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The Resource Curse: Path toward Stagnation or Development?

The Resource Curse: Path toward Stagnation or Development?

One of the most interesting political and economic phenomena that can be observed in the international arena is the fact that many developing countries that are rich in natural resources have lower economic growth rates than countries without natural resources. At the same time, among the countries with the largest oil reserves, only Canada and the U.S can be classified as democratic while the rest are either Arab monarchies or countries with weak democracies such as Venezuela and Russia. Nowadays, under the condition of low oil prices, this issue is becoming even more relevant. So why the abundant presence of natural resources slows down economic growth and political development in some countries while becoming a source for better economic and political outcomes for others?

Successful examples

The presence of natural resources has allowed several countries to transform from relatively poor economies into leaders of economic development. Because of its forest resources, Sweden transformed into an industrial economy exporting technological goods around the world (Lindahl et al. 2017). Similarly, Finland with company Nokia which for decades produced paper and wood products (Schienstock, 2007). After the high income from its initial business, it was able to create and develop a high-tech telecommunication division which has later become the world leader in the telecommunications industry. Furthermore, in several historical episodes, countries like Australia and Botswana became richer not only due to the diversification policy but due to the efficient technological use of their resources (Lederman and Maloney 2007: 198-214). It led to a more efficient search and extraction of raw material.

In these countries, because of the efforts of the well-trained geologists and engineers, new deposits of natural resources were consequently discovered, mined, and exported. The discovery of natural resources was so effective that the total stock of many types of minerals continued to increase despite the continuous mining and exhaustion of previously discovered deposits.

It is obvious that national companies can further transform into international ones and operate all over the world. Consequently, the income from natural resources can contribute to domestic investments which further lead to the accumulation of physical capital, advanced technologies, and higher qualifications of workers. This, in turn, creates a good environment for economic diversification. However, even in the absence of diversification, income may increase due to the developed commodity market thus leading to a higher level of consumption and savings.

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Human capital

Unfortunately, some countries are not able to use their resource wealth in such a manner where a systematic increase in income, steady economic growth, and political stability occur. Among the main limits in countries where natural wealth does not lead to constant economic growth is the deficit of human capital. The most frequent manifestation of a shortage of human capital is the low efficiency of its extractive industry.

The shortage of highly specialized geologists and engineers leads to an increase in the extraction of natural resources in a way where the constant discovery of such deposits is extremely unlikely and therefore, leads to the exhaustion of natural resources in a relatively short time (Zafar et al. 2019: 2-4).

For example, during the second half of the 19th century, Chile’s “economic dynamism was based on agricultural exports and mining resources”; however, around 82% of its population was illiterate. This, in turn, led to the lack of diversification policy and fast exploitation of natural resources which further resulted in a few crises (Ducoing et al. 2018: 5-6). The Chilean economy was historically facing significant impediments toward achieving economic stability and constant political development. As the Chilean economy was mainly based on mining resources such as tin and copper, it was extremely vulnerable during the falls in mineral prices.

To put it in the modern context, for many developing countries, the income from the export of natural resources still accounts for a significant share of their GDP. For example, in 2017, the income from the natural resources accounted for 42.5% of the GDP of the Republic of the Congo, 38.5% for Libya, and 37% for Kuwait (The World Bank 2017). Therefore, such reliance on natural resources makes the economy extremely fragile during periods of falls in mineral prices. To avoid this, the dependency on natural resources has to be decreased. For instance, the government of Kuwait has recently realized that most of its natural resources will not last forever. Consequently, its government has implemented the “Vision 2035: New Kuwait” program to reduce its dependency on oil and other natural resources. This, in turn, will be done through reforming the land sector which will lead to more investments and consequent economic diversification (Zakout, 2019).

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In other words, human capital plays a crucial role not only for the natural resource sector itself but also for the diversification of the economy. If the country has insufficient human capital, it becomes challenging to get highly-specialized workers necessary to implement a diversification policy even if financial support from the government is provided for this. However, what if the country, for example, will develop a great educational system? Would it be able to accumulate human capital and implement successful economic diversification?

Institutional impact

The accumulation of human capital and further economic and political development would be very challenging if the country lacks transparent economic and political institutions. In other words, if the economy is not endowed with transparent branches of power and a developed financial sector, natural resources can hardly help its economic and political development. In the case of insufficient development of the financial system, well-educated and qualified individuals will experience problems with obtaining loans and other financial help to build their businesses or to realize their professional capabilities.

Figure with the causes of the resource curse.

For example, in Russia,  highly qualified individuals in the "tech sector" experience significant challenges in getting sufficient financing for their businesses. The recent "Skolkovo" project in Russia was implemented to resolve the aforementioned issue. It was designed to be a "Russian Silicon Valley" where Russian entrepreneurs would receive large fundings for their innovative businesses. However, this project resulted in a series of financial scandals related to corruption. Now, it could hardly be called successful because of the weak return on investments. In other words, the corrupted financial sector consequently led to a weak business environment, low business activity, and the so-called human capital flight.

On the contrary, one may argue that weak institutions do not significantly affect the economic and political development as the countries with the abundant presence of natural resources can invest in human capital and infrastructure alone and therefore, achieve economic and political development without strong institutions. In other words, one may argue that institutional issues can be ignored if the country has enough economic capital to invest in education and infrastructure.

However, in this scenario, economic and political development will again not be achieved. If the country lacks strong protection of property rights and an attractive business environment, well-educated individuals will have difficulties in finding jobs that match their qualifications and therefore, will most likely find jobs outside the national labor market. Even though the investment in infrastructure can help companies reduce costs, it does not secure the ownership of earned profits. Consequently, if the investment in infrastructure is not supplemented by an improvement in the institutional environment, the potential outcome may be the appearance of infrastructure alone without the expected increase in business activity.

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In countries like Brazil, Russia, Nigeria, the problems of corruption and insufficient protection of property rights are still present. In their cases, due to corruption, a significant part of the natural wealth is even hardly transformed into infrastructure; on the contrary, the wealth from natural resources is accumulated and transformed into the personal capital of corrupted officials. If we look at the corruption index measured among 180 countries, Brazil, Russia, and Nigeria are being among the highest corrupted countries that are rich in natural resources, ranking 105, 138, and 144 respectively (Transparency International 2019). If we look at the infrastructure index measured among 160 countries, Brazil, Russia, and Nigeria are not even in the top 50, ranking 56, 75, and 110 respectively (The World Bank 2019). Therefore, if the government does not make sufficient efforts to improve the institutional environment, fight corruption and violations by officials, then natural resources and ensuing investments can hardly help economic and political development.

Drawing by Natalia Mikhaylenko

Conclusion

Overall, to effectively use the income from natural resources and achieve long-term economic and political development, it is necessary to increase the level of human capital while ensuring the presence of diverse and transparent institutions. The corruption and insufficient protection of property rights, on the other hand, will only slow down economic development leading to low business activity and the so-called human capital flight. To put it simply, the abundance of natural resources alone does not have a significant effect on economic and political development. It is rather a great tool that has to be wisely used by the heads of state and the government to achieve long-term political development and economic growth.

Written by Vladyslav Konstantynivskyi, Major in Political Science, University of British Columbia (Canada)

References

1.      World Bank (2019. International LPI. Retrieved from: https://lpi.worldbank.org/international/global?sort=asc&order=Infrastructure

2.      Transparency International (2019). Corruption Index 2019. Retrieved from: https://www.transparency.org/en/cpi/2019

3.      Ducoing, C., Peres-Cajías, J., Badia-Miró, M., Bergquist, A., Contreras, C., Ranestad, K., & Torregrosa, S. (2018). Natural resources curse in the long run? Bolivia, Chile and Peru in the nordic countries’ mirror. Sustainability, 10(4), 965. doi:10.3390/su10040965

4.      Lederman, D., Maloney, W. F., Open Knowledge Repository, & World Bank e-Library. (2007). Natural resources, neither curse nor destiny. Washington, DC;Palo Alto, CA;: Stanford Economics and Finance, an imprint of Stanford University Press.

5.      Zafar, M. W., Zaidi, S. A. H., Khan, N. R., Mirza, F. M., Hou, F., & Kirmani, S. A. A. (2019). The impact of natural resources, human capital, and foreign direct investment on the ecological footprint: The case of the united states. Resources Policy, 63, 101428. doi:10.1016/j.resourpol. 2019.101428

6.      Zakout, W., Alkhoja, G., (2019) Land sector reform is key to successful diversification of Kuwait's economy. Retrieved from: https://blogs.worldbank.org/arabvoices/land-sector-reform-key-successful-diversification-kuwait-economy#:~:text=The%20government%20has%20embarked%20on,is%20reforming%20the%20land%20sector.