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AMERICAN OIL COMPANIES have slavered over Libya’s oil and gas reserves for years. So the U.S. decision to drop Libya from the list of state sponsors of terrorism and to restore full diplomatic relations was a welcome business move for both nations. But its real significance is far greater and more strategic in nature. The Bush administration has demonstrated to rogue states, particularly in the Islamic world, that countries that renounce terrorism and weapons of mass destruction can reap benefits.

Libya is not exactly a model of democracy and respect for human rights. Its leader, Moammar Kadafi, has ruthlessly crushed political dissent since seizing power in 1969, and his security forces have been known to hold prisoners for years without charges while committing acts of torture that make Abu Ghraib look tranquil. Reprehensible as such practices are, they have nothing to do with the U.S. anti-terror list, which imposes sanctions on countries thought to be sponsors of terrorism. With Libya’s removal, the list has only five members: Cuba, Iran, North Korea, Sudan and Syria.

Libya has taken pains to atone for its sins on the terrorism front, having paid nearly $2.9 billion to the families of the victims of two airline bombings it sponsored -- a Pan Am jet that exploded over Lockerbie, Scotland, in 1988 and a French airliner over Niger the following year. Libya also has been a crucial intelligence asset for the U.S. in recent years, helping in the pursuit of Al Qaeda operatives and black-market traders in nuclear arms.

In short, there was no compelling reason, other than its human rights record, to keep Libya on the antiterror list. And if an atrocious record on human rights were enough to land a nation on the list, then the United States would have to add China, Egypt, Uzbekistan and dozens of others.

Perhaps the most important lesson to be taken from Libya’s arc from an instigator to a foe of international terrorism is that sanctions can work if they’re carefully crafted. The travel restrictions and other sanctions against Libya were multilateral, widely respected and well targeted. They provide a helpful example as the world considers imposing sanctions on countries such as Iran, which is developing its own nuclear program despite worldwide objections.

Another lesson is one that should resonate in the Arab world: The U.S. doesn’t hold a grudge. Even for those countries deepest in the international doghouse, diplomacy works better than saber-rattling. Come to think of it, that’s a lesson that should resonate in the White House too.