The debate about restructuring Iraq’s economy has begun in earnest. Paul Bremer’s proposed policies represent a free-market dream to some, a corporate takeover nightmare to others. The truth is that because they ignore Iraq’s oil, they are a pure irrelevance.
Even at the peak of Iraqi wealth in the late 1970s, oil represented half of Iraq’s economic output. After three wars and a decade of sanctions, oil is all Iraq has left. That will not change quickly.
Given the mounting death toll in the streets of Iraq, it would be a brave investor indeed who attempted serious commercial operations outside the oil sector. The occupying forces have not begun to establish the security necessary to run a typical business. Even if the security situation is resolved tomorrow, Iraq lacks the infrastructure, legal system and financial depth to sustain a modern economy.
Oil is another matter. In many parts of the world, oil production takes place despite war, dictatorship or the most stunted of commercial sectors. This is no coincidence, for war, dictatorship and slow growth have often been associated with oil wealth. Oil will not help Iraq unless the authorities take steps now to avoid the same fate.
As the Iraqi governing council drafts the country’s new constitution, it should give all adult Iraqis an inalienable right to a proportionate share of public oil revenues. Direct transfers of oil money are rarely seen, although Alaska is a notable exception. But Iraq is an ideal candidate for the policy, variants of which have been proposed by Michael Prowse in the FT on April 21 and, for Nigeria, by economists Xavier Sala-i-Martin and Arvind Subramanian. To see why this bold step is needed, we have to understand what will happen if it is not taken.
When Iraq begins to export large quantities of oil, the real exchange rate will appreciate, making it tough to export anything else. The main burden will fall on agriculture, and people will go hungry unless food is imported and distributed fairly. Manufacturing will also suffer, and with it the main chance for Iraqis to develop commercial and technical experience. The authorities will no doubt talk about diversifying the economy but few oil-rich states have managed this trick.
Because the oil price is volatile, government revenues will also be volatile, making the economy unstable and difficult for entrepreneurs to operate in. The government will probably spend the money on a large bureaucracy whose members cannot safely be sacked, or “invest” it in crazy projects that will never be completed. In oil-rich Nigeria, for example, the Ajaokuta steel complex was started in the 1970s but has never produced any steel.
This is a miserable picture but a fair one, because the fastest-developing countries are almost all poor in resources. In fact, it is probably too benign a view. As well as stunting economies, oil eats away at political systems. Iraq itself provides an obvious example. Saddam Hussein could never have held on to power without control over oil revenues. Other resource-rich states could hardly do worse but still tend to suffer corruption, underdevelopment and even civil war.
Remedies are available for the economic problems but they are useless without a competent and benevolent government. That is why fundamental reform is necessary, to nip the problem in the bud. Direct transfers of all oil revenue to citizens would solve a number of problems. Individual citizens are likely to spend their own money more wisely than weak governments would – it is hard to imagine their clubbing together to build an Iraqi version of the Ajaokuta steel mills, for instance. Individuals are also less likely to raid the cookie jar when times are good: most people understand the value of savings.
Direct transfer would undercut the politics of patronage, because Iraqis would have an automatic right to oil money, defensible in the courts. Possibilities for corruption would not go away, but they would be limited.
To raise revenue, the Iraqi government would have to behave the way serious governments do, setting up an efficient system to tax its citizens. Broad taxation is more likely to lead to better governance, because it requires an accountable relationship between government and people.
Giving Iraq’s oil directly to its citizens is a radical suggestion, but Iraq is starting from scratch anyway. The wretched experience of resource-rich states across the world suggests that it is time to give radicalism a try.
The writer is the FT’s 2003 Peter Martin Fellow