Resource curse

Generally, oil-rich countries face two problems. The first problem, which is mainly a demand-side challenge, is the issue of high volatility of oil prices. This volatility has often generated severe boom-bust cycles in oil-rich economies in the past thirty years. Professor Paul Collier, who is the leading expert in this area, argues that oil-rich countries can easily avoid this problem by adopting appropriate fiscal, monetary and exchange rate policies. This can entail setting up an oil stabilisation fund, for instance. The other problem facing oil-rich countries is the depletion of their natural resources, which is a long-term challenge. Again, this problem can be solved according to Collier, through effective investment of oil revenues, which means transforming natural assets to domestic productive assets. In short, he believes that oil can act as either a curse or a blessing, depending on the economic policies that are followed in the demand and supply side.



Let me start with a general question: Is oil a curse or a blessing?
It's an opportunity. But, it is an opportunity that comes with a health warning. First and foremost, it is an opportunity. So, it has to be a "plus" that got this health warning. And if you don't heed the health warning, then it can become a "negative". But the real tragedy is not that it becomes a negative, but it ceases to be an opportunity.

How about the new wave of research that shows that net effect of natural resource wealth is positive and is basically a blessing, irrespective of any factor.
It should be, shouldn't it?! I don't like the language of "resource curse" because it sort of…it sets the wrong agenda. It sort of sets the agenda as "avoid the awful". Whereas the right agenda is "seize the opportunity". My favourite examples are Botswana and Sierra Leon, where you got the same resource diamonds, two dirt poor countries, one becomes the fastest growing country in the world and the other one goes at the bottom of the human development index. What that tells you is that economic policy matters a lot in resource-rich countries.
I would like to contrast Botswana and Sierra Leon with, take the pair, Singapore and Hong Kong. Now, they [Singapore and Hong Kong] both developed through industrialisation, not natural resources, and they followed entirely opposite economic policies. Hong Kong, complete laissez faire, no industrial policy whatsoever, while Singapore was very targeted in its industrial policies and economic intervention. What happens? They both do fine. So there, does big difference in policy make a big difference [in economic development]? No. But when it comes to natural resources, different economic policies lead to huge differences in outcomes. So, this is a domain in economics, where policy choices really matter.

So correct me if I am wrong, you are suggesting that the reason that some oil-rich countries manage to develop and some don't has got to do with policy. Policies matter?
Absolutely.

Let me take a step back. Why do you think some oil-rich countries adopt right economic policies while others don't? Is it because of their institutions or influence of economic ideas?
There is a tripod (a metaphor for three important factors). And what is the tripod? It's (a) rules, (b) institutions and (c) a critical mass of citizen understanding. You need all three.
Rules, you need for guidance. You are going to be taking the same economic decision again and again for generations. Of course, [policy] rules are not self-reinforcing, there are just there for guidance. But if you got a rule, one advantage of a rule is that if a policymaker decides not to follow the rule, that would be noticed.

Could you clarify what you mean by a policy rule? Are these policy rules formal or informal?
It might be legislation or it might just be a policy rule. It doesn't have to be legislation. The important issue is not whether it is legislation or not, it is whether it is widely known and supported among the public. For instance, we can have a savings rule:"30% of revenues have to be saved". Then, the public would say, "but this year you only saved 10%, why?"
So, having a policy rule that is widely known and supported by the public can provide some sort of discipline. And it provides consistency over time [in economic policymaking].
But rules on their own are not enough. You also need institutions, what I mean by institutions, is teams of people with a mandate and technical ability to do something; implement the rules, let's say. And you need a lot of specialist teams with mandates and capacity if you are going to harness the benefits of natural resources with a whole range of economic decisions. So, you need rules and institutions: teams of people to do things. Rules, tell you what to do and teams are the ones who do it.
But rules and institutions alone are never enough because you [politicians] can ignore them. Good example, nothing to do with natural resources, is the euro. Euro is two fiscal rules ["Balanced Budget Rule" and "Debt Brake Rule"] and one institution [European Central Bank] that is comprised of seventeen European governments and has been established since twelve years ago. Now, how many of those seventeen governments have stuck to those rules for the past twelve years? Only one! Finland, the other sixteen have broken the rules. Why? Because there is rules, there is institutions, but there is no critical mass of citizens to support them [people don't care about those rules].

In countries where you have effective checks and balances and rule of law!
Yes, Yes…They tried to re-establish the rules about three/four years ago. So, they invited all the finance ministers to Brussels in a Thursday. In that Thursday afternoon, all the finance ministers stood up and said "from now on, it's serious, budget deficits will be 3% [of gdp]". That was the Thursday afternoon, the Friday morning, Spanish finance minister flew back to Spain and said "well, we are actually, not doing it this year". So, it didn't last 24 hours [to break the rule]. They key thing was that Spanish people didn't then say "you have broken the rule, how can you?!", they said "thank goodness"! So, a complete failure to build the critical mass of citizens to understand what was going on. So, you got to have a critical mass of citizens. How big is a critical mass? It is enough to enforce the rule and protect the institutions. Right? So, a key job is to build that critical mass. That is where communication and leadership comes in.

Let me interrupt you, because when it comes to institutions, people mean different things. For instance, the New Institutional Economics literature shows that the reason why some oil-rich countries succeed and other fails has got to do with their institutions [I am particularly referring to Daron Acemolgu's Why Nations Fail]. And this literature, broadly defines institutions as rule of law, checks and balances, democracy, etc. Do you think this factor explains the difference?
Not really. I define institutions differently as you picked up. I define them as teams of people with a mandate and the capacity to do something. Hm? So, I distinguish between rules on the one hand, and teams with a mandate on the other hand. And neither of them alone are an effective checks and balance. The real checks and balance is the critical mass of citizens.

Does your theory explain the success of resource-rich courtiers such as Chile, Malaysia, Indonesia and Botswana?
Let's take Chile. One of the things that Chile did was to build rules and institutions for smoothing expenditures in the face of volatile [copper] revenues. And if you got to do that, you have to start with a period where revenues are higher than spending. Otherwise, you have got no money to smooth when revenues are lower than spending.

Stabilisation funds basically.
Yes, yes. So, Andres Velasco, when he was the finance minister in Chile, a friend of mine [who is now a Harvard Economics Professor], he built that rules and institutions. It was hugely unpopular. But he got saved by the world economic crisis. The world economic crisis came just in time, the copper price crashed. And over night, he changed from being a national villain to a national hero. Because suddenly the rules said, "we are going to spend and we can spend, because we have saved". Hm? So, that is an example of good luck [a historical accident] leading to the built of critical mass of citizens understanding. Without that [global financial crisis], whether Andres and his fund would survive were pretty doubtful. So, building that critical mass of citizens understanding is hard. But it is essential.

So, related to this topic, why do you think some oil stabilisation funds succeed while others don't?
Because some managed to build enough citizen understanding of why it is good idea and some don't. You see, even in Norway, they struggle. Their sovereign wealth fund is marketed as a pension fund to people. But it has got nothing to do with pensions, but it is very sensibly run. Obviously, there, the economic leadership thought: "how do we get the concept [oil fund] to ordinary people". What do people do which is nearest to what we are doing [in the fund]. What do people do that builds a prudent future for them? They save for a pension! So, let's then use the label "pension" to explain what we are doing [in sovereign wealth fund]. That is nearest they can get to ordinary people understanding the benefits of an oil fund. And people say: "yes, the nation ought to be saving for a pension". So, you [policymakers] got to develop narratives, which ordinary people can get their minds around.
Having said that, I have to stress that I am not in favour of every country having a sovereign wealth fund [which is designed for investing oil revenues abroad permanently, in contrast to oil stabilisation fund]. I think it makes a lot of sense for Norway now. And the reason that it makes a lot of sense for Norway now is that they have already accumulated so much domestic investment. Literally, Norway has more invested capital [domestically] per capita than anywhere else on earth. So its capital saturated. So, the return in adding more capital in Norway is not very high. It makes more sense for them to accumulate more capital in China or Brazil than pile up more investments at home. Now, you have got to ask then, is that true in other countries? In the Gulf countries, of course it is true; loads of money with small population. So they better accumulate capital elsewhere than in the tiny Gulf.
But a populous poor country is on the opposite hand of spectrum, it hasn't got much of invested domestic capital to work. So, the core narrative shouldn't be "let's save abroad a honey pot for the future". That is stupid in the end. Instead, the narrative should be let's use the money to develop the country.
And the big "but" is that we don't have the capacity yet to invest well [in the domestic economy], to scale up investment without just producing another Nigeria with loads of useless concretes. So, that is the concept of absorptive capacity that put constrain on further investment. But the answer to that is not "let's put money abroad". The right answer to that is "let's build the capacity". That is what I mean by "investing in investing"; build the capacity to invest well [in the future].

But that justifies more spending. And then you have the classical problem of excessive spending when oil booms happen.
No. There are two separate problems. First, it is the problem of smoothing expenditures when oil booms happen. For that you have to save abroad in order to make sure your spending does not go up and down like a yoyo as oil prices change. But the more important inter-temporal problem is that oil is a depleting asset [hence the optimal investment of oil revenues]. They are actually three clocks ticking for a policymaker in a natural resource country. The slow tick is the depletion of natural assets, you are running down your oil. So you have to build up some other assets. If you are a poor or developing country you are better to build those assets domestically. The second ticking clock is the clock of "investing in investing"; build the capacity to invest well [build good policymaking institutions for example]. If you start without that capacity and try to do a lot of investments, you end up with the Shah's problem. Or with Nigeria's problem in the early 1980s. Now, how long will it take you to build the capacity to invest well, maybe ten years. Once you build that capacity, you scale up your investment. Until then, you have to put the money abroad. But it is for a different reason; it is not that you are investing abroad forever; you are "parking" it abroad until you build your policymaking institutions to use your oil money well at home. Then you bring it back. Finally, there is a third clock ticking which is the rising tide of commodity booms and busts. For that you need a smoothing fund [stabilisation fund].
So, there are three possible reasons for putting money abroad. One the "Norway reason", which doesn't apply for developing countries. The second reason for putting money abroad is that you "park" it abroad until you build your capacity to invest. That makes sense but it is temporary. And the third reason is smoothing of expenditures in the face of commodity prices, that is what Andres Velasco did. And in a way, that is the most obvious.
The tragedy of over-emphasising of sovereign wealth fund is that it shifts the attention from the core problem that is building the capacity to invest the money domestically. Unless you solve this problem, you can't develop. The process of capacity building is not very expensive.

Could you give me an example?
For public investment projects, for instance, you got to do three things. First, you got to design it. If necessary, you can buy that skill in; there are many consultant companies around the world that can design you a port. Then, you have got to select from a range of possible projects; to do this, you need a process or an organisation that selects among these possible projects saying: "no, that is not a good project, it is not sufficiently high return or it is not strategic, but that project is good, we want to do it, every country needs a well-function port, we are gaining to do it". So you got to have a process of selection and then you got to have the capacity to implement the selected projects. Rwanda is a poor country in Africa that is growing fast now. Why? Because they have put a lot of emphasis on building the capacity to implement projects well. There is an IMF new index called Public Investment Management Index that scores these four components for each country. So you can just Google it.

To summarise, can we rephrase this capacity building as kind of an institution building? Let's spend part of oil revenues on training technocrats?
Yes. But remember I define institutions as a team with a mandate and skills. The language of capacity-building or institution-building [as used by the IMF and World Bank] tends to narrowly focus on individual training: "let's train Mr X or Mr Y". But my focus is on training teams. All serious public policy decisions require teams. Teams have to have an organisational capacity; it is not a matter of individual skills. In fact, once you got a competent technocratic team that has internalised an objective, it will acquire the necessary skills in time. But most importantly, these teams have to have a high autonomy and be insulated from political pressures to operate effectively.

Can we think of "Berkeley Group" of technocrats in Indonesia in the 1970s as an example of such a team?
Absolutely. Although, they were not initially insulated from political pressures. The story of Indonesia is the story of this group of technocrats sometimes losing power, sometimes gaining power. And the decisive thing for them in getting power in the first place was the default of PERTAMINA (the state-owned oil company) at the peak of the 1973 oil boom. Now for an oil company to go bankrupt in the middle of an oil boom, you got to really work on it. Now I am told that technocrats capitalised on this opportunity and gained power. The president [Suharto] was so shocked by the bankruptcy of PERTAMINA that then he said "ok technocrats you now run things".

Now, let's go to the case of Iran during the Shah. The exact opposite happened to the technocrats there.
Yes, yes. Well, you know the story better than I do. So I am not going to tell you what happened in Iran.

But I would like to know your take on it; what made Iran different?
Maybe, it was the story of too much oil money giving the non-technocrats too much rope. And then eventually they [the non-technocrats] did hang themselves. But because the state had a lot of money, that process required serious mismanagement of oil revenues. So that would be my sort of speculation.

So, your suggestion is that when oil revenues go down technocrats gain power and when the oil revenues go up they lose power?
Yes, that would be my guess.