Oil and Iraqi Federalism - Where Hillary Clinton and I agree:

In this recent interview, Hillary Clinton (a figure with whom I rarely agree on much else) endorses an idea that I have argued for myself (see here, here, and here): a federalist system for Iraq under which each individual Iraqi citizen gets to have a share of the nation's oil wealth:

I recommended in '03 — and this went all the way up to [Vice President] Cheney, who shot it down — I recommended, while we were in charge, to create an oil trust, where you would basically say to every Iraqi, "You know what, you have a stake in this. And you can get some payment out of the oil revenue."

I thought it would be something that could demonstrate clearly that we were not on the side of the oil companies, we were not on the side of the ruling elites — we were on the side of the Iraqi people.

Nothing like that has been done. The Sunnis will not quit fighting until they are assured they're going to get some share of the oil revenue. Otherwise, the South goes to Shiites, the North goes to Kurds, and these people who have dominated not just Iraq, but the region historically, will be shamed and will be rendered second-class citizens.

As I argued in my previous writings on the subject (linked above), an oil fund that gives shares to all Iraqi citizens is a good way to ensure that decentralized federalism - a necessary part of any effective political settlement in Iraq - can be reconciled with the need to ensure that majority Sunni regions have access to the nation's oil wealth; there are few if any oil deposits in the "Sunni triangle" region where most Iraqi insurgents are based.

Clinton's comments, however, point to another advantage of this approach: the possibility that it would give ordinary Iraqis a greater stake in the new political system and therefore a new reason to oppose Baathist and radical Islamists who would seek to overthrow it (and thereby take away the new oil rights).

As to whether Sen. Clinton really did urge the Bush Administration to adopt this approach back in 2003, I have no way of knowing. However, a number of people did try to persuade the Administration to embrace it at the time, including my colleague and Nobel Prize-winning economist Vernon Smith. Unfortunately, their advice was not followed.

Now that Iraqi politicians in the new government have gotten control of the oil, it will be more difficult to get them to give it up than it would have been to create an oil trust back in 2003 when the US-led Coalition Provisional Authority still ruled Iraq. However, the United States might still be able to force the adoption of this crucial reform by using the leverage created by its massive aid payments to Iraq. If Iraqi politicians want to continue to benefit from large-scale US assistance, it is perfectly reasonable for us to require them to adopt a reform that enables their people to own a share of the nation's wealth and gives Iraqis of all ethnic and religious backgrounds an important incentive to oppose the insurgency.

Iraqi Oil Trusts - Answering Some Objections:

Jane Galt/Megan McArdle raises some objections to the Iraqi oil trust plan endorsed by Hillary Clinton, Vernon Smith, and yours truly (while accidentally confusing me with Orin Kerr). Some of her points have merit, but all share the common flaw of failing to consider the alternative: largely unrestricted government control of Iraq's oil wealth.

Here are Jane's objections, and my responses:

1) There is no good record of who is an Iraqi, so people will flood across the border to get in on it.

A variety of ID requirements could be set up to deal with this problem. I am not expert enough to determine which is the right approach, but it is neither an uncommon nor a completely insoluble issue. As commenter Lev points out, this issue was in fact handled during the 2005 Iraqi elections by requiring voters to present Saddam-era ration cards as a form of ID.

More importantly, however, the same issue arises with distributing any government benefits that the Iraqi government might choose to create with its oil money if that revenue remains under unrestricted government control. Indeed, the creation of an oil trust would increase the government's incentives to establish at least a moderately effective way to identify citizens, since voters would have an important reason to care about the issue. Will there be some fraud (probably even a lot)? Undoubtedly. But that has to be weighed against the massive corruption that currently exists in Iraqi government and is fostered by the ability of the state to dispense patronage as a result of its unrestricted control of Iraq's oil wealth.

2) The financial infrastructure for distributing the proceeds doesn't exist, i.e. most Iraqis can't cash checks and cash tends to disappear.

This problem, too, afflicts the status quo as well. Any benefits the Iraqi government currently dispenses to the population by drawing on its oil wealth also require the distribution of either checks, cash, or in-kind benefits, all of which require infrastructure to deliver and store. Moreover, it is not completely true that there is no financial infrastructure in Iraq. The CPA was able to help a number of private banks start operations. If necessary, the US or the Iraqi government could arrange to have the money held in Swiss or other offshore bank accounts, with the transaction fees kept low because of economies of scale.

Finally, poor people in underdeveloped nations have a wide range of ways to store money and ensure that it does not "tend to disappear," including community credit unions, communal organizations of various types, and micro-lending organizations such as the ones set up by this year's Nobel Peace Prize winner. These institutions all have flaws and none are as secure as, say, keeping your money at the Bank of America. But it sure beats letting all the money stay in the hands of a corrupt, self-dealing, and often incompetent government.

3) The taxation infrastructure and culture for getting the necessary money to run the government doesn't exist, and the government will quickly run out of cash.

Again, I don't see how this will be less of a problem in the status quo. Moreover, if necessary, the government could simply tax the payments to the Iraqi people before distribution (much like income tax withholding in the US). So long as the tax rate is publicly announced and transparent, this arrangement need not lead to corruption or overtaxation. And it doesn't require any more "taxation infrastructure and culture" than the status quo.

4) It will function as a giant welfare system, undermining civil society. There will be huge incentives to have extra babies.

Since people will get the payments regardless of their other sources of income, there will be little incentive to refrain from working, although I suppose there might be some substitution of leisure for income. Moreover, as a practical matter, Iraq's oil revenues probably won't be great enough to give the average citizen a cushy lifestyle (even by Iraqi standards) by living off oil trust payments alone. When and if jobs become available, there will still be plenty of incentive for Iraqis to work. It is also worth noting that much larger per capita oil trust payments than any realistically likely in Iraq have not led to a "giant welfare system" in Alaska and Norway. Finally, we again have to consider the alternative: if the government retains exclusive control of all oil revenues, it will have tremendous incentives to distribute them in such a way as to create "a giant welfare system" of its own in order to create a class of voters dependent on government largesse and therefore inclined to vote for politicians who will keep the dole money flowing. And that's not even to mention the extensive corruption, nepotism, and ethnic and religious favoritism that currently bedevil the government's allocation of oil funds.

As for the incentive to have extra babies, that may indeed be an issue. But it could be handled simply by reducing payments for children beyond, say, the first two or three. If necessary, the system could even forbid additional payments for children above a certain number.

UPDATE: Jane comments: "I think it's a fine idea . . . I was just wondering what the objections might be." In fairness, I should have mentioned that her original post was ambiguous as to whether she supported Iraqi oil trusts or not. However, my purpose was less to engage in a debate with Jane than to address the types of objections that might be raised against the Iraqi oil trust proposal. And the points Jane makes are certainly important ones to consider.