The announcement that Halliburton, the Houston, Tex.-based oil services company, was moving its headquarters to Dubai may have surprised many Americans. But for people in Dubai, it simply ratified decades of hard work.

With scant oil reserves, Dubai’s ruling family, the Maktoums, long ago realized that their state’s future lay in serving as the commercial hub of the Arab Middle East, not pulling petroleum from the desert sands. “They have had to live on their wits,” says Bulent Gultekin, a Wharton finance professor. “So they’ve tried to build Dubai into the business platform for the region.”

To that end, the Maktoums, led by the billionaire known today as “Dubai’s CEO,” Sheikh Mohammed bin Rashid Al Maktoum, have invested heavily in the infrastructure of a modern economy. They have built a first-class port, airport and airline; created lightly regulated enterprise zones to foster the development of new industries and attract foreign firms; and spent lavishly on amenities ranging from the white, sail-shaped Burj al Arab, the world’s tallest hotel, to an indoor ski slope chilled to about 30 degrees Fahrenheit.

“Sheikh Mohammed has been a real visionary,” says Todd Millay, executive director of the Wharton Global Family Alliance. “The biggest decision he has made is to create a very free economy. It’s true laissez faire without many of the regulations we have in the U.S.” Indeed, in some sectors, the country might benefit from a few more rules, Millay notes. “You see construction workers working outside in the summer when it’s 120 degrees.”

Sheikh Mohammed’s let-it-be attitude extends to the social norms that have caused so much angst in places like Saudi Arabia and Iran. Though Dubai’s native population is overwhelmingly Muslim, expatriates and visitors can buy alcoholic beverages in restaurants and bars, and western women don’t have to wear headscarves or veils. Sheikh Mo, as he’s known, is an avid breeder and racer of horses and knocks around in jeans and a T-shirt when he visits his thoroughbred farm in Kentucky.

The mix of infrastructure, economic freedom and tolerance is paying off as multinationals, including General Electric and AT&T, are increasingly selecting Dubai, which is about the size of Rhode Island, as their Middle Eastern base. Others, including Microsoft and Intel, have located sizeable offices there. The emirate also has been boosted by high oil prices, which are pumping tens of billions of dollars into the Persian Gulf area, and from political tensions and safety concerns in some nearby nations. Long peaceful, Dubai welcomes foreigners, and expatriates comprise about 80% of its population of 1.3 million.

“Everybody in the region has an interest in Dubai being a business hub,” says Mauro Guillen, Wharton management professor and newly appointed director of the Lauder Institute for Management and International Studies. “You need a safe place where you can do business. The elites in all of these countries want a haven where they can put their money and meet.” Adds Millay: “There’s no other natural ‘capital’ in the area like a New York, a Tokyo or a London.”

Port Controversy

Dubai, which is one of the seven United Arab Emirates, has served as a commercial crossroads in the Middle East for centuries. Originally, local pearl divers and date farmers traded there with merchant seamen from farther east, who came bearing silk and spices. “It’s long had commercial links with India and Iran,” says David Butter, Middle East business editor for the Economist Intelligence Unit, an affiliate of the Economist magazine. It was a British protectorate during much of the 20th century, gaining its independence in 1971.

In the 1970s, Sheikh Mohammed’s father realized that, to continue to play a central role in the region’s trade, his emirate needed a modern container port. He borrowed heavily to build it, and his bet paid off. Dubai’s port ranks as the world’s 9th busiest in container volume, and its manager, DP World, is considered a leading operator, overseeing facilities around the globe. Last year, DP World found itself mired in controversy when it bought a British company with operations at several U.S. ports, including New York and Philadelphia. Members of the U.S. Congress objected to Middle Eastern ownership, citing security concerns, and DP World, although it had the Bush Administration’s support, decided to sell the U.S. operations.

Oil was discovered in Dubai a few years before independence from Great Britain, and it led to a wealth surge there, as it did throughout much of the region. But Dubai long ago weaned itself off a dependence on petroleum, Butter says. Today, only about 5% of the emirate’s GDP comes from oil, and the reserves are expected to disappear by 2010. Even so, Dubai benefits handsomely from the economic activity that the rest of the region’s oil riches generate. Many energy company employees operate out of Dubai — often their families will remain there while they work elsewhere — and wealthy people from other Persian Gulf countries spend and invest their money there.

Those investments have fostered the real boom in today’s Dubai: real estate. “As you come from the airport, you see hundreds of high cranes and high rises,” Gultekin says. “It’s mind boggling. Twenty years ago, there were three or four high rises. Now it’s like Manhattan.”

Dubai has made the construction of superlatives a central part of its marketing strategy. At the moment, the world’s tallest building, Burj Dubai, is rising beside the world’s biggest mall. “They don’t want to disclose how tall it will be,” Guillen says. “I’ve heard that they have come up with a design that they can add to” if another building surpasses it. Another hotel, even larger than the Burj al Arab, is being planned as part of a new resort complex that will encompass 31 hotels with more than 29,000 rooms.

Just off Dubai’s coast, the world’s biggest manmade islands, shaped like giant palm trees, have been dredged out of the Persian Gulf sand. “Thousands of people are working there simultaneously to build houses,” Gultekin says. “The entire city is like a giant construction site.” Soon 300 more islands, shaped and arrayed like continents and islands on a map of the world, will join them.

According to the Yearbook of the United Arab Emirates, “Between 2000 and 2005, the number of residential buildings in Dubai increased by more than 42%, to 79,000 buildings, from 56,000. This compares with a modest growth in residential buildings of 6.7% in the previous five years.”

Beware the Bubble

There is, of course, a method to the madness. Dubai isn’t a place like San Francisco, Sydney or Vancouver, with a striking natural setting. And its beaches quickly give way to desert and the sort of climate that only camels find comfortable. Summertime highs routinely top 100 degrees Fahrenheit. “If the air conditioning broke down, it could quickly become an unpleasant place,” says Butter. “But it’s been fairly well planned. Everything is created to make life as comfortable as possible.”

Behind the opulent buildings stands the country’s equally important, if more mundane, bureaucratic infrastructure, including its ballyhooed free trade zones. The zones try to remove the usual barriers that discourage multinationals from setting up operations in a developing country like Dubai. Within the International Financial Centre, which includes a fledgling stock exchange, foreign firms can own 100% of their operations — Dubai restricts ownership outside of the free zones — and pay no tax on income or profits. Similarly relaxed rules apply in Dubai’s Internet and media zones. A new “studio city” is targeting the film industry.

Dubai also has created a special judiciary to resolve disputes involving financial firms. “They brought in British common law,” Gultekin says. “They even brought in a British judge to oversee it.”

Growth on this scale brings a host of challenges and worries. Perhaps the foremost is the real estate boom, which has the makings of a bubble — if it hasn’t already become one. “There’s a huge amount of new capacity coming online, and it’s unclear what the implications of that will be,” says Millay. “I was at a conference in Doha [in Qatar], and some American real estate guys were saying, ‘Who’s going to live in these new buildings?'”

Guillen agrees: “The biggest danger is that real estate is going wild. People are always surprised that it takes so long for a bubble to burst. But when it does burst, the fall is really big.” Another challenge is traffic, which like the construction, has reached Manhattan-like proportions. “It’s totally out of control,” Guillen notes.

A big drop in oil prices also could hurt the country since it would curtail spending by citizens and companies from other Persian Gulf states as well as by western firms that do business with them. But Butter says that Dubai has diversified its economy enough that it should continue to thrive. “We’ve had such a long period of high oil prices that the economic development throughout the region really has its own momentum, which can keep going for some time,” he notes. “Plus, a lot of the development is related to the fact that the Persian Gulf is where much of the remaining oil and gas reserves are located. These are the projects that are going to meet the incremental demand in the world oil market.”