Follow-Up: The Natural Resource Curse

This is a follow up to a comment left on my facebook wall on a blog on Mining in South Africa.

The comment

I think your getting hung up over the use of the term capitalism here.
The fact is that whoever manages the resources can manage them well/bady, ethically/unethically.
Big business very often takes all of the money from the resources of a country. The people living in the country feel no benefits and see little to nothing of the profit.. A multi national company is not necessarily interested in the economy of the poor company it is exploiting the resources of. Especially if this means that they will have to pay their workers more money. it is in their interests to keep that economy weak so that they can keep staff costs low and maximise profit. They also often have no concerns about long term and will just exploit as much as they can while they can. An elected government should (in theory) have a more vested interest in a long term strategy and in using the money generated from the resources to benefit the population (that includes investing the money in businesses that could further benefit the country's economy).
If you compare Norway to South Africa for example- the general population of Norway has benefited from their oil and the clever management of their oil.
The government has a significant stake within the oil industry and the population has benefited. (Of course many other factors apply here and I'm making generalizations)
In principle I think that the general population should be entitled to benefit from the natural resources of their country. Capitalism does not guarantee this on it's own. There needs to be some ethical management to ensure that the profits are not just making a few people rich or leaving the country entirely.

My reply:

Wow! A nice little analysis! And (almost) an invitation to go deeper into the economics of the natural resource curse J

In all cases where there are significant natural resources in a country the Government is deeply involved – this includes South Africa already, and indeed, the mining companies are already complaining that there is too much Government involvement making them uncompetitive and making it difficult for them to compete internationally.

Unfortunately, until very recently, of all these Government interventions, this has worked out very badly for the population in all but 2 places. One, you correctly cited as Norway. The other is Botswana. Interestingly, both do very well on the World Bank Governance Index, which includes corruption. It suggests, as you rightly say, that resources can be managed well or badly. Unfortunately, it seems that Governments in general manage them badly, and those that do well are the exception and not the rule.

There are several reasons why natural resources might be a curse:

1/ Political – a/ it leads to corruption which has (for various reasons) a negative impact b/ Governments concentrate on the areas which raises most tax revenue for them and ignore the rest of the economy (let’s call this ‘benign neglect’ although depending upon motivation it might be more ‘malign’).

2/ Price increases – the natural resource company, far from paying low wages and low prices for inputs actually pay *higher* prices. Nice, you might this – perhaps they are not so bad after all. Unfortunately, this pushes up prices in the economy overall and makes it very hard for firms in other sectors to survive and overall, production actually slows down in other areas. It will also tend to employ the better people in the economy taking them away from other sectors and Government – a problem in Zambia now, for example (In economics, we would call this a ‘Balassa-Samuelson effect’.)

3/ Exchange rates – almost all natural resources tend exported. People in other countries have to buy your currency to pay you. This makes your currency cost more (as demand has increased for it). Unfortunately, this makes goods from all other industries appear more expensive abroad and makes it more difficult to export. As with 2, other production ceases and overall the economy becomes less productive. (In economics, this is called ‘Dutch Disease’ – yes, it even happened following the discovery of natural gas in the Netherlands.)

Norway and Botswana seem to have avoided these curses for 2 reasons each. Both are comparatively uncorrupt places. Norway avoided 2 by investing revenue abroad using a sovereign wealth fund – that way, the money flowed in, and then out again, having only a small effect on their exchange rate and minimizing the impact on other industries. Botswana’s main other industry is tourism. But not backbackers, who are sensitive to the high prices which are a result of their diamond exports, but rather to rich tourists who are happy to pay US$10,000 to shoot a lion. These tourists are less sensitive to high prices.

In some sense, both countries have achieved good performance for their people more by luck than judgement, but in both cases, good governance prevails suggesting this is a necessary prerequisite. Unfortunately, human nature being what it is …

Other countries (notably in the Middle East) are now mimicking Norway’s sovereign wealth fund route and achieving some success.

Here is a short summary of a paper I wrote (with Richard Record) on the impact of natural resources on firms in other industries.

In reply to the fact that multilaterals may not care about the economy in general – well, yes. True. But I will invoke Adam Smith’s invisible hand; quite simply, a firm doesn’t have to care about the economy or country as a whole for sometimes, it to act in a way that is, in fact, more beneficial to a country than Government behavior might. Even if it is driven by that most base of motives: profit.

Since you invoke low wages as an example, I assume that the point is that they should pay higher wages. In fact, natural resource firms actually do tend to pay higher wages than are paid in other sectors. It is a pity that actually this can have a bad impact on the economy overall (see ‘2’ above), so I would hate to see good intentions actually making this worse.