Sustaining Development in Mineral Economies

The Resource Curse Thesis

Richard Auty

• Publisher: Routledge
• Year: 2002
• eBook ISBN: 9781134867899
• Edition: 1
• Topic: Business
• Subtopic: Economic Theory
• Index: Business

It is widely believed that natural mineral resources are desirable. However there is growing evidence that this may not always be the case. Indeed, it seems that natural assets can distort the economy to such a degree that the benefit actually becomes a curse.
In Sustaining Development in Mineral Economies, Richard Auty highlights these drawbacks and the devastating effect they can have on developing economies. With reference to six ore-exporters (viz. Peru, Bolivia, Chile, Jamaica, Zambia and Papua New Guinea) he outlines how things can go badly wrong. He particularly stresses the need to avoid `Dutch Disease' whereby competitiveness is drained out of the agriculture and manufacturing sectors so that in the long term growth falters.

1
THE RESOURCE CURSE THESIS AND MINERAL ECONOMIES

RESOURCE ENDOWMENT AND ECONOMIC GROWTH

The conventional view concerning the role of natural resources in economic development has been that the resource endowment is most critical in the early low-income stages of the development process. It assumes that, as development proceeds and a population acquires more and more skills, those skills are deployed with increasing effectiveness to counteract any resource deficiency (Ginsburg 1957). For example, Maddison (1991) notes that although the resource advantage of Australia and North America influenced their total gross domestic product (GDP) rate of growth by attracting a large inflow of migrants, its influence on per capita GDP levels and rates of growth has been declining over the long term. Moreover, Maddison notes that Australia has a lower per capita income than Japan despite the fact that its per capita resources (based upon land area as a proxy for resource endowment) are 150 times those of Japan and that it also secured a head start in economic development.

However, a growing body of evidence suggests that a favourable natural resource endowment may be less beneficial to countries at low- and mid-income levels of development than the conventional wisdom might suppose. Two important pieces of this evidence are the developing countries’ postwar industrialization efforts and the performance of the mineral-rich developing countries since the 1960s. The new evidence suggests that not only may resource-rich countries fail to benefit from a favourable endowment, they may actually perform worse than less well-endowed countries. This counterintuitive outcome is the basis of the resource curse thesis.

Taking the developing countries’ postwar industrialization first, large country size (defined in terms of a combination of geographical area and population) is potentially beneficial to industrialization. This is because large size implies a large domestic market with which to overcome the barriers to new entrants in sectors where there are economies of scale; a diverse resource base with which to generate the foreign exchange required to purchase the capital goods which industrialization requires; and the presence of complementary inputs (including domestic energy sources) for a wide range of industrial processes. Yet Perkins and Syrquin (1989) can find little evidence that the large countries have outperformed small ones in terms of economic growth.

In fact, among the larger newly industrializing countries, the biggest countries like China, India, Brazil and Mexico have made slower progress with industrial diversification than the smaller resource-deficient countries like Korea and Taiwan (Auty 1992). All six countries were pursuing an autarkic (i.e. strongly self-sufficient) industrial policy (AIP) in the 1950s, but the two smallest countries abandoned that policy in favour of a more outward-oriented competitive industrial policy beginning with Taiwan in 1958 and Korea in 1963. The deficient resource bases of the latter two countries meant that they ran up against the foreign exchange shortages of AIP much sooner than the largest newly industrializing countries. These shortages arise out of the slow maturation (i.e. emergence of the ability to compete internationally) of the overly protected manufacturing sectors under AIP.

Instead, Taiwan and Korea reverted to competitive manufactured exports sooner than the larger countries in order to overcome their foreign exchange deficiencies. This meant that, relative to the larger countries, they were deflected from their natural comparative advantage for a shorter period of time so that fewer distortions built up in their economies. By the time the larger countries encountered the AIP foreign exchange constraint in the late 1960s (as their primary product exports shrank relative to the size of the rest of the economy) their industrial policy was difficult to reform. This was due to entrenched powerful vested interests that benefited from the rents (returns in excess of normal profits) which were created by the protection of more and more industrial sectors from international competition.

The second important example of the resource curse thesis is provided by the mineral economies, one subset of which is the subject of this book. The mineral economies are defined as those developing countries which generate at least 8 per cent of their GDP and 40 per cent of their export earnings from the mineral sector. As such they comprise around one-quarter of all the developing countries. They include two main categories, the hydrocarbon producers and the hard mineral exporters (producers of ores such as copper and tin). Nankani (1979) shows that the mineral economies’ economic growth and their social welfare are inferior to those of non-mineral economies at a similar level of development. Yet, this is a counter-intuitive finding since, compared with countries that are deficient in minerals, the mineral resource provides the mineral economies with additional foreign exchange, taxes and an extra route to industrialization. That additional route is via resource-based industrialization which is the downstream processing of the ore into metal and finished products.

The roots of the mineral economies’ under-performance vis-à-vis other developing countries lie in the mining sector’s production function (i.e. ratio of capital to labour), domestic linkages and deployment of mineral rents (Auty 1985). Unlike most (but not all) developing country primary product exports, mineral production is strongly capital intensive and employs a very small fraction of the total national workforce with large inputs of capital from foreign sources. Consequently, the mining sector displays marked enclave tendencies. This means that it yields modest local production linkages (i.e. few local factories are established to supply inputs or to further process the ore prior to export). It also displays low revenue retention since a large fraction of export earnings flow immediately overseas to service the foreign capital investment. Under these circumstances, and in sharp contrast to most other primary product exports, fiscal linkage (i.e. taxes) may dominate the mining sector’s contribution to the national economy (Hirschman 1977).

The frequent existence of substantial rents (revenues in excess of production costs and a normal return on capital) on mineral ores can, however, when captured by the government through taxation, destabilize the economy. In particular, the imprudent domestic absorption of mining sector rents is capable of rendering much agricultural and manufacturing activity internationally uncompetitive. This occurs through a process known as ‘Dutch disease’. It results from a strengthening (appreciation) of the exchange rate as a consequence of the over-rapid inflow of mineral rents into the domestic economy. In some cases, such as Mexico, Venezuela and Nigeria during the 1979–81 oil boom, virtually no non-mining activity remained internationally competitive.

Table 1.1 Investment and growth rates by developing country group

In an analysis of Dutch disease Krugman (1987) argues that competitive activity lost during exchange rate appreciations may not be easily restored during subsequent downswings. This is indeed a principal finding of Gelb’s (1988) analysis of the windfall deployment of six oil exporting countries during the 1974–8 and 1979–81 oil booms. Gelb concludes that, far from improving economic performance, mineral booms may be particularly harmful. This is because the economic gains made during the upswing are frequently more than offset by the damage done during downswings. The oil exporters experienced a marked deceleration in economic growth during the oil booms. In fact, the oil exporters were strongly outperformed through the oil booms by the low-income Asian and East Asian oil importers (Table 1.1).

This book examines the resource curse thesis with reference to the second group of mineral economies, the hard mineral exporters (which, it will be recalled, are the producers of copper, bauxite and tin). It analyses their response to the series of economic shocks which impacted the post-1960s world economy. It complements Gelb’s analysis of the oil exporters’ response to mining booms by examining the response of the hard mineral exporters to the extended price downswing which the oil shocks triggered in the case of most hard minerals.

Table 1.1 confirms that, like the oil-exporting countries, the hard mineral economies tended to under-perform compared with the developing countries as a whole. Despite sustaining significantly higher investment levels than the low-income non-mining economies in 1971–83 (at 23 per cent and 17 per cent of GDP respectively), the growth in per capita GDP of the hard mineral economies was –1 per cent compared with +0.7 per cent for the non-mineral economies. Although, as Table 1.1 shows, the terms of trade (i.e. the ratio of export prices to import prices) declined slightly more for the mineral economies through the 1970s, the difference is not great enough to explain the variation in per capita economic growth rate—especially given the mineral economies’ significantly higher rate of investment. Table 1.1 suggests that the cause of the under-performance of the hard mineral economies lies not so much in a lack of investment resources as in the inefficiency with which those investment resources were deployed.

The hard mineral economies are geographically concentrated in the developing Americas and sub-Saharan Africa. The present study focuses on the developing Americas since their economies are more sophisticated than those of sub-Saharan Africa and their data sources are more reliable. Four such countries are examined: two are copper producers (Chile and Peru); the others are producers of tin (Bolivia) and bauxite (Jamaica). The selected countries span the full range of experience in mineral sector management, from the strong recovery of Chile to the protracted decline of Peru, with Jamaica and Bolivia occupying intermediate positions. However, in order to test the general validity of the conclusions drawn from the developing Americas’ sample and to facilitate cross-cultural comparison, two other producers (both copper exporters) are included: one from sub-Saharan Africa (Zambia) and the other from developing Asia (Papua New Guinea (PNG)).

THE OBJECTIVES AND PRESENTATION OF THE STUDY

This study seeks to explain why the hard mineral economies have performed less well than the developing countries as a whole and to draw policy lessons. It uses inter-country comparison because that approach isolates those problems which a set of countries share from those which are specific to one country. In this way, it is possible to overcome the principal weakness of the case study approach, namely doubts about its general applicability.

Chapter 2 examines the literature on the performance of the mineral economies in more detail. It pays particular attention to the research on Dutch disease effects and to the dispute over appropriate policy responses between structuralists and orthodox economists. But it goes beyond the macroeconomic level on which that dispute is normally conducted to consider the sectoral implications for both mining and the non-mining tradeables (i.e. those traded activities such as agriculture, manufacturing and tourism whose competitiveness is so strongly impacted by fluctuations from the mining sector). A key consideration here is the role of industrial policy since many mineral economies have used their mineral windfall to underwrite a more autarkic industrial policy than would otherwise have been possible in the absence of the mining sector’s foreign exchange earnings. In this respect there is an interesting parallel with the largest newly industrializing countries which, as noted earlier, also used their rich resource endowment to pursue AIP.

Chapter 3 turns to empirical analysis with a comparison of the economic and political pre-conditions during the late 1960s and early 1970s. It asks how resilient the non-mining economy of each country was prior to the mid-1970s price downswing. It uses three criteria: the political resolve of the government, the degree of mineral dependence (including the extent of Dutch disease) and the growth performance of the economy. The chapter ranks the four developing American economies in terms of their potential to ride out adverse external shocks.

Chapter 4 completes the overview with an examination of the variation in the external conditions which each of the four developing American countries faced in 1974–90 and how they reacted to them. It measures the severity of the external shocks (caused by abrupt changes in the price of their exports and imports and the interest charged on their foreign debt). The size of the price and interest rate shocks is measured as a fraction of GDP for each country. The differing responses to the shocks are measured in terms of trends in each country’s economic growth and structural change through the 1970s and 1980s. The results are summarized in terms of two basic economic trajectories: one is a cumulative decline and the other is a rebound into sustained improvement.

Part II examines the macroeconomic adjustment of each of the developing American countries in four separate chapters. It traces the intensification of the adjustment problem through the debt crisis as mineral prices fell and foreign borrowing became a less feasible option for cushioning reform. The analysis focuses on the macroeconomic response to the external shocks, and especially the speed with which real exchange rate and fiscal corrections were made in response to the external deterioration. The accumulation of external debt is described along with the degree to which it could be serviced.

The analysis of the individual country responses begins with Bolivia in Chapter 5, the only one of the four developing American countries to experience strong positive shocks through both the mid-1970s and the early 1980s. Consistent with the resource curse thesis, Bolivia was unable to turn its windfalls to good use, even when political and economic pre-conditions were relatively favourable. This underlines the dominance of the policy variable in determining the outcome.

Chapter 6 turns to Peru and focuses on the debate over orthodox and structuralist policies which was particularly sharp in that country. Although Peru faced the first shock with potentially the most favourable combination of political and economic conditions, it experienced the most severe deterioration. Chapter 6 reviews this outcome in the light both of Sachs’s (1989) speculation concerning the impact of a polarized income distribution on policy choice and of Lago’s (1990) lament over the apparent absence of a learning curve in Latin American culture.

Chapter 7 contrasts the accelerating decline traced out by the Peruvian economy under vacillating policy conditions with the sustained economic progress of Chile under persistently orthodox macroeconomic policies. Chile became the model Latin American economy as its tradeables sector reaped the benefits of the economic adjustment which it had launched in the mid-1970s. But the Chilean experience suggests an important qualification to the endorsement of orthodox macroeconomic policies. It suggests that the volatility of the mineral sector and its distinctive economic linkages (with fiscal linkage likely to dominate) render it a risky lead sector. This implies that policy should therefore not be sector neutral, as doctrinaire orthodoxy insists. Rather it should recognize the need to ensure competitive diversification of the non-mining tradeables, and especially manufacturing. In other words, the mineral sector should be used as a bonus with which to accelerate structural change.

The analysis of the macroeconomic policy responses of the four developing American countries concludes with Jamaica in Chapter 8. This chapter also anticipates the transition towards the micro studies in the next section of the book (Part III). This is because Jamaica’s long-delayed recovery from the mid-1970s external shock confirms the inadequacy of doctrinaire orthodox policy noted in the preceding chapter and underlines the need for a more active supply-side commitment to the non-mining tradeables. Jamaica consistently underestimated the scale of the adjustment it was required to make and neglected the competitive diversification of key non-mining tradeables sectors, above all manufacturing.

The supply-side factors are analysed in Part III. Chapter 9 examines the resilience of the mining sector in the face of external shocks (and in response to the macroeconomic policies which they engendered). Success is measured in terms of the mining sector’s capacity to retain global market share, to match international productivity trends and to generate adequate levels of investment (and effectively deploy them). An interesting phenomenon which is examined is how the mining sector may be severely damaged even after it has become the sole prop for the economy. The answer lies in the transfer of financial resources to the non-mining sector in a misguided effort to staunch rising unemployment by propping up the latter.

Chapter 10 analyses the non-mining tradeables sector. Trends in each country’s mineral dependence and Dutch disease indices are m...

Table of contents

• COVER PAGE
• TITLE PAGE
• ACKNOWLEDGEMENT
• COPYRIGHT PAGE
• FIGURE AND TABLES
• 1. THE RESOURCE CURSE THESIS AND MINERAL ECONOMIES
• PART I: COPING WITH MINERAL PRICE DOWNSWINGS
• PART II: MACRO POLICY IN FOUR DEVELOPING AMERICAN COUNTRIES
• PART III: SECTORAL RESILIENCE IN THE DEVELOPING AMERICAS
• PART IV: INTER-CULTURAL COMPARISON
• PART V: CONCLUSIONS AND POLICY IMPLICATIONS
• REFERENCES