Harnessing the potential of natural resource extraction for development

Paul Collier interviewed by Romesh Vaitilingam, 08 July 2011

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<p><em>Romesh Vaitilingam interviews Paul Collier for Vox</em></p>
<p style="padding: 0px 0px 0.5em; margin: 0px;"><em>June 2011</em></p>
<p style="padding: 0px 0px 0.5em; margin: 0px;"><em>Transcription of a VoxEU audio interview [http://www.voxeu.org/index.php?q=node/6730]</em><b>&nbsp;</b>&nbsp;&nbsp...
<p><b>Romesh Vaitilingam</b>: &nbsp;Welcome to Vox Talks, a series of audio interviews with leading economists from around the world. My name is Romesh Vaitilingam, and today's interview is with Professor Paul Collier from Oxford University. In June, 2011, Paul spoke at a conference on development policy making organized by the Centre for Competitive Advantage in the Global Economy. His talk was entitled &quot;Harnessing the Potential of Natural Resource Extraction for Development.&quot; When we spoke shortly after the conference, I began by asking him to outline the key decisions facing resource‑rich economies.</p>
<p><b>Paul Collier</b>: &nbsp;Clearly, in the past, many resource‑rich countries haven't managed to harness their potential. And if we drill down, that's because the chain of decisions that has to go right is quite a long and complicated one. And it's kind of a &quot;weakest link problem.&quot; So we can split it into five links in the decision chain. And the first one is just managing the discovery process, the prospecting process. After all, these natural resources are hidden. That stage is part of the, if you like, the economics of information. Discovery is all about generating information. Once they're discovered, what's been discovered? In economic terms, a load of rents have been discovered under the ground.</p>
<p>And so the next step in the chain is to capture those rents for society rather than for the people digging the stuff out of the ground. The people digging the stuff out of the ground are entitled to a return on their labor and capital and risks they're taking, but with natural resources, that leaves a lot of rent which needs to be socialized, and that requires some set of tax instruments so that the rents are captured by society. And that link in the chain is at the moment going horribly wrong in many contexts.</p>
<p>The third link in the chain is that resource extraction happens in some locality, and the people in that locality both have power and can become victims of the process. And it's managing that localization ‑‑ at one extreme, you get local communities of indigenous people that lose everything. They lose their whole environment, and with it, their life meaning.</p>
<p>Somewhere towards the other extreme, you get a mixture of &quot;nimbyism&quot; ‑‑ you know, &quot;not in my backyard&quot; ‑‑ or, even worse than nimbyism, the statement, &quot;This is ours. It doesn't belong to all citizens. It belongs to us.&quot; And the final step of that process is where people say, &quot;And we're not citizens of the country we've been in at all. We're going to create a new country&quot; ‑‑ secession. So, managing that process ‑‑ the legitimate interests of the local without going all the way to saying the local is entitled to full ownership.</p>
<p>So, we've discovered our natural assets, we've taxed them, we've managed the local. Then we turn to the downstream, the revenues that come into the government. What does the government do with them?</p>
<p>The next key link is the decision between consumption and savings, savings including investment. Savings being deferring consumption to the future, in some way. Clearly, because the revenues are generated by depleting a natural asset, they're not sustainable. Now, some are more sustainable than others. Some of them will last for 100 years. Some of them will last for 10 years. A lot of the discoveries we're seeing now, especially of oil, are rather small discoveries. And so they don't last very long ‑‑ 20 years, perhaps.</p>
<p>So that&rsquo;s right up at the end of the spectrum where you need a high savings rate from these revenues ‑‑ not 100%. For a poor society which invests and has a fast growth rate, it's poorer now than it will be in the future. And so there's some case for consuming a proportion, but not a high proportion.</p>
<p>Then the final link in the chain is, having decided to save a lot of the revenues, what form should those savings take, and how should they be done.</p>
<p>The model that has all the glamour ‑ 50 developing countries have asked about it ‑ is the Norwegian model. That's a really good model for Norway. Norway's model is &quot;save the money abroad&quot;. That makes a lot of sense for Norway, because Norway has more invested capital per worker than any other country in the world. Just using Norwegian oil to pile up more and more capital in Norway, will be less productive than having claims on capital in Brazil--which is what they are doing by investing abroad.</p>
<p>But of course, the lower‑income, resource‑rich countries are the opposite end of the spectrum. They are very short of capital, so they should be investing at home. But, to do that investment at home, they need to build the capacity to invest properly, which at the moment they don't have. So that final link is building the capacity to invest productively, which I call &quot;investing in investing&quot;.</p>
<p>Along the way, we've skipped over the need to smooth revenue volatility out, which is a liquidity function for holding money abroad.</p>
<p><b>Romesh</b>: &nbsp;Perhaps we could come back to that issue of commodity price fluctuations. That's a very interesting and a very topical one.</p>
<p><b>Paul</b>: &nbsp;Yes.</p>
<p><b>Romesh</b>: &nbsp;One thing I want to ask you. We know from history that so many countries have failed to use their natural resources in a way that benefits all citizens of their society. Do we have any examples of countries that have successfully followed the kind of path that you are describing?</p>
<p><b>Paul</b>: &nbsp;Oh yes. Of course, there are plenty of successful resource‑rich countries. It's just that the final step in being resource‑rich is to diversify out of being resource‑dependent. So we don't think of them as resource‑rich. But, the story of America, Australia, Norway are stories of very successful resource‑rich countries. If we look at a developing country that has moved from fragile poverty to success over a 40‑year period, it&rsquo;s Malaysia. Very successful, having a first phase of harnessing its natural assets, investing in a diversified economy, and now you no longer think of Malaysia as resource‑rich. But that's how it got started.</p>
<p>In Africa, the example would be Botswana, which hasn't yet managed the passage to diversification, but has handled its natural assets, diamonds, very prudently. It's moved from being an impoverished, semi‑arid, land‑locked country with no opportunity at all, to being pretty well the most prosperous country in sub‑Saharan Africa.</p>
<p><b>Romesh</b>: &nbsp;Your decision chain is really advice for the governments of poor countries that have a wealth of natural resources. What's the role of the development community, generally, the advanced countries, in trying to encourage poorer countries to follow this agenda?</p>
<p><b>Paul</b>: &nbsp;Yeah, well first of all we have to recognize this decision chain is the responsibility of the resource‑rich societies themselves, first and foremost. It's their struggle, and it's not enough for governments. Governments need to build rules--institutions, if you like--and those rules to be effective need to be understood and supported by a critical mass of citizens. So you need, actually, both the government to understand the need for rules, with checks balances along the decision chain, and to build a critical mass of citizens who understand it. Then, the domestic processes. What can the international community do? I point to two things. One is we can help that information process. An awful lot of it is social learning. There's a lot of knowledge out there which can now accelerate that social learning. The international community can adopt international guidelines, even if they are voluntary. Those guidelines can be very useful, as it were, to be downloaded, both literally and metaphorically, by the societies themselves. They can benchmark themselves against guidelines and see where they need to improve.</p>
<p>The other thing that the international community can do is, major actors in all this decision chain are the resource extraction companies. Very few low‑income, resource‑rich countries have their own resource extraction companies. They don't have the technology, the skilled labor, the finance. It's very expensive getting this extraction process going.</p>
<p>And so, inevitably, international companies are centrally involved. Now, some of those are from the West. Some of them are from emerging markets like Vale in Brazil or the Chinese. And it's important that we don't have a race to the bottom of misgovernance. What's been happening to date is that these companies often go in, they find the weakest link in the government, and they bribe their way through it. That can be disciplined by full revelation of payments by companies in these situations.</p>
<p>At the moment, we've got patchy legislation internationally. The Americans now, as of last July, enforce it. The rest of the world doesn't. And so getting to a common global position of enforcement is very important, because you can't have one set of companies living by one set of rules, and another just bypassing it.</p>
<p><b>Romesh</b>: &nbsp;You've been involved with something called the Natural Resources Charter. Can you talk a little bit about that and the role that might play in supporting countries thinking about how they're going to harness their natural resources.</p>
<p><b>Paul</b>: &nbsp;Yeah. So Natural Resource Charter is an alliance between academics and civil society, basically. So there are a lot of academics--economists, lawyers predominantly, some political scientists‑‑trying to put detail on this decision chain that I've described. At each stage there are a lot of complexities. So the Natural Resource Charter has produced a website, naturalresourcecharter.org. It's got an annual, quite large workshop. Over a hundred people are coming to Oxford, to an event organized by my colleague Tony Venables, to work on improving the content of the charter. The aspiration in terms of content is a sort of Wikipedia of how to manage the opportunity of natural resources. But then the Natural Resource Charter is also a political process coming out of civil society. So it has a board, it's an entirely Southern board, headed by Ernesto Zedillo, former president of Mexico, an oil‑rich country that messed up with oil. Ernesto Zedillo, now a professor at Yale, on that board. There are two Africans, a Chinese, and an Arab. So this is not the North wagging its finger at the South. This is the South in control of its destiny trying to say, &quot;Here are the guidelines for building the detailed rules, and the critical mass of informed citizens that will support those rules.&quot;</p>
<p>The actually detail of building the rules, the design of the rules, will have to be different society by society. Countries really are different. You can't say, &quot;Here's a blueprint for the institutions you need.&quot; But you can say, &quot;Here's the common set of analytic principles for these decisions.&quot;</p>
<p><b>Romesh</b>: &nbsp;Let's come back to the issue around commodity price volatility. I mean, we're going through a period of very high commodity prices. Are there particular ways that developing countries that are rich in resources, rich in these high‑priced commodities, should deal with it when the prices are high compared to when they're low?</p>
<p><b>Paul</b>: &nbsp;Yeah. Volatility extends even beyond price. There's also quantity volatility. So, you get a sudden discovery. I'm on the board of the Central Bank of Botswana, and diamonds are not volatile in price, but diamond exports are volatile in quantity, for sure. There are periods when diamond exports collapse in order to defend the price. So volatility of enormous proportion is the one constant for resource‑rich countries. Now, coping with volatility, you can't afford to have expenditure as volatile as revenue. If you try to have the expenditure as volatile as revenue, the quality of public spending will collapse. So that volatility of revenue has to be taken somewhere, it has to be cushioned somewhere. There are a number of ways of doing it. One is to hedge. After all, if we're concerned about the risk, then insurance is not a bad strategy. Politically, hedging turns out to be very difficult, because it involves finance ministers paying money for something that very often won't get called, and that makes them politically very vulnerable.</p>
<p>So insurance approaches are less common than you might think. If you don't go the insurance route, then you go the savings route. So what these countries need is not a sovereign wealth fund, they need a sovereign liquidity fund, as it were. How much liquidity? Well, countries shouldn't even aspire to fully smooth expenditures. Simulations suggest the amount of liquid assets you need to do that would be enormous, because we have no clue what the long‑term average commodity price will be. We just know we'll be wrong.</p>
<p>So I think it's better to work on something that dampens the shocks, such as a moving average of several past years. And there the conceptual trade‑off is, the more you put into liquidity, that has an opportunity cost. At the moment, the rate of return on liquid assets globally is probably around zero in real terms. The rate of return on invested assets within the economy, public assets, let's say five to 10%, that's the sort of realistic figure.</p>
<p>So building up liquidity has a cost, and the benefit is less volatility in public spending. Within public spending, you probably fully want to protect public consumption. All we know from economics of habit formation and such‑like suggests that big falls in consumption are costly. To the extent that you have to live with volatility, it would be living with investment volatility. And that's partly a matter of how you organize the investment side of things.</p>
<p>The bigger this investment is as a share of GDP, in absolute terms the more volatility you can stand. If you have a 10 percentage point swing in investment to GDP, it's better that it should be in the range 25 to 35 than the range 10 to 20. Also, you can prepare a lot of projects. When investment is low, you can still run your design capacity, design and selection process, and have a shelf full of projects ready to be implemented once the revenues are there. So these are things where you can learn to live with a certain amount of investment volatility.</p>
<p><b>Romesh</b>: &nbsp;Final question, Paul. You've talked to lots of governments in poor countries that are discovering resource wealth that they can draw on, and harness, in the way we've been talking about. How optimistic are you that over the next few years we'll see some of these countries really successfully follow the path that you're recommending that they follow?</p>
<p><b>Paul</b>: &nbsp;One reason for success is that, certainly around Africa, there's a burning sense of &quot;never again.&quot; There's a burning awareness that the past is a history of plunder, of the few expropriating from the many, of the present, expropriating from the future. And so there's a burning sense of &quot;Let's avoid that.&quot; Now, to date, they've not successfully built on that. Ghana, which was probably the best managed economy in Africa, discovered oil in 2007, and, very rapidly, the quality of public spending decisions deteriorated. This is what in fact inspired a lot of this work on the Natural Resource Charter, because general homilies about good governance are not enough. Governments and societies actually need to get up to speed on the specifics of the decision chain. We've found a lot of take‑up for the Natural Resource Charter. For example, NEPAD, which is the economic arm of the African Union, has adopted it as a flagship program. African Development Bank ringingly endorsed it. I'm working with governments and with civil society in Africa picking this charter up. So this is a struggle. Whether it will go better than last time, let's hope so. People do learn from the past.</p>
<p><b>Romesh</b>: &nbsp;Paul Collier, thank you very much.</p>
<p><b>Paul</b>: &nbsp;Thank you.&nbsp;</p>

Topics:  Development Environment

Tags:  development, resource endowments

See also:

Royal Economic Society (2011) 'How developing countries rich in natural resources should harness the revenues for growth'. RES Media Briefings: The Economic Journal, March.

More information on the National Resource Charter: http://www.naturalresourcecharter.org/

Professor of Economics at the University of Oxford and Director of the International Growth Centre


CEPR Policy Research