The Myth of the Resource Curse

Thursday, October 25, 2012
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Barbara Kelley

“Rise early, work hard, and strike oil” was Rockefeller’s advice to young people looking to become successful. Today, the formula for success is quite different: academia advises to avoid striking oil, for it will doom a country’s economy to lower growth, and its society to bad governance. This advice results from studies in economics and political science purporting to show that countries that rely on extractive industries like oil tend not to develop as robustly and be as well-governed as those without the benefit of natural resources. This is called the “resource curse.”

The subject is of more than academic interest. As the United States becomes a major energy producer, will it become subject to the resource curse? Probably not. If the phenomenon really does exist, it flourishes in countries that lack strong institutions, governmental accountability, and already diverse economies. There is no reason to believe the political cultures of established democracies like the United States would be subject to the curse.

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Discoveries of new gas fields along with innovations in recovery of shale, coal seam, and tight gas will turn the United States, Israel, Canada, Australia, and potentially other nations into major energy-producing countries. Production and estimates of reserves have grown steadily as technological innovations expand drilling and generation of power from gas.

These developments will have far-reaching effects, both economically and politically. Trade balances will be significantly altered as oil imports are reduced and gas becomes a major export.  The United States is the world’s largest petroleum consumer, importing 45 percent of our needs; eliminating that will dramatically change our balance of trade. Gas will probably still trail oil and coal as an energy source for decades (the International Energy Agency predicts oil’s dominance until at least 2035, and coal only provisionally overtaken then). But our reduced dependence will have beneficial consequences even in the near term.

What Will Happen to Oil-Producing Nations?

The changing nature of energy markets will alter the political importance of oil- producing countries. As oil declines as a percentage of U.S. energy consumption, we will have greater latitude in whether and how we engage countries that are oil producers. If oil eventually becomes substitutable with other energy sources, or exports from Canada and Mexico displace those from the Middle East, the United States would likely have less need to be involved in that region. Oil markets are global, of course, and American interests are engaged not only in our own supplies but also those of allies and interlocked economies.

Still, diversification of energy markets will mean that producers have less influence and likely less power to set prices. Russia, for example, needs a market price of $129 per barrel of oil to sustain its government spending program; the further oil prices drop as other fuels become available and substitutable, the more difficult it becomes for Russia to sustain a petro-economy. Yet Russia has so far proved incapable of diversifying its economy beyond energy production. Where other industries have developed, they are associated with corruption and political favoritism on a repugnant scale.

Russia is not alone among energy-producing countries in its inability to build a vibrant economy alongside the oil production that is its mainstay. In fact, most oil-producing countries cannot, or at least have not, diversified. Most countries that develop extractive industries—whether oil, diamonds, or minerals mining—do not create the balanced economies that characterize countries without their natural resource cornucopia.

In economics, the phenomenon is described as the Paradox of Plenty: Countries with natural resources tend to have lower rates of economic growth than those without, and tend also not to develop diversified economies.

In political science, the phenomenon is explored in terms of its effects on governance and on violence both within and between societies. It is labeled the resource curse: countries with economies built around extractive industries are more prone to domestic conflict, tend toward authoritarianism, and have significantly higher levels of corruption.

Extractive industries such as oil or diamonds tend to be fixed. They don’t expand the economic pies. Certainly, countries can affect the amount they extract, and often the prices they can charge, by improvements in production, transportation, and other policy variables. But the revenue streams are usually pretty reliably known, and political debate centers on distribution of income within a society. This holds true whether resource-producing countries are generally wealthy (the Gulf states) or poor (Nigeria): The paradox of plenty is insensitive to level of income.

Countries reliant on extractive industries also tend to tax companies rather than citizens, and such taxes are their main revenue sources. This causes the state to be less accountable to its citizens and gives it greater incentives to use repressive means against its population to serve the interests of companies and elites that benefit from government policies.

Resource Curse or Development Curse?

A World Bank study concluded that primary commodity exports correlate strongly with the likelihood of conflict: Countries in which commodity exports account for 25 percent of GDP have a 33 percent likelihood of conflict, whereas a similar country that only exported 5 percent would have only a 6 percent likelihood of conflict. This would seem to give significant support to the theory of the resource curse. But these data include not solely natural resources, but commodities more broadly, like agricultural products. Countries for which farm exports are trade mainstays would not prove the resource curse; it speaks to a country’s level of development, not the sectorial distribution.

Conflating the level of development with extractive industry, as this study does, causes serious analytic problems. Countries with lower levels of development have, in much greater incidence, the problems of governance and societal violence the resource curse claims to prove. For the resource curse to be persuasive, it must pertain across levels of development and regime type. But it does not.

Moreover, the resource curse seems less and less to correlate across development levels as the new energy resources are discovered in countries with diverse economies and stable governance. Norway is not becoming Nigeria because it is a major oil producer; it retains the ability to govern itself well and use its oil revenues in ways that foster other sectors of the economy. Australia seems unlikely to fall under authoritarian rule despite the prevalence of mining in its economy.

It could, of course, be that the anemic effects of extractive industries take considerable time to be felt across a society that has a high level of economic diversity, institutionalized governance, and habits of accountability. Norway could creep slowly away from the rectitude that has made its government a model of transparency and responsiveness to its citizens; in Australia, collusion between Big Business and politicians could grow beyond the ability of its citizens to control it.

Causation or Correlation?

The resource curse falsely attributes causation to a country’s reliance on extractive industries when, in fact, the relationship is merely correlative. That is, Nigeria is not badly governed and underdeveloped because it struck oil; it is just badly governed and underdeveloped. There are historical, political, and cultural reasons for its difficulties that matter at least as much as the economic fact of its natural resources. Making Nigeria a better country for its people does not involve reducing its reliance on oil so much as improving its governance.

Countries that have accountable governments tend to be more prosperous than those without. Countries that have the rule of law tend to be more prosperous than those without. Governance is a better indicator of potential prosperity than the industries that drive the economy. This was the logic behind the shift in development assistance ushered in by the Bush Administration, known as the Millennium Challenge approach, which works with poor countries to improve governance, advance economic freedom, and establish patterns of societal investment that set the country up for greater prosperity. It has been a huge success, showing that countries willing to address problems of governance can get themselves out of the traps of underdevelopment and bad governance.

Possessing natural resources is not a danger sign for a country; it is a potential asset that, when paired with good governance, serves its people well. Academics have rightly identified the correlation of extractive industries and bad governance in underdeveloped countries. But the deficiencies of governance look to be more important than the existence of extractive industries in determining whether a country develops a diverse economy with high growth rates.

Despite the intellectual popularity of the resource curse, it does not appear to hold much explanatory power in the case of current energy producers. It will hold much less as countries with established democratic institutions and habits become more prevalent among energy exporters.