The role and impact of the Institutions Curse in perpetuating the Resource Curse

When oil, natural gas, or similar natural resources are discovered the expectation is that their exploitation will dramatically and materially benefit the population of the host country. Notwithstanding this, developing nations frequently experience either (or both) increased corruption (through predatory rent-seeking) or paradoxically slower economic growth after the resources are discovered. This anomaly is often described as the Resource Curse.

While studies have shown that there are various drivers behind the Resource Curse, it tends to arise more frequently in countries that have institutions that either facilitate or encourage rent-seeking, as indicated in the case study of Nigeria below. The rent-seeking behaviour, in turn, tends to compete with productive activity and drains the countries’ economic vitality. Weak institutions and associated illicit conduct are commonly referred to as the “Institutions Curse”.

Developing nations frequently experience either (or both) increased corruption (through predatory rent-seeking) or paradoxically slower economic growth after the resources are discovered.

The role of institutions in determining the effects of natural resources is widely recognised in the literature. Mehlum, Moene and Torvik, for example, have demonstrated, using regression analysis, that the Resource Curse is strongly present in countries with weak institutions but is barely present in countries with the opposite. Mulwa and Mariara in this regard found that GDP growth in resource-rich countries is also dependent on the strength of property rights and other governance indicators. Their findings were supported by earlier studies by Mehlum et al. who suggested that the growth effects of resource abundance often depend on the quality of a country’s governance institutions, which determine returns on investment as well as the scope for rent-seeking. Natural resource dependence coupled with institutional weakness often invites rent-seeking and corruption with a concomitantly detrimental effect on the economy.

If these research findings are correct, the Resource Curse may simply be an idiom for doing politics inserted into a pre-existing political landscape fraught by rent-seeking forces and power-broking that directs those rents towards the patronage circles that maintain elite power. Accordingly, where the Resource Curse exists, it probably lies in the deeper political economy of institutions, rather than in economic management per se. In developing economies with weak institutions, not least in African resource jurisdictions, natural resources are often proxies for politics.

If one looks at African resource jurisdictions, there are various examples of where the discovery of natural resources has been followed by conflict, environmental damage and economic instability. Again, this was frequently owing to the absence of effective institutional and legal frameworks.

The Resource Curse is strongly present in countries with weak institutions but is barely present in countries with the opposite.

First, for obvious reasons, resource abundance provides a strong incentive for conflict and plunder in countries afflicted by institutional weakness, poor governance, and economic mismanagement. The circumstances are axiomatically aggravated by factors such as unemployment and rampant poverty. The Democratic Republic of Congo (DRC) and the countries around the Great Lakes are often cited as examples of this.

Second, the discovery of resources often occurs before the government establishes a regulatory framework to ensure that the resource in question is exploited in a sustainable manner. The absence of clear rules which dictate how the environment and community interests should be protected often results in significant harm to the natural environment.

Third, the prospects of significant wealth may prompt economic instability. According to Poelhekke and Van der Ploeg “volatility in natural resource revenues, induced by volatility in primary commodity prices, curbs growth in economies with badly functioning financial systems”. When the discovery of a significant resource promotes economic activity to focus on a single resource, a country’s economic stability may be tied to a particular commodity price (such as the Brent crude oil price). Fluctuations in commodity prices consequently have ripple effects on domestic economies. Countries whose economic stability is linked to a single commodity, such as oil, may struggle to maintain their foreign exchange reserves when the price of the commodity falls precipitously. After such an event, governments often have little choice but to use their remaining reserves to pay for essential imports or service their external debt repayments.  If these reserves are severely depleted, this may lead to a balance of payment crisis that may eventually develop into a fully blown financial crisis (key African oil producers such as Nigeria, Congo-Brazzaville and Angola are examples of this). Flawed expectations based on an expected increase in commodity prices often encourages commodity producers to go on a debt-fuelled expenditure binge with potentially calamitous economic consequences.

Resource abundance provides a strong incentive for conflict and plunder in countries afflicted by institutional weakness, poor governance, and economic mismanagement.

Finally, corruption abounds on the back of institutional weakness. Natural resource concessions that permit a company to engage in resource exploitation can be extremely valuable. This may lead to companies or individuals using undue influence to obtain such concessions, influence the terms offered in these, or gain favourable treatment in other ways. This has been most recently illustrated in the corruption trial and subsequent conviction of Israeli businessman, Beny Steinmetz. The Geneva Criminal Court recently found that Steinmetz paid bribes of US$8.5 million to Mamadie Toure, the wife of Guinea’s deceased former president Lansana Conte to help secure rights to the country’s Simandou iron ore resources worth an estimated value of US$5 billion.

The blame for the worsening of social indicators and the prevalence of the Resource Curse in resource rich countries can accordingly be placed on institutional weaknesses and resultant corruption. In an attempt to avoid the Resource Curse, a country should therefore establish well-functioning democratic institutions. The government in question should also promote transparency as to how resource revenues are collected and spent, foster a diverse industrial and economic base, a stable currency and interest rates, and a balanced import/export ratio. Botswana is an example of an African resource jurisdiction which has achieved this utilizing its singular diamond wealth.

Corruption abounds on the back of institutional weakness.

A developing nation, it translated its resource wealth from diamonds into economic growth and development opportunities for its citizens by implementing mechanisms which ensure that a significant part of its mineral resource revenue is allocated for investment in health and education. In addition, the country invested a portion of its resource wealth in its Pula Fund, a sovereign wealth fund which serves as a buffer against price volatility and preserves a share of the rents from diamond exports for future generations.

By contrast, the DRC has fallen victim to the Resource Curse. Although the DRC is the biggest copper producer in Africa and one of the top five copper producing countries globally, its mineral resources have historically contributed to politically volatility with several local conflicts ensuing over the control or distribution of wealth. Notwithstanding the DRC’s significant mineral wealth, the average Congolese citizen earns an annual income of less than US$581, resulting in the DRC ranking as one of the world’s poorest nations.

The Resource Curse is by no means unescapable. Countries such as Botswana have avoided the Resource Curse by encouraging economic diversification, investment and an equitable distribution of accrued rents. Key to Botswana’s success is the 50-50 joint venture between the Botswanan government and De Beers, initially concluded three years after independence in 1969. The joint venture, aptly named Debswana, contributes 30 per cent of Botswana’s annual revenues, which is then invested in social spending. Owing to its economic importance to the national economy, Debswana’s operations have a significant impact on development in Botswana. The Botswanan government has used its regulatory role to integrate the company’s mining activities and corporate social investment programs into national development plans.

The Resource Curse is by no means unescapable. Countries such as Botswana have avoided the Resource Curse by encouraging economic diversification, investment and an equitable distribution of accrued rents.

In many cases, strong economic institutions in place play a vital moderating role in transforming the Resource Curse into a blessing. To counteract the Resource Curse, governments should follow Botswana’s example and invest revenues received from the exploitation of natural resources in a manner which would promote further investment and growth. While this could include establishing Sovereign Wealth Funds or allocating revenues into national or sub-national budgets, the aim should be to promote job creation and skills transfer across all economic sectors. Finally, in addition to building strong economic institutions, national leaders would be wise to focus on strengthening the rule of law and property rights and promoting transparency as to how resource revenues are collected and spent.