Part 1 of this seven-part series is here; part 2 here.

A key feature of the Middle East's current disorder is the rivalry between Iran and Saudi Arabia. This has a long history, but in the last decade has once again become sharper and more overt.

Unsurprisingly, the geopolitical aspects of this rivalry capture a lot of attention. It is reflected in Saudi concern over the nuclear deal with Iran. It plays out most obviously in Syria, where Saudi Arabia has supported the opposition against the Iranian-backed regime of Bashar al-Assad. It also drove the decision by Saudi Arabia to send troops into Bahrain in 2011 and into Yemen in 2015, in both cases out a fear that Iran was meddling on its borders.

But there is another, and in many ways more significant, aspect to this rivalry: the race between Saudi Arabia and Iran to transform their economies. It is this race, rather than the proxy wars currently being fought by Riyadh and Tehran, that will ultimately determine which of these two countries will win the battle for influence in the region. 

The question of economic reform has become central this year for particular reasons. It is this year that sanctions have started to come off Iran as a result of the nuclear deal. Against that background, the Rouhani Government will be trying to make Iran attractive to foreign investment, carrying out significant economic reforms while managing popular expectation about how quickly Iran's living standards will improve.

In the case of Saudi Arabia, after a year of collapsing oil prices, and despite budget cuts and price rises, the need for far-reaching reform has become clear. At the start of the year the King's son, Prince Muhammad bin Salman, floated the radical idea of privatising the state-owned oil company, Aramco. Riyadh, like Tehran, will also have to mange popular expectations, but in its case it will be about how fast living standards might fall.

For both Saudi Arabia and Iran there is a lot at stake. The strength of their respective economies goes directly to the ability of each state to fight their proxy wars with the other in the region, from Yemen to Syria. Their economic strength matters in terms of their ability to prop up regional allies such as the el-Sisi regime in Egypt for Saudi Arabia and the Assad regime in Syria for Iran.

Economic strength obviously impacts domestic stability, which is important in and of itself; but this in turn affects Riyadh and Tehran's ability to compete for influence in the region. Look at the way Egypt's internal turmoil has seen it virtually disappear as a regional actor in the last five years.

Reform or perish, or reform and perish?

There is also something of a bind here for both countries. On the one hand they need to strengthen their economies to underpin both domestic stability and their regional influence. On the other hand these reforms, especially in a period of low oil prices, could well have unintended political consequences.

Despite having quite different economies, Saudi Arabia and Iran share a common problem. They both have large youth populations, which means they need to create lots of new jobs to ensure political and social stability. According to one estimate Saudi Arabia will need to create at least 4.5 million new jobs by 2030 to keep pace with entries into the labour market. On current trends, and even with significant substitution of Saudi workers for low-paid foreign workers, Saudi Arabia would come up about 1.5 million jobs short, potentially pushing unemployment to 20%. In the case of Iran, some 600,000 Iranians enter the workforce every year and on current trends, even with accelerated growth as a result of the end of sanctions, the official level of unemployment is estimated to rise to 14%. The real unemployment figure in Iran tends to be much higher. 

What makes this an acutely political problem is the outsized role the state plays in each economy. In Iran the private sector is about 20% of the economy; in Saudi Arabia the state still provides jobs for about two-thirds of the population. 

Governments in both countries have long acknowledged that the state cannot meet the growing demand for jobs and that this can only be done by the private sector. But both have only undertaken limited rounds of privatisation. Often this has meant selling state-owned enterprises to institutions or individuals close to the regime, effectively turning them into semi-state owned enterprises. There has also been lots of talk about increasing the size of the private sector, but little has been achieved, especially during the last decade of booming oil prices.

If oil prices now stay low for an extended period both countries will need to get serious about privatisation. But reducing the role of the state in the economy changes the nature of the social contract in each country. This applies not just to the state's role as job provider but also as a provider of free or heavily subsidised services. Under these circumstances, Saudis and Iranians will be asking: if the state no longer provides me with jobs and healthcare then why should it receive my unconditional loyalty?

Economic reform also challenges the social contract in other ways. Putting young Saudis to work, for example, doesn't just mean creating a bigger private sector to employ them, it also means giving them the skills to make them employable. But reform of the education sector, or indeed the greater introduction of females into the workforce, touches on sensitive areas in the royal family's ruling bargain with the conservative Saudi religious establishment.

The state's predominant role in the national economy is also tied to the interests of key groups and individuals in the ruling regimes. Some members of the Saudi ruling family are key economic players. In Iran the Revolutionary Guard has become a major economic actor, especially as previous rounds of Western sanctions on Iran cleared the field of foreign competitors. If new, non-regime private sector economic players emergeas a result of a process of reform, it seems likely they will eventually seek a greater role in how these states are governed.

None of this is to suggest that the process of economic reform will inevitably bring down the Saudi or the Iranian regimes. A lot will come down to how well the leaderships of both countries manage the process of economic change. There are also a number of potential wild cards, not least of which is some unexpected spike in the price of oil that allows either country to put off tricky reforms. Nevertheless, even if the process of economic change does not ultimately change these regimes, at the very least it will probably shift the way they rule.

In this regard the most consequential competition in the Middle East today is not between Iran and Saudi Arabia's battlefield proxies in Yemen and Syria, it is between their respective economic planners in Tehran and Riyadh.

Photo courtesy of Flickr user Adam Adamus.