Thursday, August 5, 2010

Natural resources and prosperity

Does natural resource abundance lead to more wealth and higher growth? This is an ample question of economic growth theory. In addition, many episodes of economic consequences of resource abundance suggest there is no single relationship between resources and growth. Many countries around the world are economically dependent on the supply of natural resources, especially in least developed and developing countries. In spite of significant amount of resources such as oil, coal, natural gas, gold and other commodities, many developing nations remain undeveloped and vastly dependent on foreign aid.

Countries such as Iran, Libya and Venezuela are among the largest oil-producing developing countries. In spite of vast supply of commodities, the data and experience do not suggest a positive impact of resources on economic growth. Prior to the 1979 Islamic revolution, Iran used to be one of the most developed countries in the Middle East. After 1979, Iran underwent an overhaul of its economic system and a beginning of large-scale state intervention in the economy. The theocratic government regime de facto suppressed private property rights and imposed strict government control over the economy. Even though Iran's oil reserves have been among the largest in the world, country's GDP per capita and structural indicators have stagnated since 1979.

Venezuela is a brilliant textbook example of how resource-abundant economy can stall as a consequence of socialist political dictatorship and unlimited constitutional power of the dictator. Libya is attributed with the largest supply of oil in Africa. Country's oil sector accounts for 95 percent of export earnings, 60 percent of public sector wages and 25 percent of GDP (link). Even though the country is the largest oil exporter in Africa and despite a GDP per capita in the rank of Russia and Lithuania, the unemployment rate is estimated at 30 percent which is the 21st highest unemployment rate in the world. In addition, Libya's business environment is marred by the lack of economic freedom resulted from high degree of corruption in public sector and judicial system. According to Heritage Index of Economic Freedom (link), Libya is the least free economy in North Africa and Middle East which is nonetheless unsurprising since in 1978 all private property rights for private businesses were eliminated.

Resource abundant countries also used to be expropriated by the colonizers in the age of colonization. Early colonizers of a vast majority of African resource-abundant countries did not focus on the permanent establishment of sound property rights and contract enforcement but solely on the extraction of natural resources. This created huge political instability and intense war conflicts on the African continent. On the other side, there are countries with abundant natural resources and high prosperity at the same time such as Norway and Canada. The political history of these countries suggests an entirely different institutional setting, based on the protection of private property and contract enforcement. Such a structure and origin of the legal system ensured low transaction costs and sound contract protection by the judicial system as the basis of economic development.

After centuries of socialist political and economic mismanagement, dictatorships in Africa and the Middle East resulted in the artificial wealth illusion demonstrated by relatively high GDP per capita and poor structural indicators such as high unemployment rate. Therefore, one should be cautious in examining the relationship between natural resources and economic growth in the longer run. Nevertheless, institutional, historical and political background of resource abundance should not be neglected.

1 comment:

  1. A very interesting post opening one of the most puzzling questions revisited by the modern growth theory.

    Even though most of the nations in the Middle East and North Africa (excluding Iran and Iraq) enjoyed solid GDP growth prior to 2008/2009 financial crisis, the downward trend of oil prices in world market exerted by the decrease in global demand, is a firm evidence of the macroeconomic vulnerability of these countries to exogenous changes in oil prices.

    Dani Rodrik wrote a wonderful piece on the myths of authoritarian growth ( which had been the foundation of growth policy in developing countries for most of the last century.

    Agreeably, countries with authoritarian political systems and without the institutions of the rule of law and constitutionally guaranteed individual freedom and freedom of the press, lack the institutions of independent judiciary and individual freedom.

    In fact, most of the abovementioned countries have experienced an uninterrupted socialist political dictatorship and a deadly dependence on flows of foreign aid.

    Considering the institutional background from a developmental perspective, the stock of natural resources is positively correlated with long-run economic growth only if aided with the enforcement of policies that not only promote growth but also political competition, individual and economic liberty.