Thorvaldur Gylfason IMF-Middle East Center for Economics and Finance (CEF) Course on Macroeconomic Management in Natural Resource-Rich Countries Kuwait City, Kuwait, 6-17 January 2013

1.Economic geography, old and new 2.Sources of growth 3.Natural resources and economic growth: Selected policy issues 4.Cases and success stories Botswana, Chile, Mauritius, Norway Mixed blessing? Keys to success? 5.Empirical evidence

 Assigned key role to natural resource wealth and raw materials  Tended to equate those resources with economic strength  Yet, many resource-abundant countries are poor, while several resource-poor countries are rich  Prime Minister Putin of Russia:  “Our country is rich, but our people are poor.” 1

National wealth Intangible capital Physical capital Natural capital In the world as a whole, natural capital constitutes a small part of national wealth, or about 6% Even so, natural capital remains important in a number of countries Advanced countries (US, Canada, Australia, and others) have outgrown their dependence on natural capital, including agriculture

bluered From blue to red: Increased resource intensity Tangible capital is produced capital plus natural capital, and does not include human capital and social capital

bluered From blue to red: Increased resource intensity Total capital is produced capital plus natural capital plus intangible capital, including human capital and social capital

human capital social capital  Recognizes several different sources of wealth, emphasizing human capital and, increasingly, social capital governance,institutions, trust  Social capital refers, among other things, to governance, institutions, and trust  Many resource-rich countries have fared badly, while several resource- poor countries have done well  There are many kinds of capital and many different sources of growth

Lee Kwan Yew  Listen to Lee Kwan Yew, founding father of Singapore ( ): natural resources people education  “I thought then that wealth depended mainly on the possession of territory and natural resources, whether fertile land..., or valuable minerals, or oil and gas. It was only after I had been in office for some years that I recognized... that the decisive factors were the people, their natural abilities, education and training.”

1.Saving and investment Real capital 2.Education, health care Human capital 3.Exports and imports Foreign capital 4.Democracy and freedom Social capital 5.Stability Financial capital 6.Diversification away from Natural capital Effects on growth are undisputed Effects on growth are somewhat controversial 2 Extensive vs. intensive growth

1.Saving and investment Real capital 2.Education, health care Human capital 3.Exports and imports Foreign capital 4.Democracy and freedom Social capital 5.Stability Financial capital 6.Diversification away from Natural capital All six are generally considered desirable in and of themselves How to attain these goals, however, is another matter All six are generally considered desirable in and of themselves How to attain these goals, however, is another matter Efficiency, institutions, and governance

 How much government involvement is needed to diversify?  Pros and cons of industrial policy (Rodrik, 2004) Picking winners seldom works, but, even so, cutting losses can be fruitful Presupposes competent civil service, but that’s OK Prone to political capture and corruption, but so is, e.g., privatization as in Russia Never works? But recall successes in South Korea and Latin America, e.g., Chile Support for R&D vs. entrepreneurship à la Pigou Do international rules leave limited scope for industrial policy? Not really

 Two suggestions  Encourage new industries in line with country’s comparative advantages and available expertise in public administration  Follow the market rather than try to take the lead  Need solutions based on general principles and tailored to specific circumstances  Not one-size-fits-all

 Opportunities for finance – and pitfalls  Banks pick customers, some win, some lose  Example from Iceland  Fishing rights are allocated free of charge to boat owners even if, by law, Iceland’s fish is a common property resource  Fishing quotas were quasi-legally, or perhaps illegally, used as collateral for crushing private debts intended to support their branching out as well as speculation  Banks were privatized in like manner, and crashed promptly

Growth Real capital Investment Human capital Education Fertility Social capital Corruption Democracy Financial capital Inflation Natural capital Resource depletion drag Leave out foreign capital for simplicity Governance affects linkages

Cobb-Douglas production function K/Y is constant Collect Y on left-hand side Solve for Y Divide through by L

If N, e.g., oil wealth, declines by u% per year, then g N = -u Oil extraction u slows down growth as does population growth g L

If N, e.g., oil wealth, declines by u% per year, then g N = -u Resource depletion drag population drag Resource depletion drag and population drag appear side by side

Natural capital EducationCorruptionDemocracyInvestmentFinance

Growth Investment Exports Education Stability Diversification Double diversification Double diversification is good for growth, and for other determinants of growth Double diversification Double diversification = economic and political diversification

Four main areas 1.Fiscal policy 2.Monetary, financial, and exchange- rate policy and the Dutch disease 3.Institutions and governance 4.Diversification  Economic  Economic, away from excessive dependence on a few resources  Political  Political, away from dependence on or subjugation to narrowly based power elites 3

 Natural resource wealth is an efficient tax base because resource taxation causes minimal distortions to economic behavior  Case in point: Iceland’s missed opportunity  Could have auctioned off catch quotas and used proceeds to abolish personal income taxes  Chose instead to allocate fishing quotas to boat owners free of charge  Then chose to privatize its banks the same way, and they all collapsed a few years later in 2008  Important to reduce other less efficient taxes to keep overall tax burden reasonable  Also, spend tax revenues efficiently Taxes vs. fees Pigovian principle

 Price stabilization funds  Build up reserves when commodity prices are high  Use up reserves when prices are low Aim is to shield producers from price fluctuations Subject to similar reservations as stabilization policies  Example from Chile  Government can run a deficit larger than the target of zero, or 1% surplus, to the extent that Output falls short of potential, or Price of copper is below its medium-term (10-year) equilibrium independent Two panels of independent experts determine the output gap and the medium-term equilibrium price of copper

Foreign exchange Real exchange rate Imports Exports without oil Exports with oil A CB Oil discovery leads to appreciation, and reduces nonoil exports Composition of exports matters

 Term refers to fears of de-industrialization that gripped the Netherlands following appreciation of Dutch guilder after discovery of natural gas deposits in North Sea around 1960  Is it a disease? No  Some say No, viewing it simply as matter of one sector’s benefiting at the expense of others, without seeing any macroeconomic or social damage done Yes  Others say Yes, viewing the Dutch disease as an ailment, pointing to the potentially harmful consequences of the resulting reallocation of resources – from high-tech, high-skill intensive service industries to low-tech, low-skill intensive primary production, for example – for economic growth and diversification

 Overvaluation of currency hurts other exports and import-competing industries  Norway’s total exports were stagnant in proportion to GDP long after oil discoveries, but no longer  Oil exports have crowded out nonoil exports Nokia is Finnish, LM Ericsson is Swedish, B&O is Danish  Norway’s almost unique unwillingness to join EU  Keeping inflation low to avoid overvaluation monetary governance  Price stability requires good monetary governance through independent yet accountable central banks  Healthy financial sector development also requires good monetary governance, including transparency China’s undervalued renminbi

 Rent seeking …  Especially in conjunction with ill-defined property rights, imperfect or missing markets, and lax legal structures  … tends to divert resources away from more socially fruitful economic activity  International initiatives to raise transparency  Extractive Industries Transparency Initiative  Extractive Industries Transparency Initiative (EITI) aims to set global standard for transparency in oil, gas and mining  Revenue Watch Institute  Revenue Watch Institute (RWI) promotes responsible management of oil, gas, and mineral resources  Natural Resource Charter  Natural Resource Charter sets out principles for how to manage natural resources for development False sense of security Neglect of education False sense of security Neglect of education Other people’s money

 Volatility of commodity prices leads to volatility in exchange rates, export earnings, output, and employment  Volatility can be detrimental to investment and growth  Hence, natural-resource rich countries may be prone to sluggish investment and slow growth due to export price volatility  Likewise, high and volatile exchange rates tend to slow down investment and growth

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 Fiscal policies need to foster efficient revenue collection as well as efficient, growth-friendly public spending  To be efficient and fair, the utilization of natural resources requires that the owners – the people – be appropriately compensated  Property rights to natural resources belong to the people by international law International Covenant on Civil and Political Rights Article 1 of the International Covenant on Civil and Political Rights states that “All people may, for their own ends, freely dispose of their natural wealth and resources”  Monetary policies need to avoid misalignment and excessive volatility of the currency

 Consider Norway  From day one, Norway’s oil and gas reserves were defined by law as common property resources, clearly establishing the legal rights of the Norwegian people to the resource rents  On this legal basis, the government has absorbed about 80% of the resource rent over the years  Government laid down economic as well as ethical principles (‘commandments’) to guide the use and exploitation of the oil and gas for the benefit of current and future generations of Norwegians

 Norway was a well-functioning, full-fledged democracy long before its oil discoveries  Democrats are less likely than dictators to try to grab resources to consolidate their political power  Elsewhere, point resources such as oil and minerals have proved particularly “lootable”  Petroleum industry has conferred sizable spillover benefits on others at home and abroad through transfer of technology as well as research and development Nigeria’s economy minister: “Oil has made us lazy” Nigeria’s economy minister: “Oil has made us lazy” Norwegians work less than Danes and Swedes, true, but no less than Germans

Why did Norway succeed? Because it is so small? – (Pop. 4.7 million) Does country size matter for success? Why did Norway succeed? Because it is so small? – (Pop. 4.7 million) Does country size matter for success?

without  Success stories without natural resources  Hong Kong  Japan  Singapore  Switzerland with  Success stories with natural resources  Botswana  Chile  Mauritius  Norway, again  How did they succeed? 4

 How Botswana succeeded  Started out at independence in 1966 with 12 km of paved roads, 22 college graduates, and 100 secondary-school graduates  Diamonds, discovered in 1967, provide tax revenue equivalent to 33% of GDP  Sub-Saharan Africa’s highest per capita GNI  Good policies, good institutions, democracy  How Mauritius succeeded  Emphasized trade and education in lieu of sugar  Cosmopolitan population  Again, good policies, good institutions, democracy  Look at some economic and social indicators Frankel (2010) Acemoglu et al.(2003) But not perfect

Per Capita GNI (USD at PPP) Increase in life expectancy in years

Per Capita GNI (USD at PPP)Democracy Increase in life expectancy in years Average democracy index Generally, democracy and growth go together

Per Capita GNI (USD at PPP)

Per Capita GNI (USD at PPP)Democracy

Per Capita GNI (USD at PPP)

Democracy

Per Capita GNI (USD at PPP)

Per Capita GNI (USD at PPP)Democracy

 The problem is not the existence of natural wealth as such...  … but rather the failure to avert the dangers that accompany the gifts of nature  Norway is, so far, a success story 80% of oil rent  Government invests 80% of oil rent entirely in foreign securities  60% in equities  40% in fixed-income securities

 Norway always had its natural resources educated labor  It was only with the advent of educated labor that it became possible for the Norwegians to harness those resources on a significant scale  Human capital  Human capital accumulation was the primary force behind the economic transformation of Norway  Natural capital was secondary

 The purpose of the oil fund  SharePension fund  Share the wealth fairly: Pension fund  Shield  Shield domestic economy from overheating and possible waste USD 450 billion  Fund has grown huge: USD 450 billion  That makes almost USD 100K per person resisted temptation  Norwegians have resisted temptation to use too much of the money to meet current needs

democracy market economy  Long tradition of democracy and market economy in Norway since before the advent of oil  Large-scale rent seeking was averted as oil was, by law, defined as a common- property resource from the beginning  Adequate investment performance  Excellent education record  Female college enrolment doubled from 46% of each cohort in 1991 to 94% in 2006

Dutch disease  Some (weak) signs of Dutch disease  Long-stagnant exports, sluggish FDI  Limited interest in joining EU and EMU  Some signs also of unwillingness to undertake difficult reforms  Health care provision  Regional policy (shared border with Russia)  Inefficient fisheries policy

 In anticipation of increased statutory Central Bank independence in1999 to immunize monetary policy from political influence, the management of oil fund was delegated by Ministry of Finance to Central Bank 1997  Aim was to immunize oil fund management from political interference by increasing the distance between politicians and the oil fund  ‘Outsourcing’ to encourage pluralism and avoid conflict of interest  Independent courts  Independent media  Independent universities

 Natural resources bring risks false sense of security  A false sense of security leads people to underrate or overlook the need for good policies and institutions, good education, and good investment may find that hard choices perhaps can be avoided  Awash in easy cash, they may find that hard choices perhaps can be avoided  Awareness of these risks is perhaps the best insurance policy against them

16 countries 4 industrial countries 12 developing countries 16 countries 4 industrial countries 12 developing countries 5

27 countries 5 industrial countries 22 developing countries 0.1% whose average per capita growth rate was 0.1% per year compared with 1.4% for the sample of 164 countries as a whole 27 countries 5 industrial countries 22 developing countries 0.1% whose average per capita growth rate was 0.1% per year compared with 1.4% for the sample of 164 countries as a whole

High-income countries Low-income countries Real capital 1716 Natural capital Subsoil assets 2 (1) 29 (6) Intangible capital Human capital Social capital 8155  Total wealth  Total wealth: estimated by perpetual inventory method as present discounted value of future consumption  Real capital  Real capital: estimated from investment figures  Natural capital  Natural capital: cropland, pastureland, subsoil assets, timber resources, nontimber forest resources, and protected areas  Intangible capital  Intangible capital: estimated as residual Source: World Bank (2006)

School life expectancy 2005 (years) Fertility (births per woman) Public health expenditure 2004 (% of GDP) Democracy (index) Corruption 2005 (index) Investment (% of GDP) Per capita growth (% per year) Mineral- rich countries Lower middle- income countries Upper middle- income countries

False contrast: No inconsistency between favorable effects of commodity price booms on output in the short run and adverse effects on long-run growth Size of balls reflects size of countries Natural capital share and growth are inversely related

-0.82 Natural capital crowds out human capital School life expectancy (SLE) is the total number of years of schooling (primary to tertiary) that a child can expect to receive

0.69 Education is good for growth

-0.74 Natural capital crowds out social capital More corruption

0.75 Corruption hurts growth More corruption

-0.67 Natural capital crowds out social capital

0.51 Democracy is good for growth

0.62 Human capital and social capital go together

0.60 Different aspects of social capital go together More corruption

-0.67 Natural capital share and growth are inversely related

-0.10 Subsoil asset share and growth are inversely related, but rank correlation is weak, so need multiple regression

Model 1 Initial income (5.2) Natural capital share Natural capital per person Democracy Investment rate (log) School life expectancy (log) Fertility Countries 164 Adjusted R Note: t-values within parentheses.

Model 1Model 2 Initial income (5.2) (3.1) Natural capital share (5.3) Natural capital per person Democracy Investment rate (log) School life expectancy (log) Fertility Countries Adjusted R

Model 1Model 2Model 3 Initial income (5.2) (3.1) (5.3) Natural capital share (5.3) (7.1) Natural capital per person 0.10 (4.5) Democracy Investment rate (log) School life expectancy (log) Fertility Countries Adjusted R

Model 1Model 2Model 3Model 4 Initial income (5.2) (3.1) (5.3) (5.2) Natural capital share (5.3) (7.1) (4.7) Natural capital per person 0.10 (4.5) 0.08 (3.7) Democracy 0.07 (2.2) Investment rate (log) School life expectancy (log) Fertility Countries Adjusted R

Model 1Model 2Model 3Model 4Model 5 Initial income (5.2) (3.1) (5.3) (5.2) (7.0) Natural capital share (5.3) (7.1) (4.7) (5.3) Natural capital per person 0.10 (4.5) 0.08 (3.7) 0.06 (3.3) Democracy 0.07 (2.2) 0.07 (2.7) Investment rate (log) 2.92 (6.8) School life expectancy (log) Fertility Countries Adjusted R

Model 1Model 2Model 3Model 4Model 5Model 6 Initial income (5.2) (3.1) (5.3) (5.2) (7.0) (7.8) Natural capital share (5.3) (7.1) (4.7) (5.3) (4.0) Natural capital per person 0.10 (4.5) 0.08 (3.7) 0.06 (3.3) 0.05 (2.5) Democracy 0.07 (2.2) 0.07 (2.7) 0.07 (2.7) Investment rate (log) 2.92 (6.8) 1.72 (3.2) School life expectancy (log) 0.94 (4.0) Fertility Countries Adjusted R

Model 1Model 2Model 3Model 4Model 5Model 6Model 7 Initial income (5.2) (3.1) (5.3) (5.2) (7.0) (7.8) (8.5) Natural capital share (5.3) (7.1) (4.7) (5.3) (4.0) (3.1) Natural capital per person 0.10 (4.5) 0.08 (3.7) 0.06 (3.3) 0.05 (2.5) 0.04 (2.3) Democracy 0.07 (2.2) 0.07 (2.7) 0.07 (2.7) 0.05 (2.0) Investment rate (log) 2.92 (6.8) 1.72 (3.2) 1.34 (2.5) School life expectancy (log) 0.94 (4.0) 0.56 (2.1) Fertility (2.8) Countries Adjusted R OLS

Model 1Model 2Model 3Model 4Model 5Model 6Model 7 Initial income (5.2) (3.1) (5.3) (5.2) (7.0) (7.8) (8.9) Natural capital share (5.3) (7.1) (4.7) (5.3) (4.0) (3.3) Natural capital per person 0.10 (4.5) 0.08 (3.7) 0.06 (3.3) 0.05 (2.5) 0.04 (2.4) Democracy 0.07 (2.2) 0.07 (2.7) 0.07 (2.7) 0.05 (2.1) Investment rate (log) 2.92 (6.8) 1.72 (3.2) 1.34 (2.6) School life expectancy (log) 0.94 (4.0) 0.56 (2.2) Fertility (3.0) Countries Adjusted R SUR

Per capita growth (%) Natural capital share (19.0) Democracy (6.4) Investment (log, 0.29) School life expectancy (log, 0.35) Fertility (1.8) Note: Standard deviations within parentheses.

Share of natural capital in total capital (%) Annual average growth of per capita GDP at PPP (%) Source: Computations based on WDI 2012 and World Bank data on natural capital. Growth = NatCap (10.0) (3.9) Growth = NatCap (10.0) (3.9) 146 countries Update

Annual average natural resource rents (% of GDP) Annual average growth of per capita GDP at PPP (%) Growth = Rents (10.1) (2.0) Growth = Rents (10.1) (2.0) 183 countries Source: Computations based on WDI 2012.

These slides will be posted on my website: n David Landes (1998) tells the story of Spain following the colonization of South and Central America which made Spain rich in gold and other natural resources: “Easy money is bad for you. It represents short-run gain that will be paid for in immediate distortions and later regrets.”