Weathering the Commodities Storm

Weathering the Commodities Storm

Are natural resources a curse or a blessing? History has taught us that for every story of economic success in exploiting natural resources there is one of failure. Consider the contrasting experiences of Nigeria and Botswana, two countries that in 1960 were considered to be amongst the poorest in the world. Both countries struck ‘gold’ in the early 1960s, except in Nigeria the gold was oil and in Botswana it was diamonds. Between 1965 and 2015 real per capita GDP in Botswana has grown at an annualised rate of 5.6%, whilst in Nigeria growth has been a sluggish 1%; and up until 2000 was actually negative.

After a prolonged period of growth in commodity prices since the early 2000s, driven primarily by China’s insatiable appetite for raw materials, many emerging and developing economies have been hit hard by the 2014-15 commodity price collapse. In a basic intertemporal setting, revenue windfalls should be saved during good times and used to support consumption and investment during bad times. But what if revenue windfalls, due either to resource discoveries or high commodity prices, have negative side-effects? How then can economies best manage their natural resource wealth during times of plenty to then be in a stronger position to weather the inevitable storms?

The ‘Dutch disease’

Academics and policy makers have been trying to answer this question for over 20 years. Original work by Sachs and Warner (1995) formalized empirically the negative link between natural resource abundance and economic growth. This phenomenon has become known the ‘resource curse’ or ‘Dutch disease’, a phrase first used by The Economist in 1977 to describe the real exchange rate appreciation and decline in manufacturing in the Netherlands when natural gas was discovered in the ‘50s.

Since then, a flurry of research has emerged either supporting or challenging this early result. It turns out that this is quite a difficult question to answer. Clearly, country characteristics matter. The level of development, quality of governance and political institutions, degree of trade and financial openness and quality of human capital, are all likely to influence a country’s ability to make the most of its natural resource wealth.

But there is more going on here. Van der Ploeg (2011) shows that controlling for these covariates is not enough. A key challenge is the endogeneity of natural resources. Not only do resource discoveries themselves depend on the market and political institutions in place in a country, but the importance of resource exports to the domestic economy also depends on the state of the non-resource economy. This makes answering the question of how resource discoveries affect economic growth a real challenge.

A short term boon …

In a recent working paper, we use a novel dataset of subterranean hydrocarbon and mineral reserves at the mine/rig level combined with world commodity price data from UNCTAD, to isolate commodity shocks for individual countries. We take our commodity price series and strip out demand side drivers of commodity prices, such as global aggregate demand and financial conditions. We then use the resulting reserve-weighted commodity shock series to investigate the impact these shocks have on per-capita economic growth and the structural make-up of output in developing economies.

It turns out that natural resource booms translate into higher income levels, higher government expenditure and an increase in the level of physical capital investment; at least over the short run. We estimate that a positive commodity shock, of a magnitude typically seen in the data, increases per capita output growth by 0.25%, government spending by 12.4% and investment by 4.4% (see figure 1).

Figure 1: Impulse response functions for positive commodity shock

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Response of: (a) real per capita GPD, (b) real government expenditure, (c) real capital accumulation

… with medium term challenges

Whilst this may seem like a positive finding, there are three important caveats. The first is that this is an average effect across low-income, resource-rich economies. Countries without the institutional capacity, political will or economic suppleness will struggle to make the most of these revenue windfalls.

Second, the converse of this result is that negative commodity price shocks will create recessions in poor countries that depend on natural resources. The recent collapse in world commodity prices between 2014q3 and 2015q1, with oil reaching its lowest levels since the early 2000s according to the IMF (2016), is a real cause for concern for commodity exporters the world over.

Finally, whilst resource booms may stimulate growth and investment in the short-run, this effect is relatively short lived; around 2 years on average. Perhaps more worryingly, our research also finds evidence of a strong de-industrialisation effect following positive commodity shocks. Valued-added in manufacturing for example, a sector which is widely thought to exhibit positive externalities and facilitate technological progress, declines significantly. This structural relocation of economic activity is consistent with the some of the early work on the ‘Dutch disease’.

What does the future hold?

For countries like Nigeria and Botswana the future looks uncertain. The commodity price collapse of 2015 led to some analysts calling this the end of the commodities ‘super-cycle’. With oil prices expected to remain in the $40-$60 range for the next few years, resource dependent countries may have to adjust to what some believe is a ‘new normal’.

Nowhere have the negative effects of a collapsing oil price been felt more directly than in Nigeria. Output has contracted, government receipts have imploded and, despite the authorities’ best efforts, the Naira has depreciated by over 50% since the beginning of the year. A similar story is unfolding in Botswana. However, given the healthy state of the public finances and large foreign exchange buffer prior to the shock, the economy looks in a substantially healthier position to weather this storm.

References

The Economist 1977

IMF. (2016). Too slow for too long. World Economic Outlook

McGregor, T. (2016). Commodity Price Shocks, Growth and Structural Transformation in Low-Income Countries. OxCarre Working Paper 163. Department of Economics, University of Oxford.

Sachs, J. D. & Warner, A. M. (1995). Natural resource abundance and economic growth. Technical report, National Bureau of Economic Research.

Van der Ploeg, F. (2011). Natural resources: Curse or blessing? Journal of Economic Literature, (pp. 366–420).