Managing oil wealth: Experience shows mixed blessings
  • 1, International Monetary Fund

Contributor Notes

Are oil patrimony and prodigality inseparable?

This paper presents a review of the principal issues emerging from an IMF Conference held in March 1983. The special drawing right has been conceived in the 1960s and has been formally provided in the first amendment to the Articles of Agreement of the IMF, which took effect in 1969. Upon the abandonment of the Bretton Woods system of fixed exchange rates and the coming of freedom for the IMF members to adopt the exchange arrangements of their choice, a lack of discipline has been felt in the international monetary system.


This paper presents a review of the principal issues emerging from an IMF Conference held in March 1983. The special drawing right has been conceived in the 1960s and has been formally provided in the first amendment to the Articles of Agreement of the IMF, which took effect in 1969. Upon the abandonment of the Bretton Woods system of fixed exchange rates and the coming of freedom for the IMF members to adopt the exchange arrangements of their choice, a lack of discipline has been felt in the international monetary system.

Jahangir Amuzegar

Reports of the threats to the economic health, social cohesion, and political stability of some oil exporting developing countries in recent months have been as much a cause of concern to their national authorities and the international financial organizations as they have been a source of disbelief to oil economists and development analysts. The internal imbalances and dislocations that have accompanied the oil boom in these countries have equally disappointed not only national planners and international bankers but also the “big push” theorists and those who believed that money alone could break the vicious circle of poverty and low productivity.

A puzzling aspect of the oil exporters’ recent problems has been their high degree of similarity. Nearly all countries, regardless of political make-up, economic structure, and institutional characteristics, have encountered the same basic problems. Inflation, budget deficits, wages that rose beyond labor productivity, inefficient industries that were bailed out, increased public spending on welfare services, and the decline of traditional exports have occurred not only in the poorer and less economically advanced nations (such as Nigeria, Indonesia, and Venezuela) that belong to the Organization of Petroleum Exporting Countries (OPEC) but also in the more industrially sophisticated ones (for example, Norway and the United Kingdom).

This review examines why all the major oil exporters have encountered some of the same difficulties—even those like Mexico which have had the benefit of early warnings and foresight. Has there been something more behind the similar challenges and similar responses than mere coincidence?

While the task here is neither to count oil’s blessings nor to assess its drawbacks, a cursory look at both the “windfalls” and the “pitfalls” may be of interest. Without doubt, petroleum’s contributions to the oil exporters’ prosperity have been significant and far-reaching. Unlike the poorer, non-oil developing countries, OPEC members have simultaneously been able to improve the domestic economy, strengthen national defense, and expand social welfare without great burdens or financial sacrifices. The average annual growth rate of manufacturing for OPEC members during 1970-80 was about 10 per cent—the highest of all the country groups in World Bank calculations. Private consumption (as a measure of social welfare) rose by nearly 7 per cent during the same period (and for the high-income oil exporters by nearly 19 per cent)—again the highest in the world. The annual rates of urbanization, increase in life expectancy, decline in infant mortality, and growth in the number of physicians per capita and the number of students enrolled in primary school have been, according to the World Development Report 1982, at, or near, the highest in the world.

For a more detailed study of this subject, see IMF Occasional Paper No. 18, Oil Exporters’ Economic Development in an Interdependent World, by the same author. For ordering details see page 9.

Considering the disadvantages of a relatively underdeveloped economic base (that is, insufficient infrastructure, limited skilled manpower, inexperienced technocracy, and virtually no indigenous industrial technology) and the handicaps of a late start in economic modernization and industrialization, the achievements in the oil exporting developing countries have been truly remarkable. But progress has been marred by an unexpected combination of economic reversals and retrenchments— not to speak of political tension, damaged business confidence, labor unease, and other social woes. The average annual rate of inflation in OPEC members during 1970-80 was in the double-digit range (for some, even more than 20 per cent)—with a median level of 14.4 per cent compared to only 2.6 per cent in 1960-70. Annual growth of imports in the 1970s was not only the highest in the world but at least twice as rapid as in the 1960s and twice as much as in non-oil developing countries. Except for four countries with relatively low absorptive capacity, all others faced balance of payments deficits on current account for most of the period. Lately almost all have also developed budgetary gaps.

While the major oil exporting developing countries have not been a homogeneous group in area, size of population, non-oil resource wealth, stage of economic development, absorptive capacity, or sociopolitical institutions, they all have been unable to find a development strategy capable of combining industrial growth with rural development, full employment, and equitable income distribution. The 2.9 per cent average annual agricultural growth during 1970-80 was not only the most sluggish of all internal sectors in all major oil exporting countries but also lower than their experience in 1960-70. Significant underemployment still plagues these countries. The average annual growth in the labor force over 1970-80 was the highest in the world, and 25 per cent higher than it had been in 1960-70. Comparable data on income distribution are not available, but occasional studies indicate no major progress in narrowing the urban/rural gaps.

Press accounts of the development efforts in these countries have commonly spotlighted excessive official spending, poor planning, inadequate cost-benefit analysis, bureaucratic bungling, waste, stagnation in non-oil exports, increasing dependence on imports, and rural migration. (See Jahangir Amuzegar, “Oil Wealth: A Very Mixed Blessing,” Foreign Affairs, April 1982.) Other analyses of the negative effects of the oil boom have held the oil bonanza responsible for encouraging profligacy, disrupting traditional social behavior, fomenting unrealistic expectations, creating a welfare state subsidized with “unearned” money, contributing to business mismanagement and labor inefficiency, building expensive and noncompetitive industrial plants, ruining agriculture, and encouraging real estate speculation.

The fiscal links…

The question is, why? The striking similarity of the experience of almost all major oil exporters leads one to conclude that something must dwell in the very process of oil-financed development somewhat independent of the political system, the stage of economic advancement, or the quality of economic planning and management.

Upon reflection, two tentative observations stand out. First, the uniformity of the predicament of the oil exporting developing countries seems to arise from a common concept of the nature of economic development and the role of the government in it. Second, the similarity of experiences among both developed and developing oil exporters seems to support the argument that public finance follows certain inexorable dictates of its own, regardless of the type of its host administration. Both of these phenomena influence the mechanisms by which oil revenues affect the economy. The focus here, however, is on the developing oil exporters.

In general, oil exports (like all foreign sales) contribute to domestic economic growth directly through increasing gross domestic product (GDP) and indirectly through their links with other domestic activities. The direct contribution of mineral exports (like oil) is, by its nature, temporary because reserves are exhaustible. A perpetual stream of oil-induced future incomes can thus be expected only from the indirect route. This consists of (1) the longer-term effects of the industry’s demand for inputs, its supply of fuel and energy to other industries, or related externalities and (2) the investment of oil revenues in longer-term productive domestic or foreign assets.

Most studies suggest that, due to its highly capital-intensive and “enclave” nature, the oil industry in almost all developing countries generates few significant forward or backward linkages of the sort mentioned. The most effective means of transmitting the oil sector’s growth to the rest of the economy is through the budget. (For a fuller discussion of these effects and their background literature, see Robert E. Looney, Economic Origins of the Iranian Revolution (New York, Pergamon, 1982, Chapter 6.) The significance of fiscal linkages is particularly crucial in the major oil exporting developing countries where, by law or custom, the government owns mineral resources (including petroleum reserves).

The reliance of the non-oil sectors’ growth on fiscal policy poses two problems. First, unlike backward and forward linkages through inputs and outputs which work through impersonal market forces, the fiscal links operate through bureaucracies, and depend on the willingness and ability of the state to use them to initiate and guide development efforts. Second, while the workings of the market may involve inadvertent and impersonal deviations from an “ideal” path to growth, the bureaucratic management of oil revenues is by nature always subjective and judgmental, dependent on the wisdom and sagacity of economic planners and portfolio managers. The market presumably reflects consumers’ preferences; the state naturally follows the leadership’s priorities.

Theoretically, at least, the government can effectively relinquish its entrepreneurial functions by channeling oil revenues to the private sector through financial intermediaries, either according to certain socioeconomic agenda or in accordance with the needs of the market. But in the majority of the oil exporting developing countries, the predominant sentiment favors direct state participation in economic activity. This activist posture, in turn, reflects four basic premises regarding (1) the imperfections of the market mechanism; (2) the benevolent neutrality of the government; (3) the compelling urgency of large-scale domestic investment; and (4) the superior value of industrialization over other forms of capital formation.

The market mechanism is seen as an imperfect agent of economic growth for many reasons. First, there are socially important side-benefits or externalities associated with certain activities that are not reflected in market prices; second, in preindustrial and largely rural (or nomadic) economies, traditional and noneconomic forces usually provide better stimuli to proper resource allocation than economic and pecuniary market signals; third, the relative poverty and greater scarcity of economic resources in the developing countries do not allow the waste involved in the automatic corrections of shortages and gluts caused by misreading market signals; and, finally, social costs and external diseconomies (resulting from distortions or imperfections in the price system) may be tolerable in richer societies, but they are not affordable by the less developed economies. The market’s allocative and distributive mechanisms, therefore, must be substituted, at least in part, by state intervention.

The government, on the other hand, is regarded as a neutral if not a benevolent agent of the growth process, disinterested in sectarian or short-sighted profit-making and mainly concerned with the common welfare. Furthermore, where mineral resources legally belong to the government, the allocation of petroleum revenues is considered a natural function of the state. And, finally, the superior levels of education and expertise of civil servants (as compared to those of “bazaar” merchants) leave them better equipped to deal with the national economic interest and the intricacies of modern international economic relations.

The necessity of a rapid deployment of oil revenues through the process of “big-push” industrialization has been justified by the fact that oil reserves in most of the petroleum exporting countries are being depleted, and the time for replacing oil revenues with other sources of foreign exchange is unavoidably short. In this “now-or-never” climate, detailed input-output calculations, strict cost-benefit considerations, and other such economic “niceties” may be rationally minimized, if not largely overlooked. The momentum started with the oil boom has to be maintained, and accelerated, before it is too late.

Industrialization has been considered by the developing nations as the surest way of maximizing the domestic value added, substituting for the eventually dwindling oil exports, joining the ranks of advanced nations, and escaping foreign politico-economic domination. Attributing the major powers’ military prowess, economic wealth, and technological superiority largely to their industrialization, the oil exporting developing countries have been determined to pursue the same route.

…and traps

These interventionist tendencies have certainly been responsible for many of the developing oil exporters’ problems. But there also seem to have been certain inescapable “fiscal traps” in the process of oil-financed development. While Parkinson’s second law that “expenditures rise to match all available revenues” might, superficially, have seemed to operate, the causes of prodigality among all oil-rich countries have been deeper and more complex. First, no checks and balances exist on the levels of oil revenues or expenditures; there have been no protesting taxpayers or effective lobbies to stop revenues growing, and no outcries against injudicious spending. Second, in the more populated oil-rich developing countries where investment needs have been many, it has been politically impossible either to take time for careful cost-benefit calculations or to refrain from spending the oil money due to a lack of economically profitable projects. Third, the use of oil revenues to subsidize the clearly needy, support socially desirable but economically marginal public works, bail out unprofitable old private industries, and buy social peace through expanding welfare services has enjoyed the highest priority in all regimes. As a result, oil money has not been spent entirely on economic development projects, and where it has, expenditures have not always been according to strict efficiency criteria. There has been a clear tendency to tolerate some “uneconomic” outlets.

The checkered records of the developing oil exporters in their efforts to achieve sustained and noninflationary growth along with output diversification seem to confirm the validity of the “environmental” approach to development, which argues that historically, exports of raw materials have led to economic development only when the social milieu and policy environment were supportive. (See Gobind Nankani, “Development problems of mineral exporters,” Finance & Development, March 1980.) A cursory look at the evolutionary impact of the oil boom indicates that the prevailing environment of poverty, underdevelopment, popular expectations, and urgency of action was not conducive to the realization of the full economic potential of the oil boom. The fiscal traps have extended beyond excesses on the part of officialdom.

… led to ironies

The story of OPEC members’ experience is by now familiar. As income on the oil account and per capita gross national product rose rapidly after 1973, so did government expenditures, private sector liquidity, national consumption, wages and salaries, and demands for imported goods, services, and even labor. Dramatic rises in real economic activity, and particularly imports, created stubborn bottlenecks in ports, roads, transport facilities, warehouses, and other aspects of infrastructure. Attempts to deal with emerging high inflation through stop-gap measures and quick fixes subsequently backfired. Unexpected shortfalls in oil revenues resulting from the worldwide recession and reduced demand for crude oil gave rise to budgetary deficits. Continued pressures on imports in the face of falling oil exports placed the balance of payments in the red for a majority of OPEC members and led to rising external debt for some. Failure of the world economy to recover from its deepest and longest postwar recession in 1980-83 aggravated debt servicing and called for new reschedulings in a few countries.

As a result, the oil boom produced some unintended and strange ironies among the oil exporting developing countries. The relative share of non-oil sectors in GDP, which was supposed to increase under the diversification strategy, actually shrank or stayed the same. State treasuries, which were to be gradually free from critical reliance on oil income, became more dependent on oil. The expansion of the oil sector, curiously enough, made the diversification objective much more remote as agricultural development lagged, and new industries concentrated upon import substitution. The share of the oil sector in GDP for 8 of the 13 OPEC members increased between 1973 and 1980; for some countries it increased to as much as 90 per cent. For the countries with high absorptive capacity the share of non-oil exports in total exports declined from a range of 6-50 per cent in 1973 to a range of 0.5-42 per cent in 1980. The share of oil revenue in total government revenues in different countries, which ranged from 31 to 93 per cent in 1971-73, reached 62-96 per cent in 1981. Inflated wages and fringe benefits, coupled with costly industrial projects, reduced the competitive potential of nontraditional exports on which much hope for foreign exchange earnings had been placed. Because of substantially increased consumption (partly through imports), generous foreign assistance, large and recurrent defense expenditures, and the concentration of domestic capital formation on public buildings, luxury housing, and import-depending industries, the oil exporters were not able to totally replace their depleted petroleum reserves by acquiring other real and productive assets at home or abroad.

While it is easy to blame overly enthusiastic planners or relaxed fiscal administrators for these reversals, the uniformity of experience in so many disparate economies during 1973-80 (and the similarity of the present “oil crisis” with other historical precedents) seem to belie any simple, direct causation. A more plausible explanation perhaps would be based on the dynamic of petroleum as a strategic commodity. Stripped of small individual differences in response, the dynamic of the oil boom (like its precedents in gold, silver, rubber, and so on) seems to indicate certain interlocking forces that create a momentum of their own and work through consecutive cycles.

At first, the newly found wealth creates an atmosphere of unrestrained euphoria where the solution to all problems seems at hand. Two reinforcing movements quickly get underway. On the one hand, the ready availability of revenues leads to easy expenditures. On the other, potential pressures to use the oil money on people’s pressing needs become irresistible as their expectations rise. Heightened expectations on the part of the populace imprison governments of all hues in a spending spiral, an exit from which may spell political doom.

Faced with unstoppable public demands, the oil money usually and quickly finds its way first into popular schemes: (such as lavish pay and perks for the army or civil service, free welfare amenities, job-saving subventions to faltering industries, and nationally prestigious projects), and then into import-substitution activities, energy-based industries, domestic agriculture, and finally into export promotion.

… and overspending

Each one of these outlets, because it is either politically irresistible, socially rewarding, or economically promising, tends to become a permanent charge for the economy. Pay raises and subsidies help foster unrealistic popular expectations and distort rational resource allocation. Sophisticated or superfluous infrastructure often tie up a good chunk of the country’s meager non-oil resources. Showcase projects impose unnecessary burdens on future oil incomes. Import-substituting industries may require a large and growing domestic market, high protection, and politically difficult internal income redistribution in favor of the consuming masses. Domestic agriculture—left to itself, without financial credit or technical assistance, or without being artifically kept alive through unsustainable subsidies—may not become viable. Energy-reliant industries (petrochemical, aluminum, steel) call for extended and heavy reliance on foreign know-how, management, skilled labor, and markets. And export promotion, usually the most-talked-about but least supported item on the investment agenda, bogs down due to increased domestic consumption and high internal inflation.

When oil revenues become stagnant or start shrinking, the retrenchment begins in a reverse order. Non-oil exports are likely to be reduced and absorbed domestically as imports fall, and the gap in aggregate domestic demand and supply widens. Subsidized and mechanized agriculture cannot make up for reduced imports, and farm prices are likely to rise. High-cost and “transplanted” industrial complexes become more difficult to staff, maintain, and operate without public subsidies. Import-substitution plants face a shortage of spare parts and raw materials. Prestige projects threaten to be delayed or abandoned half-built. Infrastructural facilities are prone to lose part of their maintenance funds. Inefficient industries demand more aid. And welfare services are likely to be gradually withdrawn or reduced in quality.

To cope with the unforeseen effects of the lack of oil revenues and to check the resulting tide of general discontent, the government’s first reaction is to borrow against future oil revenues rather than to cut back on expenditures. But there are obvious limits to such stop-gap measures. As the oil revenues remain low, and prospects for oil price and output recovery become dimmer, credit sources dry up and debt servicing emerges as a particularly tough problem. At the same time, interest groups that morally support one another when oil receipts are on the rise will resist attempts to cut their shares in the downward cycle—thus aggravating social frictions and tensions.

To be sure, many of the problems recently faced by the oil exporting developing countries have resulted from unforeseen and exogenous forces beyond any one country’s sovereign control. There has been a radical change in the character of the world oil market; the seven major multinational oil companies that previously controlled worldwide production and marketing of oil now have to share their power with a large number of small and independent traders who have little or no vested interest in “stabilizing” crude prices according to market conditions. There has also been a notable decline in demand for oil due to conservation measures, inroads by other sources of energy (particularly coal and gas), worldwide recession in 1981-83, and unusual depletion of oil stockpiles. Competition from non-OPEC producers (including the Soviet Union) has become keener and more aggressive. And, finally, frictions among some OPEC members have intensified for a variety of reasons.

Yet it can hardly be denied that the oil boom itself has been responsible for some of the setbacks. Spurred by a rapid influx of easy money, the developing oil exporters have taken a chance in pursuing a risky development-plus-welfare strategy that has inevitably taxed their resources beyond their expectations. Whether it was politically possible for them to get out from under this “oil spell,” no one yet knows; nor is it clear how they would have done so.

A careful reading of the evidence thus far seems to suggest that: (1) nowhere has the “oil rush” been a flawless patrimony; but, without it, none of the countries concerned would have reached the industrial and welfare levels they presently enjoy; (2) economic planners in all countries have fallen prey to some optimistic exponential projections of oil price rises and revenues without being able to anticipate the adverse effects of these increases on the demand for oil; (3) state ownership of oil reserves and the state bias in favor of public investment might, on the whole, have worked against an optimum allocation of oil receipts; (4) the strategy of promoting defense, development, and social welfare all at the same time, while perhaps politically inescapable, has not been technically feasible; and (5) a more gradual and predictable increase in oil prices and a slower tempo of domestic expenditures in favor of larger foreign placements of petrodollars (for some countries at least) might have achieved greater economic welfare and easier adjustment for all.

If there are any lessons to be learned from the oil exporters’ experience, they may be encapsulated in three mundane dictums: money alone is not a key to economic prosperity or political stability, nor even to national security; the mechanisms through which oil “windfalls” are spent and the structures of decisionmaking are as crucial to the final results as the development strategy itself; and managing economic development is not an easy task for any country, but is particularly difficult for those with a fragile economic base or strong vested interests.

Finance & Development, September 1983
Author: International Monetary Fund. External Relations Dept.