thorvaldur gylfason imf institute course on natural resources, finance, and development...
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Thorvaldur GylfasonIMF INSTITUTE
Course on Natural Resources, Finance, and DevelopmentStellenbosch, South Africa
November 15-26, 2010
1. Economic geography, old and new2. Sources of growth3. Extraction rules4. Natural resources and economic
growth: Selected policy issues5. Cases and success stories
Botswana, Chile, Mauritius, NorwayBotswana, Chile, Mauritius, Norway
Mixed blessing? Mixed blessing?
Keys to success?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.”
11
In the world as a
whole, natural
capital constitutes a
small part of
national wealth, or
about 6%
Even so, natural
capital remains
important in a
number of
countries
Advanced countries
(US, Canada, Australia,
and others) have
outgrown their
dependence on
natural capital,
including agriculture
From blueblue to redred: Increased resource intensity
Tangible capital is
produced capital plus
natural capital, and
does not include
human capital and
social capital
From blueblue to redred: Increased resource intensity
Total capital is
produced capital plus
natural capital plus
tangible capital,
including human
capital and social
capital
Recognizes several different sources of wealth, emphasizing human capital human capital and, increasingly, social capitalsocial capital Social capital refers, among other things,
to governancegovernance and institutionsinstitutions
Many resource-rich countries have fared badly, while several resource-poor countries have done well
There are many kinds of capital and many different sources of growth
Listen to Lee Kwan YewLee Kwan Yew, founding father of Singapore (1959-1991):
“I thought then that wealth depended mainly on the possession of territory and natural natural resourcesresources, 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 peoplepeople, their natural abilities, educationeducation and training.”
1. Saving and investment Real capitalReal capital
2. Education, health care Human capitalHuman capital
3. Exports and imports Foreign capitalForeign capital
4. Democracy and freedom Social capitalSocial capital
5. Stability Financial capitalFinancial capital
6. Diversification away from Natural capitalNatural capital
Effects on growth are undisputed
Effects on growth are
somewhat
controversi
al
22 Extensive vs. intensive
growth
1. Saving and investment Real capitalReal capital
2. Education, health care Human capitalHuman capital
3. Exports and imports Foreign capitalForeign capital
4. Democracy and freedom Social capitalSocial capital
5. Stability Financial capitalFinancial capital
6. Diversification away from Natural capitalNatural capital
All six are generally considereddesirable in and of themselvesHow to attain these goals is another matter
Efficiency, institutions, and
governance
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 circumstancesNot one-size-fits-all
Opportunities for finance – and pitfalls Banks pick customers, some win, some lose
Example from IcelandFishing 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
promptly
Resource depletion drag
Leave out foreign
capital for
simplicityGovernance
affects
linkages
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
Oil extraction
u slows down
growth as
does population
growth gL
Double diversification Double diversification is good for
growth, and for other determinants
of 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
33
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 t,
interest earned will be rpf(t)t If owner waits for t, value of tree increases
by pf(t) + pf(t+t) = pf’(t)t Optimal time to fell the tree is when MC =
MR: pf’(t)t = rpf(t)t, i.e., f’(t)/f(t) = r, i.e., g = r
Provided that price of land is constant
g = r
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
g > r
Hartwick rule defines the amount of investment in produced capital (buildings, roads, knowledge stocks, etc.) needed to exactly offset declining stocks of non-renewable 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
E(t) = extraction
cE(t) = cost of
extractionS(t) = stock or
resourcesp(t) = price of resource,
or dynamic rent, or
dynamic royalty
r = interest rate
Extract resource at a rate that makes its value grow at r
Four main areas1. Fiscal policy2. Monetary, financial, and
exchange-rate policy and the Dutch disease
3. Institutions and governance4. Diversification
EconomicEconomic, away from excessive dependence on a few resources
PoliticalPolitical, away from narrowly based power elites
44
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
Taxes vs. fees
Pigovian principle
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
Foreign exchange
Real exch
an
ge r
ate
Imports
Exports without oil
Exports with oil
A
C BOil discovery
leads to appreciation
, and reduces nonoil exports
Compositi
on of exports
matters
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 NoNo, 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 YesYes, 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 monetary governance
through independent yet accountable central banks Healthy financial sector development also requires
good monetary governance, including transparency
China’s undervalued
renmimbi
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 Extractive Industries Transparency Initiative (EITI)
aims to set global standard for transparency in oil, gas and mining
Revenue Watch Institute Revenue Watch Institute (RWI) promotes responsible management of oil, gas, and mineral resources
Natural Resource Charter Natural Resource Charter sets out principles for how to manage natural resources for development
False sense of security
Neglect of education
Other people’s money
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 spendingTo 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 International Covenant on Civil and
Political RightsPolitical 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 NorwayFrom 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
Nigeria’s economy
minister: “Oil has made us lazy”
Norwegians work less
than Danes and
Swedes, true, but no less than Germans
Success stories withoutwithout natural resources Hong Kong Japan Singapore Switzerland
Success stories withwith natural resources Botswana Chile Mauritius Norway, again
How did they succeed?
55
How Botswana succeeded 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 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
Frankel (2010)
Acemoglu et al.
(2003)
But not
perfect
Per Capita GNI (USD at PPP)
Increase in life
expectancy in years
1980-2008
-6
1
6
Per Capita GNI (USD at PPP) Democracy
7
-2
Increase in life
expectancy in years
1980-2008
Average democracy
index 1980-2008-6
1
6
Generally, democracy and growth go
together
Per Capita GNI (USD at PPP)
10
13
-6
Per Capita GNI (USD at PPP) Democracy
4
6
-1
10
13
-6
Per Capita GNI (USD at PPP)
7
5
6
Per Capita GNI (USD at PPP) Democracy
10
4
107
5
6
Per Capita GNI (USD at PPP)
5
13
12
Per Capita GNI (USD at PPP) Democracy
10
-4
-10
5
13
12
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 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 educated labor that it became possible for the Norwegians to harness those resources on a significant scale
Human capital Human capital accumulation was the primary force behind the economic transformation of Norway Natural capital was secondary
The purpose of the oil fund ShareShare the wealth fairly: Pension fundPension fund ShieldShield domestic economy from
overheating and possible waste Fund has grown huge: USD 450 USD 450
billionbillion That makes almost USD 100K per
person Norwegians have resisted temptation resisted temptation
to use too much of the money to meet current needs
Long tradition of democracydemocracy and market economy market economy in Norway since before the advent of oil Large-scale rent seeking was
averted as oil was, by law, defined as a common-property 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 Dutch diseasedisease 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 Central BankBank from 1997 onward Central Bank became independent
1999
Natural resources bring risks A false sense of securityfalse 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 may find that hard choices perhaps can be that hard choices perhaps can be avoidedavoided
Awareness of these risks is perhaps the best insurance policy against them
16 countries
4 industrial countries
12 developing
countries
66
27 countries
5 industrial countries
22 developing countries
whose average per capita
growth rate 1960-2000
was 0.1%0.1% per year
compared with 1.4% for the
sample of 164 countries as
a whole
High-income countries
Low-income countries
Real capital 17 16
Natural capital
Subsoil assets2(1)
29(6)
Intangible capital Human capital Social capital
81 55
Total wealthTotal wealth: estimated by perpetual inventory method as present discounted value of future consumption Real capitalReal capital: estimated from investment figures Natural capitalNatural capital: cropland, pastureland, subsoil assets, timber resources, nontimber forest resources, and protected areas Intangible capitalIntangible capital: estimated as residual
Source: World Bank (2006)
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)
Mineral-rich countries
11.7 4.5 2.4 -3.2 3.3 24.3 0.10.1
Lower middle-income countries
11.4 3.6 2.6 -1.2 3.0 24.3 3.6
Upper middle-income countries
13.5 2.9 3.8 2.2 4.1 25.9 1.7
False contrast: No
inconsistency between
favorable effects of
commodity price booms on
output in the short run and
adverse effects on long-run
growth
Size of balls
reflects size of
countries
-0.67
Natural capital share and growth are inversely
related
-0.82Natural capital crowds out human capital
0.69Education is good for growth
-0.74
Natural capital crowds out social capital
More
co
rru
pti
on
0.75Corruption hurts growth
More corruption
-0.67Natural capital crowds out social capital
0.51
Democracy is good for growth
0.62Human capital and social capital go together
0.60
Different aspects of social capital go togetherM
ore
co
rru
pti
on
-0.67
Natural capital share and growth are inversely related
-0.10
Subsoil asset share and growth are inversely
related,
but rank correlation is weak, so need multiple
regression
Model 1
Initial income
-0.74(5.2)
Natural capital share
Natural capital per personDemocracy
Investment rate (log)School life expectancy (log)Fertility
Countries 164
Adjusted R2 0.14
Note: t-values within parentheses.
Model 1 Model 2
Initial income
-0.74(5.2)
-0.49(3.1)
Natural capital share
-0.04(5.3)
Natural capital per person
Democracy
Investment rate (log)School life expectancy (log)Fertility
Countries 164 125
Adjusted R2 0.14 0.18
Model 1 Model 2 Model 3
Initial income
-0.74(5.2)
-0.49(3.1)
-0.96(5.3)
Natural capital share
-0.04(5.3)
-0.06(7.1)
Natural capital per person
0.10(4.5)
Democracy
Investment rate (log)School life expectancy (log)Fertility
Countries 164 125 124
Adjusted R2 0.14 0.18 0.29
Model 1 Model 2 Model 3 Model 4
Initial income
-0.74(5.2)
-0.49(3.1)
-0.96(5.3)
-1.07(5.2)
Natural capital share
-0.04(5.3)
-0.06(7.1)
-0.05(4.7)
Natural capital per person
0.10(4.5)
0.08(3.7)
Democracy 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
Model 1 Model 2 Model 3 Model 4 Model 5
Initial income
-0.74(5.2)
-0.49(3.1)
-0.96(5.3)
-1.07(5.2)
-1.24(7.0)
Natural capital share
-0.04(5.3)
-0.06(7.1)
-0.05(4.7)
-0.04(5.3)
Natural capital per person
0.10(4.5)
0.08(3.7)
0.06(3.3)
Democracy 0.07(2.2)
0.07(2.7)
Investment rate (log)
2.92(6.8)
School life expectancy (log)Fertility
Countries 164 125 124 113 113
Adjusted R2 0.14 0.18 0.29 0.27 0.48
Model 1 Model 2 Model 3 Model 4 Model 5 Model 6
Initial income
-0.74(5.2)
-0.49(3.1)
-0.96(5.3)
-1.07(5.2)
-1.24(7.0)
-1.60(7.8)
Natural capital share
-0.04(5.3)
-0.06(7.1)
-0.05(4.7)
-0.04(5.3)
-0.03(4.0)
Natural capital per person
0.10(4.5)
0.08(3.7)
0.06(3.3)
0.05(2.5)
Democracy 0.07(2.2)
0.07(2.7)
0.07(2.7)
Investment rate (log)
2.92(6.8)
1.72(3.2)
School life expectancy (log)
0.94(4.0)
Fertility
Countries 164 125 124 113 113 90
Adjusted R2 0.14 0.18 0.29 0.27 0.48 0.55
Model 1 Model 2 Model 3 Model 4 Model 5 Model 6 Model 7
Initial income
-0.74(5.2)
-0.49(3.1)
-0.96(5.3)
-1.07(5.2)
-1.24(7.0)
-1.60(7.8)
-1.70(8.5)
Natural capital share
-0.04(5.3)
-0.06(7.1)
-0.05(4.7)
-0.04(5.3)
-0.03(4.0)
-0.03(3.1)
Natural capital per person
0.10(4.5)
0.08(3.7)
0.06(3.3)
0.05(2.5)
0.04(2.3)
Democracy 0.07(2.2)
0.07(2.7)
0.07(2.7)
0.05(2.0)
Investment rate (log)
2.92(6.8)
1.72(3.2)
1.34(2.5)
School life expectancy (log)
0.94(4.0)
0.56(2.1)
Fertility -0.40(2.8)
Countries 164 125 124 113 113 90 90
Adjusted R2 0.14 0.18 0.29 0.27 0.48 0.55 0.58
OLS
Model 1 Model 2 Model 3 Model 4 Model 5 Model 6 Model 7
Initial income
-0.74(5.2)
-0.49(3.1)
-0.96(5.3)
-1.07(5.2)
-1.24(7.0)
-1.60(7.8)
-1.70(8.9)
Natural capital share
-0.04(5.3)
-0.06(7.1)
-0.05(4.7)
-0.04(5.3)
-0.03(4.0)
-0.03(3.3)
Natural capital per person
0.10(4.5)
0.08(3.7)
0.06(3.3)
0.05(2.5)
0.04(2.4)
Democracy 0.07(2.2)
0.07(2.7)
0.07(2.7)
0.05(2.1)
Investment rate (log)
2.92(6.8)
1.72(3.2)
1.34(2.6)
School life expectancy (log)
0.94(4.0)
0.56(2.2)
Fertility -0.40(3.0)
Countries 164 125 124 113 113 90 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.
These slides will be posted on
my website:
www.hi.is/~gylfason
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.”