President Evo Morales of Bolivia’s announcement May 1 that the country’s oil and natural gas resources would be nationalized, and Thursday he announced that this would be without compensation. By doing so, he exemplified both the Latin American disease, discussed here April 24, and an even more severe natural resource disease by which countries with large natural resource income are doomed to corruption and poverty. Without a global re-think on how we deal with natural resources, that disease is incurable.
In the last 30 years countries with large natural resource deposits have consistently underperformed their economic peers without such deposits. The greatest examples of this are in the oil sector, where Saudi Arabia, for example, is still less than half as rich as it was in 1980. However of the notable mineral deposits outside the oil sector, silver has not greatly enriched Bolivia, diamonds have not greatly enriched Angola, copper has not done a great deal for Chile (that country’s most spectacular development, in 1973-1990, came in a period of low and declining copper prices) and phosphates did absolutely nothing for Nauru.
Even in advanced economies, oil contributed heavily to the overvaluation of sterling and the collapse of British manufacturing in the early 1980s. More recently there is a good argument that the huge rise in oil prices since 1998 has cemented in place highly unpleasant regimes in Russia and Venezuela that would otherwise have been rightly booted out by their electorates.
It was not always thus. The South African and Australian economies were built in the 19th Century largely on the basis of gold and diamond deposits, as was the regional economy of California and the U.S. West Coast in general. Further back, extensive and cheap coal deposits played a major role in the emergence of the Industrial Revolution in Britain. Even in the 20th Century, the development of new export sectors in rubber, tin and palm oil played a major role in Malaysia’s successful economic development. Counter-examples existed – Spain’s precious metals-based colonies in Peru and Bolivia were nowhere near as successful as Britain’s agriculture-based colonies in North America, but in 1914 or even in 1950 economists would have thought you mad if you had claimed that natural resources were an obstacle to economic development.
The difference between 19th and late 20th century resource extraction policies was straightforward: the involvement of the government. In the 19th and early 20th centuries, oil and mineral resources were discovered by multinational extraction companies, and the host government was largely ignored beyond paying a modest royalty and a few bribes. Control of the resources remained firmly in the hands of the extraction company, and hence the local populace, beyond benefiting from jobs and modest royalties, were largely unaffected by the discovery of natural resources in their country. Mexico under Porfirio Diaz (1877-1911) enjoyed excellent economic growth as her minerals were discovered and exploited by U.S. and British mining companies —very much in the same way as Argentina enjoyed growth led by foreign investment in agriculture under the oligarchy of 1862-1930.
Since World War II, mineral development has been directed by local governments rather than by resource multinationals. Oil resources were nationalized in the Middle East in 1972-73 and in Venezuela in 1975, although Mexican oil had already been nationalized in 1938. Chilean copper was nationalized in stages in 1967-71, Zairean copper in 1967 and Bolivian tin and silver mines after 1952. South African gold mines are gradually being taken into state control currently, as are Russian oil resources following the break-up of Yukos in 2003-05. Thus the great majority of oil and mineral resources located outside the West are now controlled by local governments, which receive the benefits of huge and unexpected revenue surges during periods of tight supply such as the present. Even the physical extraction of resources is in many cases undertaken by state-controlled local companies rather than the Western oil and mining giants.
Like a number of other changes to the economic system that took place after World War II, notably the collectivization of development finance under the World Bank and the International Monetary Fund, the new emphasis on government ownership of resources has had terrible effects on economic development in the countries concerned. Only a few countries such as Chile, which reversed its copper mine nationalization under General Augusto Pinochet, have been able to use mineral revenues as a tool of economic development rather than seeing them form an obstacle to it.
Mineral resources owned by a foreign mining company bring in modest royalty revenues to the local government, which it can use to reduce its budget deficits and satisfy some of the country’s social needs. They also provide a modest number of jobs, although mining is far less labor intensive than it was 100 years ago, so the job creation of a mining project is limited compared to its overall size. Most important, oil and mining projects bring foreign exchange into the country, thus increasing the international purchasing power of domestic consumers and investors. Thus a large mining project brings the “purchasing power parity” exchange rate of a poor country’s currency closer to the market exchange rate, with great consequent benefit to the economy in reduced distortions.
Mineral resource projects owned by the local government, on the other hand, increase the share of the country’s resources that are controlled by the government, and in extreme cases may give the government effective control over the country’s foreign exchange market, and hence over its entire non-domestic economic activity. By concentrating the country’s most liquid resources in the hands of the government, they increase the power of the government, and short-circuit any attempts by business to reduce the dominance of the political over the economic sphere. Further, since they increase both the power and wealth of government, state owned resources increase the stakes involved in winning political power. This both reduces the integrity of government itself (for example, increasing corruption) and sucks talent out of the private sector pool towards government service, thus damaging the private sector.
It is thus not merely an empirical observation that large government-controlled mineral wealth badly hinders economic development, but an inevitable conclusion from the economic incentives involved. Even in the Middle East, the most successful oil-rich states are those such as Dubai and Bahrain, which have grown wealthy on providing services to the oil sector, rather than those such as Saudi Arabia and Kuwait where the oil itself is located. Needless to say, social and political conditions in Saudi Arabia in particular remain unstable, and the country has nothing like the stable Western-style society that from its per capita wealth it should have.
Although in theory it might be economically beneficial for the great bulk of mineral extraction revenues to be returned to the extracting company, in the world we currently inhabit it’s probably impossible to arrange this. Third world governments, seeing their economic control endangered would raise populist hell about the extraction companies, and election results such as that in Bolivia indicate that their populism will resonate with their electorates – indeed, the problem of over-powerful government appears to be even worse in democratic resource-rich countries than in authoritarian ones. Thus the principle that the great bulk of mineral revenues should accrue to the people in whose country the minerals were located is so universally accepted today that it is not worth fighting against.
Providing resource revenues to the people is however a very different matter from providing them to the government. If resource revenues are paid to the populace, perhaps through some impartially administered trust fund mechanism, they can be used for social security, education and health care needs, all of which in most modern societies are treated as public goods. By treating revenues in this way, the populace itself can be benefited, while the government can be deprived of both the mineral revenues and much of its social spending obligations, thereby being shrunk to a size at which it no longer dominates the economy and control of it is no longer of much political importance. Trust funds for social security spending were originated in 1965 in Singapore; there would seem little problem in principle in designing a cross-border trust fund for a mineral producing country, which would contain individual accounts in the names of its inhabitants, and which would be administered by an impartial and incorruptible third party from a small neutral country such as Singapore itself or Finland.
This should have been done in Iraq, as I wrote at the time. Had Iraq’s oil revenues been diverted to such a trust fund, which could have been done during the period that the United States administered the country, substantial individual payments for education healthcare and pensions would now be flowing to the Iraqi people. More important, without Iraqi oil revenue the power of the Iraqi government would be limited, and the incentive to fight a civil war to gain control of that government (or to bicker for months about how that control should be shared between Shia, Sunni and Kurds) would be correspondingly reduced. While U.S. forces remained in Iraq unrest would remain, but the momentum would by now be strongly towards peace and prosperity rather than balanced on a knife-edge.
Since it is to be hoped that outright Western invasions of Third World countries will be few and far between, the chance to impose such a structure by fiat, as could have been done in Iraq, will recur only occasionally. However, the periodic financial crises that occur in the Third World, especially to mineral-exporting countries when mineral prices are low, offer an alternative way out. Instead of providing “bailout” debt in such a crisis, the proceeds of which will only be wasted, the international institutions, governments and the banking system should insist that further aid will be provided only after a trust fund system has been set up for the country’s major natural resources, the proceeds of which will be devoted to debt service on restructured debt, plus an excess that will be used for the benefit of the local populace. By channeling revenues through such a trust fund, the excessive cyclicality of resource revenues can be removed, since trust fund payments will be made according to local social needs, while in periods of high resource prices the trust fund will be allowed to build up reserves for old age pensions and other future needs.
If a trust fund structure is adopted in a few cases, when crises occur, it will gradually become clear to Third World populations that such a structure represents their best hope of achieving some tangible benefit from their country’s mineral resources. By this means, adoption of trust funds will gradually take place worldwide, by popular demand in the countries concerned.
In this way, both the Latin American problem and the natural resources problem can be solved, and natural resources can once more benefit the countries in which they are discovered, as in the days of James Watt, Cecil Rhodes and Porfirio Diaz.
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(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)
This article originally appeared on United Press International.