DID IRAQ CHEAT THE UNITED NATIONS? UNDERPRICING, BRIBES AND THE OIL FOR FOOD PROGRAM
C.T. Hsieh & E. Moretti
The Quarterly Journal of Economics, Vol. 121, No.4 (2006) pp. 1211-48
Principal Research Question and Key Result | Did Iraq cheat the UN oil for food program by setting prices for its oil lower than market value in order that extracted rents could be shared between oil purchasers paying bribes, and the Iraqi government/leadership? The key result is that yeas they did. Around $4.3bn in rents were extracted, and of this they estimate that $1.3bn accrued directly to the Iraqi government. However, this was only 2% of the total value of the programme, so is not actually that bad by international standards.
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Theory | This is not a theoretical paper as such.
In general the mechanism at work is as follows. After the sanctions against Iraq were enforced, the oil for food programme allowed Iraq to sell tis oil provided that the proceeds were used for humanitarian purposes. Iraq could freely choose the buyers of Iraqi oil. They also had some discretion over the selling price of the oil. This incentivized Iraq to underprice its oil relative to the world price, and then share the generated rents with purchasers who would pay bribes to the administration, and receive oil at a lower than market price. If prices are set endogenously (by Iraq), then they would ideally set the official price at 0, which would allow them to collect 100% of the revenue generated by selling oil at the unofficial price. As it was, they were constrained from doing so because the UN had to agree on the official price, and Iraq would be punished if the UN was reasonably certain that they were setting the official price too low. The probability of detection is assumed to be increasing with the distance between the official prices i.e. f(Pmarket – Pofficial/SD). The price differential is normalized by the standard deviation of prices to capture the idea that it was more difficult for the UN to determine whether the official price was too low in periods of high oil market volatility. Given this constraint, Iraq would set the official price such that the marginal gain from lowering the official price was equal to the marginal increase in detection from doing so. This yields two hypotheses:
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Motivation | The oil for food programme was in terms of $$$ one of the largest humanitarian efforts undertaken in recent history. It is a rough example of conditional assistance (in that the proceeds from oil sales could only be used for humanitarian projects, and prices had to be agreed by the UN). This paper looks at how the designs of such initiatives can create incentives or opportunities for cheating/corruption. In general then, lessons learned from this episode could be used when thinking about how to design interventions. In particular, that there are striking differences between outcomes when the later policy of retroactive pricing was introduced shows how small details of programme design can have large effects on results. |
Data | |
Strategy | Two strategies:
ΔPt = α + β1Program1t + β3Program2t + β3Program3t + εt Where the program variables are periods within the years of the program 1997-99 2000-01, 2002.
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Results |
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Robustness | Looking at documentation from the Volcker review of a specific set of 5 trades made, they estimate the gains from rent extraction using their model for the same limited time period and get very similar numbers. The Volcker review was based upon review of the small amount of documentary evidence that exists.
They explore a variety of alternative explanations:
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Problems | This only looks at one possible source of rent extraction. Iraq could also have been overbilling for humanitarian supplies.
External validity is pretty low as this was a remarkable series of events.
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Implications | Programme design is of great importance. The paper does not show that aid is not effective, indeed the programme was thought to be a success in terms of its humanitarian goals, and as the extracted rents represent only around 2% of the total value of the programme, and this is quite low by other development programme standards. However, there is no guarantee that humanitarian investment would continue after the programme was to end. |