It's been a big week in East Timor. Along with getting its sovereignty, the world's newest nation signed a lucrative treaty with Australia to tap offshore petroleum reserves.
While East Timor still wants a bigger share of Timor Sea gas and oil revenue than the agreed 90 percent, even that will pump billions of dollars into Asia's poorest country in the next five years. But investors should keep in mind that the expected US$7 billion windfall is both good news and bad news.
The good news is obvious. Used wisely, the funds could provide badly needed services like education and health as well as develop vital industries like agriculture, manufacturing and tourism. Oil money, spent productively, could do much to raise the country's 800,000 people out of poverty.
The bad news is that, usually, the opposite happens. Vast amounts of commodity-created wealth rarely trickle down to those who need it most. The phenomenon is what Lawrence Summers, the former US Treasury secretary and World Bank economist, has called the "paradox of plenty." Too often, citizens of resource-rich nations fail to prosper from underground treasures like oil, diamonds and gold. History has shown their governments often do, however. Politicians and well-connected businesspeople get rich, while ignoring the development needs of the struggling masses.
Oil-wealth also leads to a kind of economic-policy tunnel vision. With the advent of oil, governments lose incentive to create other viable industries. They have little time for agriculture, textiles or manufacturing industries that could employ vast swaths of the population. Why bother when the real money's in oil? East Timor's freshly minted president, Xanana Gusmao, seems to understand the risk.
"We are lucky not to have the oil and gas revenue now," he told Bloomberg's Adam Majendie in Dili. "If we had it now, it might be a disaster."
Gusmao's challenge is to make sure disaster doesn't strike down the road either. Modern history is littered with examples of nations that simultaneously boast plentiful oil supplies and high poverty rates. Strangely, huge oil projects that promise to raise living standards for all often end up leaving nations more impoverished.
"The experience of Nigeria, Iran and Indonesia -- all big resource-rich countries -- suggests that the instant bonanza brought about by commodity exports can reduce a country's competitiveness," G. Pascal Zachary wrote in his book The Global Me. "By contrast, adversity has a healthy effect on many small nations, forcing them to work harder and smarter to gain economic advantage."
Call it the "petrolization" of the state. In her book, The Paradox of Plenty: Oil Booms and Petro-States, Stanford University Economist Terry Lynn Karl writes "oil promises to make you rich, but instead it makes you poor." She hones in on Algeria, Indonesia, Iran, Nigeria and Venezuela.
There are exceptions to the rule, of course. In Asia, look no further than Brunei -- an oil-rich nation whose per capita income is nearly 26 times Indonesia's. More often, though, things go the other way.
While each resource-rich nation's experience is different, many have been afflicted by what economists call "Dutch Disease." It's a malady whereby nations earn loads of cash from a single commodity, and from little else. Russia experienced this in recent years when oil exports drove up the ruble, undermining exports in other industries. If oil exports boost East Timor's currency, it could undermine other parts of the economy.
East Timor's historical ties to Indonesia -- the sponsor of a 24-year military occupation -- makes one wonder if it'll follow in Jakarta's footsteps. From all appearances, Gusmao intends to create competitive industries and diversify his economy. For good reason: Oil and gas will bring few jobs or businesses. The production is offshore and will be piped through a processing plant in Australia.
"We have to be careful we don't create a situation with no return," Chief Minister Mari Alkatiri told Bloomberg in Dili. "We need to avoid being a petroleum-dependent country."
Attracting foreign investment will be key. For now, East Timor is subsisting on international aid for everything from money to security to expertise. But looking ahead, officials in Dili have decided that an open economy will do the nation more good than bad. Decades ago, developing nations adopted protectionist polices. East Timor seems to know better.
Already, there's movement afoot to create an infrastructure -- laws, capital markets, financial transparency -- to pull in vast sums of foreign money. Sticking with market-oriented ideas could get East Timor a long way toward its goal of stability and prosperity.
It may be the surest way for the nation to reduce the crushing poverty hovering over it. It also could help East Timor avoid falling prey to the "paradox of plenty."
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