Natural Resources: Curse, Disease or Trap?

For many years I thought that the reason why natural resource abundance could turn into a curse was that people and governments reacted in an irrational and counter-productive way when confronted with new natural resource wealth. That seemed logical because it didn’t seem possible that additional money distributed fairly and invested wisely could do any harm.

So I was as perplexed and frustrated as everybody else when confronted with my own research results(1). Using a Computable General Equilibrium Model of the Bolivian economy we found that the current natural gas boom is likely not only to increase inequality, as might be expected, but also to increase poverty.

The latter is quite surprising given that the computer model, rather unrealistically, assumes that everybody behaves rationally and that the government invests its revenues 100% effectively in public goods that improve the productivity of everybody. No room for corruption, failed public investment projects, demonstrations, blockades, civil unrest, or any of the other everyday events in Bolivia.

Even in this, for Bolivia outrageously optimistic, scenario, additional GDP growth due to the natural gas boom is only about 1% per year or less, and inequality as well as poverty increases substantially. The largest and poorest group, rural small-holders, is predicted to have 20% lower real incomes compared to a scenario without natural gas exports.

This is mostly the result of the following:

1. Basic economic forces: A large inflow of dollars causing an appreciation of the boliviano which discourages exports and encourages imports thus suppressing national production and employment (“Dutch Disease”).

2.The structure and composition of the work force: Almost all poor people are concentrated in the two groups that are naturally excluded from participating in the government’s spending and investment boom: rural small-holders and urban informals.

3. The lack of mobility between groups. While a rural small-holder might sell or abandon his land and join the urban informal sector, it would be virtually impossible for him to obtain a formal job as teacher, doctor, secretary, petroleum engineer, or any of the other professions that prosper under the natural gas boom.

The first force is universal to all countries that experience natural resource booms, but the second and third are characteristics particular to Bolivia and other poor, underdeveloped countries, and they are the characteristics which make natural resource booms problematic. If there were no poor informal sectors, or if people could move relatively easily towards the groups that clearly benefit from the boom (especially public sector employees, construction workers, and service providers), then the natural resource boom would not be much of a problem. The economy could adjust to and live quite well with the disease. Thus, while the “Dutch Disease” is relatively harmless for the Dutch it can be quite serious for the Bolivians.

And this is before we even begin to take into account the irrational and counter-productive behavior that newfound natural resource wealth seems to inspire in some countries. A recently published book “La trampa del rentismo” (2) focuses on the additional problems that arise when natural resources prompt a switch from productive activities to rent-seeking behavior. The book shows a high correlation (0.83) between proven natural gas reserves and the annual number of social conflicts (of which 676 were registered in Bolivia in 2004). Almost all of the conflicts represent demands on the “newly rich” government by a population that has come to believe that demonstrations and blockades are equivalent to dialogue and democracy. Even very damaging activities (such as blocking the free movement of people and goods across the country or outright vandalism) is widely tolerated as part of freedom of expression with no negative consequences whatsoever for the perpetrators.

It is difficult to say which is the most problematic — the almost automatic adverse economic effects or the self-inflicted social problems — but natural resources clearly have features that justify the words “curse”, “disease” and “trap”, especially in countries like Bolivia.

The question is what to do about it?

Considering how bad the alternative options are, the abovementioned book tentatively suggests that the government might just distribute the rents directly to the population. This would clearly have a better impact on the income distribution than regular government spending and investment.

How this would affect GDP growth rates and development depends entirely on how households choose to spend the money. There are three main possibilities for each household:

1.Invest the money to improve future income earning capacity.

2.Spend the money immediately on a party (or other consumption goods).

3.Reduce work effort now that an easier source of money is available.

If most households choose the first option, a permanent increase in GDP and incomes might result from the transfers. If most households choose to have a party instead, the consequences are limited to a few lost working days. But if people reduce their labor supply in response to the transfers (as basic economic theory would suggest), then the consequence might easily be a reduction in domestic production and an increased dependency on transfers.

Which is most likely? Knowing myself and many other Bolivians, I think a combination of 2 and 3 is the most likely. A recent study (3) on the effect of Bonosol transfers (unconditional, universal pension payments) in Bolivia appears to confirm that. The study analyses consumption patterns in the MECOVI household surveys for the years 1999-2000 (no Bonosol payments) and 2001-2002 (Bonosol payments of $120 per year to people aged 65 or more). Households with no eligible member are used as control group. This allows an estimation of differences in differences between “young” and “old” households in years with and without Bonosol transfers. The sample includes 11640 households.

While the study finds no effect of Bonosol on consumption in urban households, it does find a substantial effect on rural small-holders. Indeed, consumption in the latter type of households increases by a larger amount than the transfer itself, suggesting that the households have been able to invest the Bonosol payments productively on the farm. Additional regressions test the hypothesis that Bonosol increases on-farm investment (seeds, fertilizers, animals, tools, etc), but the only significant result found was that non-poor rural farms spend more on seeds as a result of Bonosol. For poor rural household, no increase in investment was detected.

If the rural results are analyzed in more detail by the age of the oldest member in each household, the impact of the 2001-2002 Bonosol payments are detected only for those aged 73 or more, although theoretically there should be an effect for all aged 65 or more. This makes me suspect that what the difference in difference analysis is really capturing may be the effect of the initial and much larger Bonosol payment received in 1997 ($247) rather than the smaller payments in 2001 and 2002. If true, the good news is that this initial Bonosol payment, which took most recipients by surprise, then had a permanent positive effect on consumption in rural households. The bad news is that subsequent payments did not seem to have any detectable impact neither on consumption nor investment. This may be because receiving households reduce their labor supply in response to regular/expected transfers, a hypothesis which could be easily tested using the same methodology as applied in (3).

Know of any similar situations where newly discovered natural resources end up being a curse, disease, or trap? Leave a reply below.

(*) Director of the 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. Also published as Coloquio Económico No. 4 by Fundación Milenio (September, 2006).
(2) Laserna, R., J.M. Cordillo & J. Komadina (2006) La trampa del rentismo. Fundación Milenio. La Paz, July.
(3) Martínez, S.W. (2006) “Invertir el Bonosol para Aliviar la Pobreza: Retornos Económicos en los Hogares Beneficiarios” En: Fundación Milenio (2006) La Inversión Prudente: Impacto del bonosol sobre la familia, la equidad social y el crecimiento económico, pp. 109-144. La Paz, Agosto.