Michael Porter wants to revamp Qaddafi's creaky economy. But will privatization and "mini-MBAs" prevail over statism and red tape?

Can Harvard Business School competitiveness guru Michael Porter fix the Libyan economy? Since meeting one of Muammar al-Qaddafi's sons at the World Economic Forum in Davos, Switzerland, in 2004, Porter and a group of Western consultants have become deeply engaged in overhauling the Mediterranean petro-state.

Qaddafi's son, Seif al Islam (Sword of Islam), is making a career of trying to reform what is by many measures one of the world's most backward economies. Now, thanks to his relationship with Porter and Monitor Group, a consulting firm with which Porter is affiliated, a roadmap for restructuring is emerging.

Four focuses

Monitor has pored over the Libyan economy and mapped out a strategy for the next decade or so, focusing on energy, tourism, trade, and construction. Now the more difficult work begins—making real changes that free up the private sector and improve the business environment.

Porter, whose books include Competitive Strategy and The Competitive Advantage of Nations, plans to be in Tripoli on Feb. 22 to kick off this next phase with a lecture called "The New Dawn for Libya: Delivering on the Promises." He will speak at the ultramodern Corinthia Hotel—a joint Libyan/Maltese venture that has become the base for Western oil men and the site of the new U.S. Embassy.

The Libyans and their Western advisers are launching a Libyan Economic Development Board, based on the model that has worked well in Singapore. The LEDB's mandate is to clear away some of the obstacles to successful private businesses and thus diversify the Libyan economy away from the state-controlled energy sector, which accounts for about 60% of gross domestic product—an even higher proportion of the economy than in Saudi Arabia and Kuwait. Libya produced about 2.23 million barrels per day of oil and gas equivalent in 2006, according to Edinburgh consultants Wood Mackenzie. The country's location near Western Europe also enhances its status as a significant energy player.

Companies Return

U.S. companies that were forced by the U.S. government to give up their properties in Libya in the 1980s have been coming back to the country since Qaddafi ceased his efforts to develop weapons of mass destruction in 2003. Among those that have returned is Occidental Petroleum (OXY), which says it now has the most oil and gas acreage of any foreign company operating in Libya, with some 30 million acres.

Oxy regained its concession in the Sirte Basin in 2005 after a 19-year absence, and it has been an aggressive bidder in auctions held by the Libyans for exploration tracts. Marathon (MRO), ConocoPhillips (COP), and Hess (HES) also have negotiated a return to concessions they worked under the Oasis Group label. The largest foreign oil operators in Libya now are Italy's ENI (E), with 255,000 barrels per day, and Germany's Wintershall (BF), with 145,000 barrels per day. By comparison, Oxy now produces about 23,000 barrels per day.

'Nothing works'

But less has happened outside oil and gas, despite Qaddafi's admission that Libya has no choice but to reform. The country's energy industry, which employs around 43,000 people, or 3% of the workforce, accounts for nearly all of Libya's estimated $35 billion to $40 billion in export revenues. Its profits are used to subsidize a vast public sector, which employs some 51% of Libya's workforce. And employing hundreds of thousands of people in make-work jobs is not a recipe for creativity and productivity.

Libya still suffers from major obstacles to doing business. There remains a nearly impenetrable barrier of required permits and regulations. The banking system is stuffed with cash but doesn't lend it to private companies. And the workforce suffers from poor skills in everything from information technology to the English language. In fact, as Monitor delved into its study of the economy, the consultants came to a hard realization. "Nothing worked in Libya," says Rajeev Singh-Molares, a London-based senior partner at Monitor who leads the firm's Libyan team.

Indeed, though the country is the wealthiest in North Africa—with its 6 million or so people enjoying a per-capita income of about $6,000 per year—Libya scores poorly as a place to do business. Monitor ranks it 110th in the world in terms of its business competitiveness, well below neighbors Algeria and Egypt. Outside of the oil and gas sector, Libya is unable to attract more than a tiny trickle of foreign investment due to its bureaucratic obstacles and skill shortages.

Multiple Fronts

To turn things around, the reformers are working on several fronts. Along with trying to clear out red tape, they are also working on partial privatization of the banking system, which is now entirely state-controlled. Stakes in two private banks may be sold to foreign banks, with HSBC (HBC) mentioned in the list of candidates.

They are also trying to rationalize Libya's Byzantine system of managing its oil wealth. The various funds that Qaddafi has set up over the years are to be consolidated into one unit called the Libyan Investment Co. Some of the $60 billion or so that Libya now has stashed away may be invested in hedge funds and private equity in the U.S. and London.

Furthermore, a big effort is going into polishing the Libyans' skills for dealing with business and the outside world. Some 250 "emerging leaders," from cabinet ministers on down, have been enrolled in a kind of mini-MBA program.

The human factor

Whatever strategies consultants devise won't work without a huge makeover in Libya's human capital. Sanctions imposed by the U.N. in 1992 following the downing of Pan Am 103 over Lockerbie, Scotland, kept Libya isolated for more than a decade, denying a whole generation of Libyans, including engineers in the vital oil industry, educational opportunities and other contacts with the outside world.

Qaddafi came in from the cold in 2003 and 2004, resolving Lockerbie and other cases and turning over his fledgling nuclear weapons program to the U.S. and Britain. But the talent shortage remains acute: Consultants say that the same four or five names, most of them returnees from the West, come up whenever top jobs are being filled. Michael Porter is giving the cause a lift, but Libyan and Western reformers still have a long road ahead of them.