Abundance in natural resources can lead to lower growth rates through several channels: Here we will discuss two: Dutch disease effects; and poor political institutions and poor government policy.
Dutch Disease Effects
The term “Dutch disease” describes a phenomenon by which the abundance of natural resources in a country becomes in a disadvantage instead of being something from which the country could benefit through the commerce. The mechanism by which Dutch disease is manifested is through international trade. It begins with the abundant natural resources extraction, then is continued in the export of those resources and ends in the inflow of foreign exchange as result of the sale of those natural resources. The term arises from what happened to the economy in the Netherlands after large amounts of natural gas was produced in that country in the late 1960s and early 1970s.
According to World Bank authors, Dutch disease results where, “In places where natural resources are abundant—that is, where they can be produced at low cost, relative to the marginal cost of production elsewhere—they generate large profits (economic rents) for the owners. This has two major effects on the relative incentive structure in the economy. First, to the extent the resources are exported, the inflow of foreign exchange appreciates the real exchange rate: that is, it raises the price of non-tradable goods relative to that of tradable goods. Second, it increases the returns to production of the resource relative to other tradable goods. Both of these effects reduce the incentive to invest in production of other tradable goods, resulting in a production and export structure concentrated in the resource. (Sinnott, Nash, & De la Torre, 2010)
For an example, assume that a country finds it has a lot of mineral wealth – say silver. The silver is mined, and then sold for dollars in the international market. The dollars come into the country and are then converted into the local currency. This raises the value of the local currency with respect to world markets, making wages and local raw material increase in price conducting higher costs for local producers. This drives people out of potentially useful areas, often in the agricultural sector.
In the 1960s, natural gas was found off the coast of the Netherlands. This led to rise in the value of the Dutch currency, making Dutch manufacturing less competitive and harming the Dutch manufacturing sector. A solution could be for a country to give up its domestic currency, like Panama switching to dollars as its currency. However, the drawbacks from such a move could be serious, as what happened in Greece in 2013 after it switched to using the Euro as its currency.
Political Authorities and Institutional Issues
The resource curse may cause the capture of political institutions for ends and interests of those who are active or are located near natural resources. This means that the resource curse affects political institutions, making them serve special interests, reducing their ability to control and supervise economic activity.
The political authorities often collude with private companies to develop projects with the income that comes from the exploitation of natural resources. While these projects may have social purposes, many irregularities often occur. For example, projects are developed with large budgets, equipment is bought with prices above the market, estimated costs increase during the development stage of the project. All these overstatements are ways by which the authorities and private companies receive private benefits from resource extraction.
This behavior leads to what economists call “rent seeking”. This means that there are civil groups, private companies or authorities, which receive income from resources, looking for getting revenues, rents or some money without providing or developing some productive activity.
Recent research shows a direct relationship between the abundance of resources and poorly run governments, poor and weak institutions or administrations led astray by special interests. This is a direct consequence of the behavior of the authorities. The authorities direct their efforts and attention to seeking to stay in power. To remain in power, the authorities use the resources at its disposal looking to catch and supply the needs of their constituents. The regime could also develop economic activities in order to create jobs and distribute them among their potential electors. The result may ultimately be a struggle between the most advantaged and disadvantaged groups, and social unrest.
For example: Loreto, a region in the northeastern Peru, has large quantities of petroleum. The extraction of petroleum is done by companies who pay taxes. A portion of these taxes are allocated to the local governments of Loreto for developing local infrastructure and public services. However, from 2010 to 2013, corruption appears to have taken root in the local government. The authorities of the local government are being investigated to determine the extent of corruption and the use of the funds they received. The supporters of the party in government have claimed that political motives are driving the enforcement efforts. Naturally, the political party out of power has taken a different view of what is going. The resulting confrontation have often taken place in the streets of the province,
Studies about political institutions reveal a linkage between institutions and resource curse as a way in which poor economy performance is encouraged. One of these theories, the theory of institutions and the resource curse (Mehlum, Moene, & Torvik, Cursed by resources or institutions, 2005), tries to explain the impact of “institutional quality” (how well a government operates) in a country that has large natural resource endowments.
The theory focuses on the tension between production and forms of rent seeking. Producers may compete to gain the favor of authorities in order to get benefits from the natural resource. Government officeholders, due to their positions, have the ability to gain rents for themselves. This kind of linkage between institutions and rent seekers lead to impoverish the economy.
For example, Ancash, a region in the north of Peru, is a place that has important quantities of gold and silver. The extraction of these minerals is done by companies which pay taxes as part of its activities. A portion of these taxes are allocated to the local governments of Ancash for developing local infrastructure and public services. However, in the last year, investigators have discovered a net of corruption led by the president of the region. As a consequence, the Ancash Region has gone backwards in its economic development. Much of the local infrastructure has not been developed. The public works that have been built have been made by the companies directly related to the president of the region, or with connections to friends of the president.