Transcript Lecture 1

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.”