From commodity boom to financial and political crisis

Mare Sarr, Erwin Bulte , Christopher Meissner, Timothy Swanson 27 September 2008



For the past five years, the prices of petroleum, gold, other minerals, and now even food have risen inexorably. In many resource-exporting countries, average incomes have soared and the good times are rolling. But it is well known that resource wealth may be a “curse” for some countries. Countries with abundant resources often grow more slowly (Figure 1), invest less in human capital, and face internal political conflict. Countries have even been shown to develop weaker corporate governance in the face of a resource boom (Durnev and Guriev 2007). And while recent research has cast a more optimistic light on the issue by arguing that resources are not necessarily a curse where good institutions are present (e.g., Mehlum et. al. 2006 and Robinson et. al. 2006), our view is that resource booms are more easily translated into lingering ill effects through poor performance of the international financial markets and those companies that pay autocrats for their resources.

Figure 1. Natural resource abundance and growth

In our research (Sarr we analyse the history of over 50 developing countries between 1972 and 2002 and show how unstructured lending into resource-abundant countries can lead to political and economic weakness. It is remarkable to observe how international lending patterns have followed resource booms and busts (Figure 2).

Figure 2. Evolution of average net lending and resource abundance

Indeed, financial markets have chased returns in these booms in the past making large amounts of liquidity available to those states with abundant resources. They often do so with little regard to the prospects for investment of the funds. The outcome of this boom-based lending is one major culprit for explaining the resource curse. The less obvious outcome has been liquidity-induced political instability.

Consider a worst case scenario. An un-checked regime achieves power in a country that holds extensive mineral or oil deposits. The regime’s grasp on power is not unassailable, and the leader must always consider the possibility of being deposed. For this reason, the leader knows that “liquefying” its potential return (from leadership and command over the nation’s resources) is a better option than investing for the long haul. Its objective then becomes to loot these resources as quickly and completely as possible. But how is it possible to achieve rapid payment for resources that require years to mine? The leader is actually in the position of a mine owner and would have to invest in the mine in order to acquire a share of the resources that can flow from it. This would be generally good for the society, as the investment in the mine will stay (even if the leader changes) and the other parts of society share in the flows from the mine along with the leader. This un-checked ruler might invest in the mine and produce in order to get his or her hands on these assets. Figure 3 shows cumulative net investment in a hypothetical economy.

Figure 3. Simulation of capital accumulation without unstructured lending

But suppose that, to the leader’s delight, an international financial institution or organisation appears on the scene and is willing to provide immediate funds in return for a general promise of repayment. In such a scenario, one that we have seen repeated over and over again in the past, and one which is playing itself out at this very moment in many places experiencing commodity booms, the only real choice for such a regime is to accept the loans, maximise personal consumption (current and in future by stashing large sums of money abroad), run-up a large external debt, and schedule a time for departure.

In effect, the unstructured financial deal enables the junta to liquefy its otherwise sunk resources and provides an incentive for the government to loot rather than to invest in its natural assets. (Figure 4 shows cumulative investment in such a resource cursed economy) Highly unstructured financial arrangements play a key role here.

Figure 4. Simulation of capital accumulation when lending is unstructured

Such cases abound in the resource-rich parts of the world especially in those cases where the leaders are largely unchecked by the existing political process. There are the obvious offenders such as the Mobutu regime in Zaire and the more recent examples such as Idriss Deby in Chad, Sani Abacha from Nigeria and Teodoro Obiang Nguema in Equatorial Guinea.

What is the long-term damage from such short-term looting? A government that consumes financial resources also simultaneously neglects to make the investments that would provide the possibility for their re-payment in the future. The unstructured lending to resource-rich states results in higher debt levels without corresponding flows of funds to repay them. The state enters into a financial crisis or debt trap consisting of high debt and low growth. Moreover, political instability can arise since the lack of a sound and shared future prosperity increases the willingness of the opposition to vie for the right to redistribute the proceeds arising from the wealth.1 Extreme human suffering is one likely consequence of such a resource boom. Furthermore, there is now little incentive to invest further in productive endeavours in such a misaligned country, and this can doom a country to lower growth rates in the long run.

What is to be done to avoid such a cycle? Certainly natural resources alone are not to blame, and obviously countries should not be discouraged per se from prudently taking advantage of such natural endowments. Rather, it appears that there is a problematic combination of financial and political factors to consider: unchecked leaders, unquestioned deposits (of looted money in western banks2), and unstructured lending into resource rich countries. Given this, the best options are to control the flows of funds into and out of the resource-rich state. Real efforts at transparency, as discussed by Susan Ariel Aaronson, are important. Making the publication of extractive companies’ payments legally mandatory would help in theory, but they may be difficult to monitor and enforce.

More importantly, financial institutions must be made to bear the full cost of lending to rulers in an unstructured manner. Loans should be secured only by assets in the resource sector (such as capital investments in mining) not in the assets of the state at large. Such structuring of loans could make certain that the funds were properly invested by limiting banks’ rights to recovery regarding any funds that were easily removed.

Financial institutions and foreign extractive industries have been allowed to make loans to nations in the throes of asset booms too often without facing any real consequences for their misconceived actions. In the case of commodity booms, this kind of malfeasance must be scrutinised, because the problems generated in developing countries are too real and too long-lasting. The results are not just financial and economic; they are also political and humanitarian. Resource-based asset booms should not be allowed to attract unstructured financial investments. Banks and other investors should be required to invest only in the capital required to mine these assets, not in the assets themselves. If recent commodity price rises are demand-driven and only a taste of the future, it may not yet be too late to keep this and future booms from becoming a series of ghastly busts.


Mehlum, H., K. Moene, R. Torvik (2006): Institutions and the Resource Curse. Economic Journal 116: 1-20.

Robinson J. A., R. Torvik, T. Verdier (2006): “Political Foundations of the Resource Curse.” Journal of Development Economics 79: 447-46

Sarr M., E. Bulte, C. Meissner and T. Swanson (2008): “On the Looting of Nations”, Social Science Research Network Working Paper Series.


1 For example, according to the UN Commission for Human Rights Report E/CN.4/1999/4, in Equatorial Guinea, “more than 80 per cent of the national income was amassed by 5 per cent of the population”.

2 The prestigious Riggs Bank alone harboured between 300 and 500 million dollars looted by Obiang Nguema. Similarly Abacha looted Nigeria’s riches and deposited up to 4 billion dollars in the most respectable international banks: Australia and New Zealand (ANZ), Bankers Trust, Barclays, Citigroup, Goldman Sachs, HSBC, Merrill Lynch, National Westminster Bank, Paribas, Standard Chartered, Citibank and Commerzbank.



Topics:  Financial markets

Tags:  financial markets, resource curse

Lecturer in Economics, University of Cape Town

Professor of Development Economics, Wageningen University and Professor of Environmental and Natural Resource Economics, Tilburg University

Professor of Economics at the University of California, Davis

André Hoffmann Chair, Graduate Institute of Geneva