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Libya's Cursed Wealth

The mismanagement of Libya's oil and resources
According to traditional economic theory, countries endowed with natural resources are more likely to exhibit inequality, low levels of growth and a propensity for conflict. Libya is case in point, but what strategies could Libya implement in order to turn its resources into a blessing?
At the heart of the socio-economic grievances that led to Libya's revolution was the rentier economy of the Qadhafi regime. Though oil resources had permitted Libya to accumulate wealth, the country suffered from a number of macroeconomic concerns. By 1973, Libya had a dualistic undiversified economy dominated by the state, afflicted by pervasive rent seeking and regulatory deficiencies. The effects of the rentier characteristics of Libya's economy permeated both the economic and political structures of the country. Excessive oil resources had allowed the political elite to hallow out governmental institutions - allowing those in power to operate without oversight.

Though the system remained in place for over 40 years, as the revolution demonstrated, Libya's social contract was untenable: the unequal distribution of wealth, the country's poor track record on transparency, governance and corruption, as well as diminishing opportunities for the development of human capital created grievances against the former regime which could not be acquiesced in the usual manner. No longer able to buy the support of its citizens, the former government was confronted with a revolution.

Unfortunately, Libya's story is not unique. Traditional economic theory would suggest that the macroeconomic imbalances of the Libyan economy and the social unrest that ensued were unsurprising. Rather, Libya's political economy followed the usual trajectory of resource abundant economies. According to the theory of the resource curse, resource abundant economies tend to grow less rapidly and are more prone to conflict than resource-scarce economies.

Libya, like other resource rich countries in the MENA region, experienced particularly low and non-inclusive growth as well as high levels of macroeconomic volatility. Moreover, the Libyan economy was virtually undiversified and entirely dominated by the hydrocarbon sector, which generated close to 70 percent of GDP, more than 90 percent of government revenues and 95 percent of export earnings. The very limited backwards and forwards integration of the industry confined the wealth generated from oil riches to export and fiscal revenues, while it generated less than 5 percent of employment in Libya.

Perhaps the most obvious manifestation of the resource curse in Libya, however, was the impact that oil had on state institutions. Libya's clientalist state structure, which centralized economic power in the hands of the state, created an environment in which individual interests both outweighed and were in conflict with, the interests of the common good. As a result, government accountability suffered and the social contract depended on the state's ability to provide rents to its people in exchange for their acquiescence.

To illustrate the impact of the rentier mentality on Libya's governance record, in 2009, Libya ranked in the 5th and 12th percentile for voice and accountability, and government effectiveness, respectively, according to the Kauffman index (World Bank, 2009). It was in this context of poor representation and unequal distribution of wealth that the revolution took place, further aligning Libya with yet another common manifestation of the resource curse: propensity for violent conflict.

In addition to poor citizen representation, the lack of transparency in government and the tendency for rent-seeking by the state also seriously affected the development of the private sector and consequently hindered the diversification of the economy. Though the previous government attempted to reform the economy, vested interests by the political elite resulted in the inconsistent implementation of policies and reversal of reforms. As a result, Libya's private sector has been historically stifled by a number of issues including limited sources of financing to SMEs, the inconsistent application of property rights, and the focus of most of the economy's resources on the oil sector. Development of the non-oil sectors including services requires broad participation through domestic or foreign private sector investment. Poor economic governance has consistently discouraged investment in the non-oil sector.

However, the revolution in Libya has created an opportunity for the country to reverse its previous mismanagement of the oil wealth and the culture of poor governance that dominated both the private and public sector. There are thus a number of policies the country could implement in order to turn its resource into a blessing rather than a curse.

The first step Libya must take is to promote economic diversification. As Libya's experience demonstrated during the 2011 revolution, relying excessively on one resource for its revenue renders an economy extremely vulnerable to shocks in that sector. Because 70 percent of the country's GDP depends on oil revenues, the fact that the country was forced to stop exporting oil for 6 months that year resulted in a 42 percent drop in the country's GDP growth. Though economic diversification is certainly a long-term objective, Libya stands to gain greatly by pursuing this venue for sustainable growth. According to a study implemented by Monitor Group, the country has great potential in furthering the tourism, construction and services sectors among others.

However, it is important to take into account that economic diversification is an end and a number of reforms must be successfully implemented if Libya is to promote the development of other sectors of the economy. Because natural resource development must by necessity involve a long-term relationship with private parties, market unfriendly policies like those in place in Libya under the previous government not only discouraged investment in the oil sector, they also discouraged investments in alternative industries, ultimately hindering much-needed economic diversification. Libya should institute favorable and predictable regulations that promote investment including lower and uniform taxes as well as the protection of property rights.

In addition to economic diversification, it is important that Libya introduce explicit fiscal rules for the treatment of natural resource revenues. According to the IMF any windfall gains should be deposited in a special account and used for designated economic and social development. The country could also adopt a non-oil deficit target to promote economic diversification. By officially de-linking expenditure from natural resource revenues the government would be making a public commitment to responsibly manage the nation's wealth.

Implicit in the two policy recommendations listed above, Libya's success will depend on the government's ability to implement a culture of good governance. Fiscal policy rules, investment guidelines and promises to diversify the economy are insufficient to guarantee that the government will always apply a responsible strategy for resource wealth management. In order to ensure these policies help Libya to promote the efficient management of its oil wealth, it will have to promote good governance in the country.

Good governance should include the establishment of voice and accountability in the country. For Libya this will imply the institution of checks and balances in the government that will prevent the government form falling into the previous trend of rent-seeking. The recent elections which took place in Libya are an important step in establishing an accountable and representative government who will take into account the interest of its citizens while establishing fiscal policies.

Libya stands at a development crossroads in the aftermath of the 2011 revolution. The interim government can take the opportunity for reform created by the revolution to apply the important lessons drawn from Botswana's resource wealth management. In doing so, Libya's new leaders will be able to overcome the legacy of wealth mismanagement established by the former government. If distributed evenly, Libya's oil wealth could improve the standard of living of all Libyans and furthermore act as an important source of investment industries and development initiatives. Rather than allowing its vast oil wealth from becoming a liability, Libya can use its resources to ensure the responsible management of its revenues and apply these funds to promote inclusive growth.

Paula Mejia
A contributing writer for The Majalla based in Tunisia. As a freelance journalist and former consultant for the African Development Bank, her work has focused on the economic and social challenges in Africa, with a special focus on Egypt, Tunisia and Libya. She is a graduate of the London School of Economics, L'Institut D'Etudes Politiques de Paris and the University of Chicago.

© The Majalla 2012

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