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Pipelines to Nowhere: Misguided Reliance on Oil in the Developing World

Pipelines to Nowhere: Misguided Reliance on Oil in the Developing World

. 7 min read

Joseph Hasbrouck. Originally published in Spring 2017.

Once black gold is struck in a developing country, one might expect that prosperity is inevitable. Images of Dubai and other affluent locations in the Middle East have contributed to the misunderstanding that oil rich nations inevitably find wealth. In reality, Dubai, with only 4.09 percent of the United Arab Emirates’ 97.8 billion barrels in oil reserves, is not relatively rich with oil. The modern economy of the UAE has benefitted from aggressive diversification and now boasts a robust service sector that contributes 52.3 percent of the country’s GDP. The observed development is a product of strategic investment in education and infrastructure rather than solely the exportation of oil.

Misconceptions and mistakes

The claim that oil inherently leads to stable development is a misconception that looms over international development policy. The outcome of using oil as a means to the end of development depends on the viability of expansion in other sectors and the role government plays in the economy. If there is a lack of opportunity for re-investment, oil wealth never cycles and growth fails to materialize. Research indicates that countries with small populations are more adept at utilizing revenue from their geological endowments for development, as there is less aggregate cost in investing locally. When leaders look beyond immediate returns, they can effectively invest in human capital to ensure that future workers are well educated and prepared to continue pursuing the industrialization initiative. In larger countries, that same local development is more challenging, and allocating profits across different regions of a state can inadvertently cause discontent and instability.

When a government is heavily involved in the execution of development strategy, it may misuse income or utilize revenue for growth. In some countries, the control results in corruption. On the contrary, when the UAE became heavily involved in its development strategy, it capitalized on state control to turn oil profits into direct local investments in infrastructure, education, and other economic activities. When organizations like the International Monetary Fund, World Bank, or United Nations intervene to assist in development, they tend to push these states to develop a liberal economy with minimal government intervention and limited trade protections, an often an unsuccessful strategy.

A leak in the pipeline to prosperity

In poor, developing regions endowed with oil, individuals normally lack capital to establish an oil sector without state involvement. Countries must often turn to outside entities, typically multinational firms, or “supermajors,” with the resources and personnel to develop an oil industry. These companies make agreements with states for security services and rights to extract oil. Until a nation experiences significant development or gains clout in the global oil industry and can therefore make a realistic threat of nationalization, it lacks leverage needed to ensure tangible benefits for local communities. The alternative has its own implications; central control of this critical resource creates avenues for corruption. In Nigeria, a case study for development gone awry, 85 percent of oil profits accrued to 1 percent of the population according to research from the University of California, Berkeley. Those potential investors with new oil money can find lower risk opportunities in the more developed markets of Europe and the United States, so the oil revenue fails to circulate in the economy. As investments leave the country, development stagnates. The Nigerian government has taken steps to combat these problems, but success still lies down a long, arduous road.

When international agencies measure development, they often look to growth in foreign direct investment (FDI), which presents only the appearance of true economic growth. In 2007, half of all FDI in Africa was destined for the oil sector, which marks substantial improvement in diversification. Before the turn of the century, FDI in Africa totaled US$7 billion per year, but nearly 70 percent found its way to Nigeria, Angola, and South Africa, where 90 percent of that capital financed expansion in the oil sector. Transnational investment is a key marker for the success of a neoliberal project; however, the majority of it “was monopolized by a quartet of mining-energy economies,” according to Michael Watts of UC Berkeley. In places where diverse development is direly needed, economies were unable to “move up the value-added chain away from primary commodities.”

The strategy has been pursued under the pretense that such growth is essential for economic development and improving the quality of life for citizens, but the Nigerian oil boom shows an alternative ending. Rather than using oil money to build a diverse foundation, Nigerian leaders have let the resource become a crutch. In 2004, 96 percent of export revenues and 80 percent of government revenue originated in the oil industry. Nigeria was so dependent on oil that aggregate economic growth declined when oil prices fell in 2015, and other sectors contracted from the resulting uncertainty. Between 1995 and 2005 the Human Development Index (HDI) fell in Nigeria while GDP rose. Despite recently surpassing South Africa as the continent’s largest economy, the country faces one of the world’s lowest life expectancies—53.4 years—ranking 214 out of 220 countries in the US Central Intelligence Agency’s data. After the gains of oil wealth, 62 percent of Nigerians live in extreme poverty, and urban poverty in Nigeria almost tripled between 1980 and the mid-1990s. Slums in major African cities accounted for 85 percent of urban growth. Research from UC Berkeley further illustrates that between 1965 and 2004, per capita income actually declined, and the IMF even admitted that the expansion “did not seem to add to the standard of living.”

International interaction

Historically, massive multi-national corporations dominated the global oil industry. High costs barred oil investment by those in developing countries. The supermajors—the world’s largest publicly owned oil companies—were naturally hesitant to operate in the economically and politically unstable regions of the developing world, which perpetuated the areas’ status and further discouraged foreign investment. The composition of African FDI illustrates how investment fails to enter economies that have yet to experience substantial stabilization or economic activity internally. Development policy cannot rely on the benevolence of corporations which have a conflicting obligation to avoid risk.

Hoping to draw investment, NGOs have instituted reform in how governments interact with citizens and the economy. Although twenty-six countries in sub-Saharan Africa had a “liberal regime” by 1998, they faced falling export prices and unhelpful trade deals. Manufacturing sectors declined, and some cities experienced economic contraction between 2 percent and 5 percent every year. The pursuit of free trade has harmed such economies that rely on primary resources. Using aid as the incentive, institutions have mandated that nations with less robust economies behave like the United States or Western Europe, with minimal government control and investment. In addition, they only permit Pareto improvements—those in which one party’s benefit does not harm the other. Unfortunately, when nations achieve notable development, they will compete for markets with nations that have greater economic power, but this should not be feared. Even if the position is less advantageous for the developed world, stronger trade partners will inevitably create more valuable trade relationships that benefit all in the end.

The catastrophic spillover

Misguided development focused on oil has generated a number of side effects with social, economic, and environmental ramifications. Despite growing trade, local economies have failed to take off, and citizens feel robbed, even violated, by the rest of the world.  In the developing world, this feeling has sometimes manifested in terrorism. In the mid-2000s, the Movement for the Emancipation of the Niger Delta (MEND) threatened international actors if they failed to leave the region. During the fifteen months before October 2007, more than 250 hostages were abducted, and militants vied against government security forces. In 2006 and early 2007, 42 oil facilities were assaulted. Such violent responses are disastrous for developing economies that often rely on a few specialized sectors. According to an IMF publication, each act of terror per million in a population caused an economic contraction of roughly 1.4 percent. The report further explains that this effect increases the risk of investing in the county. Even in Greece and Spain, countries with significantly more development, terror slashed net FDI by more than 10 percent between the mid-1970s and 1991.

With such instability, oil and other primary resources stand out as the only viable sectors that can ensure large profits. Governments allocate security resources to protect oil’s extraction, further entrenching the resource in the economy. Growth becomes crutched on oil, but the industry’s structure is inherently less likely to realize spillover benefits. When companies receive oil profits, they often choose to invest that new capital in safer markets afar. Oil’s domination of the economy can also prevent growth because leaders want to maximize the GDP enhancement of oil; however, companies rely on foreign labor to minimize costs of training local employees. When locals do have the skills for employment, other industries also need the talent. They raise wages to attract workers, raise prices of final products, and reinforce poverty for those who can no longer afford the goods.

The economic machine of developing countries reliant on oil is necessarily fueled by global dependency on petroleum products. To ensure profits, countries take a stance against alternative energy to maintain income and fuel growth. Such countries choose to tackle the immediate concern of poverty over the long run concern of climate change.

Stopping the leak

The main failure of the international community in its global development campaign is the assumption that trade will inevitably solve problems. In this pursuit, nations focus on their natural endowments, often turning to oil. Oil works when profits can be strategically used to develop a sustainable economy. Decades ago, Libya used oil revenue to fuel a land reclamation campaign. The UAE invested in education and trading infrastructure. Oil development brings inherent benefits from extraction and transport infrastructure. When countries are in a position to bargain with international actors, they can ensure local employment and investment through social responsibility initiatives. Oil’s positive effects are clear; however, it fails to elevate the condition of locals when profits are only invested in the developed world. Foreign workers dominate high pay occupations, preventing class mobility among citizens. Where improvement can take place, a nation instead becomes economically stratified, with greater income inequality than before. Future policy must focus on educating citizens and empowering them to develop homegrown industry as the true alternative fuel for a diverse economy that can weather whatever economic climate the future brings.