Are natural resource booms a disease?
The last post by Lykke Andersen at INESAD posed an interesting question: Are natural resource booms a disease or a curse? Reporting the surprising results of one of her recent studies, Lykke suggests that a boom of natural gas exports in Bolivia may increase not only inequality but also poverty in this country. A particularly shocking observation is that, according to the aforementioned study, the largest, poorest group in Bolivia (rural small-holders) may end up with 20% lower real income after the boom.
Lykke reports that these results are due to three different factors:
1. “Basic economic factors:” The large inflow of dollars appreciates the Bolivian currency, increasing imports and decreasing exports.
2. “Structure and composition of the work force:” The poorest people (rural small-holders and urban informals) are “naturally” excluded from the sectors positively affected by the boom of natural gas exports.
3. “Lack of mobility:” Poor rural small-holders cannot easily switch professions to benefit from the boom.
Although I do believe that a natural resource boom could become a curse or a disease for some countries, I am afraid I disagree that it would be due to the aforementioned factors. Let’s look at them more closely.
1. More imports, less exports:
As an individual, would you reject a winning lottery ticket because you are afraid that once rich you will spend more money than what you currently make? Not likely. The same reasoning applies to countries. A massive inflow of dollars would, indeed, appreciate the Bolivian currency, encouraging imports (what we buy) and discouraging non-gas exports (what we make), but, surprisingly enough, it will not decrease production.
A country can produce goods in factories or produce them in the “roundabout way” through exchange. Actually, after the natural resource boom, Bolivians would be able to produce more than before doing the latter. Think about it at the individual level again. It is likely that a person does not physically produce a car, a TV, or a house but if he or she owns these goods, that person did produce them - by generating the income necessary to buy them. In fact, through the benefits of specialization, the individual produced them at a cheaper cost than the cost of physically making them himself.
The roundabout way of production does create wealth, not poverty. The United States is, arguably, the wealthiest economy in the world. But the US has been running trade deficits since 1971. They keep buying more from the world than what they sell. How do they do it? People from all over the world invest a great deal of money in the US economy. They receive a massive inflow of Euros in their capital account. This money, their positive capital account, is what allows them to have a negative trade account. Furthermore, as in the previous example, it is cheaper for the US to produce their goods this way rather than having to produce them in US factories.
What about job creation? Isn’t it better to produce in Bolivian factories and export more than what we import because in that way we create employment inside the country? Not really. Yes, some workers will lose their jobs (in the sectors that used to produce the goods that are now imported) but many others will find new jobs (in the sectors in which the country has comparative advantage). Since 1971, the US has not only run annual trade deficits almost every single year but has also created 50 million new jobs! This leads me to Lykke’s second and third points.
2 and 3. Lykke argues that the poorest groups in Bolivia will not benefit from the boom because they do not have the skills necessary to participate in the sectors related to natural gas or positively affected by it. Furthermore, members of these groups cannot easily switch to other sectors or acquire the skills necessary to do so (low social mobility). Lykke argues that it is virtually impossible for a peasant to become a teacher, doctor, or engineer - professions that would probably prosper after the boom.
But wealthier teachers, doctors or engineers would buy more food and textiles, build bigger houses, and take more vacations to the countryside. These, and other activities, would indirectly and positively affect the peasants. They would definitely be able to sell more food and textiles and could probably get more jobs as construction workers or maids in the city. If things go really well for teachers, doctors and engineers, the peasants may even benefit from some small middle class investments in the countryside (a ranch, a country house, or an industrial farm).
Can the peasants, if they want to, become teachers, doctors, or engineers themselves? They always could. The problem was that it was very costly to do so. They would have to leave their farms, work two or three low-paying jobs during the day, study at night, eat poorly, and live in horrible conditions until they got their degree. This is what low social mobility is all about: when switching professions is too costly, it does not happen. But cost is a relative term. In order to make the right decision the peasant compares the cost of becoming a doctor with the benefits of doing so. In Bolivia, right now, the costs outweigh the benefits by far and that is why not many peasants become doctors. But after the boom the story may be different. Since doctors will be doing so much better, the benefits of becoming one increase and may meet or even outweigh the costs. The costs, on the other hand, would decrease as those two or three low-paying jobs in the city would probably pay a bit more. Peasants could now find it profitable to leave the farm and get a degree. In other words, social mobility is not constant, but the result of changing economic incentives. An economic boom changes these incentives and, therefore, increases social mobility.
One can also argue that as the middle class gets wealthier and pushes the aggregate demand, the general price level would increase, reducing the real income of peasants or poor groups in the economy. But the demand and prices of products (and services) that peasants sell also increase. Even if peasants’ real income does not increase in the short run it will definitely do so in the long run. As the previous paragraph points out, an economic boom does generate higher social mobility.
I do agree with Lykke in that income inequality may increase after the boom. Middle class and industries associated with natural gas will definitely take off more rapidly than other groups. But this is good, not bad. In fact, this is the way in which most countries develop. Some groups do well at first and then pull the rest up. The bad income inequality is the one in which some groups become poorer in absolute terms. But this is not the likely result of a natural resource boom.
In summary, a natural resource boom could be a real blessing and not a disease or a curse. Bolivia would produce more goods than before in the roundabout way; doctors, teachers, and engineers (the middle class) would definitely benefit; and the peasant or rural small-holder would also benefit indirectly (as they sell more goods and services to the middle class) or even directly (as the benefits of switching professions would increase and the costs of doing so would decrease – a higher social mobility).
A natural resource boom can become a disease or curse, however, if these other factors are present:
1. The government runs the natural resource business. Politicians and business are usually not a real combination. Politicians’ criterion is, by definition, not economic efficiency but “social efficiency” (which depends on the politician in turn). Government owned companies usually end up being a source of jobs for members of political parties and a source of inefficiency and corruption. Greedy politicians in inefficient public companies may deplete the natural resource very fast without delivering its economic benefits.
2. The “institutions” or rules of the game (respect for private property rights) are weak or non-existent. If this is the case, no positive economic incentives are generated for the gas company, the middle class, or the peasants.
I am afraid that these factors are the real disease in Bolivia, hopefully not a chronic one.
