The curse of an oil economy

October 01, 2003|By David Quayat

WASHINGTON - America is jeopardizing the long-term health and stability of Iraq and, what's worse, it doesn't even know it.

Ambassador L. Paul Bremer III and his staff have started the process of reconstruction, but underlying the U.S.-led coalition's economic planning is an economic model that will leave Iraq hopelessly dependent on oil.

In the short run, oil is by necessity the lifeblood of Iraq's economy. According to the Coalition Provisional Authority's recently released budget, more than 95 percent of Iraq's revenues in the second half of this year will come from the sale of oil. In the long run, however, oil is just as likely to be a curse. An undiversified economy combined with a fragile political system torn between rival ethnic groups is a natural breeding ground for would-be despots.

In order to understand what Iraq could end up looking like in 10 years or less, it is helpful to look at other oil-rich nations. Venezuela is an excellent example. Once a stable multiparty democracy, external shocks to its oil-based economy and corrupt use of government revenues created the climate that not only tolerated but encouraged the rise of Hugo Chavez, among the least democratic of Latin America's leaders.

Countries with far-less-established democratic institutions, such as Nigeria and Saudi Arabia, have long used oil revenues to maintain the status quo political system, often buying out the population with quick-fix development schemes using oil money. What's worse, the abundance of oil wealth has done little to improve the standard of living of average Nigerians or Saudis. In fact, oil-dependent economies generally develop at markedly slower rates than other countries.

Iraq does not need to end up like these oil-dependent countries. The CPA has the power and authority to help Iraq establish a system that will manage the dependency in a healthy manner. At a minimum, this involves ensuring transparency in public finances and establishing safeguard mechanisms to prevent fraud. The larger task, though, will be developing a system that can redistribute oil revenues for the benefit of all Iraqis.

The goal for the CPA is to prevent Iraq's vast oil revenues from falling under the control of an elite cadre of leaders who can then turn the country into a corrupt network of cronies. One option would be to continue depositing oil revenues in a trust account.

In Chad, for example, the World Bank requires the deposit of oil revenues in an independently administered trust, with the government receiving only 5 percent of the proceeds. Currently, the CPA and United Nations serve as the supervising authorities over Iraq's oil profits, and although not ideal, such a trust could be administered until an Iraqi government proves capable of effectively and fairly managing such resources for the good of all Iraqis.

Yet even if the CPA can establish effective mechanisms for safeguarding against political manipulation of the oil wealth, such dependency on a single export is still economically unwise. Such countries have contracted what economists have labeled the "Dutch disease." The term describes a condition in which a dominant export often shuts out the development of other export industries, leading to higher inflation and greater vulnerability to external price shocks. Given the volatility in oil prices, a fragile Iraqi regime confronted with severe shocks would face tremendous political and economic uncertainty.

With America's ballooning deficit and the reluctance of the international community to foot the bill in Iraq, tapping into Iraq's oil resources to fund the reconstruction efforts makes sense. In the near future, however, the CPA must help to structure the Iraqi economy in such a way as to promote the sound use of oil resources and develop alternative economic sectors, including manufacturing and agriculture. Economic diversification may not solve all of Iraq's problems, but foresight now about the perils of dependence on oil will help ensure that another Saddam Hussein does not rise to power again from the oilfields of Iraq.

David Quayat, a consultant, has a master's degree from the Johns Hopkins University School of Advanced International Studies.

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