Public capital in countries with abundant natural resources: Is there a curse?

 
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February 5, 2014

When a country discovers natural resources — fossil fuels, rare metals, and more — the result can be an economic bonanza. It can also be an unmitigated disaster, with wealth for some but overall, worse social, economic and even political outcomes. This paradox is called the “resource curse,” and has been seen with — among many others — oil in Ghana and Nigeria, diamonds in Sierra Leone, and phosphate in the island nation of Nauru, which has been almost entirely strip-mined. There is even an ongoing debate about the effect of coal in Appalachia. So when U.S. geologists announced in 2010 the discovery of an estimated $1 trillion worth of mineral deposits in Afghanistan, scholars expressed fears this could lead to increased corruption and instability rather than alleviate the country’s economic problems.

There are a variety of hypotheses about how the “resource curse” might work operationally, including the creation of more venal, corrupt, rent-seeking leaders; the eruption of armed struggles over wealth; or volatile global commodity prices that foment economic and therefore social instability. Economists, policy makers and the international development community continue to debate the idea — primarily attributed to British economist Richard M. Auty, who wrote Sustaining Development in Mineral Economies: The Resource Curse Thesis in 1993 — as well as its implications. The idea is linked to an earlier concept, “Dutch disease,” a term coined by the Economist in 1977 to refer to a specific phenomenon in which a country’s manufacturing sector suffers when it discovers vast natural resources.

One of the most frequently cited works in this field is “Natural Resource Abundance and Economic Growth,” a 1995 paper by economists Jeffrey Sachs and Andrew M. Warner. Some scholars have argued that the evidence for a direct link between resources and the slowing of economic growth isn’t as strong as it was once perceived to be, while others suggest that strong institutions can mitigate any “inevitable” negative forces. For useful overviews of many of the key issues, a good resource is “The Natural Resource Curse: A Survey of Diagnoses and Some Prescriptions” by Jeffrey Frankel of the Harvard Kennedy School; and “The Political Economy of the Resource Curse: A Literature Survey,” by Andrew Rosser of the Institute of Development Studies.

In a 2013 study, “Public Capital in Resource Rich Economies: Is There a Curse?” economists Sambit Bhattacharyya of the University of Essex and Paul Collier of the University of Oxford revisit the impact of countries having natural resources. Using data on 45 developed and developing nations from 1970 to 2005, Bhattacharyya and Collier seek to determine whether natural resources have an effect on the level of public capital. To measure investment, they look at the rate of change in public capital; to measure resource wealth, they use the per-capita rents from a variety of natural resources, including energy, minerals and forestry. They also look at the relationship between resource rents and countries’ telephone, rail and road networks.

The study’s key findings include:

  • Overall, the data support the notion of a resource curse as it relates to public capital: “The possession of rents from natural-resource depletion has typically significantly reduced public capital.” Even when the authors control for fixed affects and time varying common shocks, there is “strong, statistically significant negative relationship” between the resource rent per capita and the public capital per capita.
  • “A one standard deviation (2.69) increase in log resource rents per capita leads to approximately a one tenth of a standard deviation (1.77) decline in log per-capita public capital stock in an average country. In other words, the resource rent elasticity of public capital is approximately -7%.” Thus if per-capita resource rents increase $100, public capital would fall by $7.
  • The type of natural resource matters: Extractive, “point source” natural resources — for example, oil, natural gas and minerals — can lead to a “resource curse,” while agricultural and forestry resources do not. “In other words, it is the appropriable but non-renewable point-source resources that reduce public capital rather than forestry and agriculture.”
  • The quality of democratic institutions can play a moderating role in the negative effects of natural resource rents on public capital. This finding was corroborated when the scholars used the social infrastructure index — another way of determining institutional quality — which again demonstrated that “good institutions somewhat mitigate the adverse effect of resource rents.”
  • The negative impact of high per-capita resource rents is disproportionately a problem in low-income countries, defined as those with per-capita income below $5,000 (in constant 1996 international dollars). “The undifferentiated effect of resource rents on all income groups remains negative, but the coefficient is smaller and only significant at 10%. This suggests that our results are predominantly but not exclusively driven by low-income countries.”
  • “In the absence of resource rents, the average resource rich country would have had their per-capita public capital stock 7% higher. The quality of its public-investment process, as scored by the Public Investment Management Index, would have been 1.2 points higher. Turning to observable physical capital, it would have had marginally fewer railways, but 3% more roads and 4% more telephones.”

“Our findings have important implications for managing resource revenues in developing countries,” the authors write. “Resource rents so warp incentives that politicians actually reduce public investment in their own economies. Hopefully, this manifestly sub-optimal policy choice may be more amenable to influence than the accumulation of foreign reserves, since the need for public investment is readily apparent to ordinary citizens.”

 

Keywords: fossil fuels, corruption, poverty

 

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Citation: Bhattacharyya, Sambit; Collier, Paul. “Public Capital in Resource Rich Economies: Is There a Curse?” Oxford Economic Papers, 2014, 1-24. doi: 10.1093/oep/gps073.