Usually there are reasons to celebrate when a country strikes oil. Nevertheless, many countries will end up substantially worse than if they wouldn’t have found anything. According to Michael Ross[1], oil-rich countries such as Gabon and Iraq, experienced an income decline of 45 and 85 percent respectively, from 1980 to 2006. Moreover, oil-rich countries are twice as much more likely to suffer a civil war and have 50 percent more chances of being ruled by an autocrat. Not all oil-rich countries are susceptible to this curse, the most fragile are low-income nations such as Algeria, Angola, Colombia, Nigeria, Sudan and Iraq. Moreover, oil-rich economies don’t grow nearly as much as they should, given their mineral wealth.

According to Ross, oil-income has four characteristics that makes it susceptible of being misused, these are:

  • Oil-income is big: on average, oil-based governments are 50 percent larger than non-oil governments, and in low-income countries, the government size can be as big as 800 percent larger, such as in Azerbaijan.
  • Oil-income does not come from taxes: in many countries, there is a tacit agreement by which governments do not charge taxes, but they provide free basic services such as education and health-care in exchange of not questioning the rulers. This makes governments less accountable, since people are less likely to protest for what they receive for free.
  • Oil-income is very volatile: Oil price has been as low as $18 during 1998, and for a moment, as high as $140 during 2008. With such a variability, it is difficult for a government to project future oil-income.
  • Oil-income could be secretive: When institutions are weak, oil revenues can be hidden, stolen or misreported.

Are all oil-rich countries cursed? Should a country that just discover oil give its revenue to its people equally?  First, countries such as Norway, Canada, and the U.S. were not seriously affected, in part, this is because the size of these economies was bigger than the oil-income, but also, many of these economies were already diversified away from oil. Second, if the government would give oil-money to its citizens, it would overheat the economy, causing inflation, so, what to do?

The answer may lie in Norway. Norwegians separated oil-income from current government spending by creating an investment fund with all oil-income. This fund is only allowed to invest in assets outside Norway. Currently, it is the largest sovereign fund with up to one trillion in assets distributed along 9,158 companies within 73 countries, that is, it’s heavily diversified. If all that money would be given to Norwegians, each would receive about $185,000, but the fund is reserved mainly to pensions, so it keeps growing.

The idea is to lock away oil-money, keep charging high taxes locally and keep people working, that is, the objective is to be as independent from oil as possible. To keep the local economy growing, they created a trustworthy business environment, with a high participation of women; the more people there are working, the more taxes they collect.

Rephrasing the Norwegian strategy, if you win the lottery, don’t throw yourselves to conspicuous spending, instead, put your money to work in financial investments, keep your work and spend only small amounts of the lottery’s investments returns, otherwise, evidence suggests that when you start spending carelessly, one in three people would go bankrupt, and the same happened to many countries.

Mario Alejandro Mercado Mendoza

This article builds upon a previous version, which can be found here.

Mario is Hoffmire’s colleague at the Center.

[1] Ross, Michael. The Oil Curse, How Petroleum Wealth Shapes the Development of Nations. Princeton: Princeton University Press, 2012.