Saturday, March 11, 2006

Is there a resource curse?

Plot a simple graph with economic growth on one axis and some measure of natural resource endowment on the other, and you will get a negative relationship. This is a real puzzle since it defies common wisdom. This negative relationship is called the "resource curse," as if somehow resource-rich countries are destined to be poor.

There are two explanations for why we would observe this negative relationship:

1. The "Dutch disease" explanation. Having lots of natural resources means you will have a comparative advantage in natural resource exports which tends to have relatively low productivity growth. The logic of trade theory says then that other countries will have a comparative advantage in other sectors (like industrial goods) that may have higher productivity growth. Furthermore, since productivity and comparative advantage are linked to some extent to learning-by-doing, people in resource-rich countries do not acquire the skills or experience to compete in other sectors. Therefore, the economy stagnates (this is a very simple version of the Dutch disease model).
2. The institutions explanation. If there are natural resources just waiting to be extracted from the ground, this will encourage a legion of rent-seekers to compete for the privilege of acquiring the rights to drill for oil or to mine for minerals. This rent-seeking behavior can ultimately wind up undermining the rule of law and can provoke civil conflict, both lowering economic growth and stability. Also, the lure of easy money through political connections or muscle power might tend to dampen entrepreneurship and productive economic activities.

In fact, to students of history, the "resource curse" story should sound somewhat suspicious. After all, the United States, Australia and Norway are all resource-rich countries that have managed to grow quite rapidly over the past hundred years.

So how do we explain that some resource-rich countries wind up with a high standard of living and good institutions while others wind up with the opposite result? According to Halvor Mehlum, Karl Moene and Ragnar Torvik (all based in Norway, incidentally), a possible answer is that the resource curse affects countries with already poor institutions but not countries that start out with good institutions. In other words, if we look at the sample of countries rated as having good institutions, there is no observable relationship between natural resources and growth. Their data analysis supports this hypothesis but this paper is certainly not the last word on the subject.

My take is that any attempt to explain away the resource curse by invoking institutions ultimately has to face the question of where institutions come from. Some economic historians, like Sokoloff and Engerman, for instance, think that institutions are closely linked with a country's natural resource endowments -- or at least those natural resource endowments that were relevant when the country's institutions were being put in place. I think there is likely a complex, two-way relationship between natural resources and institutions that we are only beginning to understand now.

Citation: H Mehlum, K Moene and R Torvik. "Institutions and the Resource Curse." The Economic Journal, January 2006.

NOTE: I don't think there is a free version of the paper around. However, this paper by the same authors is along similar lines.

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