Oxford Centre for the Analysis of Resource Rich Economies
Department of Economics

Abstract Brunnschweiler and Bulte (2008) provide cross-country evidence that the resource curse is a "red herring" once one corrects for endogeneity of resource exports and allows resource abundance affect growth.  Their results show that resource exports are no longer significant while the value of subsoil assets has a significant positive effect on growth.  But the World Bank measure of subsoil assets is proportional to current rents, and thus also endogenous.  Furthermore, their results suffer from an unfortunate data mishap, omitted variables bias, weakness of the instruments, violation of exclusion restrictions and misspecification error.  Correcting for these issues and instrumenting resource exports with values of proven reserves at the beginning of the sample period; there is no evidence for the rersource curse either and subsoil assets are no longer significant.  However, the same evidence suggests that resource exports or rents boost growth in stable countries, but also make especially already volatile countries more volatile and thus indirectly worsen growth prospects.  Ignoring the volatility channel, may lead one to erroneously conclude that there is no effect of resources on growth.

The Pungent Smell of "Red Herrings": subsoil assets, rents, volatility and the resource curse.

Abstract This paper investigates the scope for international rules to address market failures in trade in natural resources and the associated internationla transactions of prospecting and investment in resource exploitation.  We argue that several market failures are likely to have substantial costs.  However, due to the distinctive reatures of natural resources, the market failures are particular to them.  The ad hoc approaches which have attempted to address them to date leave scope for a more systematic and comprehensive approach by the WTO, but the distinctive features of natural resources imply that this could not simply be an application of the rules appropriate for other forms of trade.

International Rules for Trade in Natural Resources.  Journal of Globalization and Development: 1, Iss.1, Article 8 (2010).

Abstract This paper provides an overview of the relationships between natural resources, governance, and economic performance.  The relationships run in both directions, with resources potentially altering the quality of governance, and governance being particularly important for resource poor countries. Both these relationships have threshold effects; if governance quality is above some level then natural resources can lead to further improvement, while below the threshold further deterioration may take place.  Theoretical and empirical work is reviewed, the interactions between the relationships discussed, and policy implications outlined.

Natural Resources and State Fragility

Abstract This paper examines the effect of natural resources on the level of democracy in a set of countries. The main model is a fixed effects regression model, where the focus is on within-country variation over time. The effect of different resources is investigated, namely the effect of oil, diamonds and agriculture. Furthermore, a distinction is made between two broad types of resources, diffuse and point resources, to explore whether the effect on democracy is similar or different. Criticism in existing literature on the presence of the resource curse is taken into account. Production data on natural resources is used and not the common variable ‘resource exports-over-GDP', the latter being flawed. A possible endogeneity problem is taken into account, as well as the persistence of democracy over time. I find evidence for a resource curse of oil on democracy. It is present in different model specifications, such as models with either fixed effects or a lagged dependent variable. There only seems to be very weak evidence for a negative effect of point resources on democracy, compared to the effect of diffuse resources. It is argued that this might be due to the geographic concentration of these types of resources, which enables governments and elite groups to capture resource rents.

The Effect of Oil and Diamonds on Democracy: is there really a resource curse?

Abstract This paper examines the impact of oil on economic growth in transition economies of the former Soviet Union and Central and Eastern Europe.  I use oil production and reserves data in a series of panel estimations to show that oil has had positive growth effects between 1990-2006, although they appear to be diminishing for very large producers.  These positive effects are confirmed when I consider different oil ownership structures.  Oil has however had a negative effect on human capital formation, and corruption and democracy levels.  Additionally, I find that privatisation levels have had positive growth effects, while privatisation speed has had negative effects on growth.

Oil and Growth in Transition Countries

Abstract We use variation in oil output among Brazilian municipalities to investigate the effects of resource windfalls.  We find muted effects of oil through market channels: offshore oil has no effect on municipal non-oil GDP or its composition, while onshore oil has only modest effects on non-oil GDP composition.  However, oil abundance causes municipal revenues and reported spending on a range of budgetary items to icrease, mainly as a result of royalties paid by Petrobras.  Nevertheless survey-based measures of social transfers, public good provision, infrastructure, and household income increase less (if at all) than one might expect given the increase in reported spending.  To explain why oil windfalls contribute little to local living standards, we use data from the Brazilian media and federal police to document that very large oil output increases alleged instances of illegal activities associated with mayors.

Do Oil Windfalls Improve Living Standards? Evidence from Brazil

AbstractWe propose a framework for estimating forward-looking fiscal reaction functions for non-hydrocarbon tax and public spending shares and the deficit using official projections for hydrocarbon revenues and the burden of pensioners used by government agencies. We apply this framework to Norway and compare our estimates with permanent-income and bird-in-hand rules. We find that fiscal reactions have been partial forward-looking with respect to the rising pension bill, but backward-looking with respect to hydrocarbon revenues. The costs of a rapidly graying population are insufficiently taken into account in current fiscal rules, since Norway will go from a current net asset-GDP-ratio close to one into a net debt-GDP-ratio of two in 2060.

Fiscal Reactions to Anticipated Hydrocarbon Windfalls and Pension Burden: Is Norway's Stabilization Fund prudent enough?  Revised, November 2009

AbstractIn most of the developing world, sustained growth is a precarious achievement.  The longstanding volatility of output in sub-Saharan Africa and Latin America is well known, and in the 1990s, instability extended even to some of the strong performers of East Asia.  The sources of volatility remain somewhat obscure, however.  There is little consensus among economists on the sources of output fluctuations even in developed countries, and since poorer countries appear to show a much wider range of volatility patterns, the intellectual challenge is a formidable one.

Literature on the causes and consequences of volatility is growing by the day, however.  Some of the leading explanations for output volatility include the role played by macroeconomic distortions, low levels of financial sector development and weak political institutions.  Popular accounts of volatility in developing countries are based around the role of terms of trade fluctuations.  The story is deceptively simple.  Growth in a typical developing country may be more volatile by virtue of its specialization in primary commodities.  Since primary commodity prices are more volatile in global mmarkets, developing countries are more susceptible to terms of trade fluctuations - and, thereby - greater output volatility.

But this is an incomplete description of growth instability in developing countries.  It begs the questions: why do poor economies tend to specialize in a narrow range of commodities.  From the perspective of small open economies, changes in world prices can be considered as exogenous. But the effect of a given price change will depend on a country's trade structure.  And this is clearly endogenous in the long run.

Why do some countries remain locked in primary commodity exporting, while others diversify their export structures and achieve greater specialization in manufactured exports? This paper argues that a country's geographical characteristics can be an important determinant of its trade structure.  In particular, it highlights the adverse effects of remoteness for export patterns and exposure to growth shocks resulting in high levels of volatility.  Focusing on structural causes of volatility, this paper concludes that there is considerable empirical support for geography-based explanations for volatility.  The effect of geography on volatility surves even after controlling for other determinants of volatility traditionally considered in the literature.  The analysis in this paper is based on a forthcoming article in the Journal of Development Economics (see Malik and Temple (2009); an earlier more detailed working paper version is Malik and Temple (2006)).

Geography and Trade Structure: Implications for Volatility

AbstractWe introduce learning into a Hotelling model of a non-renewable resource market.  By combining learning and scarcity we add significantly to the dynamics implied by learning and substantially enhance the volatility of commodity prices.  In our learning model we show how a self confirming equilibrium exists but is not constant over time.  As scarcity increases the SCE shifts from a non-cooperative rational expectations equilibrium to a cooperative rational expectations outcome.  As a result prices trend at a rate faster than the rate of time preference.  We show the existence of escape dynamics which generate substantial volatility in commodity prices despite the fact the model is subject only to i.i.d shocks.  The shifting SCE significantly alters escape dynamics with the time to escape shortening and the magnitude of dynamics reducing as scarcity rises.  In terms of the Hotelling model, a shifting SCE and variable escape dynamics introduces greater volatility at low frequencies and substantially larger cyclical volatility.  These price fluctuations show sharp upward breaks in price and non-linear, non-stationary and asymmetric price fluctuations.  We show these results are robust to a range of extensions, including extractions costs, stochastic shifts in demand and learning assumptions closer to rational expectations.

Learning and Price Volatility in Duopoly Models of Resource Depletion

AbstractThe volatility of unanticipated output growth in income per capita is detrimental to long-run development, controlling for initial income per capita, population growth, human capital, investment, openness and natural resource dependence.  This effect is significant and robust over a wide range of specifications.  We unravel the effects of volatility by opening the black box and conditioning the variance of growth shocks on several country characteristics.  Natural resource dependence, physical and institutional barriers to trade and associated policy shocks increase volatility sharply and harm growth through this indirect channel.  The robust indirect effect of natural resources through volatility trumps any direct effects on economic development, even if natural resource dependence is measured net of extraction costs.  Financial development appears to mitigate the harmful causes of volatility.  Our panel data estimation confirms our cross-country results, but we also offer evidence that well developed financial systems amplify the effect of short-term terms-of-trade volatility on macroeconomic volatility.

The Volatility Curse and Financial Development: Revisiting the Paradox of Plenty

AbstractWe hypothesize that natural resources raise income inequality in ethnically polarized societies, but reduce income inequality in ethnically homogenous societies; and we present empirical evidence in support of this hypothesis.

Natural Resources and Income Inequality: The Role of Ethnic Divisions

AbstractWhat are the effects of regional integration and other trade policy measures in regions such as Central Asia or the Great Lakes Region of Africa where countries are remote with poor access to the outside world and where foreign exchange earnings come largely from natural resource based exports?  We show that if countries have unequal natural resource endowments, then the gains from non-preferential trade liberalisation accrue largely to the more resource rich economies, while the opposite is true for regional integration.  Regional integration is a powerful way to spread the benefits of resource wealth more widely, but may also be an obstacle to external trade liberalisation.

Economic Integration in Remote Resource Rich Regions. Revised, August 2009

AbstractThe effects of stochastic oil demand on optimal oil extractions paths and tax, spending and government debt policies are analyzed when the oil demand schedule is linear and preferences quadratic.  Without prudence, optimal oil extraction is governed by the Hotelling rule and optimal budgetary policies by the tax and consumption smoothing principle.  Volatile oil demand brings forward oil extraction and induces a bigger government surplus.  With prudence, the government depletes oil reserves even more aggressively and engages in additional precautionary saving financed by postponing spending and bringing taxes forward, especially if it has substantial monopoly power on the oil market, gives high priority to the public spending target and is very prudent, and future oil demand has high variance.  Uncertain economic prospects induce even higher precautionary saving and, if non-oil revenue shocks and oil revenue shocks are positively correlated, even more aggressive oil extraction.  In contrast, prudent governments deliberately underestimate oil reserves which induce less aggressive oil depletion and less government saving, but less so if uncertainty about reserves and oil demand are positively correlated.

Aggressive Oil Extraction and Precautionary Saving: Coping with Volatility. Revised, February 2010

AbstractWe study how natural resources can feed corruption and how this effect depends on the quality of the democratic institutions. Our game-theoretic model predicts that resource rents lead to an increase in corruption if the quality of the democratic institutions is relatively poor, but not otherwise. We use panel data covering the period 1980 to 2004 and 124 countries to test this theoretical prediction. Our estimates confirm that the relationship between resource rents and corruption depends on the quality of the democratic institutions. Our main results hold when we control for the effects of income, time varying common shocks, regional fixed effects and various additional covariates. They are also robust to the use of various alternative measures of natural resources, corruption and the quality of the democratic institutions, and across different samples. These findings imply that democratization might be a powerful tool to reduce corruption in resource-rich countries.

Natural Resources, Democracy and Corruption

AbstractFor a country fractionalized in competing factions, each owning part of the stock of natural exhaustible resources, or with insecure property rights, we analyze how resources are transformed into productive capital to sustain consumption. We allow property rights to improve as the country transforms natural resources into capital. The ensuing power struggle about the control of resources is solved as a non-cooperative differential game. Prices of resources and depletion increase faster than suggested by the Hotelling rule, especially with many competing factions and less secure property rights. As a result, the country substitutes away from resources to capital too rapidly and invests more than predicted by the Hartwick rule. The power struggle boosts output but depresses aggregate consumption and welfare, especially in highly fractionalized countries with less secure property rights. Genuine saving evaluated with welfare-based accounting prices is zero in this game, but biased upwards if calculated with the lower market prices.

Rapacious Resource Depletion, Excessive Investment and Insecure Property Rights. Revised, April 2009

Abstract Resource-rich countries have tended to be autocratic and also have tended to use their resource wealth badly. The neoconservative agenda of promoting democratization in resource-rich countries thus offers the hopeful prospect of a better use of their economic opportunities. This paper examines whether the effect of democracy on economic performance is distinctive in resource-rich societies. We show that a priori the sign of the effect is ambiguous: resource rents could either enhance or undermine the economic consequences of democracy. We therefore investigate the issue empirically. We first build a new data set on country-specific resource rents, annually for the period 1970-2001. Using a global panel data set we find that in developing countries the combination of high natural resource rents and open democratic systems has been growth-reducing. Checks and balances offset this adverse effect. Thus, resource-rich economies need a distinctive form of democracy with particularly strong checks and balances. Unfortunately this is rare: checks and balances are public goods and so are liable to be undersupplied in new democracies. Over time they are eroded by resource rents.

Testing the Neocon Agenda: Democracy in resource-rich societies.Forthcoming, European Economic Review

AbstractThis paper provides an analytic review of the upstream aspects of the exploitation of natural resources: the assignment of ownership rights, taxation, the discovery process, extraction, renewability, and clean-up. It sets these issues within the principal-agent framework. It proposes that the present common system whereby governments sell extraction rights prior to discovery through signature bonuses is likely to be socially costly, since the sale of rights occurs at a stage where irreducible risks generate a severe discount. It also proposes that the present common system whereby governments sell extraction rights by means of negotiated deals might disadvantage governments relative to more transparent and competitive systems such as auctions. While the paper is primarily analytic, it also briefly reviews African experience, suggesting that both high
commodity prices and the low value of discovered assets per hectare imply major opportunities.

Managing the Exploitation of Natural Assets: Lessons for low income countries

AbstractA windfall of natural resource revenue (or foreign aid) faces government with choices of how to manage public debt, investment, and the distribution of funds for consumption, particularly if the windfall is both anticipated and temporary. Standard policy advice follows the permanent income hypothesis in suggesting a sustained in increase in consumption supported by interest on accumulated foreign assets (a Sovereign Wealth Fund) once resource revenues are exhausted. However, this strategy is not optimal for capital-scarce developing economies. Incremental consumption should be skewed towards present generations, relative to those in the far future. Savings should be directed to accumulation of domestic private and public capital rather than foreign assets. Optimal policy depends on instruments available to government. We study cases where the government can make lump-sum transfers to consumers; where such transfers are impossible so optimal policy involves cutting distortionary taxation in order to raise investment and wages; and where Ricardian consumers can borrow against future revenues so government only has indirect control of consumption.

Harnessing Windfall Revenues : Optimal policies for resource-rich developing economies. Revised, January 2010

AbstractCountries that are reliant upon commodity exports periodically face large adverse price shocks. Given past volatility, the present high world prices for commodities may
be a precursor to such shocks. Unsurprisingly, adverse price shocks reduce the growth of constant-price GDP and we analyze which structural policies help to minimize these losses. Structural policies are incentives and regulations that are maintained for long periods, contrasting with policy responses to shocks, the analysis of which has dominated the literature. We show that structural policies have large effects. In particular, policies which enable flexibility in labour markets and which ease the entry and exit of firms, are particularly well-suited to shock-prone commodity exporters. We show that these gains are systematically unrealized. Indeed, we find a political economy paradox that the larger are the gains from good structural policy, the worse are the policies actually adopted. We account for this paradox in terms of the lack of responsiveness to the needs of the economy that resource rents induce.

Structural Policies for Shock-Prone Commodity Exporters Forthcoming, Oxford Economic Papers

AbstractThe political economy of resource rich countries is surveyed. The empirical evidence suggests that countries with a large share of primary exports in GNP have bad growth records and high inequality, especially if the quality of institutions and the rule of law are bad. The economic argument that a resource bonanza induces appreciation of the real exchange rate and a decline of non-resource export sectors may have some relevance. More important, a resource boom reinforces rent grabbing, especially if institutions are bad, and keeps in place bad policies. Optimal resource management may make use of the Hotelling rule and the Hartwick rule. However, a recent World Bank study suggests that resource rich economies squander their natural resource wealth and more often have negative genuine saving rates. Still, countries such as Botswana, Canada, Australia and Norway suggest it is possible to escape the resource curse. Some practical suggestions for a better management of natural resources are offered.

Challenges and Opportunities for Resource Rich Economies

AbstractWe provide cross-country evidence that rejects the traditional interpretation of the natural resource curse. First, growth depends negatively on volatility of unanticipated output growth independent of initial income, investment, human capital, trade openness, natural resource dependence and population growth. Second, the direct positive effect of resources on growth is swamped by the indirect negative effect through volatility. Third, with well developed financial sectors, the resource curse is less pronounced. Fourth, landlocked countries with ethnic tensions have higher volatility and lower growth. Fifth, restrictions on the current account raise volatility and depress growth whereas capital account restrictions lower volatility and boost growth. Our key message is thus that volatility is a quintessential feature of the resource curse.

Volatility and the Natural Resource Curse. Oxford Economic Papers, 2009, 61,4, 727-760

AbstractWe criticize existing empirical results on the detrimental effects of natural resource dependence on the rate of economic growth after controlling for institutional quality, openness, and initial income. These results do not survive once we use instrumental variables techniques to correct for the endogenous nature of the explanatory variables. Furthermore, they suffer from omitted variables bias as they overestimate the effect of initial income per capita and thus underestimate the speed of conditional convergence. Instead, we provide new evidence for the impact of natural resource dependence on income per capita in a systematic empirical cross-country framework. In addition to a significant negative direct impact of natural resources on income per capita, we find a significant indirect effect of natural resources on institutions. We allow for interaction effects and provide evidence that the natural resource curse is particularly severe for economic performance in countries with a low degree of trade openness. Adopting policies directed toward more trade openness may thus soften the impact of a resource curse. We also check the robustness of our results by using a variety of instruments and also employing the ratio of natural capital rather than natural resource exports to national income as an explanatory variable. We find evidence that resource abundance, measured by the stock of natural capital, also induces a resource curse, but less severely for countries that are relatively open.

Can the Natural Resource Curse be Turned into a Blessing? The Role of Trade Policies and Institutions