RESEARCH AND ANALYSIS

Natural Resources and Development Strategy after the Crisis

Milan Brahmbhatt, World Bank, Economic Advisor, Poverty Reduction and Economic Management (PREM) Network
Otaviano Canuto, World Bank, Vice President and Head of the Poverty Reduction and Economic Management (PREM) Network

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Recent events have rekindled interest in the role of primary commodities in development. Was the boom in commodity prices from 2003 through 2008 just a cyclical event or does it herald a period of long-term strength, driven by factors such as demand in fast-growing developing countries like China? It is notable that, while commodity prices fell sharply with the onset of the global recession, they generally remained much higher than previous recession lows and rebounded smartly over the course of 2009 (figures 1 and 2). If a period of commodity strength is imminent, what are the implications for development policies?
Although it has fallen over time, developing country specialization in commodities remains high. Commodities still comprise over 60 percent of the merchandise exports of the average developing country, although this is down from 90 percent in the 1960s. Half of developing countries still have commodity export dependence of over 70 percent.(1)
  

What is the outlook for primary commodity prices?

The present consensus appears to be that real commodity prices do not display any permanent trend over the long run. In technical terms it is not possible to reject the so-called unit root hypothesis for real commodity prices Such processes tend to be highly correlated over time, so it is possible for them to move significantly lower or higher for long periods even in the absence of an underlying trend. Based on statistical properties alone, then, one would not be surprised to see a sustained period of high prices following the earlier period of low prices from the mid-1980s through the 1990s.

Are there plausible fundamentals to support such an outlook? The price of commodities relative to the price of manufactures can be analyzed in terms of the demand for and supply of primary commodities relative to the demand for and supply of manufactures.

On the supply side, investment in energy and minerals was slashed when prices were low in the 1980s and 1990s and is recovering only slowly, due to skill shortages, technical difficulties in developing new reserves (for example, deep offshore), and political uncertainty in regions with new reserves. Relative demand for commodities could also rise in the medium term to the extent world growth after the financial crisis is more dependent on developing countries and demand in these countries is more commodity intensive than elsewhere. There is also evidence that real commodity prices tend to be high when real interest rates are low, as at present. So both supply and demand factors could support the present relatively high level of real commodity prices into the medium term, although these factors will tend to dissipate in the longer term. Most current forecasts are consistent with this scenario, projecting only a gradual easing in real commodity prices from existing levels by 2015. (Figure 3).
  

Is there a natural resource “curse” (or blessing)?

The short answer is “it depends,” that natural resources are “neither curse nor destiny”. Recent work finds that negative long-run growth effects associated with natural resources are mostly related to oil and minerals —concentrated “point source” resources that stimulate rent-seeking and redistributive struggles. Further, high oil and mineral prices mostly have a negative impact on long-run growth in countries with bad governance.

In part this is because countries with weak governance are more likely to adopt poor economic policies to manage commodity booms, for example by increasing public spending too much and too rapidly as a way of buying votes or expanding political patronage networks. But resource booms create challenging problems in macroeconomic management even for economies with good governance. These include Dutch Disease effects which result in appreciation of the real exchange rate and output contraction in the manufacturing sector, as well as volatility in government spending and real exchange rates that damages investment and growth because of increased uncertainty.

Resource–abundant countries also face longer-run questions about the optimal pace of resource depletion. Is the country’s strategy sustainable, transferring sufficient capital to future generations to allow them to achieve at least the same welfare as today? Countries with high resource depletion are often on unsustainable development paths, with negative net savings.
  

What policies can help poor countries best manage commodity resources for development?

Given the role of weak governance, efforts to enhance transparency and strengthen checks and balances on natural resource extraction are vital, as are broader anti-corruption reforms. There has also been much attention to the use of separate Natural Resource Funds to counter corruption and facilitate good revenue management, although such funds are more likely to succeed if part of broader efforts to strengthen governance and fiscal policy. Policies regarding the actual allocation of resource revenues are also crucial, for example whether to return revenues to citizens (via tax cuts or transfers) or to retain them in public hands, and how to allocate public revenue between government consumption and investment (or reductions in debt).

A common benchmark, the permanent income rule, suggests saving all resource revenues after funding a certain permanently sustainable increase in consumption, usually by establishing a Natural Resource or Sovereign Wealth Fund to invest in foreign assets. There is however something anomalous about viewing the permanent income rule - where poor, capital-scarce countries invest in rich countries - as a long-run development strategy. Some analysts argue that the permanent income rule is optimal only under special circumstances that do not apply to most developing countries, notably the ability to freely borrow and lend at the world rate of interest. Given potentially high domestic rates of return, especially if the government can supply scarce public goods that raise returns on private investment, a better strategy may be to spend more on high-return domestic public investments.

The success of such a strategy will depend on how efficiently public investment funds are allocated and managed. So reforms to strengthen public investment management, cost benefit analysis, monitoring and evaluation, and budget processes and institutions provide another crucial element of a successful resource–based development strategy.

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Note: A longer version of this article is available under the same name as World Bank Economic Premise Number 1, February 2010. back to text