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    Middle East
     Aug 12, 2008
Fleeced in the Persian Gulf
By Hossein Askari

With higher oil prices on world markets, wealth and opulence invariably come to mind at the mention of any Persian Gulf country - Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, the United Arab Emirates (UAE), and even Iran. These countries, and Iraq, have enormous wealth that is locked up in oil and natural gas underground - about 65% and 40% of known global oil and gas reserves respectively. But the distribution of oil and gas reserves among the countries is not even, and is especially uneven given the vast differences in population size, namely, oil and gas reserves on per capita terms.

Kuwait, Qatar and the United Arab Emirates (more accurately the emirate of Abu Dhabi) are just super rich; Saudi Arabia is in the middle, followed by Iraq and Iran. It is not just the wealth

 

underground that makes Kuwait, Qatar the UAE and, to a lesser degree, Saudi Arabia, so rich; it is also their invested assets abroad in their sovereign wealth funds.

So with all this wealth, you would expect citizens of all of these countries to be in an enviable economic position and with a bright future. Not true. While this may be the case for some of the countries, one thing is for certain in all of them, including Iraq: the citizenry have been, and are being, fleeced to a degree unrivalled in human history. The world only watches and does not notice or care. How are they fleeced? What does this mean for the future? What is the solution?

At the outset, let's accept three truths that are evident. The wealth in these countries has come from oil and natural gas depletion. Oil and gas will not last forever. Oil and gas belong to the citizens (today's and tomorrow's) of these countries, not to the rulers, not to government officials, not to a select group of citizens, but to all citizens. The simple corollary of these three truths is that all citizens, now and in the future, should receive similar, if not the same, economic benefits from oil and gas depletion. But they don't and are not likely to do so the future if things go as they have; it's not even close.

The evidence is clear-cut. The family rulers in the Gulf Cooperation Council countries (GCC) - Kuwait, Qatar, Saudi Arabia, the UAE, and to a lesser extent in Bahrain and Oman - are rich beyond belief. Have they achieved such status from hard work or unusual abilities? No. A small cadre of fortunate citizens, sycophants of the regimes in power, is also super rich in these same six countries, as well as in Iran and even in Iraq. Income distribution, which should be pretty even given that wealth comes from oil and gas and belongs to all citizens, is highly skewed in all of these eight countries.

The fleecing of the citizenry takes a number of forms depending on the country. In the GCC, the rulers have direct access to the national treasury and oil and gas revenues. They take what they want. Any way you look at it, this can only be called daylight robbery. In all the countries - the GCC as well as Iran and Iraq - corruption is rampant. While in some GCC countries payments to a local agent are mandatory, such payments are in most cases just camouflaged bribes. Additionally, most princes in the GCC and most government officials in all of the countries expect bribes on government contracts, not in the 1 to 2% range, but sometimes exceeding 10%.

These are not the only ways in which citizens are robbed. Family rulers in most of these countries waste oil and gas revenues to buy the support of foreign powers to maintain their absolute rule, be it by awarding large military contracts or even direct business contracts to Western leaders once they are out of office and to their families, cronies and companies closely associated with them.

But the most widespread, universal and costly fleecing of the general citizenry is through ill-conceived economic and social policies that hide and mask the robbery that prevails. Rulers in most GCC countries and in Iran and Iraq waste their citizens' birthright through what can only be described as unconscionable economic policies that effectively translate to robbery by a few. Let me explain.

The task of all these countries is to transform oil and natural gas in the ground into non-oil sources of income for current and future generations. There are two broad options for implementing this fundamental economic transformation - the development of a non-oil economy fueled by government expenditures or a comprehensive development of sovereign wealth funds with clearly targeted distributions of fund resources to the general citizenry.

The first and the conventional approach would be to rely on the government to adopt comprehensive development policies that promote the establishment of non-oil sources of production, non-oil goods and services where the countries enjoy a comparative advantage. This must be implemented in a way that upholds economic justice, as oil and gas depletion, the source of financing, is the birthright of all citizens, current as well as all future citizens.

To achieve the transformation to non-oil sources of production while maintaining economic equity is not easy. Countries need (i) a well-conceived and comprehensive economic plan and (ii) a sophisticated income tax system to address equity issues, because the major beneficiaries are the recipients of large government contracts, the friends of rulers and governments. No country in the region has even one of these necessary ingredients. Let's look at each deficiency.

Governments do not have the entrepreneurial prowess to pick areas of comparative advantage and to run business enterprises. Instead they have the tendency to throw money into subsidies and wasteful projects that buy allegiance, projects that may be high profile white elephants or that satisfy the needs of a particular constituency. These oil revenue-driven government expenditures invariably fuel inflation, lead to an overvalued currency and impede the development of non-oil sources of national output and exports.
Economists label this unfortunate outcome "Dutch Disease", after a similar phenomenon that occurred years earlier in the Netherlands: a sharp rise in government expenditures, fueled by income from natural resource depletion, impeding the development of non-oil exports. In today's Persian Gulf, Iran is a good example of a country with Dutch Disease.

With rising oil revenues, the Iranian government has increased government expenditures. Prices for imported goods have increased somewhat along with global inflation but the much larger price increase has been on what economists refer to as non-tradable goods, things that cannot be readily imported. The prices of non-tradables have increased at a much faster rate than those of imported goods because their more limited domestic supply cannot keep up with demand.

In effect, this leads to a currency that is overvalued, namely, an increase in the real price of domestic goods relative to imported goods. In turn, domestic businesses are given the incentive to supply more non-tradable goods to the detriment of developing non-oil exports. The most high-profile item among non-tradable goods is real estate, land and housing. This is Dutch Disease as it has unfolded in Iran and elsewhere in the Persian Gulf.

In Iran, as a result, inflation has been running at 20-30% per year over the past five to seven years. But real estate has gone through the roof. The price of residential land in Tehran's best neighborhood that was about $50 per square foot 10 years ago is roughly $1,000 today, or about $40 million per acre! An old 1,200 square foot apartment that could be bought for about $50,000 10 years ago is around $800,000 today. Such a bubble makes all Iranians real estate speculators and impedes the development of non-oil industries and services that could compete in the global marketplace.

Let us look at the end result of all this on economic equity. Oil depletion has not resulted in viable non-oil sources of national output to provide income for the general citizenry today and in the future. The very small minorities of Iranians who own choice real estate have been made very rich, while the average Iranian pays higher prices! But the story does not end here. The governments in the region have also effectively maintained a currency peg. In the case of Iran, over the same last five to seven years the Iranian rial has moved in a narrow range with the US dollar, while Iran's inflation rate has exceeded US and global inflation by 15 to 20% per year.

The Iranian rial should have depreciated dramatically and real estate speculators should have not reaped such excessive dollar-denominated (as compared with rial-denominated) gains, but alas the government has supported their greed by maintaining the peg using scarce foreign exchange earned from the exports of oil and gas. This has meant that real-estate owners could convert rials into dollars, with little or no exchange risk, and take their financial gains out of Iran. And this they have done with a vengeance.

By my estimates, capital flight from Iran has been roughly $250 billion to $300 billion over the past seven years. In short, a big chunk of Iran's oil revenues has gone out of the country in the pockets of a few. This phenomenon, though most evident in the case of Iran, is evident in all Persian Gulf countries.

While economists have long pointed out the deleterious effect of Dutch Disease on developing non-oil export industries, they have totally missed the fleecing effect. They don't see this real-estate bubble as robbery. But robbery is the only word that can describe it. This robbery is made all the worse as the average citizen faces higher prices and no capital gains to even offset the negative effects of inflation. The average citizen's standard of living has declined while a few have become rich beyond belief.

It is all the more robbery because no one in Iran or elsewhere in the Persian Gulf pays a capital gains tax on their ill-gotten gains. There is no income or capital gains tax in the GCC; and in Iran, government employees are the only segment of society that effectively pay the income tax that is due. The private sector, that is wealthy owners of real estate, evades taxes on a massive scale.

These are the ways that fleecing occurs. How can it be stopped? What is an alternative policy to alleviate the deleterious effects of Dutch Disease and the resulting fleecing that has gone unnoticed and unreported? We turn to the second approach to managing oil and gas depletion.

The alternative approach has been discussed on these pages before. Briefly and essentially, governments should adopt the following steps:
  • Over a period of 10 or so years, governments should wean themselves from oil and gas revenues and support their general expenditures from income taxes;
  • In the same period, they should develop a comprehensive, effective and equitable income tax system.
  • They should embrace a comprehensive sovereign wealth fund, eventually placing all government revenues in the fund within the prescribed 10-year period.
  • These sovereign wealth funds should issue an annual check of the same real value to every citizen (possibly over a certain age and contingent on certain criteria) now and for all future time.
  • The sovereign funds, the transformed birthright of all current and future citizens (not the private bank account of family rulers), should be managed by professional managers in a transparent and professional manner and answerable to the citizenry.

    If such an approach were adopted, government economic policies would be "forced" toward improvement, equity would be enhanced and fleecing dramatically reduced. If deplorable economic policies and the tolerance of economic injustice continue unabated, the region will continue to be unstable with yet another disruption always on the horizon.

    To stop the fleecing and reverse course, international economic institutions (the International Monetary Fund, World Bank, Organization for Economic Cooperation and Development), Western leaders and non-governmental organizations must publicize the egregious acts of pillaging state treasuries and policies that rob the citizenry of their birthright. They must shame family rulers and governments into changing their practices and economic policies. At the same time these countries must be persuaded to adopt a different approach - comprehensive and transparent sovereign wealth funds - for managing their oil and natural gas wealth.

    Hossein Askari is professor of international business and international affairs at George Washington University.

    (Copyright 2008 Asia Times Online (Holdings) Ltd. All rights reserved. Please contact us about sales, syndication and republishing.)

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