How the Collapse of Oil Hurts Poor Countries

Source-Bloomberg

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Futures prices for Brent crude traded around $49 a barrel at the end of last week, illustrating a collapse that has oil prices at 40 percent the level of last year’s peak. For major oil producing countries, that will likely lead to shrinking economies and growing budget deficits. This might not be such bad news if you to subscribe to the theory of “the resource curse”: the notion that possession of bountiful natural resources is not a blessing but a curse, the root of many problems that afflict developing countries. According to this line of thinking, the plummeting price of oil could even facilitate better governance, lead to stronger long-term economic growth, and even reduce the likelihood of war.

If true, this theory would be reason enough for policy makers in the West to celebrate the collapse of the global oil market. Unfortunately, the chances that low oil prices will spur a wave of democratic change in the developing world are slim at best. That’s because the vaunted resource curse may not be all it’s cracked up to be.

Natural resource rich countries are indisputably in for a painful year: Oil and gas account for two-thirds of Russia’s exports, for example, and oil income provides about 45 percent of the government’s revenues. At any oil price of below about $100—twice current prices—the government will run a deficit. The International Monetary Fund suggests that the “fiscal breakeven” price for Saudi Arabia and Iraq is similar to Russia’s; oil-producers Nigeria, Algeria, Iran, and Libya face even more acute budget crises and probable recessions.

The price collapse is almost mechanically guaranteed to reduce the share of major producers’ gross domestic product and exports that comes from oil. This is what believers in the “resource curse” think is essential for long-term growth in the developing world.

There are many theories as to why resource dependence is bad. During resource booms, other sectors of the economy become less competitive and therefore fail to develop. In Africa, much of the wealth derived from the continent’s abundant natural resources has been plundered by corruption and civil war. Oil revenues sustain autocracies and inefficient governments, which can pilfer the treasury and ignore popular opinion because there’s no “social contract” between political leaders and taxpayers. That social contract is at the heart of efficient government; proponents of the resource-curse theory say that without a social contract, countries are unable to emerge from stagnant pre-industrial misery.

Declining prices may force governments that rely on oil sales to finance themselves by instead relying more heavily on tax revenues from companies and citizens. The long term effect, say adherents of the resource-curse theory, will be more efficient and more responsive governments and more rapid development, from Lagos to Riyadh.

Recent research suggests that the resource curse may not be such a curse. If anything, it is partial, context-specific, and of less overall significance than was previously thought. Frederick van der Ploeg of the University of Oxford and Steven Poelhekke from De Nederlandsche Bank provide some evidence that the volatility of resource prices may have a small, indirect effect on long-term growth rates in countries—but weak institutions in those countries are far more significant. Alexander James, an economist at the University of Alaska, found that resource-dependent countries don’t experience slower growth than other countries in their non-resource sectors; the problem is that the resource sector itself tends to grow slowly. Resource-dependent countries don’t grow slowly because resource extraction has corrupted national institutions or made other sectors less efficient. Instead they “tend to grow slowly when the international price of the resource falls,” he concludes.

And while oil wealth may marginally help sustain autocratic regimes, it is difficult to find a consistent impact on most other measures of the quality of a countries’ government institutions. Markus Bruckner at the University of Adelaide even suggests, with colleagues, that higher oil prices—not lower ones—can sometimes help push autocratic oil regimes towards democracy.

The debate over the resource curse isn’t settled: Economist Kevin Tsui of Clemson University finds that very large oil discoveries in autocratic states lead to lower levels of democracy three decades later. But even he suggests that the effect is “smaller in magnitude than what has been claimed in the [economics] literature.” Countries, including Russia and Iran, could do with a push toward greater democracy. But the idea that lower oil revenues will lay the path to sustained democratic development and stronger growth in resource-rich dictatorships is wishful thinking.

 

 

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