Managing Windfall Wealth: How Oil

Resources Can Generate Development

Rather than DecayLarry Diamond with the assistance of Jack MosbacherLecture to Ghana Centre for Democratic DevelopmentJune 25, 2014

Africa’s Comin

g Resour

ce Boom

Africa’s Coming Resource Boom

12 New Exporters, 25 billion barrelsWest Africa (Gulf of Guinea)

Gambia, Ghana, Liberia, Sao Tome and Principe, Senegal, and Sierra Leone

East Africa (Rift Valley)Ethiopia, Kenya, Malawi, Mauritius, Tanzania, and Uganda

Transformative ImpactTotal GDP (2011): $163 billion~$3 trillion$60-$100 billion annually Increase of over 1/3

The Resource CurseCountries with valuable natural resource wealth tend to experience:

Lower economic growthMore economic volatilityImpaired human developmentDramatically worse governanceLess political freedom & democracyHigher instance & severity of civil war

The Resource Curse:Economic Causal

Mechanisms Inherent instability of commodity

markets—“boom and bust” cycles

Windfall wealth wasteful spending and borrowing

Dutch Disease: resource wealth appreciation of exchange rate weakening of agriculture and manufacturing”

Political Causal Mechanisms Massive infusions of revenue into the central

state massive corruption, “predatory state” Huge stakes in controlling the state intense

political conflict and violence Ethnic & regional conflicts over the

distribution of revenue New state wealth funds larger coercive

apparatus Preemption or rupture of the bonds of

citizenship between the state and individuals

Oil, citizenship & democracy

The U.S. in 1776:“No taxation without

representation”Contemporary oil states:

“No representation without taxation”

No Taxation, No Accountability

1. (Windfall) resource wealth replaces taxation as main source of government revenue

2. The state becomes detached from citizens: no longer needing their tax revenue or compliance

3. Citizens become detached from the state, or in a position of beseeching politicians and state officials for some small share of the oil wealth

4. Governance descends into a protection racket, the state as organized crime

Regime Performance in AfricaScores on Mo Ibrahim Indices, 0-100

ROL Acctability Econ Oppty Human dev0

10

20

30

40

50

60

70

80Democ's Semi-Dem Autoc's Oil Autoc

Regime Performance in Africa

Further ComparisonsDemoc’s

Semi-Democ’s

Autoc’s

OilAutoc’s

Avg Rank (n=47)2013 Mo IbrahimGovernance Index

9.6 24.9 31.8 35.3

Per Capita GDP, 2012w/o Eq Guinea

$3,582 $873 $869 $7,948

($4,730)

Human Develop Mo Ibrahim Index

67.7 52.9 50.7 50.9

Under 5 Mortality

6.5% 9.1% 9.3% 11.7%

Oil KillsIn its most extreme form—in very poor and institutionally weak countries—dependence on oil and gas exports grossly stunts development and creates a political economy and culture of predatory corruption.Perform this mental exercise: What if Angola and Nigeria did not have oil? What would their human development indicators look like today?

Life Expectancy in YearsGhana and Nigeria

2000 2006 2012Ghana 58.4 61.7 64.6Nigeria 46.3 49.5 57.3

% Mortality rates, children under 5(Oil Countries in Bold)

Country 1980 1990 2000 2012 % reduction

2012 Per CapitaGNI, $

Ghana 16.8 12.8 10.3 7.2 57% $1,550Nigeria 21.5 21.3 18.8 12.4 42% $1,43

0Mozambique

25.4 23.3 16.6 9.0 65% $ 510

Angola 22.6 21.3 20.3 16.4 27% $4,580

Sao Tome & Principe

9.1 10.4 8.7 5.3 42% $1,320

Eq Guinea

21.7 18.2 14.3 10.0 54% $13,560

Senegal 20.5 14.2 13.9 6.0 71% $1,040Gabon 11.6 9.2 8.6 6.2 47% $10,0

70

Under-Five Mortality Rates in Countries with Similar Per Capita

GNI levels, 2012Country Per Capita

Income% mortality rate of Children under 5

Angola $ 4,580 16.4Thailand $ 4,620 1.3Equatorial Guinea

$13,560 10.0

Seychelles $11,640 1.3Gabon $10,070 6.2Costa Rica $ 8,740 1.0

Selected Development Indicators

Ghana Nigeria Botswana

Under 5 Mortality (%)

7.2 12.4 5.2

Rank (1=worst) 36 9 52Adult Literacy Rate (%)

72 51 85

UNDP Human Development Score (0-1)

.558 .471 .634

Development Indicators, 2012 (in %)

Child Death %ile Adult lit % HDI0

102030405060708090

18

72

56

5

51 47

27

85

63

Ghana Nigeria Botwana

How Many Excess Deaths In Nigeria?

UNICEF estimates 827,00 Nigerian children under 5 years old died in 201212.4% of those die every year. Under-5 mortality rate in Nigeria is 12.4%. In Ghana it is 7.2%If Nigeria had Ghana’s under-5 mortality rate, of 7.2%, it would have suffered 347,000 fewer child deaths in 2012

Over the past decade, some three million Nigeria children have died who would not have if Nigeria had Ghana’s under-5 mortality rate.

WB Governance Indicators, 2012

0102030405060708090

100

5650

6052 50

11 10

27

113

7970

64

7989

Ghana Nigeria Botwana

Oil Bad GovernanceIf Nigeria had merely the middling levels of governance of Ghana, not to mention the better levels of Botswana, several hundred thousand children a year would be spared a needless death. My assertion:1. Nigeria has demonstrably poorer

governance than Ghana (and the other democracies of Africa).

2. The principal reason why Nigeria’s governance is so much worse is 40 years of nearly total dependence on oil income.

A Glimpse Into Africa’s Oil and Governance Future

Africa's Future Oil States:Ratio of Rents to Taxes, Before and

After Oil

Kenya Ghana Benin Tanzania Mauritius Ethiopia0%

50%

100%

150%

200%

250%

22% 22%44%

111%

7%

171%

45% 53%

84%

153%

208%222%

Before Oil After Oil

Ratio

of R

ents

to T

axes

Africa's Biggest Future Risks of Oil Curse:

Ratio of Rents to Taxes, Before and After Oil

Senegal Malawi Uganda Sierra Leone

Gambia, The

Liberia Sao Tome

0%

200%

400%

600%

800%

1000%

1200%

1400%

1600%

1800%

33%212% 284%

204%124%

614%

74%138%

446%

721%

1217% 1284%1364%

1654%Before Oil After Oil

Rati

o of

Ren

ts to

Tax

es

The Quality of Governance:Current vs. Future African Oil

Exporters

CategoryCurrent

ExportersFuture

ExportersSSA

AverageControl of Corruption 14 36 32Government Effectiveness 13 36 27Regulatory Quality 19 41 30Rule of Law 15 37 29

Institutional Reforms &

Policy Responses

Oil-to-Cash: An Overview

Direct distribution of a portion of oil revenues to citizens as taxable income

1. Government receives revenue from oil and gas sales

2. A portion of revenues (e.g., 50%) is distributed annually to all citizens in direct cash payments

3. Distributed cash is treated as taxable income and collected as part of personal income tax. “Tax rate” can be set at any level.

4. Payments can be made as dividends from sovereign wealth fund

The Alaska Model1976: Voter referendum creates the Alaska Permanent Fund as a way of investing a portion of the state’s new oil wealth (in essence, a sovereign wealth fund)1980: State legislature creates the Alaska Permanent Fund Corporation to manage the fund1982: State government decides to distribute annually a portion of the fund as dividends to each individual citizen of Alaska, adult or child.1977-2012: Fund grows from $734,000 to $42.1 billionRecent annual dividends range: $878 to $3,269 per person

Acting Alaska Revenue Commissioner Angela Rodell announces the 2013 Permanent Fund Dividend

Alaska’s giftBecause of the low population, Alaska has no income taxAlaska has among the lowest rates of poverty and inequality of any state in the US.

Virtues of Oil-to-CashAttack the fundamental causes of the resource curse

Create domestic tax baseIncentivize active citizen participation & engagementIncentivize government accountabilityCreate/restore connection between public officials and citizensLimit the windfall, boom/bust mentality surrounding government revenue

Technical ChallangesHow to get the money to the people?Underdevelopment of banking infrastructureDanger of leakage in corruption

Oil-to-Cash: Is it feasible?In 2009, regular direct transfer payments were made to 170 million people in 60 countriesAdvancements in personal ID technologies

Biometric identifiers: fingerprints, facial and retinal recognition, etc.450 million people in developing countries

Progress in electronic/mobile banking800 million cell phones in AfricaPromise of mobile banking platforms

Example: Kenya’s M-Pesa

The Politics of Oil-to-Cash

States do not want to surrender revenuePoliticians and state officials want direct access to oil revenues

But, 9 of the 12 future oil exporters are democracies:

Oil to cash may resonate with democratic publicsPromise for Opposition PlatformsSaving grace for otherwise doomed incumbents?

Common Objections, & Responses

See CGD Policy Paper 24, June 2013, by Todd Moss & Stephanie Majerowicz

Only the state can promote economic developmentMuch development is bottom-up. Small entrepreneurs are short of capital. Ordinary people are short of money to feed and educate their children, and get them health care.This does not eliminate the state, but enables another source of development energy.Only states can invest in public infrastructureBut they will not do so effectively until subjects become citizens and demand accountability

Objections and Replies, cont.

Cash Payments to citizens will stoke inflationSo can state expenditure of oil bonanzasManage and mitigate “through careful monetary policy”Cap transfers at a realistic level, relative to inflationWhy not use the oil wealth to subsidize basic goods?Consumer subsidies violate elementary market principles. They are “inefficient, regressive, highly distortionary, and expensive.” They also promote waste (e.g. of energy) and corruption/smuggling.

Objections and Replies, cont.The ignorant, unwashed masses will waste the money“Studies suggest that the cash transfers tend to lead to increased spending on health, nutrition, sanitation, and education.” (p. 14)Transfers can be focused on women, or women and children, and made conditional on healthy behaviors.Studies show that some portion of the transfers is invested in productive activity.The men will grab the money and get drunkGive the women the money and a whistle.

Objections and Replies, cont.

Corruption and clientelism will just distort the transfersPeople will have more incentive to monitor the system and defend their rightsNeed to raise citizen awareness and civic capacityLimit administrative/political discretion (but this is in tension with conditionality)What if the country has no mobile banking systemMany of these prospective oil producers have plenty of time to put in place all the needed financial and administrative infrastructure

Objections and Replies, cont.What political leader is going to surrender the right to loot the national treasury, get rich, and remain in power indefinitely?Opposition leaders who want to get elected.Ruling presidents in political troubleRival factions of a ruling partyThe occasional reformist who actually has some interest in seeing his or her country develop.And it is much easier to implement this before the oil revenue starts flowing and the political economy changes. Doesn’t this sideline other reforms of the resource curse that are gathering momentum?

Need for a Comprehensive Approach:

Throw Everything At ItRadical Transparency in the Oil and Gas sector:

All extractive industries “publish what they pay”Government fully reports all revenue streams from extractive industries

Budget TransparencyRevenue stabilization/sovereign wealth fundCounter-corruption reformsFreedom of InformationVigorous independent media and civil society

Counter-Corruption Reforms

1. Create strong, constitutionally protected counter-corruption agencies

2. Ensure they have independent power to investigate and prosecute; and adequate staff and resources

3. Ensure vigorous, politically neutral leadership of agencies these (and other) agencies of accountability; e.g., give appointment power to the Supreme Court

4. Make all assets declarations of public officials publicly available on the Internet

Countering CorruptionRaise the costs and risks of engaging in corrupt conductIncrease the rewards of honest behavior; increase official pay, and ensure it is paid on time.“Fry big fish”Educate and mobilize the publicGet civil society and official accountability institutions working together

Strategies for ReformMobilize coalitions for governance reform:• From below, in civil society• From within, among reform minded-elements of

the state, the parliament, and the party system• From without, among international donors,

partners, and international civil society• Use the Open Government Partnership as

leverage to press government to work with civil society to develop an Action Plan to improve government transparency