Curing the Curse of Resources II

Jul 13, 2012 Editorial

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We continue with the warning from some very qualified economists writing on VOX-EU, about how resource-rich countries such as Guyana might deal more effectively with the funds that can flow from the exploitation of the resources. Very frequently, these funds can paradoxically become a “curse”.
Resource-rich countries frequently face large and volatile capital flows which complicate the conduct of monetary and exchange rate policy. Chile’s floating exchange rate coupled with an inflation-targeting regime has in recent years proved remarkably successful in sheltering the economy from external shocks.
Many African countries, however, are fearful of embarking on a fully-flexible exchange rate regime. Therefore, a more gradualist path to exchange rate flexibility with inflation-targeting will probably be pursued in many countries, with all of the transitional difficulties that this will entail. The experience of Ghana, which adopted inflation-targeting with limited exchange rate flexibility since 2002-03, is an interesting example of a gradualist approach.
Yet another challenge is the Dutch Disease – that is, the tendency for natural resource booms to result in overvalued currencies that depress non-resource exports of goods and services, import-competing local industries and long-run economic growth, but also tend to jack-up interest rates and short-run capital inflows, thus creating macroeconomic and financial volatility.
An important question here is how to stabilise exchange rates and sterilise current-account inflows in times of high commodity prices as well as capital inflows that are correlated with resource windfalls.
Because equilibrium domestic interest rates are almost always above those in advanced countries, the costs of sterilisation can be significant and can create tensions between the fiscal authorities and the central bank. As is clear from the case of Botswana, however, insofar as periods of high commodity prices are also periods of large government surpluses held at the central bank, a properly managed counter-cyclical fiscal policy will provide a degree of automatic sterilisation.
Experiences with industrial policy around the world suggest that it is not straightforward to design an appropriate incentive structure that would help lay the ground for economic diversification in resource-rich countries.
Old-style industrial policies where government is directly involved in the production process need to be avoided. Indeed, those policies in many cases have been captured by local elites, opening the door to corruption and undermining the broader institutional framework. New industrial policies have focused on designing incentive-compatible rules aiming to achieve a private sector-led economic diversification.
Success stories that have yielded economic diversification suggest that low, predictable and non-distorting taxes on entrepreneurial activity can help foster diversification.
Also, the use of commodity proceeds to establish a supportive physical and social infrastructure can raise returns and encourage private investment in other sectors. The financial sector can also play an important role in fostering economic diversification. In particular, efforts to deepen and broaden financial systems in resource-based economies would help achieve that goal.
Perhaps the biggest challenge facing resource-rich countries results from rent-seeking behaviour that undermines their existing institutions, including political diversification and democracy.
Specifically, abundant natural resources tend to distort the allocation of talent, sometimes attracting the wrong sort of people and methods to politics. Especially in countries with weak institutions, talent tends to shift out of private entrepreneurial activity into more lucrative rent-seeking activities, with detrimental implications for efficiency and sustainable economic growth. Institutions need to 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 intermediating resources to help build small- and medium-sized enterprises in the non-resource-rich sectors of the economy.
Generally, more effective checks and balances and more transparency in the management of natural-resource revenues can help counteract the misallocation of talent into socially unproductive activities.
It needs to be recognised that those issues are less prevalent in democratic countries with mature industrial economies than in those that were least developed as well as undemocratic at the time of mineral-resource discoveries. This, if anything, merely underscores the importance of a careful approach to institution building.

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