Inputs for Policy Design: Tools of Economic Diversification in the UAE

Abstract

This report examines how the United Arab Emirates can leverage three key policy tools to accelerate economic diversification and transition to a knowledge-based economy: Foreign Direct Investment (FDI), Free Zones, and Sovereign Wealth Funds (SWFs). While the UAE has successfully attracted substantial FDI inflows and diversified its export basket over the past two decades, the country continues to underperform in economic complexity and faces challenges attracting knowledge-intensive investments, particularly in research and development activities. The analysis reveals that Free Zones have evolved beyond regulatory arbitrage advantages to become mechanisms for public-private coordination and specialized public goods provision, though their contribution to broader knowledge spillovers remains limited by restrictions on mainland business interactions. Similarly, while the UAE’s SWFs have increasingly pursued domestic diversification objectives through strategic acquisitions and partnerships, their impact could be improved by better aligning foreign investments with domestic capabilities and leveraging multiple channels for knowledge transfer beyond firm relocation. The report recommends a quality-oriented approach to FDI attraction focusing on innovation and R&D activities, adaptive Free Zone management that responds to evolving firm needs, and strategic SWF investments guided by economic complexity metrics, emphasizing that successful diversification requires intensive public-private and public-public coordination across all three tools to provide the necessary inputs for new, complex activities to appear in the UAE’s economic and industrial landscape.

Growth Lab Working Paper Series No.

257