Thorvaldur Gylfason IMF INSTITUTE Course on Natural Resources, Finance, and Development...

Thorvaldur GylfasonIMF INSTITUTE

Course on Natural Resources, Finance, and DevelopmentStellenbosch, South Africa

November 15-26, 2010

1. Economic geography, old and new2. Sources of growth3. Extraction rules4. Natural resources and economic

growth: Selected policy issues5. Cases and success stories

Botswana, Chile, Mauritius, NorwayBotswana, Chile, Mauritius, Norway

Mixed blessing? Mixed blessing?

Keys to success?Keys to success?

6. Empirical evidence

Assigned key role to natural resource wealth and raw materials

Tended to equate those resources with economic strength

Yet, many resource-abundant countries are poor, while several resource-poor countries are rich

Prime Minister Putin of Russia: “Our country is rich, but our people are poor.”

11

In the world as a

whole, natural

capital constitutes a

small part of

national wealth, or

about 6%

Even so, natural

capital remains

important in a

number of

countries

Advanced countries

(US, Canada, Australia,

and others) have

outgrown their

dependence on

natural capital,

including agriculture

From blueblue to redred: Increased resource intensity

Tangible capital is

produced capital plus

natural capital, and

does not include

human capital and

social capital

From blueblue to redred: Increased resource intensity

Total capital is

produced capital plus

natural capital plus

tangible capital,

including human

capital and social

capital

Recognizes several different sources of wealth, emphasizing human capital human capital and, increasingly, social capitalsocial capital Social capital refers, among other things,

to governancegovernance and institutionsinstitutions

Many resource-rich countries have fared badly, while several resource-poor countries have done well

There are many kinds of capital and many different sources of growth

Listen to Lee Kwan YewLee Kwan Yew, founding father of Singapore (1959-1991):

“I thought then that wealth depended mainly on the possession of territory and natural natural resourcesresources, whether fertile land ..., or valuable minerals, or oil and gas. It was only after I had been in office for some years that I recognized ... that the decisive factors were the peoplepeople, their natural abilities, educationeducation and training.”

1. Saving and investment Real capitalReal capital

2. Education, health care Human capitalHuman capital

3. Exports and imports Foreign capitalForeign capital

4. Democracy and freedom Social capitalSocial capital

5. Stability Financial capitalFinancial capital

6. Diversification away from Natural capitalNatural capital

Effects on growth are undisputed

Effects on growth are

somewhat

controversi

al

22 Extensive vs. intensive

growth

1. Saving and investment Real capitalReal capital

2. Education, health care Human capitalHuman capital

3. Exports and imports Foreign capitalForeign capital

4. Democracy and freedom Social capitalSocial capital

5. Stability Financial capitalFinancial capital

6. Diversification away from Natural capitalNatural capital

All six are generally considereddesirable in and of themselvesHow to attain these goals is another matter

Efficiency, institutions, and

governance

How much government involvement is needed to diversify? Pros and cons of industrial policy (Rodrik,

2004) Picking winners seldom works, but cutting losses

can be fruitful Presupposes competent civil service Prone to political capture and corruption, but so is,

e.g., privatization as in Russia Never works? But recall successes in South Korea

and Latin America, e.g., Chile Support for R&D vs. entrepreneurship à la Pigou Do international rules leave limited scope for

industrial policy?

Two suggestions Encourage new industries in line with

country’s comparative advantages and available expertise in public administration

Follow the market rather than try to take the lead

Need solutions based on general principles and tailored to specific circumstancesNot one-size-fits-all

Opportunities for finance – and pitfalls Banks pick customers, some win, some lose

Example from IcelandFishing rights are allocated free of charge to

boat owners even if, by law, Iceland’s fish is a common property resource

Fishing quotas were quasi-legally used as collateral for crushing private debts intended to support their branching out as well as speculation

Banks were privatized in like manner, and crashed

promptly

Resource depletion drag

Leave out foreign

capital for

simplicityGovernance

affects

linkages

Cobb-Douglas production function

K/Y is constant

Collect Y on left-hand side

Solve for Y

Divide through by L

If N, e.g. oil wealth, declines by u% per year, then gN = -u

Oil extraction

u slows down

growth as

does population

growth gL

Double diversification Double diversification is good for

growth, and for other determinants

of growth

Listen to King Faisal of Saudi Arabia (1964-1975):

“In one generation we went from riding camels to riding Cadillacs. The way we are wasting money, I fear the next generation will be riding camels again.”

Question:When is the best time to fell a tree?

Answer: When the growth rate of the tree equals the rate of interest, or thereabouts

Simple logic based on dynamic optimization

33

Volume of lumber per tree is f(t) where t is time, with f’(t) > 0 because tree grows over time at g = f’(t)/f(t)

Value of tree is pf(t) where p is price per unit This is what owner can sell the tree for at time t If he cuts down the tree and invest pf(t) for t,

interest earned will be rpf(t)t If owner waits for t, value of tree increases

by pf(t) + pf(t+t) = pf’(t)t Optimal time to fell the tree is when MC =

MR: pf’(t)t = rpf(t)t, i.e., f’(t)/f(t) = r, i.e., g = r

Provided that price of land is constant

g = r

If price of land pL is variable, total revenue becomes h(t) = pf(t) + pL

By same logic as before, optimal time to cut tree is when h’(t)/h(t) = pf’(t)/[pf(t)+pL] = r

Price of land equals its present value: pL = e-rt[pf(t)+pL]

Therefore, pL = pf(t)[e-rt/(1-e-rt)] Plug this into h’(t)/h(t) = pf’(t)/[pf(t)+pL] = r This gives h’(t)/h(t) = (1-e-rt)f’(t)/f(t) = r Hence, MC = MR gives f’(t)/f(t) = r/(1-e-rt) >

r

g > r

Hartwick rule defines the amount of investment in produced capital (buildings, roads, knowledge stocks, etc.) needed to exactly offset declining stocks of non-renewable resources … … so that standard of living does not fall as

society moves into indefinite future Hartwick rule –"invest resource rents!" –

requires nation to invest all rent earned from exhaustible resources currently extracted Rent is defined along paths that maximize

returns to owners of resource stock If part of rent is consumed, total wealth declines

Hotelling rule specifies the optimal rate of extraction of an exhaustible – i.e., nonrenewable – resource …… so that the stock of the resource declines

to zero at a pace that maximizes the revenue or rent from the resource to its owner

Too slow extraction will not produce maximum rent, nor will too rapid extraction

The trick is to find the optimal rate, i.e., the rate of extraction that maximizes the present value of the resource rent

E(t) = extraction

cE(t) = cost of

extractionS(t) = stock or

resourcesp(t) = price of resource,

or dynamic rent, or

dynamic royalty

r = interest rate

Extract resource at a rate that makes its value grow at r

Four main areas1. Fiscal policy2. Monetary, financial, and

exchange-rate policy and the Dutch disease

3. Institutions and governance4. Diversification

EconomicEconomic, away from excessive dependence on a few resources

PoliticalPolitical, away from narrowly based power elites

44

Natural resource wealth is an efficient tax base because resource taxation causes minimal distortions to economic behavior Case in point: Iceland’s missed opportunity Could have auctioned off catch quotas and used

proceeds to abolish personal income taxes Chose instead to allocate fishing quotas to boat

owners free of charge Then chose to privatize its banks the same way,

and they all collapsed a few years later in 2008 Important to reduce other less efficient taxes

to keep overall tax burden reasonable Also, spend tax revenues efficiently

Taxes vs. fees

Pigovian principle

Price stabilization funds Build up reserves when commodity prices are high Use up reserves when prices are low

Aim is to shield producers from price fluctuations Subject to similar reservations as stabilization policies

Example from Chile Government can run a deficit larger than the

target of zero, or 1% surplus, to the extent that Output falls short of potential, or Price of copper is below its medium-term (10-year)

equilibrium Two panels of independent experts determine the

output gap and the medium-term equilibrium price of copper

Foreign exchange

Real exch

an

ge r

ate

Imports

Exports without oil

Exports with oil

A

C BOil discovery

leads to appreciation

, and reduces nonoil exports

Compositi

on of exports

matters

Term refers to fears of de-industrialization that gripped the Netherlands following appreciation of Dutch guilder after discovery of natural gas deposits in North Sea around 1960

Is it a disease? Some say NoNo, viewing it simply as matter of

one sector’s benefiting at the expense of others, without seeing any macroeconomic or social damage done

Others say YesYes, viewing the Dutch disease as an ailment, pointing to the potentially harmful consequences of the resulting reallocation of resources – from high-tech, high-skill intensive service industries to low-tech, low-skill intensive primary production, for example – for economic growth and diversification

Overvaluation of currency hurts other exports and import-competing industries Norway’s total exports have been stagnant in

proportion to GDP since before oil discoveries Oil exports have crowded out nonoil exports

Nokia is Finnish, LM Ericsson is Swedish, B&O is Danish Norway’s almost unique unwillingness to join EU

Keeping inflation low to avoid overvaluation Price stability requires good monetary governance monetary governance

through independent yet accountable central banks Healthy financial sector development also requires

good monetary governance, including transparency

China’s undervalued

renmimbi

Rent seeking … Especially in conjunction with ill-defined

property rights, imperfect or missing markets, and lax legal structures

… tends to divert resources away from more socially fruitful economic activity

International initiatives to raise transparency Extractive Industries Transparency Initiative Extractive Industries Transparency Initiative (EITI)

aims to set global standard for transparency in oil, gas and mining

Revenue Watch Institute Revenue Watch Institute (RWI) promotes responsible management of oil, gas, and mineral resources

Natural Resource Charter Natural Resource Charter sets out principles for how to manage natural resources for development

False sense of security

Neglect of education

Other people’s money

Volatility of commodity prices leads to volatility in exchange rates, export earnings, output, and employment

Volatility can be detrimental to investment and growth

Hence, natural-resource rich countries may be prone to sluggish investment and slow growth due to export price volatility

Likewise, high and volatile exchange rates tend to slow down investment and growth

Source: http://notendur.hi.is/gylfason/pic22.htm

Fiscal policies need to foster efficient revenue collection as well as efficient, growth-friendly public spendingTo be efficient and fair, the utilization of

natural resources requires that the owners – the people – be appropriately compensated

Property rights to natural resources belong to the people by international law Article 1 of the International Covenant on Civil and International Covenant on Civil and

Political RightsPolitical Rights states that “All people may, for their own ends, freely dispose of their natural wealth and resources” (Wenar, 2008)

Monetary policies need to avoid overvaluation and excessive volatility of the currency

Consider NorwayFrom day one, Norway’s oil and gas

reserves were defined by law as common property resources, clearly establishing the legal rights of the Norwegian people to the resource rents

On this legal basis, the government has absorbed about 80% of the resource rent over the years

Government laid down economic as well as ethical principles (‘commandments’) to guide the use and exploitation of the oil and gas for the benefit of current and future generations of Norwegians

Norway was a well-functioning, full-fledged democracy long before its oil discoveries

Democrats are less likely than dictators to try to grab resources to consolidate their political power Elsewhere, point resources such as oil and

minerals have proved particularly “lootable” Petroleum industry has conferred sizable

spillover benefits on others at home and abroad through transfer of technology as well as research and development

Nigeria’s economy

minister: “Oil has made us lazy”

Norwegians work less

than Danes and

Swedes, true, but no less than Germans

Success stories withoutwithout natural resources Hong Kong Japan Singapore Switzerland

Success stories withwith natural resources Botswana Chile Mauritius Norway, again

How did they succeed?

55

How Botswana succeeded Started out at independence in 1966 with 12 km

of paved roads, 22 college graduates, and 100 secondary-school graduates

Diamonds, discovered in 1967, provide tax revenue equivalent to 33% of GDP

Sub-Saharan Africa’s highest per capita GNI Good policies, good institutions, democracy

How Mauritius succeeded Emphasized trade and education in lieu of sugar Cosmopolitan population Again, good policies, good institutions,

democracy Look at some economic and social indicators

Frankel (2010)

Acemoglu et al.

(2003)

But not

perfect

Per Capita GNI (USD at PPP)

Increase in life

expectancy in years

1980-2008

-6

1

6

Per Capita GNI (USD at PPP) Democracy

7

-2

Increase in life

expectancy in years

1980-2008

Average democracy

index 1980-2008-6

1

6

Generally, democracy and growth go

together


10

13

-6


4

6

-1

10

13

-6


7

5

6


10

4

107

5

6


5

13

12


10

-4

-10

5

13

12

The problem is not the existence of natural wealth as such ... … but rather the failure to avert the

dangers that accompany the gifts of nature

Norway is, so far, a success story Government invests 80% of oil rent 80% of oil rent

entirely in foreign securities 60% in equities 40% in fixed-income securities

Norway always had its natural resources

It was only with the advent of educated labor educated labor that it became possible for the Norwegians to harness those resources on a significant scale

Human capital Human capital accumulation was the primary force behind the economic transformation of Norway Natural capital was secondary

The purpose of the oil fund ShareShare the wealth fairly: Pension fundPension fund ShieldShield domestic economy from

overheating and possible waste Fund has grown huge: USD 450 USD 450

billionbillion That makes almost USD 100K per

person Norwegians have resisted temptation resisted temptation

to use too much of the money to meet current needs

Long tradition of democracydemocracy and market economy market economy in Norway since before the advent of oil Large-scale rent seeking was

averted as oil was, by law, defined as a common-property resource from the beginning

Adequate investment performance Excellent education record

Female college enrolment doubled from 46% of each cohort in 1991 to 94% in 2006

Some (weak) signs of Dutch Dutch diseasedisease Stagnant exports, sluggish FDI Limited interest in joining EU and

EMU Some signs also of unwillingness

to undertake difficult reforms Health care provision

Management of oil fund delegated by Ministry of Finance to Central Central BankBank from 1997 onward Central Bank became independent

1999

Natural resources bring risks A false sense of securityfalse sense of security leads

people to underrate or overlook the need for good policies and institutions, good education, and good investment

Awash in easy cash, they may find may find that hard choices perhaps can be that hard choices perhaps can be avoidedavoided

Awareness of these risks is perhaps the best insurance policy against them

16 countries

4 industrial countries

12 developing

countries

66

27 countries

5 industrial countries

22 developing countries

whose average per capita

growth rate 1960-2000

was 0.1%0.1% per year

compared with 1.4% for the

sample of 164 countries as

a whole

High-income countries

Low-income countries

Real capital 17 16

Natural capital

Subsoil assets2(1)

29(6)

Intangible capital Human capital Social capital

81 55

Total wealthTotal wealth: estimated by perpetual inventory method as present discounted value of future consumption Real capitalReal capital: estimated from investment figures Natural capitalNatural capital: cropland, pastureland, subsoil assets, timber resources, nontimber forest resources, and protected areas Intangible capitalIntangible capital: estimated as residual

Source: World Bank (2006)

School life expectancy 2005 (years)

Fertility 1960-2000 (births per

woman)

Public health

expenditure 2004

(% of GDP)

Democracy 1960-2000

(index)

Corruption 2005

(index)

Investment 1960-2000 (% of GDP)

Per capita growth

1960-2000 (% per year)

Mineral-rich countries

11.7 4.5 2.4 -3.2 3.3 24.3 0.10.1

Lower middle-income countries

11.4 3.6 2.6 -1.2 3.0 24.3 3.6

Upper middle-income countries

13.5 2.9 3.8 2.2 4.1 25.9 1.7

False contrast: No

inconsistency between

favorable effects of

commodity price booms on

output in the short run and

adverse effects on long-run

growth

Size of balls

reflects size of

countries

-0.67

Natural capital share and growth are inversely

related

-0.82Natural capital crowds out human capital

0.69Education is good for growth

-0.74

Natural capital crowds out social capital

More

co

rru

pti

on

0.75Corruption hurts growth

More corruption

-0.67Natural capital crowds out social capital

0.51

Democracy is good for growth

0.62Human capital and social capital go together

0.60

Different aspects of social capital go togetherM

ore

co

rru

pti

on

-0.67

Natural capital share and growth are inversely related

-0.10

Subsoil asset share and growth are inversely

related,

but rank correlation is weak, so need multiple

regression

Model 1

Initial income

-0.74(5.2)

Natural capital share

Natural capital per personDemocracy

Investment rate (log)School life expectancy (log)Fertility

Countries 164

Adjusted R2 0.14

Note: t-values within parentheses.

Model 1 Model 2

Initial income

-0.74(5.2)

-0.49(3.1)


-0.04(5.3)

Natural capital per person

Democracy


Countries 164 125

Adjusted R2 0.14 0.18

Model 1 Model 2 Model 3

Initial income

-0.74(5.2)

-0.49(3.1)

-0.96(5.3)


-0.04(5.3)

-0.06(7.1)


0.10(4.5)

Democracy


Countries 164 125 124

Adjusted R2 0.14 0.18 0.29

Model 1 Model 2 Model 3 Model 4

Initial income

-0.74(5.2)

-0.49(3.1)

-0.96(5.3)

-1.07(5.2)


-0.04(5.3)

-0.06(7.1)

-0.05(4.7)


0.10(4.5)

0.08(3.7)

Democracy 0.07(2.2)


Countries 164 125 124 113

Adjusted R2 0.14 0.18 0.29 0.27

Model 1 Model 2 Model 3 Model 4 Model 5

Initial income

-0.74(5.2)

-0.49(3.1)

-0.96(5.3)

-1.07(5.2)

-1.24(7.0)


-0.04(5.3)

-0.06(7.1)

-0.05(4.7)

-0.04(5.3)


0.10(4.5)

0.08(3.7)

0.06(3.3)

Democracy 0.07(2.2)

0.07(2.7)

Investment rate (log)

2.92(6.8)

School life expectancy (log)Fertility

Countries 164 125 124 113 113

Adjusted R2 0.14 0.18 0.29 0.27 0.48

Model 1 Model 2 Model 3 Model 4 Model 5 Model 6

Initial income

-0.74(5.2)

-0.49(3.1)

-0.96(5.3)

-1.07(5.2)

-1.24(7.0)

-1.60(7.8)


-0.04(5.3)

-0.06(7.1)

-0.05(4.7)

-0.04(5.3)

-0.03(4.0)


0.10(4.5)

0.08(3.7)

0.06(3.3)

0.05(2.5)

Democracy 0.07(2.2)

0.07(2.7)

0.07(2.7)


2.92(6.8)

1.72(3.2)

School life expectancy (log)

0.94(4.0)

Fertility

Countries 164 125 124 113 113 90

Adjusted R2 0.14 0.18 0.29 0.27 0.48 0.55

Model 1 Model 2 Model 3 Model 4 Model 5 Model 6 Model 7

Initial income

-0.74(5.2)

-0.49(3.1)

-0.96(5.3)

-1.07(5.2)

-1.24(7.0)

-1.60(7.8)

-1.70(8.5)


-0.04(5.3)

-0.06(7.1)

-0.05(4.7)

-0.04(5.3)

-0.03(4.0)

-0.03(3.1)


0.10(4.5)

0.08(3.7)

0.06(3.3)

0.05(2.5)

0.04(2.3)

Democracy 0.07(2.2)

0.07(2.7)

0.07(2.7)

0.05(2.0)


2.92(6.8)

1.72(3.2)

1.34(2.5)


0.94(4.0)

0.56(2.1)

Fertility -0.40(2.8)

Countries 164 125 124 113 113 90 90

Adjusted R2 0.14 0.18 0.29 0.27 0.48 0.55 0.58

OLS

Model 1 Model 2 Model 3 Model 4 Model 5 Model 6 Model 7

Initial income

-0.74(5.2)

-0.49(3.1)

-0.96(5.3)

-1.07(5.2)

-1.24(7.0)

-1.60(7.8)

-1.70(8.9)


-0.04(5.3)

-0.06(7.1)

-0.05(4.7)

-0.04(5.3)

-0.03(4.0)

-0.03(3.3)


0.10(4.5)

0.08(3.7)

0.06(3.3)

0.05(2.5)

0.04(2.4)

Democracy 0.07(2.2)

0.07(2.7)

0.07(2.7)

0.05(2.1)


2.92(6.8)

1.72(3.2)

1.34(2.6)


0.94(4.0)

0.56(2.2)

Fertility -0.40(3.0)

Countries 164 125 124 113 113 90 90

Adjusted R2 0.14 0.18 0.29 0.27 0.48 0.55 0.58

SUR

Per capita growth (%) 2.42 1.00

Natural capital share (19.0) 0.47 0.19

Democracy (6.4) 0.35 0.14

Investment (log, 0.29) 0.39 0.16

School life expectancy (log, 0.35) 0.48 0.20

Fertility (1.8) 0.73 0.30

Note: Standard deviations within parentheses.

These slides will be posted on

my website:

www.hi.is/~gylfason

David Landes (1998) tells the story of Spain following the colonization of South and Central America which made Spain rich in gold and other natural resources:

“Easy money is bad for you. It represents short-run gain that

will be paid for in immediate distortions and later regrets.”

Thorvaldur Gylfason IMF INSTITUTE Course on Natural Resources, Finance, and Development...

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Transcript of Thorvaldur Gylfason IMF INSTITUTE Course on Natural Resources, Finance, and Development...