Cover Image
close this bookThe Courier N 130 Nov - Dec 1991 - Dossier: Oil - Reports: Kenya - The Comoros (EC Courier, 1991, 96 p.)
close this folderDossier
View the documentOil
View the documentOil and its uses
View the documentPetroleum: working for ACP-EEC cooperation
View the documentPetroleum replacement polices in the ACP Stales
View the documentThe Resource Curse thesis: sowing oil windfall
View the documentOPEC - aIms, achievements and future challenges
View the documentOil development: time depart from false illusions
View the documentKerosene as a household fuel
View the documentRedundant oil figs - what to do when the oil runs out
View the documentOil and gas in Ethiopia: the legal basis
View the documentAn overview the Angolan oil industry
View the documentThe pace of oil: an environmentalist’s viewpoint

The Resource Curse thesis: sowing oil windfall

by Richard AUTY

It is often assumed that the natural resource endowment of a country is of critical importance to economic performance at lower per capita income levels but that it becomes progressively 1ess significants development takes place and modern skills diffuse through the economy. However, there is growing evidence among the developing countries that a favourable resource base (say the huge domestic market and diversified resource endowment of a large country like Brazil or the rich mineral reserves of Peru) may actually prove counter-productive.

For example, resource-deficient Korea and Taiwan have industrialised much more efficiently than resource-rich Brazil and Mexico while the mineral economies - whether exporters of oil or hard minerals - have not always done as well as developing countries which lack the resource bonus. Table 1 shows the mineral economies’ performance deteriorated more than that of the average developing country between 1971 and 1983. Yet the mineral resource brought higher levels of investment as well as an additional source of foreign exchange, taxation and an alternative route to industrialisation via resource-processing (Resource-based industrialisation or RBI).

Table 1: Investment and Growth Rates by Developing Country Group

While the inverse relationship between resource endowment and economic performance is not a universal law, it has occurred often enough to spawn the resource curse thesis. Basically, this thesis suggests that a well-endowed country is tempted to enjoy its advantage vis-is other countries in the form of a less demanding and/or a less prudent development strategy while the less well-endowed country, mindful of its more marginal position, eschews risk and applies effort which more than compensates for its disadvantage. This article explores the resource curse thesis in more depth with reference to the oil-exporting countries and especially Trinidad and Tobago, Nigeria and Indonesia.

The 1974-78 and 1979-82 oil booms

The oil shocks of 1973 and 1979 each transferred around 2% of global GDP from the oil-importing countries to the oil-exporters. The resulting oil windfalls ranged- from an increase equivalent to an extra 200% of non-mining GDP annually for Saudi Arabia in 197478 to 3% extra for Mexico in 1979-82. Within this range, Trinidad and Tobago received windfalls equivalent to almost two-fifths of its GDP annually while those of Nigeria and Indonesia were closer to one-fifth of their GDP.

The oil exporters expected the increased resources would lead to faster economic growth and rapid economic diversification as they invested the windfall to reduce their future oil dependence. In fact, the results were disappointing and many oil exporters (including Trinidad and Tobago, Nigeria and Mexico) experienced sharp falls in their per capita GDP.

One important policy lesson is that the mineral bonus encourages over-optimism: the projections made for global economic growth and energy prices were universally and erroneously positive. This was especially true after the second oil shock when continued high rates of global economic growth were projected alongside real increases in energy prices of 3%. That forecast promised the expansion of the oil-windfalls and it encouraged governments to ease the more cautious economic policies which they had introduced towards the close of the 1974-78 boom.

In fact, the oil shocks triggered structural changes in the economies of the industrial countries which reduced the rate of energy and materials they consumed per unit of GDP. On top of this the industrial countries unexpectedly deflated their economies in the early-1980s in order to curb inflation. The net result was that oil supply quickly outstripped demand and real energy prices fell, forcing the oil-exporters to curb abruptly the high levels of domestic investment and consumption they had become used to.

A second important lesson is that domestic policy can Emit the damage arising from erroneous forecasts. Some oil-exporting countries responded to the post-boom conditions better than others. Oil-exporting countries need to do three things in order to deploy their windfalls prudently:

- save a proportion of the oil windfall in overseas accounts so that the inflow of resources is not large enough to trigger domestic inflation and cause the real exchange rate to appreciate (ie cause the currency to strengthen).

- use part of the windfall to boost domestic investment - provided the extra capital expenditure does not overtax domestic construction capacity and thereby trigger inflation and cost over-runs (which lower the efficiency of investment).

- increase consumption, preferably by targeting the neediest in the community and providing the means for them to enhance their ability to lock after themselves.

Domestic policy failures

In fact, such prudent policies for windfall management were the exception rather than the rule. Even the strongest governments, like that of Indonesia, found political pressures for over-rapid domestic windfall absorption difficult to resist. Figure I shows that after an initial phase of saving, investment and consumption absorbed all the oil windfall by 1978. Growing deficits were avoided by most countries thanks to the fortuitous occurrence of the second oil shock. However, some countries like Nigeria and Venezuela used their oil as collateral for foreign loans so that far from saving some of the windfall they actually accumulated large foreign debts.

Investment rose sharply in the oil-exporting countries through the oil booms. It went first into infrastructure projects and then increasingly into prestigious RBI (such as steel and petrochemicals) which was often implemented by newly-created state-owned enterprises (SOEs). Such projects were usually poorly executed with large cost overruns that left them uncompetitive and gave a very poor or even negative return on the resources invested.

Steel featured prominently in most RBI strategies despite warnings from feasibility studies and these projects proved especially weak. Table 2 compares the estimated production costs of six oil-exporters’ steel plants with best practice. Nigeria invested more than $6 billion in two steel plants and three dispersed mills which will never repay the capital invested. Elsewhere, Trinidad and Tobago lacked a market and the government lost almost $1 billion on its potentially competitive plant before privatisation. Even the more prudent Indonesians found steel very disappointing because they also expanded too quickly.

Finally, government resources went increasingly into subsidies, as Figure 2 shows for Trinidad and Tobago. This was a major way in which the oil windfalls increased local consumption. But instead of channeling state assistance to the weakest in society, the gains went largely to the middle class as energy and other state-controlled prices were frozen (often in the name of curbing inflation) or as mortgage relief. In addition, the oil booms led to a strengthening of the exchange rate which increased domestic (mainly middle class) purchasing power over imports - a policy that was meant to curb domestic inflation.

Post-boom adjustment

In this way, over-rapid domestic absorption of the oil windfalls led to | inefficient investments and unsustainable patterns of consumption. As oil prices fell and revenues declined, consumers resisted cuts in real incomes and governments were reluctant to make prompt reductions in the real exchange rate. Meanwhile, the new RBI projects like steel proved disappointing since few of them could generate enough revenue to service their debt let alone substitute for, lost oil exports and taxes.

Table 2: Steel RBI projects: estimated full capacity costs and actual capacity use

But non-oil sectors had been seriously weakened. As noted, the over-rapid windfall absorption during the oil booms often strengthened the real exchange rate and inflicted severe ‘Dutch disease’ (loss of competitiveness) on agriculture and non-RBI manufacturing. Taking 1970-72 as a base, the Trinidad and Tobago real exchange rate rose 70% by 1984 and that of Nigeria by almost 300%. Agriculture and non-RBI manufacturing lost competitiveness and either contracted or came to rely on very high levels of protection.

Figure 1: Oil Windfalls and their uses 1973-81

Figure 2: Trinidad and Tobago: Fiscal Evolution

Like RBI, they could not compensate for falling levels of oil windfall taxes and foreign exchange.

Yet in the prudently managed Indonesia economy rate had declined by 8% between the early-1970s and 1984, making non-oil exports more competitive. After a brief slowdown in the mid-1980s, the Indonesian economy resumed its rapid rate of growth as thndonesian government used the crisis to downswing of the mid-1980s was especially painful in countries like Nigeria and Trinidad and Tobago. The costs of their adjustment more than offset the gains they had made during the booms. In the case of Nigeria, per capita incomes fell way below pre-boom levels. Given the pre-boom rapid rate of Nigerian economic growth and the country’s large and competitive agricultural exports (which collapsed during the oil booms), the 1974-78 and 1979-82 oil booms have almost certainly been a curse rather than a blessing.