Oil discoveries provide resources to some low-income countries on a scale that dwarfs aid.
Yet their effects have often been adverse. Oil has been associated with economic stagnation and the destruction of other export activities.1 At the political level, it is associated with violent conflict.2 Why has oil been so damaging and what can be done about it? Why has oil been damaging? Historically, representative government arose because governments needed to raise large revenues for warfare. Conceding representation and scrutiny to taxpayers was the price of popular compliance in taxation. By reducing the need for taxation oil reduces pressure for scrutiny: people are less concerned about the misuse of public money if they have not been taxed in order to generate it. How much this weakening of pressure for accountability matters depends upon the pre-oil situation. If the country was already a functioning democracy, as in Norway, accountability can easily be maintained.
In addition to the lack of accountability, large revenues induce a contest for the control or influence. Resources devoted to the struggle to capture control are a pure waste from the social perspective – termed ‘rent-seeking’. Yet if rent-seeking is unchecked, people will devote resources to it equal to the value of the rents available. If this happens the society will be no better off, but in the process the character of the society will have radically changed. Rent-seeking might draw the brightest people into politics instead of business, because the returns to political power are so high. It might also draw people into criminality. For example, highly organized gangs tap into pipelines and ship plundered oil out of the country. Criminal and political actions sometimes shade into each other. In the Delta region of Nigeria, a movement that was initially protesting against injustice and environmental degradation rapidly evolved into gang warfare between villages for the control of the right to run protection and kidnapping rackets.
The purest form of politically expressed rent-seeking is secession. Civil wars in oil exporting countries are almost always secessionist, whereas elsewhere many civil wars are ideological. The people living in the vicinity of the oil have an obvious economic interest in claiming the resources for themselves. Nation states are usually recent agglomerations of previously distinct political entities, and this process of assimilation has often been contested. Hence, oil is often discovered in regions where some political groups – albeit often on the fringe – are already claiming autonomy. The presence of natural resources enables such groups to add a credible economic argument to what is otherwise likely to be merely a romantic appeal. An example of this transformation is the (non-violent) rise of Scottish nationalism which can be precisely dated to between the 1970 and 1974 general elections. At the 1970 election, as in all previous elections, the Scottish National Party won only a tiny share of the vote and gained only a single seat in parliament.
In 1974 its vote rose to 30%. The transforming event that brought about this change was surely OPEC’s dramatic increase in the world oil price in 1973. The oil off the shores of Scotland was suddenly seen as valuable: the party campaigned on the slogan ‘it’s Scotland’s oil’.
Oil may be distinctive in its romantic connotations of affluence. For example, the GAM, the rebel movement that has been attempting to achieve secession of Aceh from Indonesia, has used the analogy of Brunei in its propaganda, claiming that the population of Aceh could be equally rich. This is a massive, and presumably deliberate exaggeration, but may well appeal to the popular imagination. A million people came out into the streets to support the GAM. Of course, the economic attraction of secession is compounded by the detachment of government: grievance reinforces greed.
While government detachment and the lure of secession provide motives for rebellion, oil may also make rebellion materially more feasible. Rebellion is usually expensive. Oil companies are threatened with sabotage of pipelines, and their employees are kidnapped and ransomed. A related phenomenon is ‘war booty futures’. Here the rebel group finances its activities by selling extraction rights contingent upon subsequent victory. This is reputedly how President Sassou-Nguesso returned to power in the Republic of Congo.
In addition to these political effects, oil can have directly damaging economic effects. The classic economic analysis is ‘Dutch disease’: oil displaces other exports.
In economic terms this is an efficient response, at least in the short run. Because the society is richer, it needs to produce more of the goods and services that cannot be imported, and these are produced with resources released by the now-redundant export sector.
Although in narrow economic terms this restructuring might be efficient, it might have political-economy effects that are dysfunctional. As the non-oil export sector withers away, pressure to stay internationally competitive diminishes, and this may slow the pace of productivity growth.
Remaining industry may look only to the domestic market and seek its profits through lobbying the government for protection rather than through maintaining competitiveness.
A further economic effect is the likely imbalance between public and private investment.
Even if the government invests the oil revenue, it directly controls only public investment such as infrastructure. Private investment may become less attractive as a side-effect of the contest for control of the oil rents. For example, in Nigeria a huge increase in public capital formation coincided with a collapse in private investment. Currently Nigeria has around three times as much public capital as private capital, whereas the average for both the OECD and East Asian economies is five times as much private capital as public capital. In such circumstances public investment is likely to be relatively unproductive.
A final economic effect of oil is exposure to price shocks. Even post-OPEC oil prices have swung massively – between $10 and $30 a barrel. During the booms governments take on commitments that cannot be sustained during the slumps. A particularly common approach – Congo, Cameroon – has been to protect and subsidize high-cost manufacturing industry in good times, being forced to abandon it in the slumps. The capital invested in these unsustainable activities is a pure waste.
What can we do? These political and economic effects of oil have cumulatively been sufficiently serious to waste a huge opportunity to finance development. What can the international community do about it? The most direct action is to promote revenue transparency. Until oil revenues are transparent it is not possible to scrutinize how they are spent.
Transparency is therefore necessary to address the problem of ‘detachment’. In addition, transparency can reduce the problem of secessionist pressure. Recall from the example of the GAM in Aceh that rebel movements deliberately exaggerate the value of oil revenues. Secrecy makes such exaggeration easier.
Adding Fuel to the Fire: The Role of Petroleum in Violent Conflicts 11 The NGO Global Witness has led efforts to encourage transparency. One approach is to demand compulsory reporting of payments by individual oil companies.
However, this has disadvantages. It is politically difficult to achieve international action on the basis of compulsion: some companies see it as a breach of confidentiality, and the governments that receive oil resource revenues see it as yet another developed country insinuation that they are corrupt. Further, if companies were to report using different accounting years, or different concepts of revenue, it would be impossible to arrive at a credible aggregate figure: too much disaggregated information would, paradoxically, provide too little information for effective scrutiny. An alternative approach, which has been suggested by the UK government, is for companies to be required by the government of the oil-rich country to report on a confidential basis to an international agency, which would then publish aggregate information. This has several advantages. First, the host government would have the choice as to whether to make reporting a requirement. Hence, it would not itself be the subject of compulsion but would rather be a critical participant in producing transparency. Once a ‘template’ for revenue reporting is established, governments adopting it would be signaling their commitment to honest governance. This ability to signal would itself be most useful to governments that face a problem of poor reputation – it provides a mechanism whereby they can live down the past. The template would require all companies, including national companies, to report. By contrast, if the reporting requirement were to come from OECD countries it would apply only to some companies and so would disadvantage them – in turn making OECD countries reluctant to impose such discriminatory requirements. Finally, by introducing an informed international intermediary, the reported data can be required to conform to some standard concepts.
Transparency of revenues is only a step towards the scrutiny of expenditures. Without transparency of revenues scrutiny of expenditures loses much of its point, but transparency is not in itself scrutiny. The purpose of scrutiny is to establish how oil revenues are spent and this in turn requires scrutiny of the entire budget. In most oil-rich developing countries the institutions that would normally undertake such scrutiny – parliamentary committees, allied with an auditor-general office and an investigative press – are currently insufficiently effective. The international community can promote scrutiny both by building the capacity of these institutions and by pressuring governments into accepting their enhanced role. The reward for change in government behavior is greatest for those governments burdened by a poor reputation – whether with their own electorates or with foreign investors. In some contexts institutions of scrutiny need to be established from scratch. For example, in Chad as a result of the Chad-Cameroon pipeline new government institutions were established, – helped by pressure from oil companies – along with an ad hoc group drawn from civil society. Experience to date suggests that even this ad hoc approach has been quite effective. The precise architecture of scrutiny would need to differ, country-by-country, depending upon what is already in place.
Between them, transparency and scrutiny would curtail rent-seeking. They would also reduce the incentive for secession. Secessionist groups would no longer be able to exaggerate the scale of revenues, nor would they be able to contrast the prospect of local accrual of revenues with embezzlement at the national level. The best defense against secession is likely to be credible evidence that revenues are being used for nationally equitable expenditures such as primary education. Transparency and scrutiny provide at least some counter to the problem of ‘detachment’. Gradually, the population may come to recognize that oil is indeed owned by the nation.
12 Exposure to price shocks can be reduced through insurance, savings, and export diversification. As an example of insurance, the World Bank is a major creditor to both oil exporting countries and oil importing countries. Currently, debt service to the Bank by oil exporters is around $6 billion per year, and debt service by oil importers is around $12 billion per year. Hence, there is at least in principle the potential for these two payments streams to move in a precisely offsetting fashion, conditioned on the oil price. When oil prices were high, oil exporters would take over some of the debt service obligations of oil importers and vice versa. The World Bank would gain by reducing its default risk, and both oil exporters and oil importers would gain from less volatile net incomes.
Transparency, scrutiny and stability would improve the climate for private investment. This in turn would facilitate export diversification. Indonesia shows that it is possible: over the same period that oil destroyed Nigeria’s other exports, Indonesia broke into a range of nontraditional export markets. Dutch disease need not imply an absolute decline in non-oil exports.
Conclusion Oil revenues have been a missed opportunity for many developing countries, yielding stagnation and corruption. At the heart of this failure has been a lack of transparency in the receipt of revenues, a lack of scrutiny in how they have been spent, and a lack of stability in the economy. The international community is now seriously concerned to transform such countries. Hesitantly, and with setbacks, it is moving beyond using aid as the only instrument, towards ‘policy coherence’ – the attempt to make other policies, such as trade and military intervention, more supportive of development. The disastrous cocktail of secrecy and instability in oil-rich societies is not inevitable. A few specific actions could make a large difference.
