The mining industry finds itself back on the jury docket this week after the Fraser Institute published its findings on the controversial “Resource Curse”. The article, entitled Economic Freedom and the “Resource Curse”: An Empirical Analysis, explores whether mineral resource wealth is an economic blessing or a curse, particularly for developing nations where growth and reduction of poverty are vital.
The authors of the report, after considering new and existing data, come to the conclusion that whether a country benefits from natural resources depends largely on the integrity of its institutions and economic freedom — government bureaucracy, legal structure, property rights, monetary policies and international trade. Simply put, the higher the level of economic freedom a country enjoys, the greater the benefit from resources.
“Sound economic institutions and the opportunity for people and nations to benefit from resource wealth are inextricably connected,” said Fred McMahon, Fraser Institute director of the Centre for Trade and Globalization studies.
Until recently, few questioned that resources would bring wealth to nations. Since the industrial revolution, resources have played a vital role in the distribution of wealth as countries around the world learned to harness resources on a far greater scale than ever before.
Faith in resources as a driver of economic growth was shaken in 1995 when authors Jeffrey Sachs and Andrew Warner argued that resource abundance leads to negative economic growth, or what has been called a “resource curse.”
In their 1995 paper, Sachs and Warner summarized a number of theoretical arguments to explain the negative association between resource abundance and economic growth, such as the Dutch disease.
The phrase “Dutch disease” was coined by The Economist in 1977 to explain the decline of the manufacturing sector in the Netherlands after the discovery of a large natural gas field. Revenues from natural gas were said to cannibalize the Netherlands’ manufacturing sector by increasing the exchange rate and making the manufacturing sector less competitive.
The Fraser Institute’s new paper calls this argument to task. It argues that Sachs and Warner were correct in observing that some countries with an abundance of resources experience a resource curse. They also found that metals and ores in particular bring a stronger resource curse than natural resources in general. Gold, silver and diamonds are all too often exploited by despotic rulers who have little interest or understanding of sound economic policy.
However, the Fraser Institute report argues that the resource curse is a post hoc, or false cause argument. The proof, they say, is that the curse is turned into an economic blessing with relatively low levels of institutional development. That is to say, countries rich in metals and ores see economic growth as long as their governments exhibit some level of economic freedom.
The good news is that even relatively low levels of economic freedom allow nations to benefit from resources, but the higher the level, the greater the benefit.
The peer-reviewed Fraser Institute report offers an empirical analysis weighing countries’ resource abundances against the Economic Freedom of the World index to determine the impact of institutions on economic growth and how institutions interact with natural resources. Of the four categories of natural resources-fuel, food, agricultural raw materials, and ores and metals, only ores and metals were found to have a significant effect on economic growth.
The study suggests that for countries lacking sound economic institutions, natural resource dependence can weaken economic growth.
Fortunately, the level of economic freedom on a worldwide basis has risen consistently for the last quarter century, so more and more countries are benefiting from their resource wealth.
McMahon points out that the resource curse has always been a moot point.
Many nations such as Canada, the United States, Australia, and New Zealand have historically built prosperity and reduced poverty by resource development. Today, many nations benefit from both strong institutions and resource wealth, nations like Chile, Brazil, Thailand, and the Philippines.
Now if only Robert Mugabe and Victor Chavez would get on board.
Disclosure: No positions.