Two features make natural resources different. The first is that such resources are found in nature. From an economic point of view only extraction is required for the generation of wealth. This implies that natural resources require no prior productive processes. When something does not requires productive process then there is no previous productive chain. This means that extractive activity can be developed without strong linkages to society in the rest of the country. Therefore, extractive activities based on natural resources can be conducted in a way isolated from productive activities performed in the country.

The second feature is that natural resources, because they cannot be produced, at some point run out. Thus, they are non-renewable.

Examples of natural resources that reflect these characteristics are oil; minerals like silver, copper, gold, iron; and marine resources that are non-renewable.

The term resource curse represents an economic phenomenon associated with the abundance of natural resources in certain countries. The term summarizes a paradox that those naturally gifted resource countries do not always develop and grow their economies.

It should be understood that if a country has a significant resource allocation, it should use them to their advantage. However, this has not always been the case in many countries with large reserves of resources. In fact, some studies reveal that such resource abundance has been pernicious to countries who own them. It is the meaning of what is termed the “resource curse.”

The term might seem to indicate that the resources themselves are generating the curse, for example, that the goods were not of good quality, or that using them inherently creates harm. However, studies show that the curse comes not in the good as such, but in the use made of them and the conditions of the country, its people, institutions, and authorities that have received plenty of resources.

Following are two use definitions of the phrase "resource curse.”

Karabegovic (2010), states, “In the past, natural resources were thought to create economic growth and prosperity. However, in recent years, debate has flared over whether natural resources, such as minerals and metals, oil, agricultural resources, and so on, stimulate economic growth or act as a hindrance to growth. The idea that natural resources actually hinder growth is known as the “curse” of natural resources.”

Kronenberg (2004) indicates, “The curse of natural resources is a well-documented phenomenon for developing countries. Economies that are richly endowed with natural resources tend to grow slowly. Numerous researchers have found a significant negative correlation between natural resource abundance and economic growth. This finding seemed puzzling at first, because classical economic theory would predict that abundant natural resources should be good for the economy.”

Evidence accumulated over the last 15 years leaves little room for doubting the existence of a ‘resource curse’. Countries heavily dependent on natural resources – geographically concentrated resources like hard-rock minerals, oil, and gas – have performed worse, in both economic and political terms, than countries without the apparent ‘benefit’ of such natural endowments. (Arellano-Yanguas, 2008).

Interesting Examples

Empirical studies have revealed an apparent paradox: despite a few notable exceptions like the US, the richest countries today are, in general, rather poorly endowed with natural resources. (The word ‘today’ is important here. During the time of the Industrial Revolution and well into the 19^th century, natural resources – especially energy sources like running water and coal – were in fact necessary requirements for growth. Apparently, the paradox emerged only in the 20^th century. One reason may be that falling transport costs reduces dependence on domestic energy sources.) Most Western European countries, whose economies are based on manufacturing and services, have few natural resources.

Another example is the experience of several Asian “tiger” economies. None of South Korea, Hong Kong, Singapore, and Taiwan, the Asian tiger economies, possesses significant natural resource endowments, but their average growth rates during the second half of the twentieth century have been higher than anywhere else in the world. South Korea and Taiwan achieved this even with difficult political circumstances (Kronenberg, 2004).

One important finding in development economics is that natural resource abundant economies often grow more slowly than economies without substantial resources. For instance, growth losers, such as Nigeria, Zambia, Sierra Leone, Angola, Saudi Arabia, and Venezuela, are all resource-rich, while the Asian tigers: Korea, Taiwan, Hong Kong, and Singapore, are all resource-poor. On average resource, abundant countries lag behind countries with fewer resources. Yet we should not jump to the conclusion that all resource rich countries are cursed. Many “growth winners” such as Botswana, Canada, Australia, and Norway are rich in resources. Moreover, of the 82 countries included in a World Bank study, five countries belong both to the top eight nations according to their natural capital wealth and to the top 15 nations according to per capita income. (World Bank, 1994). (Mehlum, Moene, & Torvik, Intitutions and the Resource Curse, 2006)

We discuss two contrasting examples of “resource curse” below.

Venezuela

Venezuela is blessed with oil in abundance. According to the World Factbook, Venezuela is the first of a list of countries with crude oil - proved reserves, and is one of the top producers and exporters of oil in the world. Oil exports account for over 95% of Venezuela’s exports, 50% of government revenue, and 30% of GDP (Rossi, 2011). Clearly, the oil represents the sustenance of life in Venezuela. The government, politics and economy revolve around this natural resource Yet, as of this writing (summer 2014), Venezuela is living through perhaps its most difficult period since its independence.

In the mid-2010’s, challenges in Venezuela are characterized by a poor economic performance, the worst in South America, combined with a lack of stable political institutions, and crisis of authority.

With respect to political institution, while there is a democratic government, this has not meant the renewal or change in the political party that governs the country. Both the deceased President Hugo Chavez and Nicolas Maduro, Chavez’ successor, represent continuity in power which has lasted fifteen years.

“Dutch disease” took place in Venezuela in the 1970s when the government, using the money coming from oil exports, made the decision to cancel all agriculture related debt with the hope of eliminating this financial burden and increasing agricultural production. However, the opposite effect took place; most landowners of large farms sold or closed their latifundios (large farm estates) and moved to urban environments where they established other businesses not related to agriculture. Consequently Venezuela (like Nigeria) lost much of its agricultural sector due to its resource wealth. The fall of the agricultural sector and the rise of the oil industry and other service sectors have created high levels of immigration and internal migrations from rural zones to principle cities. These influxes of new arrivals over the years have created high levels of crime, violence, unemployment and poverty in these cities. (Egoávil, 2011)

Chile

The country of Chile has had outstanding economic performance, taking advantage of the natural resources it possesses.

Chile produces a third of the copper used in the world. In the past 40 years, Chile has ably handled and channeled revenues from the sale of copper. With the income from the export of copper Chile has prompted the development of other economic activities.

Similarly, decisions that authorities have taken over this time have allowed Chile to successfully lead the transition from poverty to development. In addition, these same decisions have prevented Chile from being affected by the resource curse

At first, given that the mining sector was critical for Chile, the government passed measures to strengthen the sector. The measures sought to create an attractive environment for investment in mining in particular for capital coming from abroad. However, they were not the only measures that were taken. The government of Chile adopted an economic structure with four pillars. The first was the adoption of a predictable and responsible fiscal policy, balancing tax revenues and government spending. The second pillar was the adoption of a monetary policy guided by an explicit inflation target. The third reason was the gradual opening up of financial and trade sectors. Finally, the fourth pillar was to create a solid financial system, private banks and appropriate regulatory policies.

Why the resources curse?

Experience shows that economies with low supply of natural resources have had to deal with limited resources and this situation has pushed them to seek alternative development paths. Those routes to growth and development were based in productive activities rather than in extractive activities. So, having witnessed those experiences, is it possible that economies blessed with resources can use this source as element of leveraging their growth and development? (i.e., can resources be used for growth?) In addition, while the answer must be yes, such a path is likely to be more complex and difficult than one might expect. The complexity and difficulties are due to the many undesirables effects that are involved where there is abundance of resource.

Perhaps one reason is that where there are plenty of resources and things seem to be go well for a country, authorities, population, institutions, etc., become complacent. So, a country’s society does not think it needs to consider more than the extraction and export of the resources. They do not need to think in terms of the long-run, of a goal of creating more sophisticated economy activities,

Therefore, the resource curse is not a path economies must follow. A society can take full advantage of a resource wealth. Taking this path, however, may be difficult and take decades to travel. The path, however, depends on the choices a society makes.

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.

Figure 13.1 Loreto Region in northeastern Peru.

Credit: Wikimedia Commons [1]

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.

Figure 13.2 Ancash Region in the north of Peru.

Credit: Wikimedia Commons [2]

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.

Peru has been blessed with natural resources, such as gold, silver, and copper, as the map below indicates.

Figure 13.3 Peru Mining Radiography.

Credit: Adapted from Peru’s National Society of Mining and Petroleum

For centuries, the export of minerals has brought more foreign exchange to the country; however, these have also been a source of social conflict in places where the ore is extracted.

Peru - an Example of Resource Curse and its Evolution

Many pre-Columbian gold artifacts have been found in Peru, such as Tumi, a ceremonial knife, and textiles whose tissues are threads of gold. The story goes that the Spanish conquest of Peru in the sixteenth century began when a group of soldiers took the decision to go to South America to become rich, because the rumors spoke of “El Dorado,” a region where everything was made of gold.

Example of a Tumi knife.

Credit: Sean Pathasema/Birmingham Museum of Art [3]

Today, the gold, silver, copper, iron and other minerals, as well as oil and gas, represent the abundance of natural resources for Peru. Exports of these natural resources are the main source of foreign exchange for the country.

Extractive activities are performed by state enterprises and private companies. These companies pay large amounts of taxes. These taxes become the source of resources that are distributed between the national and local governments.

Peruvian history shows that the country has been inflicted with the resource curse for decades, and this condition has delayed Peruvian economic and political development. Peru, as with other many Latin-American countries, has suffered from a lack of political institutions and military governments that try to use the resource abundance as a short-run solution to economic challenges. After many years and a large political crisis caused by the Shining Path terrorism movement in the 1980s and 1990s, a new economic and political order was established that has been the base of current economic development.

Peru Looking for a Different Path: Managing the Resource Curse

Beginning in the mid-1990s, the Peruvian government employed a set of measures that caused a structural reform of the country. In the economic sphere, the aim was to make Peru more open to trade and investment and to have stronger institutions in the field of economic management. Such institutions include the Superintendency of Banking and Insurance, Tax Authority, Superintendence of Customs Administration, The Central Bank, The Ministry of Economy and Finance, as the more representative institutions among others.

Cuy – A Peruvian Delicacy. Don’t ask what it is!

Credit: Wikimedia Commons [4]

The economic discipline that has followed this change in policy has allowed the Peruvian economy to grow. In these years Peru has been able to develop productive capacities and services in areas other than those of the extraction of natural resources. This has meant that today while mineral exports represent an important source of foreign exchange, these are not as in yesteryear, the largest single source. There is now a local productive chain capable of exporting products such as textiles, food, financial services, and gastronomic services among others. (To enjoy the benefits of this new policy, we suggest you check out your local Peruvian restaurant.) All these changes have reduced the extreme dependence of Peru on natural resources.

While there has remarkable economic progress in Peru, its political institutions have not advanced as far as one might wish. For example, it appears that much of the spending of local governments benefits the elite few and not the wider population. Studies show that, in 2013, 90% of local authorities have been the subject complaints of corruption and misuse of funds.

The Stress of the Resource Curse

What link? "First link" doesn't really inform students. The first link shows how mining had bring some conflict to the village where the ore is extracted. A good summary is contained in the video below. (Don’t’ forget to pay attention to Dr. Kleit’s favorite Peruvian economic commentator, Miguel Santillen!)

From 2004 to 2014, the Peruvian economy grew at a very strong rate of six percent per year. Much of this growth, however, was driven by unusually high resource prices. As the video linked discusses, commentators in Peru became concerned as resource price soften in 2014. Their concern was that the society had become accustomed to economic growth. If the price of resources fell, economic growth would be reduced or eliminated, leading to social unrest.

There are other sources of social unrest. The people who live near mining projects are often concerned about the environmental effects of such projects. There are often political demonstrations opposing mining projects. This has led to a delay or sometimes a denial of permission to being mining from the government.

The source of opposition to mining projects appears to come from several sources. First, local residents often do not benefit greatly from mining projects. This may occur because they are poor negotiators, or because their local leaders do not always have their interests at heart. In addition, local residents often have limited access to judicial systems. Thus, if a mining company violates a regulation or an agreement it has with a community, the local people may have difficulty forcing the mining company to comply with regulations or live up to its promises. Another way of looking at this is that mining companies who do desire to support their local communities may have a difficult time showing that they are committed to such a policy. They, therefore, may have trouble gaining the support of nearby residents, even when the mining company will act to improve the quality of life in the region.

This summary differs in format to the previous lessons. It would look odd if only this lesson was different, so I would adapt this to match the others. See other summary pages for an example.

Two features distinguish natural resources. Natural resources are non-renewable and their exploitation can be performed almost independently from the productive development of the country where they are located.

The resource curse is a condition in which a country is not able to obtain benefits from its abundant natural resources. Indeed, this abundance can cause the opposite effect on growth, i.e. the country could experiment some decrease or negative effect in its economy, institutions and society.

The resource curse is exacerbated in those countries with poor institutional development.

Natural resources that are involved in resource curse are, for instance, oil; minerals like silver, copper, gold, and iron; and marine resources that are non- renewable.

Dutch disease is a phenomenon by which the inflow of foreign exchange to a country tends to weaken its production structure rather than benefit them.

In the international experience, there are countries where the resource curse has been felt with greater emphasis. Examples of these countries are Venezuela and Nigeria. By contrast, there are countries such as Chile and Norway, where the abundance of natural resources has been the source of development.

Peru is an example of a country where there has been many periods of the resource curse. However, the measures taken by governments in the past twenty years have enabled the country to redirect its production structure and stabilize its economy.

For instance, the resources obtained by the State due to the mining activity, is that they are the sectors of education, health, and the development of infrastructure that are being prioritized.

It also important to note the participation of foreign investors in the development of the mining activity which brings to the Peruvian economy not only more taxes and royalties but better technologies.

If you log on to Canvas you will find the task to be completed for this lesson: an online multiple choice quiz.

Have you completed everything?

You have reached the end of Lesson 13! Double check the list of requirements on the first page of this lesson to make sure you have completed all of the activities listed there.

References