Middle East Economic Survey

VOL. LI

No 27

7-July-2008

IRAQ

Iraqi Oil: Turning The Curse To A Blessing (1/2)

By Muhammad-Ali Zainy

Dr Muhammad-Ali Zainy is Senior Energy Economist and Analyst at the London-based Centre for Global Energy Studies. He holds degrees in engineering, law and mineral economics from England, Iraq and the US respectively; he is also the author of ‘The Iraqi Economy: Past, Present and Future Prospects’. This paper was presented to the Conference on Iraq Oil Policy: A Review on 25 February at the Center for Iraqi Researches Fondation Maison des Sciences de L’Homme, Paris. Part 2 will be published next week.

Rentier Economy

A rentier economy is an economy that depends to a large extent on revenues obtained from rent or exploitation of an exhaustible natural resource such as oil. A country with such an economy is traditionally called a ‘rentier state’, where the government lives off an unearned income coming from the production and export of the natural resource.

The Arab oil and gas exporters represent typical rentier states where petroleum (oil and gas) exports form a significant portion of the country’s total exports, the contribution of the petroleum sector dominates the country’s GDP and petroleum export revenues are the significant source of financing the annual government budget. These conditions are illustrated in Figures 1, 2, and 3 and Table 1 for the Arab members of OPEC for the year 2006; Norway is added as a comparative example, for reasons to be explained later.

The share of petroleum exports in the total exports of OPEC’s Arab members is shown in Figure 1 for the year 2006. This share ranged from 51% in the case of the UAE to 99% in the case of Libya. Normally, a country’s exports are almost the sole source of its foreign exchange and, in order for the country to be able to import as well as support the value of its own currency, such foreign exchange must at least cover its import needs, or else the trade balance will be in deficit. There is nothing wrong with a country exporting oil and gas and generating ample foreign exchange, provided that there is no abnormal dependence on this process. What may go seriously wrong is a large extent of dependence on such exports, where Libya would be a manifest example in this illustration. If anything goes wrong with the ability to export petroleum, this country is in deep trouble.

The other indicator of a rentier state is illustrated in Figure 2, where the GDP is dominated by the value added of the oil and gas sector. This domination is very pronounced in the case of Iraq, where the oil and gas sector during 2006 made 93% of the total GDP. Iraq, however, is a special case at present time, because of the ongoing American occupation, widespread violence and lack of security throughout Iraq and, above all, collapse of the non-oil sectors of the economy, a legacy of Saddam Husain’s rule and UN economic sanctions. Leaving Iraq aside for the moment, we see that the oil and gas sectors during 2006 made up 62% in Qatar, 60% in Libya and 50% in Saudi Arabia. These shares are large indeed and show the relative lack of diversification of the economic base of these countries. Among this group of Arab states the UAE, again, scores the best figure, with the contribution of the petroleum sector to the total GDP of only 27%, thanks to the good performance of the vibrant industrial and services sectors of this country.

The last illustration, shown in Figure 3, concerns financing the governments’ budgets of rentier states. Oil and gas revenues of these states provide the major portion of the government budget revenues. Again leaving Iraq aside for later, we see that petroleum export revenues financed 91%, 90% and 86% of the 2006 government budgets of Kuwait, Saudi Arabia and the UAE respectively. The only relatively lucky government is that of Algeria, which seems to have other means of non-oil income to finance 50% of the budget – not bad compared with the others, but still very vulnerable to downward dips in oil and gas income.

Effects Of The Rentier Economy

It is generally observed that the government of a rentier state tends to be autocratic, unaccountable and dissociated from the rest of the country’s people with regard to their rights, needs and aspirations. Furthermore, the economy of such a state is generally retarded when compared with the economy of a state with no dependence on the export revenues of mineral extraction (oil, copper, bauxite, etc).

Several reasons have been put forward by development economists to explain why countries with huge mineral wealth – oil in the case of Iraq – tend to display, more often than not, certain adverse effects or, as fashionably called, a “resource curse” exemplified in typically underdeveloped economies and weak, if not primitive, political institutions¹. One of the factors put forward to explain this effect is the severely fluctuating income of these countries resulting from the price volatility of their extractive export commodities. Such fluctuating income leads to “boom and bust years” which would obliterate rational economic planning and performance².

Another reason is the overvalued currency of the resource-rich country, or what has become to be known as the “Dutch Disease”, referring to the discovery and exploitation of natural gas in the Netherlands in the 1960s and the consequent adverse impact on its manufacturing sector. The negative effect of an overvalued currency of a country is exemplified in the impediment to growth of its export sectors. The result is that such a country would lose its competitiveness in exports of manufactured and agricultural goods, leading to the deterioration of these sectors. This effect is generally observed in all OPEC member countries, including the Arab ones.

These reasons, important as they are, can explain only part of the problem. The best explanation, though, comes as follows: as a result of the availability of resource-export revenues, the governments of resource-rich countries do not have to constantly worry about finding ways and means to finance their annual budgets, which are normally needed to run the country. With ample oil revenues, for instance, these governments become mostly self-sufficient – sometimes replete with cash – and the necessity to tax the people for the purpose of generating enough income to finance the budget vanishes absolutely.

This state of financial self-sufficiency leads to a corrosive or toxic state of affairs in two main ways. One way is that the government’s lack of need for tax-generated income reduces its incentive to promote a diversified tax-based economy strongly underpinned by the private sector. The other way is that the under-taxed, and mostly untaxed, citizens lose the desire to hold government accountable for its policies and actions. The result is weak civil society characterized by lack of checks and balances and proper growth-promoting institutions.

An exception to this thesis would be Norway. It is claimed that, at the time that Norway became revenue-rich from the sale of natural gas (as of the mid-1970s), democracy in this country was well-entrenched, along with its relevant institutions, and that prevented corruption and other toxic consequences. This now explains why Norway, despite being hydrocarbon-rich, fared well compared with the Arab members of OPEC as reflected in Figures 1, 2 and 3. While the percentage shares of oil exports in total exports, oil GDP in total GDP and oil revenues in total budget revenues for Norway in 2006 were 51%, 23% and 39% respectively, the corresponding average percentage shares for the Arab members of OPEC in the same year were 84%, 52% and 83% respectively, showing that Norway is not strongly dependent on natural resource exports for its foreign exchange earnings, its economic base is fairly wide and diversified and the revenue of the Norwegian government budget is tax-based and not dependent on earnings from oil and gas exports (see Table 1).

Good But Inconsistent Hypothesis

If the economic environments of most resource-rich countries seem to encourage the establishment of autocratic governments (Norway being the exception because democracy was there before the country became resource-rich), then it follows that if these resource-rich Arab countries, like Saudi Arabia and other GCC states, Iraq, Libya and Algeria, were resource-poor instead, they would have developed democratic regimes, perhaps a long time ago. This cannot be farther from the truth. What supports this contention is a quick look at the existing resource-poor Arab countries. The governments of Syria, Jordan, Yemen, Egypt, Tunisia, Sudan and Morocco are not exactly democratic, nor are the governments of many resource-poor countries in Africa, Asia and Latin America, if we want to go beyond the Arab example.

It is the drive of a people, their past and present conditions, and the type and agenda of the government holding power in a country that will, most likely, lead to the establishment of a democratic system in a certain country and the absence of it in another. If we take South Korea as an example of a resource-poor country becoming democratized as well as economically developed, it may be the effect of what we might call the “America-Japan” factor or the “pull-push” effect of these two countries. It may very well be that a proud people like the Koreans, who were brutally treated and humiliated by Japan, and whose country was forcedly annexed during 1910-45, had developed the driving force and determination to rise and excel in the wake of winning their freedom after Japan’s defeat in WW II (North Korea fell under the communist sphere of influence after the war). The strong resentment or repellence caused by the Korean horrendous experience with Japan may be called the Japanese “push factor”. On the other hand, the American “pull factor” or the paradigm of democracy and successful economy led South Korea on the road to establishing one of the best educational systems in the world, adopting a market economy and opening up to foreign direct investment as well as turning to democratic rule.

On the opposite side of this equation are the resource-poor Arab countries. They did not democratize, nor did they build successful economies. In essence, their behavior wasn’t in any way similar to that of South Korea. A number of reasons could be put forward to explain this situation. One of them is the strong pull factor of Islam with its present autocratic tradition, in which tradition became enmeshed in a state of departure from reason and liberal thinking. That, unfortunately, took place after the collapse of the rational school of thought in the 9^th century, and the consequent victory of salafist ideology and adherence to a literal interpretation of the Quran to the detriment of Islam’s fundamental tenets. All of that was encouraged and done on the behest of theocratically absolute rulers, whose interests were very well served by such reactionary fall-down. Because of this factor it becomes, then, feasible to say that it is easier for an African nation, free of any burdens of a religion and attractions of a past, to become democratic, than for an Arab nation pulled to its past by religion and a collective memory of a glorious civilization in the not-too-distant past.

Another reason to explain the Arab situation is the Israeli factor. The struggle to liberate the occupied Palestinian lands offered opportunities for many Arab nationalist officers, as well as those harboring ambitions to control and rule, to carry out military coup d’etats under the pretexts of ridding their countries of their reactionary governments and liberate Palestine from Israeli occupation. Very soon those countries became rife with such slogans as “everything is for the battle” and “nothing can rise above the battle”, which, virtually, impeded any potential for economic progress and, at the same time, emasculated the people and stripped them of their capabilities to demand democratic rule and respect for human rights, since all energies, allegedly, had to be saved for the “battle” while the issues of human rights, democratic rule and economic progress could, somehow, wait until Palestine was liberated.

In reality, however, those officers, and the nationalist parties that supported them, did nothing in the way of liberating Palestine and, indeed, they lost more land to Israel as a result of their misadventures. Instead of nurturing democratic traditions in their countries – be they resource-rich or resource-poor – and building strong, diversified and growth-sustaining economies run by strong, educated and free people, which is the only way to stand up to Israel and win back the usurped Palestinian lands, they instead opted to subjugate their peoples, and chain them and deprive them of their rights and of any semblance of a decent living, thus rendering them poor, weak, helpless and ineffective. Furthermore, this new ruling elite steadfastly held to power and, along with their immediate families and cronies, indulged in self-enrichment, fostering in the process corrupt states with poor and underdeveloped economies.

One indicator of the dismal state of the Arab countries is their frightening level of corruption, as recently reported by Transparency International, which speaks plenty of entrenched corruption in the Middle East and North Africa (MENA) region, as Table 2 shows. Judging by the score of the 2007 Corruption Perception Index (CPI), where 10 indicates the lowest level of corruption and zero the highest, Israel turned out to be the least corrupt among MENA countries followed by Qatar and the UAE, while Iraq, the “castle of Arab steadfastness”- as the Iraqi Ba'th rhetoric goes - was rendered to the bottom of the most corrupt countries in the MENA region and only surpassed by Somalia in this dubious “honor”, thanks to Saddam’s legacy of corruption, which started with the Iran-Iraq war and unashamedly accelerated under those who came to rule afterwards. When compared on an international level, Israel, again, comes on top of the MENA list, ranking 30 among 180 countries, followed by Qatar and the UAE ranking 32 and 34 respectively (Denmark, Finland and New Zealand, not shown in the table, came on top of the world list). The worst perpetrators, or most corrupt in the world, turned out to be Iraq with a rank of 178 (just two levels away from the bottom), followed by Somalia ranking 179 and Myanamar (not shown) ranking 180 in the bottom of the corruption list.

One last example which does not fit the hypothesis of the resource curse is Chile under Allende and Pinochet. Despite this country being copper-rich, Salvador Allende was elected in 1970 in a democratic manner to become the country’s president. Democracy, however, did not prevent Allende from adopting a populist program which involved nationalizations, price control and wage increases. Soon, the private sector started shrinking, capital flight ensued, inflation became out of control and the economy stagnated. While the Chilean economy was growing in real terms, during the pre-Allende period of 1961-70, at an average rate of 4.1% per annum, this rate shrank to just 0.5% per annum during Allende’s presidency 1970-73 (see Figure 4). In a coup d’etat – the key organizer was the CIA – Augusto Pinochet’s dictatorship was brought about in 1973. Setting aside that dictatorship’s brutality and human rights abuses, the Pinochet regime (and those democratically elected after Pinochet’s failure in 1988 to secure another eight-year presidential term) pursued sound economic policies, including adopting a market economy open to foreign direct investment and fostering a strong private sector. Other than a couple of minor downturns, such sound economic policies resulted in a remarkable period of economic growth, as Figure 4 shows.

Difference In Performance

To go back to the oil-rich Arab regimes, their economic performance did not just assume one path, but was different from one country to another. Libya and the UAE do not have democratic regimes, but the UAE’s performance fared far better than Libya’s as the years passed. During the 20-year period 1987-2007, Libya’s real economic growth averaged a dismal 1.3% per annum compared with 3.9% per annum for the UAE. During the period 1990-2007, the UAE’s real economic growth jumped to 5.4% per annum compared with only 3.4% per annum for Libya (see Figure 5). The reason for the UAE’s better performance is due to what we can call “enlightened governance”.

Let us take the performance of Saudi Arabia’s economy under different periods. During the period 1969-81, the kingdom’s real economic growth averaged a fantastic 11.7%, thanks to the expansion of production in the oil sector during that period and the advent of high oil revenues which allowed dual expansions in investment and consumption (see Figure 6). During the period 1981-87, Saudi Arabia’s oil revenues suffered a precipitous decline due to the dual deterioration in Saudi oil production as well as oil export price. As a result, the Saudi economy retreated at a frightening average rate of -4.5% per annum, during which period the Saudi regime was almost completely apathetic despite the painful economic retreat.

With the debilitating stroke of late King Fahd in 1995 and the relatively progressive and reform-minded King ΄Abd Allah (then Crown Prince) taking over as de facto ruler of Saudi Arabia, the economy (real GDP growth as a proxy) started moving upwards and achieved an average real growth rate of 3.3% per annum during the period 1995-2007. Precisely with the more enlightened governance of King ΄Abd Allah, and despite the inertia of the conservative Sudairi half-brothers and the entrenched Wahhabi establishment, the Saudi economy achieved a much better growth of 5.3% per annum during the 5-year period 2002-07. Such performance was mainly due to higher oil production and prices, generating huge oil revenues which, in turn, allowed more investment and consumption. More importantly, however, it was due to instituting some serious reforms, including partial economic restructuring, opening up to foreign direct investment and accessing the World Trade Organization. With, hopefully, more to come in terms of speedier and wider economic restructuring, and more daring social and political reforms, King ΄Abd Allah’s legacy would more likely be remembered as the best in pushing the kingdom in the direction of proper economic and political development.

Notes:

1. See Nancy Birdsall and Arvind Subramanian, ‘Saving Iraq From Its Oil’, Foreign Affairs, July/August 2004, pp 77-89.

2. See for example CGES, ‘Saudi Arabia to 2020: Oil, Economics and Politics’, Spring 2002, Part Two.

Figure 1: Values Of Oil Exports And Total Exports Of Arab Member Countries Of OPEC In 2006

Source:  OPEC, IMF.

Figure 2: Contribution Of Oil Sector To GDP Of Arab Member Countries Of OPEC In 2006

Note:  All data for 2006, except Kuwait’s and UAE’s data are for 2005.

Source:  IMF, Others.

Figure 3: Contribution Of Oil Export Revenues To Government Budgets In Arab Member Countries Of OPEC In 2006

Source:  OPEC, Others.

Figure 4: Chile’s Real GDP Index During 1961-2007 (1970 = 100)

Source:  IMF.

Figure 5: Real GDP Index Of Libya And The UAE During The Period 1980-2007 (1990 = 100)

Source:  IMF.

Figure 6: Saudi Real GDP Index During 1969-2007 (2007 = 100)

Table 1: Selected Economic Indicators Of Arab Members Of OPEC And Norway (2006)

Source:  Various (including OPEC and IMF).

Table 2: Corruption In MENA Countries (2007)

Source:  MEES, 22 October 2007.