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    Middle East
     Aug 30, 2012


THE GULF'S BLACK TREASURE
Islamic tools to the rescue

This is the 15th article in a special series on oil and the Persian Gulf. For previous articles, please see the foot of the page.

As we have said again and again in this series of articles, oil could have been, and should have been, a blessing in the Middle East but it has turned out to be more a curse.

Why has the economic and political development of in these oil-exporting countries been so dismal? The "oil curse" has had many tentacles. With vast oil revenues, the temptation to rob the citizenry has been irresistible for rulers, and the elite - the family and friends of the rulers, cronies, senior military and anyone who had even a remote opportunity to enrich themselves.

To differing degrees in all of these oil-exporting countries, those in

 

power (family and other undemocratic rulers):
  • Have used oil revenues to buy short-run support for their regime with their citizenry through subsidies, handouts and other benefits;
  • Have bought the services of important lobbyists (ex-senior government officials and corporations) in the United States and Europe to back their rule;
  • Have wasted billions on imported arms to buy foreign support, arms that most likely would be used against their own people;
  • Have impeded the development of viable institutions, especially the rule of law that could check their plunder; and
  • Have robbed their countries for personal enrichment to an extent that may be turn out to be unparalleled in the history of man - but leaders around the world, including those at the International Monetary Fund and the World Bank, say nothing.

    As the rulers impeded the development of effective institutions, they paid little notice to the fact that institutions are at the foundation of sustained economic development and growth, and in particular the development of a thriving private sector.

    The implications of economic failure in the region are most visible and ominous in high unemployment. Years of corruption and plunder at the expense of development and growth are coming home to roost; sub-par economic growth over decades and change in age structure present the more populous countries with an unemployment problem that is a ticking bomb for the foreseeable future.

    What can they do? The oil exporters should, without delay, re-orient the role of oil in their economies. In all these countries, oil resources belong to the state and are, in turn, the birthright of current and future generations. Oil does not belong to rulers to generously "share" with citizens. The state has the responsibility to preserve equal benefits from all exhaustible resources for all generations.

    Oil is an important part of these countries' stock of capital and its depletion should be replaced by capital of another form to preserve the rights and benefits of current and future generations. In the case of Islamic communities, this must be done in such a way that all citizens - current and future generations - benefit equally; just as we should consider ourselves stewards of our environment so that those who follow us can enjoy the same, so should we also take care of exhaustible resources for the equal benefit of all generations.

    As a rule, oil revenues should not finance consumption, public or private. If the oil is used to finance consumption, then eventually the country's economy will fall off the cliff when oil runs out, that is, with a gross domestic product of zero.

    Using oil revenues to finance consumption is detrimental, but what about building infrastructure and developing industries to provide jobs now and in the future? If a government selects infrastructure projects and industries to develop, will they be the most needed ones? Won't those who get construction contracts benefit more from oil funds than the rest of the citizenry? And if all revenues are used now, will future generations receive their fair share of benefits from oil depletion?

    The role of the government should be reduced; a healthy private sector should be encouraged and nurtured; and the government should rely on taxes to finance its activities-something it would have to earn by developing a healthy private sector economy.

    There is only one efficient and just way to manage oil depletion and its associated revenues. First, wean the government from oil revenues over a period of say 10 years (a period of time to develop an efficient and equitable tax system to provide revenues for the government). Place oil revenues into a well-managed sovereign wealth fund (SWF) and give an equal real payout directly to each citizen, today and for all time. The management of such a fund must be transparent and outside of the personal control of the rulers and must be designed to afford appropriate incentives to individuals to live productive lives and to contribute to economic and social prosperity.

    This may sound like a difficult task, but it is not. The real payout could be readily calculated and updated, as a moving average, to reflect changes in the oil and gas markets and population. Such an approach would reduce wasteful government expenditures, be they subsidies or military expenditures. These could no longer be financed by easy money. Individuals would be in a position to spend their money as they wished, thus this would be the most efficient way to transfer benefits to the citizenry, as done partially in Alaska.

    The government would be forced to become more efficient and accountable because it would have to rely on taxes for revenues, as do most countries. Rulers and their cronies would lose access to oil revenues and would have to find productive work instead of corrupt rent-seeking activities that impede the development of good institutions, a pre-requisite for sustainable private sector growth.

    There are of course a number of operational issues with such a fund. It seems reasonable that only citizens should be the beneficiaries of any payout from the fund as the oil belongs to citizens of all generations. A pertinent question is whether payouts should be given to adults only? If payouts are given to all citizens regardless of age, is it reasonable to assume that a minor would be sufficiently responsible? Should the payment then be made to the parent or the guardian of a minor?

    If yes, then such a policy could encourage population growth (and the more children one has the larger the share of the fund's payout). On the other hand, if the first payment (representing the accumulated annual payouts from the prior 16 or 18 years) to a citizen is set contemporaneous to the attainment of adulthood, would that expectation of such a financial "windfall" create moral hazards and result in unintended waste?

    Given the above moral hazard, one could argue for instituting compensating factors that would serve to minimize unintended consequences. Specifically, the first payment from the fund could be tied to some socially acceptable (or desirable) criteria. For instance, for those in 18-to-30 age bracket, the first and subsequent payouts could be made conditional to the citizens' achieving a minimum level of educational proficiency, or indeed, for having a history of productive and legal employment if not attending school.

    Such a condition would encourage literacy amongst the populace and could support economic growth. Another condition that could be attached to a citizen's right to receive current and future payouts from the fund is the maintenance of a clean civilian record.

    A potentially interesting application of the fund is to explore a design to mimic the role that social security plays in the wealthier countries. Thus, payouts could be higher when a citizen reaches a certain given (retirement) age. These and other features could have a significant effect on a number of related factors, such as birth rates. For our limited illustrative purposes here, we assumed none of the above-mentioned options.

    An obvious attack on any scheme is that individuals would become lazy, would not work and in the process society would become less productive. While this is a legitimate concern it need not become a fact of life. If governments develop effective institutions, adopt rational and consistent economic policies and generally provide a supportive business climate, citizens will be more motivated (and will have the resources) to invest and invigorate private sector growth. At the same time the eligibility to receive payments from the fund could be tied to definable, objective and socially desirable achievements.

    From an efficiency standpoint, it is more efficient to give each individual the same fixed real sum of money every year than to indirectly give him or her the same amount by means of various subsidies. The reason is simple. All individuals would not want the same subsidies. One may want food and shelter, while another may want clothing and healthcare.

    What if social and private returns diverge significantly? The social return to certain infrastructure and other inputs such as education are so high that a dollar spent on these increases the welfare of society by more than the aggregate welfare of all current and future generations by dividing up this dollar between all current and future members of society.

    The point is that if we had all such information and could make such interpersonal welfare judgments, it is possible that individual transfers may not always be the socially optimal solution. But even the provision of infrastructure, such as a roads, from oil revenues could be questioned as future generations may benefit less (if the road would not exist in the future) or more (if the road results in significant economic boom in the future).

    To adjust for economic and social distortions, these countries desperately need an effective system of taxation. In Islam, taxation by the state to fulfill social requirements is clearly envisaged and endorsed. Yet none of the Persian Gulf oil exporters have an effective income tax system to address social and economic needs.

    If these major oil exporters want to re-orient their economies, then such a fundamental turnaround is the best way forward. It would show the citizenry that they are willing to truly reform; to share the wealth of the country equitably; to address corruption at its roots; and to establish a system that would provide financial support equitably to all, while supporting a private sector that could create badly needed employment opportunities.

    NEXT: Policy package for turnaround

    Previous articles in this series are:
    Part 1: Riddle of the sands
    Part 2: The sweet and sour of oil
    Part 3: The driver of oil prices
    Part 4: OPEC in the driving seat
    Part 5: The OPEC bogeyman
    Part 6: OPEC and the sanctions highway
    Part 7: Oil-price shocks lie in wait
    Part 8: Whose oil is it anyway?
    Part 9: The dark side of oil
    Part 10: Institutions matter
    Part 11: Oil-rich rulers blind to the future

    Part 12: 'Arab Spring' without a bloom
    Part 13: Reform - or be kicked out
    Part 14: Oil's toxic partner: Guns

    Hossein Askari is Professor of Business and International Affairs at the George Washington University.

    (Copyright 2012 Hossein Askari)




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