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Title: The%20Natural%20Resource%20Curse%20and%20How%20to%20Avoid%20It%20Jeffrey%20Frankel%20Harpel%20Professor%20of%20Capital%20Formation%20

The 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

The 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).

  • 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

  • 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.

Growth falls with fuel mineral exports
Are 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.

  • 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
  • especially ways of managing price volatility.
  • Some lessons apply to commodity importers too.
  • Including lessons of policies to avoid.

  • 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.

5 Possible Natural Resource Curse Channels
  1. Volatility
  2. Crowding-out of manufacturing
  3. Autocratic Institutions
  4. Anarchic Institutions
  5. Procyclicality including
  6. Procyclical capital flows
  7. Procyclical monetary policy
  8. Procyclical fiscal policy.

I 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

The trend since 1960 has been up
A.Saiki, Dutch Nat.Bk.
Nominal prices2010100
Real prices nominal in 2000
  • (1) Volatility in global commodity prices
    arises because supply demand are inelastic in
    the short run.

Commodity prices have been especially volatile
over the last decade
Effects of Volatility
  • Volatility per se can be bad for economic growth.
  • Hausmann Rigobon (2003), Blattman, Hwang,
    Williamson (2007), and Poelhekke van der Ploeg
  • 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.

2. 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
  • 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
  • It can foster growth in both sectors.
  • E.g. Canada, Australia, Norway Now Malaysia,
    Chile, Brazil

3. 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.

Econometric findings that oiland other
point-source resources lead to poor
  • 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).

What 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.

The 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.

An example, from economic historians Engerman
Sokoloff (1997, 2000, 2002)
  • Why did industrialization take place in North
  • 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

4. Anarchic institutions
  1. Unsustainably rapid depletion of resources
  2. Unenforceable property rights
  3. Civil war

4.1 Unsustainably rapid
  • When exhaustible resources are in fact
    exhausted, the country may be left with
  • Three concerns
  • Protection of environmental quality.
  • A motivation for a strategy of economic
  • The need to save for the day of depletion
  • Invest rents from exhaustible resources in other
  • Hartwick (1977) and Solow (1986).

The example of Nauruphosphate mining
4.2 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.

Madre de Dios region of the Amazon rainforest in
Peru, the left-hand side stripped by illegal
gold mining.
4.3 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

(5) Procyclicality
  • The Dutch Disease describes unwanted
    side-effects of a commodity boom.
  • Developing countries are historically prone to
  • especially commodity producers.
  • Procyclicality in
  • Capital inflows Monetary policy
  • Real exchange rate Nontraded Goods
  • Fiscal Policy

The Dutch Disease 5 side-effects of a commodity
  • 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

The 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

The Dutch Disease 5 side-effects of a commodity
  • 3) An increase in nontraded goods prices
    relative to internationally traded goods
  • 4) A resultant shift out of non-commodity traded
  • esp. manufactures,
  • pulled by the more attractive returns in the
    export commodity and in non-traded goods.

The Dutch Disease 5 side-effects of a commodity
  • 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.

Procyclical 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
  • 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
  • e.g., asymmetric information or the need for

Procyclical 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
  • 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
  • Should appreciate when export commodity price
    goes up.

Procyclical 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

OK. But real appreciation adds to boom in NTGs.
Procyclical 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
  • Correlation of income spending mostly positive
  • particularly in comparison with industrialized

  • 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.

Two budget items account for much of the
spending from oil booms
  • (i) Investment projects.
  • Investment in practice may be white elephant
  • which are stranded without funds for completion
    or maintenance when the oil price goes back
  • Gelb (1986).
  • (ii) The government wage bill.
  • Oil windfalls are often spent on public sector
  • 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..
Correlations between Gov.t Spending
GDP 1960-1999

Adapted from Kaminsky, Reinhart Vegh (2004)
G always used to be pro-cyclical for most
developing countries.
The 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

Correlations between Government spending GDP
Frankel, Vegh Vuletin (2012)
In the last decade, about 1/3 developing
countries switched to countercyclical fiscal
policyNegative correlation of G GDP.
Summary 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
  • to achieve resource blessing instead of resource

Appendix 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).

  • 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?

Hotelling (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.

The 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.

What 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
  • 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).
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