Democracy Lab

Embarrassment of Riches

Natural resources would seem to promise easy money. Welcome to the dark side.

Can great wealth do more harm than good? Everybody enjoys moral tales about Richie Riches made miserable by the worship of Mammon at the expense of family, friendship, and self-respect. But can wealth (in particular, natural wealth) be a liability for a whole country?

Actually, the question is relevant for a startlingly large number of economies in transition ranging from Saudi Arabia and Iraq to Venezuela and Russia. And while the consequences of being the resource king of the neighborhood are mixed -- Angola barely survived the consequences of generous deposits of oil and diamonds, while Chile has thrived on mountains of copper -- the dilemma known to economists as the "natural resource curse" does offer insights into the delicate, complex process of development.

Let's get one thing settled. Yes, a whole host of countries (in no particular order, Canada, Australia, the United States, Malaysia, Norway) have managed very nicely indeed with big natural resource endowments. But happy endings (or, for that matter, happy middles) seem more the exception than the rule. Why?

Resource-rich countries typically depend heavily on just a few commodities to pay for imports, to service foreign debts and to fund government services. Nothing inherently wrong with that, save one thing: Natural resource prices are far more volatile than the prices of most industrial goods and services.

Oil, of course, is a great example: The price of a barrel (adjusted for inflation) has topped $100 twice since 1998 -- and slipped to less than $20 in between. But what goes for oil also goes for most hard-rock minerals. Copper tripled between 1998 and the peak of the 2008; tin hit $38,000 a ton in the early 1980s, then sunk below $5,000 early in the new millennium. Nor have crops -- especially the tropical food crops that spell the difference between a strong economy and a week one for a number of small countries -- been immune to the roller coaster ride. Coffee prices increased five-fold between 2002 and the spring of 2011; cocoa tripled between early 2007 and early 2010.

Now, countries could offset the impact of this volatility in all manner of ways, most of which come down to saving in boom times and spending in lean. And some (like Norway, Chile, and even Russia) do just that. But most developing countries lack the political will or the institutional constraints to take the long view. Typically, they become trapped by commodity price cycles, over-committing on the up side and suffering the consequences in terms of budget deficits, currency volatility, and inflation when the balloon deflates. Among other problems, the resulting macroeconomic instability makes it difficult to attract investment in manufacturing and services: arguably just what these countries need to diversify away the impact of commodity price volatility.

There's a related problem for commodity exporters called "Dutch disease." It was named (by The Economist magazine) after the problems encountered by the Netherlands when vast natural gas fields were discovered offshore in the late 1950s. Gas exports brought a bonanza of foreign exchange earnings, tending to drive up the exchange value of the Dutch currency. And that, in turn, made other Dutch exports (notably, manufactured goods) uncompetitive in foreign markets - which made manufacturers and their employees very unhappy.

Note that Dutch disease may or may not hurt an economy as a whole; not every country needs a healthy manufacturing sector to thrive. But there's a case to be made (especially in the case of poor countries) that manufactured exports generate all sorts of positive spillovers that spur development. For example, large-scale manufacturing creates a demand for sophisticated finance and management, both of which are foundations to economic growth.

Nonetheless, the pernicious effects of Dutch disease are pretty clearly visible in contemporary Russia, which exports little besides oil, gas, and minerals. (The main exception is weapons, but that's a whole other story). Russian industry, much of which was beyond repair in the last, dark days of the Soviet Union, lost all its foreign markets once its former satellites were free to look to the decadent West to buy tractors that started on cold mornings and airplanes that rarely crashed. Today, Russia can't attract investment to build a competitive industrial base for a whole bunch of reasons -- not least of them the fact that revenues from natural resource exports prop up the exchange rate of the ruble.

These arguments hardly seem adequate, though, as an explanation for, say, the Dickensian poverty of oil-rich Nigeria or the vertigo-inducing imbalance of the Saudi Arabian economy, where two young men in five are unemployed and there's an 18-year waiting list for home mortgages. In such cases, the link between resources and stagnation is institutional development (or, rather, the lack thereof).

In very poor countries like Nigeria (or Gabon, Equatorial Guinea, or the Democratic Republic of Congo), resource wealth leads to corruption, which in turn leads to dysfunctional government. Oil and mineral wealth, as opposed to wealth linked to the production of low-margin good and services, makes corruption overwhelmingly tempting. A manufacturer that operates in a competitive global market may credibly threaten to leave (or never show up in the first place) if officials stick their hands out at every opportunity. By contrast, an oil company that can extract crude for, say, just one-tenth of what it's worth on the market has a far greater incentive to pay bribes in order to keep on pumping.

Corruption allows government to build and lock-in authority through patronage rather than through the efficient delivery of services. Indeed, it creates (or at least perpetuates) a zero-sum economic culture in which the most realistic path to success is to skim the cream rather than to make something people actually value. And corruption, it's worth remembering, is a communicable disease, typically infecting everybody from traffic cops to tax collectors if it's understood that the Big Men are on the take, too.

Consider Nigeria, which ranks 133rd out of 183 countries on the World Bank's Ease of Doing Business Index -- largely because its business environment is so hobbled by corruption. It takes the better part of a year and fees equal to ten times the per capita income to obtain an electricity connection. Bureaucracy run amok, you say? Sure, but there's method to the madness, since every bottleneck creates a profit opportunity for the bureaucrat who can grease the wheels of the creaky government machinery.

But even where the result of easy resource wealth is not blatant corruption, it can inhibit growth by reducing the pressure for change. In Saudi Arabia, just 12 percent of working-age women are in the work force -- a culturally driven waste of productive capacity that is perpetuated because oil generates enough income to make it tolerable. Saudi men refuse to do drudge work (or much work at all), and get away with it because the state can afford to keep them on the dole, paying Pakistanis or Palestinians to keep the coffee hot and the streets repaired. Here, merit gives way to family, tribal connection, and feudal order. The process of natural selection broadly writ, in which institutions that encourage productive activity trump unproductive institutions, is blunted.

As I suggested earlier, some countries cope well, or even thrive, with huge natural wealth. And not all of them are rich. Chile, for example, has largely neutralized the budget-busting, growth inhibiting effects of an export sector dominated by copper. But Chile had fairly strong growth-inducing institutions to begin with, and now ranks 39th on the Ease of Doing Business Index. Moreover, as Harvard's Jeffrey Frankel has shown, it's possible to put in place automatic mechanisms that buffer commodity price volatility and reduce the temptation for politicians to play Santa Claus in boom times.

All that said, the natural resource curse is very real, and especially difficult to overcome in poor countries. Indeed, there's a pretty good argument to be made that a lack of resources is, on balance, a blessing. Before you scoff, consider that South Korea's GDP per capita was below that of Nigeria's in the 1960s.



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