Why Is It So Difficult to Use Natural Resources for Development?

In this series of essays, I will be researching the interconnection between natural resources and development. I will look into countries that have been considered as successful in escaping the resource curse.  Also, at current attempts to diversify economies away from oil in the Persian Gulf region.

My first paper is a general attempt at synthesizing the concept of the resource curse, effects of natural resource abundance in developing economies and ways to mitigate them and diversify revenues. Sources used are at the bottom of the article. This work is not novel, it is an attempt at summarizing information from other papers.


Introduction

The debate encompassing the relationship between the availability of natural resources and their revenues’ of appreciation since the 1950s. Then, a country rich in natural resources was seen as blessed, only a minority of economists saw it otherwise. Geographer Norton Ginsburg argued that: ‘The possession of a sizable and diversified natural resource endowment is a major advantage to any country embarking upon a period of rapid economic growth’. In the 1960s, Walter Rostow, a prominent development theorist, stated that natural resources may help a country transition from ‘underdevelopment’ to industrial ‘take-off’, in a manner similar to their influence in the United States, Australia, and Great Briton. The concept had been dealt with via a view of reductionism; where the size of natural resource endowments was used to assess the development performance of a nation.

By the 1980s, a new scholarly view had risen to identify negative attributes with resource abundance. These opinions suggested that negative economic, social and political outcomes may arise from the plentiness of natural resources in general or at least a particular type of them within an economy. A few years later, they were associated with poor economic efficiency, lower levels of democracy or even civil war. Hence, the term ‘Resource Curse’ came to emergence. Today, this view is prominent within international financial institutions like the International Monetary Fund (IMF) and the World Bank (WB). Also, amongst researchers, Non-Governmental Organizations (NGOs) and country officials. Yet, questions are still asked; whether natural resources are really bad for development or not? What causes a resource curse? And most importantly, how to overcome the effects of it?

Concept & Facts

The failure to fully benefit from the wealth generated from natural resources by governments of resource-rich countries coupled with their ineffective response to the welfare needs of the public has been defined as the paradox of plenty, or the resource curse.  Compared to their non-resource rich peers, these countries are seen to be mired in authoritarianism, corruption, higher rates of conflict, and lower rates of economic stability and growth.

This concept is the stark opposite to the common-sense goal of a country rich of sub-surface assets, in the form of hydrocarbons or minerals, where it seeks to convert them into surface assets, as in the physical and human capital, to support employment and economic growth. Only a handful of economies have been successful in leading such a transformation while it has failed in the majority of other cases. Up until 2000, a year of significant commodity price hikes, growth in non-resource countries was higher than that in resource-rich ones. Even after 2000, the per capita growth was on par in both groups according to the IMF.

There are several stages of economic benefit from non-renewable resources to reach their final utilization applications. Deposits have to be discovered, developed, marketed, turned to monitory value then divided to final recipients. There are many claimants throughout this chain; investors, government, and other stakeholders. What are the terms of such division of wealth? Who decides it and how will it be utilized? Most likely, the intense pressure will build upon the government for current spending as opposed to long-term investments. Even then, local projects of high social impact will be difficult to identify and implement. On the other end, banking revenues offshore will depend on the nature of the country’s economy; whether it is in dire need of capital injections or not.

Exports & Fiscal Revenues as a share of Natural Resources.
Figure 1: Exports & Fiscal Revenues as a share of Natural Resources.

A resource cursed country is that where at least 20% of exports or fiscal revenues are dominated by non-renewable natural resources according to the IMF. This classification expands to cover 51 countries according to the IMF. In 25 of these nations, more than three-quarters of exports are made up of these resources while in 20 of them, half of the government revenues are secured from resource-based sectors.

There are a number of traits common for those nations; (1) dependence on natural resources for fiscal revenues and export sales, or even both. This fiscal dependency is acutely noticed in oil producers as in Figure 1. As seen, 10 countries, within the group of 24 countries plotted, showcase a dependency on natural resource revenues for more than half of their receipts while 17 of them have two-thirds of their exports constituting of natural resources. (2) Lower savings as shown in Figure 2, where resource rents and adjusted net savings are graphed as a percentage of GDP. Many of the

Figure 2: Exhaustible Resource Rents and Adjusted Net Savings.

countries are below the linear regression line, indicating a strong negative effect on savings. (3) As a group, resource-rich countries perform lesser than their opposites. This has been confirmed by studies conducted by Sachs & Warner (1995, 1997), who documented a severe GDP per capita impediment. Also, a 10-percentage point increase in the resource ration of GDP leads to depressing growth by 0.77-1.1 percentage points annually. (4) These nations are also victim to the volatility of commodity markets. The World Bank has documented this phenomenon through the coefficient of variation of export revenues, where they typically exceed those of non-resource countries by 50% in the case of mineral-rich nations and 100% for oil abundant countries. A transition is then witnessed by the IMF, where a volatility of government spending is consequential to the volatility of income. This results in pro-cyclical governmental public spending habits.

Characteristic Challenges

I.  The absence of democracy: the lack of taxation in resource-rich countries, especially those with vast oil and gas reserves increases the probability of an authoritarian regime. In general, it is seen that when a government is less dependent on citizens for revenues, the system tends to consider less the latter’s demands. The opposite is clearly noticed by political scientists in countries where taxation is an important pillar of revenues, governments are more responsive. Figure 3 illustrates the role of taxation and effect on citizen participation in government. On the other end, citizens feel less invested in the politics and economics of national budgeting. Secrecy of resource sourced income and the budgetary process may add another layer of prevention denying a clear explanation of whether these funds are well spent or not.

Figure 3: Incentive for oversight for resource-rich and non-resource rich countries.

II.  A probability of conflict: the presence of commodity grade natural resources in a country may provoke or sustain conflict as different parties within the country of their availability fight for control over them while using their revenues to finance such clashes. They can even attract foreign hostility and invasion. The likelihood of civil war in an oil-rich country is seen to have doubled since 1990. Examples include the Democratic Republic of Congo, Angola, and the Niger Delta. This tendency to instigate or be the target of war has been termed as Petro-aggression. Iraq’s invasion of Iran and Kuwait are seen as prime case studies of such international conflict over resources.

III. Inefficient spending and borrowing: as discussed before, the volatility of resource-based income due to the cyclic boom and bust nature of the commodity markets may transition to a unpredictability of government spending. When revenues rise, several projects are invested into, even if they make no economic sense, and as prices or production lowers, painful cuts have to be made. Verily, the majority of these overspend on generous government salaries, fuel subsidies, large monuments and airports while disregarding or underspending on health, education and social services. Few are an exception, like Persian Gulf GCC nations where income is high, and populations are small. For lower income, resource-rich nations, they often are entrapped into a borrowing to sustain growth. During periods of high prices, creditworthiness is improved, and lending institutions tend to target these countries. In the 1980s, Nigeria, Mexico, and Venezuela (Figure 4) went into debt crises as a result of such reckless behaviors, even the private sector was impacted as it tends to over-invest when government spending is high but fall into bankruptcy when it diminishes.

Figure 4: Revenue volatility leads expenditure volatility in Venezuela.

IV.  Dutch disease: as revenues associated with the resource sector grow, they tend to negatively hinder other sectors of the economy through inflation and foreign exchange rate appreciation. especially those that are considered as fiscally tradeable. Examples include manufacturing and agriculture. Also, a movement of capital and labor is triggered towards the resource sectors or non-tradable import activities. The latter is seen to expand as the production of resources increase. Overall, this phenomenon is known as the Dutch disease. Figure 5 illustrates the process by which the Dutch disease propagates in an economy. Harm can be felt almost immediately by non-resource sectors while the overall impact may continue for decades. Examples of rampant Dutch disease effects were documented in Iran, Venezuela and Trinidad and Tobago. Others were considered to have escaped this effect, like Chile, Malaysia, Norway, and UAE.

V.  Patriarchy and gender discrimination: there is a disproportionate impact seen on women within resource-rich countries. Especially in the Middle East, women constitute a fewer proportion of the workforce and are poorly represented in government. Women employment in labor-intensive manufacturing sectors is reduced with the presence of the Dutch disease. On the other hand, resource-rich regions in Africa register higher rates of HIV/AIDS and other life threating diseases. The influx of male workers to mining communities has been associated with higher occurrences of gender-based violence incidents. Women are seen as a vital factor in a long-lasting strategy of poverty reduction, hence they should be included as stakeholders in any resource-oriented development.

Figure 5: How does the ‘Dutch Disease’ occur?

VI.  Limited capture of benefits: contractual agreements between government and investors may reduce the eventual monetary value received from production to local states and communities. Effectively, these parties are on the losing end of such fiscal regimes. They fail to compensate them for depleting their resources, damaging their environment and distributing their livelihood. The rush to secure investment or discover commodity grade resources often places governments on the deprived side of contracts as generous schemes are produced where royalties and taxes are minimal on investors. The Average Effective Tax Rate (AETR), a measure of the taxation imposed on companies, is 50% for oil projects in developed nations like Canada, the United States, and South Africa, while may go beyond 70% for underdeveloped ones like Angola, Libya, and Timor Leste. Moreover, non-tax benefits that accrue to locals are quite a few to the contrary of the common perception that extractive businesses will produce local private business development, improved workforce skills or large-scale employment. In such industries, foreign employment is rampant, and the scale is limited in comparison to the size of capital and machinery they draw.

VII.  Weaker governance: with the infusions of higher capital into single point source of revenues projects like mining and oil production, there is a tendency for elites to capture large sums of cash coming from these projects rather than supporting productive enterprises that may provide wider employment opportunities. Corruption can become mired and different tools are utilized for pursuing rent-seeking like sovereign wealth funds, national oil companies, and contracting schemes. Often transparency, societal checks, and legislative monitoring are hindered purposefully for the benefit of a tight circle of friends and family. This is known as rent seizing. Both rent-seeking and seizing weaken the performance and efficiency of public institutions. Example countries include Afghanistan, Tunisia, and Sierra Leone.

VIII.  Social and environmental effects: the needs of the people within the communities that harbor resource extraction and production have to balance with the impact on the environment surrounding these projects given their point-source nature. The exploitation of the minerals, land, and water may place these companies in direct conflict with local society. Also, the influx of foreigners and local migrants to these areas may trigger economic, social and cultural problems. Durst from mining, landscape scarring, noise pollution, contamination of water column and seismic disturbances are examples of environmental issues faced.

Mitigation & Diversification

The supply response of the economy is key to determining whether the resource industry is capable of displacing other sectors. In economies where there is a high level of employment of labor, a shift takes place as workforce readjust to answer the demand of the expanding non-tradable sector. This leads non-resource tradable sectors to contract as they lose competitiveness to extractive industries. However, in lower income countries where levels of labor employment are low, revenues from the resource sector, when spent by government, can create job opportunities in non-tradable sectors like services, retail, health, and education. Hence, countries have the chance to limit the impact of the Dutch disease as the balance of payments will bend less to higher natural resource exports via a reduction in non-resource exports and a greater inclusion of imports. Yet, mitigation can be achieved even further through the following conditions:

I.  Economy flexibility: the economy has to be structured with the objective of being more open to international trade in mind while developing the capacity to overcome possible bottlenecks. Governments have to ease the entry of other (non-resource oriented) firms to the country, especially Foreign Direct Investment (FDI). The labor market has to become responsive and adaptable by providing learning and continuing education opportunities to the workforce to ease their transition to other industries. On the other hand, migration to urban centers has to be supported with infrastructure projects that take into consideration the influx of non-residents and pressure on the transport system. Also, power consumption and supply have to be guaranteed. These proactive measures when undertaken are categorized under investing-in-investing by economists. They have to be identified and addressed prior to a resource bankrolled boom.

II.  Smoothing spending: as many resource-rich countries are underdeveloped and poor in capital, spending has to be kept in check by the authorities while non-resource sectors are being developed to absorb the liquidity infusions by the local economy. Fiscal discipline requires strong central government and institutions. This can be achieved via the utilization of a parking fund where a portion of revenues are kept until domestic investments become rate of return competitive with their international peers. Also, to mix the investment portfolio of the nation by obtaining equity in foreign assets. A stabilization fund can help the economy survive and projects continue amidst cyclical fluctuations of commodity markets. However, as discussed before, these funds may become tools for elitism and corruption if misused. Norway’s Pension Fund is a great example of an efficient operation of sovereign wealth funds.

III.  Monetary and exchange rate policies: as resources are discovered, produced or even contractually signed, an anticipation of long-term appreciation of the country’s currency may happen. In some cases, the currency appreciation starts even earlier than extraction. These expectation driven changes may accelerate falling into the Dutch disease as tradable sectors start to decline even before the expansion of non-tradable sectors, all through a premature movement of capital and labor. Recession cases in some sectors have been documented in Zambia, where copper price reduction leads to a collapse of nominal return on government bonds, also, in the United Kingdom with the expansion of North Sea oil. Hence, the exchange rate has to be kept flexible to moderate the pressure on employment, investment, and GDP.

In addition to successful mitigation, there is an urgent need to devise policies where non-resource sectors are developed to become contributors to the nation’s revenues. Economists recommend the funding of such schemes with income generated by resources, as they eventually are public funds that need to be guided towards the benefit of the public’s economy. There are some different approaches:

I.  Backward linkages: sectors that can provide local input for usage within the resource industry are encouraged via the inclusion of requirements for domestic content within the contractual frameworks. Studies have shown that there a significant local impact of such schemes but are limited in terms of quantity. Successful examples include the Norwegian marine engineering industries and internationally established national oil companies like Aramco, Petronas, and CNPC. Yet, their experiences have proved hard to replicate. This approach has not created a transformative growth into new non-resource-based activities. Brazil’s Petrobras experience shows that questionable approaches can be used to game the laws. Also, the cost is eventually borne by the government in the form of lower taxes and receipts. An innovative approach is to allow international companies to raise the capacity and quality of local manufacturers and private businesses to become qualified service suppliers and consequently compete on global markets.

II.  Forward linkages: with increased production, the capacity to process and transform natural resources on-site prior export may create value-added industries. The availability of capital, economic capability and local workforce skills do affect the success of such projects, like petrochemicals and steel. Although transportation costs have reduced recently, there is a higher success rate of such forward linkages when they become high creating a price wedge. In such circumstances, local sectors are developed to absorb the available raw resources and cover the needs of local or neighboring markets. In the 19th century, manufacturing growth was close to coal and iron ore mines. Gas is seen as an expensive commodity to liquefy and transport, this may help gas-rich countries to develop greater electricity capacity or petrochemical industry.

III.  Non-resource related growth: as both backward and forward linkages are directly associated with the expansion of resource sectors. Governments can pursue the development of non-resource sectors by investing the former’s revenues into development banks catering to the local private sector or via national development policies. Malaysia’s ethnic woes in 1969 lead the government to take a brave decision to impose central control over oil revenues and utilize it for the creation of labor-intensive economic zones that attracted FDI into manufacturing industries like electronics. Also, to create a commodity mix that expanded beyond crude oil and natural gas to include palm oil, rubber, and tin.

Conclusions

Resource-rich, low-income countries are more vulnerable to exhibit the effects and experience the challenges associated with the resource curse. However, this phenomenon is not inevitable. Many countries that bare vast natural resource wealth was able to mitigate these tendencies and do not exhibit them anymore. In effect, economies like Norway, Chile, and Malaysia proved that natural resources can be a catalyst for development. Yet, these are the minority of a group, where the majority are strongly exhibiting the effects outlined in this paper. Infamously, these are Venezuela, Angola, Iran, and others.

Policy makers have different tools and approach to mitigate their economies away from being highly dependent on the revenues sourced from a single commodity. Fiscal discipline has to be practiced and political patronage avoided in order to reduce the probabilities of corruption and elitism. Diversification is a must to escape an eventual Dutch disease if resource revenues are efficiently converted to non-resource exporting sectors.

References:

Rosser, A. (2006). The political economy of the resource curse: A literature survey. Retrieved from http://www.ids.ac.uk/publication/the-political-economy-of-the-resource-curse-a-literature-survey

Venables, A. (2016). Using Natural Resources for Development: Why Has It Proven So Difficult? The Journal of Economic Perspectives, 30(1), 161-183. Retrieved from http://www.jstor.org/stable/43710015

NRGI (2015). The Resource Curse: The Political and Economic Challenges of Natural Resource Wealth Natural Resource Governance Institute, NRGI Reader (March 2015). Retrieved from https://resourcegovernance.org/sites/default/files/nrgi_Resource-Curse.pdf

 

Interested in energy, economics, and current affairs. I endeavor to learn and share my views with the world. I hold an MSc in Petroleum Economics & Management from IFP School, Paris.

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