Countries that have an abundance of natural resources—and this includes many countries in sub-Saharan Africa—often show a record of relatively poor economic performance compared with non-resource-rich countries.
The consensus in both academic and policy circles is that the presence of abundant natural resources poses a number of potential challenges to these countries.
Six of them can be readily identified:
(i) a loss of competitiveness in potentially dynamic, non-natural resource sectors, (ii) a consequent narrowing of the production base,(iii) excessive reliance on commodities for both government revenues and export earnings,
(iv) high vulnerability to fluctuations in commodity prices,
(v) macroeconomic and financial volatility, and
(vi) rent-seeking behavior that can undermine governance and exacerbate the difficulty of building robust, growth-enabling institutions.
The ideas in this book, "Beyond the Curse: Policies to Harness the Power of Natural Resources," were first presented at a seminar that was aimed primarily at policymakers in sub-Saharan Africa and brought together ministers, central bank governors, other senior policymakers, and well-known academics.The seminar focused on how to manage these challenges so as to reap the benefits of resource wealth while avoiding the pitfalls.
Diagnosis
Starting from a diagnosis of the wide range of challenges to macroeconomic management and financial policies that resource-rich countries face, the seminar sought to propose solutions that are context-specific, drawn from the most successful experiences, and capable of being implemented in Africa. Discussed at the 2010 seminar, therefore, were fiscal, monetary and exchange rate policies; savings policies; institutional arrangements to safeguard economies against volatility; economic diversification; and institution building.
The consensus among both speakers and participants at the seminar was that government revenues derived from natural resource extraction should be used conservatively in order to avoid excessive real appreciation and to safeguard inter- generational equity.
Preserving intergenerational equity requires saving and investing a large part of the proceeds to benefit future generations. At the same time, when investing these proceeds, it is not easy to make the choice between investing in external financial assets and investing in domestic physical and human capital (including infrastructure).
A deliberate and measured pace of domestic spending, carefully focused on absorptive capacity, can limit real appreciation and attenuate the negative consequences to the economy’s tradable sector. Moreover, history is replete with examples of large government spending programs that have been inefficient and wasteful.
Preserving intergenerational equity requires saving and investing a large part of the proceeds to benefit future generations. At the same time, when investing these proceeds, it is not easy to make the choice between investing in external financial assets and investing in domestic physical and human capital (including infrastructure).
A deliberate and measured pace of domestic spending, carefully focused on absorptive capacity, can limit real appreciation and attenuate the negative consequences to the economy’s tradable sector. Moreover, history is replete with examples of large government spending programs that have been inefficient and wasteful.
Knowledgeable senior officials at the seminar from Norway, Chile, Botswana, and Mexico outlined the history of how their governments addressed the problems posed by the existence of natural resources. Their measures included conducting countercyclical fiscal policies and setting up institutions that limit rent-seeking behavior.
While seminar participants were cautious about spending policies, they recognized that populations in low-income countries have high expectations regarding higher public spending. Large resource windfalls often trigger political pressures to enlarge government spending, in particular in countries with vulnerable populations. Managing those expectations is an important task in all resource-rich countries, and particularly in those with recently discovered resources.
Better with the private sector
All countries with significant natural resources, especially those whose resources are recently discovered, must choose between putting the extraction activity in the hands of multinational companies or keeping it in the hands of state-owned companies.
The weight of country experiences worldwide tilts the balance in favor of leaving the extraction as much as possible to the private sector, provided that
(i) the companies are selected on a competitive basis, and
(ii) the government has the capacity to ensure that contract negotiations lead to a balanced deal where the short- and medium-term objectives of both parties are reconciled.
Indeed, such an “optimal contract” would ensure that the inherent time-inconsistency problem is addressed. In other words, governments in resource-rich countries should credibly commit not to expropriate for themselves foreign investments after they have been sunk in exploration and extraction. In this discussion, many countries around the table recognized their lack of capacity to negotiate such contracts and expressed a need for independent international advice and assistance in this crucial area.
The weight of country experiences worldwide tilts the balance in favor of leaving the extraction as much as possible to the private sector, provided that
(i) the companies are selected on a competitive basis, and
(ii) the government has the capacity to ensure that contract negotiations lead to a balanced deal where the short- and medium-term objectives of both parties are reconciled.
Indeed, such an “optimal contract” would ensure that the inherent time-inconsistency problem is addressed. In other words, governments in resource-rich countries should credibly commit not to expropriate for themselves foreign investments after they have been sunk in exploration and extraction. In this discussion, many countries around the table recognized their lack of capacity to negotiate such contracts and expressed a need for independent international advice and assistance in this crucial area.
Taxing natural resources
Taxes on rents are relatively efficient and less distorting. Therefore, higher levels of taxation in the natural resource sector make sense and facilitate lower taxes in other sectors. However, this usually leads to a structure of government revenues that is dependent on commodity prices and earnings and so can be highly volatile. There is therefore a need to establish medium-term spending plans, to decouple current spending from volatile government revenues, and to enact a strategy for countercyclical fiscal policy (especially because capital flows that also respond to current account strength, and thus commodity prices, can exacerbate cyclicality).
Fiscal institutions have proven to be instrumental in achieving such decoupling between spending programs and revenues. For countries that cannot establish institutional arrangements capable of credibly committing to countercyclical fiscal policies, the use of financial instruments—such as the Asian puts used to hedge government oil revenues in Mexico—are an effective second-best policy option.
Effect on exchange rate
Chile’s floating exchange rate coupled with an inflation-targeting regime has proved remarkably successful in recent years at sheltering the economy from external shocks. Many African countries are fearful of embarking on a fully flexible exchange rate regime, however. This is not the so-called “fear of floating” in the conventional sense—when a degree of fixity leads to foreign exchange liabilities that constitute a balance-sheet disincentive to floating—but simply a reluctance to embark on major institutional change based on a belief that the supportive institutional structure will take time to prepare.
It is clear that a more gradualist path to exchange-rate flexibility with inflation targeting will be pursued in many countries, with all the transitional difficulties that this will entail. In fact, the experience of Ghana, which adopted inflation targeting with limited exchange-rate flexibility in 2002-03, clearly illustrates this point.
It is clear that a more gradualist path to exchange-rate flexibility with inflation targeting will be pursued in many countries, with all the transitional difficulties that this will entail. In fact, the experience of Ghana, which adopted inflation targeting with limited exchange-rate flexibility in 2002-03, clearly illustrates this point.
The seminar stimulated much discussion about how to sterilize current account inflows (at times of high commodity prices) and the capital inflows that are correlated with these windfalls. Because their equilibrium domestic interest rates are almost always higher than those in advanced countries, in resource-rich countries the costs of sterilization can be significant and can create tensions between the fiscal authorities and the central bank. As the case of Botswana makes clear, however, insofar as periods of high commodity prices are also periods of large government surpluses held at the central bank, a properly managed countercyclical fiscal policy will provide a degree of automatic sterilization.
Diversifying away from dependence
Experiences with industrial policy around the world suggest that it is not a straightforward matter to design an appropriate incentive structure to help lay the groundwork for economic diversification in resource-rich countries. Seminar participants recognized that some government intervention is unavoidable but also stressed that such policies should be tailored to the context of each economy. It was also recognized that too-active industrial policies would open the door to corruption and thus risk undermining the broader institutional framework.
From the discussions certain things emerged that are clearly undesirable, such as commodity rents that are distributed through very high government salaries, which would have a detrimental effect on private sector development. On the other hand, low, predictable, and non-distorting tax rates on entrepreneurial activity could help foster diversification. Similarly, the use of commodity proceeds to establish a supportive physical and social infrastructure could raise returns and encourage private investment in other sectors.
INSTITUTIONAL ASPECTS
The existence of natural resources tends to distort the allocation of talent. Especially in countries with weak institutions, talent tends to shift out of private entrepreneurial activity and into more lucrative rent-seeking areas, with harmful implications for sustainable growth. Participants in the seminar spent a good deal of time focusing on how institutions should be designed to guard against such developments. For example, strong and reliable property rights can foster financial sector development, allowing the financial system to play a more active and significant role in mediating resources to help build small- and medium-size enterprises in the non-resource-rich sectors of the economy.
More generally, checks and balances and greater transparency in managing natural resource revenues can help counteract the misallocation of talent into unproductive activities. However, it was acknowledged that the problem was less difficult in countries with mature industrial economies than in those that were least developed when mineral resources were discovered. This, if anything, merely underscored the importance of a careful approach to institution building.
More generally, checks and balances and greater transparency in managing natural resource revenues can help counteract the misallocation of talent into unproductive activities. However, it was acknowledged that the problem was less difficult in countries with mature industrial economies than in those that were least developed when mineral resources were discovered. This, if anything, merely underscored the importance of a careful approach to institution building.
VoxEU blog "Beyond the curse: Policies to harness the power of natural resources"
iMFdirect blog on the escaping the "resource curse"
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