The Challenge of Natural Resource-led Development in Small Economies

1. The Challenge of Natural Resource-led Development in Small Economies Dr. Maiju Johanna Perälä Department of Economics The University of the West Indies, Mona Prepared for the presentation at Association of Caribbean Economists’ conference on ”Economic Growth and Transformation—Reassessing Challenges and Prospects at the Datwn of the 21st Century”

2. Purpose of the paper • To provide an explanation why growth has failed in some countries over the long-term, especially those that are small in size • To investigate whether natural resource endowment type is relevant as argued within the development economics literature (Hirschman 1977,1981; Auty 1995, 2001) • To clarify a mechanism that generates (or has potential to generate) a resource curse, an important explanation for failing growth in the post era

3. Main arguments and findings • Natural resource endowment type matters for growth, or for lack of it, especially when coexisting with the lack of social cohesion • Oil and mineral resource endowment more negatively correlated with growth than an agricultural one • The above findings are robust to different growth regression specifications (cross-section, time-series) • The phenomenon is especially troublesome for small economies as, in addition to the resource curse phenomenon, they face a greater challenge for manufacturing development.

4. Stylized facts of growth failures • Regionally concentrated: Sub-Saharan Africa and Latin America and the Caribbean • Stage of development is relevant: Tend to occur at early phases of development • Size of the economy matters: More likely to occur in small than large economies

5. Regional concentration: long term failures

6. Regional concentration:recent failures

7. Regional concentration:growth successes

8. Stage of development

9. Relevance of size

10. Observations on failures • Striking patterns: persistence and regional concentration • Raises questions whether common explanation(s) for these failures can be found • Growth failures appear to have had difficulties in initiating growth, focus on initial conditions seems appropriate

11. African growth literature Lack of openness (SW 1997), poor policies (Collier&Gunning 1999). Ethnic divisions, neighborhood effects (EL 1997, 1998) Low investment and high population growth (Hoeffler 2002) Challenges of economy size Relatively small domestic markets, manufacturing potential requires favorable external market conditions More vulnerable to external fluctuations due to greater exposure Lack of diversification within the economy, terms of trade fluctuations stronger effect Small developing countries more reliant on primary products that experience greater volatility Natural resource abundance and growth Easy riches lead to sloth (Bodin 16th Century) Natural resource curse thesis (Auty 1995, Gelb et al 1998) Dutch disease (Corden 1984, Neary & van Wijnbergen 1986, Ros 2000) Terms of trade (Prebisch 1950, Singer 1950) Instability (Gelb et al 1988, Tarshis 1986) Staples and economic development (Hirschman 1977, 1981) Analytical survey (Ros 2000) Common explanations for failing growth

12. Linkages view on development • Natural resource endowment type matters to development (Hirschman 1981) • Captures the notion how “one thing leads to another”, interdependence of economic activity, linkages application to natural resource-led development • Process of growth through various linkages: • Production linkages • Consumption linkage • Fiscal linkage Developmental linkages

13. Physical production linkages Forward linkage Imported inputs Production C Production A Backward linkage Domestic production of inputs Final demand or production B

14. Consumption linkage Consumption linkage from labor incomes Final demand Production A via L-intensive methods Consumption goods industry Potential backward linkages Potential forward linkages

15. Sociopolitical environment critical Fiscal linkage Enhance production linkages Government Limited production linkages Enhance consumption linkages ‘Enclave’ production Production A Limited consumption linkages Typical of mineral and fossil fuel extractive industries

16. Challenge of fiscal linkage • Indirect, it requires: • ability to collect taxes • well-designed development policy • capacity to implement the policy and to target the funds in most productive activities • indirectness leaves room for mistargetting of funds, or even for their loss through rent-seeking • Challenge posed by economy size: • management more costly to small economies, economies of scale not as attainable as for large ones (ratio of government expenditures/gdp smaller for large ecos, fixed costs of governance higher per population for small ones)

17. Linkages approach to staples • The nature of economic activity determines the relative importance of each linkage • Agricultural production  labor-intensive, likely to generate a consumption linkage • Mining and fossil fuel extractive industriesenclaves • Enclaves, limited production and consumption linkages, the importance of fiscal linkage is elevated and the role of political economy aspects and development policy are brought to the forefront • Fiscal linkage, critical for small developing countries rich in extractive natural resources poses a greater challenge given that it is more costly, depleting development funds

18. Linkage approach continued • Technological apects of staples can be limiting, but not deterministic • Sociopolitical environment important • If environment is conducive to welfare maximizing policieslimited development potential of a staple can be overcome through an efficient management of the fiscal linkage (through effective development policy)

19. Empirical methods • Simple statistical evidence—highlights the phenomenon • Initial conditions analysis • initial real per capita income and education level • Sachs and Warner (1997) initial conditions • Cross-country growth regression analysis • Sachs and Warner (1997), Barro (1991), MRW (1992), King and Levine (1993), DeLong and Summers (1991)

20. Sample and natural resource data • 95 market economies with population more than half a million (sample confirms with established studies and methods). • Natural resouce endowment categorization following Auty (2001): • resource rich economies—per capita cropland >0.3 hectares • extractive (point source) economies—fuel and mineral exports > 40 % of total exports • agricultural (diffuse) economies—remaining

21. Proxying social cohesion and enclave effect • Social cohesion is considered to capture sociopolitical environment, proxied by ethnolinguistic fractionalization (ELF) (EL 1997, Mauro 1995) • Interaction term between extractive endowment and ELF should capture ’enclave effect’ in a poor policy environment

22. Growth Failures & Resource Endowment: long term failures by country

23. Growth & Resource Endowment: failures and successes by country group

24. Growth and Social Fragmentation by Endowment Type: fragmented economies

25. Growth and Social Fragmentation by Endowment Type: cohesive economies

30. Estimated Growth Effects of Enclave Effect Table from Perälä (2007)-Resource Flow Concentration…

31. Concluding remarks • Broadens the debate on natural resource abundance and growth to type of natural resource & the ensuing political economy considerations • Mineral and/or oil richness combined with lack of social cohesion is found consistently negatively correlated with growth (distinct growth experience from agricultural economies) • Brings forth evidence that mere natural resource richness is not negatively correlated with growth (rather, coexistence with lack of social cohesion important for a negative growth outcome) • Empirical results are useful in explaining the cause of resource curse, highlighting the importance of political economy aspects • The challenge is especially predominant in small economies, with smaller domestic market, greater challenge for manufacturing developing, more reliance on external markets and greater cost challenge for the management of the fiscal linkage.

32. Other related contributions: • Perälä, Maiju Johanna. 2007. Explaining Growth Failures: Does the Type of Natural Resource Endowment Matter? (paper in review) • Perälä, Maiju Johanna. 2007. Resource Flow Concentration and Social Fractionalization: A Recipe for Curse? Journal of Economic Studies, 35(5), forthcoming • Perälä, Maiju. 2003. Persistence of Growth Failures: Does the Type of Natural Resource Endowment Matter? UNU/WIDER Discussion Paper #37. • Perälä, Maiju Johanna. 2002. Explaining Growth Failures: An Empirical Investigation of Natural Resource Type and Growth. In Essays on Economic Development and Growth, 124-186, University of Notre Dame dissertation.