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Rebuilding Libya—Without Oil

10:39 AM, Sep 2, 2011 • By DALIBOR ROHAC
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As heartening as it is to see Muammar Qaddafi lose his grip on power, our expectations of Libya's future need to take into account this ethnically diverse country’s complicated reality. The biggest problem is Libya's enormous oil reserves.


Shortly after oil was discovered in Libya, the GDP exploded—going from about $40 per capita in the early 1950s to $1,018 by 1967. These days, hydrocarbon revenues account for 95 percent of Libya's exports and for 90 percent of government revenue—even in the Middle East where a number of national budgets rely largely on energy resources, Libya's economy is one of the least diversified in the region.

The combination of resource dependence and fragile institutions corrupts the political process and encourages kleptocracy and cronyism. Worse yet, in ethnically heterogeneous countries, the presence of valuable natural resources increases the risk of violent conflicts over those resources. Large parts of Sub-Saharan Africa are plagued by the problem—just think of Angola or Nigeria.

Qaddafi's demise means the end of a patronage system, one in which the al-Maghera and the al-Qaddafi tribes were favored by the colonel, to the detriment of the rest of the country. Perhaps Libya will be able to make good on the opportunity to replace this system with a liberal democracy. But managing its oil revenues in a way that won't jeopardize Libya's transition to democratic governance will require that Libyan tribes agree not to use oil revenues to cover the government’s budget.

Libyans can look at the experience of other countries, such as Norway, where oil revenue maintains the country’s sovereign wealth fund, without being used to cover government's everyday spending. To be sure, Norway, unlike Libya, started with a productive economy with a significant taxable base before oil was discovered. In Libya, at least in the short-term, the government would not be able to operate without oil revenues.

It is possible to imagine a constitutional arrangement, agreed upon by all of Libya's tribal leaders, which would stipulate a limit on the amount of oil revenue that could be used for public spending. Moreover, it is possible, at least in principle, to make a binding commitment to use the revenue only to fund specific public goods, benefiting the population at large—safety and security or the judicial system. To fund other spending programs—particularly those that are more prone to capture by interest groups—the new Libyan government should be obliged to raise revenue through taxation.

In any case, even under the most optimistic scenario, reducing Libya's dependence on oil will only be gradual. Its success will ultimately depend on creating a productive private economy that is independent of oil production and that could be taxed. The pre-revolution development of the non-oil sector, which was once projected to grow at 7.5 percent in 2011, should give us some hope. If such growth is restored, Libya could be only years away from having a reasonably diversified economy.

Sure, the idea of taxing the private sector in order to counteract the dominant role oil revenues play in financing Libya's public budget is unlikely to elicit massive popular support. But Libyans need to understand the perils that lie ahead if Libya's factions decide to use oil as a political tool.

Dalibor Rohac is deputy director of Economic Studies at the Legatum Institute in London.

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