Oil Boom: Peril or Opportunity? Sub-Saharan Africa is in the midst of an oil boom as foreign energy companies pour billions of dollars into the region for the exploration and production of petroleum. African governments, in turn, are receiving billions of dollars in revenue from this boom. Oil production on the continent is set to double by the end of the decade and the United States will soon be importing 25 percent of its petroleum from the region. Over $50 billion, the largest investment in African history, will be spent on African oil fields by the end of the decade.

The new African oil boom -- centered on the oil-rich Atlantic waters of the Gulf of Guinea, from Nigeria to Angola -- is a moment of great opportunity and great peril for countries beset by wide-scale poverty. On the one hand, revenues available for poverty reduction are huge; Catholic Relief Services (CRS) conservatively estimates that sub-Saharan African governments will receive over $200 billion in oil revenues over the next decade. On the other hand, the dramatic development failures that have characterized most other oil-dependent countries warn that petrodollars have not helped developing countries to reduce poverty; in many cases, they have actually exacerbated it.

Africa's oil boom comes at a time when foreign aid to Africa from industrialized countries is falling and being replaced by an emphasis from donor nations on trade as a means for African countries to escape poverty. The dominance of oil and mining in Africa's trade relationships, coupled with this decline in aid flows, means that it is especially vital that Africa make the best use of its oil.

CRS is committed to helping to ensure that Africa's oil boom improves the lives of the poor through increased investment in education, health, water, roads, agriculture and other vital necessities. But for this to occur, these revenues must be well managed. Thus, this report addresses two fundamental questions: How can Africa's oil boom contribute to alleviating poverty? What policy changes should be implemented to promote the management and allocation of oil revenues in a way that will benefit ordinary Africans?

Capital-account liberalization was once seen as an inevitable step along the path to economic development for poor countries. Liberalizing the capital account, it was said, would permit financial resources to flow from capital-abundant countries, where expected returns were low, to capital-scarce countries, where expected returns were high. The flow of resources into the liberalizing countries would reduce their cost of capital, increase investment, and raise output (Stanley Fischer, 1998; Lawrence H. Summers, 2000). The principal policy question was not whether to liberalize the capital account, but when -- before or after undertaking macroeconomic reforms such as inflation stabilization and trade liberalization (Ronald I. McKinnon, 1991). Or so the story went.

In recent years, intellectual opinion has moved against liberalization. Financial crises in Asia, Russia, and Latin America have shifted the focus of the conversation from when countries should liberalize to if they should do so at all. Opponents of the process argue that capital account liberalization does not generate greater efficiency. Instead, liberalization invites speculative hot money flows and increases the likelihood of financial crises with no discernible positive effects on investment, output, or any other real variable with nontrivial welfare implications (Jagdish Bhagwhati, 1998; Dani Rodrik, 1998; Joseph Stiglitz, 2002). While opinions about capital-account liberalization are abundant, facts are relatively scarce.

This paper tries to increase the ratio of facts to opinions. In the late 1980's and early 1990's a number of developing countries liberalized their stock markets, opening them to foreign investors for the first time. These liberalizations constitute discrete changes in the degree of capital-account openness, which allow for a positive empirical description of the cost of capital, investment, and growth during liberalization episodes.

Figure 1 previews the central message that the rest of this paper develops in more detail. The cost of capital falls when developing countries liberalize the stock market. Since the cost of capital falls, investment should also increase, as profit-maximizing firms drive down the marginal product of capital to its new lower cost. Figure 2 is consistent with this prediction. Liberalization leads to a sharp increase in the growth rate of the capital stock. Finally, as a direct consequence of growth accounting, the increase in investment should generate a temporary increase in the growth rate of output per worker. Figure 3 confirms that the growth rate of output per worker rises in the aftermath of liberalization.

While the figures do no harm to the efficiency view of capital-account liberalization, a number of caveats are in order. For example, it is legitimate to interpret a fall in the dividend yield (Fig. 1) as a decline in the cost of capital, if there is no change in the expected future growth rate of dividends at the time of liberalization. But stock-market liberalizations are usually accompanied by other economic reforms that may increase the expected future growth rate of output and dividends (Henry, 2000a, b). Because liberalizations do not occur in isolation, it is important to think carefully about how to interpret the data. Neoclassical theory provides a good starting point for framing the issues.

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The use of theory to justify uniform pricing for government-debt auctions has been criticized. The existing theory is not general enough to prescribe the optimal mechanism, so judgment is needed. But this is to be expected (it was also the case with the spectrum auctions). The world is more complicated than theorists' models. If we are to use theory in policy we must learn to live with a bit of extrapolation.

Theory is not always usable. The outstanding policy success of theory, the sale of spectrum rights, is a special case. Subtle as it is, the spectrum market demands far less of rules to underpin it than, say, an equity or a labor market. As China's reforms illustrate, sometimes the extrapolation from simple theory to complex reality is just too big.

Protesters who marched around the world last week were wrong to assume that American inaction against Iraq will make their children safer or the Iraqi people better off. (Wouldn't it be nice if the Iraqi people could express their opinion about their country's future rather than having to listen to George W. Bush, Saddam Hussein or street protesters speak on their behalf?) The protesters were right, however, to question whether war against Iraq will produce more security at home and real freedom for the Iraqi people.

Americans should have confidence that the Department of Defense has a game plan and the capacity to destroy Hussein's regime, but we have less reason to feel the same level of confidence about the blueprint and resources earmarked to rebuild Iraq because no one talks about them.

The time for circulating such plans and amassing such resources is now, before the bombs begin to fall. A war to disarm Hussein alone is not legitimate. Only a military conflict that brings about genuine political change in Iraq will leave the Iraqi people better off and the American people more secure. Winning the war will be inconsequential if we fail to win the peace.

To demonstrate a credible commitment fto rebuild a democratic Iraqi over the long haul, the Bush administration could do the following today:

First, if we must go to war, we cannot go alone. American armed forces can destroy Hussein's regime without France or Germany, but the U.S. Agency for International Development will struggle to rebuild a new Iraqi regime without the assistance of others.

Second, President Bush must state clearly before the conflict begins that an international coalition will govern Iraq for an interim term. Again, the burden will fall mainly on American armed forces and their commanders. But the less the occupation looks like an American unilateral action, the better.

Third, the Bush administration must secure a commitment from all stakeholders in a post-war Iraqi regime about the basic contours of a new constitution for governing Iraq before war begins. Right now, these claimants on a future Iraqi regime are weak. They need the United States to come to power, which gives American officials considerable leverage now. Once Hussein's regime falls, however, they will be less beholden to the Americans. Without a clearly articulated plan in place before the fall of Hussein's regime, the process of constituting a new government could quickly become chaotic and unpredictable.

Fourth, President Bush must make absolutely clear now -- before war -- that the United States has no intention of seizing Iraqi oil fields, which belong to the Iraqi people. Bush must distance himself from statements made by unnamed government officials that the United States plans to appropriate Iraqi oil revenues as reparations.

This absurd idea -- believed by many throughout the world -- must be squelched immediately and unequivocally. Instead, the Bush administration should consider privatizing the Iraqi oil business through a mass voucher program. Give every Iraqi citizen a small stake in the ownership of these resources. At a minimum, an international consortium, not an American general, must assume stewardship of the Iraqi oil business during occupation.

On Day One after Hussein is defeated, Bush must demonstrate a real commitment to the promotion of democracy in the region. Most importantly, the rebuilding of Iraq must begin immediately. The delays we are witnessing in Afghanistan cannot be repeated.

In this cause, the American people should also help through the direct delivery of aid, student exchanges, or sister-city programs. Those who rallied in support of peace last week should remain mobilized to promote peace and development in Iraq after a military conflict, when the Iraqi people will be in greatest need.

In parallel, Bush must demonstrate a more serious commitment to rebuilding a state in Afghanistan -- hopefully as a democracy, but at least as a functioning, coherent state that can maintain order and promote development. This can happen only if the warlords are contained, an assignment that will require several times the several thousand peacekeeping troops now in the country. Western aid workers in Afghanistan -- including those working on democracy -- complain that internal security is a precondition for any aid to be effective.

In addition, Bush must formulate a policy toward Iran, which could begin by stating clearly that the United States does not intend to use force against that country. The current ambiguity about American intentions only strengthens the hard-liners within Iran and weakens the reformers. More fundamentally, the United States must develop a more sophisticated policy toward Iran, one which engages reformers within the Iranian government and assists democratic forces in society, but does not legitimate hard-line clerics who control the regime. The model is American policy toward the Soviet Union in its waning years.

And President Bush should redouble his administration's efforts to help create a democratic Palestine. A democratic Palestine is not a reward to the Sept. 11 terrorists, but their worst nightmare. Of course, this undertaking is enormous, but no larger than the task of installing democracy in Iraq after invasion.

Bush should also call his counterparts in Saudi Arabia, Pakistan and Egypt and tell them privately the truth -- regime change in their countries has already begun. If they initiate political liberalization now while they are still powerful and their enemies are still weak, they might be able to shape the transition process according to their interests as the king did in Spain and Augusto Pinochet did in Chile. If the Saudis, Pakistanis and Egyptians wait, however, their regimes are more likely to end in revolution like Iran in 1979 or Romania in 1989.

Even if President Bush undertakes all these initiatives, an invasion of Iraq is still likely to produce a net loss of political liberalization in the region in the short run. Dictatorships in the region are not going to suddenly liberalize in response to the American occupation of Iraq. In the face of angry publics, they will do the exact opposite -- just as autocrats across Europe did two centuries ago when Napoleon tried to bring democracy to the continent through the barrel of a gun.

American leaders, therefore, will face greater and more complex challenges after the war than before the war. To succeed, Bush and his successors need a long-term game plan. Above all, the president must explain to the American people that the United States will be involved in the reconstruction of a democratic Iraq and the region for decades, not months or years.

The worst-case scenario -- for both Americans and Iraqis -- is a quick war, followed by a terrorist attack on American troops stationed in Iraq, followed by a call for early American disengagement. Twenty years ago, the United States helped to destroy the Soviet-sponsored regime in Afghanistan, but then failed to help build a new regime in the vacuum. We experienced the consequences of such shortsightedness on Sept. 11, 2001. In Iraq or elsewhere in the region, we cannot make the same mistake again.