RESEARCH AND ANALYSIS

“The Natural Resource Curse: A Survey”

Jeffrey Frankel; Harpel Professor of Capital Formation and Growth, Harvard University

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It is striking how often countries with oil or other natural resource wealth have failed to grow more rapidly than those without. This is the phenomenon known as the Natural Resource Curse. The principle is not confined to individual anecdotes or case studies, but has been borne out in some econometric tests of the determinants of economic performance across a comprehensive sample of countries. Already-classic contributors to the rapidly growing literature include Auty (1993, 2001) and Sachs and Warner (1995, 2001).

This paper considers seven aspects of commodity wealth, each of interest in its own right, but each also a channel that some have suggested could lead to sub-standard economic performance. They are:

1. Allegedly adverse long-term trends in world commodity prices (the Prebisch-Singer hypothesis, as opposed to Malthus, Hotelling, and the “peak oil hypothesis”).
2. Volatility in world commodity prices, resulting from low short-run elasticities
3. Permanent crowding out of manufacturing, where developmental spillover effects are allegedly concentrated (as in the Matsuyama model, 1992)
4. Poor institutions
5. Unsustainably rapid depletion, with the market failure originating in unenforceable property rights over non-renewable resources (“open access”), particularly in anarchic frontier conditions, and sometimes exacerbated by international trade.
6. Civil war,
7. And cyclical Dutch Disease.

The literature on channel 4, poor institutions, begins with Engerman and Sokoloff, (1997, 2000). Lands endowed with extractive industries (“point source” sectors: oil, minerals, and plantation crops) historically developed institutions of slavery, inequality, dictatorship, and state control. Meanwhile, other countries (in those climates originally suited to fishing and small farms) developed institutions based on individualism, democracy, egalitarianism, and capitalism. When the industrial revolution came along, the latter areas were well-suited to make the most of it. Those that had specialized in extractive industries were not, because society had come to depend on class structure and authoritarianism, rather than on individual incentive and decentralized decision-making. The theory is thought to fit Middle Eastern oil exporters especially well.

The literature on channel 7 takes us into the macroeconomics of the business cycle. The Dutch Disease phenomenon arises when a strong, but perhaps temporary, upward swing in the world price of the export commodity causes some or all of the following side effects:

  • a large real appreciation in the currency (taking the form of nominal currency appreciation if the country has a floating exchange rate or the form of money inflows and inflation if the country has a fixed exchange rate);

  • an increase in spending (especially by the government, which increases spending in response to the increased availability of tax receipts or royalties);

  • an increase in the price of nontraded goods (goods and services such as housing that are not internationally traded), relative to traded goods (manufactures and other internationally traded goods other than the export commodity),

  • a resultant shift of labor and land out of non-export-commodity traded goods (pulled by the more attractive returns in the export commodity and in non-traded goods and services), and

  • a current account deficit (thereby incurring international debt that may be difficult to service when the commodity boom ends 1).

What makes the Dutch Disease a “disease?” One interpretation, particularly relevant if the complete cycle is not adequately foreseen, is that the process is all painfully reversed when the world price of the export commodity goes back down. A second interpretation is that, even if the perceived longevity of the increase in world price turns out to be accurate, the crowding out of non-commodity exports is undesirable, perhaps because the manufacturing sector has greater externalities for long-run growth (“de-industrialization”). But the latter view is just another name for the Natural Resource Curse; it has nothing to do with cyclical fluctuations per se. In a real trade model, the reallocation of resources across tradable sectors, e.g., from manufactures to oil, may be inevitable, regardless of macroeconomics. But the movement into non-traded goods is macroeconomic in origin.

Recently, skeptics have questioned the Natural Resource Curse. They point to examples of commodity-exporting countries that have done well, persuasively arguing that natural resource endowments do not necessarily doom a country to slow growth. But they further question the negative relationship even as a statistical generalization. They argue that “resource dependence” and commodity booms are not exogenous. The reverse causality between industrialization and commodity exports can have either a negative sign (those countries that fail at manufacturing have a comparative advantage at commodity exports, by default) or a positive sign (good institutions and technological progress are just as useful for developing natural resources as they are for the other sectors of the economy).

It is best to view commodity abundance as a double-edged sword, with both benefits and dangers. Clearly the relevant policy question for a country with natural resources is how to make the best of them. The paper concludes with a consideration of ideas for institutions that could help a country that is endowed with, for example, oil overcome the pitfalls of the Curse and achieve good economic performance.

The most promising ideas include:

  • indexation of oil or mineral contracts to world prices of the commodity

  • hedging of export proceeds on forward markets

  • denomination of debt in terms of the world price of the export commodity

  • Chile-style fiscal rules, which prescribe a structural budget surplus and use independent panels of experts to determine what long-run price of the export commodity should be assumed in forecasting the structural budget.

  • An inflation target for the central bank that emphasizes product prices, rather than the CPI on which the fashionable monetary regime of Inflation Targeting is usually based

  • transparent commodity funds,

  • and lump-sum per capita distribution of oil revenues.
     

Notes:
1.
Manzano and Rigobon (2008) show that the negative Sachs-Warner effect of resource dependence on growth rates during 1970-1990 was mediated through international debt incurred when commodity prices were high. Arezki and Brückner (2010a) find that commodity price booms lead to increased government spending, external debt and default risk in autocracies, and but do not have those effects in democracies. Arezki and Brückner (2010b) find that the dichotomy extends also to the effects on sovereign bond spreads paid by autocratic versus democratic commodity producers. back to text

 

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