Resource Curse Hypothesis
Introduction
Problem statement
Over the past few years, resource abundant countries have witnessed poor economic performance, in comparison with the resource-poor countries. The poor performance has not always been the case, as natural resources prompt quality in some states, while others experience a stagnation of the economic development. The resource curse hypothesis is rooted upon the notion that contrary to the common belief, countries with abundant resources do not perform well economically. According to the hypothesis, abundance of resources is a curse, not a blessing, to the particular state. The resource curse mainly results from the quality of institutions.
Research Questions
What are the main factors contributing to the resource-curse hypothesis?
What are the effects of quality of institutions on resource curse?
What is the difference between resource abundant and resource dependent countries?
Contribution
The purpose of this paper is to focus on resource abundant versus resource dependent countries, and to evaluate their differences in GDP. Furthermore, it evaluates the impacts of institutional quality on resource copiousness. Leong and Mohaddes (2011, p. 1) noted that the resource curse paradox is such that countries rich in natural resources have lower GDP relative to the nations that lack minerals, natural gas, oil and other forms of non-renewable energy sources. Countries with abundant resources are faced with the ‘Dutch Disease’, attributed to the fact that the more resources a country has, the less the competitive advantage, as exports decline in value with time.
A significant factor facilitating the resource curse hypothesis is institutional quality. Quality of institutions plays a huge role in differentiating resource abundant and resource dependent countries (Balogun et al. 2016, p.787). They are the internal structures of a country in terms of political, economic, societal and technological processes. Countries with weak institutions face the problem of resource dependency, as they are incapable of utilizing their available resources to their economic benefit (Armstrong, and Taylor 2014, p.2). Consequently, quality institutions define the country’s utilization of resources for economic growth. Resource curse exists in countries with weak institutions. While institutional quality has the potential to positively improve the economic performance of a country, abundance of resources may negatively affect its growth.
Factors Influencing Resource Curse Hypothesis
Dutch Disease
Allegedly, the Dutch disease is the major economic cause of resource curse. Export industries dealing in other products and services other than natural resources, for instance the manufacturing sector, experience an appreciation of the national currency since the earnings resulting from the natural resources are partially absorbed by the local non-tradable sectors (Mobarak and Karshenan 2012, p. 2). The Dutch Disease refers to the notion that in every boom and significant upward trend of resources, there is a possibility of unexpected adverse effects. It is the negative implications of the economy after an upward trajectory of foreign currency inflows. For instance, when a country discovers new, unexplored gas and mineral reserves, there is likelihood of adverse consequences, despite the possible increase in income and wealth. Palma (2014, p.11) states that the Dutch disease arises when an upward swing in the worldwide prices of exports causes an increase in the currency of the rich-resource states. Other possibilities resulting from increased prices of exports include increased government spending, deficiency of the current account, increased prices of commodities such as housing, which are not traded in the international market, and a downward spiral shift in labor.
The Dutch disease results into an increase in export prices and worldwide economic growth. However, what makes it challenging is once the prices fall to their normal levels, it results into significant losses by the government. Consequently, even if the prices do not fall decline, the manufacturing sector will be overcrowded, and the potential for growth in the long run will diminish (Torvick 2001, p.3).
Apart from commodity price increases, the Dutch disease can result from other factors such as shift in the fiscal policy of the exporting countries, capital flows to the developing countries, and trade surpluses resulting from commodity booms (Davis 1995, p.1770). When a country discovers new deposits and sources of supply, there is an increased production in the market, leading to trade surpluses. Eventually, the product booms cause low prices for the product, and new deposits will not bring in revenues for the government.
Another significant factor causing the Dutch Disease is the increase of capital flows to the developing countries. To sustain their consumptions and investments, countries should borrow during the period of economic downturns and repay the debts during the economic upturns. However, there are cases when countries borrow during economic upturns. As a result, the developing countries start mounting markets that are more financial-oriented, leading to increased prices of the financial assets. Therefore, when countries borrow during Boom period, their financial debts are facilitated by borrowing internationally. They are left with huge financial debts that are paid with the gains from investments.
Volatility of the Market Prices
Over the past fifty years, there have been rapid changes in the international business environment and evolution of markets. The changes have facilitated fluctuations of prices and constant market evolution. Prices for raw materials such as petroleum and gas are subject to severe fluctuations in the market. In most countries with abundant natural resources, the economic performance is influenced by the revenues from the exports of the resources (Leong and Mohaddes 2011, p.1). Hence, the government becomes fully dependent on the resources. Sudden changes in the prices of the resources have adverse effects on the revenues and general income levels. During fluctuations, the government is forced to break contract with international cartels and reduce its export processes. Volatility is accelerated by government debts and huge expenditures. When the market exchange rates for the raw materials change, the capital inflow is greatly affected, and results in adverse effects on the exports. Consequently, the decline in the prices of raw materials affects the ability of the government to pay its long term debts and conduct business internationally. When this happens, there will be few international investments into the country, and the resources will lose their value in the global markets. Bankers and other foreign financiers no longer offer credit to the government, and the country becomes vulnerable to high interest rates.
According to Prebisch (1950, p.8), prices of agricultural products and minerals will decline eventually, attributed to the inelasticity of demand for products in relation to the world economy. The more the income, the less the individuals spend on raw materials. It is for this reason that for countries with copious agricultural products, their economic development is slow. Another reason behind price volatility and resource abundance is that after a few years, the prices of oil and minerals increase at a significant rate. Imperishability of oil and gas products is a major reason for price volatility. Therefore, countries with abundance of these resources control their prices and market value and determine the exports into the international business trade. Based on these beliefs, the countries quickly sell the commodities to get rich faster, before the high prices diminish. In addition, the resources are significantly affected by the increasing interest rates. Hence, the more the prices commodities are expected to generate in the long run, the higher the interest rates for their prices.
Another line of argument used by scholars on the resource curse hypothesis is that the resources per se are not an issue but the market prices are volatile thus creating revenue disparities. Evidently, the natural resources harbor the most volatile world prices therefore translating to uncertainties with regards to the core producers that extend to other industries in the resource-endowed nations. According to Mobarak and Karshenan (2012, p. 4), the great vagueness with regard to primary commodity manufacturers reduces factor accumulation by heightening the risk levels and the option value of forecasting product development and price changes.
Rent Seeking
The third explanation, rent seeking is attributed to institutions complacency due to the allowable rents that result from a boom in natural resources. Subsequently, incentives needed for economic diversification and development are reduced given that the government focuses on the ‘easy rents’ derived from the natural resources sector. The rents increase public consumption relative to investment projects (Battacharya and Hodler 2010, p.611). Moreover, the vicious function of rent seeking such that exogenous models are designed with the sole assumption that the rents attributed to resources are appropriable essentially fosters bribes and distortion of the public rule, and diversion from economically uplifting activities to publicity for self-gain.
The rent-seeking approach states that in any given country, there is a lot of wealth floating around that the government has no use for. Investors therefore find it more profitable to take matters into their own hands, and engage in unproductive activities that do not create wealth for the country. The approach is rooted from the uncertainty of who owns the major resources in the country. People therefore fight for the significant resources, and this does not generate any revenue for the institutions. This effect is called the common pool problem, where the where the private entrepreneurs overspend and mismanage the available resources in order to pay their tax burdens without caring for the economic impact (Tullock 2013, p.1).
Degeneration of the Terms of Trade
Terms of trade between countries determine the extent to which a state can export its products internationally (Dur et al. 2014, p.360). The more abundant a country’s resources are, the more favorable the trade terms. Eventually, the terms of trade may change significantly, contributing to low economic growth. To control the prices of exported products, the importing countries may increase trade barriers and foreign exchange currencies (Aggarwal and Urata 2013, p.2). Consequently, a country with abundance of resources is met with competition from other countries supplying the same products, and eventually, their prices are reduced. Some countries have import substitution policies that prevent their investors from conducting business with certain countries. In such cases, the resource-rich country is no difference from the low-resource states. Such policies include high trade tariffs, and barriers to foreign entry.
Quality of Institutions
The final explanation, which serves as the main focus on the dissertation is of the literature strand that assesses institutional quality as a contributor of poor financial performance in resource-rich states. A study conducted by Xinhua et al. (2010, p.10) on resource curse hypothesis and economic growth in XinJiang established that institutions are critical in determining the GDP rate of the particular nation. Nations that are characterized by weak institutions, essentially in developing nations such as Nigeria, periods of resource blasts elevate the worth of the politicians and accord power that is required to stimulate the consequence of policies or elections to their favor. Rather than action as an economic development enabler, weak institutions are instrumental in assisting politicians to take advantage of resource abundance that cause over abstraction and poor distribution of natural resources. Conversely, the quality institutions seal loopholes for misallocation and over extraction of the resources by selfish individuals thereby fostering the formulation of strategies that utilize the resource boom for economic development.
Institutions of a country are connected to its political structure and stability. The quality of institution is a determinant of stability, economic growth and democracy of a country. There exists a significant relationship between the eminence of institutions and the resource curse hypothesis. The structures and processes determine the possibility of suffering from the resource curse. For countries whose institutions are weak, booms in the resources do not generate any market value. In addition, the resource abundance results into civil wars and conflicts as they are not properly managed, endorsed to the fact that the income generated from the booms is used to serve the interest of the few people in positions of power in the society. In such countries, resources are not sufficiently allocated, and the overall effect is the decline in economic growth.
Resource Dependent versus Resource Abundant Countries
Resource endowment is a determinant of economic development and seen in many nations particularly in Africa. Leong and Mohaddes (2011, p.1) observed 112 nations using data over a five year period and reported that though rents attributed to resources drive per capita income, their volatilities, which are driven by operating institutions lead to negative economic development. From the study, the two scholars argued that volatility instead of lavishness of natural resources is the main facilitator of resource curse. However, the quality of institutions can counteract the adverse volatilities brought by the resource rents and lead to substantive economic growth in the form of rising GDPs. Cori and Monni (2014, p. 28) seconded Leong and Mohaddes (2011, p.1) arguments through her study on Ecuador and asserted that resource abundance can become a source of economy blessings only if governing policies and structures that promote welfare of the citizens are enacted. Resource dependent countries are those whose economies rely on the available natural resources. In contrast, resource abundance refers to the extent to which natural resource endowment of a country can be evaluated by its par capita income. Resource cures is inherent in resource abundant states, where they are incapable of experiencing rapid economic growth.
In the article on the reasons why natural resources are a curse on developing nations, Stewart (2012, p.4) claimed that there is a high correlation between authoritarian rule of law and dependency on energy. The author reports that in more than twenty-three nations that obtain revenue from natural resources, 60% are yet to achieve democracy. In his book, Stewart observes ease of obtaining revenues eradicate the probability of accountability by the government on the citizens through the reduction of tax incentives from other productive activities that would be used to offer social services. In addition, revenues in form of rents create substantive amount of wealth to individuals that is used to create networks for sealing corruption patronages. The networks enable power consolidation by a few elite individuals leading to sharp inequalities. The resource endowed Middle East Region essentially Saudi Arabia evidences the economic gap that is fostered when politicians and wealthy individuals take advantage of their networks to amass more revenue for their individual needs at the expense of the citizens.
Relationship between Institutional Quality and Resource Curse
Investors in the natural resources sector such as oilfield development and production weigh between rent-seeking and earnings potential (Gylfason 2001, p.849; Wright and Csezuta 2003, p.8). The relative prosperity of operations is dependent on domestic institutions that craft and implement the rule of law and bureaucratic efficiencies. An economy that has quality institutions leads to equilibrium, such that there is no difference between investors and producers. On the other hand, low quality institutions lead to the scenario whereby a section of the investors are rent-seekers. As such, resource abundance leads to lower income in the latter case. Cori and Monni (2014) based their analysis on the government of Ecuador and the impacts of natural resources on economic development and asserted that resources are a curse in countries that have weak institutions.
Indicators of Quality Institutions
Human Development Index
The Human Development Index (HDI) is used to evaluate the performance of countries on the basis of education levels, per capita income, and life expectancy (Rep 2006, p.1). Quality institutions have high HDI, while weak institutions have low HDI. Quality institutions are characterized by their ability to integrate the different players in the country for the overall economic development and growth. They are capable of managing their assets, and rarely suffer from the resource curse hypothesis. Due to the abundance of resources and effective management practices, there are low unemployment levels and hence, there is prevalence of high per capita income. In addition, these institutions have effective policies that facilitate employment, education, environmental conservation, and use of latest technologies in manufacturing. Therefore, quality institutions have high HDI (Noorbakhsh 1998, p.520). Consequently, weak institutions have low HDI, due to their inability to control the corruption among the private investors, political instabilities, and civil conflicts. They do not have proper business channels and clear policies on who is in charge of specific resources. They suffer from the resource curse hypothesis, and have little or no economic growth.
GDP
Gross Domestic Product (GDP) measures the worth of all goods and services manufactured in a state over duration of one year. GDP is one of the most effective strategies for measuring quality of institutions. Weak institutions have low GDP, while quality institutions experience high GDP. The differences in the value results from resource abundance and dependence of countries.
Political Stability
The political climate of a country determines the quality of institutions. Politics have the potential to negatively or positively affect the economic growth rate. For instance, corrupt politicians contribute to low economic growth, since they embezzle money from significant resources of a country. In addition, peaceful political climate provides a good environment for business and investments. Weak institutions have poor political conditions, while quality institutions have peaceful environments that support businesses and growth of markets.
Factors Influencing Institutions
Resource rich countries are often associated with weaker institutions for a variety of reasons. Firstly, individuals in these countries are enlightened, and it is therefore easier for them to take advantage of the resources and use them for their personal gain. Such countries are controlled by a group of the elite wealthy investors whose only concern is increasing their wealth. Significant resources such as minerals, oil, and gas are controlled by small private businesses that capture most of the income for themselves.
Secondly, political instability is a significant factor that influences the quality of institutions and resource abundance. Majority of resource-rich countries have poor political structures that do not foster a favorable environment for growth and development. Countries that have regular political conflicts are incapable of benefiting from their natural resources. Their political structures negatively affect businesses and reduce the potential for investment into the country. For instance, majority of countries in Africa have abundant natural resources that do not contribute to their economic development, due to political instability. Most countries experience frequent civil wars and political conflicts, thereby minimizing their potential for attracting international investors.
The technological structure a country is another factor that influences quality of institutions. Resources such as oil and gas require extensive technologies for drilling and transforming raw materials into final products. Some countries in the Middle East have large and extensive oil reserves, and contribute a large percentage of the global oil production. These countries, however, lack the latest technologies that enhance faster manufacturing and production. Therefore, by the time the oil is ready for export, some countries with better technologies will have already sold to the available investors.
Effects of Weak Institutions
Poor economic institutions result into civil wars, increased conflicts, political instability, autocracy, and poor economic performance. The majority of weak institutions have poor economic growth rate, and their GDP and per capita income remain stagnant (Balcerzak and Pietrzak 2017, p.2). Resource abundance in these countries is faced with significant challenges that contribute to their low economic performance. They do not have proper management of the naturally occurring raw materials, and the available resources are fought over by the private investors. Due to poor political environment, these institutions are incapable of attracting investors from foreign countries. As a result, their economic growth is poor.
Secondly, weak institutions result into autocracy. Countries that are rich in resources such as minerals, oil and gas experience autocratic rule, whereby the government is in control of the oil and gas reserves. Such institutions are resource dependent, and therefore rely on particular resources for their economic growth. The government therefore has to be in control of these organizations, as their success greatly impacts the overall economy of the country.
Effects of Resource Curse
Resource curse hypothesis has significant impacts on the economic, political, socio cultural, and legal structures of a given country. Countries with abundant resources do not always experience high economic growth and this impacts the quality of institutions and determines their potential for expansion.
Effects on GDP
The resource curse has different effects on the GDP, depending on the country. Resource abundant countries with weak institutions have overall low GDP. On the other hand, countries with quality institutions have high GDP levels (Brunnschweiler 2008, p.3) the low GDP levels are attributed to the fact that quality institutions are capable of controlling the various structures, processes and procedures for the overall benefit of the economy. These states have high political stability, and provide favorable environments for local investments. As a result, there will be increased exports and overall economic growth. The United Arab Emirates is an example of a quality institution, with abundance of oil and gas resources. Weak institutions have poor managerial practices, with corrupt private investors and politicians who accumulate the state’s wealth to themselves. In the long run, the economic growth remains stagnant, and the GDP declines.
Effects on Employment and Income
Resource abundant countries have low unemployment rates, as workers are employed in different sectors to oversee the exportation of resources (Stijns 2006, p.1070). The resources provide people with an opportunity to increase their income levels in the short term. For instance, a new oil discovery will create more jobs and improve the wealth of a nation. However, after a few years, price volatility, the Dutch effect, rent seeking and decline in trade barriers causes loss of jobs and reduction in income level. The resource curse stipulates that these countries have low economic growth and development in the long run. Therefore, when exports decline, unemployment rates increase. A good example is the United States, where the oil industry has many job opportunities during boom period. During depression, there are low income levels and the per capita income decreases. Low income levels result into loss of jobs.
Political Effects
Abundance of resources contributes to the political stability of countries. The oil and gas producing countries have authoritarian rule, as the government exerts control on the oil reserves. This is accredited to the fact that the countries depend on these resources for economic growth, and the government has to therefore monitor the activities of the investors.
Resource Abundant Countries
The resource course hypothesis stipulates the impossibility of a resource-abundant country to do well economically. Countries with abundant raw materials should therefore improve upon their institutions to ensure quality resource management, and to deflect from the resource curse (Auty 2001, 4). Some of the most famous resource-rich countries include the Democratic of Congo, the UAE, South Africa, India, Bolivia, among others. One thing all the mentioned countries have in common is that despite having some of the largest resources in the world, they experience poor economic growth rate. Figure 1 evaluates the relationship between resource dependent countries and their GDP Levels between 1975 and 2010.
Figure 1: Relationship between GDP growth and Resource Dependent Countries (Auty, 2001, p.2).
The Democratic Republic of Congo produces the largest amount of cobalt in the world. In addition, it supplies more than 30 percent industrial diamonds worldwide, making it one of the chief producers. However, the country has poor GDP levels, with a stagnant economic growth. similarly, Sierra Leone and Bolivia have abundant natural resources and supply to all parts of the world, but their economic conditions are weak.
One the contrary, there are few resource abundant countries that experience high economic growth rates. As long as there are quality institutions, a country will be able to manage its resources and effectively contribute to its overall economic development (Stewart, 2012). Botswana is one of the world’s largest diamond producers. It produces 29 percent of all diamonds, and is not affected by the resource curse. Botswana experiences high economic growth rate, attributed to its abundant resources. Similarly, Norway is the second largest manufacturer of natural gas in the world. With its abundant resource and quality systems, it ranks among the richest states in the world, and its economic growth rate keeps increasing at a high rate. There are other resource-rich countries that are performing well economically as a result of their quality institutions.
Resource Dependent Countries
Resource dependent countries rely on particular raw materials for the overall economic development. Majority of oil and gas producing countries fall under this category. Countries such as the UAE, Turkey, and Saudi Arabia rely on petroleum for economic development. In the event of fluctuations of prices, or unexpected risks, the industries have the potential to adversely affect the whole economy. Resource dependent countries rely solely on one major reserve for economic growth. Examples of such countries are in the Middle East, with their petroleum and gas industries. In these countries, oil plays a momentous role in building the economy and hence, fluctuations in the market prices affect the whole economy.
Figure 2: Comparison of Institutional Qualities in Mining Abundant Countries (Balogun et al, 2006, p.788).
Figure 2 discusses mining abundant countries in the sub-Saharan Africa. It gives a comparative analysis of the quality of institutions that are rich in minerals.
Conclusion
All things considered, it is evident that abundance of resource in a country does not necessary men it has high economic development. On the contrary, the more the resources, the low the economic growth, accredited to the resource curse theory. There are many factors contributing to this hypothesis, including the Dutch disease, price volatility, rent seekers, and weakening of the terms of trade. However, quality of institutions is the most significant cause for the hypothesis. There are different types of institutions, and their ability to manage the available resources is what determines their success. Poor institutions should therefore change their processes and structures, to enable collaboration among the different players in different countries. Quality institutions have the potential to avoid the resource curse hypothesis.