Is natural resource wealth compatible with good governance?

Abstract

This paper analyzes the effects of natural resource wealth on the economic and political environment of a country. A dynamic game-theoretic model is used to highlight the policy choice of the government vis-à-vis the opposition. The government utilizes both economic and other policy tools to further its own interests. These policies include repression, co-option of the opposition (by way of sharing the natural resource wealth), taxation, the level of commitment to expanding the resource base through further exploration, and extraction of existing resources. The opposition is in the private sector and chooses how much of its wealth to save and invest and on whether or not to accept what is offered to it by the government and, if not, to start a civil war. In contrast to other political economy models that involve such phenomena as repression and civil wars and which view the political game as one between the government and the marginalized peasantry, this model views the game as between the government and another élite group. The model is used to explain several quite different political outcomes observed in countries endowed with natural resources. These include repressive regimes, democratic regimes, benevolent autocracies/‘sham democracies’, instability and civil war. The analysis shows how these outcomes depend on technology driving the process that converts income into consumption, the likelihood of finding additional natural resource wealth through exploration, the size of the private sector and other factors. The model is also illustrated empirically by comparing the governance and other characteristics of countries with different levels of natural resource wealth.

Keywords:

• political economy
• natural resources
• democracy
• JEL Classification: C71
• D73
• D74

Acknowledgments

This paper was presented at the Sixth International Conference on the Economics and Finance of the Middle East and North Africa of the Lebanese American University in Byblos and the Third International Conference of the Middle East Economic Association in Byblos, Lebanon May 27–29, 2004. The authors express their appreciation to Fahyre Alencar de Loiola for her research assistance and to Ibrahim Elbadawi, Samir Makdisi, Clement Henry, and numerous participants at presentations at the Third International Conference of the Middle East Association and the United Nations Economic and Social Commission for Western Asia for useful comments on earlier versions of the paper.

Notes

This quote is taken from Ross (1999).

For empirical studies, see Barro (1999) and Ross (2001). Using time-series cross-national data from more than 100 countries and over at least 25 years, they both find that democracy tends to decrease as reliance on natural resources rises and to increase as the middle-class share of income rises.

See also Nili (2003) who combines the two imbalances.

A prominent example of the first three curses is Nigeria. Not only did the development of oil undermine the viability of the country's huge agricultural sector (as predicted by the Dutch disease models) and result in huge overbuilding of industrial plants and wasted infrastructure and sharp decline in the quality of education, but also, once oil was discovered in Nigeria in the area of Biafra, the revenues were directed exclusively to the federal state. This induced Biafrans to start their eventually unsuccessful war for independence. Even after that movement was crushed at great expense to the country, there have been numerous disturbances in other areas where oil production is taking place. Iraq under Saddam Hussein is another example where the oil was mainly in the Shiite South and Kurdish North but the revenues were directed to the central state, dominated by Saddam and the largely Sunni Baath party. Outright civil war was avoided only by ruthless repression.

The decline of oil revenues in Bahrain has coincided with the recent partial democratization of that country's government.

K ₀ can be thought of as agricultural output if the opposition group happens to be constituted of landowners, or of consumer durables if the opposition group is made up of merchants or manufacturers.

The interpretation of θ can be made richer by thinking of a decrease in θ as tantamount to an increase in the level of repression.

Note that given the explicit utility function for the government used in this paper and given that π _G  = θ , the level of co-option is never going to be zero even under the most repressive circumstances.

This situation would arise if ϵ _t  = ϵ ^l drops below a critical level (derived below).

Note that

, implying that the productive value of the initial natural resource stock becomes insignificant in the infinitely distant future. Hence, without new resource discoveries, it would become increasingly difficult for the government to use natural resource wealth to generate income and co-opt the opposition in order to remain in power.

This is obtained by observing that ∂ u _G > 0 implies that ∂ τ /∂ θ > (c − (1 − 2θ )ϕ R)/K + τ .

These are subjective scores obtained by investors that are developed and made available by the International Country Risk Guide (ICRG).