The History and Social Consequences of a Nationalized Oil Industry



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The History and Social Consequences

of a Nationalized Oil Industry
Adam Bird & Malcolm Brown

June 2nd, 2005


E297c

Ethics of Development in a Global Environment

Prof. Bruce Lusignan


Introduction:

Concentrations of world capital experienced massive redistribution during the twentieth century. One example of radical redistribution occurred as a result of the development and nationalization of the petroleum industry. Countries subsisting in the 1940s on some of the world’s lowest gross national products (GNPs) are now major contenders in the world market as a result of large oil revenues over the last 60 years. However, the development of the petroleum industry did not occur overnight and producing countries have not always realized large profits due to the exploitation of private developers and a hostile world market.

However, major oil producing countries now receive large portions of their GNP from petroleum operations. This paper traces the growth of the petroleum industry and the entities that have benefited from it economically. Once a model of the modern recipients of oil revenues has been developed the question arises, how is this money spent? How have the people of oil producing countries benefited from the large capital gains resulting from oil revenues? In this paper we will attempt to place the social consequences of the modern oil industry in perspective with its historical development.
Section 1: OPEC’s Roots, History and Development
Before the discovery of oil in the Middle East, Iraq, Iran, Saudi Arabia, and Kuwait were all poor undeveloped countries. In Iran (Persia until 1935) for example

The peasants, who constituted the build of the population, made their living by farming on land generally belonging to an absentee landlord. They lived in small mud villages close to a subsistence level, the unfortunate victims of ignorance, disease, and poverty. Although legally free, for all practical purposes they were bound to the soil they cultivated. The landlords, who frequently measured their wealth by the number of villages they owned, generally lived in the larger cities, leaving the management of the villages to their stewards.1


The situations in all of these countries were similar. The majority of the population consisted of extremely poor peasants. No middle class existed to curb the power of the few rich families and a person had little chance of improving his status. The countries had few natural resources and for the most part the land was not particularly arable.

At the beginning of the twentieth century oil was discovered in Iran and later in Saudi Arabia, Kuwait, and Iraq as well. Extraction of the discovered oil reserves in these undeveloped nations was necessarily different from already industrialized countries. Developed countries already had the money, technology, and knowledge of the industry required to mine and market the oil within their borders. Countries like Venezuela and Saudi Arabia did not have many people with the money or knowledge of the industry required to make use of the natural resources their country controlled. As a result developing nations with extensive petroleum reserves were unable to mine or market their petroleum. They needed the aid of the large foreign oil corporations in order to realize any profits from their resources.

The international petroleum industry was almost entirely developed and dominated by seven companies. Five of the companies were American (Chevron, Exxon, Gulf, Mobil, and Texaco), one was British (British Petroleum), and one was Anglo-Dutch (Royal Dutch/Shell).2 These major oil companies saw the opportunity for profit presented by the impoverished petroleum rich countries and decided to capitalize. This led to a series of concession agreements between the seven major oil corporations of the world, and the soon to be oil producing countries in the Middle East, Africa, and South America. The details of these contracts vary, but they all shared a few common features. The governments gave the companies exclusive rights to explore and develop hydrocarbon production within a limited area for a limited amount of time. The companies acquire title to any hydrocarbons they mine. However, the companies take all of the financial and commercial risks involved with the enterprise and they must make payments to the host governments in the form of surface taxes, royalties, production taxes, etc.3

At face value the contracts might seem to be equitable considering the host nations are profiting from resources that they could not mine themselves without doing any work. In reality though, the contracts were not at all fair to the developing nations. The contracts were for a finite amount of time and area, but they covered huge expanses of land. Contracts with three companies covered the whole of Iraq. A single contract covered the entire southern half of Iran, and another one covered all of the United Arab Emirates.4 On top of this they were of incredibly long duration. Iran’s initial deal, which was not unusually long, lasted for sixty years. When it expired a new contract was negotiated to last twenty-five years with the option of renewal for up to 15 extra years.5

The oil companies, who realized what a good deal this was for them, did not allow the oil possessing countries any means of backing out of their contracts. They made sure that the concession agreements contained choice-of-law clauses. This is an agreement that any disputes rising from the contract will be mediated by a third party, and not subject to the laws of the host country.6 As a result, the developing nations were unable to alter their contracts, short of nationalization, without the companies themselves agreeing. Most of the countries with the exception of Venezuela even signed away their right to tax the companies in exchange for one time royalty payments.7

For the first few decades the undeveloped nations with oil were happy to have the concession agreements. The oil deals brought an unprecedented amount of money to the poverty stricken nations. However, it was not long before they began to realize that they were being exploited. Venezuela, which had the most favorable concession agreement, was the first to act. Since the country still maintained its right to raise taxes on the companies, Venezuela passed legislation in 1943 designed to increase the total royalties and tax paid by oil companies to 50% of their total profits. Because the price of oil was continually increasing, the 50/50 profit split had already become uneven again by the following year. The law was reformed twice with the same result, until a law was passed in 1948 setting the tax at whatever value was required to ensure equal profit sharing.8

The oil companies did not actually have a major problem with this change. They already had to pay income taxes not only to the oil producing countries, but also to their own governments. Five out of the seven big companies (and all of the ones that had holdings in Venezuela) were American. In the United States any tax that the oil companies paid to the oil producing nations was directly deducted from their income tax. As a result the Venezuelan tax hike did not really reduce the profits seen by the oil companies. On top of this Venezuela had the right to set taxes at whatever rate the government desired, and it was hard to argue that a fifty-fifty split of the profits was unfair. Since they did not really lose much and Venezuela actually gave them a slight extension on their concession agreement as incentive, the oil companies went along with the law without much contention.

Though Venezuela managed to increase the profit it was seeing from the production of its oil, the companies still held the dominant position. More important than the companies power hold on the individual oil producing countries was their grip on the oil market as a whole. They were essentially, though not legally speaking, a cartel. Since some companies had a surplus of oil and others did not have enough, they worked out an agreement whereby the companies with surpluses would sell their extra oil to the others at a reduced rate. This had the effect of limiting the supply, and increasing prices (The United States government tried for years to catch the oil companies for anti-trust law violations, but was unsuccessful since their actions were technically legal).9

The higher prices of oil actually benefited the oil producing countries since their profits were directly tied to the oil companies. However, the same power which allowed the companies to control prices also gave them the ability to control where that extra money went. The seven major oil companies each had rights in several different producing nations and controlled almost all of the world’s oil supplies. Since they each had several countries from which they could extract their oil they could easily reduce production in one location and raise it in another giving them a powerful bargaining advantage over individual countries.

At that time the individual governments knew very little about what was going on with their oil. They had no idea where the oil was being extracted from, who it was being sold to, or at what price. All they really knew was how much oil the companies claimed to have sold, and how much money they received for it. There was no communication between countries, so no government knew how much other nations were making from their oil. The Venezuelan government realized that the companies might reduce production in the country because of the slight increase in price. To counteract this they sent ambassadors to the other oil producing countries in the Middle East. If they could be convinced to adopt fifty-fifty deals of their own then there would be no reason for the companies to reduce production in Venezuela.

Initially the other oil producing countries were unreceptive to the Venezuelans’ strategy. However, Saudi Arabia soon became aware that any payments made by the companies to oil producing nations were deducted from their income tax. The main problem then became the no tax increase clause in their agreement, which prohibited them from working out the same deal that Venezuela had. The oil companies, realizing that they it would be hard to refuse the claim after instituting a similar one with Venezuela were in a bit of a bind. The United States government cared more about ensuring access to oil than the extra tax revenue, however, so they allowed the oil companies to consider the increased payments a tax rather than a royalty so that it could still be deducted from their income tax.10 It was not long before all of the oil producing nations had similar fifty-fifty profit sharing contracts.

Most of the Middle Eastern countries were content with the fifty-fifty profit sharing. Iran, however, had a more radical idea in mind. The sentiment grew in the Majlis (Iranian Parliament) that nationalization was the way to go. Prime Minister Ali Razmara, who was the main anti-nationalization force, was assassinated in 1951 and a nationalization bill was passed in the Majlis soon afterward. British Petroleum (BP) was the only oil company that had a concession agreement in Iran. In the interest of maintaining profits, BP increased production in Iraq and Kuwait while looking to England for support in keeping their interests in Iran after negotiations failed. Both England and America attempted to work out deals with Iran’s new Prime Minister Mohamed Mossadegh (who took power by popular support, against the will of the Shaw) but none were reached and as a result, oil exportation ceased entirely. After two years without oil income the country was feeling the effects and Mossadegh began to lose support. So in 1953 the CIA (at the request of England) funded a coup which retuned power to the Iranian Shaw and landed Mossadegh in prison.11

Consequently, the movement for nationalization in Iran was crushed. After the destabilization of their government and three years without oil revenue Iran ended up with a fifty-fifty deal equivalent to what they had been offered before trying to nationalize. On top of this, oil interests in Iran were spread among all of the major oil companies, not just BP. This not only helped to increase the oil companies’ hold on the market, it also made negotiations much more complicated for the Iranian government. England and America had made an example of Iran that would not be forgotten by any of the oil producing nations for a long time.

The increased profits that the oil producing nations were seeing as a result of the fifty percent profit sharing deals were soon starting to be offset by decreasing oil prices. In 1954 Brazil was looking to secure an oil supply for its new Cubatoa refinery. Chevron won a contract to provide two thirds of the oil required by undercutting Exxon’s offer. This was a surprise to most of the industry because Chevron was shipping their oil all the way from Saudi Arabia even though Exxon’s came from Venezuela. This event marked the beginning of competition between the major oil companies, which had cooperated up until this point as a de facto monopoly to maintain high prices.

The result of this competition was a slow but steady decline in oil prices. The situation was not improved at all as independent oil companies began to take a larger share of the market. In 1956 Venezuela announced that it would be awarding new concession agreements. Though most of them went to major companies several went to independent ones. Iran and Saudi Arabia also created new concession agreements, giving independents a larger share in 1957. The Soviet Union which was a relatively small exporter (only about 100 kilo barrels per day) also began to make its presence felt. After large quantities of oil were discovered in 1956 oil exports began increasing by about 40% per year until they reached almost 700kbd in 1961.12

In the interest of maintaining profits, oil companies lowered the posted price of oil, which determines the majority of their taxes. In fact, Venezuela tax payments the only ones based on the actual market price of oil. Everywhere else they were calculated using posted prices. These prices were supposed to reflect the price of oil on the global market, and were loosely based upon the cost of oil in the United States adjusted for the cost of shipping. In reality, however, these prices did not accurately represent the cost of oil.

This system worked in favor of the oil companies because they themselves controlled the posted prices. They were able to increase the actual price of oil without changing the posted prices. Thus, an increase in their oil profits did not necessarily mean an increase in taxes they paid. The oil producing nations knew very little about the oil industry beyond what the companies told them, so they were fairly oblivious if posted prices did not increase with actual oil prices. Though the oil companies were perfectly happy to see increased profits by not raising posted prices to reflect real prices, they did not hesitate to lower them when actual prices declined.

The developing nations might not have noticed the fact that they were being slighted as prices increased, but they definitely took note when posted prices started to decrease. As the cost of oil dropped in the late fifties Middle Eastern countries began to complain when the oil companies repeatedly reduced their posted prices. It aggravated them even more that the oil companies would drop the prices without warning them in advance. With the outcome of Iran’s attempt at nationalization in mind, however, none of them actually did much beyond voicing their discontent, and a few empty threats.

In 1958 a revolution in Venezuela brought the end of their military dictatorship. The following year a democratically elected government was instituted and Pèrez Alfonzo was appointed Minister of Mines and Hydrocarbons. Venezuela had been immediately affected by the decline in oil prices since their taxes were based directly upon them. One of the first acts of the new government was to raise income taxes. This resulted in a net tax of 70% on oil companies. When the president of Exxon, the largest oil company in Venezuela, complained about the country reneging on verbal agreements he was [exiled] kicked out and told not to return.13 Though the increased taxes more than made up for the declining oil prices, Pèrez Alfonzo had a plan to put the cost of oil back on the rise. From basic economics he realized that since countries had the power to limit production, together they could control oil prices by reducing supply. He approached the other oil producing nations with the idea of forming a coalition of oil producing countries in 1959, but there was no immediate action on the proposal.

By the following year, however, the oil producing nations had had enough of the companies reducing posted prices without warning. Another price drop in August 1960 pushed Iran, Iraq, Kuwait, and Saudi Arabia over the edge.14 They were impressed by accomplishments in Venezuela as a result of the strong actions the country had taken with regard to the oil companies. They decided to follow Pèrez Alfonzo’s advice, and the first meeting of OPEC was held on September 10th, 1960.

Though the oil producing nations had been stirred to action, they did not take a particularly strong stand. The five members of the newly formed group drafted a set of three resolutions at their first conference.

1) Endeavor to get August posted price reductions rescinded and ensure that no further price changes be made without prior consultation;

2) Study a system for the stabilization of prices through the regulation of production;

3) Set up a permanent organization to be called the Organization of the Petroleum Exporting Countries, which was to have a permanent secretariat and meet twice a year.15

The OPEC members didn’t even demand the freezing of posted prices, but requested only that they be warned before the prices were lowered. The weak tone of the resolutions suggests that even together the nations were afraid to really stand up to the oil giants. The oil producing nations had begun to unite, but they were still not able to work together. Iraq attempted to take over Kuwait almost immediately after the founding. Iran, for whom the power of the oil companies was most palpable, was basically a puppet for the US government. They reported everything that went on in OPEC meetings directly to the American government, seriously undermining the group’s effectiveness. Saudi Arabia, realizing that the countries must all work together to if anything were to be accomplished, would not agree to anything that Iran did not back. As a result the weak stance taken in their initial resolutions would continue to characterize the actions of OPEC during its first ten years.

OPEC might not have significantly affected the way the oil industry was run during its early years, but it did have an important effect on its member nations. Before the group was formed there had been very little cooperation between oil producing nations. Though OPEC could not make all of its members work together right away, it gave them a foundation on which to build. Beyond this, it also helped the member nations better understand the oil industry as a whole. It was not until OPEC that the oil producing nations really became aware of the details of how the oil companies mined and sold their oil and to whom. This greater knowledge of the oil industry combined with the support group that OPEC provided would give the producing nations the edge in negotiations with the oil companies, if they could ever work together.

New countries joined OPEC, including Qatar (1961), Libya (1962), Indonesia (1962), United Arab Emirates (1967), and Algeria (1969). Even with these additions the group accomplished little more than a few increases in posted prices during its initial years. In 1966 they adopted a Declaratory Statement of Petroleum Policy in Member Countries. This policy, among other things, contained a few provisions that were to become important. The first allowed oil-producing nations to limit production in the interest of conservation. The second stated that oil-producing nations should set posted prices on which taxes would be based. The third said that governments should be allowed to participate in ownership of oil companies to a reasonable degree.16

Though they OPEC adopted them, these resolutions were not immediately put into effect. The countries did not seem to realize the power that they wielded as a united front. Libya and Algeria however, decided to change all that in May of 1970 by making a stand against the oil companies. With the support of Iraq the two countries demanded an increase in the posted price of oil. A time limit was set on negotiations, and the three set up a support fund to help alleviate any economic damages that might result. They were aided in their endeavor by the timely rupture of the Trans Arabian Pipeline, which limited supply from Saudi Arabia.

In June of 1970 Algeria nationalized several parts of companies which produced petroleum for the country itself. In July Libya began ordering a series of reductions in the amount of oil companies could produce daily in the interest of conservation, as per the OPEC resolution. The oil companies were hard pressed to handle these reductions because of the already limited petroleum supply caused by the ruptured pipeline. Nonetheless they grudgingly complied since their alternative was to cease production entirely. The cutbacks continued, until early September when the companies began to cave and give in to Libya’s demands. By the end of September all of the oil companies had agreed to increase their posted prices and raise Libya’s profit share from 50% to 55%. The Libyan government stopped issuing cutbacks, but it did not retract those that had already been issued.

In only a few months Libya accomplished more than OPEC had in several years. This showed the oil producing countries that it was possible to stand up to the oil companies and win. The lack of support for the oil companies by their respective governments also became apparent as a result of this incident. Since about 1968 fears concern had been growing of oil shortages. Demand was expected to double over the next twelve years, while American and Russian oil production was declining.17 The American and British governments cared more about maintaining supply than the oil companies’ profits. It became clear that if the oil producing nations threatened to cut supply, America and England would put pressure on the companies to settle things peacefully and without supply interruptions.

Libya had won and demonstrated that taking a firm stance would get results. At the next meeting of OPEC in December of 1970, a resolution was passed to increase posted prices, as well as a minimum of 55% profit sharing for all member countries. The following meeting in February of 1971 saw these resolutions become a demand, backed by threats or embargos, production reduction or cessation. Within a few days the oil companies caved, and agreements were signed increasing posted prices and profit sharing.

OPEC member governments now began to seek control of the oil companies acting within their countries. Lead by Saudi Arabia’s oil minister Ahmed Zaki Yamani, Iran, Iraq, Kuwait, Qatar, Abu Dhabi, and Saudi Arabia sought participation. The idea of participation was introduced as a milder form of nationalization. Rather than completely controlling the industry the governments would take control of production and sell directly to the oil companies at market value. Negotiations began late in 1971, and after a few months an a few threats, the companies gave in. An agreement was reached that the governments would receive 25% participation beginning in January 1973. Each year for the next three years they would gain another 5%, and in the fourth they would receive 6%, resulting in 51% participation by the oil producing nations. As compensation the countries would pay the net book value of the company adjusted for inflation, which was significantly less that the actual value of the companies being acquired.18

The countries that did not benefit from this agreement created deals of their own. Algeria nationalized 51% of all the French companies in 1971, and Libya also forced a similar agreement. The rising price of oil, however, was making their previous profit sharing agreements ineffective. The large profit increases that the oil companies would see in 1973, would lead to more disagreements, and raise participation to 100% (basically nationalization) by the end of 1973.19 The oil producing nations that were once being exploited by the wealthy oil companies were now firmly in control. OPEC was on its way to becoming a powerful cartel, which would dictate future of the oil industry.

Section 2: Social Effects of Oil Revenues

Poverty Reduction:

Prior to the exportation of oil OPEC member countries suffered some of the worst poverty on earth as a result of scarce water and arable land. However, large oil revenues now present a great opportunity to alleviate hunger, and need. At the 2002 OPEC Summit, OPEC leaders reiterated the fact that OPEC’s highest aspiration is to alleviate the poverty of underprivileged peoples. This analysis seeks to determine what impacts the reduction of poverty has on the economies of OPEC and to what extent poverty reduction has been successful since 1975, when all OPEC members had nationalized oil production.

Absolute poverty, as described by the UN is subsisting on less than $1 US per day. The term poverty itself describes a broad range of circumstances associated with need, lack of resources and hardship. The 1$/day level is merely a standard at which a person is clearly experiencing hardship and need. This is not to say that all who subsist on more than 1$/day are free of poverty. However, the UN’s definition of poverty is a valuable benchmark in determining how many are living in absolute destitution and it will be referred to repeatedly in this paper. Once a clear understanding of what populations are living in poverty is achieved, a plan must be developed in the hopes of alleviating their need. In general, “The most important aim of development efforts is to reduce poverty, which can be accomplished by economic growth and/or by income redistribution.”20

Since the formation of OPEC its Middle Eastern members have shown significant reductions in poverty. In fact when compared to areas of the world that had similar poverty levels during the nineteen seventies such as Southeast Asia, ME OPEC countries have shown roughly double the reduction of people below the absolute poverty line.

MENA stands out as the developing region with the lowest incidence of IDG poverty ($1.00 per day) throughout the 1990s at less than 2.5 percent of the population. While the transitional economies of Eastern Europe and Central Asia began the decade with a lower headcount index, the extreme contraction in incomes following the fall of Communism more than doubled the proportion of the population living in poverty by 1998 to 3.7 percent. The region’s low poverty headcount is particularly striking in contrast with that of Latin America – a region at roughly twice the level of per capita income – which was 12.1 percent of the population in 1998.21
Although these figures refer to Middle Eastern and North African (MENA) countries ME OPEC members all fall into this group and their performance in poverty reduction contributes strongly to this statistic. This large reduction in poverty would have been much more difficult, or perhaps impossible without the huge augmentation of GNP that OPEC countries have experienced in the past thirty years as a result of the burgeoning oil industry. Still, this should not detract from the remarkable achievements which have been made.

Reduction of Resource Inequality and its Implications:

The number of people living in absolute poverty conveys valuable information about a region’s condition, but a more complete understanding of social conditions can be achieved by examining the average resource inequality in a region. In this analysis resource inequality represents the combination of income inequality and capital inequality. In other words, resource inequality is the average disparity between the incomes of the rich and poor and the average disparity between property holdings of the rich and poor. Several studies conclude that resource inequality between social groups may hinder economic growth.

The bottom line is not complicated. Cross-country studies provide increasing evidence that at least among developing countries, high levels of inequality inhibit growth. Theorists have provided various stories to explain the link. Some but not all of the stories in fact reflect the negative effects of poverty – in the face of various capital market and government failures, the poor have difficulty acquiring and using productive assets and thus cannot easily get on the growth train, and their resulting low productivity inhibits overall growth.22
Wealthy members of society will most likely trade in both high and low price markets. High price markets include expensive goods and services, such as imported vehicles and well-educated labor. Low price markets consist of inexpensive goods and services, including staple foods and menial labor provided by lower income members of society. However, those members of society with low income are limited to participate exclusively in the low income market. As a result, large income inequality limits the total amount of commerce possible in a region. As the inequality decreases between a region’s groups, they are able to engage in commerce together more frequently, which can ultimately lead to economic growth.

Concurrently, it is sometimes argued that very low income inequality can actually decrease economic growth. The former USSR serves as an example, where resource equality was a central principal in social planning. Wages were set very close to ensure high income equality and property was owned entirely by the state, resulting in total capital equality. Unfortunately, resource equality reached a point where working hard no longer presented sufficient economic incentives and productivity declined. Although it may be the case that extremely low levels of inequality can inhibit economic growth as a result of low productivity, it is unlikely that resource inequality in ME OPEC countries will approach these levels in the near future. It follows that for ME OPEC countries, reducing resource inequality will lead to a net economic growth. This coupled with the growth benefits associated with alleviating poverty dictate that ME OPEC countries aim to simultaneously reduce poverty and income inequality.

In order to proceed further with an analysis of resource inequality, it must be quantified. The Gini coefficient lends itself well to this analysis, defined as, “a number between 0 and 1, where 0 corresponds with perfect equality (where everyone has the same income) and 1 corresponds with perfect inequality (where one person has all the income, and everyone else has zero income).”23 The Gini coefficient is used in many studies analyzing inequality and is calculated using the Brown formula,
G = 1 - ∑ ( X i-1 - X i )*( Y i-1 + Y i )

i=0

where G = Gini coefficient

X = accumulated portion of the population variable

Y = accumulated portion of the income variable


Although they are certainly correlated, reduction of poverty may not significantly decrease resource inequality. For example, a country which begins with a large income inequality—implying an elite group of super-rich adjacent to a large group of very poor—that experience a large reduction of poverty may not automatically see a large decrease in income inequality because the groups’ relative incomes are still extremely disparate. A simplified country model can be used to illustrate this point. Consider a country with only two population groups: rich and poor. The poor account for 95% of the population and originally subsist on an average of $3/day while the rich 5% population maintains an average income of $200/day. Using these values the initial Gini coefficient is (.836), reflecting the high level of income inequality. After some serious social work by the government, the poor group’s average income rockets to an average $7/day, resulting in huge poverty reduction. However, the new Gini coefficient is (.818), which represents a 1.8% reduction in average income inequality. Of course, this is an extremely simplified model. However, the point remains that even with a large reduction in poverty a region may not realize a large reduction in resource inequality.

In addition to notable reductions in poverty ME OPEC countries have experienced considerable reduction of resource inequality since 1975. It is difficult to obtain accurate Gini coefficients for ME OPEC countries alone. However, credible data exists that tabulates the Gini coefficients of Middle Eastern and North African (MENA) countries together and it can be used to imply ME OPEC nations’ performance.


First, although the MENA region began 1970 with one of the highest rates of income inequality in the world (Gini = 0.440), since that time it has also recorded one of the largest rates of improvement in income distribution. In fact, MENA is only one of two regions – South Asia (SAR) being the other – to record improvements in income inequality over time. Second, because of these improvements, the MENA region now has one of the most equal income distributions in the world (Gini = 0.360). Overall, MENA’s very enviable success in improving income inequality may provide an important explanation for the regions unusual success in reducing poverty.24

A Policy of Growth:

The successes of ME OPEC countries both in reducing absolute poverty and resource inequality are extremely noteworthy. Still, the development of a middle class is essential to reduce resource inequality further and excite more rapid economic growth. Developing such a middle class proves especially difficult in Middle Eastern countries because the majority of current employment is in agriculture. This is not a sector which provides many high income positions. The economic sector that is clearly the most lucrative (nets the highest revenues) is the oil industry. Unfortunately, petroleum manufacturing and distribution is not a very labor intensive process. There simply aren’t a large number of positions available in the petroleum industry, and substantial industry revenues cannot be disseminated directly to the population via employment. As a result, this economic sector does not provide a practical means of reducing the resource gap. Instead, the revenue generated by the petroleum industry is absorbed primarily by ME OPEC countries’ respective governments. This capital clearly plays a vital role in the development of infrastructure and investment in large industrial operations, but is consequently disseminated to the populace slowly. The large capital amassed from the oil industry can generally be spent in two ways—those ways that are socially productive or unproductive.

Socially productive or essential expenditures include health, education, sanitation and nutrition, which are viewed as non-consumptive human-capital formation (creating a skilled workforce and a literate and healthy population with a long life-expectancy). On the other hand, non-productive public consumption includes unnecessary military spending (beyond minimum security needs) and expenditure on excessive government administration beyond the needs of internal security for citizens.25
The development of a middle class population is dependent on high levels of education. Highly educated individuals tend to stimulate economies by holding service positions, which are boons for economic growth because they require no resources beyond infrastructure and human effort. Conversely, the employment uneducated individuals can obtain—typically farming related in Middle Eastern countries—requires extensive natural resources . The assets necessary for farming enterprises, including arable land and large quantities of water are extremely scarce in most ME OPEC countries. As a result, having a sector of the economy driven by educated service, or manufacturing opens prospects for growth that are impossible from the economic sectors requiring only skilled labor and natural resources. Educated individuals further inspire economic growth because of a tendency towards entrepreneurship. An educated middle class can open new businesses and the prospect of consequent social mobility drives business owners to somehow make their trade profitable, all of which results in higher GNP and a more active and broad economy.

Creating more opportunities for higher education in ME OPEC countries could eventually result in extensive economic gains. Actually, education levels have improved in ME OPEC countries since the formation of OPEC. Specifically, “in the Middle East between 1965 and 1990 enrollment in primary schools improved by . . . 29%.”26 This increase in primary school enrollment can be contrasted with enrollment in Universities during the same period, which rose a staggering 400%.27 It appears that per capita gains in elementary education are amplified at the secondary and collegiate levels. Investment in primary education can result in escalating rates of economic return as more individuals who obtain secondary and university education contribute to the development of an educated, working middle class.

Unfortunately, average levels of education for women have not improved nearly so much as average education levels among men in ME OPEC countries. In fact, “the difference between women and men in school enrollments and health indicators is among the largest in the world. For example, there is a 28 percentage point gap between male and female literacy in MENA, the highest among developing regions.” (1) Leaving the female population uneducated relegates them to labor industries and domestic work. The lack of female education can most likely be attributed to the social models typical of traditional Muslim societies. Unfortunately, this leaves a huge human resource untapped and greatly hinders the potential growth of ME OPEC countries.

Despite the potential benefits of concentrating public spending in socially productive sectors, many ME OPEC countries invest large portions of their GNPs in military development.

In a region where nearly 80 million adults are illiterate, and in which ten countries have infant mortality rates above the [region] average of 50 per 1,000, governments in 1986-91 spent about US$200,000 per person on its armed forces. This average is higher than the USA (US$130,000 / [person]) and is 12 times the public spending on education per person.28

Military investment is not only detrimental to economic development and consequent poverty relief because it divests potential funds from education and health. Payments to arms manufacturers such as Lockheed Martin and Boeing divert capital into foreign markets, weakening the currencies of ME OPEC countries. In fact the consequences of military investment become threefold when ME OPEC countries spend funds originating from foreign aid. In this case ME OPEC countries suffer from the interest accumulated on their debt, the weakening of currency associated in international spending, and the diversion of funds from socially productive investment.


Arab Aid:

Although domestic spending might be further idealized to stimulate growth and reduce poverty, one means of world poverty reduction that all OPEC countries excel in is foreign aid. The history of OPEC aid traces back to a conference in Algiers that occurred in 1975. At this summit OPEC leaders, “reaffirmed ‘the natural solidarity which unites their countries with the other developing countries in their struggle to overcome under-development’ and called for measures to strengthen co-operation with those countries.”29 The result was the formation of the OPEC Special Fund in 1976. This soon developed into a permanent international aid agency known as the OPEC Fund for International Development, formally established in 1980.

The organization, commonly known as the OPEC Fund provides economic aid to those countries listed as most impoverished according to the U.N. More specifically, the OPEC Fund aims, “to promote cooperation between OPEC member countries and other developing countries as an expression of South-South solidarity and to help particularly the poorer, low-income countries achieve economic advancement.”30 In order to achieve these goals, OPEC member countries donate large sums of money and the OPEC fund distributes it by offering concessionary loans, financing private sector projects in developing countries, and providing grants for research, food, and technical development. By 2003 a total of 130 developing countries received $76 Billion in aid from the OPEC fund.

One might assume that Arab aid is channeled primarily to those developing countries maintaining close relations with the Middle East and sharing Middle Eastern political interests. On the contrary, Arab aid is sent to many, “nations with little in the way of links, either religious, cultural, economic or political.”31

Hence much has been done with the capital realized from the oil industry in ME OPEC countries. Assertions made in this paper tend to generalize the conditions and strategies of all ME OPEC countries, while in actuality individual OPEC countries economic and social performance vary significantly. However, this paper attempts to isolate trends which are beneficial or detrimental to the people of ME OPEC countries, and not to evaluate the performance of individual countries. Much has been done to reduce poverty and the resource inequality in ME OPEC countries, which, in turn, results in economic growth and magnified poverty relief. However, if ME OPEC members opt to draft budgets that concentrated spending in education and healthcare as opposed to military development, they may eventually realize far greater returns in standard of living and economic growth.

Works Cited


1. Adams, Richard H. Jr., and Page, John, “Holding the Line: Poverty Reduction in the Middle East and North Africa, 1970-2000.” Poverty Reduction Group, The World Bank 1818 H Street, NW Washington, DC 20433 (2001), <http://www.mafhoum.com/press3/96E14.pdf>
2. Ali, Ali A. G., and Elbadawi, Ibrahim A., “Poverty and the Labor Market in the Arab World: The Role of Inequality and Growth.” The American University in Cairo Press (2000), <http://www.sacdo.com/Dev/dev_web/Categories/FeaturedArticles/ibrahim_elbadawi/doc/Arab2fin1.pdf>
3. Benamara, Abdelkader, and Ifeagwu, Sam, eds. OPEC Aid and the Challenge of Development: Seminar to Mark the 10th Anniversary of the OPEC Fund for International Development. 23 June 1986. Vienna, Austria.
4. Bigsten, Arne, and Levin, Jörgen, “Growth, Income Distribution, and Poverty: A Review.” Department of Economics, Göteborg University (2000), <http://cent.hgus.gu.se/epc/data/html/html/PDF/gunwpe0032.pdf>
5. Birdsall, Nancy, “Why Inequality Matters: The Developing and Transitional Economies.” Mt. Holyoke College, South Hadley, Massachusetts

(2000), <http://www.mtholyoke.edu/acad/econ/bird5.pdf>


6. Deininger, Klaus, and Squire, Lyn, “New Ways of Looking at Old Issues: Inequality

and Growth.” Journal of Development Economics Vol. 57 (1998) 259–287, <http://qed.econ.queensu.ca/pub/faculty/lloyd-ellis/econ835/readings/deininger.pdf>


7. Dixon, PM, Weiner J., Mitchell-Olds T, Woodley R. “Boot-strapping the Gini coefficient of inequality” Ecology 1987; 68: p.1548-1551
8. Van Eeghen, Willem, and Soman, Kouassi, “Poverty in the Middle East and North Africa.” The World Bank Group (1993), <http://www.worldbank.org/mdf/mdf1/menapoor.htm>
9. El-Ghonemy, M. Riad. Affluence and Poverty in the Middle East. London: Routledge, 1998.
10. Para, Francisco. Oil Politics: A Modern History of Petroleum. New York, New York: I.B. Tauris & Co. Ltd, 2004.
11. Al Saud, HRH Prince Talal bin Abdul Aziz. Speech. “Arab Aid: A Durable and Steadfast Source of Development Finance.” Dubai, United Arab Emirates. Dec. 2003.
12. Stocker, George W. Middle East Oil: A Study in Political and Economic Controversy. Kingsport, Tennessee: Vanderbilt University Press, 1970.


1 Stocker, George W. Middle East Oil: A Study in Political and Economic Controversy. Kingsport, Tennessee: Vanderbilt University Press, 1970, 4.

2 Para, Francisco. Oil Politics: A Modern History of Petroleum. New York, New York: I.B. Tauris & Co. Ltd, 2004, 8.


3 Para, 9.

4 Para, 10.

5 Stocker, 130.

6 Stocker, 138.

7 Stocker, 132.

8 Para, 18.

9 Para, 11.

10 Para, 18.

11 Para, 27.

12 Para, 82.

13 Para, 84.

14 Stocker, 352.

15 Stocker, 353.

16 Stocker, 439.

17 Para, 114-15.

18 Para 158.

19 Para, 162.

20 Deininger, Klaus, and Squire, Lyn, “New Ways of Looking at Old Issues: Inequality and Growth.” Journal of Development Economics Vol. 57 (1998) 259–287, <http://qed.econ.queensu.ca/pub/faculty/lloyd-ellis/econ835/readings/deininger.pdf>


21 Adams, Richard H. Jr., and Page, John, “Holding the Line: Poverty Reduction in the Middle East and North Africa, 1970-2000.” Poverty Reduction Group, The World Bank 1818 H Street, NW Washington, DC 20433 (2001), <http://www.mafhoum.com/press3/96E14.pdf>


22 Birdsall, Nancy, “Why Inequality Matters: The Developing and Transitional Economies.” Mt. Holyoke College, South Hadley, Massachusetts

(2000), <http://www.mtholyoke.edu/acad/econ/bird5.pdf>




23 Van Eeghen, Willem, and Soman, Kouassi, “Poverty in the Middle East and North Africa.” The World Bank Group (1993), <http://www.worldbank.org/mdf/mdf1/menapoor.htm>


24 Adams, Richard H. Jr.

25 El-Ghonemy, M. Riad. Affluence and Poverty in the Middle East. London: Routledge, 1998, 91.

26 El-Ghonemy, 100

27 El-Ghonemy, 100

28 El-Ghonemy, 95.

29 Benamara, Abdelkader, and Ifeagwu, Sam, eds. Opec Aid and the Challenge of Development: Seminar to Mark the 10th Anniversary of the OPEC Fund for International Development. 23 June 1986. Vienna, Austria, ix.


30 Al Saud, HRH Prince Talal bin Abdul Aziz. Speech. “Arab Aid: A Durable and Steadfast Source of Development Finance.” Dubai, United Arab Emirates. Dec. 2003, 53.

31 Al Saud, 19.



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