Tuesday, November 20, 2007

Incentives for Chaos Revisted

In the summer of 2004 I wrote about the wealth transfers and thus incentives major oil exporting nations were receiving due to the highly probable security/insurgency premium in Iraq. Here are some quick blurbs from this piece:
stability in Iraq and in the Middle East in general is a continuum of choices, and the extremes on both ends have extremely expensive payoffs. Extreme levels of stability in Iraq will cost the Russians between fifteen and thirty billion dollars a year, and the Saudis even more money ($17-$35 billion is my best guess)....its resultant payoff matrix leads to some very mixed incentives that we see acted upon every day.......

same basic set of payoffs are being calculated and played by all of the non-industrialized oil-exporters. Some level of instability is extremely profitable to them, especially an instability that so far has not resulted in the destruction of any actual production or export ability. The importance of this realization is simple; the incentive to cooperate with the United States is low for these countries, and if Iraq and the rest of the Middle East begins to stabilize, there is some direct economic incentive beyond the clear national security incentive that Iran possesses, to help the insurgents in Iraq.
Swedish Meatballs (via John Robb) expands on this insight today based on the reporting that the US is claiming that a significant portion of the insurgencies are financially motivated and the news is not good if the objective is a tampering down of violence to pre-April 2004 levels.
Disrupting the insurgents' finances is certainly to be encouraged, but if the new IO theme is factually correct -- meaning that Iraqi men are joining AQI for the pay -- then we are completely farked.

The ubiquity of monetary incentivization is the reason that we long ago lost the "War on Drugs." People will do almost anything to feed their families. [my emphasis]

As long as the insurgency was considered to be ideologically or sectarian-based, there remained at least some hope that political accommodation with some faction (or factions) could be reached.

We can never de-motivate a pecuniary insurgency -- the money will always manage to come from somewhere.
There are quite a few players who receive very good rates of return on minimal investments in instability in Iraq, and the situation is such that small groups can and have created cascading failures that change the entire incentive structure back towards destabilization and decentralization. Assuming a global short run elasticity of demand of crude oil is roughly 0.03 as this paper suggests or the more conventional assumptions of short term elasticity of .10 to .15, a 1% increase in supply in world crude markets which is roughly what the Kirkuk fields would provide if there was reliable working export routes would lead to anywhere from a 7% to 30% decrease in global oil prices with the most probable range of 7% to 12% decrease.

That is a lot of money to be lost on a daily basis. And if the insurgencies are financially motivated to a working degree, instability is a cheap investment. In the same Washington Post article concerning the interview with the AQI cell leader, he states that the Mosul operations cost him little:
"In a 30-minute interview, Abu Nawall described his work managing the $6 million or so annual budget of the Mosul branch of the Islamic State of Iraq, an insurgent umbrella group believed to have been formed by al-Qaeda in Iraq..... [my emphasis]

The 28-year-old said he was responsible for running the bureaucracy and arranging payments to the 500 or so fighters for the group in the city, who he said try to carry out as many as 30 attacks a day.
So $6 million a year for anywhere for up to 10,000 attacks per year or at least $600 per attack for material, labor, bribes, and pensions/death benefits to families; this is a dirt cheap operation here. A US infantry squad patrolling for a night without contact probably costs about the same. The cost figure per attack is probably higher due to the fewer attacks per day actually carried out, but even if you divide by ten, the attack figure is cheap from the perspective that a 7% reduction in oil prices means a global loss of ~$500 million dollars per day in oil revenue.

The top 15 oil exporters, as of 2006, with US EIA data, exported roughly 39 million barrels per day. They would be looking at daily revenue losses of $240 to $250 million dollars if Kirkuk-Ceyhan opened up at full capacity compared to the counter factual of an effective shut-in continuing. Over a year, that is a loss of $87 billion dollars. Now that is serious revenue and it could be greater depending on how inelastic you believe oil prices are.

If subsidizing the Iraqi insurgencies to the tune of a couple hundred million dollars per year prevents Kirkuk-Ceyhan from coming on line, the return on investment of instability is 8,000% to 10,000%. And given the toxic waste that was passed through the US financial system to get a couple dozen extra basis points in return, an investment that could plausible yield an 8,000,000 basis point spread over US Treasuries looks pretty damn attractive.

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