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An Oil-for-People Program

by Susan Lee

April 30, 2003

Ms. Lee is a member of the Journal\'s editorial board.

Oil matters to everybody. But oil really, really matters to Iraq. And it matters beyond the fact that oil constitutes Iraq's largest national asset. Properly handled, the organization and disposition of Iraq's oil wealth can be the driver for everything from the sublime, like democracy and a market economy, to the gritty, like paying down Iraq's debt and rebuilding its infrastructure. No surprise, then, that the blabocracy is already generating proposals at top speed.

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The most fruitful way to think about Iraqi oil is in two parts -- how to handle this asset to realize as much revenue as possible, and who gets that revenue.

Getting the most money from oil means selling, or privatizing, it. And getting the most money from selling means having an open auction with as many bidders as reasonably possible. M.A. Adelman explained how to do this on this page on April 2. Under his scheme, producing oil fields would be divided by reservoir and prospective oil deposits would be divided into the smallest manageable tracts. The resulting plots would be sold at an open auction. Not only would such a division promote maximum competition, but the existence of a larger number of smaller plots would give local entrepreneurial talent an opportunity to bid.

The answer to the second question -- who gets the money from the sale -- should be a slam-dunk. Since the oil belongs to the Iraqi people, they (and not the government) should be the direct beneficiaries. Essentially, then, the problem becomes how to privatize the revenues from the sale.

The best scheme would satisfy the following requirements: participation should be as broad as possible to include every Iraqi citizen; property rights should be constructed to allow the proceeds from the sale of that property to go directly to citizen-owners; transaction costs should be low; prices should reflect the most efficient price that a developed market can offer; and prices should be readily available so citizens can make informed decisions. The last two conditions require that the market should be deep, continuous and transparent.

Sound too pie-in-the-sky for a country that has been deprived of working financial markets for decades? Not really, thanks to a clever idea put forward by economists Terry Anderson and Vernon Smith (who won the Nobel Prize for Economics in 2002), and statistician Emily Simmons. In a paper written for the Cato Institute in 1999, the authors outlined a scheme to privatize federally owned land in the U.S., but the idea can easily be used as a template for Iraqi oil.

Using their scheme, the Iraqi government would award, to each citizen, certificates representing a claim on the nation's oil wealth. These certificates would resemble a no par stock certificate and function as the currency for oil purchases. If the land already producing oil is worth $100 billion as observers estimate, then each Iraqi would receive certificates worth roughly $4,000. Since that figure is about double the annual wage of a middle-class Iraqi, awarding 10, or even 100, certificates per citizen would make sense in terms of personal asset management.

At any rate, the total amount of certificates would represent all the oil land -- productive and prospective. These certificates would be alienable -- that is, they could be freely traded or transferred. Trading and price discovery could be facilitated by listing the certificates on a stock or commodities exchange. The exchanges, of course, would be free to create futures and/or options markets in these certificates. The certificates would retain their value until the last inch of oil land is surveyed and auctioned.

The actual mechanism would look something like this: As the oil land is surveyed and divided into discrete units, an open auction for the deeds of each unit would be held. The deeds won by auction would be paid for in certificates. Buyers of the deeds -- anyone from an Iraqi citizen to a giant oil company -- must pay with certificates purchased on the market either before or right after the auction. (The existence of a futures or option market would allow potential buyers to hedge their purchases.) Holding a rolling auction -- probably over several decades -- has several virtues. The economy avoids the inflationary impact of a huge, sudden capital inflow; certificate holders can time their cash flow by deciding whether to sell early in the process or at the end of the auction period; and prices for individual certificates could be kept low by declaring "stock splits."

Of course, there will be some Iraqis who are missed during the registration period and don't get certificates. Since they still have a claim on the oil wealth, Vernon Smith suggests the creation of a reserve so that certificates can be awarded as these people present themselves.

* * *

This proposal cuts out the government and thus reduces opportunities for waste, graft and corruption. And it has a giant bonus. Since the government is going to need money to rebuild infrastructure and pay down debts, it will have to recapture some of the oil wealth through taxation. And taxpayers, in a democracy, tend to be vigilant. A ruling party that abuses the power of the purse will be turned out of office.

The combination of the Adelman and Anderson-Smith-Simmons schemes solves all the big issues in an elegant fashion. It would transfer ownership in a way that guarantees oil resources are put to their highest use, while paying full value directly to the Iraqi people -- and it is fair and democratic. All blabocratic schemes ought to be measured against it.

Reprinted from The Wall Street Journal © 2003 Dow Jones & Company, Inc. All rights reserved.