The Challenge of Natural Resourceled Development in Small Economies

1
The Challenge of Natural Resource-led Development
in Small Economies

• Dr. Maiju Johanna Perälä
• Department of Economics
• The University of the West Indies, Mona
• Prepared for the presentation at
• Association of Caribbean Economists conference
  on Economic Growth and TransformationReassessing
  Challenges and Prospects at the Datwn of the
  21st Century

2
Purpose of the paper

• To provide an explanation why growth has failed
  in some countries over the long-term, especially
  those that are small in size
• To investigate whether natural resource endowment
  type is relevant as argued within the development
  economics literature (Hirschman 1977,1981 Auty
  1995, 2001)
• To clarify a mechanism that generates (or has
  potential to generate) a resource curse, an
  important explanation for failing growth in the
  post era

3
Main arguments and findings

• Natural resource endowment type matters for
  growth, or for lack of it, especially when
  coexisting with the lack of social cohesion
• Oil and mineral resource endowment more
  negatively correlated with growth than an
  agricultural one
• The above findings are robust to different growth
  regression specifications (cross-section,
  time-series)
• The phenomenon is especially troublesome for
  small economies as, in addition to the resource
  curse phenomenon, they face a greater challenge
  for manufacturing development.

4
About this presentation

• Stylized facts of growth failures
• Explanations for failureslinkage approach to
  staples (development economics approach)
• Methodology
• Sample and data sources
• Empirical analysis
• Simple statistical evidence
• Initial conditions analysis
• Robustness regressions
• Conclusions

5
Stylized facts of growth failures

• Regionally concentrated Sub-Saharan Africa and
  Latin America and the Caribbean
• Stage of development is relevant Tend to occur
  at early phases of development
• Size of the economy matters More likely to occur
  in small than large economies

6
Regional concentration long term failures
7
Regional concentrationrecent failures
8
Regional concentrationgrowth successes
9
Stage of development
10
Relevance of size
11
Observations on failures

• Striking patterns persistence and regional
  concentration
• Raises questions whether common explanation(s)
  for these failures can be found
• Growth failures appear to have had difficulties
  in initiating growth, focus on initial conditions
  seems appropriate

12
Common explanations for failing growth

• African growth literature
• Lack of openness (SW 1997), poor policies
  (CollierGunning 1999).
• Ethnic divisions, neighborhood effects (EL 1997,
  1998)
• Low investment and high population growth
  (Hoeffler 2002)
• Challenges of economy size
• Relatively small domestic markets, manufacturing
  potential requires favorable external market
  conditions
• More vulnerable to external fluctuations due to
  greater exposure
• Lack of diversification within the economy, terms
  of trade fluctuations stronger effect
• Small developing countries more reliant on
  primary products that experience greater
  volatility

• Natural resource abundance and growth
• Easy riches lead to sloth (Bodin 16th Century)
• Natural resource curse thesis (Auty 1995, Gelb et
  al 1998)
• Dutch disease (Corden 1984, Neary van
  Wijnbergen 1986, Ros 2000)
• Terms of trade (Prebisch 1950, Singer 1950)
• Instability (Gelb et al 1988, Tarshis 1986)
• Staples and economic development (Hirschman 1977,
  1981)
• Analytical survey (Ros 2000)

13
Linkages view on development

• Natural resource endowment type matters to
  development (Hirschman 1981)
• Captures the notion how one thing leads to
  another, interdependence of economic activity,
  linkages application to natural resource-led
  development
• Process of growth through various linkages
• Production linkages
• Consumption linkage
• Fiscal linkage

Developmental linkages
14
Physical production linkages
Forward linkage
Imported inputs
Production C
Production A
Backward linkage
Domestic production of inputs
Final demand or production B
15
Consumption linkage
Final demand
Consumption linkage from labor incomes
Production A via L-intensive methods
Consumption goods industry
Potential backward linkages
Potential forward linkages
16
Fiscal linkage
Sociopolitical environment critical
Enhance production linkages
Government
Limited production linkages
Enhance consumption linkages
Production A
Enclave production
Limited consumption linkages
Typical of mineral and fossil fuel extractive
industries
17
Challenge of fiscal linkage

• Indirect, it requires
• ability to collect taxes
• well-designed development policy
• capacity to implement the policy and to target
  the funds in most productive activities
• indirectness leaves room for mistargetting of
  funds, or even for their loss through
  rent-seeking
• Challenge posed by economy size
• management more costly to small economies,
  economies of scale not as attainable as for large
  ones (ratio of government expenditures/gdp
  smaller for large ecos, fixed costs of governance
  higher per population for small ones)

18
Linkages approach to staples

• The nature of economic activity determines the
  relative importance of each linkage
• Agricultural production ? labor-intensive, likely
  to generate a consumption linkage
• Mining and fossil fuel extractive
  industries?enclaves
• Enclaves, limited production and consumption
  linkages, the importance of fiscal linkage is
  elevated and the role of political economy
  aspects and development policy are brought to the
  forefront
• Fiscal linkage, critical for small developing
  countries rich in extractive natural resources
  poses a greater challenge given that it is more
  costly, depleting development funds

19
Linkage approach continued

• Technological apects of staples can be limiting,
  but not deterministic
• Sociopolitical environment important
• If environment is conducive to welfare maximizing
  policies?limited development potential of a
  staple can be overcome through an efficient
  management of the fiscal linkage (through
  effective development policy)

20
Empirical methods

• Simple statistical evidencehighlights the
  phenomenon
• Initial conditions analysis
• initial real per capita income and education
  level
• Sachs and Warner (1997) initial conditions
• Cross-country growth regression analysis
• Sachs and Warner (1997), Barro (1991), MRW
  (1992), King and Levine (1993), DeLong and
  Summers (1991)

21
Sample and natural resource data

• 95 market economies with population more than
  half a million (sample confirms with established
  studies and methods).
• Natural resouce endowment categorization
  following Auty (2001)
• resource rich economiesper capita cropland gt0.3
  hectares
• extractive (point source) economiesfuel and
  mineral exports gt 40 of total exports
• agricultural (diffuse) economiesremaining

22
Proxying social cohesion and enclave effect

• Social cohesion is considered to capture
  sociopolitical environment, proxied by
  ethnolinguistic fractionalization (ELF) (EL 1997,
  Mauro 1995)
• Interaction term between extractive endowment and
  ELF should capture enclave effect in a poor
  policy environment

23
Growth Failures Resource Endowment long term
failures by country
24
Growth Resource Endowment failures and
successes by country group
25
Growth and Social Fragmentation by Endowment
Type fragmented economies
26
Growth and Social Fragmentation by Endowment
Type cohesive economies
27
(No Transcript)
28
(No Transcript)
29
(No Transcript)
30
(No Transcript)
31
Estimated Growth Effects of Enclave Effect
Table from Perälä (2007)-Resource Flow
Concentration
32
Concluding remarks

• Broadens the debate on natural resource abundance
  and growth to type of natural resource the
  ensuing political economy considerations
• Mineral and/or oil richness combined with lack of
  social cohesion is found consistently negatively
  correlated with growth (distinct growth
  experience from agricultural economies)
• Brings forth evidence that mere natural resource
  richness is not negatively correlated with growth
  (rather, coexistence with lack of social cohesion
  important for a negative growth outcome)
• Empirical results are useful in explaining the
  cause of resource curse, highlighting the
  importance of political economy aspects
• The challenge is especially predominant in small
  economies, with smaller domestic market, greater
  challenge for manufacturing developing, more
  reliance on external markets and greater cost
  challenge for the management of the fiscal
  linkage.

33
Other related contributions

• Perälä, Maiju Johanna. 2007. Explaining Growth
  Failures Does the Type of Natural Resource
  Endowment Matter? (paper in review)
• Perälä, Maiju Johanna. 2007. Resource Flow
  Concentration and Social Fractionalization A
  Recipe for Curse? Journal of Economic Studies,
  35(5), forthcoming
• Perälä, Maiju. 2003. Persistence of Growth
  Failures Does the Type of Natural Resource
  Endowment Matter? UNU/WIDER Discussion Paper 37.
• Perälä, Maiju Johanna. 2002. Explaining Growth
  Failures An Empirical Investigation of Natural
  Resource Type and Growth. In Essays on Economic
  Development and Growth, 124-186, University of
  Notre Dame dissertation.