Resource Curse

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Resource Curse defined:

The resource curse is commonly defined as the tendency of states with large reserves of natural resources, such as oil or diamonds, to be less developed than similar states lacking such resources.

These studies, which include Auty (1990), Gelb (1988), Sachs and Warner (1995, 1999), and Gylfason et al. (1999), among others, have emerged late in the 20th century, as evidence accumulated on the poor growth experience of resource-rich countries in the post-world-war II period.

Does the curse really exist? (J.D. Sachs, A.M. Warner)

Empirical support for the curse of natural resources is not bulletproof, but it is quite strong.

Political economy of the resource curse: Mechanisms explaining why countries rich in natural resources appear to perform badly in economic terms

1. Dutch disease.

2. Boom and bust cycles. Booms exacerbate both state spending and rent seeking behavior. Case of Mexico's small oil windfall in 1979-81

3. Weakly institutionalized states and skewed state societal relations:

* Failure to build viable tax regime

* Inevitable transformation into rentier states. Mechanisms how rent enfeebles the country. Creating disincentive for state leaders to build strong institutions.

The Myth of Resource curse:

The Resource Curse does not exist: (C. N. Brunnschweilera, E. H. Bulte 2008)

In discussing the impact of natural resources on growth, it is useful to distinguish between resource abundance (a stock measure of in situ resource wealth), resource rents (the flow of income derived from the resource stock at some point in time), and resource dependence (the degree to which countries do or do not have access to alternative sources of income other than resource extraction, again at some point in time). Although possibly correlated, these concepts are not equivalent. In fact, there exists a discrepancy between the theory behind the curse, and the empirical work used to support it. While abundant resource rents are a crucial element in the theory, most previous analyses rely on a measure of resource dependence, and our analysis suggests that resource dependence may not be a proper exogenous variable. Treating resource dependence as endogenous, we find it to be insignificant in growth regressions, with no effect on institutional quality. While we find resource abundance to be significantly associated with both growth and institutional quality, the association runs contrary to the resource curse hypothesis: greater abundance leads to better institutions and more rapid growth. In short, the received result that resource wealth impedes growth appears to be a red herring, and suggestions that countries should turn their back on resource wealth to lower resource dependence and not jeopardize economic growth may have to be reconsidered.

Impact of colonization and European settlement on the development of institutions (Daron Acemoglu et. al AER 2001)

Europeans adopted very different colonization strategies, with different associated institutions. In one extreme, as in the case of the United States, Australia, and New Zealand, they went and settled in the colonies and set up institutions that enforced the rule of law and encouraged investment. In the other extreme, as in the Congo or the Gold Coast, they set up extractive states with the intention of transferring resources rapidly to the metropole. These institutions were detrimental to investment and economic progress. The colonization strategy was in part determined by the feasibility of European settlement. In places where Europeans faced very high mortality rates, they could not go and settle, and they were more likely to set up extractive states. These early institutions have persisted to the present. Determinants of whether Europeans could go and settle in the colonies, therefore, have an important effect on institutions today. We estimate large effects of institutions on income per capita using this source of variation. This relationship is not driven by outliers, and is robust to controlling for latitude, climate, current disease environment, religion, natural resources, soil quality, ethnolinguistic fragmentation, and current racial composition.

Different experiences of the resource curse: Nigeria v/s Botswana

* Nigeria (the world's seventh largest oil Producer): Nigeria squandered its mineral wealth and actually made its citizens worse off. Its government has accrued $350 billion in oil revenues since independence, and yet its economy has shrunk; in purchasing power parity (PPP) terms, Nigeria's per capita GDP was $1,113 in1970 but only $1,084 in 2000, and during this same period, its poverty rate, “measured as the share of the population subsisting on less than US$1 per day increased from close to 36 percent to just under 70 percent.”Thus despite its vast oil wealth, Nigeria is among the 15 poorest nations in the world.

* Botswana: The case of Botswana illustrates how a natural resource curse is not necessarily the fate of all resource abundant countries, and that prudent economic management can help avoid or mitigate the detrimental effects of the resource curse. The discovery of large diamond deposits allowed Botswana to witness an important export boom and the world's fastest growth in GDP. The country moved from being the 25th poorest country in 1966 to an upper-middle economy thirty years later. The most important factor in Botswana's long term sustained economic growth was its ability to avoid common problems associated with export booms and the adoption of sound economic policies. Its main objectives were to avoid external debt, stabilize growth and to encourage economic diversification.

Neither curse nor destiny - Solutions to fight resource curse and their limitations:

1. Sound fiscal and monetary policy.

2. Economic diversification.

3. Natural resource funds.

4. Transparency, accountability and public involvement.

5. Direct distribution to population rather than through public works projects or state subsides; it will make better investment choices and have a greater incentive to save these windfall rents than govt. officials.

None of the aforementioned solutions are intended to rectify institutional weakness, but rather, to either simply ignore or circumvent it.

Creation of robust institutions via privatization of resources rents to domestic owners

Russia provides a powerful illustration of this proposition.

Russian Oil sector v/s Gas Sector

In the mid-1990s, Russia began privatizing its oil sector to domestic investors but retained state control over the gas sector. Since then, the degree of reform and economic promise in these two leading sectors has diverged significantly.

How private ownership leads to creation of robust institutions?