© 2018 by Daniel Anthes

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The natural resource curse and its potential transmission channels

Natural resources can lead to bad macroeconomic performances and rising inequalities among citizens on the one side, but also go hand in hand with benefits and rising welfare on the other. The key question is why countries such as Botswana, Chile, Indonesia or Malaysia have been developing without serious problems, while others have performed badly despite having an abundance of natural resources. The resource curse is believed to per se not have a significant direct and negative impact on growth and development, but rather to manifest via certain transmission channels.

 

 

Economic dimension

 

For quite some time the economic dimension of the resource curse has provided the most popular explanation for the resource curse in academic literature. In that context, the Dutch disease (a term invented by The Economist in 1977 to explain the economic stagnation in The Netherlands as a result of large natural gas field discoveries) as the phenomenon of a change in the structure of production (due to large natural resource discoveries or rising commodity prices) became an established impediment for the economic performance of resource-rich countries. According to the classic model theory of the Dutch disease by Corden & Neary (1982), an economy consists of three sectors: the natural resource sector, the non-resource tradable sector (termed as the “lagging” sector and usually understood as manufacturing and agriculture), and the non-tradable sector (including retail trade, services and construction). Given the fact that prices for both tradable sectors are set on world markets and prices for the non-tradable sector are set domestically (the real exchange rate hereby describing the realtionship between tradable and non-tradable prices), following effects lead to the Dutch diease (Brahmbhatt et al. 2010: 2):

 

The spending effect comes into play in the course of a booming natural resource sector and increased domestic income leading to higher aggregate demand and spending by the public and private sector. Subsequently to increased demand, prices and output of non-tradables rise (because of the short-term inelasticity of the sector). Due to rising wages in the economy, profits in the non-resource tradable sector will squeeze (since prices are fixed at international levels), hereby eventually leading to an increase of the real exchange rate.

The resource movement effect takes place when a boom in the resource sector increases demand for labor and capital, hereby shifting production factors away from the non-resource tradable sector. Therefore output of the rest of the economy is reduced. As a consequence, prices of the non-tradable sector rise relative to prices of the tradable sector, since they are set domestically.

 

So in general structural changes predominantly refer to a contraction or stagnation of other tradable sectors, as well as an appreciation of the country’s real exchange rate. The resulting overdependence on the resource sector, which can be considered a comparably less dynamic sector, finally leads to deindustrialization processes within the gradually less diversified economy and harms economic growth in the long-run (van Wijnbergen 1984; Matsuyama 1992; Gylfason et al. 1999). This is first and foremost due to the fact that manufacturing and other non-resource tradable sectors are seen as structural drivers that possess specific growth-enhancing qualities, such as positive technological spillovers, learning by doing effects, and increasing returns to scale in production, which grant sustained growth once natural resources have been depleted (Brahmbhatt et al. 2010: 3).

 

Moreover, natural resource dependence makes countries particularly vulnerable to external shocks due to the exceptional volatility of world commodity prices (see also chapter 4.2.). Van der Ploeg & Poelhekke (2009), who see volatility as the key channel for the resource curse, show that resultant volatility in natural resource revenues curbs growth in economies with badly functioning financial systems. Pointing to research from Cashin et al. (2002), they argue that since real exchange rates are affected by volatile commodity prices, and also many resource-rich countries suffer from poorly developed financial systems, macroeconomic volatility becomes exacerbated and further hampers the growth performance (Aghion et al. 2006; Rose & Spiegel 2007). In this context, Pineda & Rodriguez (2010) likewise refer to volatility in nat-ural resource revenues, and point to some adverse effects of resultant income variability, in fact that development planning becomes difficult, social spending sporadic and foreign investors wary. Lederman & Maloney (2007) argue that a heavy dependence on natural resources and thus a trade structure lacking export diversification is responsible for lower growth rates. Arezki & van der Ploeg (2007) at this point show that the more open a country is to international trade, the better it can use its natural resources. Hereby, van der Ploeg & Poelhekke (2008) find empirical evidence that volatility (of commodity prices and revenues derived from exports) is the main reason for the occasionally negative effect of natural resources on economic growth – if Africa could turn down its export volatility to the level of Asia, it would experience a 2 percentage growth increase per annum. At this point it should be noted, however, that aspects mentioned here could also somehow be related to the political dimension of the resource curse, since the handling of potential adverse effects of natural resources requires macroeconomic and fiscal policy frameworks that have to be designed and implemented by the government.

 

Political dimension

 

Meanwhile, there has been a shift in academic literature analyzing the detrimental effects of natural resource abundance on growth and development. Although the above mentioned initial explanations for the resource curse were in principle purely economic, it has gradually become evident that the key issues for understanding the phenomenon are political. At this point, there is broad consensus that natural resource wealth and politics (or rather governance and state institutions) interact conversely – in fact, natural resources can affect politics, but politics can also affect natural resources (or rather their social, economic and/or ecologic value).

 

Fig. 1: Political economy of natural resources (Collier 2010: 1107 adapted by author)

 

Ross (1999: 307 ff.) differentiates between three central argumentations within the framework of the political dimension of the resource curse: cognitive, societal and state-centered explanations. Cognitive explanations build on the economic dimension of the resource curse, implying a boom within the resource sector leading to short-sighted acting governments and inducing myopic behavior of policy leaders. This is why governments tend to fail at diversifying the country’s exports and maintaining fiscal discipline facing potential export shocks. Caselli & Cunningham (2009) highlight a get-quick-rich mentality and short-sightedness of policy leaders, who disregard the adverse effects of their actions on the generations that come after natural resources have been depleted. Societal explanations refer to the fact that exports of natural resources empower certain interest groups, hereby leading to patronage policies, which eventually impede growth. Finally, state-centered explanations focus on the deterioration of institutions through the presence of natural resources. At the centre of this explanation thread stands the rentier state theory, which basically assumes that governments become less accountable to their society, since they receive their revenues from an external source and thereby find less incentives to tax their citizens.

 

“States are revenue satisficers, not revenue maximizers; and […] when a state’s demand for revenue diminishes, so will the soundness of its economic policies.” (Ross 1999: 313).

 

Barma et al. (2011: 45 f.) support this aspect, arguing for a deterioration of governance due to extracting natural resources, since other ways of government revenue mobilization (such as tax collection) become obsolete. As a matter of fact, administrative and institutional capacities become indispensable. Busse & Groening (2011) endorse this study by claiming to have found empiric evidence for a negative impact of natural resource exports on the quality of bureaucracy, as well as an enhancing effect on corruption levels in general.

 

Andersen & Aslaksen (2013) point to Robinson et al. (2006: 1) who say that “[…] the political incentives that resource endowments generate are the key to understanding whether or not they are a curse.” They also argue that in order to collect not only current, but also future revenues from natural resources, governments try to stay in power. Revenues hereby serve as a crucial endowment to increase chances of maintaining office, mainly through patronage politics as well as strategic spending and political oppression. This rentier effects thus lead to governments using resource revenues for low tax rates and high public spending to dampen the pressure of political reforms. Also van der Ploeg & Poelhekke (2008) argue that particularly during commodity booms politicians lose sight of growth-promoting policies and often engage in exuberant and unsustainable public spending that eventually lead to so-called withe elephants. Robinson & Torvik (2005) refer to white elephants as projects with a negative social surplus, but with a high political attractiveness. They argue that it is the very inefficiency of such projects that make them so politically appealing, since only some politicians can cred-ibly commit to build such projects and thus there is an effect on the voting behavior.

 

This is directly linked to the so-called “oil hinders democracy” literature, kicked off by Ross (2001), which basically assumes that countries rich in natural resources are prone to be ruled by authoritarian regimes. For instance, Ross (2008), Cuaresma et al. (2011), Andersen & Aslaksen (2013), and Lam & Wantchekon (2002) all show that oil and mineral wealth tend to make states less democratic and/or prolong the survival of authoritarian leaders respectively. Also, large rents from natural resources may foster election campaigns, since oppositional groups want to become the future government to harvest rents themselves – for this reason one can assume that endowments with natural resources may destabilize political structures and shorten durations of governments in power. Generally, the value of the resource rents, the type of resources, and especially the political and institutional environment are said to define whether the relationship between natural resource wealth and political survival is positive, neutral, or negative (Andersen & Aslaksen 2013: 1).

 

Further focusing on the role of the political regime, many argue that it is crucial to differ between presidentialism and parliamentarism regimes for the outcome of natural resource dependence. Persson et al. (2000) find that presidential regimes try to use revenues from natural resources in order to satisfy special interests, rather than investing in broad-based and growth enhancing projects that benefit the population as a whole. Andersen & Aslaksen (2008) find no resource curse in parliamentary democracies, while presidential and non-democratic regimes rich in natural resources tend to grow more slowly.

 

Speaking more broadly, this is why governance and institutional quality are said to be crucial transmission channels between dependence on natural resources and growth (De Rosa & Iootty 2012). In fact, many research studies provide robust empiric results that good institutions deflate the damaging effects of resource dependence on growth – so when there are independent, accountable and transparent institutions established prior to the findings of natural resources, the curse is most likely to be avoided. Collier & Goderis (2007 and 2012) find out that commodity booms might increase growth in the short-term, but in the long-term this effect is adverse. In fact, after two decades the typical commodity-exporting country has an output 25 percentage points lower than would be if there was no commodity boom in the first place. They argue, however, that this resource curse can be mitigated if institutions are of particular quality. Of course, at this stage of the extractive industries value chain the government and/or other political institutions in charge of revenues flowing in the country after resource export are the key actors. For that reason it is without any doubt that the quality of governance is of decisive importance for the outcome of the country’s revenue management. Also, checks and balances significantly improve the country’s economic performance (Collier & Hoeffler 2009). Whereas some say that natural resources could have a negative impact on governance and political institutions (Sala-i-Martin & Subramanian 2003; Bhattacharyya & Hodler 2010), others cast doubt on this and argue that the causality runs the other way – in fact, that bad institutions (or bad governance) can be associated with an abundance of nat-ural resources (Brunnschweiler & Bulte 2008; Alexeev & Conrad 2009).

 

Conclusion

 

Clearly, by now there is a large literature bearing on the question of how natural resources influence a country's economic, political and social development. Despite many studies supporting the existence of a natural resource curse, overall the empirical literature points to mixed results, suggesting also the possibility of natural resources becoming a blessing. Similarly diverse are studies analyzing potential transmission channels of a resource curse. However, by now there is a broad consensus that especially governance and institutions matter for development in resource-rich and resource-dependent economies. Of course, at this point the successful management of natural resources relies on home-grown strategies that take into account the given opportunities and address the challenges specific to each country - only then an abundance of natural resources can be a blessing for the country's citizens. 

 

 

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Foto: http://static.guim.co.uk/sys-images/Guardian/Pix/pictures/2010/3/5/1267804609970/ Environmental-and-human-i-020.jp

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