How can $700 million in hydrocarbon revenues be bad for the poor?

It was recently shown in an academic paper (1) that the natural gas boom in Bolivia is likely not only to increase inequality but also to increase poverty.

How can this be true? How can windfall revenues of $700 million per year, received by a clearly pro-poor government, increase poverty???

Three main mechanisms are at work:

      1)Government spending cannot be pro-poor even if it tries, at least not in the short run:

A large part of government spending inevitably goes to pay teachers, health personnel, bureaucrats, armed forces and consultants, none of which are among the poorest 50% of the population. When the government purchases equipment and materials it is not from rural small holders and urban informals – the two groups that encompass almost all of the poor in Bolivia.
Some of the spending is obviously meant to benefit the poor, such as public education and public health services. This may indeed have positive effects in the long run, but it does not increase the incomes of the poor immediately, in the same way as it does for public sector employees and providers.

2)Dutch Disease – appreciation of the boliviano:

The large inflow of dollars into the economy will tend to make dollars abundant and thus cheaper, and at the same time bolivianos more expensive. This causes a change in the exchange rate which will make Bolivian goods more expensive for foreigners (reducing exports) and foreign goods cheaper for the Bolivians (increasing imports). With less exports and more imports, local production will fall together with local employment in the productive sectors. When Bolivian consumers start buying Pringles instead of local potato chips or driving their own imported car instead of using the buses or trufis, then a lot of small Bolivian businesses, both rich and poor, will suffer.

3)Cost of living increases:

The poor people, who do not get higher incomes because of the gas boom, will see their real incomes fall because the costs of living increases. This increase is due to higher demand from all the richer people who do get higher incomes through government spending and investment. The price increases especially affects non-tradable goods and services, such as housing, transportation, water, electricity, construction materials, etcetera.

What is the solution, then? What should the government do with all this money if they don’t want to increase inequality and poverty?

Two options spring to mind:

1)Create public enterprises to employ the poor (nationalization)

2)Give the money directly to the poor instead of spending it (transfers)

The first option is tempting, but unlikely to be successful. Public enterprises are most appropriate in natural monopoly markets (where one enterprise is optimal), because otherwise they would go into markets where they would compete unfairly with private enterprises. But natural monopolies are usually extremely capital intensive, which means that they use a lot of money, some managers, and some specialists, but little unskilled labor. So the public enterprise option is likely to increase inequality and poverty just as other types of government spending.

The second option does indeed improve the income distribution, but likely at the expense of domestic production. Why work hard if there is an easier way of getting money? And if the money is particularly targeted at the poor; why risk becoming non-poor and loose the right to the transfer?

The word “curse” does indeed seem quite appropriate in relation to natural resource abundance. Maybe with increased autonomy we can contain the curse within a few departments.

Know of any similar situations where hydrocarbon revenues lead to greater inequality? Leave a reply below.

(*) Director, Institute for Advanced Development Studies, La Paz, Bolivia. The author happily receives comments at the following e-mail: landersen@inesad.edu.bo.

(1) Andersen, L. E., J. Caro, R. Faris & M. Medinaceli (2006) “Natural Gas and Inequality after Nationalization” Institute for Advanced Development Studies. Development Research Working Paper Series No. 05/2006.