Managing Sovereign Wealth With Corrupt Leaders

When accountability isn't a factor.

January 20, 2011

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1135221_hi-jacking_hotspotSome resource rich countries are so corrupt that setting up a commodity fund for managing resource rents would be pointless. After all, there has to be some symmetry between the sponsoring government’s motives and those of the SWF. If there isn’t, no design or governance trick will prevent a SWF from falling victim to political or bureaucratic encroachment. As an example, this was the problem with the Chad case back in 2005. The motives of Chad’s leaders weren’t aligned with the motives that underpinned the country’s “oil fund”.

Recall that Chad had agreed (with the World Bank) to set up an oil fund that would be held in an escrow account in London and monitored by an independent body. In exchange, the country received some loans to help develop a pipeline. But, at the time the deal was going through, both Forbes and Transparency International had Chad listed as the most corrupt country…in the world. So, yeah, it was going to be pretty tough to get a SWF to work in this environment. And, as we might have expected, the governance of the fund did fail. Chad subsequently passed a new law giving the government more access to profits from the pipeline.

So, the case offers an important challenge for development analysts and scholars: How should countries — where the most basic tenets of a society are breaking down —  use resource revenues to facilitate development?

It’s in this context that I’d like to direct your attention to Todd Moss’ new paper on the Oil to Cash program. It offers a pretty compelling plan for resource rich countries in the developing world to overcome the resource curse. The idea is really quite simple: direct cash transfers to the poor. Here’s Todd:

“One option…is to distribute new natural resource income directly to citizens in a regular, universal, and transparent payment. Such an approach may bring strong economic and political benefits, and may help countries not only avoid the corrosive effects of the resource curse but also help to create demands for transparency and accountability.”

Indeed, the idea is to create accountability by making the government raise money through taxes:

“Taxes, social contract theory tells us, are the foundation of accountability between the state and its citizens (Bräutigam 2008). This idea traces its roots to the development of democratic institutions in England and France, where cash-strapped governments had to bargain with taxpayers in order to raise the revenue to finance expensive wars (Tilly 1985; North and Weingast 1989). In exchange for taxes, citizens demanded public services, rights and greater voice in government actions (Bates and Lien 1985).”

In short, these countries must try to avoid the classic pitfalls of a rentier state:

“…stripped of the power of the purse, citizens are unable to exert leverage on the government for public service provision and responsible management. In other words: ‘Without taxation, no representation.'”

So, to summarize, the government (probably with the help of some foreign company) extracts the resource from the ground and receives money. The government then gives this money directly to the people in the form of cash transfers. Next, the government is forced to tax the same people to whom it literally just gave the money in order to raise revenues to run the government. In the end, this process strengthens the social contract, as the government will depend on the people, and the people will be able to influence the government.

It’s a cool idea for a commitment mechanism. And I can tell that I’m not doing it justice. So go read the paper. It’s really worthwhile.

This post originally appeared on the Oxford SWF Project website.

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