The Resource Curse

Econ 2218March 8-10

Peter Burton

The Resource Curse(The Paradox of Plenty)

Countries and regions with an abundance of natural resource, especially concentrated resources such as minerals and fossil fuels, tend to have lower economic growth and worse development outcomes

The Resource Curse

The Resource Curse

The Resource Curse

“Ten years from now, twenty years from now, you will see: Oil will bring us ruin...oil is the Devil’s excrement.” Juan Pablo Perez Alfonzo

(Venezuelan politician), 1973

The Resource Curse

Original References:Auty, R. (1990), Resource-Based

Industrialization: Sowing the Oil in Eight Developing Countries, Oxford U. Press

Gelb, A. (1988), Windfall Gains: Blessing or Curse? , Oxford U. Press

Good Summary:Sachs, J and A. Warner (2001), The curse of

natural resources, European Economic Review 45, 827-838

The Resource Curse

Possible Reasons:1)Conflict2)Responsible Government 3)Exchange Rate Appreciation (Dutch Disease)4)Revenue Volatility5)Excessive Debt6)Corruption7)Specialization8)Reduced Education

The Resource Curse

Counterargument:

Association could have reverse causation:

Conflicts and bad policies may discourage all other economic activity before it stops resource extraction and export

The Resource Curse

Possible Reasons:1)Conflict:

a) Jurisdictional fights over the control of resources/revenues

b) Armed conflict over resourcesc) Resource revenues may fund

other conflicts (e.g., diamonds in Zaire)

The Resource Curse

2) Responsible Governmenta) Resource taxed rather than citizens

less citizen pressure for effective gov’t. and revenues less connected with general well-being

b) Those benefiting see an effective civil service as a threat lobby to cut regulation/overview

The Resource Curse

3) Appreciation of Exchange Rate “Dutch Disease”

Refers to Netherlands in early 1960s• Natural gas exports resulted in

appreciation of exchange rate• Manufacturing (and agriculture)

harmed by high exchange rate – Their exports more expensive to others

The Resource Curse

The Resource Curse

4) Revenue Volatility

Many natural resources prices are far more volatile than other prices

Example: Last six yearsDow Jones Industrial Index

(blue)Amex Oil Index (green)

The Resource Curse

4) Revenue Volatility cont’d

–Difficult to plan–Difficult to maintain government

programmes–Not honouring contracts may

discourage investment and encourage emigration

The Resource Curse

5) Excessive Debta) Prospect of future resource

revenues encourages borrowing• Worsened by appreciation

(inexpensive to borrow)• Resources act as collateral

(others more willing to lend)

The Resource Curse

5) Excessive Debtb) Less able to repay when prices

fall or resource depleted• Worsened by currency

depreciation • Worsened by penalty charges

on late repayments

The Resource Curse

6) CorruptionConcentration of resource revenues

may fuel political corruptionUsually do not need policies that

encourage a well-functioning economy. Instead may seek• Regulation wavers(e.g.,

environmental, labour)• Reduced royalty/taxation rates

The Resource Curse

6) Corruption (cont’d)

Whether lobbied for or not, there may be incentives to reduce democratic institutions or increase oppression of those who might oppose the resource development

The Resource Curse

7) SpecializationLucrative resource sector out-competes other sectors

- lures most productive/best-educated workers

- High exchange rate discourages other exports (Dutch disease)

The Resource Curse

7) Specialization (cont’d)Expect:

a) Increased specialization over time b) Attempts at diversification often

fail/very costlyc) Resource sector generally provides

few jobs and have few (forward or backward) linkages to other areas of the economy (further concentrating power)

The Resource Curse

8) Reduced EducationIndividuals and governments

see a reduced need for education while incomes/revenues are high

Discourages innovation and further growth

The Resource Curse

What can be done?

I) Reduce appreciation of currencyDo not bring revenues into country

(i.e., put revenues in a fund that is invested abroad)- gives a more stable income stream- provides an asset for future generations

The Resource Curse

What can be done? (cont’d)

II) Increase domestic savings- run large government surpluses- tax breaks for long-term saving- reduce consumption borrowing

The Resource Curse

What can be done? (cont’d)

III) Heavy taxation/royalties on industry...try to avoid booms

- the resource will still be there if not extracted now

The Resource Curse

What can be done? (cont’d)

IV) Invest in education and infrastructure to increase competitiveness of other sectors

The Resource Curse

What can be done? (cont’d)

V) Increase anticorruption efforts• Tighten rules on lobbying • Improve rule of law• Improve monitoring of human

rights

The Resource Curse

What can be done? (cont’d)

V) Increase anticorruption efforts• Further embed democratic

procedures and institutions• Increase monitoring of all levels of

the government, civil service (including police and army) and judiciary

The Resource Curse

What can be done? (cont’d)

V)Increase anticorruption efforts• Better define property rights of all

those in resource extraction area (often indigenous peoples)

The Resource Curse

Intuition of what should with a resource?

Hartwick (1977) “Hartwick’s Rule”

- A natural resource is an asset. - If you care about future generations, any extraction of the resource should be used to acquire other assets that are at least as valuable