Natural Resource Endowment: A Mixed Blessing?

Abstract

This paper deals with the implications of natural resources for the conduct of economic policies and the role and design of institutions in resource‐rich countries. The paper briefly reviews the experience of a few resource‐rich countries, highlighting the successes of those that have done well as well as some of the fiscal, monetary, and exchange rate policy issues that arise along the way. Special attention is given to Norway, the world’s third largest oil exporter, and the role of good governance, including democracy. The paper then turns from anecdotal to econometric analysis by offering a quick glance at some of the empirical cross-country patterns that can be brought to bear on the relationship between natural resources, economic growth, and some of the main determinants of growth, including democracy.

Full text

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First draft.
18 October 2010.


Natural Resource Endowment:
A Mixed Blessing?

Thorvaldur Gylfason*


Abstract
This paper deals with the implications of natural resources for the conduct of economic
policies and the role and design of institutions in resource-rich countries. The paper briefly
reviews the experience of a few resource-rich countries, highlighting the successes of those
that have done well as well as some of the fiscal, monetary, and exchange rate policy issues
that arise along the way. Special attention is given to Norway, the world’s third largest oil
exporter, and the role of good governance, including democracy. The paper then turns from
anecdotal to econometric analysis by offering a quick glance at some of the empirical cross-
country patterns that can be brought to bear on the relationship between natural resources,
economic growth, and some of the main determinants of growth, including democracy.

Keywords: Economic growth, natural resources, governance.
JEL: O11.

* Professor of Economics, University of Iceland. Address: Department of Economics, University of Iceland, 101
Reykjavík, Iceland. Tel.: +354-525-4500. Fax: +354-552-6806. Email: gylfason@hi.is. This article is drawn from
the author’s lecture at a high-level seminar on Natural resources, finance, and development in Algiers 4-5
November 2010, organized by the Central Bank of Algeria and the IMF Institute.

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1. Introduction
Economic geography is no longer what it used to be. For a long time, economic geographers
studied raw materials and their distribution around the world and assigned a crucial role to
natural resource wealth and raw materials, their ownership, and trade routes. Ownership of
those important resources tended to be equated with economic and political strength. The
European powers’ scramble for Africa from 1881 onward – this was when France occupied
Tunis with Germany’s consent – was mainly a scramble for the great continent’s resources.
The slave trade from the mid-15th century onward can be viewed the same way.
It did not take long to become clear that natural resources do not always confer widely
shared benefits on the peoples who own them. Even after the end of colonial rule in Africa
and elsewhere, many resource-abundant countries – Congo is a case in point – remained in
dire straits. Some other countries – Nigeria, for example – that discovered their natural
resources after independence also did not make rapid economic progress for reasons that
seem to be related in part to poor management of their natural resources. Russia’s former
President, now Prime Minister Vladimir Putin has said: “Our country is rich, but our people
are poor.” Even so, some natural resource rich countries have made impressive progress.
Botswana, Chile, and Mauritius will be singled out in what follows. And several resource-
poor countries managed to become rich, including Hong Kong, Japan, and Singapore.
In the light of experience, the new economic geography puts relatively less emphasis on
natural resources by recognizing several distinct sources of wealth, especially the
accumulation of human and social capital. There are many different kinds of man-made
capital, and, accordingly, many separate sources of economic growth which the people and
their governments can bring under their control. By social capital is meant the quality of
formal and informal institutions, including governance, transparency, and trust.
In the world as a whole, natural capital constituted a small part of total national wealth in
2005, or six per cent.1 If intangible capital – that is, human and social capital – is left out of
the computation, natural capital constitutes 26 per cent of total tangible capital around the
world. Tangible capital comprises produced capital, urban land, natural capital, and net
foreign assets. For comparison, sub-Saharan Africa’s natural capital amounts to 28 per cent
of the continent’s total wealth and 70 per cent of its total tangible capital (Figures 1 and 2).

1 The Wealth of Nations, The World Bank (2010).

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In the Middle East, the numbers are 34 per cent and 58 per cent, respectively.
In his memoirs, Lee Kuan Yew, the founding father of Singapore (1959-1991), described
his thinking as follows:
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.2
Earlier, in 1966, Prime Minister Lee had this to say in a speech at the Delegates’
Conference of the National Trade Union Congress in Singapore:3
In the last 20 or more years since the end of the Second World War, we have seen how
the human factor has been one of the most potent factors for economic growth and
national recovery as against the natural geographic and mineral resources of a given
society. Two nations, Germany and Japan, were both beaten down to their knees. Both
lost large tracks of territory … Both found their smaller remaining territories crammed
with refugees ... And, in both cases, they were able to recover through an ability to
mobilize their human resources. First, there was the basic willingness of the worker to
work and pay for what he wants; and second, high standards of technical expertise and
American markets and investments. But the latter were not decisive. The decisive factor
was the human resources at their disposal. And Germany and Japan have emerged with a
strength to be reckoned with in Europe and in Asia.
Recent economic growth theory suggests the interaction of several sources of economic
growth and development as important to growth. For example, the conversion of natural
capital to human and social capital to boost growth requires, or is at least helped by, good
institutions and governance. For another example, investments in human capital and social
capital tend to go hand in hand and reinforce one another. Here two types of classification
can be helpful.
First, growth can be extensive, driven forward by the accumulation of capital, or it can be

2 Quoted from Lee Kuan Yew (1998), The Singapore Story, Memoirs of Lee Kuan Yew, Singapore Press Holdings,
Singapore.
3 Source: http://stars.nhb.gov.sg/stars/tmp/lky19661002.pdf, pp. 3-4.

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intensive, springing from more efficient use of existing capital and other resources. Among
the numerous alternative ways of promoting economic and social efficiency, one of the most
effective is the accumulation of human capital through education, on-the-job training, and
health care. There are many other ways as well to increase efficiency and economic growth.
For instance, free trade can empower individuals, firms, and countries to break outside the
confines of their production frontiers that, under autarky, would entail lower standards of
life. Other examples abound, as the burgeoning economic growth literature of recent years
has made clear. Moreover, it has come to be widely recognized that the quality of
institutions and good governance can help generate sustained growth and so can also
various other factors that are closely related to economic organization, institutions, and
policy.4 The determinants of growth are generally closely related and influence growth
together as well as separately. In growth theory, everything depends on everything else.
A second classification distinguishes among several different types of capital that, like
plants, are capable of growth at different rates:
(i) Saving and investment to build up real capital – physical infrastructure, roads and
bridges, factories, machinery, equipment, and such;
(ii) Education, training, health care, and social security to build up human capital, a better
and more productive work force;
(iii) Exports and imports of goods, services, and capital to build up foreign capital, among
other things, to supplement domestic capital;
(iv) Democracy, freedom, equality, and honesty – that is, absence of corruption – to build
up social capital, to strengthen the social fabric, the glue that helps hold the economic
system together and keep it in good running order;
(v) Economic stability with low inflation to build up financial capital – in other words,
liquidity – that lubricates the wheels of the economic system and helps keep it
running smoothly; and
(vi) Manufacturing and service industries that permit diversification of the national
economy away from excessive reliance on low-skill-intensive primary production,
including agriculture, based on natural capital.

4 See Fischer and Sahay (2000), Campos and Coricelli (2002), and Acemoglu and Johnson (2005).

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Most would accept that the six items on the list – real capital, human capital, foreign capital,
social capital, financial capital, and natural capital – are desirable and helpful in themselves,
and most would also agree on the desirability of diversification of economic activity. How
these goals can be attained is another matter, however. The above list could be extended,
but let us rather notice a couple of things about this short list.
First, capital appears in many different guises, some tangible, some not, but in all its
guises it needs to be built up gradually through painstaking investments at the expense of
current consumption. A strong capital base requires a lot of good and durable investments in
different areas. Second, natural capital differs from the other kinds of capital on the list in
that it may be a good idea – for reasons to be discussed below – to be on guard against
excessive reliance on this particular kind of capital. Here it is important to distinguish clearly
between natural resource abundance and natural resource dependence. By abundance is
meant the amount of natural capital that a country has at its disposal: mineral deposits, oil
fields, forests, farm land, and the like. By dependence is meant the extent to which the
nation in question depends on these natural resources for its livelihood. Some countries with
abundant natural resources, for example, Australia, Canada, and the United States, outgrew
those resources and are no longer especially dependent on them. Other resource-abundant
countries, for example, the Organization of Petroleum Exporting Countries (OPEC), do
depend on their resources, some practically for all they have got. Still other countries, say,
Chad and Mali, have few resources and yet depend on them for the bulk of their export
earnings because they have little else to offer for sale abroad. Others still have few resources
and do not depend in any important manner on the little they have, such as, for example,
Jordan and Panama. The idea that diversification away from natural resources may be good
for long-run growth centers on dependence rather than abundance even if the distinction
may in some instances be hard to make in practice. It is quite conceivable that excessive
dependence on a few natural resources may hurt economic growth, even if an abundance of
natural resources, if well managed, may be good for growth. By contrast, no country has
ever suffered from excessive reliance on human capital built up through education.
The rest of the paper is organized as follows. First, we consider the implications of natural
resources for the conduct of economic policies and the role and design of institutions in
resource rich countries. Second, we briefly review the experience of a dozen resource-rich
countries, highlighting the successes of those that have done well, with special emphasis on