Sunday, 23 November 2008

The Resource Curse in Middle Eastern Oil Producing States

To most, the discovery of oil would appear to be the basis of great prosperity. However, the economies of most countries, in the Middle East and beyond, that have been endowed with resource wealth have historically underperformed in comparison to countries that were not as well endowed. Empirical evidence shows that countries in East Asia, such as Korea and Taiwan, have grown and developed at much faster rates than Middle Eastern oil-producing countries, in spite of having started with approximately the same development levels in the 1950s. Such examples have led to the advent of the ‘resource curse’ theory, an economic explanation for why resource abundance leads to underdevelopment. The ‘resource curse’ is a collective term for individual theories that demonstrate overdependence on a single resource to be the result of revenue volatility, destabilizing exchange rate effects known as the ‘Dutch disease’, crowding out effects, corruption and rent-seeking, and authoritarian rule. These consequences result from both exogenous and endogenous factors.

This essay will present the theoretical and empirical argument for the resource curse in Middle Eastern OPEC member states (excluding North African members). It puts forth that a wide range of literature identifies two factors associated with resource exploitation that contribute to underdevelopment: economic overdependence on a single sector, and state ownership of the resource. This paper will first present the negative consequences of overdependence, and then discuss state regimes’ inability to implement policies to distribute resource wealth in a socially optimal manner.

Evidence shows that economic development tends to be less successful in primary resource-based economies than in manufacture-oriented economies (Murshed 2004). Perala (2000) presents evidence that all but 6 of 42 developing countries suffering from growth failure – having a per capita income level in 1998 previously achieved between the 1960s and 1980s, can be described as having primary-resource based economies. Due to rising oil prices in recent years, the per capita incomes of the oil producing Middle Eastern economies have grown, however, development still lags far behind. Qatar, Saudi Arabia and UAE rank 9, 46, and 16 in GDP per capita in purchasing power parity terms (IMF 2006). But, the same countries rank 46, 76, and 49 in the World Bank’s 2006 human development index. These statistics beg the question, why, contrary to common sense, would resource wealth result in economic underdevelopment?

Part of the problem of underdevelopment in these Middle Eastern states, stems from dependence on oil exports for an excessive portion of national income. The oil industry contributes about 45% of Saudi Arabia’s and Iran’s GDP, 50% of Kuwait’s GDP and to similar extents in all the Middle Eastern OPEC states (World Bank 2003). Such dependence on a single sector leaves national income vulnerable to volatility in resource prices. Oil and gas revenues, particularly due to the securitization of the energy market, can be subject to extreme price swings in short periods of time, caused by external factors. In fact, yesterday geopolitical concerns and worries about a weak dollar led crude oil to a new record high, past $97 per barrel, only to see prices slump today on a U.S. government report that oil inventories fell less than expected. Such price fluctuations make pursuing prudent government policy a daunting task. Increased oil prices can lead to a direct injection of large amounts of funds into exporting economies, leading to inflationary pressure and market distortion. Falling oil prices can slow growth, cause a withdrawal of investor confidence, and a potential recession. For instance, in 1986, when the price of oil fell from $28 to $10 a barrel over the course of several months, export revenues fell dramatically in the oil producing Middle East, unemployment soared, and economic growth slowed.

Price fluctuations can also have seriously destabilizing exchange rate effects when resource revenues make up a substantial portion of GDP. Known as the ‘Dutch disease’, a gain in windfall revenues from the export of a resource can result in a contraction in the output of non-resource sectors. A dramatic increase in the price of oil, as was brought about by OPEC countries in the 1970s, resulted in a massive current account surplus in exporting states. In a floating exchange rate system, incurring a current account surplus leads to currency appreciation, making the nation’s other exports less competitive. In OPEC countries, the result was a contraction in the non-oil and gas traded sectors (Stevens 2003). Inder Sud, director of the Middle East Department of the World Bank stated at the Middle East Forum in 2000, “Oil-producing countries have experienced the "Dutch disease": oil revenues have raised the prices of non-traded goods such as land and labor. At the same time, prices of traded goods - commodities that can be exported - are not very profitable. This vicious cycle has hampered some of the export-led efforts.” The specific contraction of the manufacturing sector in these countries, caused by Dutch disease, can be a source of “chronic slow growth.”

Dependence on a primary resource can also lead to the de-prioritization of investment in non-resource-orientated sectors, compounding the diminished competitiveness brought about by the Dutch disease. Unlike traditional crowding out, where government spending crowds out private investment, over allocation of saved private and government funds towards a single economic sector crowds out the funds available for others. Investment in the extraction of oil in OPEC Middle Eastern states has reduced the capital available for industrial and service-based sectors to develop. Moreover, the finite nature of oil, for example Saudi Arabia can only extract the resource for another 70 years (Mouawad 2005), would make continued lack of economic diversification crippling. Abdullah Alireza, Saudi minister without portfolio and member of the state’s Supreme Economic Council, has recognized the need to correct this issue: “The diversification of our national income and our economy away from oil is key to our well-being. It’s absolutely key,” (Herald Tribune 2005).

State ownership of oil resources in Middle Eastern OPEC states is another underlying cause behind economic underperformance. The reality of most oil producing states is one where revenue from exports accrues directly into the state treasuries. In Saudi Arabia, oil sales account for 90 percent of government revenue (Mouawad 2005). This inevitably results in a great degree of government intervention in the market. Stevens (2003) argues that resource and revenue control leads to these interventions being ill conceived.

Revenue gains from resources allow the government to have an abundance of funds at their disposal. Given that, with the exception of Iran and Iraq, none of the Middle Eastern OPEC countries are democracies, pressure to appease the public with direct injections of funds into the economy has been a popular policy. However, spending revenues too quickly leads to higher prices and increasing inflationary pressure, overheating, and exacerbation of the Dutch disease through currency appreciation.

Corruption and rent seeking have also characterized government involvement. The theoretical argument, simply stated, is that the availability of a large quantity of funds is likely to increase temptation for corruption and rent seeking on the part of the decision makers (Stevens 2003). Empirical evidence appears to support this, as all the Middle Eastern OPEC states rank very poorly on the Corruption Perceptions Index (Transparency International 2007). Corruption itself is known to result in negative income distribution effects in the economic sphere and undermine regime legitimacy in the political sphere. Iran, which ranks 131st on the Corruption Perceptions Index list, suffers from a particularly high degree of corruption, nepotism and income inequality – the richest 10 percent of Iranians account for a third of the national income and have a vested interest in the oil industry (Sherman 2004).

‘Rent seeking’ is another issue of concern that stems from states having access to windfall resource revenues. The term itself refers to the behavior of special interest groups attempting to acquire wealth from government transfers of funds. Rent seeking results in market distortions leading to income inequality. Auty (1998), as cited by Stevens (2003), argues that rent seeking distracts goals of long-term development toward maximizing rent creation and capture. Therefore, such behavior leads to lower income and growth along the steady state. Also, special interest groups benefiting from rent acquisition can form powerful lobbies, able to exert pressure on the. Examples include rent-seeking religious charities, advocacy groups, and other civic associations in the Arab world. Okruhlik (1999) goes one step further by stating that the Saudi Arabian state is itself a “functional extension of the ruling family.”

Finally, Wantchekon (1999) presents empirical evidence that forms a connection between natural resource dependence, authoritarian governments and socio-political instability. Wantchekon’s study finds that a one percent increase in resource dependence as measured by the ratio of exports to GDP approximately leads to an 8 percent increase in the probability of authoritarianism. Indeed, Freedomhouse’s 2006 Freedom in the World survey assigns “Not Free” (the lowest) ratings to Saudi Arabia, Iran, Iraq, Qatar and UAE and a “Partly Free” rating to Kuwait.

The wealth of literature on the subject points to the resource curse, stemming from overdependence on oil revenues and state ownership of oil resources, as a source for the economic underdevelopment in Middle Eastern OPEC states. Kuran (2004) argues that this is compounded by religious and historical mechanisms, resulting in institutional stagnation.

The fact that oil-producing developing states have universally been plagued by the resource curse points to a deeper connection between resource abundance and underdevelopment. Luong and Weinthal find a “direct relationship between the discovery of oil, its development for export, and the emergence of a rentier state, which “procures revenue from external sources and then redistributes it to the population as a form of social and political control.” All African petrostates or resource dependent countries have authoritarian governments or have experienced a very slow process of political reforms (Wantchekon 1999). Similarly, oil-producing states in central Asia have been associated with the problems of the resource curse.

Norway is the single outlying example of an oil producing state that has avoided the resource curse. Norway effectively locked away its oil wealth in an‘oil fund’, a permanent offshore investment vehicle that cannot be accessed by citizens. In this way, the volatility of oil price fluctuation cannot impact the domestic market, while resource wealth accrues for future generations. Moreover, political groups cannot manipulate or distribute the oil revenues. While Norwegian policies have been effective in controlling the resource curse, voters’ desire to access oil wealth has led to substantial political pressure (Listhaug 2004). Similarly, Canada, after the recent discovery of its oil sands, has attempted to implement measures akin to the Norwegian system. However, the locking away of oil wealth remains an unpopular policy. To mitigate the resource curse, Middle Eastern OPEC countries should take up such policies in a gradual manner to stabilize oil revenue injections. Wealth from the oil sector should be progressively used to fuel investment in the secondary and tertiary sectors – manufacturing, capital-intensive industry and service provision. This will lead to lessened economic dependence on oil and develop an economy that will continue to function after oil depletion. The example of growth in Asia also points to the necessary prioritization of human capital development and technological progress, factors that tend to go hand in hand.


Carapico, Sheila. "NGOs, INGOs, GO-NGOs and DO-NGOs: Making Sense of Non-Governmental Organizations." Middle East Report. MERIP. .
Corruption Perceptions Index 2007. Transparency International.
"Country Profile: Iran." New Internationalist. Aug. 2004. .
Curran, Jeanne, and Susan Takata. "An Economic Perspective: Economics – as Much as Religion – May Explain the Middle East Crisis." 2002. California State University. .
Gruen, George E. The Oil Resources of Iraq: Their Role in the Policies of the Great Powers. Columbia UP.
Kuran, Timur. "Why the Middle East is Economically Underdeveloped: Historical Mechanisms of Institutional Stagnation." The Journal of Economic Perspectives 18 (2004): 71-90.
Listhaug, Ola. A Mild Resource Curse: the Impact of Oil Wealth Dissatisfactions on Political Trust in Norway. Norwegian University of Science and Technology, Trondheim and Centre for the Study of Civil War, PRIO. 2004.
Listhaug, Ola. A Mild Resource Curse: the Impact of Oil Wealth Dissatisfactions on Political Trust in Norway. Norwegian University of Science and Technology, Trondheim and Centre for the Study of Civil War, PRIO. 2004.
Luong, Pauline J., and Erika Weinthal. Prelude to the Resource Curse:OIL AND GAS DEVELOPMENT STRATEGIES IN CENTRAL ASIA AND BEYOND. Yale University and Tel Aviv University.
"Middle East: Economic Growth and Decline." Global Perspectives. .
Mouawad, Jad. "Saudi Arabia Works to End Its Dependence on Oil Revenue." International Herald Tribune 13 Dec. 2005.
Murshed, S M. On Natural Resource Abundance and Underdevelopment. World Development Report 2003: Dynamic Development in a Sustainbable World. World Bank, 2003.
Murshed, S M. When Does Natural Resource Abundance Lead to a Resource Curse? Environmental Economic Programme. 2004.
Okruhlik, Gwenn. "Rentier Wealth, Unruly Law, and the Rise of Opposition: the Political Economy of Oil States." Comparative Politics 31 (1999): 295-315.
Richards, Alan. The Political Economy of Economic Reform in the Middle East: the Challenge to Governance. RAND Project: "the Future of Middle East Security". 2001.
"Statistics of the Human Development Report." Human Development Reports. 2006. UNDP. .
Stevens, Paul. "Resource Impact - Curse or Blessing? a Literature Survey." Journal of Energy Literature 9 (2003): 3-42.
Sud, Inder. "Spurring Economic Growth in the Middle East: What Needs to Be Done?" Middle East Department At the World Bank. Middle East Forum, New York. 6 Sept. 2000.
Wantchekon, Leonard. Why Do Resource Dependent Countries Have Authoritarian Governments. Yale University. 1999.
World Economic Outlook Database. International Monetary Fund. Washington, DC: IMF, 2007.