Download Resource Wealth and Social Progress, April 23, 2014

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Ed Dolan’s Econ Blog
The Curse of Riches:
Resource Wealth and Social Progress
April 23, 2014
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The Curse of Riches
 In the popular imagination, abundant
natural resources are a great boon
 The reality is often different—many
countries that are rich in natural
resources are economic basket cases
 Meanwhile economies like Japan,
Taiwan, and Hong Kong prosper with few
natural resources to draw on
Gas Flaring in the Niger Delta
April 23, 2014 Ed Dolan’s Econ Blog
The Curse of Riches
 A widely cited study by Jeffrey
Sachs and Andrew Warner showed
that countries with large shares of
resource exports grew more slowly
than those with fewer resources
 This slideshow explores two
possible reasons for the curse of
riches:
 The Dutch disease
 The political economy of resource
wealth
April 23, 2014 Ed Dolan’s Econ Blog
The Dutch Disease
 The Dutch disease refers to the tendency of
natural resource exports to cause
overvaluation of a country’s exchange rate
 As that happens, its non-resource
industries become uncompetitive on world
markets resulting in loss of jobs and income
 The “disease” gets its name from the
effects of the discovery of large North Sea
gas deposits by the Netherlands in the
1950s and 1960s
A North Sea Gas Platform
April 23, 2014 Ed Dolan’s Econ Blog
Effects of Resource Exports on Exchange Rates
 This figure shows supply and demand of
Norwegian krone (NOK) on the foreign
exchange market
 Suppose the initial exchange rate is
1 NOK = 0.10 USD
 A large offshore oil discovery by Norway
increases exports
 The increased sales of oil, in turn, generate
new demand for krone
 The demand curve shifts to the right and
the exchange rate appreciates to
0.14 USD/NOK (point E1)
 Norway develops the Dutch disease as
producers of Norwegian fish, cheese, and
manufactured goods find they are less
competitive on world markets
April 23, 2014 Ed Dolan’s Econ Blog
Central Bank Intervention to Offset Appreciation
 To prevent unwanted appreciation of the
krone, the Norwegian central bank could
issue new krone and use them to buy
dollars on foreign exchange markets
 The increased supply of krone would offset
the effect of increase demand and partly or
wholly offset the upward pressure on the
value of the Norwegian currency
 The new equilibrium would be at E2 instead
of E1
April 23, 2014 Ed Dolan’s Econ Blog
Risk of Inflation
 However, massive purchases of dollars by
the central bank would flood Norway with
new krone, risking an increase in inflation
 As inflation drove up prices and wages,
producers of Norwegian good would find it
harder to compete on world markets,
despite stabilization of the exchange rate
 Conclusion: Intervention by the central
bank can stabilize the nominal exchange
rate but it cannot prevent the Dutch
disease—it only changes the form taken by
the disease
April 23, 2014 Ed Dolan’s Econ Blog
Fighting the Dutch Disease with a National Wealth Fund
 A better way to fight the Dutch disease is to
invest part of the dollars earned from sale
of oil in a national wealth fund
 Doing so absorbs part of the increased
demand for dollars, reducing upward
pressure on the krone (point E3 instead of
E1)
 The national wealth fund invests in bonds
or other assets that earn income for the
future
 Income or principle from the national wealth
fund can be spent during a temporary
economic downturn or spent in the future
after oil resources are exhausted
April 23, 2014 Ed Dolan’s Econ Blog
Currency Overvaluation and Purchasing Power Parity
 One way to tell whether a country’s
currency is over- or undervalued is to look
at its per capita GDP, in dollars, adjusted
for the cost of living
 Economists call this GDP stated at
purchasing power parity (PPP)
 If a country’s cost of living is low, its per
capita GDP stated at PPP is higher than its
per capita GDP stated at the market
exchange rate. That suggests the currency
is undervalued
 If it’s cost of living is high, its per capita
GDP stated at PPP is lower than when
stated at the market rate. It’s currency is
overvalued
Examples:
• Norway’s per capita GDP
converted to dollars at the
market rate is $100,000 but
its cost of living is high.
Measured at PPP, its per
capita GDP is $55,000
• India’s per capita GDP
converted at the market rate
is about $1,500 but its cost
of living is relatively low.
Measured at PPP, its per
capita GDP is $4,000.
April 23, 2014 Ed Dolan’s Econ Blog
Purchasing Power Parity and Per Capita GDP
 In this chart, a country whose per
capita GDP is the same at the
market rate and PPP falls on the
diagonal line. (The US is on the
line by definition)
 Countries below the line have
currencies that are overvalued
relative to PPP
 On average, wealthy countries
tend to have currencies that a
overvalued and poor countries
tend to have currencies that are
undervalued relative to PPP, as
shown by the dotted trend line
April 23, 2014 Ed Dolan’s Econ Blog
Overvaluation of Currencies of Wealthy Resource Exporters
 This version of the diagram adds
11 major resource exporting
countries, shown as red diamonds
 The wealthiest of these resource
exporters have currencies that are
more overvalued than we would
expect based on their per capita
GDP alone (that is, they are below
the dotted trendline)
 Conclusion: These wealthy
resource exporters are the most
vulnerable to the Dutch disease
April 23, 2014 Ed Dolan’s Econ Blog
The Political Economy of the Resource Curse
Resource wealth can undermine a country’s
political economy in a way that adds to the
resource curse
 Main focus of political activity is to obtain a
share of resource wealth
 Widespread corruption at all levels of
government
 Neglect of conditions required for growth of
non-oil sector
 Short political time horizon may neglect longterm investment even in resource sector
 Highly unequal distribution of wealth
Demonstrators in Venezuela protest
corruption and economic
mismanagement
April 23, 2014 Ed Dolan’s Econ Blog
The Social Progress Index
 A country’s GDP can be considered an
input to a country’s social welfare
 The Social Progess Index (SPI)
measures outputs such as health,
education, access to information,
personal freedom, and good
governance
To view or download the complete
social progress index, visit
www.socialprogressimperative.org
April 23, 2014 Ed Dolan’s Econ Blog
The Social Progress Index and GDP
 On the whole, higher “inputs” of
GDP give higher “outputs” on
the social progress index
 The trendline shows the
average relationship
 The relationship is not
completely tight. It is easy to
find pairs of countries where
one has higher GDP and lower
SPI score
 The relationship is nonlinear.
Lower-income countries get
more social progress per added
dollar of GDP
April 23, 2014 Ed Dolan’s Econ Blog
The Social Progress Index and GDP for Resource Exporters
 This chart adds eleven large
resource exporters (red
diamonds)
 On average, the resource
exporters get less social
progress per dollar of added
GDP than other countries
 Three wealthy countries,
Canada, Australia and Norway
are exceptions to this pattern
April 23, 2014 Ed Dolan’s Econ Blog
How Do Some Countries Escape the Curse of Riches?
How do some countries escape the curse
of riches?
 Countries like Australia, Canada, and
Norway developed institutions of
political democracy, civil society, and
rule of law before they became wealthy
resource exporters
 Their early development benefitted
from natural resource in the form of
farmland, forests, and fisheries
 Unlike “point-source” resources such
as oil and ores, the outputs from farms,
forests, and fisheries are widely owned,
hard to monopolize, and less likely to
lead to corruption of political life
Australian farm scene, 1872
April 23, 2014 Ed Dolan’s Econ Blog
Summary: The Curse of Riches
 Resource wealth, especially pointsource resources such as oil and ores,
are sometimes more of a curse than a
blessing
 The Dutch disease, which acts through
overvalued exchange rates, seems to
be a greater problem for wealthy
resource exporters
 The political economy of the resource
curse seems to be a greater problem
for lower income resource exporters
 The most fortunate countries are those
who developed democratic institutions
before they became wealthy and
manage their resource wealth wisely
April 23, 2014 Ed Dolan’s Econ Blog
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