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from the October 2012 issue

The Beginning and End of the Oil Curse?

Why does oil wealth so often become a curse for developing states?  In the developing world, oil-producing states are fifty percent more likely to be ruled by autocrats, and more than twice as likely to have civil wars, as non-oil states. They are also more secretive, more financially volatile, and provide women with fewer economic and political opportunities.  For the last thirty years, good geology has led to bad politics.

Not all states with oil are susceptible to the curse: countries like Norway, Canada, and Great Britain, which have high incomes, diversified economies, and strong democratic institutions, have extracted lots of oil and had few ill effects.  Petroleum wealth is overwhelmingly a problem for low- and middle-income countries, not rich ones.

Even in the developing world, geology is not destiny.  Nigeria and Mexico have made transitions to democracy; Mexico and Angola have drawn large numbers of women into the economy and government; Ecuador and Kazakhstan have avoided civil wars; and Oman and Malaysia have had fast, steady, and equitable economic growth.  The better we understand why oil can be a curse, the more we can offer appropriate remedies.

Where Does It Come From?

Most of the political and economic problems of the oil states can be traced to the unusual properties of petroleum revenues, which have four distinctive qualities: their scale, their source, their stability, and their secrecy.

Their scale can be massive.  After Azerbaijan began to ramp up oil and gas production in the early 2000s, government expenditures rose by 600 percent over just eight years.  After Equatorial Guinea began to exploit its oil in 2001, government spending rose by 800 percent over the next eight years.  The sheer volume of these revenues makes it easier for undemocratic governments to silence dissent.  It is also an important reason why so many oil-producing countries have violent insurrections: people who live in a country’s oil-rich regions often want a larger share of the immense revenues collected by the central government.

Yet the size of these revenues alone cannot account for the oil curse: many peaceful, democratic European countries collect more government revenues than many conflict-ridden, autocratic oil producers.  The source of these revenues also matters: oil-funded governments are not financed by taxes on their citizens, but by the sale of state-owned assets – that is, their country’s petroleum wealth.  This helps explain why so many oil-producing countries are undemocratic: when governments are funded through taxes, they become more constrained by their citizens; when funded by oil, they become less susceptible to public pressure.

Other problems can be traced to the stability—or rather, the instability—of oil revenues, which is hard for governments to manage, and helps explain why they frequently squander their resource wealth.  Revenue instability also aggravates regional conflicts, making it harder for governments and rebels to settle their differences: a peace agreement that looks fair to the warring parties during a revenue “boom” can suddenly look unfair during a subsequent “bust”—and vice versa.   

Finally, the secrecy of petroleum revenues compounds these problems.  Governments often collude with international oil companies to conceal their transactions, and use their own national oil companies to hide both revenues and expenditures.  When Saddam Hussein was Iraq’s President, more than half of his government’s expenditures were channeled through the Iraqi National Oil Company, whose budget was secret.  Other countries have similar practices.  Secrecy is a key reason why oil revenues are so commonly lost to corruption; why oil-fueled dictators can remain in power, by concealing evidence of their greed and incompetence; and why insurgents are often reluctant to lay down their arms, because they distrust offers by the government to share their country’s oil revenues more equitably.

Petroleum has other troublesome qualities: for example, the extraction process typically creates few direct benefits, but many social and environmental problems, for the surrounding communities.  But the most important political fact about oil—and the reason it leads to so much trouble in so many developing countries—is that the revenues it bestows on governments are unusually large, do not come from taxes, fluctuate unpredictably, and can be easily hidden.

The Beginning of the Curse

Oil revenues have not always had these properties, and oil wealth has not always been a curse.  Until the 1970s, the oil-producing countries looked much like the rest of the world.  But in the 1970s, a wave of nationalizations swept the developing world.

In some ways, nationalization was a giant step forward for oil-producing countries: they gained greater control over their national assets; they began to capture a much larger share of the industry’s profits; and in the 1970s they were able to raise world prices to record levels, causing an unprecedented transfer of wealth from oil-importing states to oil-exporting ones.

The revolution in energy markets gave the oil-rich governments greater influence than they could have imagined.  But for their citizens, the results were often disastrous: the powers once held by foreign corporations passed into the hands of their governments, making it easier for rulers to silence dissent and hold off democratic pressures; ethnic minorities in oil-producing regions took up arms to fight for a larger share of the government’s revenues; and in many states, the tidal wave of revenues produced new jobs for men but not women.  While citizens enjoyed booming economic growth in the 1970s, most of these gains disappeared after prices collapsed in the 1980s.

The Petroleum Frontier

According to the US Energy Information Administration, in the next twenty-five years global demand for oil and other liquid fuels will rise by an estimated 28 percent, and the demand for natural gas will rise by about 44 percent.  To meet this rising demand, companies are increasingly drilling in low-income countries. 

Historically, oil has been found in countries that are already well-off. Since the price of oil began to rise around 1999, this has begun to change: the petroleum frontier has moved to ever-poorer countries.  Thanks to booming oil prices, international companies have found that the risks of working in poor, remote, and often badly governed countries are increasing outweighed by the benefits of finding new reserves. Since 2004, Belize, Brazil, Chad, East Timor, Mauritania, and Mozambique have all become oil and gas exporters.  In the next few years, perhaps fifteen new countries—all of them relatively poor, and most of them in Africa—are likely to join the list.  

This means that a flood of new revenues is just beginning to hit some of the world’s poorest countries.  On the surface, this sounds like spectacularly good news—a historically unique opportunity to escape from poverty.  Yet the low-income countries that most desperately need money are also the most likely to be struck by the oil curse.  Unless something is done, these windfalls will hurt, not help, people who live on the petroleum frontier.

Fortunately, much can be done to alleviate the oil curse—first and foremost, by changing the troublesome qualities of their oil revenues.  There is no “one-size-fits-all” solution that can be applied to all countries; but in my book, The Oil Curse (Princeton University Press 2012) I describe an array of strategies to alter the size, source, stability, and secrecy of oil revenues.  Countries can better manage the size and source of their revenues by, for example, extracting their mineral wealth more slowly, giving citizens a regular cash “dividend” from their oil revenues (like Alaska), using barter contracts, or partially privatizing their national oil companies (like Brazil).  To improve the stability of their revenues, they can use traditional stabilization funds, or—better still—oil-denominated loans.

There is one remedy that can help everywhere: greater transparency in how governments collect, manage, and spend their oil revenues. Improved transparency could force governments to become more accountable to their citizens, reduce the danger of violent conflict, and shrink the economic losses caused by corruption.  Transparency reforms in the oil-importing countries—whose voracious demand for fossil fuels is at the root of the resource curse—could also have a powerful effect. 

Reforms are most urgent for countries on the cusp of petroleum booms.  Every few months, new oil and gas deposits are discovered somewhere in Africa, Latin America, the Middle East, or Asia.  If the oil curse had a beginning, perhaps it can also have an end—so that the citizens of oil-rich developing countries can truly benefit from their riches beneath their soil.

© 2012 by Michael L. Ross. All rights reserved.

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