recipient, had significantly lower inflows than Israel in those corresponding years: an annual average of $28 million from 1980-1985, followed by $110 million, $47 million, $189 million, $39 million, and a net outflow of $87 million from 1986 to 1990.
In terms of investment rate and the foreign capital share in capital formation, Israel's average annual investment rate exceeded 20% in the periods 1971-1975 (29.0%), 1976-1980 (23.2%), and 1981-1985 (20.3%), dropping to 16.9% for 1986-1989. The average annual share of foreign capital in its capital formation for these four periods was 2.9%, 1.1%, 1.6%, and 3.0%, respectively.
By comparison, Kuwait, a representative GCC state, had average annual investment rates of only 9.6% and 16.6% for 1971-1975 and 1976-1980, respectively, lagging behind Israel by 19.4 and 6.6 percentage points. Its rates rose to 20.5% and 18.8% for 1981-1985 and 1986-1989, slightly exceeding Israel's by 0.2 and 1.9 percentage points. However, the average annual share of foreign capital in Kuwait's capital formation was a mere fraction of a percent, even turning negative due to net outflows: 0.02%, 0.02%, 0.01%, and -0.03% across the four periods.
By the year 2000, the combined inward FDI stock of the five GCC nations stood at $27.1 billion, with an outward FDI stock of $10.5 billion. In contrast, Israel alone had an inward FDI stock of $20.4 billion and an outward FDI stock of $9.1 billion.
By the end of 2024, the inward FDI stock of the five GCC countries had surged to $615.9 billion, with an outward FDI stock of $644.7 billion—several times larger than Israel's corresponding figures of $265.2 billion and $114.8 billion. Notably, the UAE alone surpassed Israel in both metrics, with an inward FDI stock of $270.6 billion and an outward FDI stock of $285.6 billion.
By the end of 2025, the inward FDI stock of the five nations had further grown to $707.4 billion, with an outward FDI stock of $800.4 billion. Israel's figures for the same year were $298.7 billion and $126.4 billion, respectively. The GCC quintet achieved this performance against a backdrop of persistently declining international oil prices since 2023 and the Middle East war ignited by the Hamas attack on Israel in 2023, making their success particularly noteworthy.
Simultaneously, the industrial composition of FDI projects in GCC countries has been continuously upgrading. The information technology investment projects attracted by places like the UAE and Qatar are especially significant for the Arab world's efforts to catch up with Israel's innovation and technology sector.
Spillover Benefits of Diversification Reach the Region
The mutually reinforcing activities of attracting investment, making outward investments, and re-export trade have collectively driven the industrial upgrading of GCC states. Although the Middle East is historically a crossroads, in today's global economic system, a significant portion of its international trade hub function is manifested in the re-export trade of GCC countries like the UAE and Qatar.
The industrial diversification and economic growth of GCC nations are providing increasing opportunities for the socio-economic development of other regional countries, spanning goods trade, investment, and worker remittances. For Iran, which has endured years of sanctions, the GCC states, especially the UAE, hold exceptional importance. The UAE serves as arguably Iran's most crucial external economic and trade "window," or at least one of the most important.
As the most developed and capital-abundant nations in the Middle East, the GCC countries embody the Arab world's hope for economic development and industrial upgrading to keep pace with global trends. The economic fortunes of the GCC and the smooth operation of their trade and investment have the most significant impact on other Middle Eastern nations.
Hormuz Turmoil Exposes Vulnerability of GCC Diversification
While the achievements of GCC industrial diversification and economic development are significant, they are also fragile, dependent on security and the free navigation of two critical straits: Hormuz and Bab el-Mandeb (linking the Red Sea to the Suez Canal). Their strategy requires maintaining friendly relations with both major powers, the US and China, to secure a favorable global environment for their central goal of industrial upgrading, and normalizing relations with Israel to improve the regional environment.
However, from the renewed Israeli-Palestinian conflict starting October 7, 2023, to the current Hormuz Strait turmoil triggered by the US-Iran conflict, the territorial security, freedom of navigation, and regional environment of the GCC states have been shaken and damaged. If the GCC nations were largely able to stay out of the direct line of fire during the 2023-2025 war, this year has seen attacks on a series of landmark commercial buildings in GCC countries, with Dubai's Burj Al Arab hotel forced to close for a year of repairs. Under such circumstances, can their industrial diversification and economic development processes continue? Can they maintain the momentum of attracting investment and surpassing Israel in both directions?
It is certain that such instability will severely dampen the motivation for external investment to continue flowing into GCC countries while simultaneously triggering capital outflows from them. If the regional security situation remains difficult to improve over the long term, the rational choice for GCC nations would be to significantly reduce investment in emerging industries within their own territories and instead increase investment in the emerging industries of industrialized nations like the US and China. This "bandwagon" approach would be an attempt to ride the wave of global industrial and technological upgrading.
Examining a broader context, the Arab world holds a relatively low position in the international economic system, and the development of new energy sources is increasingly reinforcing this trend toward marginalization.
An analysis of changes in international economic standing over the 45 years from 1980 to 2024, measured by nominal GDP in US dollars, reveals the following: The share of the 22 Arab League countries in world GDP fluctuated between 1.69% (1995) and 3.68% (2013), standing at 3.16% in 2024. The share of the 57 member states of the Organisation of Islamic Cooperation fluctuated between 4.89% (1994) and 9.27% (2013), with the share reaching 9% only in the years 2012-2014, and was 8.26% in 2024.
For the Middle East, this overarching trend originally heightened the urgency of achieving regional peace to concentrate resources on industrial upgrading. However, conflict and the "obstruction" of the Hormuz Strait shipping lanes are now eroding this very vision.
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