The Natural Resource Curse The Natural Resource Curse II:II:

Recommendations Recommendations to Avoid the Pitfalls to Avoid the Pitfalls

Jeffrey FrankelJeffrey FrankelHarpel Professor, Harvard UniversityHarpel Professor, Harvard University

Mongolia Economic ForumMongolia Economic Forum

Ulan Bator, Mongolia, March 2011Ulan Bator, Mongolia, March 2011

Institutions & Policies to Institutions & Policies to Address the Natural Address the Natural Resource Curse Resource Curse

A wide variety of measures A wide variety of measures have been tried to cope with have been tried to cope with the commodity cyclethe commodity cycle. . [1][1]

Some work better than others.Some work better than others.

[1][1] E.g., Davis, et al E.g., Davis, et al (2003) and(2003) and Sachs Sachs (2007).(2007).

Policies/Institutions to Policies/Institutions to Deal Deal

with the NRCwith the NRC

I. Attempts to deal with volatilityI. Attempts to deal with volatility1.1. Unsuccessful attempts to reduce volatilityUnsuccessful attempts to reduce volatility2.2. Coping withCoping with volatility: Devices to share risk volatility: Devices to share risk

II. Monetary / Exchange rate policyII. Monetary / Exchange rate policy

III. How to insure saving in boom timesIII. How to insure saving in boom times

IV. Imposing external checks for countries IV. Imposing external checks for countries with weak internal institutions.with weak internal institutions.

I. Dealing with VolatilityI. Dealing with Volatility

A number of institutions have been A number of institutions have been implemented in the name of reducing implemented in the name of reducing volatility.volatility.

Most have failed to do so, Most have failed to do so, and many have had detrimental effects.and many have had detrimental effects.

Marketing boardsMarketing boards Taxation of commodity productionTaxation of commodity production Producer subsidiesProducer subsidies Other government stockpilesOther government stockpiles Price controls for consumersPrice controls for consumers OPEC and other international cartels OPEC and other international cartels

Lesson: Accept the existence of Lesson: Accept the existence of volatility, and adopt institutions volatility, and adopt institutions to to

cope with itcope with it3 Devices to share risk efficiently3 Devices to share risk efficiently

1.1. For energy producers who sign For energy producers who sign contracts with foreign companies.contracts with foreign companies.

2.2. For producers who sell For producers who sell their minerals themselves.their minerals themselves.

3.3. For debtors dependent For debtors dependent on mineral revenues.on mineral revenues.

1. Price setting in contracts 1. Price setting in contracts with foreign companieswith foreign companies

Price setting in contracts between producing countries and Price setting in contracts between producing countries and foreign mining companies is often plagued by a problem that is foreign mining companies is often plagued by a problem that is known to theorists as “time inconsistency”:known to theorists as “time inconsistency”:

(i) A price is set by contract. (i) A price is set by contract. (ii) Later the world price goes up, and then the government (ii) Later the world price goes up, and then the government

wants to renege. It doesn't want to give the company all the wants to renege. It doesn't want to give the company all the profits, and why should it? profits, and why should it?

But this is a “repeated game.” But this is a “repeated game.” The risk that the locals will renege makes foreign companies The risk that the locals will renege makes foreign companies

reluctant to do business in the first place. reluctant to do business in the first place. It limits the amount of capital available to the country, It limits the amount of capital available to the country,

and probably raises the cost of that capital. and probably raises the cost of that capital. The process of renegotiation can have large transactions The process of renegotiation can have large transactions

costs, such as interruptions in the export flow.costs, such as interruptions in the export flow.

Solution for price setting in Solution for price setting in contractscontracts

Indexed contracts:Indexed contracts: the two parties agree ahead of time, “if the the two parties agree ahead of time, “if the

world price goes up 10%, then the gains are world price goes up 10%, then the gains are split between the company and the split between the company and the government” in some particular proportion. government” in some particular proportion.

Indexation shares the risks of gains and losses,Indexation shares the risks of gains and losses, without the costs of renegotiation or without the costs of renegotiation or damage to a country’s reputation from reneging.damage to a country’s reputation from reneging.

2. Hedging in commodity 2. Hedging in commodity futures marketsfutures markets

Producers who sell their minerals on international spot markets, Producers who sell their minerals on international spot markets, are exposed to the risk that the $ price rises or falls. are exposed to the risk that the $ price rises or falls.

The producer can hedge the risk by selling The producer can hedge the risk by selling that quantity on the forward or futures market.that quantity on the forward or futures market.

Hedging Hedging => no need for costly renegotiation if world price changes. => no need for costly renegotiation if world price changes. as with indexation of the contract price. as with indexation of the contract price. The adjustment happens automatically. The adjustment happens automatically.

Mexico has hedged its oil revenues in this way.Mexico has hedged its oil revenues in this way.

One possible drawback, if a government ministry hedges: One possible drawback, if a government ministry hedges: the Minister receives no credit for having saved the country from disaster the Minister receives no credit for having saved the country from disaster when the world price falls, but is excoriated for having sold out the when the world price falls, but is excoriated for having sold out the national patrimony when the price rises.national patrimony when the price rises.

Mexico thus uses options to eliminate only the risk of a fall in price.Mexico thus uses options to eliminate only the risk of a fall in price.

3. Denomination of debt 3. Denomination of debt in terms of the mineral pricein terms of the mineral price

An copper-producer should An copper-producer should index its debt to the copper priceindex its debt to the copper price..

So debt service obligations automatically So debt service obligations automatically rise & fall with the world price. rise & fall with the world price.

Debt crises Debt crises hit Mexicohit Mexico in 1982 in 1982 andand Indonesia, Russia & Ecuador in 1998, Indonesia, Russia & Ecuador in 1998,

when the $ prices of their oil exports fell, when the $ prices of their oil exports fell, and so their debt service ratios worsened abruptly.and so their debt service ratios worsened abruptly.

This would not have happened if their debts This would not have happened if their debts had been indexed to the oil price.had been indexed to the oil price.

As with contract indexation & hedging, adjustment As with contract indexation & hedging, adjustment in in the event of fluctuations in the oil price is the event of fluctuations in the oil price is automatic.automatic.

II. Monetary/ Exchange Rate II. Monetary/ Exchange Rate policypolicy

Fixed vs. floating exchange rates Fixed vs. floating exchange rates

Nominal anchors as alternatives Nominal anchors as alternatives to the exchange rateto the exchange rate

2 candidates for nominal anchor 2 candidates for nominal anchor that are no longer popular that are no longer popular

Inflation targetingInflation targeting Orthodox implementation: the CPIOrthodox implementation: the CPI Unorthodox versions for Unorthodox versions for

commodity producerscommodity producers PPT

Fixed vs. floating exchange Fixed vs. floating exchange ratesrates

Each has its advantages. Each has its advantages. The main advantages of a fixed exchange rate: The main advantages of a fixed exchange rate:

it reduces the costs of international trade, it reduces the costs of international trade, it is a nominal anchor for monetary policy, it is a nominal anchor for monetary policy,

helping the central bank achieve low-inflation credibility. helping the central bank achieve low-inflation credibility.

The main advantage of floating, The main advantage of floating, for a mineral for a mineral producer:producer: automatic accommodation to terms of trade shocks. automatic accommodation to terms of trade shocks.

During a mineral boom, the currency tends to appreciate, During a mineral boom, the currency tends to appreciate, thereby moderating what would otherwise be a danger thereby moderating what would otherwise be a danger

of excessive capital inflows and overheating of the of excessive capital inflows and overheating of the economy; economy;

and the reverse during a mineral bust.and the reverse during a mineral bust.

A loose recommendationA loose recommendation

A balancing of these pros & cons => A balancing of these pros & cons => an intermediate exchange rate regime such as managed an intermediate exchange rate regime such as managed floating.floating.

In the decade 2001-11, many followed the intermediate In the decade 2001-11, many followed the intermediate regime, regime, in between in between a few commodity producers in the floating corner (Chile & a few commodity producers in the floating corner (Chile &

Mexico) Mexico) and a few in the firmly fixed corner (Gulf oil producers & and a few in the firmly fixed corner (Gulf oil producers &

Ecuador). Ecuador).

While they officially declared themselves as floating While they officially declared themselves as floating (often under IT), in practice these intermediate countries (often under IT), in practice these intermediate countries intervened heavily, taking perhaps ½ the increase in intervened heavily, taking perhaps ½ the increase in demand for their currency in the form of appreciation but demand for their currency in the form of appreciation but 1/2 in the form of increased foreign exchange reserves. 1/2 in the form of increased foreign exchange reserves. Examples among oil-producers include Kazakhstan & Russia.Examples among oil-producers include Kazakhstan & Russia.

Particularly at the early stages of a boom, Particularly at the early stages of a boom, there is a good case for intervention in the there is a good case for intervention in the foreign exchange market, adding to reserves foreign exchange market, adding to reserves especially if the alternative is abandoning an especially if the alternative is abandoning an

established successful exchange rate target.established successful exchange rate target.

In subsequent years, if the increase in world In subsequent years, if the increase in world commodity prices looks to be long-lived, commodity prices looks to be long-lived, there is a stronger case for accommodating it there is a stronger case for accommodating it through appreciation of the currency.through appreciation of the currency.

A loose recommendation, A loose recommendation, continuedcontinued

Nominal anchors for monetary Nominal anchors for monetary policypolicy

If the exchange rate is not to be nominal If the exchange rate is not to be nominal anchor,anchor,

something else must be…something else must be… especially where institutions lack credibilityespecially where institutions lack credibility

2 alternatives for nominal anchor 2 alternatives for nominal anchor have had ardent supporters in the past, have had ardent supporters in the past, but are no longer in the running:but are no longer in the running:

the price of gold, as 19th century gold standard; the price of gold, as 19th century gold standard; the money supply, the choice of monetarists; and the money supply, the choice of monetarists; and

Inflation targetingInflation targeting Orthodox implementation: the CPIOrthodox implementation: the CPI Unorthodox versions for commodity producersUnorthodox versions for commodity producers

PPT

Professor Jeffrey Frankel

Inflation targeting has, for 10 Inflation targeting has, for 10 years, been the conventional years, been the conventional

wisdom wisdom for how to conduct monetary for how to conduct monetary

policy.policy. among economists, central bankers, IMF…among economists, central bankers, IMF…

A narrow definition of Inflation Targeting? A narrow definition of Inflation Targeting? 11/ /

IT is defined as setting yearly CPI targets, IT is defined as setting yearly CPI targets, to the exclusion of:to the exclusion of: - asset prices- asset prices

- exchange rates- exchange rates

- export prices, - export prices, Some reexamination is warranted.Some reexamination is warranted.

11// A broad definition: Flexible inflation targeting ≡ “Have a long run target A broad definition: Flexible inflation targeting ≡ “Have a long run target for inflation, and be transparent.” Then who could disagree?for inflation, and be transparent.” Then who could disagree?

Professor Jeffrey Frankel

The shocks of 2007-2010 showed The shocks of 2007-2010 showed some disadvantages to Inflation Targetingsome disadvantages to Inflation Targeting ..

One disadvantage of IT: One disadvantage of IT: no response to asset price bubbles.no response to asset price bubbles.

Another disadvantageAnother disadvantage::

It gives the wrong answer in case of trade shocks:It gives the wrong answer in case of trade shocks: In response to a rise in prices of export commodities, In response to a rise in prices of export commodities,

it does not allow monetary tightening and it does not allow monetary tightening and appreciation.appreciation.

In response to a fall in world prices of exports,In response to a fall in world prices of exports,it does not allow a depreciation to help equilibrate.it does not allow a depreciation to help equilibrate.

Professor Jeffrey Frankel

Proposal to Product Price Targeting

Intended for countries with volatile terms of trade, e.g., those specialized in minerals.

The authorities peg the currency to a basket that gives heavy weight to prices of its mineral exports, rather than to the $ or € or gold or CPI.

The regime combines the best of both worlds:

(i) The advantage of automatic accommodation to terms of trade shocks, together with

(ii) the advantages of a nominal anchor.

PPT

III. Make National Saving Procyclical

Hartwick rule: rents from mineral wealth should be Hartwick rule: rents from mineral wealth should be saved, against the day when deposits run out.saved, against the day when deposits run out.

At the same time, traditional macroeconomics says At the same time, traditional macroeconomics says that government budgets should be countercyclical: that government budgets should be countercyclical: running surpluses in booms, & spending in running surpluses in booms, & spending in recessions. recessions.

Mineral producers tend to fail both these principles: Mineral producers tend to fail both these principles: they save too little on average and more so in booms. they save too little on average and more so in booms.

They need institutions to insure that export earnings They need institutions to insure that export earnings are put aside during the boom time, are put aside during the boom time, into a commodity saving fund, into a commodity saving fund, with rules governing the cyclically adjusted budget surplus.with rules governing the cyclically adjusted budget surplus. Davis et al Davis et al (2001a,b, 2003).(2001a,b, 2003).

Chile’s fiscal institutionsChile’s fiscal institutionsChile’s fiscal policy is governed by a set of rules. Chile’s fiscal policy is governed by a set of rules. 

   

11st st rule: Target for the budget deficit = 0.  rule: Target for the budget deficit = 0.     

This may sound like the budget deficit ceilings This may sound like the budget deficit ceilings under Europe’s Stability & Growth Pact,under Europe’s Stability & Growth Pact,

but such attempts have failed, because they are too rigid but such attempts have failed, because they are too rigid to allow the need for deficits in recessions, to allow the need for deficits in recessions, counterbalanced by surpluses in good times.  counterbalanced by surpluses in good times. 

The alternative of letting politicians explain away deficits The alternative of letting politicians explain away deficits by declaring them the result of unexpected slow growth by declaring them the result of unexpected slow growth also does not work, because it imposes no discipline. also does not work, because it imposes no discipline. 

2nd rule: The government can run a deficit to the extent 2nd rule: The government can run a deficit to the extent that:that: (1) output falls short of potential, in a recession, or(1) output falls short of potential, in a recession, or (2) the price of copper is below its equilibrium(2) the price of copper is below its equilibrium..

Chile’s fiscal institutionsChile’s fiscal institutions, continued, continued

33rdrd rule: rule: two panels of experts have the job, each mid-year, to two panels of experts have the job, each mid-year, to judge: what is the output gap judge: what is the output gap and and the 10-year equilibrium the 10-year equilibrium copper pricecopper price

Thus in the copper boom of 2003-08 when, as usual, Thus in the copper boom of 2003-08 when, as usual, the political pressure was to declare the rise in the copper the political pressure was to declare the rise in the copper price permanent thereby justifying spending on a par price permanent thereby justifying spending on a par with export earnings, the panel ruled that most of the with export earnings, the panel ruled that most of the price increase was temporary price increase was temporary so most of the earnings had to be saved.  so most of the earnings had to be saved.  This turned out right, as the 2008 spike was indeed temporary.    This turned out right, as the 2008 spike was indeed temporary.    The fiscal surplus reached almost 9 % when copper prices were The fiscal surplus reached almost 9 % when copper prices were

high.  high. 

The country saved 12 % of GDP in the SWF.    The country saved 12 % of GDP in the SWF.    This allowed big fiscal easing in the recession of 2008-09, This allowed big fiscal easing in the recession of 2008-09,

when the stimulus was most sorely needed.when the stimulus was most sorely needed.

Commodity funds or Sovereign Wealth Commodity funds or Sovereign Wealth Funds Funds

Reducing net inflows during boomsReducing net inflows during booms Lump sum distributionLump sum distribution Invest in education, health, and roads.Invest in education, health, and roads.

Other fiscal institutions

IV. Efforts to Impose External IV. Efforts to Impose External ChecksChecks

The Chad experimentThe Chad experiment

The Extractive Industries The Extractive Industries Transparency Initiative: “Publish Transparency Initiative: “Publish What You Pay”What You Pay”

More drastic solutionsMore drastic solutions

External checks: External checks: The Chad experimentThe Chad experiment

In 2000 the World Bank agreed to help Chad, a new oil producer, to finance a new pipeline. Its government is ranked by Transparency International as one

of the two most corrupt in the world.

The agreement stipulated that Chad would spend 72 % of its oil export earnings on poverty

reduction (health, education & road-building) & put aside 10 % in a “future generations fund.”

External checks: External checks: The Chad experiment,The Chad experiment, continuedcontinued

ExxonMobil was to deposit the oil revenues in an escrow account at Citibank;

the government was to spend them subject to oversight by an independent committee.

But once the money started rolling in, the government reneged on the agreement.

External checks,External checks, continued continued

Extractive Industries Transparency Extractive Industries Transparency Initiative, launched in 2002, includes the Initiative, launched in 2002, includes the principle “Publish What You Pay,” principle “Publish What You Pay,” International oil companies commit to make International oil companies commit to make

known how much they pay governments for known how much they pay governments for oil, oil,

so that the public at least has a way of knowing,so that the public at least has a way of knowing,when large sums disappear. when large sums disappear.

Legal mechanisms adopted by SLegal mechanisms adopted by Sãão Tomo Toméé & Principe void contracts if information & Principe void contracts if information relating to oil revenues is not made public. relating to oil revenues is not made public.

Further proposals would give extra powers Further proposals would give extra powers to a global clearing house or foreign bank to a global clearing house or foreign bank where the Natural Resource Fund is located, where the Natural Resource Fund is located, e.g.e.g. freezing accounts in the event of a coup. freezing accounts in the event of a coup. [1][1]

Well-intentioned politicians may spend Well-intentioned politicians may spend commodity wealth quickly out of fear that their commodity wealth quickly out of fear that their successors will misspend whatever is left. successors will misspend whatever is left. If so, adopt an external mechanism that constrains If so, adopt an external mechanism that constrains

spending both in the present in the future.spending both in the present in the future.

[1] Humphreys & Sandhu[1] Humphreys & Sandhu (2007,(2007, p. 224-27).p. 224-27).

When Kuwait was occupied by Iraq, access to Kuwaiti When Kuwait was occupied by Iraq, access to Kuwaiti bank accounts in London stayed with the Kuwaitis.bank accounts in London stayed with the Kuwaitis.

External checks,External checks, continued continued

Devices to share risksDevices to share risks

1. In contracts with foreign companies, 1. In contracts with foreign companies, partially index the price to the world mineral partially index the price to the world mineral price.price.

2. Hedge mineral revenues in options markets2. Hedge mineral revenues in options markets

3. Denominate debt in terms of mineral prices 3. Denominate debt in terms of mineral prices

Summary: 10 recommendations for oil producing countries

4. Allow some currency appreciation in response 4. Allow some currency appreciation in response to a rise in world commodity prices, but also add to a rise in world commodity prices, but also add to foreign exchange reserves.to foreign exchange reserves.

5. If the monetary regime is to be Inflation Targeting, 5. If the monetary regime is to be Inflation Targeting, consider using as the target, in place of the CPI, consider using as the target, in place of the CPI, a price measure that puts more weight a price measure that puts more weight on the export commodity (e.g., PPT).on the export commodity (e.g., PPT).

6. Emulate Chile: to avoid over-spending in boom 6. Emulate Chile: to avoid over-spending in boom times, allow deviations from a target surplus times, allow deviations from a target surplus only in response to permanent oil price increases, only in response to permanent oil price increases, as judged by independent expert panels.as judged by independent expert panels.

Summary: 10 recommendations for oil producers, continued

Macroeconomic policyMacroeconomic policy

7. Run Commodity Funds transparently 7. Run Commodity Funds transparently and professionally. and professionally.

8. Invest in education, health, and roads.8. Invest in education, health, and roads.

9. Publish What You Pay. Consider lump-sum 9. Publish What You Pay. Consider lump-sum distribution of mineral wealth, equal per capita.distribution of mineral wealth, equal per capita.

10. Mandate an external agent, for example 10. Mandate an external agent, for example a financial institution that houses a financial institution that houses the Commodity Fund, to provide transparency the Commodity Fund, to provide transparency and to freeze accounts in the event of a coup.and to freeze accounts in the event of a coup.

Summary: 10 recommendations for oil producing countries, continued

Anti-corruption institutionsAnti-corruption institutions

Addendum: Addendum:

Elaboration on exchange rate Elaboration on exchange rate regimes regimes for oil exportersfor oil exporters

including the PEP & PPT proposalsincluding the PEP & PPT proposals

Professor Jeffrey Frankel

Implications of External Shocks Implications of External Shocks for Choice of Exchange Rate Regimefor Choice of Exchange Rate Regime

Old wisdom regarding the source of Old wisdom regarding the source of shocks:shocks: Fixed rates work best if shocks are mostly Fixed rates work best if shocks are mostly

internal demand shocks internal demand shocks (especially monetary);(especially monetary);

floating rates work best if shocks tend to be floating rates work best if shocks tend to be real shocks real shocks (especially external terms of trade).(especially external terms of trade).

• Oil producers face big trade Oil producers face big trade shocks shocks => accommodate by floating.=> accommodate by floating.

Edwards & L.YeyatiEdwards & L.Yeyati (2003)(2003)

Professor Jeffrey Frankel

Targeted variable

Vulnerability Example

Monetarist rule

M1 Velocity shocks US 1982

Inflation targeting CPI

Import price

shocks Oil shocks of

1973-80, 2000-08

Nominal income targeting

Nominal GDP

Measurement problems

Less developed countries

Gold standard Price

of gold Vagaries of world

gold market 1849 boom; 1873-96 bust

Commodity standard

Price of agric. & mineral

basket

Shocks in imported

commodity

Oil shocks of 1973-80, 2000-08

Fixed exchange rate

$ (or €)

Appreciation of $ (or € ) 1995-2001

6 proposed nominal targets and the Achilles heel of each:

Professor Jeffrey Frankel

A more moderate version: Product Price Targeting

Target an index of domestic production prices. [1]

The important point is to include oil in the

index and exclude import commodities, whereas the CPI does it the other way around.

[1] Frankel (2009).

PPT

Oil and DemocracyOil and Democracy

Middle Eastern governments’ access Middle Eastern governments’ access to oil revenue rents may have freed to oil revenue rents may have freed them from the need for taxation of them from the need for taxation of their peoples, which in turn freed their peoples, which in turn freed them from the need for democracy. them from the need for democracy.

Political Development Political Development in Resource-Rich Countriesin Resource-Rich Countries

Oil and DemocracyOil and Democracy, continued, continued

Tax revenue requires democracy Tax revenue requires democracy under the theory “no taxation without under the theory “no taxation without representation.”representation.” Mahdavy (1970) was apparently the first —Mahdavy (1970) was apparently the first — followed by Luciani (1987), Vandewalle (1998) & many followed by Luciani (1987), Vandewalle (1998) & many

others.others.

Huntington (1991) generalized the principle Huntington (1991) generalized the principle beyond Middle Eastern oil producers beyond Middle Eastern oil producers to states with natural resources in other parts to states with natural resources in other parts of the developing world.of the developing world.

Econometric findingsEconometric findings

Statistical studies across large cross-Statistical studies across large cross-sections of countries find that economic sections of countries find that economic dependence on oil and mineral is correlated dependence on oil and mineral is correlated with authoritarian government:with authoritarian government: Ross (2001), Barro (2000), Wantchekon (2002), Ross (2001), Barro (2000), Wantchekon (2002),

Jenson & Wantchekon (2004), and Ross (2006).Jenson & Wantchekon (2004), and Ross (2006).

Some find that authoritarian regimes have Some find that authoritarian regimes have lasted longer in countries with oil wealth.lasted longer in countries with oil wealth. Smith (2004, 2007), Ulfelder (2007).Smith (2004, 2007), Ulfelder (2007).

Counter-argumentsCounter-arguments

Karl (1997): Venezuela was already authoritarian when Karl (1997): Venezuela was already authoritarian when oil was developed, and in fact transitioned to democracy oil was developed, and in fact transitioned to democracy at the height of its oil wealth. at the height of its oil wealth.

None of the Central Asian states are democracies, None of the Central Asian states are democracies, even though Kazakhstan is the only one with major oil even though Kazakhstan is the only one with major oil production. production.

Haber & Menaldo (2009) do not find in historical time Haber & Menaldo (2009) do not find in historical time series data the statistically significant link from oil to series data the statistically significant link from oil to democracy democracy that is typical of cross-section and panel studies.that is typical of cross-section and panel studies.[1][1]

Noland Noland (2008)(2008) claims that oil rents are not a robust factor claims that oil rents are not a robust factor behind lack of democracy in Middle Eastern countries.behind lack of democracy in Middle Eastern countries.

Similarly, Dunning Similarly, Dunning (2008)(2008) for Latin America (with fixed effects). for Latin America (with fixed effects).

[[1]1] Loss of statistical power in pure cointegration time series tests may explain Loss of statistical power in pure cointegration time series tests may explain this.this.

Democracy, growth, & Democracy, growth, & causalitycausality

The question whether oil dependence tends to The question whether oil dependence tends to retard democracy should probably not be retard democracy should probably not be regarded as a component of the causal regarded as a component of the causal relation between oil and economic relation between oil and economic performance. performance.

Some correlates of democracy – rule of law, Some correlates of democracy – rule of law, political stability, openness to international political stability, openness to international trade, initial equality of economic endowments trade, initial equality of economic endowments and opportunities – do tend to be good for and opportunities – do tend to be good for economic growth. But each of these other economic growth. But each of these other variables can also exist without democracy. variables can also exist without democracy.

The evidence is much clearer that The evidence is much clearer that economic growth leads to economic growth leads to

democracydemocracythan the other way aroundthan the other way around

Econometrics:Econometrics: Helliwell (1994), Helliwell (1994), Huber, Rueschemeyer & Stephens Huber, Rueschemeyer & Stephens

(1993),(1993), Lipset (1994) and Lipset (1994) and Minier (1998).Minier (1998).

Economic growth leads to Economic growth leads to democracydemocracy

Examples include Examples include Asian economiesAsian economies such as Korea or Taiwan. such as Korea or Taiwan.

Some believe that Lee Kwan Yew in Singapore Some believe that Lee Kwan Yew in Singapore and Augusto Pinochet in Chile could not have and Augusto Pinochet in Chile could not have achieved their economic reforms without achieved their economic reforms without authoritarian powers authoritarian powers the one certainly more moderate & benevolent than the the one certainly more moderate & benevolent than the

other. other.

Why has China has grown so much faster Why has China has grown so much faster than Russia since 1985?than Russia since 1985? Some answer: because Deng Xiao Peng chose Some answer: because Deng Xiao Peng chose

to pursue economic reform before political reform to pursue economic reform before political reform while Mikhail Gorbachev did it the other way around.while Mikhail Gorbachev did it the other way around.

Does democracy lead to Does democracy lead to growth?growth?

The statistical evidence is at best mixed The statistical evidence is at best mixed as to whether democracy as to whether democracy per seper se is good for is good for economic performance. economic performance.

Barro Barro (1996)(1996) finds that it is the rule of law, finds that it is the rule of law, free markets, education, & small government free markets, education, & small government consumption that are good for growth, consumption that are good for growth, not democracy per se. not democracy per se.

Tavares & Wacziarg Tavares & Wacziarg (2001)(2001) find that it is find that it is education, not democracy per se. education, not democracy per se.

Alesina, et al, Alesina, et al, (1996)(1996) find that it is political find that it is political stability.stability.

The The combinationcombination of ofdevelopment + weak institutions development + weak institutions

+ oil+ oil Bhattacharyya & Hodler Bhattacharyya & Hodler (2009)(2009) find that find that

natural resource rents lead to corruption, but natural resource rents lead to corruption, but only in the absence of high-quality democratic only in the absence of high-quality democratic institutions.institutions.

Collier & Hoeffler Collier & Hoeffler (2009)(2009) find that when find that when developing countries have democracies, as developing countries have democracies, as opposed to advanced countries, they tend to opposed to advanced countries, they tend to feature weak checks and balances; feature weak checks and balances; thus, when developing countries also have high thus, when developing countries also have high

natural resource rents the result is bad for natural resource rents the result is bad for economic growth.economic growth.

Democracy is an end in itself,Democracy is an end in itself, aside from whether it promotes economic aside from whether it promotes economic

growth.growth. Even here, one must note that the benefits of Even here, one must note that the benefits of

the formalities of elections can be over-the formalities of elections can be over-emphasized.emphasized.

For one thing, elections can be a sham. For one thing, elections can be a sham. Robert Mugabe, Hamid Karzai, & George W. Bush Robert Mugabe, Hamid Karzai, & George W. Bush

each claimed to have been elected, without having each claimed to have been elected, without having in fact earned more votes than their opponents.in fact earned more votes than their opponents.

Western style or one-man one-vote elections Western style or one-man one-vote elections should probably receive less priority in should probably receive less priority in developing countries than the fundamental developing countries than the fundamental principles of rule of law, human rights, freedom principles of rule of law, human rights, freedom of expression, economic freedom, minority of expression, economic freedom, minority rights, and some form of popular representation.rights, and some form of popular representation.

Zakaria Zakaria (1997, 2004).(1997, 2004).