Avoiding the Resource Curse

Written by Ryan McGuine //

Economic history is full of countries with abundant stocks of natural resources exporting them to generate revenue. Famous examples include agricultural products in Latin American countries, oil in Persian Gulf countries, and minerals in African countries. Despite this, economic history is short on countries that have successfully converted natural resource revenues into long-term, sustained economic growth. In fact, this effect is so pronounced that Jeffrey Sachs and Andrew Warner alleged in their seminal paper that countries with bountiful supplies of natural resources actually grow more slowly than countries that do not — a phenomenon known as the “resource curse.”

One dimension to the resource curse is pure market-driven effects. These are informally referred to as “Dutch Disease,” a term coined in reference to the decline of labor- and technology-intensive sectors like manufacturing in the Netherlands following the discovery of large natural gas reserves in 1959. This decline is cause for concern, since industrialization has been the most reliable path to sustained economic growth throughout history.

Dutch Disease acts through two pathways. The first pathway is a “spending effect,” whereby more money in the economy drives up prices for nontradable goods (think: haircuts, tuition, real estate). This makes it more difficult for those not involved in the booming sector to afford everyday costs. The second pathway is a “resource movement effect,” whereby capital and labor move away from the production of tradable goods (think: manufactured goods) toward the booming sector. This reduces an economy’s diversification, and curtails the relative contribution to output and employment of its most productive and dynamic sectors.

There are also political economy aspects to the resource curse, related to who reaps the benefits from the country’s possession of natural resources. Natural resources represent wealth that does not have to be earned through the hard work of learning and value creation. This type of wealth extracted from relatively unproductive activities is referred to as “rent,” and attempts to capture it can be thought of as trying to increase their share of the economic pie without increasing its size. It is common for governments to over-rely on resource wealth for government spending in place of effective taxation systems, and to borrow excessively as a bet on future resource income. In addition, politicians in power can distribute rents in such a way to maintain undemocratic regimes by both rewarding loyal constituents, and clamping down on oppositional forces.

Traditional thinking on avoiding the resource curse has two dimensions: economic policies to counter Dutch Disease, and good governance to counter rent-seeking behavior. One policy tool available to combat the economic aspects of the resource curse is limiting government spending in times of high resource prices. Countries can also mandate that funds earned from resources be invested in more productive sectors or saved in a sovereign wealth fund. The good governance dimension — broadly suggesting support for the rule of law, property rights, and checks on executive power — implies that inclusive institutions protect resource wealth from being used by those in power for their own gain. The case for democracy’s importance in the equitable distribution of resource wealth was freshly reiterated by Thiemo Fetzer and Stephan Kyburz.

However, the benefits of rapid democratization with respect to the conversion of natural resource abundance into shared national wealth are not as straightforward as is sometimes suggested. Sam Hickey, Abdul-Gafaru Abdulai, Angelo Izama, and Giles Mohan argue that Uganda makes much better use of its newfound oil wealth than Ghana, despite the fact that Uganda is governed by an authoritarian regime and Ghana is a democracy. Uganda’s President Museveni invested early in developing a core group of competent technocrats, and his maintenance of power over decades has lent consistency to the country’s political-bureaucratic relationship, generating trust by international partners. Meanwhile, Ghana’s high levels of political competition and deep history of clientelistic politics has led politicians to allocate resource-derived funds toward popular, unproductive projects in order to secure re-election.

The lesson here is that democracy alone is not sufficient to eliminate clientelism, and may even exacerbate it, preventing resource wealth from being used effectively for development. Mr Hickey et al. suggest that “state capacity” — the ability of a government to mobilize financial resources, and to create and enforce laws and regulations — drove Uganda’s success, and is a better indicator than democracy of responsible resource wealth investment. European countries had the luxury of building state capacity long before there was political competition putting pressure on states to distribute resources to particular groups. By contrast, many developing countries in the Postwar Era have been tasked by the West with instituting sweeping reforms to simultaneously build capable states, and deal with political competition relatively quickly. The way this challenge was undertaken has resulted in administrative systems which look like those of modern states, but which lack the same capacity.

This wary approach toward the rapid adoption of Western-style institutions echoes work by Lant Pritchett, Kunal Sen, and Eric Werker on rules compared to deals. According to them, the idea that the ease of doing business in a country is determined by its rules as they appear on the books, misrepresents the situation in many developing countries. Rather, the informal business environment matters at least as much, if not more, than the de jure legal environment for attracting investment. Indeed, surveys suggest that the fraction of firms that report making good deals in a country is barely correlated with the quality of its regulation. It seems plausible that a ministry or two full of competent civil servants might be able to make and keep good deals with private parties to effectively generate revenue out of natural resource stocks and distribute it in a way to promote growth, no matter the quality of the rest of the government.

Yuen Yuen Ang goes a step further and rejects outright the linear thinking that defines the debate over whether good institutions are a prerequisite for growth. Instead, she claims that development is a “coevolutionary process” whereby markets and institutions are constantly evolving and interacting with one another in different ways as they evolve. Miss Ang uses China as a case study of a country that took advantage of its “weak” institutions to launch its meteoric growth after 1980. The first goal, then, should be to harness existing institutions to create markets. In turn, the emerging markets stimulate better institutions, and good institutions preserve markets. By using institutions’ ability to preserve markets as their measure of success, Miss Ang leaves room for them to take different forms — they need not look identical to those in the West in order to preserve markets.

Before dismissing democracy’s role in avoiding the resource curse, it should be noted that the success of a bad-rules, good-deals environment depends on the individuals involved. This is an inherently unstable arrangement. If the incentives faced by those in power make it more profitable to extract rents from resource wealth and use it for personal gain, they probably will eventually. To quote Milton Friedman, “It’s nice to elect the right people, but that isn’t the way you solve things. The way you solve things is by making it politically profitable for the wrong people to do the right things.” Countries should not wait for good institutions to begin incrementally improving state capacity and creating markets, since change can only be initiated from what we have, not from what we want. However, preserving long-term growth requires more than just state capacity, and the end goal should still be good governance, but within country-specific institutional frameworks.

 

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