Gulf states are booming due to record oil prices, yet the region?s fastest rising economic star is Dubai, where oil reserves are actually dwindling. The United Arab Emirates (UAE), of which Dubai is part, has gone from being one the most oil-dependent Gulf economies in 1980 to one of the least dependent. People returning to Dubai after a few years? absence say they hardly recognize the place as towering office blocks, housing estates, shopping malls and business parks spring out of the desert.

Forty part-built apartment towers ? the world?s biggest single-phase housing project ? loom over Jumeirah beach, along which tribesmen would lead their camels until only two decades ago. Advertising campaigns revel in superlatives to draw the eyes of the world to Dubai: the world?s tallest tower, the biggest man-made islands, the richest horse race, the only underwater hotel, the only seven star hotel, a ski slope in the desert.

Even with record oil prices, the weight of the energy sector in the UAE has been falling. The Organization of Petroleum Exporting Countries (OPEC) member?s economy grew 7.4 percent in real terms last year but the oil and gas sector expanded by only 2.9 percent, according to government figures. Dubai?s capital market is surging as investors plough money into industries that hope to compete globally thanks to cheap labor and energy, low-tax free trade zones and an ideal location at the crossroads of Asia and Europe.

?They are expanding into areas where they have a competitive advantage,? said Zahed Chowdhury, Head of Research at the Hong Kong and Shanghai Banking Corporation (HSBC) in Dubai. Similar experiments are in progress the length of the Gulf. Abu Dhabi, which still has plentiful oil reserves, is trying to extract more value from its energy reserves by investing in petrochemicals and fertilizers. Poorer emirate Ras al-Khaimah is finding a niche in cement and pharmaceuticals, Bahrain in finance, Oman in tourism.

The change of tack came in the early 1990s, when weak oil prices exposed a worrying dependence on crude oil revenue and left some governments struggling to cope with the demands of a surging population. They decided that an expanded, competitive private sector was the only way to head off a longer-term employment crisis.

<B>Worrying dependence</B>

?In the previous oil boom there was a tendency on the part of governments to embark on very large infrastructure projects that turned out to be unproductive,? said Daniel Hanna, Middle East economist for Standard Chartered Bank. ?I think that?s clearly not happened this time.? He estimates that oil revenue generated in the Gulf will grow to $230 billion this year from $180 billion in 2004, but the amount of money invested in markets outside the region has remained almost the same.

The reason: the extra funds are being plowed into domestic economies through private investments or local capital markets. The combined value of the Gulf region?s stock markets has gone up 400 percent since 2001. The value of trades on the Dubai Financial Market rocketed to 204 billion UAE dirhams ($55.5 billion) between the start of 2005 and the end of last week from 51 billion dirhams in all of 2004. The market?s value has grown 87 percent in eight months.

But doubts persist over whether that flurry of investment will leave in its wake an economy that remains viable if oil exports go into decline. Some analysts say governments need to move quicker to beef up corporate disclosure and market transparency to give surging capital markets more solid foundations. ?f you fail to do that then the liquidity in the private sector that stood by you in the beginning will walk out the door at the drop of a hat,? said HSBC?s Chowdhury.

While Dubai?s role as the region?s dominant trading hub seems assured, its other niche as a haven for Western visitors depends on the liberal environment it offers in a region of conservative social values. Dubai aims to triple annual tourist numbers to 15 million by 2010, but that goal could prove impossible if the free-wheeling emirate falls victim to an attack from a radical Islamist group, as have Saudi Arabia and Kuwait. Tensions in the labor market are far from being resolved, with governments failing to integrate their citizens into the private sector because they lack skills or motivation.

In a report last week, the International Monetary Fund said increasing unemployment among UAE nationals is likely to pose a serious problem for the country and that more jobs are needed for the growing national labor force. The government has boosted training and offered incentives to encourage citizens to take up private sector jobs, but at the end of last year expatriates still accounted for 91.5 percent of total employment in the country.

Western observers say free markets across the Gulf cannot survive for long without political freedoms and urge more democracy and freedom of speech. Millions of manual workers from Asia do not set down roots in the Gulf because their hosts see them merely as a source of cheap labor and withhold the right to vote or even to move jobs without the approval of a sponsor. ?Things like labor law, like freedom of speech, these will become an increasingly relevant part of the overall mix that defines quality of life, property prices and which businesses want to move here,? said Chowdhury.

<B>Tom PFEIFFER</B>