Monday, 26 November 2012

The Resource Course - Can a economy be sick?


Most readers would be ready to assume that if a once-poor nation suddenly stumbles on a handful of natural resources, then it's economic (and perhaps, political) progress would suddenly skyrocket, and it's citizens would be much better off than before... Unfortunately, such assumptions are not alway true. The poetically named Resource Curse, a.k.a. the Paradox of Plenty, and it's subset, the Dutch Disease serve with alarming examples about how a natural resource boom might actually strangle economic progress and cause political instability. Today's post, primarily based on Michael L. Ross's paper from UCLA, presents the competing explanations.

All in all, I wish we had discovered water. - Sheik Ahmed Yamani, Oil minister, Saudi Arabia

Source: Guardian Images

Prominent examples

That an abundance of natural resources may lead to political progress (democratisation) is easily dismissable when looking at the Gulf states: Saudi Arabia, the UAE, Kuvait, etc. In these countries, a small political elite is able to maintain autocratic rule relatively peacefully, due to their economic legitimisation through distributive programmes (most oil companies are state-controlled). Another, geographically distinct example would be Hugo Chavez's Venezuela.
Yet an autocratic regime effectively utilizing natural resources may actually be the lesser of two evils. In countries like Congo and Sierra Leone, an abundance of precious natural resources (diamonds) has lead to appalling civil wars and countless deaths,  Congo's alone being the most bloody military conflict since the Second World War. 
So why does resource abundance makes states autocratic, unstable, or even failed? The two lines of explanations come from political scientists and economists, respectively.


Economic explanations


Economic explanations are fewer in number, but unified and well-developed. They are well-supported by statistical data and a scientific handling of theories; nonetheless, the models fail to provide universally satisfying answers to every past phenomenon. 
Contemporary economic research suggests four possible causes for resource curses:

1) A gradual decline of interest in primary goods by international markets over time;
2) The volatility of international raw commodity market prices;
3) The lack of connection between the natural resource sector and the rest of the economy;
4) The "Dutch Disease".


1)Gradual decline
That exporters of raw materials such as oil, diamonds, copper or even cash corps face worse trading terms over time is not immediately obvious when we think of the power the OPEC had on international trade in the 1970's.  However, those days have passed; since the 1980's, increasing volume (and hence, decreasing price) of raw commodities and the collapse of international trade agreements (read: price cartels) have caused terms of trade (exportable goods price/importable goods price) to fall steadily at least since the 1900s.
 The problems with this explanation is that it's effects are virtually untraceable on the individual level; a study of terms of trade for 26 seperate commodities has found that 5 had positive, 5 had negative trends, while the other 16 were trendless between 1900 and 1983. 


2)Trade income volatility
Between 1960 and 1980, a series of studies have found that the instability of raw exportables may actually increase domestic investments, which would act as a safety net against volatile export incomes. However, more recent research is less clear on the issue; the correlation between volatility and the resource curse now seems to be between mildly positive and neutral - commodity exporter countries seem to be suffering from abysmally low growth rates even when controlled for export imbalances.

3)Lack of connection
While in the first half of the 20th century, most mining and resource companies were multinationals repatriating their incomes, by the 1970's the trend has been reversed and most raw resource-handling companies have been nationalized. However, this doesn't seem to have changed the revenue distribution; a study of resource exports between 1967 and 1986 has found that growth in the sector had virtually no effect on the growth of the non-exporting sectors. This lack of connection seems to be a possible cause for the resource course; yet it's discussion has been fading since the 1970's.

4)The "Dutch Disease"
The romantic term for the final economic explanation was created by The Economist in 1977
to describe the decline of the manufacturing sector in the Netherlands after the discovery of a large natural gas field in 1959. This increased resource exports, which then increased the real exchange rate of the Dutch currency; secondly, the booming resource sector drew jobs and capital away from the industrial and agricultural sectors which started to make losses.
The problem with this explanation applied to developing countries is that the disease is, Dutch; total employment (and hence, a shift of workforce from elsewhere to resources) can't be assumed in emerging economies, where large labour surpluses are often part of the economic problem in the first place. 

Theoretically, all four economic effects above could be lessened or erased by government action.
1)They can consciously plan for the gradual decline of the resource export incomes;
2)They can use fiscal policy and commodity stabilization funds to defend the economy from trade imbalances;
3,4)And hey can use the export incomes to subsidize and invest in the non-exporting sector.
Government's failure to do so - even, as in Congo and Sierra Leone, to carry out the duties of the state - has shown that the question must be adressed from the political side as well.

Political explanations


Political scientists, on the other hand, aren't developing models, but rather case studies; while their examinations of individual events may be deep, they fail to connect the cases to reveal a broader pattern behind the resource curse, and embarassingly, this may even represent a "disregard for the practice of hypothesis testing". While due to these factors, there are no unified theories of the resource curse among political scientists, opinions nontheless fall into three main categories, blaming:

 1) Short-sitedness of policymakers in the following of a resource discovery;
2) The private sector profiting from raw resource extraction, lobbying the government into pursuing growth-impeding policies;
3) Weakening state institutions in the face of a resource boom.

1) The cognitive approach
That a single resource-based export sector may distort the thinking of decisionmakers and make them "lazy" is an old and popular idea in social studies; among others, Adam Smith and John Stuart Mill were among it's early propagators. However, it poses some serious problems; not only does it violate the general economic assumption of human rationality, but it's also often claimed in an ad hoc manner, without developing testable theories. Without further development of a "cognitive failure theory" (even though it could explain why governments fail to act against trade volatility and the Dutch Disease) is hard to be taken seriously. 

2) The societal approach
Some political scientists have claimed that during resource curses, the government is coerced into maintaining ISI (import-supplementing industrialization, protecting resource exporter industrialists)  policies instead of export-based ones, harming long-term growth. However, the cases supporting this statement (Columbia, Brazil vs. the export-based Asian Tigers) are few in number, and generally exclude Africa. Additionally, the approach assumes that resource extraction is in the hands of the private sector; this is once again untrue in many economies (see 3 above). These factors leave us with a final possible political answer.

3) The institutionalist approach
Cognitive and societal explanations set aside, it is difficult to explain the role of government's based on a solely judicial basis. The most famous of these efforts is the hybrid rentier state hypothesis, which claims that governments facing a resource boom - involuntarily changing from a smaller state into a larger one - lack the tools and data and istitutions to conduct viable development policies. (A variant of these claims is explored in the book and blog Why Nations Fail, written by economists Daron Acemoglu and James Robinson.)
While the basic assumption of this approach (that smaller, poorer states would somehow be better off) can definitely be tested, it's application has been based on mostly case studies and was insufficiently controlled against other variables which could explain resource courses.

Conclusion


The long list of possible causes above beautifully represents the challenges and characteristics of multidisciplinary research in the social sciences. While economic theories are well-developed, their further refinement and balancing would require a deeper understanding of political mechanisms - a field stricken by the absence of hypothesis testing and unified theories, where the framework of economic research could be well-utilized. In the end, only the collaboration of economists and political scientists may conclude and complete the explanation of resource crises - and answer a small part of the question of why poor countries remain poor while rich ones continue to grow?

Sources:

Michael L.Ross: The political economy of the resource course. Berkeley, University of California, Los Angeles.

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