Recent empirical research by Jeffrey Sachs and Andrew Warner in Natural Resource Abundance and Economic Growth has uncovered a strong and robust cross-country relationship between economic growth and the abundance of, or dependence on, natural resources. There are five main channels through which natural resource dependence seem to influence growth.
First, countries that are rich in natural resources experience booms and busts, not only due to commodity price fluctuations in world markets but also due to resource discoveries that typically create intermittent upswings in export earnings that cause the national currency to appreciate in real terms to the detriment of other export industries. This phenomenon is known as the “Dutch disease.” It is what happened in the Netherlands in the early 1960s following the discovery of large reserves of natural gas within Dutch jurisdiction in the North Sea. The Dutch got over this ailment pretty quickly, so the Dutch disease is a misnomer, but the name stuck. In Iceland for example, exports of goods and services have been stagnant since 1870 (this is not a misprint!), hovering around a third of GDP all this time. Iceland’s dependence on the export of fish, has kept the real exchange rate of the national currency too high and too volatile for a long time, thus stifling the growth of non-fish – exports.
In second place, according to Resource Abundance and Economic Development (Auty, Richard M. [ed.]) countries that are rich in natural resources tend to be marred by rent seeking on the part of producers who thus divert resources away from more socially fruitful economic activity. The combination of abundant natural resource rents, ill-defined property rights, imperfect or missing markets, and lax legal structures may have quite destructive consequences. In extreme cases, civil wars break out – such as Africa’s diamond wars – which not only divert factors of production from socially productive uses but also destroy societal institutions and the rule of law.
In less extreme cases, the struggle for huge resource rents may lead to a concentration of economic and political power in the hands of elites that, once in power, use the rent to placate their political supporters and thus secure their hold on power, with stunted or weakened democracy and slow growth as a result. Rent seeking can also take other, more subtle forms. For example, governments may be tempted to thwart markets by granting favored enterprises or individuals privileged access to common-property natural resources, or they may offer tariff protection or other favors to producers at public expense, creating competition for such favors among the rent seekers. Extensive rent seeking – that is, seeking to make money from market distortions – can breed corruption in business and government, thus distorting the allocation of resources and reducing both economic efficiency and social equity.
Insofar as natural resource abundance involves public allocation of access to scarce common-property resources to private parties without payment, thereby essentially leaving the resource rent up for grabs, it is only to be expected that resource-rich countries may be more susceptible to corruption than others. Empirical evidence and economic theory suggest that import protection (which is often extended to foreign capital as well as goods and services), cronyism, and corruption, as explained in Pranab Bardhan’s Corruption and Development: A Review of the Issues tend to impede economic efficiency and growth.
Furthermore, natural resource abundance may fill people with a false sense of security and lead governments to lose sight of the need for good and growth-friendly economic management, including free trade, bureaucratic efficiency, and institutional quality. Put differently, abundant natural capital may crowd out social capital, by which is meant the infrastructure and institutions of a society in a broad sense: its culture, cohesion, law, system of justice, rules and customs and so on. Incentives to create wealth through good policies and institutions may wane because of the relatively effortless ability to extract wealth from the soil or the sea. Manna from heaven can be a mixed blessing.
Natural capital may crowd out human capital as well as social capital by hurting education. Specifically, natural resource abundance or intensity may reduce private and public incentives to accumulate human capital. Awash in cash, natural-resource-rich nations may be tempted to underestimate the long-run value of education. Of course, the rent stream from abundant natural resources may enable nations to give a high priority to education – as in Botswana, for instance, where government expenditure on education relative to national income is among the highest in the world. Even so, empirical evidence shows that, across countries, school enrolment at all levels is inversely related to natural resource abundance or intensity. There is also evidence that, across countries, public expenditures on education relative to national income, expected years of schooling, and school enrolment are all inversely related to natural resource abundance. This matters because more and better education is good for growth.
Fourth, natural resource abundance may blunt private and public incentives to save and invest and thereby impede economic growth. Specifically, when the share of output that accrues to the owners of natural resources rises, the demand for capital falls, and this leads to lower real interest rates and less rapid growth. In other words, natural capital may crowd out real capital as well as human and social capital. Moreover, if mature institutions are conducive to an efficient use of resources, including natural resources, and if poorly developed institutions are not, then natural resource abundance may also retard the development of financial institutions in particular and hence discourage saving, investment, and economic growth through that channel as well. As in the case of education, it is not solely the volume of investment that counts because quality – i.e., efficiency – is also of great importance. Unproductive investments – white elephants! – may seem unproblematic to governments or individuals who are flush with cash thanks to nature’s bounty.
Fifth and last, natural resource abundance may reduce openness by discouraging exports and capital inflows. The Dutch disease manifests itself through reduced incentives to produce non-primary goods and services for export which the overvalued currency of the resource abundant country renders uncompetitive at world market prices. Hence the reduction in trade. Rent seeking appears in many guises, including demands by domestic producers for protection against foreign competition, for example in the form of restrictions against foreign direct investment. Natural capital may thus crowd out foreign capital. This form of the Dutch disease – from natural resource riches to foreign capital controls – needs closer scrutiny in future empirical research.
There are several ways to measure natural resource abundance. The share of primary exports in total exports of goods and services or GDP is one measure. The share of primary production in employment or the labor force is another. A third is the share of natural capital (i.e., oil reserves, mineral deposits, forests, agricultural land, etc.) in national wealth, defined as the sum of natural capital as described above, real capital accumulated through investment in machinery and equipment, and human capital built up through education and training. All three measures are inversely related to economic growth across countries. Here I will resort to using the share of agriculture in GDP as a proxy for natural resource abundance. A small or at least declining share of agriculture in GDP is a sign of successful diversification, industrialization, and the development of services. Moreover, agriculture in developing countries is generally less high-skill labor intensive than industry and services. As a result, agriculture contributes less than other industries to growth through education. There are countries where the economic predominance of agriculture goes hand in hand with a lack of general education that would be required for better governance and more rapid economic growth.
By Thorvaldur Gylfason
Research Professor of Economics at the University of Iceland and Research Fellow at the Centre for Economic Policy Research (CEPR) in London, SNS – the Swedish Center for Business and Policy Studies in Stockholm, the Center for Economic Studies (CESifo) at the University of Munich, and the U.S.-Japan Center of Business and Economic Studies at New York University.
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