Avoiding the resource curse in Africa

Over the last four decades, resource abundant countries in the developing world have consistently under-performed resource poor countries when it comes to economic growth, income inequality and good governance.

It has been well established that the more intense a country’s reliance on mineral exports (measured as a percentage of GDP), the more slowly its economy grows.

As an example, according to the Africa Development Bank (ADB), between the periods of 1960 to 1990, the GDP per capita of mineral rich countries increased by 1.7% compared to the 3.5% growth of mineral poor countries

These counter-intuitive trends however are more complex than the above economic data suggest. The abundance of a resource is after all, not the cause of poor growth.

Rather, the abundance of a specific resource(s) creates incentives for poor wealth management which in turn result in incremental rather than exponential economic growth.

Governments within the developing world depending on a set of few commodities are particularly susceptible to a number of macroeconomic challenges.

The first is the excessive volatility of commodity prices.

This has had severe implications for commodity dependent nations. In other words, nations whose national revenues are mainly drawn from the export of a particular resource – because cycles of booms and busts in real national incomes – create problems for macroeconomic management.

Short-term revenue instability is a particularly challenging context for macro-economic planning and fiscal policy management given that expenditure patterns in these types of countries tend to follow revenue patterns.

Cycles of booms and busts in the commodity price also translate into cycles of booms and busts in fiscal expenditures. As a result fiscal policy becomes pro-cyclical, implying that spending goes up (and taxes down) in periods of booming prices and spending goes down (and taxes up) in periods of price busts.

In addition, the expenditures of pro-cyclical fiscal policies are not necessarily efficient.

Research indicates that spending often fuels expenditure on the current account and a low-return on public investment programs. This approach to fiscal management is an understandably common pitfall when looked at from the perspective of governments which often operate on a short-time horizon.

Always seeking to extend their tenure – be it through elections or expansive state policies – governments in the developing world are likely to spend windfall revenues quickly and in an inefficient manner. An example of this type of short term strategy is increasing wages and subsidies, which for those same political reasons are difficult to reduce once revenue dries up.

Investment in low-return and over-ambitious projects, is another common wealth management mistake made by resource-abundant economies.

The problem of foreign debt accumulation also becomes prevalent because many resource-abundant economies consider busts to be temporary and booms to be long term.

As a result, these countries begin to borrow on the strength of their well-performing commodity and continue to do so as a means to finance their deficits when their commodity performs poorly and their revenue drops.

Yet another common problem that contributes to the resource curse is Dutch disease.

As a country’s management focuses more on the booming sector, the competitiveness of other sectors, primarily manufacturing and agriculture, diminish resulting from the price appreciation of the currency during resource booms.

Related to this issue is the problem of limited economic diversification.

Resource abundant economies tend to over emphasize the importance of resource extraction in their economy which in turn reinforces their dependence on that product and its place in the market cycle.

Perhaps one of the most problematic issues resulting from resource abundance and the poor management of resource wealth is institutional weakening.

There is a tendency for large windfall revenues to weaken institutions.

For instance, direct access to income from the commodity reduces the incentives for a government to establish a tax system. At the same time, however, the implicit reciprocity between tax collection and the social services provided by the state are severed.

As a result, commodity booms thus encourage rent-seeking and patronage networks by removing citizen participation in the creation of state revenues, therefore rendering the state decreasingly accountable to its citizens.

Finally, the macro-economic and fiscal policy challenges created by resource abundance are further pronounced by the uncertainties surrounding the long term sustainability of some natural resources.

Economies dependent on non-renewable resources constantly face a trade-off between current revenues and future revenues. That is, they are not only challenged by inter-temporal budget constraints, or the impact of boom and bust cycles on their revenue, but on inter-generational equity.