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Thorvaldur Gylfason IMF INSTITUTE Course on Natural Resources, Finance, and Development Stellenbosch, South Africa November 15-26, 2010 1. 2. 3. 4. Economic geography, old and new Sources of growth Extraction rules Natural resources and economic growth: Selected policy issues 5. Cases and success stories Botswana, Chile, Mauritius, Norway Mixed blessing? Keys to success? 6. 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.” National wealth Intangible capital Physical capital Natural capital Recognizes several different sources of wealth, emphasizing human capital and, increasingly, social capital Social capital refers, among other things, to governance and institutions Many resource-rich countries have fared badly, while several resourcepoor countries have done well There are many kinds of capital and many different sources of growth Listen to Lee Kwan Yew, founding father of Singapore (1959-1991): “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 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 How much government involvement is needed to diversify? Pros and cons of industrial policy (Rodrik, 2004) Picking winners seldom works, but cutting losses can be fruitful Presupposes competent civil service 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? 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 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 Social capital Human capital • Corruption • Democracy • Education • Fertility Financial capital • Inflation Real capital • Investment Growth Natural capital 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 gN = -u Education Finance Corruption Natural capital Investment Democracy Diversification Education Exports Investment Stability Growth Listen to King Faisal of Saudi Arabia (1964-1975): “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.” Question: When is the best time to fell a tree? Answer: When the growth rate of the tree equals the rate of interest, or thereabouts Simple logic based on dynamic optimization Volume of lumber per tree is f(t) where t is time, with f’(t) > 0 because tree grows over time at g = f’(t)/f(t) Value of tree is pf(t) where p is price per unit This is what owner can sell the tree for at time t If he cuts down the tree and invest pf(t) for Dt, interest earned will be rpf(t)Dt owner waits for Dt, value of tree increases by pf(t) + pf(t+Dt) = pf’(t)Dt Optimal time to fell the tree is when MC = MR: pf’(t)Dt = rpf(t)Dt, i.e., f’(t)/f(t) = r, i.e., g = r If Provided that price of land is constant If price of land pL is variable, total revenue becomes h(t) = pf(t) + pL By same logic as before, optimal time to cut tree is when h’(t)/h(t) = pf’(t)/[pf(t)+pL] = r Price of land equals its present value: pL = e-rt[pf(t)+pL] Therefore, pL = pf(t)[e-rt/(1-e-rt)] Plug this into h’(t)/h(t) = pf’(t)/[pf(t)+pL] = r This gives h’(t)/h(t) = (1-e-rt)f’(t)/f(t) = r Hence, MC = MR gives f’(t)/f(t) = r/(1-e-rt) > r Hartwick rule defines the amount of investment in produced capital (buildings, roads, knowledge stocks, etc.) needed to exactly offset declining stocks of nonrenewable resources … … so that standard of living does not fall as society moves into indefinite future Hartwick rule –"invest resource rents!" – requires nation to invest all rent earned from exhaustible resources currently extracted Rent is defined along paths that maximize returns to owners of resource stock If part of rent is consumed, total wealth declines Hotelling rule specifies the optimal rate of extraction of an exhaustible – i.e., nonrenewable – resource … … so that the stock of the resource declines to zero at a pace that maximizes the revenue or rent from the resource to its owner Too slow extraction will not produce maximum rent, nor will too rapid extraction The trick is to find the optimal rate, i.e., the rate of extraction that maximizes the present value of the resource rent Extract resource at a rate that makes its value grow at r Four main areas 1. Fiscal policy 2. Monetary, financial, and exchangerate policy and the Dutch disease 3. Institutions and governance 4. Diversification Economic, away from excessive dependence on a few resources Political, away from narrowly based power elites 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 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 Two panels of independent experts determine the output gap and the medium-term equilibrium price of copper Real exchange rate C B A Imports Exports with oil Exports without oil Foreign exchange 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? 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 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 have been stagnant in proportion to GDP since before oil discoveries 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 Price stability requires good monetary governance through independent yet accountable central banks Healthy financial sector development also requires good monetary governance, including transparency 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 (EITI) aims to set global standard for transparency in oil, gas and mining Revenue Watch Institute (RWI) promotes responsible management of oil, gas, and mineral resources Natural Resource Charter sets out principles for how to manage natural resources for development 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 Source: http://notendur.hi.is/gylfason/pic22.htm 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 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” (Wenar, 2008) Monetary policies need to avoid overvaluation 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 Success Hong Kong Japan Singapore Switzerland Success stories without natural resources stories with natural resources Botswana Chile Mauritius Norway, again How did they succeed? How 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 Botswana succeeded 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 -6 14000 12000 10000 8000 Botswana Congo, Dem. Rep. Sierra Leone 6000 4000 2000 6 0 1 Per Capita GNI (USD at PPP) -6 14000 12000 10000 8000 Botswana Congo, Dem. Rep. 7 6 -2 2 6000 Botswana Sierra Leone 0 4000 0 8 4 Sierra Leone 2000 10 6 1 -2 -4 -6 -8 Per Capita GNI (USD at PPP) Democracy 10 14000 12000 Chile Peru 10000 13 Zambia 8000 6000 4000 2000 -6 0 Per Capita GNI (USD at PPP) 10 14000 12000 12 Chile 10 Peru 8 10000 13 Zambia 8000 4 6 6 -1 4 2 6000 0 -2 4000 2000 -6 0 -4 -6 Chile -8 Peru -10 Zambia -12 Per Capita GNI (USD at PPP) Democracy 14000 12000 Costa Rica 7 Fiji 6 10000 Mauritius 8000 6000 4000 2000 0 Per Capita GNI (USD at PPP) 5 14000 12000 12 Costa Rica 7 10 Fiji 6 8 10000 Mauritius 10 6 8000 6000 4000 10 5 4 Costa Rica 2 Fiji 0 Mauritius 2000 -2 0 4 -4 -6 Per Capita GNI (USD at PPP) Democracy 70000 60000 5 Algeria Norway 50000 Saudi Arabia 40000 30000 12 20000 10000 0 Per Capita GNI (USD at PPP) 13 70000 60000 12 5 Algeria 8 Norway 50000 6 Saudi Arabia 4 40000 30000 2 12 0 Algeria Norway Saudi Arabia -2 -4 13 -6 -8 -10 -10 -12 Per Capita GNI (USD at PPP) -4 0 20000 10000 10 10 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 Government invests 80% of oil rent entirely in foreign securities 60% in equities 40% in fixed-income securities Norway always had its natural resources 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 accumulation was the primary force behind the economic transformation of Norway Natural capital was secondary The purpose of the oil fund Share the wealth fairly: Pension fund Shield domestic economy from overheating and possible waste Fund has grown huge: USD 450 billion That makes almost USD 100K per person Norwegians have resisted temptation to use too much of the money to meet current needs 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 commonproperty 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 Some (weak) signs of Dutch disease Stagnant exports, sluggish FDI Limited interest in joining EU and EMU Some signs also of unwillingness to undertake difficult reforms Health care provision Management of oil fund delegated by Ministry of Finance to Central Bank from 1997 onward Central Bank became independent 1999 Natural resources bring risks A false sense of security leads people to underrate or overlook the need for good policies and institutions, good education, and good investment 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 United States Russian Federation Saudi Arabia Iran, Islamic Republic China Mexico Canada Venezuela, RB United Arab Emirates Kuwait Algeria Nigeria Indonesia Brazil United Kingdom Norway 0 500 1000 1500 2000 Millions Kuwait United Arab Emirates Saudi Arabia Brunei Oman Bahrain Norway Trinidad and Tobago Gabon Venezuela, RB Canada Turkmenistan Russian Federation Algeria Australia Iran, Islamic Republic Kazakhstan Congo, Republic United States Malaysia Syrian Arab Republic Azerbaijan Mexico Angola Ecuador Chile United Kingdom 0 50 100 150 200 Thousands High-income countries Real capital Low-income countries 17 16 Subsoil assets 2 29 (1) (6) Intangible capital Human capital Social capital 81 55 Natural capital Total wealth: estimated by perpetual inventory method as present discounted value of future consumption Real capital: estimated from investment figures Natural capital: cropland, pastureland, subsoil assets, timber resources, nontimber forest resources, and protected areas Intangible capital: estimated as residual Source: World Bank (2006) Mineralrich countries Lower middleincome countries Upper middleincome countries School life expectancy 2005 (years) Fertility 1960-2000 (births per woman) Public health expenditure 2004 (% of GDP) Democracy 1960-2000 (index) Corruption 2005 (index) Investment 1960-2000 (% of GDP) Per capita growth 1960-2000 (% per year) 11.7 4.5 2.4 -3.2 3.3 24.3 0.1 11.4 3.6 2.6 -1.2 3.0 24.3 3.6 13.5 2.9 3.8 2.2 4.1 25.9 1.7 Growth of per capita GDP, adjusted for initial income (% per year) 8 -0.67 6 4 2 0 -0.2 0.0 0.2 0.4 0.6 -2 -4 -6 -8 -10 Natural capital as share of total wealth 0.8 1.0 25 -0.82 School life expectancy 20 15 10 5 0 -0.2 0.0 0.2 0.4 0.6 -5 Natural capital as share of total wealth 0.8 1.0 Growth of per cepita GDP, adjusted for initial income (% per year) 8 -8 0.69 6 4 2 0 0 5 10 15 -2 -4 -6 School life expectancy 20 25 -0.74 10 Corruption perceptions index More corruption 12 8 6 4 2 0 0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 Natural capital as share of total wealth 0.8 0.9 1.0 Growth of per capita GDP, adjusted for initial income (% per year) 8 0.75 6 4 2 0 0 2 4 6 8 10 -2 -4 -6 -8 -10 More corruption Corruption perceptions index 12 15 -0.67 10 Democracy 5 0 -0.2 0.0 0.2 0.4 0.6 -5 -10 -15 Natural capital as share of total wealth 0.8 1.0 Growth of per capita GDP, adjusted for initial income (% per year) 8 6 -15 -10 -5 0.51 4 2 0 0 -2 -4 -6 -8 -10 Democracy 5 10 15 15 0.62 10 Democracy 5 0 0 5 10 15 -5 -10 -15 School life expectancy 20 25 More corruption Corruption perceptions index 10 -15 9 -10 -5 0.60 8 7 6 5 4 3 2 1 0 0 Democracy 5 10 15 Growth of per capita GDP, adjusted for initial income (% per year) 8 -0.67 6 4 2 0 -0.2 0.0 0.2 0.4 0.6 -2 -4 -6 -8 -10 Natural capital as share of total wealth 0.8 1.0 Growth of per capita GDP, adjusted for initial income (% per year) 8 -0.10 6 4 2 0 -0.5 0 0.5 1 1.5 -2 -4 -6 -8 -10 Subsoil assets as share of total wealth 2 2.5 Model 1 Initial income Natural capital share Natural capital per person Democracy -0.74 (5.2) Investment rate (log) School life expectancy (log) Fertility Countries 164 Adjusted R2 0.14 Note: t-values within parentheses. Model 1 Model 2 -0.74 (5.2) -0.49 (3.1) -0.04 (5.3) Countries 164 125 Adjusted R2 0.14 0.18 Initial income Natural capital share Natural capital per person Democracy Investment rate (log) School life expectancy (log) Fertility Initial income Natural capital share Natural capital per person Democracy Model 1 Model 2 Model 3 -0.74 (5.2) -0.49 (3.1) -0.04 (5.3) -0.96 (5.3) -0.06 (7.1) 0.10 (4.5) Investment rate (log) School life expectancy (log) Fertility Countries 164 125 124 Adjusted R2 0.14 0.18 0.29 Initial income Natural capital share Natural capital per person Democracy Model 1 Model 2 Model 3 Model 4 -0.74 (5.2) -0.49 (3.1) -0.04 (5.3) -0.96 (5.3) -0.06 (7.1) -1.07 (5.2) -0.05 (4.7) 0.10 (4.5) 0.08 (3.7) 0.07 (2.2) Investment rate (log) School life expectancy (log) Fertility Countries 164 125 124 113 Adjusted R2 0.14 0.18 0.29 0.27 Initial income Natural capital share Natural capital per person Democracy Model 1 Model 2 Model 3 Model 4 Model 5 -0.74 (5.2) -0.49 (3.1) -0.04 (5.3) -0.96 (5.3) -0.06 (7.1) -1.07 (5.2) -0.05 (4.7) -1.24 (7.0) -0.04 (5.3) 0.10 (4.5) 0.08 (3.7) 0.06 (3.3) 0.07 (2.2) 0.07 (2.7) 2.92 (6.8) Investment rate (log) School life expectancy (log) Fertility Countries 164 125 124 113 113 Adjusted R2 0.14 0.18 0.29 0.27 0.48 Initial income Natural capital share Natural capital per person Democracy Model 1 Model 2 Model 3 Model 4 Model 5 Model 6 -0.74 (5.2) -0.49 (3.1) -0.04 (5.3) -0.96 (5.3) -0.06 (7.1) -1.07 (5.2) -0.05 (4.7) -1.24 (7.0) -0.04 (5.3) -1.60 (7.8) -0.03 (4.0) 0.10 (4.5) 0.08 (3.7) 0.06 (3.3) 0.05 (2.5) 0.07 (2.2) 0.07 (2.7) 2.92 (6.8) 0.07 (2.7) 1.72 (3.2) 0.94 (4.0) Investment rate (log) School life expectancy (log) Fertility Countries 164 125 124 113 113 90 Adjusted R2 0.14 0.18 0.29 0.27 0.48 0.55 Initial income Natural capital share Natural capital per person Democracy Model 1 Model 2 Model 3 Model 4 Model 5 Model 6 Model 7 -0.74 (5.2) -0.49 (3.1) -0.04 (5.3) -0.96 (5.3) -0.06 (7.1) -1.07 (5.2) -0.05 (4.7) -1.24 (7.0) -0.04 (5.3) -1.60 (7.8) -0.03 (4.0) -1.70 (8.5) -0.03 (3.1) 0.10 (4.5) 0.08 (3.7) 0.06 (3.3) 0.05 (2.5) 0.04 (2.3) 0.07 (2.2) 0.07 (2.7) 2.92 (6.8) 0.07 (2.7) 1.72 (3.2) 0.94 (4.0) 0.05 (2.0) 1.34 (2.5) 0.56 (2.1) Investment rate (log) School life expectancy (log) Fertility Countries 164 125 124 113 113 90 -0.40 (2.8) 90 Adjusted R2 0.14 0.18 0.29 0.27 0.48 0.55 0.58 OLS Initial income Natural capital share Natural capital per person Democracy Model 1 Model 2 Model 3 Model 4 Model 5 Model 6 Model 7 -0.74 (5.2) -0.49 (3.1) -0.04 (5.3) -0.96 (5.3) -0.06 (7.1) -1.07 (5.2) -0.05 (4.7) -1.24 (7.0) -0.04 (5.3) -1.60 (7.8) -0.03 (4.0) -1.70 (8.9) -0.03 (3.3) 0.10 (4.5) 0.08 (3.7) 0.06 (3.3) 0.05 (2.5) 0.04 (2.4) 0.07 (2.2) 0.07 (2.7) 2.92 (6.8) 0.07 (2.7) 1.72 (3.2) 0.94 (4.0) 0.05 (2.1) 1.34 (2.6) 0.56 (2.2) Investment rate (log) School life expectancy (log) Fertility Countries 164 125 124 113 113 90 -0.40 (3.0) 90 Adjusted R2 0.14 0.18 0.29 0.27 0.48 0.55 0.58 SUR Per capita growth (%) 2.42 1.00 Natural capital share (19.0) 0.47 0.19 Democracy (6.4) 0.35 0.14 Investment (log, 0.29) 0.39 0.16 School life expectancy (log, 0.35) 0.48 0.20 Fertility (1.8) 0.73 0.30 Note: Standard deviations within parentheses. 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.”