Last year the Middle Eastern country of Bahrain, a small island off the coast of Saudi Arabia, asked Wharton management professor Peter Cappelli for advice on how to reform its labor markets.

For Cappelli, director of Wharton’s Center for Human Resources, it was hardly your typical consulting job. “They are in the process of creating institutions from scratch,” says Cappelli, who met the Bahrainis through the U.S. State Department and has written a report suggesting ways for them to modernize everything from the treatment of expatriate workers to higher education. “They are asking questions like, ‘Should we have unemployment insurance and government-sponsored worker training? Should we have a welfare system?'”

Cappelli’s task isn’t quite as daunting as it sounds. Bahrain is a small country, only four times the size of Washington, D.C. Its population of about 675,000 is less than that of Indianapolis or Baltimore. But Bahrain plays a big role for the United States in the Persian Gulf because of its political stability and pro-Western policies. Home to the U.S. Navy’s Fifth Fleet, it is literally an island of calm in a region wracked by strife.

Bahrain’s king, Shaikh Hamad bin Isa Al Khalifa, has steered his country toward reform since becoming ruler in 1999. In a 2001 referendum, the first in which women voted, Bahrainis chose to shift from a traditional monarchy to a constitutional one. In 2002, the country held its first parliamentary election in nearly 30 years.

Because of its open, tolerant government, Bahrain has been spared much of the civil unrest and fundamentalist upheaval experienced by a number of other Muslim countries. “But if unemployment continues to increase, you could easily imagine that Bahrain, too, could have problems,” Cappelli says.

King Hamad is attempting to diversify the country’s economy, which, like many in the Middle East, has long depended on oil. Bahrain was one of the first Middle Eastern countries to suck black gold from its sands, but because of a limited supply, it may also be the first to run out. Some predictions say its wells will run dry in as little as a decade. As Cappelli notes, “They can’t float the economy on oil anymore.”

Bahrain invested its oil wealth prudently. It developed one of the Middle East’s better educational systems, thereby helping to create a white-collar workforce that enabled it to become a Middle Eastern banking center. In some ways, banking represents a return to the country’s past. During the Bronze Age, the archipelago was the home of the Dilmun trading empire, thanks to its location along the trade routes linking Mesopotamia and the Indus Valley. It was then a lush oasis in an increasingly arid region. A few scholars have suggested that ancient Bahrain might have been the model for the biblical Garden of Eden.

Those days are long gone. Today, Bahrain is mainly desert, with its population clustered along the coasts. Like many developing countries, it is experiencing a surplus of unskilled workers. The population is undergoing a big growth spurt, “and the economy can’t absorb all the new workers,” Cappelli explains. The result is high unemployment; Cappelli guesses about 10% although some estimates run as high as 15%.

Bahrain’s joblessness has been exacerbated by a large number of expatriate workers, typically from Pakistan and Bangladesh. The country has no minimum wage and, by law, these workers cannot change jobs; in effect, they are tied to their low-wage positions. But their opportunities in Bahrain are better than those at home, so they remain, and continue to displace Bahrainis.

The king’s son, Crown Prince Shaikh Salman bin Hamad bin Isa Al-Khalifa, has taken the lead on tackling unemployment and labor-market reform. Cappelli describes Prince Salman, who attended college in Washington, D.C., and graduate school in England, as very western. “In terms of language ability, he could pass for an American. He’s very familiar with western arguments, with the business and political literature. He’s an astute policy thinker.” His offices are more like a senator’s suite than a palace, he adds.

During a weeklong visit to Bahrain last year, Cappelli particularly noticed the gulf between the working conditions of white-collar and blue-collar workers. “If you go through an office, it looks like an office anywhere in the U.S. or Europe,” he says. “But if you go to where their expatriate workers are, it looks like the Third World. You see hand tools, not machinery. The country has this endless supply of cheap labor, so it doesn’t have to invest in capital equipment. It’s a really bifurcated economy.”

Because Bahrain hasn’t invested in high-tech machinery, its workers, and therefore its economy, are less productive than they could be. “In Scandinavia and in most of the rest of the world, as overall economies grew wealthier, the wages for unskilled jobs also grew and the conditions of these jobs improved,” Cappelli notes in his report. “Higher labor costs created incentives for employers to invest in productivity improvements … In Bahrain and the oil countries, in contrast, even as the overall economy grew and average prosperity rose, the steady supply of low-wage workers meant that wages for these low-end jobs stagnated, working conditions did not improve, and labor productivity lagged behind the rest of the world.” 

A big supply of cheap, docile workers creates other problems, too. Bahrainis haven’t developed the sort of management expertise that exists in the United States and Europe. When employees have no choice but to leave the country, their bosses have little incentive to study labor relations, employee compensation or even leadership. “Workers who are desperate for work and who are being paid well above their opportunities elsewhere will put up with a great deal in terms of abuse,” Cappelli writes. 

Expatriates: A Question of Mobility
An obvious solution to Bahrain’s unemployment problem would be to boot the expatriates. But the country can’t do that because it now depends on their low wages. “The price of everything from car washes to home construction is lower as a result [of their presence],” Cappelli notes. “If one compares a country like Brazil, with its huge supply of unskilled labor, to a country like Sweden with relatively little, one finds that the standard of living for the middle class and above is considerably higher in Brazil: Even lower-level managers can afford to have a maid, a cook and a gardener.”

What Cappelli, therefore, proposed for Bahrain was a simple policy change with profound economic consequences: Let expatriate workers switch jobs. That should bring into balance the wages and employability of the guest workers and low-skill Bahrainis. If foreigners are allowed to change jobs, their wages probably would rise. Because they would no longer be handcuffed to their employers, they would not be seen as preferable to Bahrainis. “Expatriates might well be preferred on other dimensions, such as their greater motivation given more limited opportunities in their native lands, but the artificial advantages of a legally constrained relationship would be eliminated,” Cappelli notes.

Of course, a big policy change such as this might cause an uproar. Employee turnover could spike, and employers could find themselves shelling out higher wages to keep workers. “Employers will complain bitterly and blame the government,” Cappelli predicts. But they would have a tough time making their complaints stick. After all, employers who treat and pay their employees decently don’t tend to lose people. Meanwhile, even with this change, government officials must figure out a way to limit the number of foreign workers coming to Bahrain. “They have to stop the flow of expatriate workers,” Cappelli says. “They have to cut that off quickly.”

In the past, the government has reviewed applications from employers who wanted to hire expatriates, making sure that qualified Bahraini workers were not available. The government could continue to do that, but should change its screening criteria, Cappelli suggests. Instead of looking at just the supply of Bahraini workers, the government should look at all workers, including free-agent foreigners. If the country already had enough carpenters or pipe fitters, of whichever nationality, the government should stop admitting more.

These adjustments would address Bahrain’s domestic employment dilemma, but they won’t tackle its equally critical international competitiveness problem. Simply put, Bahrain is too small to go it alone. For the economy to grow strongly, companies have to become players in international markets, and to do that, they require skilled workers. Bahrain needs to become the Singapore of the Persian Gulf – a small country with big ambitions and well-educated workers, Cappelli argues. “Singapore has made a huge investment in infrastructure. It has government rules and procedures that are fair, not corrupt, and a very professional civil service.”

An effective public sector is key because improvement of workers’ skills is a task that the government, educators and employers must pursue cooperatively, Cappelli stresses. The sorts of training programs this cooperation produces vary from country to country. What’s important is starting the process. “At least in other countries, efforts to reform education have been reasonably popular politically, and there is little risk from advocating and advancing reform efforts.”

At minimum, the government needs to stoke this cooperation by collecting and providing information on labor markets. Ideally, it would release data about opportunities, such as which sectors are growing and hiring. It would also offer data on training programs and potential employees, including who has received credentials or certifications.

Bahrain might also consider developing a community-college system along the lines of the U.S. model, Cappelli says. These schools are supported by local governments and have strong ties to local employers. “North Carolina, for example, uses the community college system to subsidize employers and attract new ones into the state by providing occupational training for the employer’s workforce.”

To the same end, Bahrain should think about expanding the Crown Prince’s Scholarship Program so that it follows Singapore’s model. There, recipients of scholarships to study at foreign universities are required to return home and work for a few years for the government. “This program essentially ‘pays’ for the scholarships, allowing them to be expanded, and also helps inject new thinking and very able workers into the government.”

Few things are more fundamental to a person’s welfare than a decent job. As Cappelli points out in his report, nearly every country in the world is struggling to find jobs for at least some segment of its population. But the stakes in Bahrain are even bigger than usual.

The importance of this project, Cappelli says, relates to “questions that I can’t easily answer about the politics of the Middle East,” he says. “And it’s all getting more difficult in the context of war in Iraq.” As for his own role in helping the country of Bahrain improve its economy, Cappelli notes that, while it is indeed “a little nerve-wracking to think about the potential implications of advice, it helps to remember how much trouble the country is likely to get into if it doesn’t engage in reform. And my advice is filtered through so many different processes that the illusion of influence is probably greater than the reality.”