The UAE's national labour force will almost triple by 2030, presenting an arduous challenge in a country where the public sector is the employer of choice for most Emiratis.
The Government already strains to employ its Emirati workforce, and the need to move nationals into the private sector is becoming more and more urgent.
While most policy options available have shown to be ineffective, well-crafted wage subsidies could be the key to rebalancing the labour market quickly with the least social and economic tension.
At the core of the challenge, the labour market is characterised by three parallel markets - Emiratis working in the public sector, those in the private sector and expatriate workers in the private sector.
Each boasts different wage standards and rules for employees with the same skills and capabilities.
A World Bank report showed that Emiratis in the public sector make the highest monthly wages, averaging Dh15,600 (US$4,247), while Emiratis in the private sector follow, averaging Dh10,450, and expatriate workers - who range from labourers to executives - form the lowest tier, averaging Dh4,500.
In a free economy, market forces would correct these distortions. But, like elsewhere in the region, regulatory barriers prevent the market finding its equilibrium.
Government wages are inflated, giving Emiratis a false benchmark even when they consider private-sector employment. And finally, several factors - most notably open labour immigration, lack of taxation for government services, rigid mobility rules and limited labour law enforcement capabilities - serve to artificially deflate expatriate wages. The World Bank estimates expatriates earn about 50 per cent less than they would in a functioning market.
Given these incentives, it is easy to see why few nationals seek private-sector jobs. Many would rather remain unemployed while waiting for an opening in the public sector. Also, since expatriate wages in the private sector are about 60 per cent lower than those given nationals, private-sector employers are reluctant to hire Emiratis. These distortions show clearly in employment data. In 2009, 93 per cent of the national workforce, or 250,000 Emiratis, were employed by federal or local governments. Of about 3.8 million private-sector jobs, only about 20,000 were held by Emiratis, mostly in the financial sector or in state-owned companies. The remainder were taken by expatriate workers.
But national data also reveals strains within the system. The average unemployment rate among nationals has risen from just under 9 per cent in 2000 to 14 per cent in 2009. Most troublesome, youth unemployment is already estimated at about 30 per cent, and by 2020, an additional 250,000 Emiratis are expected to join the 310,000 already in the workforce (270,000 with jobs and 40,000 without), bringing the total number of Emiratis needing jobs to 560,000.
In considering the options available to the UAE to bring its labour policy forward, immediate private wage subsidies brought in while more profound reforms take root offer clear advantages over the alternatives. While there is a slight chance such a programme could be abused, other policy measures available to the Government are critically flawed.
If the UAE continues on its current trajectory, with the Government trying to absorb these new workers into the public sector, the fiscal pressure would significantly increase. Expanding the government payroll by 200,000 to accommodate new workers would cost the UAE about Dh40 billion a year.
Government employment will be the most expensive form of subsidising work for nationals. Already the average cost of each government employee is about Dh150,000 higher per year than the value of the public services and goods produced.
Radical reformers might favour drastic measures to move nationals into the private sector and stave off massive unemployment.
Two policy interventions in particular are needed to remove structural barriers.
The first is to level the playing field for expatriate and national workers in the private sector, bringing salaries to levels that would attract Emiratis and eliminating hidden employer subsidies and other measures that deflate private-sector wages. The second would be to bring wages in the public sector to more realistic levels.
Both are sensible and necessary long-term programmes that should be launched quickly. Without some buffer, however, they would be likely to trigger significant social, economic and political waves. Almost every Emirate family would see its household income drop, while private companies would struggle to cope with increased costs and decreased competitiveness, especially those in labour-intensive industries such as construction, retail and tourism.
Another option would be to mandate a specific quota of Emiratis for private companies, by withholding work permits for foreign workers unless the quota is met.
Experience in the region shows that such heavy-handed measures bring negative consequences. They encourage companies to sidestep the rules, for instance by hiring unskilled "ghost workers", nationals on the payroll who do not contribute value, and other forms of corruption and fraud.
Forcing companies to take workers, who do not want to work for them, creates little incentive on both sides for performance and investment in capabilities.
In contrast to these options, wage subsidies in which the Government tops up private wages to create a more attractive package can effectively help to move Emiratis into the private sector with relatively little social or political disruption. To succeed, the programme needs to be crafted to avoid undue pressure on the government budget and must be enacted parallel to other labour reforms that correct fundamental market distortions.
Research by the World Bank and McKinsey & Company suggests subsidy levels of about Dh5,000 a month would effectively bridge the structural wage gap. Naturally, there may be variations by region and skill levels.
Such a programme could be financed through a levy on expatriate workers. While the programme would be costly, with the Government's portion increasing from Dh2bn to Dh6bn a year, it would be much less expensive than lifelong government employment. The subsidy would be slowly phased out as longer-term structural reforms take effect.
Wage subsidies protect household income levels and do not add costs to private employers, giving such an effort clear advantages over other options. Indeed, there should be a direct benefit to national incomes, since expatriate workers tend to remit about three quarters of their salaries to families in their home countries, while Emirati workers would spend or save most of their wages in the country.
The labour market would come more directly under market forces, putting hiring decisions in the hands of employers and creating more options for national employees. It would also encourage nationals to focus on career advancement and companies to provide training opportunities. Finally, the policy could be adjusted as needed to target specific worker groups, such as women or rural labourers, industries or professions.
Wage subsidies alone will not solve all the unemployment problems.
In some rural areas, for instance, unemployment is driven by lack of real opportunities, rather than structural imbalances. Without a smart immigration system, targeted training interventions and other active labour market measures, subsidies will be ineffective. However, experience shows that without bold, immediate financial incentives other measures will be equally ineffective.
The UAE must decide now how to cope with a national workforce that is growing rapidly. After reviewing the plausible policy options on the table to move Emiratis into the private sector, wage subsidies accompanied by structural reform offer the greatest immediate benefits with the least risk to economic, political and social stability.
Jorg Schubert is a partner at McKinsey & Company's Middle East office and leads the public-sector practice in the region