Oil-spill economics: How Ghana can succeed

Thorvaldur Gylfason 27 March 2011

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Ghana is about to become a major oil producer. The country’s newfound oil 60 km offshore is expected to bring in $4.5 billion this year and ultimately about $9 billion a year from 2013 onward for quite some time.1

With expected increases in the oil reservoir and potential production of 500,000 to 1 million barrels per day from about 2018 onward, the nominal total revenue flows from oil could reach between $18 billion to $36 billion per year. For comparison, Ghana’s GDP in 2008 was $17 billion and its merchandise exports were $7 billion.

The oil discovery thus promises to make an important contribution to Ghana’s economy. Even so, the Ghanaian authorities are aware that abundant oil wealth does not constitute a one-way ticket to seventh heaven. Understandably, they are eager to avoid replicating the 40-year experience of oil-rich Nigeria next door. So let’s begin in Nigeria. 

“Oil has made us lazy”

Nigeria’s per capita GDP grew more than twice as fast in the first decade after independence, 1960-70, as it did thereafter despite the colossal export revenue boom of the 1970s and beyond. Why did growth slow down? Some time ago, Ms. Nenadi Usman, then Nigeria’s finance minister, told the Financial Times: “Oil has made us lazy”. She was not referring to her country’s farmers; no, she meant the generals and their political friends.

Per capita growth in Nigeria has averaged 1.1% per year since 1960. Life expectancy has increased by ten weeks per year on average for a total of ten more years of life for the average Nigerian from independence. This is not much to show for all of Nigeria’s oil proceeds. For comparison, life expectancy in Benin and Togo, sandwiched between Ghana and Nigeria, went up by 18 to 21 years during the same period. Beninese and Togolese infants can now expect to reach their sixties while life expectancy in Nigeria is 48 years compared with 57 years in Ghana. Many other oil-rich countries have a similar tale to tell as Nigeria of conflict, corruption, and economic stagnation, in varying proportions, including Algeria, Angola, Gabon, Iraq, Iran, Libya, Mexico, Equatorial Guinea, Saudi Arabia, Sudan, and Venezuela. Why? That‘s what oil-spill economics is all about.

The risks are real

Oil spills beyond the obvious kind manifest themselves in several different ways.

  • First, an upswing in export earnings following an oil discovery tends to strengthen the currency, thereby reducing the profitability of other export and import-competing industries. This is the essence of the Dutch disease (Sachs and Warner 1995). An overvalued currency hampers growth in much the same way as an undervalued currency boosts growth; think China.
  • Second, due to fickle prices, booming oil exports are often accompanied by volatility in export earnings and national income, and volatility is not good for growth.
  • Third, abundant oil tends to attract the wrong sort of people to politics. Democracy is rare in oil-rich countries (Ross 2001). The most successful oil-exporting country of all, Norway, was a fully fledged democracy long before the first barrel of oil emerged. While oil wealth is not known to have weakened an existing democracy anywhere except perhaps in Venezuela from the 1990s onward, oil wealth seems in many countries to have slowed down the transition from autocracy to democracy through clientelism and low taxes. Low taxes and generous transfers and subsidies, even if they amount to only a small fraction of each citizen’s fair share of the nation’s oil wealth, weaken popular demand for democracy.
  • Fourth, abundant oil tends to imbue policymakers with a false sense of security and blind them to the need for building up human resources and social capital, key ingredients of growth.

To stem the gross mismanagement of Nigeria’s oil wealth and to jumpstart growth, it has been suggested that Nigeria’s oil revenues be transferred from public to private hands (Sala-i-Martin and Subramanian 2003). But the private sector is not infallible either as events in world financial markets, including Nigeria, since 2007 have shown once again. Consider the following analogy. If judges are found to be corrupt, the solution is not to privatise the judicial system. Rather, the solution must be to replace the failed judges and reform the system by legal means aimed at securing the integrity and impartiality of the courts. If the privatisation route is taken, however, it matters to whom in the private sector the oil rent is transferred. If part of the rent is divided evenly among the adult population as in Alaska, the allocation can to a certain extent be deemed fair if not necessarily efficient. If, on the other hand, the resource rent is granted to select interested parties as in Iceland where, since 1984, fishing quotas have been handed virtually free of charge to boat owners, in much the same way as the Icelandic banks were delivered to political cronies at modest prices a few years later with, by now, well-known results (Gylfason et al. 2010, Ch. 7), then the allocation fails the fairness test as well as the efficiency test.

From oil to human rights

Here is the catch. Natural resources belong to the people. As a matter of near-universal principle, a people’s right to their natural resources is a human right proclaimed in primary documents of international law and enshrined in many national constitutions (Wenar 2008). Article 1 of the International Covenant on Civil and Political Rights states that “All people may, for their own ends, freely dispose of their natural wealth and resources …” The first article of the International Covenant on Economic, Social and Cultural Rights is identical. Except in the US, where rights to oil resources were legally transferred to private companies, natural resources are, as a rule, common property resources. This means that, by law, the resource rent accrues in large part to the government as trustee for the people. In practice, the government may choose to outsource the oil production and reclaim its rent afterwards within a legal framework stipulating, among other things, the ways in which the government reclaims the people’s share of the rent through royalties, taxes, or fees. Fee is a better word than tax in this context because fees are typically levied in exchange for providing specific services such as a permission to harness a common property resource. Therefore, resource taxes should rather be referred to as fees or depletion charges (Gylfason and Weitzman 2003). In a nutshell, the people’s right to their natural resources grants the government the legal authority to claim the oil rent on behalf of the people. The way this is done varies from place to place.

The legal aspect of natural resources as human rights has another key implication. The accrual of natural resource rents to the government presupposes representative democracy and, hence, by international law, the legitimacy of the government’s right to dispose of the resource rents on behalf of the people. This principle is, for instance, acknowledged in the Iraqi constitution of 2005 which proclaims in Article 108 that “Oil and gas are the property of the Iraqi people in all the regions and provinces.” Again, by international law, this proclamation presupposes democracy. In the same spirit, Article 16 of the Nigerian constitution states that “The State shall direct its policy towards ensuring: (a) the promotion of a planned and balanced economic development; (b) that the material resources of the nation are harnessed and distributed as best as possible to serve the common good; ...” Good intentions notwithstanding, Nigeria has failed to achieve item (b). By contrast, the Norwegian government, in its role as guardian of the people, has kept a tight grip on the country’s oil wealth while at the same time setting up a governance structure intended to safeguard the Oil Fund, now Pension Fund, from political interference by storing most of the oil proceeds abroad (Gylfason 2008, Gylfason and Weitzman 2003).

African countries with pressing economic and social needs cannot be expected to show the same patience as the Norwegians. Norway has abstained from spending all its oil revenues at once because (a) there is no way such a small country, with a population of 5 million, could invest so much money profitably at home; (b) there is a certain risk that impatient politicians would squander the money on unprofitable public investment projects; and (c) the Norwegian krone would appreciate to the detriment of non-oil exports and import-competing industries if the money were spent at home. Ghana, with a population of 24 million, is different in that there can be no doubt that many private and public investment projects there can offer higher economic and social returns than equities in foreign stock markets. The trick is to find a good way to identify such projects without regard to political returns. Even if they are in a hurry, African countries can put in place mechanisms designed to minimise the risk that the people are deprived of the resource rents that are legally, as well as morally, theirs.

Ghana’s golden opportunity

Ghana‘s constitution from 1992 is unambiguous concerning the rights of the nation to its natural resource wealth, stating in Article 257 that: “Every mineral in its natural state in, under or upon any land in Ghana, rivers, streams, water courses throughout Ghana, the exclusive economic zone and any area covered by the territorial sea or continental shelf is the property of the Republic of Ghana and shall be vested in the President on behalf of, and in trust for the people of Ghana.” This means that any misappropriation of the natural resource rents would contravene the constitution.

Ghana is the first African country where a major oil discovery, by African standards, is greeted by a well-functioning, albeit young, democracy. On the Polity IV democracy index that reaches from -10 in Saudi Arabia to 10 in most of the OECD region, Ghana now scores a respectable 8. Here lies Ghana’s historical opportunity.

Ghana has it within its grasp to adopt governance structures designed to separate the management of its oil wealth from short-term political pressures and, with honour, to show other nations the way. With an independent judiciary and independent central bank, Ghana knows by experience how to set up and live with institutions for the purpose of immunising from the vicissitudes of the political process those public policy spheres deemed not to belong in the hands of politicians. This can be done, for example, by setting up an independent yet democratically accountable special authority to help decide how best to dispose of the Ghanaian people’s earnings from their common oil wealth for the benefit of all Ghanaians, including unborn generations.

References

Gylfason, Thorvaldur (2008), “Norway’s Wealth: Not Just Oil”, VoxEU.org, 6 June.

Gylfason, Thorvaldur, and Martin L Weitzman (2003), “Icelandic Fisheries Management: Fees vs. Quotas”, CEPR Discussion Paper 3849, March.

Gylfason, Thorvaldur, Bengt Holmström, Sixten Korkman, Hans Tson Söderström, and Vesa Vihriala (2010), Nordics in Global Crisis, Ch. 7, The Research Institute of the Finnish Economy (ETLA), Taloustieto Oy, Helsinki.

Ross, Michael (2001) “Does Oil Hinder Democracy?”, World Politics, 53:325-361.

Sachs, Jeffrey D and Andrew M Warner (1995, revised 1997, 1999), “Natural resource abundance and economic growth,” NBER Working Paper 5398.

Sala-i-Martin, Xavier and Arvind Subramanian (2003), “Addressing the Natural Resource Curse: An Illustration from Nigeria”, IMF Working Paper 03/139, July.

Wenar, Leif (2008), “Property Rights and the Resource Curse”, Philosophy and Public Affairs, 36(1):1-32.


1 These revenue estimates assume an oil price of $100 per barrel, with continued instability in the Near East and North Africa and continued upward pressure on oil demand from emerging market economies.

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Topics:  Development Environment International trade Politics and economics

Tags:  democracy, oil, resource curse, Human rights, Ghana, oil spill economics

Professor of Economics, University of Iceland; Research Fellow, CESifo and CEPR Research Fellow

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