Institutions, Oil and Macroeconomic Management… What Does it Take to End the Resource Curse?

This blog is written by Hoda Selim, an economist at the Economic Research Forum

Natural resource wealth has been often blamed for the poor economic and development outcomes in oil-rich Arab countries. It has been claimed that the special characteristics of natural resources, such as price volatility, uncertainty and exhaustibility, pose challenges for effective macroeconomic management. Symptoms of the oil curse are many, and include: overall macroeconomic volatility, excessive borrowing during resource busts, Dutch disease, excessive consumption, and low or inefficient total investment.

In this context, policymakers were advised to improve the management of their wealth. But, could it be that long-standing and deep-rooted but weak institutions in the Arab World are the root cause of the oil curse?

Research has attempted to show that it was oil that hurts democracy through the creation of a rentier state. However, the current literature has almost reached a convergence that the resource curse is conditional on the quality of institutions (i.e., that resource-rich economies with strong political checks and balances are able to turn the resource curse into a blessing). In other words, political institutions shape incentives for economic institutions or, alternatively, they affect how resource rents are collected, allocated and used, and therefore influence macroeconomic management and economic outcomes.

Weak institutions in the Arab World have predated resource discovery and have had adverse implications on macroeconomic management, meaning that they are the root of the curse. At the same time, natural resources have consolidated the weak institutional set-up. Over time, the interaction between these two factors became intertwined, preventing these countries from embarking on a sustainable development path.

Recent empirical work in the context of commodity Arab exporters has provided strong support for the conditional resource curse hypothesis. When institutional factors (quality) are ignored, resource rents adversely affect economic growth. More importantly, as they are included, the adverse effect natural resources have on growth continues to dominate the effect of better institutions. In other words, even as the quality of institutions improves, natural resources continue to have a harmful (but slightly smaller) effect on growth.

Large oil resources, like those present in the Arab World, are a blessing. The modest progress made cannot be blamed only on the way the economy was managed or simply on the abundance of oil. The interdependence between politics and resource management is the essence of the resource curse, where politics affect exploitation of resource wealth and, in turn, rents influence politics.

For the Arab world, avoiding the oil curse is not only critical for its development but also extremely challenging for its public policy and institutions. In fact, in 2013, out of the 195 countries covered by Freedom House, 88 were considered “free,” of which none were Arab oil-rich economies. Only one country is considered partly free, Kuwait. Moreover, most countries, especially in the Gulf Cooperation Council (GCC), have not undertaken any political reform since the 1970s.

In order to achieve sustained growth and prosperity, Arab governments must improve on the prevailing design of political institutions, including the introduction of a strong system of political checks and balances. It is hoped that stronger political institutions would improve macroeconomic institutions and outcomes, related to both fiscal and monetary policies, which in turn would improve the management of natural resources, achieve more savings and implement more effective public spending programs. These reforms are expected to release resources for the diversification of the non-resource sector. Finally, it is hoped that the adherence to the Extractive Industries Transparency Initiative (EITI) and the National Resource Charter (NRC) could trigger the adoption of some reforms on political accountability and more transparent and effective management of natural resources.

 

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