The Bear's Lair: What to do with the oil

By MARTIN HUTCHINSON, UPI Business and Economics Editor   |   March 24, 2003 at 6:04 PM
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WASHINGTON, March 24 (UPI) -- Once Saddam Hussein is defeated, the U.S.-led coalition that has defeated him will have its most difficult economic decision: what to do with Iraq's oil revenues, to ensure that they benefit the Iraqi people as a whole, rather than simply fueling a destructive and greedy government machine.

It's a difficult problem. Of all large-scale revenue sources, oil has proved itself the most destructive to the quality of local governments and the welfare of local peoples.

Examples abound. Venezuela, in spite of being a democracy and relatively well-off, has been appallingly run since the 1950s, completely failing to develop a viable non-oil economy. Mexico, one of the world's wealthier countries in 1945, declined into an orgy of corruption owing to its oil wealth, with the worst corruption coming during the 1970-82 period, when oil was at its most valuable. Indonesia, while a dictatorship, was a beacon of Asian success until President Suharto's last years, but has descended into a mire of corruption since the middle 1990s. Since Suharto's departure in 1998, none of his three democratically elected successors has shown any ability to make the Indonesian economy work.

And then there's Nigeria.

There aren't a lot of favorable counter-examples. Tiny countries like Kuwait, Dubai and Qatar do OK, proving that if you have ENOUGH oil wealth -- say $100,000 per annum per head of population -- you can manage to avoid dissipating it. Even Saudi Arabia, the world's oil-wealthiest country, saw its per capita gross domestic product decline from $25,000 to $7,000 from 1980 to 2000, proving that in spite of the Suharto example, autocracy is no cure for oil-financed corruption. Britain, Norway and Russia have shown that oil wealth in modest quantities can be a boom, but all three countries had strong non-oil economies before the oil wealth appeared (in the case of Britain and Norway) or a huge non-oil sector that co-existed alongside it (Russia).

It is pretty clear therefore that simply removing Saddam and installing a democratic government will not ensure good government in Iraq. Since the country has the world's second-largest oil reserves and only a weak non-oil economy, there is no chance that it will follow the path of Britain, Norway and Russia, and every likelihood that even a democratic Iraq will become a second Venezuela or Nigeria, failing to enrich its people and squandering the money in worthless government projects and unbounded corruption. And, of course there remains the possibility that such an Iraq will continue at some level to sponsor terrorist activity.

So what are the alternatives? Until last Monday, under the 1995 "oil-for-food" program, Iraq's oil revenues were handled by the United Nations. This rendered a large portion of the Iraqi population -- some 14 million out of the country's population of 24 million -- dependent on handouts from the U.N.'s relief administrators. As the citizens of the Berkshire village of Speenhamland found out in 1795, a pure handout program of this kind, in a society that has a high poverty level and considerable social dislocation, simply creates dependence and reduces economic activity. Naturally, the "oil for food" program has also done nothing for Iraq's agriculture. While possibly a necessary (if ineffectual) remedy at a time Iraq was subject to international sanctions, U.N. administration of Iraq's principal source of foreign exchange earnings is bound to cause huge political and economic trouble going forward.

Another possibility would be for the oil revenues to be administered by the World Bank or the IMF, which would use them to pursue a carefully thought out development strategy according to the governing policies of the international institution concerned. This has two problems. First, it would be perceived in Iraq as an exercise in U.S. imperialism, since the World Bank and IMF are perceived in the Third World, rightly or wrongly, as instruments of U.S. policy. Second, it would provide no tangible benefits for the Iraqi population themselves (other than by U.N.-type handouts, which have the problems outlined above) but would simply provide a huge "gravy train" for the international institutions and their associated consultants, by which the money will be wasted on ineffectual projects, while the true needs of the population go unmet.

If you think I'm exaggerating, consider Bosnia, a relatively prosperous country with a good education system before 1991, into which tens of billions of dollars of international aid have been poured, without any sign of having created a viable economy. The reason for this is quite simple: The international aid agencies, bound by their own agendas, paid little attention to the needs of the Bosnians themselves. In every other country that broke away from the former Yugoslavia, one of the first orders of business was to provide a mechanism to restore to the populace their foreign currency savings, which had been expropriated by the Yugoslav National Bank in 1991, and used to fund the Serbian war machine. Once this had been done, new business formation and the restoration of a functioning economy were once again possible, since these savings were of course the main source of small business financing. In Bosnia, the problem was ignored by the aid agencies, and by the government they controlled, and the small business sector is consequently notably absent from the current Bosnian economic scene.

The central problem in all the above schemes for spending Iraq's oil revenues is that they depend on a central Marxist fallacy: that the oil under a country, and the oil production issuing from the country, are rightfully the property of that country's government.

This is equivalent to nationalizing the U.S. semiconductor industry, on the grounds that the U.S. government had provided for the education of William Shockley and his successors who invested in the various devices involved. The principle makes no sense economically; still more does it make no sense morally.

In economic reality, there are two groups of people who have a right to the revenues from Iraq's oil industry: the oil companies that developed it, and the owners of the land under which the oil was discovered. In the event that private property rights were undeveloped in the region when the oil was found, the latter ownership devolves, not on the Iraqi government, but on the Iraqi people themselves.

The majority of Iraq's oilfields were developed by the Iraq Petroleum Corp., a consortium founded in 1925, and owned by British Petroleum (23.75 percent) Shell (23.75 percent) Compagnie Francaise des Petroles (23.75 percent) ExxonMobil (23.7 percent, between the two constituent companies) and the late Nubar Gulbenkian, the famous "Mr. Five Percent" wheeler dealer, owner of that percentage of the company. IPC was partially expropriated in 1964 and fully nationalized in 1972, the latter by a government of which Saddam was already the guiding figure.

There would thus seem no reason to recognize the expropriation, and every reason to return the operation of the oilfields to the British, Anglo-Dutch, French, U.S. and Portuguese (the Gulbenkian Foundation, domiciled in Lisbon) entities whose rights were so brutally overruled by Saddam's thugs. The Iraq National Oil Company, a corrupt tool of the Saddam regime, can legitimately be cut out of the business.

It is also however clear, through examination of current operating agreements in the oil industry, that the great majority of the oil revenues, perhaps 75 percent to 80 percent, should accrue to the landholders, in this case (subject to any well-founded title claims by individuals on particular oil fields) to the Iraqi people as a whole -- NOT to the government. By ensuring that oil revenues accrue to individual Iraqis, not to their government, the coalition can provide the Iraqi people with a huge tangible benefit from the invasion, and spread the money widely enough so that any funding for terrorism or a military machine is insignificant.

The requirement therefore is for a fund that holds the money, and that contains individual accounts in the name of the Iraqi people, who derive benefit from their holdings and have at least some degree of control over the way the money is invested. Fortunately, there is an excellent model for such an entity: Singapore's Central Provident Fund, with currently 2.9 million members and assets of $45 billion.

The CPF was set up initially in 1955, but its growth dates from 1968, when by a provision of Singapore law a percentage of every employee's salary (currently 20 percent paid by the employee plus 16 percent paid by the employer) up to SGD 6,000 ($3,000) per month is paid into the fund, to accrue in solid investments and pay for the employee's future retirement, health and later housing (by means of home mortgage withdrawal) needs. The fund's investments are managed by trustees, who provide "a fair market return at minimal risk" which is linked to bank deposit rates. However, fund members may also choose their own investment vehicles from an approved list for their accrued fund balances.

Iraq's short-term potential oil production is around 2.5 million barrels per day, with the possibility of an increase to 3.5 billion barrels per day within 3-5 years from investment in new fields. At an oil price of $25 per barrel, with 80 percent of oil revenues devoted to the fund, an Iraqi CPF would have initial revenues of $18.25 billion per annum, or $760.42 for every Iraqi man, woman and child. In addition, going forward, a portion of employed Iraqi's earnings, maybe 10 percent, could be added to his account in the fund.

Over a period of years, as the fund's revenues and assets grew, this should prove sufficient to provide the Iraqi people with basic retirement, health and unemployment benefit needs, as well as educational services for Iraq's children. It would best be managed by the staff of Singapore's CPF, who have 35 years experience in running this type of scheme, and are as far as humanly possible incorruptible (Singapore ranked fifth-lowest in the world, after three Scandinavian countries and New Zealand, in Transparency International's most recent annual corruption rankings.)

By instituting an Iraqi CPF, with individual accounts, funded by the oil revenues, and managed by staff of the Singapore CPF, the coalition would over a 2-3 year period allow the Iraqi people to develop an asset over which they had (if they wished) individual investment control, which would fund their basic social program needs. The new Iraqi government, in turn, would have to depend on non-oil sources, such as sales and income taxes on the Iraqi people for its revenues. It would thus be relatively impoverished, but would also have no need to provide basic social security, health or education services for its people. With at most 10 percent of Iraq's GDP under its control, it would be unable to afford expensive military adventures, would have very limited control over the Iraqi economy, and relatively few and minor avenues for serious corruption.

An Iraqi people who had their basic social security, health and education needs taken care of by a Central Provident Fund managed by incorruptible and capable Singaporeans, and whose government was modest and not very corrupt, would be the happiest polity in the unhappy Middle East. That, at least, is something worth fighting for.

(The Bear's Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that, in the long '90s boom, the proportion of "sell" recommendations put out by Wall Street houses declined from 9 percent of all research reports to 1 percent and has only modestly rebounded since. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)

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