Political institutions and the curse of natural resources

Antonio Cabrales, Esther Hauk

17 June 2011

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There is nothing new about the “natural-resource curse”. It is first mentioned in 1993 in a book by Richard Auty titled Sustaining Development in Mineral Economies: The Resource Curse Thesis. The term was then popularised among economists following the influential paper by Jeffrey Sachs and Andrew Warner in 1995. What these authors (and many others) have shown is that countries with greater natural endowments tended to grow more slowly than the rest in the second half of the twentieth century. A related phenomenon is what is called the Dutch disease, a term apparently invented by The Economist to explain the stagnation in the Netherlands as a result of the discovery of a large natural gas field.

One common explanation for the Dutch disease is that the discovery and exploitation of natural resources usually leads to large profits. These profits then induce entry into the mining industry at the expense of other sectors, increasing national income and demand, which creates inflationary pressures. At the same time, a trade surplus is generated by capital inflows and the real exchange rate appreciates. This makes the profits of other exporters fall sharply, which attracts even more capacity into the natural resources sector. The long-term consequence, once the boom ends, is stagflation and an overvalued real exchange rate.

But the curse does not affect all countries homogeneously. Some countries, including the Netherlands, seem to be immune to the disease. Australia, Botswana, Norway and Canada have developed without serious problems despite having abundant natural resources. These discrepancies suggest that we need to understand when natural resources are a blessing and when they are a curse. One piece of evidence pointing to an explanation comes from the paper by Mehlum et al. (2006), who use Sachs and Warner’s 1995 data to show that the effect of resources on growth is positive when institutions are of a certain quality.

Democratic countries tend to have better institutions and are therefore less likely to be cursed by natural resources. But empirical findings also suggest a reverse causality known as the political Dutch disease. For example, Ross (2001) and Lam and Wantchekon (2002) have shown that oil and mineral wealth tend to make states less democratic. What’s more, many revolutions are linked to rents derived from natural resources (Collier and Hoeffler 1998). In particular, oil, gemstones, minerals and other mineral resources are associated with civil conflict, while agriculture is not.

A fresh perspective and the curse-or-blessing of natural resources

In recent research (Cabrales and Hauk 2011), we propose an explanation for this phenomenon. We start by probing deeper into the relationship between natural resources and growth by connecting human capital and institutions.

We show that the correlation between natural resources and human capital is negative for countries with low levels of institutional quality, but positive for countries with high institutional quality. Here human capital is measured by the average number of years of schooling of its population. The indicators of institutional quality are from the World Bank, namely government effectiveness, control of corruption, and regulatory quality.

A political economy model: Voice or revolution

To explain this observation, together with the others we mentioned, we present a political model which emphasises the behaviour and incentives of politicians. We do this because the importance of institutions suggests that the behaviour of politicians is fundamental to explain the differential economic performance of resource abundant countries.

More concretely, we extend the standard voting model to give voters political control beyond elections. In our model, as in reality, citizens have instruments in addition to elections that allow them to avoid policies which could cause them large welfare losses. We introduce these considerations in the model by assuming that citizens can initiate a revolution. This introduces a new restriction into our political economy model; policies should not give rise to a revolution.

With this assumption in mind, current rulers in a country will face two types of potential threats. One comes from elections, the other from revolutions. Governments have two policy instruments at their disposal to use the proceeds from natural resources: a direct transfer or a subsidy for the investment in human capital, which has a positive spillover on the entire population. Whatever they do not use, they keep for themselves. Human capital increases the productivity of the population – which crucially includes the opposition and potential revolutionaries.

The equilibrium of the game has the following characteristics.

  • In the presence of a vigorous electoral competition, parties compete mainly on the basis of providing training opportunities to the population, which is the efficient way to provide extra resources.

The spillover of human capital guarantees that direct transfers would lead to underinvestment in human capital.

  • When electoral competition is not a sufficiently strong threat (either because there are no elections, or because the opposition is made ineffective in various ways), rulers are more worried about a violent revolution.

In that case, the incumbent is afraid of education. An educated population is more prone to rebellion, because they know that if they do revolt successfully, they will manage resources more efficiently. In that scenario, they prefer to offer panem et circenses rather than a good math course to keep revolutions at bay.

Another important finding is that the model can explain why natural resources not only can reduce growth when institutions are weak, but they can also weaken political competition itself, making the circle even more vicious. This is not always the case, because there are several forces at work. As resources increase, the government can pay higher direct transfers, thus increasing its chances of winning. On the other hand, the competitors can also offer better terms, especially through higher human capital. The effect of higher direct transfers (i.e. when resources are worse for competition) tends to dominate for high levels of per capita natural wealth, whereas the effect of human capital (so that resources improve competition) does so for lower levels of per capita natural wealth.

In a final note, we should add that although the literature has focused on mineral resources because of data availability, we believe that effects may be similar with other kinds of resources. For example, in several regions of Spain where tourism is an important source of revenue, educational outcomes are worse than one would expect given their levels of income per capita. Tourism is an extractive industry heavily dependent on natural resources such as good weather, nice beaches and old monuments. Similarly, Djankov et al. (2005) have identified international aid as a source of problems for growth and institution building.

References

Auty, RM (1993), Sustaining Development in Mineral Economies: The Resource Curse Thesis, Routledge.

Collier, P and A Hoeffler (1998), “On the economic causes of civil war”, Oxford Economic Papers, 50(4),563-573.

Djankov, S, JG Montalvo, and M Reynal-Querol (2005), “The curse of aid”, Working Paper, Universitat Pompeu Fabra.

Lam, R and L Wantchekon (2002), “Political Dutch disease”, Working Paper, Northwestern University.

Mehlum, H, KO Moene, and R Torvik (2006), “Institutions and the resource curse”, Economic Journal, 116(5), 1-20.

Ross, ML (2001), “Does oil hinder democracy?”, World Politics, 53:325-361.

Sachs, JD and AM Warner (1995), “Natural resource abundance and economic growth”, Working Paper, Harvard Institute for International Development.

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Topics:  Environment Institutions and economics Politics and economics

Tags:  democracy, Corruption, natural resources, resource curse, Dutch disease, revolutions

Professor of Economics, University College London and Universidad Carlos III de Madrid (on leave); and CEPR Research Fellow

Scientific Researcher, Institute of Economic Analysis

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