The Paradox of Plenty : Oil Booms and Petro-states

Terry Lynn Karl

University of California Press, 1997.
Book Review by Baris Sanli

Why did the oil-rich countries end up being worse than the resource poor countries? This is a
question frequently discussed. Recently, BBC has broadcasted a discussion titled : "Oil:
Blessing or Curse". The program was recorded in a Middle Eastern country and there was no
clear cut agreement between the advocates of two sides. Terry Lynn Karl's Paradox of Plenty
presents a very compelling answer to this question, through case studies of countries,
statistical data and across different parameters.

The oil revenues of producer countries have been skyrocketed once again with the recent
price hike. Oil has hit as high as $140 and most of the analysts expects its value to surpass
$200 in near future. The export revenues of oil exporting countries has reached an all time
high. There are record GDP growth rates reported from these countries, but will this last
forever? Will Angola, Russia, Azerbaijan, Kazakhstan suffer from "paradox of plenty"?

Paradox of Plenty is highly cited book trying to find out the reasons behind the dilemma of
petro-states. Her main case country is Venezuela, one of the founding members of OPEC. By
doing that she starts from a Latin American country and compares and contrast her initial
findings with other countries including Algeria, Nigeria and Norway. When you finish her
book, a substantial belief in the importance of solid institutions in a country captures you.

Her book is "rooted in the political economy approaches of Karl Marx, Adam Smith and the
new institutional economists.". In it, she argues "that dependence on a particular export
commodity shapes not only social classes and regime types, as others have demonstrated so
well, but also the very institutions of the state, the framework of decision-making, and the
decision calculus of policymakers".

The general argument discussed in the book is how commodity-led growth induces changes in
property rights, relative power of interests groups and organizations and the role and character
of the state vis-a-vis market. From this question, she comes to the revenue basis of the state
and the tax structure. The collection and distribution of the state revenues influence "how the
organization of political and economic life and changes government preferences with respect
to public policies"

A General View

The book is organized in three parts. The first part starts from theoretical explanations and
elaborates the general views on commodities, booms and states. The second part is the
Venezuelan case study of the arguments. The third part compares the results obtained so far
with other oil exporting countries.

1. The modern myth of King Midas: Structure , Choice, and the Development Trajectory
of States

The chapter discusses the theoretical basis for the arguments and defines petro-states as units
of analysis. She also defines terms like oil exporter, capital deficient oil exporters. Also in this
part, she elaborates her general argument by asking John Stuart Mill's classic question : "how
can the repeated occurrence of similar patterns across different countries be explained?". This
part also gives a hint about why she has chosen Venezuela as a case study. Apart from the
other Middle Eastern and North African (MENA) countries, "Venezuela was a noted 'outlier'
prior to the 1990s; its generally strong growth and more than thirty five year old democracy
were the most striking signs of a path distinct from the uneven performances and bureaucratic
authoritarian cycles of its Southern Cone neighbours". (p. 21)

2. Spanish gold to black gold: commodity booms then and now

The chapter deepens the theoretical basis of the argument with another case study from a
different time period : 16th century Spain and her gold from the America. "A sudden influx of
great wealth is not always a development 'good'". (p.24) she claims. From a Dutch Disease
point, in which this influx leads to currency appreciation and harms other sectors in a country,
the oil wealth is curse rather than a blessing. The argument is elaborated with contemporary
examples and than the focus turns to 16th century Spain. "In these golden years modern
capitalism was born" from John Maynard Keynes is a relevant sentence regarding our course.
The "easy road" that gold of America provided for policy makers and the way spending is
attributed to character of a state are given as the important arguments of Spanish case. In this
chapter she also argues that "booms themselves are cannot be held responsible for the failure
of the leaders to change discourse". By referring to Schumpeter's book titled Business Cycles
"with regard to Spain 'increase in the supply of monetary metals does not, any more than
autonomous increases in the quantity of any other kind of money, produce any economically
determined effects. It is obvious that these will be entirely contingent upon the use to which
the new quantities are applied".

3. The special dilemma of the Petro-State

How mineral revenues alter the framework for decision making is a question which is at the
core of this chapter. It is not only "policy environments" but also "autonomy of goal
formation, the types of public institutions adopted, prospects for building other extractive
capabilities and the locus of authority" are affected by these revenues. (p.44). As she calls the
relevant agents as "Extractive States", she gives the characteristics that make a state
extractive. The organized interests and political vicious cycles of the petro-states are
discussed. Then she comes to the fiscal and tax related arguments, from there she elaborates
how oil money depletes state capabilities.

4. Making of a Petro-State

From chapter four to the end of chapter eight, a historical view of Venezuelan oil booms and
busts and their aftermaths are given. There are certain examples are relative to Schumpeter's
arguments in this part. If the bureacracy or other institutions are not well established in a
country, the sudden flow of export revenues may alter most of the state structure.
"Caudillismo, a set of political rules based entirely on force, was the expression of fragility of
the governing apparatus and it left an enduring mark on state formation" she claims as she
refers to Gilmore. "A heritage of personalism and presidentialism" that she calls
"ultrapresidentialism" determines how Venezuelan history will change after the oil booms.
This "path dependence" in Venezuela's history determines the very essentials of state
structures, affects the reactions of the state to financial flows and the rest of the story.

5. Oil and Regime Change: The Institutions of Pacted Democracy

Karl describes a pacted democracy, in Venezuelean case democracia pactada,as symbiotic
interaction between the overwhelming incentives created by the petro-state and the particular
type of democracy. This type of structures are established through elite bargains and
compromises during the transition from authoritarian rule (p.93). In this part, she also argues
petroleum was the single most important factor in shaping the structural conditions for the
breakdown of military rule, the subsequent creation of a reformist political space and the
maintenance of a democracia pactada ...(p.94). Through the developments after the late
1935s, but particularly focusing on the late 1950s (end of military rule), she tries to argue how
the transition happened and how oil revenues have structured the institutions in Venezuela.

6. Instant Impact of a Bonanza

In the subsequent events, revenues are seen as a key to transition to democracy, like campaign
slogan of Carlos Andres Perezs Democracia con Energia (Democracy with Energy). One of
the important pieces from this chapter is the following excerpt : By 1976, the per capita
fiscal income of Venezuela equaled that of West Germany and was double that of
Italy(p.122). Perezs desire for power and weakening of check and balances of the
democratic system to refrain him from obligations has at first sight seem like working. La
Gran Venezuela, a modern industrialized economy, has been turned to a bitter game as
Perez requested Special Powers Act by claiming The government cannot develop its plans
efficiently through normal channels. His intentions was a plan to pull Venezuela into the
twentieth century. (p. 128). This act altered the norms of pactismo(p. 130). In the time
slice that this chapter discusses, is the foundation of Fondo de Inversiones de Venezuela (FIV)
to sterilize the petrodollars, before entering and harming domestic economy. (p. 131). But
because of special presidential powers, this fund became a toy for president.

7. The politics of rent seeking

This chapter starts with a fundamental sentence for the story Had Venezuela possessed a
relatively coherent bureaucracy, a functioning civil service, routine tasks and standard
operating procedures, its public institutions should have been able to place some barriers to
halt the contradictory demands and gigantic programs put forward in the first year of the
Perez administration (p.138). The Venezuelan system is now trying to balance the acts of the
previous system and trying to build a efficacious state by National Council of Sectoral
Corporations which would be a centralized agency for all the sectoral corporations. By
1976 the nationalization was accomplished. (p. 152). The chain of events created an economic
clique called Twelve Apostles that is close to president. To create a developed nation, the
spending soared, massive projects were started. But as the 1973 oil boom cooled down, the
country itself found itself with budget deficits in the hands of presupuestiveros (budget
eaters). (p.158)

8. From boom to bust: The crisis of Venezuelan Democracy

The OPECs strategy to increase price by limiting volumes has ended up in 1985. The sharp
price reductions by Saudi Arabia has unveiled the financial problems of the state. Thus even
when oil prices and government income plunged, government behaviour didnt change: public
expenditures and investment outlays did not go down. (p. 162). The second oil boom (1979-
1981) ended. In the late 1980s and the early 1990s, mega-projects like expansion of Guri
Dam and Caracas metro were costing to the administration dearly. Country's oil fields
were suffering a serious decline in output. (p.170). With the rentier situation and deficiency of
tax structure can be summed up in President Lusinchis statement : In Venezuela only the
stupid pay taxes (p.172). But the taxes were needed by the state by late 1980s. The state
turned to foreign debt to sustain her spending. By the end of the 1980s, for every dollar
earned on a barrel of oil, Venezuela was paying $0.40 back to foreign banks. (p. 173). By
late 1988s, governing party had no more room to maneuver (p. 178). IMF precipitated
packages hit the streets. On February 4, 1992, young military officers attempted to overthrow
Latin Americas second oldest democracy. (p.182). Increasing the taxes have been seen by
way out by President Perez, but because of his demise of pactismo, he failed to gather
support. On May 20, 1993, ... the Supreme Court moved to indict Perez on charges of
embezzling $17 million in government funds. This paved the way for his removal.

9. Petro-States in Comparative Perspective

From this point on, Venezuela story is compared with other petrostates. Firstly, similarities
and variations in outcomes in Venezuela, Nigeria, Algeria, Iran and Indonesia are
investigated. The main properties of these countries are the high public expenditures to make
speedy use of their oil rents to perpetuate their resource-based development model. (p. 191).
The development priorities changed from country to country. Then, the reasons for Indonesian
exceptionalism are highlighted. The claimed reasons behind the Indonesian
exceptionalism are better control over its expenditures, pursued a development strategy
more balanced among physical infrastructure, education, agricultural development and
capital-intensive industry; directed a higher proportion of spending toward rural areas; and
accrued less for foreign debt. (p.191) Afterwards a contrasting example of Norway is
discussed. By 1975, Norway was a typical patient of Dutch Disease, inflation has risen to high
levels, ... current-account deficit became the highest of any OECD country except United
States. These events were followed by a government change from Labor Party to
Conservative Party. Norway was a typical civil servants state resembling what Weber
labeled as an ideal bureaucracy operating under rational legal authority. This civil-service
state was the complete antithesis of Venezuela and the other politicized states examined
previously. (p. 217) . Norway did not depend on borrowed state capacity from
international advisers...

10. Commodities, Booms and States Revisited

The revenue of the state is the state by Edmund Burke that Karl refers to at the opening
sentences of the chapter. Oil exports is the similar political behavior exhibited across
historical time, geographical regions, regime types, religions and cultures regardless of the
diverse intentions expressed by policy makers. This political behaviour either creates weak
institutions or weakens the current institutions. Booms make policy makers believe in
politics without limits (p.225). She then argues whether private investors may mitigate the
problem of Venezuelan path. She continues with the advantages of democracy. Through out
the chapter she emphasizes state and stateness. In this type of states, policy makers
operate in the incentive structure shaped by this commodity [petroleum]. Also, institutional
frameworks are the critical key to the relative success of economies. (p.239). The key
sentence in this chapter is developmental outcomes depend on the character of the state
institutions. Lessons from the past suggest a perverse relationship between some forms of
natural resource endowment and successful state building she says. (p. 242). As she puts
forward Adam Smiths argument on Tartars, claiming Tartars, Asian NICs may be rich
precisely because they are resource poor... The need to overcome this poverty may have been
one of the chief catalysts for building effective states. And she calls this as the paradox of
plenty.

A Remark before Personal Discussion

Writer of this review is well aware the lecturer is an expert on Institutional Economics.
Therefore, it is for sure that, the lecturer knows the best of the underlying reasons for
Paradox of Plenty.

From Polanyis Perspective

In his book, Great Transformation, Polanyis arguments are generally centered

around markets. Paradox of plenty in this sense does not fit to his main theme, but Polanyis
arguments provide a dimension to our understanding.

Especially double movement which defines as the market expanded continuously but this
movement was met by a countermovement checking the expansion in definite directions,
incorporates a similar theme like paradox of plenty. This is also argued by Schumpeter
relating to capitalism.

So can we call Polanyis argument as paradox of markets? It is maybe a natural phenomena

regarding every expansion ends up with a contraction. From human heart to universe this
provides the oscillations for diversity. But Polanyis arguments are relevant to our case, in the
sense that massive influx of revenue which has been gained through a concentrated sector
(from a land and manpower utilisation perspective, oil industry depends on geographically
fixed fields and fields are operated by limited number of rigs) creates a huge spending in turn
increases budget deficit in the long run and breaks the sustainability of the spending.

On the other hand, taxation is another term that can be regarded in this sense. The massive oil
revenues eliminates the need for taxing the citizens. Although Karls main argument is around
the understanding of institutions of a state, taxation is essential for the establishment for well-
formed institutions in the framework of accountability. As in the Venezuelan case, a
misleading thinking like only the stupid pays the tax, results with demising the strength of
state institutions. The elimination of taxation can be regarded as a relief for citizens, but then
the only source for state revenues becomes petrodollars. The elite formation hunts around this
interest. Since citizens are not taxed, it becomes harder to tax them as the recent oil price
hikes demonstrates. This breaks the link between the rulers and citizen. No taxation without
representation is a key sentence in this sense.

Polanyis one other argument that can be applied to our paradox is from this part: While
under the regime of feudalism and of the village community, noblesse oblige, clan solidarity,
and regulation of the corn market checked famines, under the rule of the market the people
could not be prevented from starving according to the rules of the game (Polanyi, p. 167). In
the book, we have seen a transition from a state ruled by military generals trying to be
democratic. The aims and goals of the initial democratization game has changed with the
arrival of petrodollars. A poor nation trying to survive and built institutions for her own sake,
has became a state that is borrowing institutional framework from foreign advisors. This
may be due to the short sightedness of her leaders as discussed by Schumpeter.
Nevertheless, petrodollars change and shake the rules of the games like markets. Across
different examples we can not claim that religion, ideology or geography is a determinant, but
the situation of the state before the arrival of petrodollars is an important factor. As the
petrodollar influx oscillates the rulers began to borrow solutions from future.

One of the remarkable things from the Polanyis arguments that captured my mind is the
argument of Dr. Mead from page 166. The process by which a group of savages is converted
into gold-miners or ships crew or merely robbed by all incentive to effort and left to die
painlessly beside streams still filled with fish. As we regard the society before the arrival of
petrodollars as savages (just for illustration purposes), oil turned the whole society in to a
more unstable and painful situation, despite their closest neighbours without oil revenues
experienced a much more steady but slow growth in a more stable environment. If we look to
Venezuela and Colombia, the example partially fits to the context(Karl gives numeric
examples). In Venezuela, we may not talk about SRM, because after the arrival of oil
revenues a nationalization and centralization of the enterprises have started. But the flow of
money paved the way for more spending, elimination of the necessity of taxation for
government revenues and raised the expectations for development. It completely changed the
context for savages. The touch of petrodollars has completely distorted the rules of the
game, social structures, linkages and most importantly the evaluation of institutions in
petrostate. If Venezuela has not been touched by petrodollars, she may have been trying to
find a way out of poverty and military dictatorship by herself. Whether the results will be
better or worse is arguable, as she locates in the backyard of US.

Nevertheless, the desire to develop like white man as speedy as possible, not only broken
the existing structures and aims of this black man, but also he ended up losing the progress
he made so far. It does not mean that speedy development is bad, but achieving this through
destroying the initial aims or existing structures slowly costs Venezuela at a price. Today, still
the country is in political ambiguity and oil production is dropping. Is the history repeating
itself?

From Schumpeters perspective

Schumpeter and his quotation have been mentioned previously. One of the important
questions that came to the mind is whether Venezuela may be regarded as a capitalist state?
My personal answer is not positive. Neither his theory about the evolution of bourgeois
society (through changing life habits and slowly leaving the ground for lower classes) fits for
our purposes. But his remarkable observations provides us a framework for the initial period
before and after the first oil boom.

Particularly the weaker the logical element in the process of the public mind and the more
complete the absence of rational criticism and of rationalizing influence of personal
experience and responsibility, the greater are the opportunities for groups with an ax to grind
(Schumpeter, p. 263). This is how the demise of taxation and throwing the oil revenues to the
people as a bribe results in. The breaking up of the logical structure on responsibility provides
the way for rentier elite to gain control. This elite in turn throws more money to the public for
silence, although he gets a bigger share of the revenue. But as the oil revenues hits bottom, the
system becomes only sustainable for the short run with foreign debt and then becomes
unsustainable.

In this regard, several reasons for the paradox is well defined in Schumpeters Human Nature
in Politics part and Another Theory of Democracy chapter. However the most striking of
all is how the short sightedness of politicians affected Venezuela, where Indonesia achieved a
better record. Norway example also fits well to how a traditional bureaucratic structure can
help the country from opportunist politicians.

The arrival of petrodollars have changed the political structure. Although the intention was to
develop to a Grand Venezuela, the way for the aim has been represented as
ultrapresidentialism . This part does not fit Schumpeters argument, because the country lost
its democratic stance from there on. But this is actually how politicians behave, they try to
grasp more power to themselves and try to break their chains from obligations. The rentier
elite however, is willing to kiss the hands of the new power base at any cost, which links
itself to the state and priorities itself more than the people

From Arrighis Perspective

In the Arrighis book, Spanish Empire, as a territorialist ruler, has made alliance with
Genoese capitalist oligarchy to superseed the wealth and power of Venice. The underlying
fundamentals of a rentier situation and decline of Spain is parallel to Karls explanation :
Narrow monetary wealth, irresponsible finance and an indolent rentier class were important in
the decline that was taking hold in Spain one hundred to one hundred and fifty years after
Columbuss voyages(Phillips 1993:205).

There are also numerous references to how financial expansion leads to rentier behaviour.
Such as ... for that matter in Reaganite America, the capitalists-turned-rentiers ... were only
concerned with the very short turn (p.174). Talking about elites in rentier states that may
hold true, but in most of the petrostates we see and hear from their leaders about ambitious
development plans. But achieving this requires a step-by-step plan with careful risk
management. Because most of the megaprojects has problems like cost overrides, project time
schedule delays and uncertainty in cash flows, the promises of boom times became curses at
bust times.

In his book, he gives an anecdote from Huntington claiming that Japan is in fact an
extraordinary weak country due to its most fundamental weaknesses in energy, food and
military security. In Venezuelan and other petrostates cases, generally military security and
energy is coupled, but due to the nature of rentier economics the countries suffer from
depreciating agricultural sector. This in turn changes the agricultural output, yet apart from
certain African countries, we have never seen any petrostate suffering from famine. Yet, none
of the petrostates are powerful states in the sense than Huntington argues.

The one of the main themes of Arrighi is the relationship between capital accumulation and
state formation. This looks like a subject that may overlap with Karl. The main differences are
the viewpoints and the results. Petrostates as a modern concept (after 1950s) can be regarded
as a marginal topic in state related social sciences. Arrighi, on the other hand argues a more
general and encapsulating concept.

Conclusion

In her book, Terry Lynn Karl doesnt talk about ideologies or economic schools. She starts
with a simple question on petrostates. She comes to the conclusion that the oil revenues can
be destructive or negative or harming for state institutions and for the relations between rulers
and the subjects, if that country does not have stable development path and traditional
bureacracy prior to oil boom.

Polanyis arguments are related to the subject interms of the transition that petrodollars cause.
Schumpeters arguments are helpful for understanding the political games to control oil
revenues. Arrighis views are partially shedding a light on the rentierism and budget deficits.

As a conclusion, Karls Paradox of Plenty is a very interesting book. The subjects she writes
about are still valid today. When you look at the Venezuela, little has changed. About the other
oil producing countries, late comers like Azerbaijan and Kazakhstan are also experiencing the
relevant problems. Russia has the similar problems. Especially while reading certain parts like
ultrapresidentialism, one can hardly keep himself away from thinking Putins Russia. It will
be really interesting to see the development trajectories of these countries. The promise of
authoritarian rule to effectively distribute revenues in the short term, turns to a disaster in the
long run.

As the oil prices hit new highs, we can easily claim that boom is happening now. Every rising
thing will eventually fall down and oil prices are no exception. Institutions are the skeletons
of a state. Man can be a leader, a founder or a saviour. But the short time span of a man as a
leader, founder or saviour, can not match the long life of institutions and their accumulation of
experience. Man can achieve a progress by himself in the short run but only institutionalised
goals can sustain this progress in the long run.