Suburban Emergency Management Project

SEMP Biot #227: What is a Rentier State?
June 24, 2005

The theory of the “rentier state” says that countries that receive substantial amounts of oil revenues from the outside world on a regular basis tend to become autonomous from their societies, unaccountable to their citizens, and autocratic. The theory is used to help explain why Iran, the Gulf States, many African states ( Nigeria, Gabon) and other countries (e.g., Netherlands) with abundant resource wealth perform less well than their resource-poor counterparts. How does this happen, according to the rentier state theory? The short answer, according to Yates (1), is that a rentier state and rentier economy lead to a rentier mentality, which dooms a country’s economy and long-term prospects.

1. Iranian Roots of the Rentier State Theory

The rentier state theory originally developed in relation to Iran’s mid-20 th century economy. The West became involved with Iran’s oil in the following way. In 1941, Germany invaded its former ally, the Soviet Union, which quickly re-allied with Great Britain. The British and the Soviets then occupied Iran, fearful that its leader, Reza Shah, would align its oil-rich country with Germany. The Shah’s son, Mohammed Reza, came to the throne and Iran became the major conduit for British and later American aid to the USSR in what came to be known as the “Persian Corridor.” (2) (See also SEMP Biot #137: “Fall of the Shah of Iran” at: http://www.semp.us/biots/biot_137.html).


Mohammed Mossadegh, the ousted prime minister, entering court for his trial in 1953.
Source: http://graphics.nytimes.com/library/world/mideast/041600iran-cia-mossadegh.1.jpg.


Map of the “Persian corridor.”
Source: http://www.army.mil/cmh-pg/books/wwii/persian/photos/map2.jpg.

In 1953, the Shah was forced to flee Iran by Mohammed Mossadegh, the nation’s prime minister and “godfather of populist petroleum politics.” (Yates, p. 12) After negotiations for higher oil royalties failed in 1951, the Iranian parliament, led by Mossadegh, voted to nationalize Iran's oil industry and replace the British-owned and -operated Anglo-Iranian Oil Company (infuriating Winston Churchill and, subsequently, President Eisenhower) with the National Iranian Oil Company.

(Mossadegh’s nationalization of Iran’s oil subsequently served as a model for the nationalization of the Suez Canal by Nasser (1956), which in turn set a precedent for Northern and sub-Saharan African nationalizations such as Algeria (1967), Libya (1970), Nigerian (1970), and Gabon (1974).) A joint Anglo-American secret operation overthrew Mossadegh in 1953 and reinstated Mohammad Reza Shah who, over the next 25 years, allocated oil revenues to build up a huge military, among other things. His increasingly autocratic governance in combination with the pent-up nationalism (bottled up since Mossadegh’s overthrow) erupted in the 1979 Iranian revolution that swept Ayatollah Khomeini into power.

Hussein Mahdavy (3), the economist who first popularized rentier state theory, believed that the 1951-1956 period represents a landmark in the economic history of the Middle East: an historical era when radical nationalizations transformed ex-colonial models of petroleum exploitation into what he termed ‘fortuitous etatism.’” Etatism is state socialism whose goal is the subordination of the individual unconditionally to the state to mold his or her destiny and to vest all initiative in the government alone.(4) Massive amounts of foreign currency and credit generated by petroleum development flooded into the state coffers and, Mahdavy argues, turned at least some oil-producing countries into rentier states. Kuwait and Qatar are extreme examples of the phenomenon, with limited capabilities for industrialization and few alternatives to rentierism. The case of Iran was very important to Mahdavy because, given its size and potential, it had alternatives that the extreme cases lacked. Indeed, Mossadegh had fought for diversifying Iran’s economy at the same time it nationalized its oil industry.

2. The Raging Rentier Economy

In the 1970s, the growing strength of the OPEC cartel, the Arab oil embargo of 1973, and the fall of the Shah of Iran in 1979 put combined pressure on market forces to push both the price and the rent of oil to unprecedented magnitudes. For example, Libya in 1970 nationalized British Petroleum, took over 50% of the Italian state oil company ENI, expropriated Hunt oil holdings, and nationalized 51% of other companies operating in his domain, including Armond Hammer’s Occidental Petroleum. President El Hadj Omar BONGO Ondimba of Gabon (since 1967, one of the longest-serving heads of state in the world) in Western Africa in 1973 settled for a more cautious 25% stake in his country’s two producing firms, meanwhile converting to Islam and lobbying for membership in OPEC, which was dominated by Islamic states (Gabon is Christian 55%-75%, animist, Muslim less than 1%). (5)


Map of Gabon.
Source: http://premium.cnn.com/
WORLD/9704/28/zaire/gabon.lg.jpg
.


Gabon’s long-serving (since 1967) President Bongo.
Source: http://news.bbc.co.uk/2/hi/africa/2646825.stm.

In 1974, Gabon acquired associate member status in OPEC and promptly increased the price of Gabonese crudes to fall in line with those of other cartel member states. Accordingly, the price per barrel of Gabon’s “Mandji” crude increased from $2.40 in January 1973 to $13.03 in January 1974, and “Gamba” crude from $2.40 to $13.79. “This veritable explosion of oil prices was not due to any physical shortage of oil” but rather was the result of “the successful use of the oil weapon by the Arab states in connection with the Middle East war of October 1973” (Yates, p. 68) in which the Egyptians and the Syrians launched a surprise attack against Israel. Douglas Yates traces Gabon’s descent into a rentier economy from 1974. Today, most of the price of oil in the Middle East consists of economic rent. “More typically, rents comprise 95 to 97% of gross receipts of low-cost oil.” (Yates, p. 20.)

Two economists, Hazim Beblawi and Giacomo Luciani (6), became interested in Mahdavy’s theory of rentierism and the effect of a windfall of wealth on oil-producing countries. Beblawi and Luciani preferred the term “rentier economy” to rentier state, suggesting that the rentier state is really a subset of a rentier economy, and that the nature of the state is best examined primarily through its size relative to that economy and the sources and structures of its income. A rentier economy is an economy in which “rent plays a major role, and in which that rent is external to the economy.” (Yates, p. 13)

3. Four Characteristics of a Rentier Economy

Beblawi delineates four characteristics of a rentier economy. First, rent situations must predominate in that there really is no such thing as a pure rentier economy. Second the rent must come from outside the country. Third, in a rentier state only the few are engaged in the generation of rent, while the majority is involved in its distribution and consumption. Translated, this means that government leaders make the deals and take in the revenue and then allocate to the public, which is not involved in creation of the wealth. Fourth, the government must be the principal recipient of the external rent in the economy.

The point here is that external rent liberates the state from the need to extract income from the domestic economy. (Yates, p. 15.) The government can embark on large public expenditure programs without resorting to taxation. The government becomes an allocation state, which is very different from a production state. A production state relies on taxation of the domestic economy for its income; taxpayers stay involved with government decisions because they are supporting them with onerous taxes. An allocation state, by contrast, does not depend on domestic sources of revenue but rather IS the primary source of revenue itself in the domestic economy. The primary goal of the allocation state’s economy is spending.

One might think that massive spending on government projects, such as dams and roads, without resorting to domestic taxation or burdensome public debt, should have given the rentier states a short-cut to developing their countries. This has not happened, which caught economists by surprise. Mahdavy said: “Perhaps one of the more crucial problems that need to be studied is to explain why the oil exporting countries, in spite of the extraordinary resources that are available to them, have not been among the fastest growing countries in the world.” (Yates, p.15.)

The answer to the enigma, according to Yates and classical economists, is that the rentier is a parasite who violates the most sacred doctrine of the liberal ethos: hard work. (p. 18.)

4. The Rentier Mentality

Rentier theory makes a distinction between ‘earned’ and ‘unearned’ income, according to Yates, and assumes that a rentier economy creates a specific mentality. The economic behavior of a rentier is distinguished from conventional economic behavior ‘in that it embodies a break in the work-reward causation.’” (Yates, p. 21.) “Rewards of income and wealth for the rentier do not come as the result of work but rather are the result of chance or situation.” Mahdavy observed a complacent attitude among the rentier states, which contrasted vividly with the sense of alarm and urgency prevalent in most other underdeveloped countries with massive impoverishment of the general populace and general backwardness.

Mahdavy wrote, “Whereas in most underdeveloped countries, this kind of relative regression will normally lead to public alarm and some kind of political explosion aimed at changing the status quo”…in a rentier state, the welfare and prosperity imported from abroad “preempts some of the urgency for change and rapid growth” and may in fact coincide with “socio-political stagnation and inertia.” (Yates, p. 21.)

The rentier mentality is a “psychological condition with profound consequences for productivity: contracts are given as an expression of gratitude rather than as a reflection of economic rationale; civil servants see their principal duty as being available in their offices during working hours; businessmen abandon industry and enter into real-estate speculation or other special situations associated with a booming oil sector; the best and brightest abandon business and seek out lucrative government employment; manual labor and other work considered demeaning by the rentier is farmed out to foreign workers, whose remittances flood out of the rentier economy; and so on. In extreme cases income is derived simply from citizenship.” (Yates, p. 22)

5. Rentier Economies and External Price Shocks

Rentier economies are, like other monoproducers, highly vulnerable to external price shocks. This happened in the 1980s when oil prices crashed, thus slashing oil revenues to rentier economies. Rather than diversifying the rentier economy, most rentiers waited out the crash by implementing austerity measures. Mahdavy said, “however one looks at them the oil revenues received by the governments of the oil exporting countries have very little to do with the production processes of their domestic economies. Input from local industries, including wages and salaries, payment to local contractors and purchase of local supplies is so insignificant that for all practical purposes one can consider the oil revenues as a free gift of nature.” (Yates, p. 23.) As a result, says Yates, “the petroleum industries in the oil-rentier states tend to be enclave industries that generate few backward or forward linkages.” (p. 23) For a look at an enclave industry beautifully recorded for posterity in expensive ARAMCO books, go to SEMP Biot #126 and read about ARAMCO in Saudi Arabia (http://www.semp.us/biots/biot_126.html).


Netherlands’ North Sea oil fields.
Source: http://www.hydronamic.nl/Projectsheet%20_Hanze.htm.


Agricultural industry in the Netherlands.
Source: http://www.jaredrobinson.com/images/garden_tulips.jpg.

When external price shocks occur, rentier states experience “Dutch Disease, which is the adverse effect on a country's other industries that occurs when one industry substantially expands its exports, distorting the patterns of growth in the agricultural and other tradable productive sectors of the economy. It takes its name from the situation in the 1970s when booming North Sea gas exports pumped massive oil rents into the Netherlands (of all places). “These gas export revenues appreciated the Dutch guilder and, in so doing, exposed Dutch industries to more intense foreign competition and higher unemployment,” writes Yates. (p. 28)

The Dutch Disease generates sectoral reallocation of productive resources in response to a favorable price shock (e.g., 1973, 1979) when increased revenues attract further investment: “[T]he stagnation in the agricultural and forestry sectors area result of transfers of resources, mainly capital and labor.” (p. 28) In a country suffering from Dutch Disease the booming sector attracts rural workers away form agricultural production while at the same time contributing to a relative devaluation of local foods stuffs. Capital is re-allocated to the oil sector, where returns are higher than in either agriculture or manufacturing.”

6. Labor in Rentier Economies

Labor in a rentier economy suffers distortion. “Wages earned by some, for example, in a booming oil sector can artificially drive up wages earned by others in unrelated sectors through the ‘demonstration effect’” (Yates, p. 29; see also SEMP Biot #173: “What is demonstration effect?” at: http://www.semp.us/biots/biot_173.html). Labor is also affected by the rentier mentality, as ‘getting access to the rent circuit is a greater preoccupation than reaching productive efficiency.” (Yates, p. 29). Foreign nationals and migrant workers increase during an oil boom in rentier economies and, during bust cycles, these same workers are booted out of the country because they compete with domestic labor.

In rentier economies, prosperity should NOT be equated with development. Real economic development is measured not by increased per-capita income, which is high in rentier economies, but by a transformation of the social forces of production. Real per capital income in a rentier economy is considerably lower than the simple division of gross national revenue by estimates of the national population would have us assume because income distribution is skewed. Rentier states may have high per-capita incomes on paper, but in reality, the have a lot of very, very poor people. “So long as ‘prosperity’ of the rentier states derives from external rent, technological and organizational improvements will remain undeveloped and real economic development illusory.” (Yates, p. 31)

7. Social and Political Repercussions of Rentier Economies

In rentier states, there is very little production so there is very little to tax. In addition, the massive amounts of revenues flowing into state coffers permits state governments to purchase consent of the governed without paying the political price of unpopular taxes. But taxation has two purposes: to generate government revenues and to redistribute wealth and income in society. “By liberating itself form the necessity of tax collection, the rentier state unwittingly diminishes its own administrative capacity.” (Yates, p. 33.)

Since the government in a rentier economy distributes benefits, the opposition, rather than focusing its attention on the underlying rentier state dysfunction, rattles on about how benefits are distributed. One anthropologist studying the Gabonese observed that they “are remarkably uninvolved in any indigenous private commercial sector.” (Yates, p. 211.)

Rentier economies have elites, such as President Bongo, that displace traditional elites. They control the distribution of external rent, which translates into political influence, and they don’t equate ethical superiority of work and the rightful representation based on merit. Rather, the rentier mentality isolates position and reward form their causal relationship with talent and work.

8. Can Ruinous Rentier Economies be Changed?

Diversification and privatization of the economy are the main answers offered by some, and Mahdavy suggests that, above all, the solution to the economic problems of a rentier state is not more government expenditure, but less. Further, he believes that meaningful diversification will not come from above, but from below [revolution?]. Yates concludes that “elites previously preoccupied with consuming the national wealth must now find ways of creating it. And if the ideas of the whole society, whence and whither this new national income?” (Yates, p. 214.)

Editor’s Note : The point at which a country is called a rentier state is arbitrary: some countries have more rentierism, others less. Certainly Saudi Arabia is in the “more” category, though it has tried to correct this over time. Nevertheless, one wonders just how much the unrest leading to Al Qaeda terrorism against the West by the likes of Osama bin Laden, the son of a local Yemen-Saudi contractor. Is it perhaps a consequence of growing up in a disembodied Saudi citizenry that participates little in creating the wealth of the economy (or must try to do so in competition with major Western powers), and is also rigidly scripted by Wahhabi religious fanatics? As a male growing up in the Gulf States, some African states, and elsewhere, what does he do with his life if his community provides him with nothing to do with his life other than siring children that he may never even meet and conducting jihad?

1. Douglas A. Yates: “The Rentier State in Africa.” Africa World Press, Trenton, NJ, 1996.

2. “United States Army in World War II: The Middle East Theater: The Persian Corridor and Aid to Russia” by T. H. Vail Motter, Center of Military History United States Army, Washington, D.C., 1952. Available online at: http://images.search.yahoo.com/search/images/view?back=http%3A%2F%2F
images.search.yahoo.com%2Fsearch%2Fimages%3Fp%3D%2522persian%2Bcorridor%2522%26e
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.

3. Hussein Mahdavy, "The Patterns and Problems of Economic Development in Rentier States: The Case of Iran," in M.A. Cook, ed., “ Studies in Economic History of the Middle East.” London: Oxford University Press, 1970.

4. Definition of etatism at: http://www.mises.org/etexts/mises/og/chap3a.asp; accessed June 24, 2005.

5. For distribution of Gabon’s religions, see: http://www.odci.gov/cia/publications/factbook/geos/gb.html, accessed June 24, 2005.

6. Hazem Beblawi, "The Rentier State in the Arab World," in Hazem Beblawi and Giacomo Luciani, eds., “ The Rentier State.” New York: Croom Helm, 1987.

 

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