Suyash'Raj'Bhandari'
Are natural resources a blessing or a curse for developing countries? (30 marks)
The discovery of vast amounts of oil or valuable minerals in a country may be something one would
hope for. After all, a booming mining industry would create thousands of jobs, strengthen exports,
bring about geo-political power and make the nation wealthier. However, time and again we have seen
nations with valuable resources fail to escape the poverty trap. 29% of the people in the bottom billion
live in resource rich nations yet millions scrape by on less than a dollar a day. Why is this the case?
This paper will analyse whether natural resources are a curse or an easy ticket out of the bottom
billion.
Undermining Accountability and Democracy
Let us first consider the Gulf States, whose citizens are able to live tax free as rentiers (people living
on unearned wealth – referring too the economic term “rent”). Countries with oil such as Kuwait and
Saudia Arabia have been able to transition into “middle income” nations purely from oil wealth.
Petroleum accounts for 43% of Kuwait’s GDP, 75% of governments income and 87% of export
revenues. Similarly, oil accounts for more than 90% of Saudi Arabia’s exports and nearly 75% of
government revenues. Although we would all support the idea of living in a tax-free state, closer
analysis would suggest that resource revenues undermine the basic yet fundamental relationship
between the state and its people. Taxation plays an important role in ensuring that the people are able
to hold the government to account. If tax money is of little importance due to resource revenue, then
governments have no pressure or incentive to provide for its people. The gradual erosion of checks
and balances over time eventually results in the nation becoming a dictatorship run by a few elites.
The world’s oil supply is mainly concentrated in the Middle East where most regimes are autocratic,
suggesting that oil rents decrease the likelihood of a society being democratic. Paul Collier states in
his research that autocracies outperform democracies in the presence of large surpluses from natural
resources. But why is this the case? Collier concludes that resource rich democracies underperform as
politicians are too focused on simply winning the next general election. Not only do democratic
governments under invest (as long term investments doe not guarantee short-term results and are thus
ignored by politicians) but they also invest badly, with too many white-elephant projects.
Moreover, when resource rents exist the politics of patronage enter electoral competition. When
governments have excess cash they are likely to buy and sell votes with public funds. It is common to
see corrupt governments paying community leaders to vote for them (especially effective in countries
of the bottom billion where ethnic differences are strong). Those who benefit from natural resource
wealth are also likely to block technological and institutional improvements, since this can weaken
their power.
At this point you may ask yourself “If resource rich democracies do poorly then why not simply
justify resource rich autocracies? After all they are better suited at achieving economic growth.”
However, it is debatable as to whether or not political and economic freedom should be sacrificed for
economic growth. Additionally, even if autocracies grow faster, only a few elite members running the
country enjoy the benefits of growth. In Saudi Arabia approximately 25% of the population live below
the poverty line (not much different from the population living under the poverty line in Nepal – a
resource poor democracy). Furthermore, growth in authoritarian regimes and the regime itself are
usually short lived.'
In terms of political economy, it is clear that resource wealth does little for people in both democratic
and authoritarian regimes. But let us now consider the more detailed economic limitations of resource
wealth.
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Dutch Disease
Resource rich nations tend to suffer from what economists refer to as “Dutch Disease”, a term
introduced after the effects of North Sea gas on the Dutch economy. As countries export large
volumes of natural resources their currency tends to rise against other currencies. Consequently,
domestic goods become more expensive on the global market and thus exports of other decrease due
to poor price competitiveness. Furthermore, as these industries suffer from a declining overseas
market there is less investment, innovation and research being carried out. Technological progress and
innovation in higher value industries comes to a halt and the nation becomes dependent on the exports
of primary commodities.
In the 1970’s Nigeria mainly received its revenue from oil exports and thus the other production of
exports such as peanuts and cocoa collapsed, as they were relatively unprofitable. The decline in
agricultural activity had a negative effect on Nigerian farmers and held back technological
advancements in the agricultural industry. Although the slow progress of the agricultural industry isn’t
wholly to blame, Nigeria did make the mistake of not focusing on the labour intensive manufacturing
and service industries (as China and India have). As a result, they have remained a low-income
country heavily reliant on natural resources.
Dutch Disease has also affected high-income countries such as Canada and Australia. Some
economists argue that Canada's rising dollar has hampered its manufacturing sector due to foreign
demand for natural resources, with the Athabasca oil sands becoming increasingly dominant.
Similarly, “Dutch Disease” was evident during the Australian Gold Rush and still is today when we
take a closer look at the mining commodity boom.
Yet Professor Gordon from the University of Laval has stated “the so called ‘Dutch Disease’ has
actually left Canada’s economy much stronger”. There is no doubt that Canada’s manufacturing sector
has decline as a result of the growing oil production in Alberta but the manufacturing jobs lost were
simply replaced by better paying jobs in the oil industry. He goes on to argue that labour shifting
between sectors and industries is natural in an economy. Compared to other wealthy countries, Canada
has had an anomalously strong manufacturing sector for the past 40 years. The sector’s relative
strength can be largely attributed to a very low dollar in the 1990s that allowed industry to hire
workers here more cheaply. However, Prof. Gordon argues that this was not sustainable nor was it
ideal for the country’s economy. So shifting emphasis from one sector to another should not
necessarily be considered a curse.
Shifting focus between industries is significantly easier in a developed nation like Canda, where the
critical infrastructure is already in place. Thus, it is still sensible to conclude that most developing
nations will suffer from Dutch disease. However, the effects of unstable commodity prices can be
damaging to even some of the strongest economies in the world.
Market Volatility
The market price of natural resources has always fluctuated and therefore export revenues are
extremely inconsistent. During price booms government ministries tend to spend outrageously on
public services, which leads to a short term increase in employment. However, the main issue lies in
the way governments deal with public funds during a crash. As Paul Collier states in the “Bottom
Billion”, what gets cut is not the spending on frivolous items during the boom, but rather on the things
that are politically most vulnerable (i.e. investment). During price crashes oil revenues fall drastically,
financial institutions suffer and become unwilling to lend, government spending falls and
unfortunately the ordinary people pay the price. Given the fact that these countries do not have any
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other industries to rely on, during a crash the whole economy contracts and the inability of the
political institutions to deal with the crash only make matters worse.
For many years Rwanda has relied on coffee as a cash crop. In1989, when the price of coffee crashed
the economy was hit hard and this led to a great decrease in purchasing power, and increased domestic
tensions. The value of Rwandan coffee exports, the crucial source of income, decreased from $144
million in 1985 to $30 million in 1993. As Rwandan farmers began losing their income they
desperately tried to grow food crops, but these attempts largely failed since extensive coffee
production had made the soil useless for other crops. Famine broke out across the country.
Within the next 4 years the tragic Rwandan genocide took place with the bloody conflict between the
Hutus and Tutsis. Although the idea that economic instability can lead to political instability is
controversial, there are reports that conclude there is a correlation between the two.
Excessive Borrowing
Price shocks can also lead to excessive borrowing as governments try to dampen the negative effects
on the economy. Additionally, government borrowing is also encouraged by the changing exchange
rates. When real exchange rate increases (Dutch disease) interest payments on debt become cheaper so
myopic governments may decide to borrow money from organisation such as the IMF. When
resources prices start to fall, real exchange rates fall, and the government has less money available to
pay off its growing debt.
Nigerian and Venezuelan debts rose dramatically during the 1970s oil boom but when oil prices fell in
the 1980s, banks stopped lending and countries were had to face increasing penalty interest charges
that worsened their debts.
Conflict
Consider a low-income country with weak political institutions. The struggle for power between
political parties and rebels is tense but has not yet turned into a full-scale war. The discovery of
valuable stones such as diamonds has just been made. Government income has increased and
diamond mining is underway. In this scenario, not only is there a greater incentive for the rebels to
capture the state (and benefit from the diamond export revenue) but also to take over diamond mines
to fund the purchasing of arms.
In countries such as Sierra Leone, the Democratic Republic of Congo, Rwanda and Nigeria, natural
resources have fuelled civil wars. The sale of “blood diamonds” has funded RUF insurgents in Sierra
Leone for over a decade. Over 120,000 people were killed in the civil war and a further 2 million were
displaced. It is not unusual in such cases for international companies to provide rebel groups with
massive amounts of financial backing in return for resource concessions in the event of rebel victory.
After refusing to admit there was any problem regarding ‘blood diamonds’, De Beers, the world’s
largest diamond producer, drastically changed their attitudes towards the issue in the hopes that they
would become a corporate role model. The fact that most multinational companies lack basic moral
principles means that it is all to tempting for them to get involved and make matters worse.
Natural resources have clearly been used to fund civil wars but can cause civil strife indirectly.
Consider the example of Rwanda earlier on. The crash in coffee prices had a devastating effect on the
economy as it reduced government revenues, people’s incomes and curtailed economic growth.
Interestingly, Paul Collier argues that a lack of economic growth can lead to conflict and this is
particularly relevant to the Rwandan genocide. His studies have found that low incomes indeed
heighten the risk of war but the probability of civil war is further increased by slow growth or
stagnation. A typical low-income country faces a risk of civil war of about 14% in any five-year
period. Each percentage point added or removed from the growth rate has the same effect on the
likelihood of civil war. Consequently, resource rich countries that are not able to efficiently utilise
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their natural wealth are at risk of plunging into political chaos.
Throughout history we have seen evidence that resource rich countries are also at risk of facing
international military intervention or invasion. The invasion of Kuwait in 1990 was mainly caused by
disputes concerning oil resources in Kuwait. Iraq claimed that Kuwait had stolen Iraqi petroleum and
consequently Sadam Hussein invaded Kuwait. More recently, the American invasion of Iraq has also
come under much criticism and many people believe that Iraq’s resources were a major factor in
America deciding to take military action.
Asymmetric Information
In Paul Collier’s “Plundered Planet” he notes that beneath each square kilometer of the OECD there
are approximately €100,000 of known sub-soil assets. Yet despite the heavy reliance of African
nations on exports of natural resources, beneath the average square kilometer there is only €20,000 of
known sub-soil assets. The stark difference is not due to geographical differences, since Africa
probably actually has more sub soil assets beneath its land (since the OECD have been extracting their
resources for over two centuries). The reason lies in the process of assigning companies the right to
extract Africa’s resources. Resource extraction is a major problem since the African government is not
transparent or held to account by its people. The people who are the rightful owners of the rights to
natural assets cannot effectively control the decisions of their political representatives during the
negotiations. Whenever rights are sold through secret bilateral negotiations, the outcome is far from
ideal due to problems of asymmetric information. The information problem is that extraction
companies know far better than governments what extraction rights are worth and the chances of
minerals actually being discovered. It is not unusual for companies to be offered decade-long
monopoly extraction right deals. However, if resources are found most of the money flows overseas
and the local people rarely benefit. Why? The lack of transparency in the process means that
negotiators often cannot be effectively supervised, inviting opportunities for bribery. The Annan
Report claims that a recent deal in the DRC cost the country an estimated $725m.
Turning the Curse into a Blessing
However, unlike the inevitable nature of volatile prices, Collier states there is a possible solution to
dealing with asymmetric information. Encouraging corporate transparency can reduce opportunities
for bribery. The Extractive Industries Transparency Initiative (2003) has over 30 signatories from
governments and companies committed to transparent reporting of their activities. Ghana has adopted
a new transparency approach and seen its natural resource revenue increase by over 400% in 2011.
Moreover, as a part of the U.S. government's 2010 Dodd-Frank Reform Act, American companies
must guarantee that the raw materials they purchase are not tied to the conflict in Congo, by tracking
and auditing their mineral supply chains. The “Enough Project” in the DRC aims to protect local
communities from conflict that may be caused by the struggle to gain power over the resource mines.
Lessons from Norway
Sceptics of the resource trap are likely to turn to Norway as an example of a nation that has very
carefully used their oil to become one of the most developed nations in the world. It is certainly true
that resource rich countries in the developing world would do well to take note of how Norway
avoided the resource trap. Firstly, most of Norway’s resource revenues have been put into
the Government Pension Fund Global. By using the fund to invest in other industries in the economy,
the state has been able to absorb 80% of the resource rent. The net cash flow from petroleum activities
and the return on its investments has also been used to finance the government’s fiscal deficit.
Secondly, Norway also has a functioning representative democracy largely free from corruption. The
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government is transparent and can be held accountable for its actions. Furthermore, by taxing both its
oil earnings and its citizens heavily, Norway has been able to distribute its oil wealth to its citizens.
The policies laid out by the Norwegian parliament in 2004 are based on two premises.
1. Oil revenues/funds should be used as an instrument to ensure that a portion of the country’s wealth
should benefit future generations.
2. The fund should not contribute to unethical acts, such as violations of fundamental humanitarian
principles, serious violations of human rights, gross corruption, or severe environmental degradation.
By 2012 Norway had boycotted 55 companies for forced labor, child labor, environmental damages
and corruption allegations. The government has played a crucial role in establishing the importance of
corporate ethics regarding oil extraction in Norway.
However, Norway’s success does not prove the resource trap does not exist; rather, it serves as an
example as to how the developing nations can turn the curse into a blessing. Transforming political
institutions, diversifying the economy, and laying out a set of new policies can take years, maybe even
decades, but there is no reason why it cannot ultimately be achieved. The sooner countries alter their
economic and political systems, the sooner its citizens can reap the rewards from natural resources.