OWNERSHIP: Citizen Revenue Distribution Funds: Iraq

["William B. Ryan" <william_b_ryan@hotmail.com>]

Fair Use Claimed

Thomas I. Palley
Director, Globalization Reform Project
Open Society Institute, Washington, DC 20036
e-mail: tpalley@osi-dc.org

DISCUSSION PAPER

Combating the Natural Resource Curse with Citizen
Revenue Distribution Funds: Oil and the Case of Iraq

Executive Summary

Iraq provides another example of the natural resource
curse, whereby natural resource revenues cause
economic stagnation and detrimental political
outcomes, rather than growth and development. This
paper examines the idea of an oil revenue
distribution fund (ORDF) that would directly
distribute part of Iraq's oil revenues to Iraqis.
Such a fund can unleash positive lasting economic and
political transformation. However, it is critical
that the decision about creating a fund be made by
the Iraqi people, through legitimate democratic
institutions. Only this can ensure lasting political
legitimacy.

On the economic side, an ORDF can empower citizens to
lead economic growth. Oil rich countries frequently
suffer from economic activity skewed toward excessive
government, which also promotes corruption and
conflict. An ORDF can help rectify this. On the
political side, it will give ownership to citizens,
thereby creating an incentive for political
engagement to protect that ownership.

The paper also proposes a companion fund to
distribute some oil revenues to provincial and local
governments. This can ensure a fair regional
distribution of revenues, thereby reducing the
potential for regional grievances which can lead to
civil war.

These funds should be accompanied by regulations
asserting transparency and accountability in the oil
sector. All oil companies, state and private, must
publish oil production contracts and publish what
they pay government. This can help ensure that oil
revenues are properly recognized, and corrupt
sweetheart deals are avoided. As a first step, Iraq
should immediately sign up for the transparency
procedures inaugurated under the Extractive
Industries Transparency Initiative, which has been
endorsed by the G8.

These proposals also apply to other resource rich
developing countries. They are especially relevant
for Caspian basin and West African countries where
large oil flows are coming on line. These countries
risk being afflicted by the natural resource curse
owing to weak undemocratic governance and cultures of
corruption. ORDFs and transparency measures can help
combat the curse.

Developing efficient states with good governance
takes a long time. Developing oil fields and building
pipelines happens far faster. ORDFs and transparency
measures can be put in place immediately. They are
policies one might want even if quality of governance
is high - as in Alaska. They are doubly desirable
when governance is weak, and the need for
institutions to handle oil revenues is immediate.


July 2003.

The views expressed in this paper are those of the
author and not those of the Open Society Institute.

Introduction: the case for oil revenue distribution
funds1

In a recent New York Times op-ed (April 9, 2003),
Steve Clemons of the New America Foundation has
proposed that Iraq establish an Alaska-style oil fund
that would pay annual dividends to the citizens of
Iraq.2 In Alaska, revenues from oil leases have been
invested in a permanent fund which has grown to $23.5
billion in 2002, and part of the fund's income is now
distributed directly to Alaskans as a dividend.
Clemons has proposed that a similar fund be set up in
Iraq. The proposal is that Iraq should save a fixed
portion of its oil revenues which would be invested
in a portfolio of international equities and bonds.
This portfolio would effectively become the national
trust fund, and the fund's income would be
distributed to Iraqi citizens on an annual basis.
Overtime, the fund would grow as a result of
continuing saving of part of oil revenues, and so too
would the dividend distribution.

The current paper proposes a modification of this
proposal, suggesting the creation of an Iraq oil
revenue trust fund that would directly distribute oil
revenues to Iraqi citizens. Thus, rather than saving
a share of revenues in a trust fund and building up
the fund over time, a significant portion of oil
revenues would be immediately and directly paid to
Iraq's citizens. As an opening suggestion, the paper
proposes that twenty five percent of revenues be
distributed - though this figure is amenable to
change.

In addition, the paper proposes the establishment of
a companion fund that would distribute a share of oil
revenues to provincial and local governments. This
second fund can ensure a fair regional distribution
of revenues, thereby reducing the potential for
regional grievances which can lead to civil war. This
is a major concern in Iraq which is afflicted by
significant regional divisions.

The reason for this more robust approach to oil
revenue distribution is that there is an urgent need
for political and economic reform in Iraq, and this
need cannot be met under the more gradual Alaska oil
fund approach. The Alaska fund was established in
Alaska, a state with high quality of governance. The
gradual accumulation of revenues has over the last
twenty five years built up the Alaska portfolio, and
as the portfolio has grown, so too has the dividend
distribution. This has had the intended effect of
provisioning for the future, and building citizen
ownership and engagement. However, whereas a slow
process of accumulation was right for Alaska, it is
not right for Iraq which starts from a condition of
economic collapse, and with a history of autocratic
kleptocratic governance. Consequently, an accelerated
transformation is needed in Iraq. This bespeaks the
need for large-scale direct distribution of oil
revenues, rather than gradual intermediated
distribution done via a trust fund financed by
financial asset accumulation.

An oil revenue distribution fund stands to benefit
Iraq. But the arguments for directly distributing
revenues to citizens and provincial and local
governments also apply to other natural resource rich
developing countries. Owing to weak undemocratic
governance and cultures of corruption, these
countries are often afflicted by the natural resource
curse whereby oil fosters economic stagnation and
civil conflict, rather than growth and development.
Developing efficient states with good governance
takes a long time. Developing oil fields and building
pipelines happens far faster.3 Oil revenue
distribution funds and transparency measures can be
put in place immediately. They are policies one might
want even if quality of governance is high - as in
Alaska. They are doubly desirable when governance is
weak, and the need for institutions to handle oil
revenues is immediate.

More than this, revenue distribution funds change the
structure of the economy and incentives in ways that
can trigger lasting economic and political change.
Not only do they diminish the natural resource curse
with its risk of stagnation and civil conflict, they
also institute affirmative changes that (i) empower
citizens to take charge of the process of economic
growth, and (ii) give citizens an incentive to engage
in democratic politics.

Finally, it is critical that any decision to
implement an oil revenue distribution fund be taken
by the Iraqi people, through legitimate democratic
institutions. Paul Bremer, the top U.S. administrator
in Iraq, has recently expressed support for such a
fund (New York Times, July 13, 2003). Whereas it is
appropriate for Bremer to contemplate some form of
temporary distribution during the transition to
constitutional democracy in Iraq, any permanent
arrangement must be the decision of the Iraqi people.
This is the only way an arrangement can have lasting
political legitimacy.

The natural resource curse revisited

Iraq is abundantly rich in oil, having proven
reserves of 112 billion barrels, which represent
10.8% of total world proven reserves. Moreover, many
believe that Iraq's potential may be far greater as
the country is relatively unexplored due to years of
war and sanctions.4 However, like many other
countries rich in natural resources, Iraq has failed
to benefit from its oil wealth. In a real sense, Iraq
exemplifies the workings of the "natural resource
curse." The autocratic regime of Saddam Hussein used
Iraq's oil revenues to finance domestic political
suppression, military aggression, and state looting -
as exemplified by wasteful spending on presidential
palaces and transfers of funds to personally owned
foreign bank accounts. The result has been two
decades of economic stagnation, during which Iraqi
per capita GDP has fallen by over fifty percent.5
Iraq has also fought two costly destructive wars of
aggression with Iran and Kuwait, and it has had to
endure the censure of the international community in
the form of United Nations sponsored economic
sanctions.

The problem of the natural resource curse is now
gaining prominence. The Economist (May 24, 2003)
recently featured stories on oil wealth as the
"Devil's excrement," and on the role of natural
resources in fuelling civil war. Building on a decade
of scholarship (Gelb, 1988; Sachs & Warner, 1995;
Karl, 1997; Ross, 1997, 1999) on this important
subject, the NGO community is actively promoting a
new policy agenda aimed at addressing the curse.
Global Witness (December 1999) was an early
contributor with its report, Crude Awakening: The
Role of Oil and Banking Industries in Angola's Civil
War and the Plundering of State Assets. Oxfam America
(Ross, 2001) released a report, Extractive Sectors
and the Poor, in 2001. In May 2003 the Open Society
Institute's Caspian Revenue Watch (Tsalik, 2003)
released a major study, Caspian Oil Windfalls: Who
Will Benefit?. The study focused on needed
transparency and accountability improvements to the
state oil stabilization funds that have been set up
in Azerbaijan and Kazakhstan. Christian Aid also
released a report, Fuelling Poverty: Oil, War and
Corruption, in May 2003. And most recently, Catholic
Relief Services (Gary and Karl) released its report,
Bottom of the Barrel: Africa's Oil Boom and the Poor,
in June 2003.

The natural resource curse hypothesis maintains that
rather than fuelling growth and development, natural
resource wealth can become the cause of economic
stagnation, corruption, and civil war. Early research
focused on macroeconomic dimensions of the curse. One
key problem is "Dutch disease," whereby the real
exchange rate appreciates as capital flows into a
country in response to a natural resource boom.6 This
appreciation renders domestic manufacturing and
agriculture uncompetitive, causing lost jobs and
higher unemployment. These lost jobs are not
compensated for by growth in the natural resource
sector, which is capital-intensive. The decline of
manufacturing and agriculture also makes the economy
dependent on natural resources, contributing to
economic volatility since natural resource earnings
are highly volatile.

A second macroeconomic problem concerns fiscal policy
and inflation. Oil booms tend to raise expectations,
and contribute to unrealistic projections of future
income. This in turn leads to loss of control over
public spending, including taking on of high cost
public infrastructure projects, often financed with
foreign borrowing. These projects can also become the
vehicle for corruption and influence peddling. The
net result is loss of fiscal discipline that
contributes to inflation, the build up of external
indebtedness, and the development of cultures of
corruption.

In addition to these macroeconomic problems, the
natural resource curse undermines governance and
democracy. Oil generates large streams of foreign
exchange, and these flows become the basis for
patronage that supports dictatorship and autocracy.7
A second feature is that oil and mineral dependent
economies tend to spend a significantly greater share
of their GDP on military expenditures. Finally, oil
and mineral dependent economies are significantly
more prone to conflict and civil war.

There is strong empirical support for all of these
findings. Sachs and Warner (1995) have documented in
cross-country statistical regression analysis that
higher levels of oil and mineral dependence tend to
reduce a country's rate of economic growth. This
finding has been replicated by Leite and Wydmann
(1999) and Glyfalson et al. (1999). Ross (1999, 2001)
documents that after controlling for levels of GDP,
countries that have higher mineral and oil dependence
(defined as oil and mineral exports relative to GDP)
also score lower on the UN Human Development Index,
have larger shares of their population in poverty,
devote a greater share of government spending to
military spending, and are more authoritarian. Leite
and Weidman (1999) and Glyfalson et al. report that
higher mineral and oil dependent countries exhibit
greater  corruption, and Collier and Hoeffler (2000)
report that they also have a greater probability of
civil war for any given five year period.
There are four ways that oil and mineral dependence
tend to promote civil war and conflict. First, slower
growth and poverty creates resentment and frustration
that are the tinder for civil war. Second, corruption
in government fosters drive for regime change. Third,
authoritarian rule enables one party to grab control
of resources and use them for its own benefit,
thereby creating resentment among political
outsiders. This promotes regional secession movements
- as exemplified in Aceh and Southern Sudan. Fourth,
sale of looted natural resources can provide rebel
groups with financing - as exemplified by conflict
diamonds, and trade in cocaine and opium.

As is argued below, there are good grounds for
believing that direct oil revenue distribution funds
may be the most effective way of circumventing the
natural resource curse.  Not only do such funds have
positive macroeconomic growth and development
properties, they can also help address the causes of
civil war and contribute to affirmative political
development.

Iraq could greatly benefit from such a fund. It has
already suffered from the natural resource curse, but
the future may be bleaker still given that central
government has collapsed. Owing to Iraq's tremendous
ethnic and religious regional differences, there are
significant centripetal forces making for civil war
and conflict. In this circumstance, oil distribution
funds can help guard against a break-up of the Iraqi
state, with all the negative regional implications
that this would carry.

Advantages of an oil revenue distribution fund (ORDF)

Natural resources and oil wealth should be of benefit
to countries. The fact that they often are not is
because of failures of governance that are connected
with failures of democracy and public accountability.
An important contribution of an ORDF is that it may
significantly remedy this political failure by
creating a sense of citizen ownership, in turn
prompting buy-in to the political system. The reason
is that citizens eligible for fund payouts would have
an incentive to monitor governments and participate
in the political process to guard this benefit. ORDFs
create an entitlement, and with that entitlement
comes political buy-in - just as entitlement to
Social Security encourages political engagement
within the U.S. system. Another parallel is with
home-ownership, which can be viewed as contributing
to political stability by creating a vested middle
class. ORDFs can do some of the same by giving all a
stake in economic society.

Lack of widespread public political participation is
one source of governance failure. Government
corruption is another. Here too, an ORDF stands to
help by effectively pre-empting kleptocracy. Since a
portion of oil revenues would be pre-committed to
public pay-out, this would leave less in the hands of
government officials that could be stolen.
The simplicity of an ORDF offers further protection
against corruption. The fund would publicly declare
its annual dividend payment, and the size of that
payment would become public knowledge. Every eligible
Iraqi would therefore know what they are supposed to
receive, which would guard against skimming in the
distribution process. The principal sources of
corruption the fund would have to guard against would
be making payments to non-existent persons, and
making multiple payments to the same person.

Moreover, by taking these monies out of the hands of
government, this could also reduce the risk of civil
war and conflict. The academic research cited earlier
clearly shows that natural resources can drive civil
conflict, as parties struggle to gain control of over
resource revenues. Excluded groups have an incentive
to try and wrest control, while dominant groups have
an incentive to take a disproportionate share of
benefits. Creating a system in which all receive an
equal pre-determined share can alleviate these
tensions. Once the resource is seen as belonging to
the public, the incentive to wrest government control
for personal benefit is reduced as the value of
control over government is diminished.

Another advantage of an ORDF is that it is likely to
encourage efficiency in the oil industry. Since the
size of payments to citizens will depend on the
efficiency of the oil industry, this should
contribute to political pressure to improve
efficiency.

Beyond these political economy benefits, there are
also more standard economic gains from such funds.
When oil revenues constitute a large portion of the
economy, - as much as 50% of GDP in the case of Iraq
-, channeling them through government means that
government effectively runs the economy. Not only
does government have too large a say over economic
activity, it also becomes the target for corruption
and rent-seeking.8  Moreover, government may lack the
capacity to efficiently absorb and dispense these
revenues in a welfare-maximizing fashion. Under such
conditions, shifting toward decentralized absorption
is desirable. This can be done by distributing oil
wealth to the people, and letting them spend it on
what they deem is needed for their welfare. Economic
development surely involves the accumulation of
public capital and infrastructure, and this requires
government investment. But economic development also
requires the accumulation of private capital, based
on the decentralized decisions of individuals.
Putting extra money into the hands of individuals can
help this process.

Linked with this important benefit, is the fact that
such distributions can promote domestic demand, which
in turn can contribute to economic growth. Moreover,
the contribution to domestic demand should be
enhanced since the oil dividend will be paid
equitably across society. This should help remedy a
persistent problem in developing countries, which is
the failure to develop robust domestic demand-led
growth that contributes to deep domestic market
development. Instead, developing economies have too
often sought to rely on export-led growth, which
tends to promote enclave development that lacks
strong linkages with the rest of the economy (Palley,
2002). This feature is particularly true of countries
that have relied on oil and mineral extraction.
Another economic benefit of an ORDF is that it can
contribute to the development of credit markets. The
dividend distribution will provide eligible citizens
with a steady stream of income, and this income can
then be used as collateral to borrow against. In many
developing countries lack of access to credit is a
restriction on entrepreneurship and development. The
dividend entitlement can serve as seed money giving
people access to credit. And as people borrow, this
will stimulate small business, stimulate the growth
of credit markets, stimulate financial development,
and entrench laws of contract, commerce, and
property.

ORDFs also stand to have a progressive impact on
national income distribution. Though each eligible
person (rich and poor alike) will receive the same
absolute payment, this will amount to a much larger
percentage increase in poor people's income. Rather
than being a weakness, this common payment feature is
a strength. First, it contributes to transparency and
simplicity. Second, there is a political message in
treating rich and poor alike in a developing country
context. Third, there is little to be gained from
trying to micro-engineer the oil dividend payment to
enhance its progressivity. Most developing countries
are characterized by a wealthy elite, a small middle
class, and a large class of poor people. Paying less
to the wealthy would free up relatively little money,
at the cost of creating complexity and potential for
political resentment.

Finally, a last benefit of an ORDF is that it will
require an administrative structure to implement it.
This structure can become the backbone of a formal
economy in which workers and entrepreneurs pay taxes,
workplace conditions are regulated, and the
government is able to track economic activity. Once
again there is a parallel with Social Security in the
U.S. economy, where an individuals' Social Security
number provides the basis for many different forms of
economic record keeping, both public and private.

Disadvantages of an ORDF?

The advantages of a ORDF are multiple. Are there any
drawbacks? One claimed drawback is that it could
generate a welfare dependency effect. Under this
hypothesis, an oil dividend entitlement is supposed
to produce a national epidemic of laziness. This is
of course possible, but if so it bespeaks an urgent
public policy need to raise upper income bracket tax
levels - especially on dividend and interest income -
as too much income promotes laziness. The bottom line
is that though being economically meaningful for poor
Iraqis, any oil dividend will not be sufficient to
provide an affluent lifestyle. Consequently, the
incentive to economic action will remain intact.

A second problem is that oil dividends will reduce
the amount of funding available for public
infrastructure, health, and education spending. As a
developing country, Iraq has huge needs in these
areas - particularly after two decades of war and
economic sanctions. This need is undisputed, but at
the same time there must be grave doubts about Iraq's
governmental capacity to undertake these types of
investment.

In addition, private individuals have pressing
private needs, and using part of Iraq's oil revenues
to meet these needs may yield greater social welfare
gains. Economic development policy always involves
trade-offs. Funding an ORDF will reduce funds
available for infrastructure spending. The question
is do the benefits, in terms of contribution to
private sector and political development, outweigh
the losses from reduced infrastructure spending.

Finally, the net loss of public investment resulting
from funding an ORDF may be quite small. First,
marginal public investments which add the least to
welfare will be cut first, while more essential
investments will be retained. Second, reducing
government revenues will reduce the incentive for
corruption and rent-seeking. By hardening the
government budget constraint, the Iraqi government
may end up providing better value for money, thereby
diminishing the net reduction in public investment
spending.

A third objection is that making such dividend
payments risks creating a political culture of
opposition to government and collectively provided
public goods, both of which are needed ingredients
for a successful economy. Here, the argument is that
individuals will come to persistently push for
increased oil dividend payments, thereby ultimately
starving government of funding, to the detriment of
the economy. The danger of creating such a political
culture is real, but it is also the case that having
an inefficient corrupt government contributes to the
creation of anti-government sentiment. Thus, putting
in place an ORDF which helps to reduce government
corruption and inefficiency, may on balance
strengthen support for government rather than reduce
it.

A last possible disadvantage concerns the potential
impact of an oil fund dividend on population growth.
The possibility of this effect is contingent on
specification of the eligibility requirement. In
particular, if all citizens - including children -
are eligible, this could provide an incentive for
Iraqi's to have more children. Iraq has a relatively
young population, and it would be unwise to create a
need for even faster job growth in a country and
region with high unemployment. This suggests that
only adult citizens be eligible, thereby removing any
incentive to have children to get additional oil
dividends. Furthermore, by reducing the number of
recipients, it would raise the payment per recipient,
in turn strengthening the incentive for adult Iraqis
to become politically engaged to protect the ORDF.

The case for a companion provincial and local
government fund

An ORDF would distribute oil revenues to individual
citizens. In addition, countries may wish to
establish a provincial and local government revenue
fund. This arrangement would reserve a share of oil
revenues for distribution to provincial and local
government, with distribution done on a per capita
basis.9 Such a fund has the important political
benefit of placing regional distribution of oil
monies on automatic pilot, thereby reducing potential
for regional grievances that can cause civil war.

This proposal has special salience for Iraq, which is
divided into three mutually hostile regions - the
Kurdish north, the Sunni middle, and the Shiite
south. These divisions create the real prospect of
civil war and the possibility of the disintegration
of Iraq - a prospect that stands to be enhanced if
regions feel that they are being short-changed by
central government. A fund that ensures a fair
regional distribution of national revenues can help
defuse this problem.

A comparison with alternative possible arrangements

Privatization

An ORDF represents one possible arrangement for
dealing with large oil revenues in a environment of
weak democratic governance. Another widely canvassed
possibility is privatization, which involves selling
the state oil industry and oil production rights to
private sector investors. In most instances, the
majority of these assets are likely to end up in the
hands of multinational oil companies.

Privatization has been a big part of the development
agenda pushed by the international financial
institutions (the International Monetary Fund, the
World Bank, and the multilateral regional development
banks) over the last two decades. The argument is
that it promotes productive efficiency by restoring
the profit motive. It also resonates with the neo-
liberal political agenda of shrinking the economic
involvement of the state. For these reasons, it is
popular among economic conservatives.

However, privatization suffers from significant
political and economic problems, and these problems
are especially acute in Iraq. Regarding political
problems, the fact that Iraq is an occupied country
means that privatization may be interpreted by Iraqis
as a self-interested action of the occupying power.
This perception stands to be reinforced by the fact
that most of Iraq's oil industry would end up in the
hands of foreign multinational oil companies, the
largest of which are American and British.

Not only does this lack of political legitimacy stand
to create short term political problems, it also
stands to undermine the privatization process.
Investors, recognizing the lack of political
legitimacy and the fact that a future Iraqi
government might unilaterally reverse privatization,
will bid less for the assets. The lower prices
obtained under the privatization process will then
further undermine legitimacy by deepening beliefs
that privatization was not in Iraq's self-interest.

Beyond these political difficulties there are other
problems with privatization. First, the history of
large scale privatization is fraught with failure.
This is particularly evident in the former Soviet
Union, where the selling-off of industry created a
new oligarchy, and the state failed to get money's
worth. Now, not only is the Russian state
significantly poorer than it would have been had
privatization worked as predicted by the book, but
new problems - perhaps worse than the earlier ones -
have also been created. Earlier, the problem was
productive inefficiency and the featherbedding of an
inefficient state bureaucracy. The new problem is an
oligarchy whose wealth enables it to exert a
corrupting and corrosive influence on democratic
governance and the economy.

A second problem with large scale privatization in
weak governance countries concerns what to do with
the proceeds. Even if privatization is effected
legitimately at fair market prices, there remains the
problem of what to do with the proceeds. A principal
problem in natural resource rich countries is
kleptocratic government. Privatization may compound
this problem. If done properly, privatization sale
proceeds should equal the net present value of all
future profits. In effect, privatization converts
future profits into a lump sum. This conversion gives
kleptocratic governments an even larger sum to spend
and steal - a case of jumping from the frying pan
into the fire. If privatization aims to cure
corruption, theft and waste of state revenues,
nothing could be worse than putting even larger
amounts of money under government control.

Applied to Iraq, the bottom line is that oil sector
privatization is unlikely to work for both political
and economic reasons. These arguments against oil
privatization also apply in other developing
countries.

Share distributions

An alternative to privatization is a full or partial
distribution of shares in state companies to
citizens. The advantage of full distributions is that
they would ensure that ownership and control passes
to the private sector, whereas if the government
retains a significant stake it can exercise de facto
control. The putative benefit of a share distribution
scheme is that it provides citizens with a vested
interest, thereby creating incentives for greater
political involvement to ensure good business
management and good governance.

Balanced against this, there are significant
drawbacks to share distribution schemes. First, the
initial distribution creates hundreds of thousands of
small shareholdings that are extremely costly to
administer. Second, many of these shareholdings tend
to be sold immediately, thereby driving down the
share price - though this effect can be delayed by
barring immediate sale upon distribution. Third, if
history is any guide, over the longer term there is
consolidation of holdings. Consequently, the putative
political benefit of mass engagement of small
shareholders is forfeited. Fourth, and finally, share
distributions prejudice the interests of future
generations in favor of today's generation. In Iraq,
a share distribution would hand over the oil industry
to today's Iraqis, allowing them to spend the wealth
as they wish. Some, no doubt, would invest the
proceeds in ways that benefit future generations, but
the forces of inter-generational altruism are
imperfect. Consequently, a share distribution will
fail to properly protect the interests of future
generations.

In sum, share distributions tend to generate limited
and short-lived political gains, while prejudicing
the interests of the future. They yield only a
fraction of the benefits available from an ORDF, yet
have all the costs and many others as well.

Oil stabilization and saving funds

A third alternative is the creation of an oil
stabilization and saving fund. Such funds have been
examined by the IMF (Davis, et al., 2001). Their
basic purpose is to shield the government budget from
the revenue uncertainty and volatility of natural
resource revenues, and to save for future generations
given that natural resources are often non-renewable.

Such funds can make a contribution to improved
governance, particularly by contributing to greater
transparency of natural resource revenue flows. They
can also help guard against the problem of "Dutch
disease" by ensuring that some of the revenues are
directed to accumulation of foreign assets. This
helps prevent exchange rate appreciation which
undermines international competitiveness. Finally, to
the extent that government spending is tightly tied
to fund revenues, they can contribute to fiscal
discipline.

These are real benefits, yet at the end of the day
such funds represent a relatively shallow form of
reform. This is because there remains the problem of
governing the fund, and ensuring that its revenues
are used for the benefit of citizens rather than
wasted or stolen. Furthermore, governments can avoid
the putative income constraint by borrowing. The
bottom line is that to work well, oil stabilization
funds need good governance. However, these funds do
not themselves produce the institutional and
political change needed for good governance. In
effect, the money remains in the hands of dishonest
governments that sit atop systems in which incentives
for citizen political engagement are limited. This
contrasts with an ORDF in which the money is
distributed to the citizenry, thereby changing
incentives for political engagement.

Democracy and transparency: other measures to
strengthen an ORDF

The workings and effectiveness of an ORDF can be
greatly strengthened by other institutional changes.
For every institution there is the question of "who
will monitor the monitors:" The challenge is ensuring
that the institution is run efficiently in the
interests of its legal beneficiaries.

Democracy is a key ingredient, as it can serve as a
means by which citizens protect their interests
against government failure. Democratic process (i.e.
formal elections) is the easy part. The difficult
part is creating a culture of democracy marked by
trust in the process (i.e. if you lose an election
you hand over power), and inclusion of the interests
of supporters of the party out of power.

The introduction of formal democratic processes can
help ensure the success of an ORDF. However,
interestingly, an ORDF can also help ensure the
success of democratic reforms. This is because the
fund will automatically distribute revenue to all
citizens, thereby giving all an incentive to engage
politically. Simultaneously, by reducing government
revenues, it will reduce the ability of government to
favor select groups at the expense of others. This
feature is particularly important in Iraq, which is
divided into three major ethnic blocs - Kurds, Sunni
Muslims, and Shiite Muslims - which have a history of
antagonism and mistrust.

Embedding the rules of the ORDF in the constitution,
and requiring that changes to the rules meet the
requirements of constitutional change can be another
important protection. Since constitutional change
needs super-majorities, this guards against simple
majority governments making changes that exclude
opponent groups.

Transparency of the ORDF and the oil industry will
also be critical. This means the fund should have
audited public accounts, and it should publish its
revenues and administrative costs in a transparent
accessible fashion. The U.S. Social Security system
again provides a model, publishing as it does an
annual detailed report, and sending a simple annual
statement to every beneficiary.

To the extent that the state oil company remains the
single producer, it must be subject to full
transparency and accountability. Its financial
accounts and production figures must be audited and
made public, while its top management and board of
directors must be subject to public accountability
and control. In the event that production is leased
to private producers, these producers must "Publish
What They Pay (PWTP)" government in the form of
signing bonuses, lease purchase costs, production
sharing, oil payments in kind, and taxes.10 PWTP is
an important transparency mechanism that uses the
power of double-entry bookkeeping to guard against
corruption, since the payments of companies sum to
provide a check on the reported oil revenue of
government. Having companies publish what they pay is
in the public interest, since it contributes to a
system in which incentives for corruption are
minimized.

In addition to publishing what they pay, oil
companies should Publish What They Contract - that is
publish the commercial details of their oil
production contracts with government. These contracts
should be subject to public competitive bidding, and
an ombudsman process allowing for complaints about
corruption and violation of process should be
established as part of the ORDF. Competitive bidding
and publication of contracts is essential to ensure
that countries get value, and to bar sweetheart deals
purchased with illegal side-payments.

The Extractive Industry Transparency Initiative
(EITI), launched by Prime Minister Blair in the
United Kingdom in June 2003 with the cooperation of
other G8 leaders, offers the perfect vehicle for
beginning the change process. EITI is intended to
reduce corruption in natural resource industries by
having governments and companies publish what they
earn and publish what they pay respectively. It is a
country level voluntary compact, to which countries
and companies both sign on. And much work has already
been done designing appropriate revenue and payment
reporting templates.

Iraq, even while under U.S. administration, should
sign on to this process.11 It is a step toward
transparency that will be needed no matter what. And
it is a step that will facilitate the transition to
peace and democracy by showing that the occupying
administration is indeed accounting properly for
Iraq's oil production. Moreover, since EITI is an
international process, it can contribute to the
internationalization of governance in Iraq, thereby
helping the U.S. begin smoothly transitioning from
its current politically difficult position which has
it widely viewed as an occupying power.

Finally, natural resource rich developing countries
frequently need financial assistance from the IMF and
World Bank, as will Iraq. This assistance should be
closely tied to natural resource revenue flows. To be
eligible, governments should have to provide detailed
estimates of anticipated oil production and
revenues.12 The fact that countries want the
assistance provides a nice incentive for an honest
revelation of their revenue potential. Understating
for purposes of siphoning off monies for corrupt
purposes, will reduce the amount provided.

Further details about fund payments how the fund
might work

If an ORDF is established in Iraq, an important issue
will be who is eligible for distributions. One
possibility is to make all Iraqi citizens eligible.
Given Iraq's population of 25 million, and assuming
annual oil revenues of $11 billion of which 25
percent are distributed, this would translate into an
estimated per capita payment of $110 per year.13 For
Iraqi households this represents a significant
payment since Iraq's estimated per capita GDP was
$2,500 in 2001, of which households only saw a
fraction (perhaps 60%).14

An alternative is to make distributions to only adult
citizens. Iraq has a population of approximately 25
million, of which 17 million are adults. Again
assuming a distribution of  $2.75 billion (i.e 25% of
$11 billion), this would translate into a larger
estimated payment of approximately $160 per adult - a
bonus equal to as much as 10% of the average Iraqi's
income.

There are a number of reasons for preferring a system
that only distributes to adults. First, a principal
goal of the arrangement is to obtain citizen
political buy-in. This requires reaching the adult
population, and it is best done by making
meaningfully large payments to adults. Second, making
payments to all citizens could have unintended
negative population effects by creating an incentive
to have additional children. This is something to be
avoided. Like other Arab countries, Iraq has a
relatively youthful population, and it also has
chronically high unemployment. Creating a plentiful
supply of decent-wage paying jobs represents one of
Iraq's great economic challenges, and increasing the
rate of population growth only compounds the scale of
this challenge.

Can Iraq afford an ORDF?

The analytical arguments for an ORDF are strong. That
raises the question of whether Iraq can afford such a
program. The principal objection to such a fund is
that the costs of reconstruction in Iraq will be
enormous, and these costs already exceed Iraq's
projected income. Diverting income into an ORDF would
therefore further the shortfall.

This shortfall argument is fundamentally flawed. The
test for Iraq should be how to best spend its scarce
resources so as to promote maximum political and
economic development. For Iraq, the greatest return
will come from putting in place measures that avoid a
return of the natural resource curse. An ORDF is the
best way to ensure that outcome. It stands to raise
political engagement and improve democracy, reduce
government corruption, and reduce the likelihood of
civil conflict by diminishing cause for regional
grievance. An ORDF also promises to accelerate
private sector economic development through a process
of demand-led growth. And as the supply-side of the
economy grows, this can provide the tax base needed
to fund public infrastructure.

If the shortfall argument fails with regard to an
ORDF for individual citizens, it fails even more
comprehensively regarding a fund for distributing to
provincial and local government. In this case, it is
not a matter of taking away money from government,
but rather one of changing the distribution within
government. Instead of central government directing
the reconstruction effort, provincial and local
governments would. This may even improve the quality
of reconstruction. At the same time, it ensures
regional fairness, thereby reducing the danger of
civil war and the break-up of the Iraqi state.
One area where reconstruction investment will be
critical is the oil industry itself. Investment in
this industry is needed to ensure a steady and
growing flow of revenues to Iraq. However, as with
any business, investment expenditures which are long
lived and pay back over many years, are best financed
by borrowing. Iraqi oil in the ground may be used to
collateralize such borrowing, but this should still
leave current oil revenues free for distribution.
Thus, investment in the oil industry, if
appropriately financed, is not inconsistent with an
ORDF.

One last concern is Iraq's foreign debt, which is
estimated to be somewhere between $300 - 400 billion.
Iraq is unlikely to be able to pay back this debt,
and nor should the debt be allowed to prevent Iraq
from pursuing those policies that are in its best
interest - which includes setting up an ORDF. Once a
national government is constituted, Iraq should
approach the Paris Club for significant debt
cancellation. If this is not forthcoming, Iraq should
consider invoking the doctrine of "odious debt" to
repudiate some of its debts. This doctrine was
invoked by the U.S. after the Spanish - American war
of 1898, and has standing in international law
(Adams, 1991). The basic rule is that debt can be
considered odious if (1) it was incurred without the
consent of the people (i.e. by non-democratic
regimes), (2) it was not used to benefit the people,
and (3) lenders were aware of (1) and (2). These
conditions almost certainly apply to much of the debt
incurred under the regime of Saddam Hussein.

Conclusion

This paper has proposed the creation of an oil
revenue distribution fund that would directly
distribute part of oil revenues to Iraqi citizens.
Such a fund could unleash positive and lasting
economic and political transformation in Iraq. On the
economic side, it stands to empower citizens to lead
the process of economic growth. Oil rich countries
frequently suffer from corruption and conflict, and
economic activity is skewed toward excessive
government and unproductive activity. An oil
distribution fund can help rectify this. On the
political side, it would give citizens a sense of
ownership, thereby creating an incentive for
political engagement to protect that ownership.

A companion fund that distributes oil revenues to
provincial and state governments could ensure a fair
regional distribution of revenues, thereby reducing
the potential for regional grievance which can cause
civil war.

These measures should be accompanied by regulations
asserting transparency and accountability in the oil
sector. All oil companies, state and private, should
be obliged to publish oil production contracts and
publish what they pay government. This can help
ensure that oil revenues are properly accounted for,
and corrupt sweetheart deals are avoided. As a first
step, Iraq should also immediately sign up for the
revenue transparency procedures inaugurated under the
Extractive Industries Transparency Initiative, which
has been endorsed by the G8.

These proposals also apply to other resource rich
developing countries. They are especially relevant
for Caspian basin and West African countries where
large oil flows are starting to come on line. These
countries risk being afflicted by the natural
resource curse owing to weak undemocratic governance
and cultures of corruption. Rather than fostering
growth and development, oil often causes stagnation
and civil conflict. Oil distribution funds,
accompanied by transparency measures, can make a
critical contribution to growth, democracy, and
political stability. Development of efficient states
and good governance takes a long time. Developing oil
fields and building pipelines happens far faster. Oil
funds and transparency measures can be put in place
immediately. These are institutions and policies that
one might want even if the quality of governance were
high - as in Alaska. They are doubly desirable when
governance is weak, and the need for institutions to
handle oil revenues is immediate.

A final issue concerns the politics of creating oil
funds. Any permanent ORDF must be the creation of the
Iraqi people, done through legitimate democratic
institutions. Only that can ensure lasting political
legitimacy. However, in the immediate transition to
democracy period, U.S. Administrator Paul Bremer III,
should consider making temporary distributions. This
would give credibility to U.S. claims that the war
with Iraq was not about oil by showing that oil
revenues are being directed for the benefit of
Iraqis. It would also represent a high impact - high
visibility political and economic policy program,
delivering immediately when time is of the essence.
Lastly, revenue distribution should appeal to both
economic policy conservatives and liberals. For
economic conservatives, they represent shrinking
government and giving money back to citizens to
control their own economic destiny. For economic
liberals, they can ensure that a nation's wealth is
equitably and fairly shared.

References

Adams, P., Odious Debt: Loose Lending, Corruption,
and the Third World's Environmental Legacy,
Earthscan, Toronto, 1991.

Bremer, L. P., "The Road Ahead in Iraq - and How to
Navigate It," New York Times, July 13, 2003.

Bueno de Mesquita, B., and Root, H., "The Political
Roots of Poverty: The Economic Logic of Autocracy,"
National Interest, Summer 2002, 27 -37.

Christian Aid Report, "Fuelling Poverty: Oil, War,
and Corruption," May 2003.

Clemons, S., "Sharing, Alaska-Style," New York Times,
April 9, 2003.

Collier, P., and A. Hoeffler, "Greed and Grievance in
Civil War," Policy Research Working Paper 2355,
Development Research Group, World Bank, May 2000.

Davis, J., R. Ossowski, J. Daniel, and S. Barnett,
"Stabilization and Savings Funds for Nonrenewable
Resources: Experience and Fiscal Policy
Implications," Occasional Paper 205, International
Monetary Fund, Washington, DC, 2001.

Gary, I., and T. L. Karl,  "Bottom of the Barrel:
Africa's Oil Boom and the Poor," Catholic Relief
Services, June 2003.

Gelb, A., Oil Windfalls: Blessing or Curse, New York:
Oxford University, 1988.

Glyfalson, T., T.T. Herbertsson, and G. Zoega, "A
Mixed Blessing: Natural Resources and Economic
Growth," Macroeconomic Dynamics, 3 (June 1999), 204 -
25.

Karl, T., The Paradox of Plenty: Oil Booms and Petro-
States, Berkley: University of California Press,
1997.

Leite, C., and J. Weidman, "Does Mother Nature
Corrupt? Natural Resources, Corruption, and Economic
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Palley, T.I., "A New Development Paradigm Domestic
Demand-led Growth: Why It is Needed and How to Make
It Happen," Foreign Policy in Focus, Discussion
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Ross, M., "The Political Economy of the Resource
Curse," World Politics, 51 (2), 1997.

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Politics, 53 (April 2001a), 325 - 361.

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America, October 2001.

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1 In thinking about this issue I have benefited from
discussion on Steve Clemon's Alaska-style fund
proposal held at IMF headquarters, Washington DC, on
June 3, 2003.  The usual disclaimers apply.
2 Proposals in a related vein have also been put
forward by others. For instance, The Economist (April
19, 2003, p.10) suggests "it would be wise to pay
some cash out of oil revenues to every Iraqi."  The
current paper fully articulates the economic and
political case, and expands and formalizes this
proposal.
3 This point is emphasized by Gary and Karl (2003) in
their report on Africa's oil boom. They urge a "big
push" in the policy environment so that policy can
catch up. Oil distribution funds represent such a
push.
4 Se U.S. Department of Energy Iraq Country Analysis
Brief,
http://www.eia.doe.gov/emeu/security/esar/esar.html
5 "Special Report Iraq: Economy - assessing Iraq's
Economic Future," Janet Matthews Information
Services, Quest Economics Database, MEED Weekly
Special Report, June 20, 2003.
6 This phenomenon is referred to as Dutch disease
after the experience of the Dutch economy following
the discovery of large North Sea natural gas deposits
in the 1960s.
7 Bueno de Mesquita and Root (2002) analyze the
political economy of autocracy, and emphasize the
role of patronage. Even dictators need a political
base of support, and oil is the perfect commodity for
financing patronage.
8 Rent-seeking is the economists' term for describing
the political process (lobbying, bribery, etc.) of
seeking to get abnormal profits.
9 Note, whereas distributions to families on a per
capita basis create an incentive to have additional
children, such distributions to state governments do
not as individuals do not directly get the benefit
but they bear all the cost.
10 It is important that taxes be paid to the oil
revenue distribution fund. Absent this, government
could raise taxes on the oil industry, squeezing out
all the financial surplus and leaving nothing
available for the fund.
11 At this stage it would be Iraq's national oil
company that publishes what it pays government.
Later, if some of Iraq's oil production were leased
to private sector firms, they too would publish. EITI
is intended to apply to both private and state oil
companies, as ensuring transparency in the state
sector is a major problem. Having Iraq's state oil
company sign up would establish an important
precedent that would benefit all countries.
12 This policy suggestion was put forward by an IMF
official at the June 3, 2003, discussion on Clemons'
Alaska-style oil fund proposal.
13 The $11 billion figure is based on a daily
production rate of 1.5 million barrels sold at a net
profit of $20 per barrel. Oil prices are widely
anticipated to be around $25 per barrel, and Iraq has
low costs of production which are generously covered
by assuming costs of $5 per barrel.
14 The estimate of Iraq's per capita GDP is from the
CIA.

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