19 May The Challenge of Natural Resource-led Development in Small Economies Dr. Maiju Johanna Perälä Department of Economics The University of the West Indies, Mona Prepared for the presentation at Association of Caribbean Economists’ conference on ”Economic Growth and Transformation—Reassessing Challenges and Prospects at the Datwn of the 21st Century”

19 May Purpose of the paper To provide an explanation why growth has failed in some countries over the long-term, especially those that are small in size To investigate whether natural resource endowment type is relevant as argued within the development economics literature (Hirschman 1977,1981; Auty 1995, 2001) To clarify a mechanism that generates (or has potential to generate) a resource curse, an important explanation for failing growth in the post era

19 May Main arguments and findings Natural resource endowment type matters for growth, or for lack of it, especially when coexisting with the lack of social cohesion Oil and mineral resource endowment more negatively correlated with growth than an agricultural one The above findings are robust to different growth regression specifications (cross-section, time- series) The phenomenon is especially troublesome for small economies as, in addition to the resource curse phenomenon, they face a greater challenge for manufacturing development.

19 May About this presentation Stylized facts of growth failures Explanations for failures—linkage approach to staples (development economics approach) Methodology Sample and data sources Empirical analysis –Simple statistical evidence –Initial conditions analysis –Robustness regressions Conclusions

19 May Stylized facts of growth failures Regionally concentrated: Sub-Saharan Africa and Latin America and the Caribbean Stage of development is relevant: Tend to occur at early phases of development Size of the economy matters: More likely to occur in small than large economies

19 May Regional concentration: long term failures

19 May Regional concentration: recent failures

19 May Regional concentration: growth successes

19 May Stage of development

19 May Relevance of size

19 May Observations on failures Striking patterns: persistence and regional concentration Raises questions whether common explanation(s) for these failures can be found Growth failures appear to have had difficulties in initiating growth, focus on initial conditions seems appropriate

19 May Common explanations for failing growth African growth literature –Lack of openness (SW 1997), poor policies (Collier&Gunning 1999). –Ethnic divisions, neighborhood effects (EL 1997, 1998) –Low investment and high population growth (Hoeffler 2002) Challenges of economy size –Relatively small domestic markets, manufacturing potential requires favorable external market conditions –More vulnerable to external fluctuations due to greater exposure –Lack of diversification within the economy, terms of trade fluctuations stronger effect –Small developing countries more reliant on primary products that experience greater volatility Natural resource abundance and growth –Easy riches lead to sloth (Bodin 16 th Century) –Natural resource curse thesis (Auty 1995, Gelb et al 1998) –Dutch disease (Corden 1984, Neary & van Wijnbergen 1986, Ros 2000) –Terms of trade (Prebisch 1950, Singer 1950) –Instability (Gelb et al 1988, Tarshis 1986) –Staples and economic development (Hirschman 1977, 1981) –Analytical survey (Ros 2000)

19 May Linkages view on development Natural resource endowment type matters to development (Hirschman 1981) Captures the notion how “one thing leads to another”, interdependence of economic activity, linkages application to natural resource-led development Process of growth through various linkages: –Production linkages –Consumption linkage –Fiscal linkage

19 May Physical production linkages Production A Imported inputs Domestic production of inputs Final demand or production B Production C Backward linkage Forward linkage

19 May Consumption linkage Production A via L-intensive methods Final demand Consumption goods industry Potential backward linkages Potential forward linkages Consumption linkage from labor incomes

19 May Fiscal linkage Government Production A Limited production linkages Limited consumption linkages Enhance production linkages Enhance consumption linkages ‘Enclave’ production Sociopolitical environment critical Typical of mineral and fossil fuel extractive industries

19 May Challenge of fiscal linkage Indirect, it requires: –ability to collect taxes –well-designed development policy –capacity to implement the policy and to target the funds in most productive activities –indirectness leaves room for mistargetting of funds, or even for their loss through rent-seeking Challenge posed by economy size: –management more costly to small economies, economies of scale not as attainable as for large ones (ratio of government expenditures/gdp smaller for large ecos, fixed costs of governance higher per population for small ones)

19 May Linkages approach to staples The nature of economic activity determines the relative importance of each linkage Agricultural production  labor-intensive, likely to generate a consumption linkage Mining and fossil fuel extractive industries  enclaves Enclaves, limited production and consumption linkages, the importance of fiscal linkage is elevated and the role of political economy aspects and development policy are brought to the forefront Fiscal linkage, critical for small developing countries rich in extractive natural resources poses a greater challenge given that it is more costly, depleting development funds

19 May Linkage approach continued Technological apects of staples can be limiting, but not deterministic Sociopolitical environment important If environment is conducive to welfare maximizing policies  limited development potential of a staple can be overcome through an efficient management of the fiscal linkage (through effective development policy)

19 May Empirical methods Simple statistical evidence—highlights the phenomenon Initial conditions analysis –initial real per capita income and education level –Sachs and Warner (1997) initial conditions Cross-country growth regression analysis –Sachs and Warner (1997), Barro (1991), MRW (1992), King and Levine (1993), DeLong and Summers (1991)

19 May Sample and natural resource data 95 market economies with population more than half a million (sample confirms with established studies and methods). Natural resouce endowment categorization following Auty (2001): –resource rich economies—per capita cropland >0.3 hectares –extractive (point source) economies—fuel and mineral exports > 40 % of total exports –agricultural (diffuse) economies—remaining

19 May Proxying social cohesion and enclave effect Social cohesion is considered to capture sociopolitical environment, proxied by ethnolinguistic fractionalization (ELF) (EL 1997, Mauro 1995) Interaction term between extractive endowment and ELF should capture ’enclave effect’ in a poor policy environment

19 May Growth Failures & Resource Endowment: long term failures by country

19 May Growth & Resource Endowment: failures and successes by country group

19 May Growth and Social Fragmentation by Endowment Type: fragmented economies

19 May Growth and Social Fragmentation by Endowment Type: cohesive economies

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19 May Table from Perälä (2007)-Resource Flow Concentration… Estimated Growth Effects of Enclave Effect

19 May Concluding remarks Broadens the debate on natural resource abundance and growth to type of natural resource & the ensuing political economy considerations Mineral and/or oil richness combined with lack of social cohesion is found consistently negatively correlated with growth (distinct growth experience from agricultural economies) Brings forth evidence that mere natural resource richness is not negatively correlated with growth (rather, coexistence with lack of social cohesion important for a negative growth outcome) Empirical results are useful in explaining the cause of resource curse, highlighting the importance of political economy aspects The challenge is especially predominant in small economies, with smaller domestic market, greater challenge for manufacturing developing, more reliance on external markets and greater cost challenge for the management of the fiscal linkage.

19 May Other related contributions: Perälä, Maiju Johanna Explaining Growth Failures: Does the Type of Natural Resource Endowment Matter? (paper in review) Perälä, Maiju Johanna Resource Flow Concentration and Social Fractionalization: A Recipe for Curse? Journal of Economic Studies, 35(5), forthcoming Perälä, Maiju Persistence of Growth Failures: Does the Type of Natural Resource Endowment Matter? UNU/WIDER Discussion Paper #37. Perälä, Maiju Johanna Explaining Growth Failures: An Empirical Investigation of Natural Resource Type and Growth. In Essays on Economic Development and Growth, , University of Notre Dame dissertation.