Petrol peril

Why Iraq's oil wealth may do more harm than good

By Daphne Eviatar, 4/13/03

JUAN PABLO PEREZ ALFONSO, the Venezuelan oil minister and cofounder of OPEC, was onto something. Years ago, even as the price of oil skyrocketed and his country swam in its viscous wealth, he didn't fall for the idea that this was ''black gold.'' ''The devil's excrement,'' he called it. ''We are drowning in the devil's excrement.''

That's not how most people see it today. Watching Iraqis celebrate the end of Saddam Hussein's regime in the devastated streets of Baghdad, many observers may take comfort in the thought that, in the long run, Iraqis will have the resources to rebuild and even prosper. After all, they have all that oil. Last week, White House spokesman Ari Fleischer said, ''Iraq will have a huge financial base from within upon which to draw. And that's because of their oil wealth.''

But having the world's second largest oil reserves doesn't necessarily improve Iraq's long-term prospects. On the contrary, the growing consensus among academics is that oil-rich developing countries are worse off than resource-poor ones. If oil exports account for a significant portion of their economies, studies show, they're likely to develop slowly, repress their people, and suffer from frequent conflict. As economists Jeffrey Sachs and Andrew Warner ask in a well-regarded 1995 study of resource-rich developing countries, ''Is there a curse to easy riches?''

The puzzle of the so-called ''resource curse,'' as Sachs and Warner recognized, dates back centuries. In the 1600s, imperial Spain went into decline despite its gold-rich colonies. In the 19th and 20th centuries, resource-poor Switzerland and Japan sped ahead of oil-rich states like Russia. And the so-called Asian Miracle provides the perfect counter-example today: The barren lands of Korea, Taiwan, and Hong Kong are models of modern development, while Angola, Nigeria, and Congo, soaked in oil, are among the poorest and most conflict-ridden in the world.


Black gold, or resource curse?

Top oil producers, as a percentage of world total
Saudi Arabia 11.8
United States 9.9
Russia 9.7
Iran 5.2
Mexico 5.0
Venezuela 4.8
China 4.6
Norway 4.5
Rest of the world 44.5

Source: International Energy Agency, 2001

Oil exports, as a percentage of total merchandise exports

Nigeria 99.6
Algeria 97.2
Saudi Arabia 92.1
Iran 88.5
Venezuela 86.1
Norway 63.9
Russia 51.0
Mexico 9.7
United States 1.9

Source: World Bank, 2000

Oil has shaped world history since at least the late 19th century. Although Alexander the Great supposedly burned it to frighten his enemies' war elephants, petroleum wasn't routinely employed as an energy source until the mid-1800s, when it was put to use in the kerosene lamp. With the advent of the gasoline-powered internal combustion engine, it went on to fuel the industrial explosion of the 20th century. As Daniel Yergin writes in ''The Prize: The Epic Quest for Oil, Money and Power'' (1992), oil powered the first world war and was critical to the course of the second: The Japanese went after petroleum in the East Indies, while Hitler invaded the Soviet Union in large part to capture the oil fields of the Caucasus. Besides making the suburbs possible, oil-an essential component in chemicals, fertilizers, and plastics-has driven the enormous material progress of the industrialized world. So why, in so many places, has the path of development so often sloped downward?

Historically, the poor fortune of resource-rich countries was attributed to sloth. As the 16th-century French political philosopher Jean Bodin put it: ''Men of a fat and fertile soil are most commonly effeminate and cowards; whereas contrariwise a barren country makes men temperate by necessity, and by consequence careful, vigilant and industrious.''

Academics today offer more complicated explanations. But the gist is that if oil is discovered in a poor country, it's a bit like winning the lottery: just as the laborer might abandon his job, the government makes so much money exporting petroleum that it doesn't develop other industries. Governments then use the windfall to shelter their citizens from the painful process of competition, subsidizing inefficient businesses and expanding government payrolls.

Furthermore, an oil boom compounds the normal difficulties of industrial development because it inflates the local currency, ultimately making it cheaper to import goods than to produce them at home. This chain of events is known among economists as ''Dutch disease,'' a reference to the decline of Dutch industry after the discovery of massive natural gas reserves in the 1960s. A country can sustain itself on easy money for a while, as many did in the 1970s, but skyrocketing prices inevitably drop, as they did in the `80s. And economies collapse. Oil-rich Algeria, for example, booming three decades ago, suffers from 30 percent unemployment today. Saudi Arabia and Venezuela have experienced similar slides.

Although economies based on other re-

sources-say, diamonds or copper-face comparable problems, the trend is most pronounced for oil producers. Stanford political scientist Terry Lynn Karl, in ''The Paradox of Plenty: Oil Booms and Petro-States'' (1997), explains that oil tends to make up a far larger share of a country's exports than other minerals. In Venezuela, for example, oil provides more than 80 percent of export revenue; in Nigeria, it's more than 95 percent. And the oil industry requires even bigger capital investments than the mining industry, while often employing only 1 to 2 percent of the work force. Foreign oil companies, who can afford the investments, control the industry in many countries, and whisk much of the profit abroad. Meanwhile, the money that stays home goes straight to the central government-and often into the pockets of corrupt leaders.

That, in turn, contributes to another common feature of oil-producing states: They tend to be authoritarian, and exceptions to the general rule that higher-income countries are more likely to be democracies. Michael Ross, the UCLA political-science professor who reported this finding in an article in the journal World Politics in 2001, notes several possible reasons. First, an oil-rich government can provide vast social services without taxing the public. ''Because there's no taxation, there's less demand for representation,'' says Ross. These governments also tend to buy off the opposition and amass large internal security forces capable of crushing dissent. Finally, the skewed development of oil-dependent states means they lack the working- and middle-class citizens who have historically been the force pushing for democracy.

Compounding the problem, the slow growth and poverty associated with oil dependence also tends to fuel civil strife, Ross and others have found. This is most obvious in Africa, where the oil-producing states are among the poorest. In Nigeria, oil revenues are at the heart of ongoing civil unrest and widespread government corruption, despite the transition to civilian government in 1999. And in Angola, oil profits (along with the illicit diamond trade) fueled a 27-year civil war that only ended last year after the death of the insurgents' leader.

''Where oil is the main source of wealth, you're inevitably going to have a polarized society,'' warns Michael Klare, director of the Five College Program in Peace and World Security Studies at Hampshire College and author of ''Resource Wars: The New Landscape of Global Conflict'' (2001). ''It could be along class lines, ethnic lines, or regional lines, but whoever controls the state usually also controls oil income, and it's inevitably corrupting.''

Of course, an oil-rich country is not necessarily destined for doom. Consider, for example, the case of Norway. The world's third-largest exporter of oil, Norway has a steady growth rate, almost no poverty, and negligible unemployment. But then, it was already that way when it struck oil in the North Sea in the 1960s. Norway had a diverse economy based on agriculture, forestry, fishing and manufacturing, among other things, and its oil industry has developed amid much planning, bargaining, and public debate. Norway has created an economy that retained its progressive tax structure, re-invested its oil profits throughout the economy, and saved money to cushion future market shocks.

Unfortunately, Iraq couldn't be more different from Norway. During the 1970s oil boom the government created a vast welfare state and invested heavily in industry, infrastructure, and education, but it also poured billions into its military and security forces. Ever since the Iran-Iraq war of the 1980s, the country's infrastructure has been deteriorating, and studies estimate that it would require $40-$60 billion just to restore Iraq's oil facilities to good working order.

Once the tap is turned back on, how should a democratic Iraq manage its oil? After all, the business operates very differently around the world. In the weakest states, many of which are in Africa and Central Asia, and which lack the resources to conduct their own oil exploration, private multinational oil companies run the show. Their favorable contracts with the government, known as production-sharing agreements, give them ownership of the oil in particular fields and control the rules governing exploration and extraction. They are usually exempt from regulations and domestic taxes, instead paying a fixed fee to the government.

But better-off countries won't cede that kind of control. Many countries in Latin America and the Middle East nationalized their oil industries in the 1970s and have been reluctant to invite the multinationals back in. Venezuela, for example, didn't re-open its industry to foreign investments until the mid-1990s. Mexico allows only limited foreign investment, and the major oil-producing states of the Middle East-Saudi Arabia and Kuwait, for instance-have virtually slammed the door. Unfortunately, academic studies so far have not considered the long-term economic or political effects of these different arrangements. Michael Ross says the World Bank has repeatedly refused to fund his proposed studies on the subject.

Whatever roles the United States and the United Nations play in the reconstruction of Iraq, there's no question that foreign investment will be allowed. Once a new Iraq government takes power, there are some steps it could take to improve the likelihood that oil will help rather than hinder democracy and development.

First, it can make sure all contracts between a new Iraqi authority and private oil companies be made public, including all oil company payments to the government. That would go a long way toward reducing government corruption and encouraging public participation in decisions on how to spend oil revenues. The government could also create an independently monitored oil fund that collects oil profits and invests them in the creation of national infrastructure and broad-based economic development. It could also establish a trust fund, modeled on Norway's, that invests some of its oil income abroad to provide for the country during the inevitable market downturns.

Experts stress that there's nothing inevitable about the ''resource curse.'' Graham Davis, an economics professor at the Colorado School of Mines, who's been debating the theory for years, insists that ''there's no pattern we can rely upon to say a country that has oil therefore will not be democratic or will not develop adequately,'' he says. ''It's a trend. It's not a rule. One has to look at the kind of legal and economic institutions that are set up to serve the country. If they're bad ones-with lack of transparency, lack of judicial oversight-then the oil tends to be put to bad use.''

President Bush is optimistic. ''The nation of Iraq, with its proud heritage, abundant resources, and skilled and educated people, is fully capable of moving toward democracy and living in freedom,'' he said in February. That's certainly what most observers are hoping for. But for a new Iraqi government, it will be no small task. Iraq will need to defy the weight of not only its own history, but that of every other oil-producing nation in the developing world.

Daphne Eviatar is a Brooklyn-based writer and contributing editor at The American Lawyer

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