Title: The%20Natural%20Resource%20Curse%20and%20How%20to%20Avoid%20It%20Jeffrey%20Frankel%20Harpel%20Professor%20of%20Capital%20Formation%20
1The Natural Resource Curse and How to Avoid
ItJeffrey FrankelHarpel Professor of Capital
Formation Growth
- IMF Institute for Capacity Development (formerly
IMF Institute) July 27, 2012
2The Natural Resource CursePart I Channels
- Some seminal references
- Auty (1990, 2001, 2007)
- Sachs Warner (1995, 2001),
- By now there is a large body of research,
- which I have surveyed (2011, 2012a, b).
3- Many countries that are richly endowed with oil,
minerals, or fertile land have failed to grow
more rapidly than those without. - Example
- Some studies find a negative effect of oil in
particular, on economic performance - including Kaldor, Karl Said (2007) Ross
(2001) Sala-i-Martin Subramanian (2003) and
Smith (2004). - Some oil producers in Africa the Middle East
have relatively little to show for their
resources.
4- Meanwhile, East Asian economies achieved
western-level standards of living despite having
virtually no exportable natural resources - Japan, Singapore, Hong Kong, Korea Taiwan,
- rocky islands or peninsulas
- followed by China.
5Growth falls with fuel mineral exports
6Are natural resources necessarily bad?
No, of course not.
- Commodity wealth need not necessarily lead to
inferior economic or political development. - Rather, it is a double-edged sword, with both
benefits and dangers. - It can be used for ill as easily as for good.
- The priority should be on identifying ways
- to sidestep the pitfalls that have afflicted
commodity producers in the past, to find the
path of success.
7- Some developing countries have avoided the
pitfalls of commodity wealth. - E.g., Chile (copper)
- Botswana (diamonds)
- Some of their innovations are worth emulating.
- The 2nd half of the lecture will offer some
policies institutional innovations to avoid the
curse - especially ways of managing price volatility.
- Some lessons apply to commodity importers too.
- Including lessons of policies to avoid.
8- But, 1st How could abundance of commodity
wealth be a curse? - What is the mechanism
- for this counter-intuitive relationship?
-
- At least 5 categories of explanations.
95 Possible Natural Resource Curse Channels
- Volatility
- Crowding-out of manufacturing
- Autocratic Institutions
- Anarchic Institutions
- Procyclicality including
- Procyclical capital flows
- Procyclical monetary policy
- Procyclical fiscal policy.
10I have chosen to exclude a 6th channel, The
Prebisch-Singer (1950) Hypothesis
- that commodities supposedly suffer a long-run
downward relative price trend. - Vs. persuasive theoretical arguments that we
should expect commodity prices to show upward
trends in the long run - Malthus
- Hotelling
11The trend since 1960 has been up
A.Saiki, Dutch Nat.Bk.
Nominal prices2010100
Real prices nominal in 2000
12- (1) Volatility in global commodity prices
arises because supply demand are inelastic in
the short run.
13Commodity prices have been especially volatile
over the last decade
Source UNCTAD
14Effects of Volatility
- Volatility per se can be bad for economic growth.
- Hausmann Rigobon (2003), Blattman, Hwang,
Williamson (2007), and Poelhekke van der Ploeg
(2007). - Risk inhibits private investment.
- Cyclical shifts of resources back forth across
sectors may incur needless transaction costs. - gt role for government intervention?
- On the one hand, the private sector dislikes risk
as much as government does takes steps to
mitigate it. - On the other hand the government cannot entirely
ignore the issue of volatility - e.g., exchange rate policy.
14
152. Natural resources may crowd out manufacturing,
- and manufacturing could be the sector that
experiences learning-by-doing - or dynamic productivity gains from spillover.
- Matsuyama (1992), van Wijnbergen (1984) and Sachs
Warner (1995). - So commodities could in theory be a dead-end
sector. - gt Mere hewers of wood and drawers of water
remain forever poor (Deuteronomy 2911) if they
do not industrialize. - My own view a country need not repress the
commodity sector to develop the manufacturing
sector. - It can foster growth in both sectors.
- E.g. Canada, Australia, Norway Now Malaysia,
Chile, Brazil
163. Autocratic or oligarchic institutions may
retard economic development.
- Countries where physical command of natural
resources by government or a hereditary elite
automatically confers wealth on the holders - are likely to become rent-seeking societies
- and are less likely to develop the institutions
conducive to economic development, - e.g., decentralization economic incentives
- as compared to countries where moderate taxation
of a thriving market economy is the only way
government can finance itself.
17Econometric findings that oiland other
point-source resources lead to poor
institutions
- Isham, Woolcock, Pritchett, Busby (2005)
- Sala-I-Martin Subramanian (2003)
- Bulte, Damania Deacon (2005)
- Mehlum, Moene Torvik (2006)
- Arezki Brückner (2009).
The theory is thought to fit Middle Eastern oil
exporters well. E.g., Iran. Mahdavi
(1970), Skocpol (1982, p. 269), and Smith (2007).
18What are poor institutions?
- A typical list
- inequality,
- corruption,
- intermittent dictatorship,
- ineffective judiciary branch, and
- lack of constraints to prevent elites
politicians from plundering the country.
19The rent cycling theory as enunciated by Auty
(1990, 2001, 07, 09)
- Economic growth requires recycling rents via
markets rather than via patronage. - In oil countries the rents elicit a political
contest to capture ownership, - whereas in low-rent countries the government must
motivate people to create wealth, - e.g., by pursuing comparative advantage,
promoting equality, fostering civil society.
20An example, from economic historians Engerman
Sokoloff (1997, 2000, 2002)
- Why did industrialization take place in North
America, - not the South?
- Lands endowed with extractive industries
plantation crops developed slavery, inequality,
dictatorship, and state control, - whereas those climates suited to fishing small
farms developed institutions of individualism,
democracy, egalitarianism, and capitalism. - When the Industrial Revolution came, 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 authoritarianism, rather than on
individual incentive and decentralized
decision-making.
214. Anarchic institutions
- Unsustainably rapid depletion of resources
- Unenforceable property rights
- Civil war
21
22 4.1 Unsustainably rapid
depletion
- When exhaustible resources are in fact
exhausted, the country may be left with
nothing. - Three concerns
- Protection of environmental quality.
- A motivation for a strategy of economic
diversification. - The need to save for the day of depletion
- Invest rents from exhaustible resources in other
assets. - Hartwick (1977) and Solow (1986).
22
23The example of Nauruphosphate mining
244.2 Unenforceable property rights
- Depletion would be much less of a problem if
full property rights could be enforced, - thereby giving the owners incentive to conserve
the resource in question. - But often this is not possible
- especially under frontier conditions.
- Overfishing, overgrazing, over-logging are
classic examples of the tragedy of the commons.
- Individual fisherman, ranchers, loggers, or
miners, have no incentive to restrain
themselves, while the fisheries, pastureland or
forests are collectively depleted.
24
25Madre de Dios region of the Amazon rainforest in
Peru, the left-hand side stripped by illegal
gold mining.
http//indiancountrytodaymedianetwork.com/2011/02/
27/amazon-gold-rush-laying-waste-to-peruvian-rainf
orestE28099s-madre-de-dios-20021
264.3 War
- Where a valuable resource such as oil or diamonds
is there for the taking, factions will likely
fight over it. - Oil minerals are correlated with civil war.
- Fearon Laitin (2003), Collier Hoeffler
(2004), Humphreys (2005) and Collier (2007). -
- Chronic conflict in places such as Sudan comes
to mind. - Civil war is, in turn, very bad for economic
development.
26
27(5) Procyclicality
- The Dutch Disease describes unwanted
side-effects of a commodity boom. - Developing countries are historically prone to
procyclicality, - especially commodity producers.
- Procyclicality in
- Capital inflows Monetary policy
- Real exchange rate Nontraded Goods
- Fiscal Policy
27
28The Dutch Disease 5 side-effects of a commodity
boom
- 1) A real appreciation in the currency
- 2) A rise in government spending
- 3) A rise in nontraded goods prices
- 4) A resultant shift of production out of
manufactured goods - 5) Sometimes a current account deficit
28
29The Dutch Disease The 5 effects elaborated
- 1) Real appreciation in the currency
- taking the form of nominal currency appreciation
if the exchange rate floats - or the form of money inflows, credit inflation
if the exchange rate is fixed - 2) A rise in government spending
- in response to availability of tax receipts or
royalties.
29
30The Dutch Disease 5 side-effects of a commodity
boom
- 3) An increase in nontraded goods prices
relative to internationally traded goods
- 4) A resultant shift out of non-commodity traded
goods, - esp. manufactures,
- pulled by the more attractive returns in the
export commodity and in non-traded goods.
30
31The Dutch Disease 5 side-effects of a commodity
boom
- 5) A current account deficit,
- as booming countries attract capital flows,
- thereby incurring international debt that is
hard to service when the boom ends. - Manzano Rigobon (2008) the negative
Sachs-Warner effect of resources on growth rates
during 1970-1990 was mediated through
international debt incurred when commodity prices
were high. - Arezki Brückner (2010a, b) commodity price
booms lead to higher government spending,
external debt default risk in autocracies, - but do not have those effects in democracies.
- the dichotomy extends also to effects on
sovereign bond spreads. - But many developing countries avoided borrowing
in the 2003-11 boom.
31
32Procyclical capital flows
- According to intertemporal optimization theory,
capital flows should be countercyclical - Net capital inflows when exports are doing badly
- And net capital outflows when exports do well.
- In practice, it does not always work this way.
Capital flows are more procyclical than
countercyclical. - Gavin, Hausmann, Perotti Talvi (1996)
Kaminsky, Reinhart Vegh (2005) Reinhart
Reinhart (2009) and Mendoza Terrones (2008). - Invalidates much of existing theory,
- though certainly not all.
- Theories to explain this involve capital market
imperfections, - e.g., asymmetric information or the need for
collateral.
33Procyclical monetary policy
- If the exchange rate is fixed,
- surpluses during commodity booms lead to rising
reserves and money supply. - possibly delayed by sterilization attempts.
- Example Gulf States during recent oil booms.
- Floating can help, accommodating trade shock.
- But,
- under pure floating appreciation can be
excessive. - under IT CPI rule says to tighten money
appreciate when import commodity price goes up
(or other adverse supply shock). - Thats backwards. (E.g., oil importers in
2008.) - Should appreciate when export commodity price
goes up.
34Procyclical real exchange rateCountries
undergoing a commodity boom experience real
appreciation of their currency
- taking the form of nominal currency appreciation
- for floating-rate commodity exporters, Colombia,
Kazakhstan, Russia, S.Africa, Chile, Brazil. - or the form of money inflows inflation
- for fixed-rate commodity exporters, Saudi Arabia
UAE.
OK. But real appreciation adds to boom in NTGs.
35Procyclical fiscal policy
- Fiscal policy has historically tended to be
procyclical in developing countries - especially among commodity exporters
- Cuddington (1989), Tornell Lane (1999),
Kaminsky, Reinhart Vegh (2004), Talvi Végh
(2005), Alesina, Campante Tabellini (2008),
Mendoza Oviedo (2006), Ilzetski Vegh (2008),
Medas Zakharova (2009), Gavin Perotti
(1997). -
- Correlation of income spending mostly positive
- particularly in comparison with industrialized
countries.
36- The procyclicality of fiscal policy
-
- A reason for procyclical public spending
receipts from taxes royalties rise in booms.
The government cannot resist the temptation to
increase spending proportionately, or more. - Then it is forced to contract in recessions,
- thereby exacerbating the swings.
36
37Two budget items account for much of the
spending from oil booms
- (i) Investment projects.
- Investment in practice may be white elephant
projects, - which are stranded without funds for completion
or maintenance when the oil price goes back
down. - Gelb (1986).
- (ii) The government wage bill.
- Oil windfalls are often spent on public sector
wages. - Medas Zakharova (2009)
- Arezki Ismail (2010) government spending
rises in booms, but is downward-sticky.
Rumbi Sithole took this photo in Bayelsa
Statein the Niger Delta,in Nigeria. The state
government received a windfall of money and
didn't have the capacity to have it all absorbed
in social services so they decided to build a
Hilton Hotel. The construction company did a
shoddy job, so the tower is leaning to its right
and its unsalvageable..
37
38Correlations between Gov.t Spending
GDP 1960-1999
procyclical
Adapted from Kaminsky, Reinhart Vegh (2004)
countercyclical
G always used to be pro-cyclical for most
developing countries.
39The procyclicality of fiscal policy, cont.
- Procyclicality has been especially strong in
commodity-exporting countries. - An important development -- some developing
countries, including commodity producers, were
able to break the historic pattern in the most
recent decade - taking advantage of the boom of 2002-2008
- to run budget surpluses build reserves,
- thereby earning the ability to expand fiscally
in the 2008-09 crisis. - Chile is the outstanding model.
- Also Botswana, China, Indonesia, Korea
39
40Correlations between Government spending GDP
2000-2009
procyclical
Frankel, Vegh Vuletin (2012)
In the last decade, about 1/3 developing
countries switched to countercyclical fiscal
policyNegative correlation of G GDP.
countercyclical
41Summary of Part I
- Five broad categories of hypothesized channels
whereby natural resources can lead to poor
economic performance - commodity price volatility,
- crowding out of manufacturing,
- autocratic institutions,
- anarchic institutions, and
- procyclical macroeconomic policy, including
- capital flows,
- monetary policy and
- fiscal policy.
- But the important question is how to avoid the
pitfalls, - to achieve resource blessing instead of resource
curse.
4242
43Appendix I chose to exclude a 6th channel, The
Prebisch-Singer (1950) Hypothesis
- that commodities supposedly suffer a long-run
downward relative price trend. - Theoretical reasoning world demand for primary
products is inelastic with respect to income. - Vs. persuasive theoretical arguments that we
should expect commodity prices to show upward
trends in the long run - Malthus (esp. for food)
- Hotelling (for depletable resources).
44- The up trend idea goes back to Malthus (1798) and
early fears of environmental scarcity - Demand grows with population (geometrically),
- Supply does not.
- What could be clearer in economics
- than the prediction that price will rise?
45Hotelling (1931)
- Firms choose how fast to extract oil or minerals
- King Abdullah of Saudi Arabia, with interest
rates 0 in 2008,apparently believed that the
rate of return on oil reserves was higher if he
didn't pump than if he did - "Let them remain in the ground for our children
and grandchildren..." - Arbitrage gt
- expected rate of price increase interest rate.
46The empirical evidence
- With strong theoretical arguments on both sides,
either for an upward trend or for a downward
trend, it is an empirical question. - Terms of trade for commodity producers had
- a slight up trend from 1870 to World War I,
- a down trend in the inter-war period,
- up in the 1970s,
- down in the 1980s and 1990s,
- and up in the first decade of the 21st century.
47What is the overall statistical trend in
commodity prices in the long run?
- Some authors find a slight upward trend,
- some a slight downward trend. 1
- The answer depends on the date of the end of the
sample. - 1 Cuddington (1992), Cuddington, Ludema
Jayasuriya (2007), Cuddington Urzua (1989),
Grilli Yang (1988), Pindyck (1999), Reinhart
Wickham (1994), Hadass Williamson (2003),
Kellard Wohar (2005), Balagtas Holt (2009),
Cuddington Jerrett (2008), and Harvey, Kellard,
Madsen Wohar (2010).