Mother Earth: Ally or Adversary? Thorvaldur Gylfason

What economists do Three stages of economic inquiry 1.Observe economic behavior 2.Look for patterns 3.Build models to explain the observed behavior patterns Facts are not enough Need models to fit the facts Can reverse the process Build models first and then test them

Natural resources and economic growth Observation Resource-rich countries have not grown rapidly, contrary to expectations Case in point: OPEC economies have contracted since 1965 Many other resource-based economies have also grown slowly Look at the pattern, and ask: Can economic theory explain it?

Natural capital and growth Natural resource dependence tends to impede growth Madagascar Mali Cameroon Mauritius r = Botswana r = rank correlation 8 Asian countries S/Y = African countries S/Y = 0.05 Notice two clusters

Is this surprising? King Faisal of Saudi Arabia ( ) would hardly have been surprised: “In one generation we went from riding camels to riding Cadillacs. The way we are wasting money, I fear the next generation will be riding camels again.”

Theory: Five linkages 1.Dutch disease Reduces level, skews composition, or raises volatility of trade and investment 2.Education 3.Investment 4.Rent seeking Protectionism, corruption, greed, inequality 5.False sense of security Poor quality of policies and institutions But Norway is, so far at least, an exception Foreign capital Social capital Human capital Real capital Natural capital tends to crowd out

Real capital and growth Natural capital crowds out real capital r = Niger Chad Lesotho Guinea Bissau

Real capital and growth Botswana China NicaraguaNiger Investment is good for growth r = 0.65 An increase in investment by 4% of GDP goes along with an increase in per capita growth by 1% per year. 4% 1% Quantity and quality

Interpretation of results Growth Investment Growth Resources Investment Resources + =

Human capital and growth Natural capital crowds out human capital r = Uruguay New Zealand Saudi Arabia Finland

Human capital and growth Finland Thailand New Zealand Jamaica Education is good for growth r = 0.72 An increase in secondary- school enrolment by 30% of each cohort goes along with an increase in per capita growth by 1% per year. Notice diminishing returns to education

Interpretation of results Growth Education Growth Resources Education Resources + =

Financial capital and growth Natural capital crowds out financial capital r = Japan China New Zealand Switzerland

Financial capital and growth Indonesia Japan Switzerland Jordan Financial depth is good for growth: Money greases the wheels of commerce and production r = 0.66

Financial capital and growth Indonesia Japan Switzerland Jordan This helps explain why inflation hurts growth: Inflation reduces financial depth and thereby inhibits growth r = 0.66

Interpretation of results Growth Financial depth Growth Resources Financial depth Resources + =

Foreign capital and growth Natural capital crowds out foreign capital r = Botswana Sweden Switzerland Netherlands Guinea Bissau

Foreign capital and growth Foreign direct investment is good for growth Netherlands Norway Papua New Guinea Madagascar r = 0.62

Foreign trade and growth Foreign trade is also good for growth Guinea Bissau Belgium Korea Malaysia r = 0.42

Interpretation of results Growth FDI Growth Resources FDI Resources + =

Social capital and growth Natural capital crowds out social capital Increase in natural capital by 3% of national wealth goes along with an increase in Gini by 1 point. 7 African countries where saving is 5% of GDP and per capita growth is -1% per year Notice cluster r = 0.41 Inequality of access to education and land: Same pattern Brazil

Social capital and growth Equality is good for growth: No sign here that too much equality hurts growth Korea Norway China Sierra Leone r = Brazil South Africa

Social capital and growth Equality is good for growth Korea Norway China Sierra Leone r = An increase in Gini index by 12 points goes along with a decrease in per capita growth by almost 1% per year. Brazil South Africa

Interpretation of results Growth Inequality Growth Resources Inequality Resources + =

Social capital and growth Natural capital crowds out social capital r = Zambia Indonesia Finland New Zealand

Social capital and growth Honesty is good for growth because corruption creates inefficiency Botswana Kenya Indonesia Norway New Zealand r = 0.40

Interpretation of results Growth Corruption Growth Resources Corruption Resources + =

Bottom line Natural resources can hurt growth by crowding out 1.Real capital via blunted incentives to save via blunted incentives to save 2.Human capital through neglect of education through neglect of education 3.Social capital through rent seeking, corruption, inequality, etc. through rent seeking, corruption, inequality, etc. 4.Financial capital 5.Foreign capital

Bottom line Natural resources bring risks 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 A false sense of security tempts people to underrate or overlook the need for good policies and institutions, good education, and good investment

These slides can be viewed on my website: An old story The End 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.”