iKoz

Coal extract

When I was nine I asked my mother why Australia, Europe and North America – the developed world - was so rich when comparably people in Africa, South America and much of Asia were so poor. Her response was simple and easy to understand: Resources. That countries blessed and well endowed with natural resources such as: coal, oil, gas, uranium ore, iron ore, zinc, copper, gold, rubber, timber, diamonds and silver were richer than countries who were on the unlucky side of the natural commodities luck-of-the-draw.  This explanation satisfied the younger, naïve and curious Kylos.

But like so much of what your parents tell you when you’re younger and how many people try to answer complicated questions with simple answers, it is actually very wrong.  In fact poverty is not determined solely by natural resources or commodities and in fact many impoverished countries are instead blessed with an abundance of natural resources.  Mexico, Angola, Ecuador, Sudan, Iran, Venezuela, Peru, Iraq, Russia, Indonesia, East Timor, Azerbaijan, Nigeria and Algeria are comparably blessed with relatively higher concentrations of natural resources, but in contrast Japan, France, Germany, Switzerland, Taiwan (ROC), South Korea, Israel, England, Denmark and the USA** (relative to its population and size) are much less blessed.  Most people would quickly realise that all the comparably resource poor countries of the second group are vastly richer than the resource-rich first group. Of course there are exceptions:  Australia, Canada, the United Arab Emirates, Qatar  and Saudi Arabia are all resource rich-”rich” countries, but I am trying to counter the false impression most people have: that the natural distribution of commodities is the ultimate determinant of the division between richer and poorer countries. A graphic example of this is that between 1965-1998 the global production and consumption of oil expanded, but the oil-rich Organisation of Petroleum Exporting Countries (OPEC) nations suffered an average real GDP decline of -1.3% per year during this period (Gylfason, 1998).

The paradox that countries richer in resources are often poorer, or have a tendency for lacklustre economic growth is known as the Resource Curse. The link between resource dependence and poor economic development has been argued by numerous authors such as Gelb, 1998; Karl, 1997; Ross, 1999, 2001  (cited in Robinson, Torvik and Verdier, 2006).

It seems counter intuitive but then if you focus it does become more obvious. Commodities might be essential for the production and consumption of everything, but they are only the start of the process. I’m sitting at a wooden table, wearing brand name clothing, using my Apple Computer powered by electricity, drinking a bottle of Diet Coke, nearby objects include an iPod and numerous books. The point is that I am using the useful products of commodities and the value of these products derives primarily from their innovation and conversion from raw materials. Real wealth comes not from the commodities but the value adding process. Still the worlds natural resources are heavily concentrated and if people are to use the final products of commodities then some country, somewhere has to extract them – so this doesn’t entirely explain away the Resource Curse paradox. A number of possible explanations are listed below.

• Governments favour Natural Resources over other industries.  To a government the economic benefit of resource extraction is more obvious than other activities. A government is likely to be attracted to investing in mining, forestry or oil extraction – but less likely to  be attracted to investment in perfumes, restaurants or emerging technology. Government favouritism of resources through investment, state owned companies, tax breaks and other incentives redistributes capital and labour away from more economically viable activity to [perhaps] less viable resource extraction.

• Real exchange rates appreciate because of a demand for commodity exports, reducing the competitiveness of other export or external industries in the economy such as manufacturing, tourism and services.

• The proceeds from resource extraction are concentrated in a small group of owners or a state enterprise.  Many government entities such as Russia’s Gazprom or a handful of companies (local or multinational)  usually own the factors of production for resource extraction. This means that the wealth from resource extraction is concentrated in the hands of a few. In contrast more diversified economies have multiple industries with diverse ownership and a sizeable middle class. This provides the country with a richer population that supports sustainable economic growth from domestic demand.

• Resources don’t encourage social and political reform. Since resources endow a country with easy revenue it keeps an existing regime in place. It is no coincidence that many resource rich states are also dictatorships or have highly corrupt governments. Countries which rely on resource revenue don’t have to pursue the economic, political and social reforms that promote economic development.

• The prices for commodities are volatile and the fluctuation causes severe economic ‘booms’ and ‘busts’. In 1999 the price of a barrel of oil was ~$17/ barrel, but in July, 2008 it had risen to ~$147/ barrel, subsequently crashing to ~$33/ barrel by December of that year. All commodity prices fluctuate by extremes being sensitive to external global demand. The extreme fluctuation can have severe economic consequences for a resource-exporting country.

• Dependency: over time the demand for a commodity can decline and a country that was over invested in resource extraction might have difficulty adjusting. For instance currently Australian coal exports are heavily dependent on demand in China (PRC) and if that level of demand were to suddenly change it would cause severe economic ramifications. Similarly Middle Eastern States would likely suffer huge economic retardation if the world was to shift away from oil consumption towards renewable energy.

• Indebted:   a favourable exchange rate, high tax receipts, high corporate profits and rapidly rising real wages tend to encourage unsustainable indebtedness in the public [government] and private sector.

• Commodity extraction is unsustainable:  eventually resource extraction is no longer viable.

• Civil war and conflict.  Control of resources has a tendency in countries of extreme poverty to cause conflict.

• Higher inflation and wage growth at the expense of real productivity growth usually occurs during mining booms.

The resource curse is particularly strong in Africa. Many African countries like Libya, Nigeria and Angola are abundant in natural resources, but the continent has the most endemic levels of poverty. For historical examples one might think of the precipitous rise and fall of the Habsburg Spanish Empire. Conquest of the New World, followed by intensive extraction of gold and silver made Spain rich and powerful. However ultimately the Spanish Empire declined at the expense of England and France because resource extraction of gold and silver didn’t derive real wealth just higher long run inflation. In contrast the rise of Germany, Japan, South Korea and Taiwan: all resource poor countries is an example of how a country doesn’t need resources to become wealthy. While I am not essentially arguing that the resource curse has to exist,  I am saying that resources don’t inherently deliver prosperity for a country. A tendency of government favouritism for resources, the prolificacy that resource wealth tends to foster and the negative effects of cyclical commodity price fluctuations are among the reasons why resource extraction may ultimately pave the way for economic ruin in some countries.

Australia is well endowed with natural resources  and resources are increasingly becoming our dominant export. There is no reason why Australia shouldn’t continue to extract resources at a sustainable level, but it is important to remember that resource riches are not the straight forward easy path to prosperity. There are risks that this country far from being a lucky country enriched with resources, could be the cursed profligate remnant of a bygone commodities boom. Everything will be okay however so long as governments encourage sustainable policies and avoid political favouritism.

As for the implications of the 40% Resource Rent Super Profits Tax (RRSPT), well this policy is likely to have multidimensional policy effects:  it could dilute the investment and production in mining- thus weakening Australia’s long term economic growth,  or it could provide government with revenue which if invested wisely might encourage diversification of the economy, or the tax could slow some of the effects of the current mining “boom” and ensure that the industry remains sustainable, finally it might ferment a nasty side effect wherein future governments are totally dependent on mining tax revenue. At least part of the motivation for the RRSPT is to reduce the increasing dependency on mineral exports in order to develop a more sustainable diversified economy.

References

Alayli, M. (2005) Resource Rich Countries and Weak Institutions: The Resource Curse Effect.

Robinson, J. Torvik, R. & Verdier, T. (2006). Political foundations of the resource curse.