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Business Activities / Extractive industries

Is the ‘resource curse’ inevitable or avoidable?

If a country is awash with natural resources, it follows that it should have a thriving economy and a prosperous population. Why, then, does the opposite happen so often in developing countries?

oil-resource-curse
All countries want ‘oil riches’ and the proceeds from other natural resources, but many succumb to the ‘resource curse’. (Photo by Rodger Bosch/AFP via Getty Images)

The so-called ‘resource curse’ (also known as ‘the paradox of plenty’ or the ‘Dutch disease’) is a name given to the impact upon a poorly managed but resource-rich country, with symptoms including stunted economic growth, politicians being corrupted and rising levels of inequality rippling through the population. For those who subscribe to the ‘resource curse’, the belief is that these countries would have seen better, more sustainable progress had they never ‘benefitted’ from these riches.

However, with developed or economically important countries such as Canada, the US, China, Australia and Russia recording the highest figures when it comes to mining output and number of mines, there isn’t a clear connection between being active in the mining sector or commodity markets and having a growing, diverse economy.

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Furthermore, these countries are enjoying a steady flow of job creation as a direct result of their mining sectors.

So why is it that some countries see more success with their mining industries than others, and what exactly breeds this stigma surrounding so many mining-dependent economies? What holds back the social and economic development of these countries and how does that connect to their mining sector, to the point where a ‘resources curse’ is said to plague them?

How does mining dependency occur?

As illustrated in the above chart, the largest mining countries are evidently untouched by the 'resource curse' and have largely managed to build robust and diverse economies.

Canada, Australia and the US are all actively growing their mining sectors, yet none of these countries are considered to be touched by the curse or to be overly dependent on their commodities.

Low-income countries almost by definition do not have the same technical capacities... as Western countries have, and that deficiency has led to the ability in some cases for corrupt practices to thrive. Alan Roe, economist

So what is it that makes the economies of so many other countries so mining-dependent?

There are two main factors that create mining-dependent economies. The first is that the geographical lottery of natural resources often falls upon historically low-income countries. The second is that these low-income countries – for a variety of reasons – can often experience difficulty in attracting investment. Naturally these countries come to not only rely upon their natural resources but are depend upon them for capital inflows.

Alan Roe, an academic economist and policy adviser who has researched natural resources and their socio-economic impact extensively, explains the important role corruption plays in creating these economies: “It is the case that low-income countries almost by definition do not have the same technical capacities – whether that is in terms of engineering capabilities, or in terms of managing and regulating their economies – as Western countries have, and that deficiency has led to the ability in some cases for corrupt practices to thrive.”

The above chart details the top ten countries that are most dependent on their mining sector. Topping the list is Suriname, located in South America, which depends on the export of commodities such as oil, gold and bauxite for almost half of its GDP.

For the majority of mining-dependent countries, their governments own the resource rather than a company or individual. This means that if a government were to set an oil or gas concession, for example, it is the government that benefits from the resulting capital inflows, not the investing corporation. This creates a reliance on good ethical governance in order to avoid becoming a country that is dependent on its raw materials.

Historically this level of power and money has held a close relationship with corruption and authoritarianism. It can often also breed the conditions for the so-called ‘pre-source curse’ to be enacted.

This is when governments start borrowing capital against the projected revenues for the commodities before the resource inflows are attained. For example, if a source of a raw material is discovered, immediately there is an expectation that this will benefit the country and as a result, the government will often start acting as though this benefit (capital and otherwise) is a given before the benefits have materialised.

The reality is that receiving this commodity benefit is often at the end of a long-term, complex chain of events in which lots of things can go awry. Alongside this, there is also a lack of strategy surrounding the nature of volatile commodity price cycles. The ‘pre-source curse’ can see countries borrowing against the commodity price when it is high, leaving them vulnerable to debt if and when the price drops.

An asset manager mentality is needed

Victor Hugo Rodriguez, founder, president and CEO of financial services company LatAm Alternatives, explains that being a mining-dependent country does not have to be a curse, but it requires a certain type of governance.

Focusing on your core competency as a country is actually a good thing, but you have to manage it with the mentality of an asset manager. Victor Hugo Rodriguez, LatAm Alternatives

“Focusing on your core competency as a country is actually a good thing, but you have to manage it with the mentality of an asset manager," he says. "Running a country is similar to the role of an asset manager – you have money, and you need to deliver that money to society. So, how do you hedge?”

The complex and changing nature of mining and commodity prices calls for high maintenance levels of resource management and an understanding of how those price cycles work.

Rodriguez gives more detail: “With every natural resource in the mining sector you have a capital market that is giving you the ability to compete between speculators and commercials, and that is done in the future markets. So, there are ways that you can hedge any potential downsides of your raw material productivity.”

In mining-dependent economies, the capital gained from commodity price booms is often spent quickly, which then leaves that economy vulnerable to sharp price declines.

This volatile pattern regularly results in resentment from the communities living near these raw material production points. This is because there has been an expectation of a benefit such as jobs or reinvestment into the area or into education and training to streamline those mining processes.

When these benefits don’t materialise – whether due to the capital being misdirected through corruption, unfair political governance or bad planning when it comes to drops in the commodity price – disappointment can fester, resulting in prejudice against not only the government but also the investing corporations. Understandably, this can work as a disincentive for investing companies.

In mining-dependent economies there can sometimes be a disconnect with understanding where the responsibility lies for the mishandling of resources. Often it is not understood that the corporation investing into the extraction of raw materials has little to no control over the flow of capital these mines produce or over the framework surrounding the mining sector.

It is this mismanagement of raw materials and the resulting capital, along with the lack of a legal framework and ethical regulations to direct these inflows, that creates the socio-economic gaps for these countries.

So, how exactly do resource-rich countries find themselves victim to corruption and what can be done to address it?

Oil and poverty in Equatorial Guinea

An oft-cited example of the ‘resource curse’ in action is Equatorial Guinea, a small West African country located between Cameroon and Gabon. Despite striking oil in the mid-1990s, approximately half of its 820,000 population live in poverty, there are high infant mortality rates and many do not have access to clean drinking water.

A significant portion of the capital inflows from Equatorial Guinea's oil are believed to be lost to corruption. President Teodoro Obiang has ruled the country since 1979, and despite its poverty issues, the Obiang family have garnered a reputation for lavish spending.

Obiang’s son (who also holds the title of first vice-president) frequently headlines for his expensive taste. His collection includes Ferarris and Bentleys, mansions in illustrious locations such as Malibu and Paris, and even an extensive Michael Jackson memorabilia collection. The president himself is reported by Forbes magazine to have a net worth of $600m, making him one of the world's wealthiest heads of state.

Venezuela's advanced 'resource curse'

Venezuela is another country that is often pointed to as providing a classic example of the ‘resource curse’. It started in 1922, when a huge oil well was discovered in the country. After drilling down the well, oil was said to have sprayed out more than 40 metres high.

Rodriguez of LatAm Alternatives, originally from Venezuela, says: “We were a rich country in terms of natural resources, not necessarily just oil, but it was quickly realised oil would be the most important.”

Venezuela had a booming economy but there was always this factor disproportionately affecting the country and that was corruption, which  created major deficits. Victor Hugo Rodriguez

Oil companies flocked to the country to claim a piece of the action and Venezuela’s attention turned to capitalising on its newfound abundant resource. The country became the largest global oil exporter by 1928, a title it has since lost to Saudi Arabia.

This comes despite Venezuela being home to the largest global oil reserve as of 2019, according to the BP Statistical Review of World Energy 2020, with 17.5% of the world's stocks.

However, oil has not brought widespread riches and prosperity to the country, and it has become a Latin American poster child for political unrest and economic sanctions. In 1976, Venezuela nationalised the oil industry. “Venezuela took control of the industry and decided to do partnerships with providers of technology and bigger companies," Rodriguez explains. "From then until the mid-1990s, Venezuela had a booming economy but there was always this factor disproportionately affecting the country and that was corruption, which  created these major deficits. It basically derailed the way we should have been reinvesting.”

Venezuela continued to experience turbulent times, even when it was governed by politicians widely considered to have good intentions. The now-infamous Hugo Chavez was considered to hold these 'good intentions' in the earlier years of his presidency in the early 2000s.

During this time, Venezuela saw huge demand for its oil from developing countries such as India and China. This influx of capital gave Chavez the funds he needed to pursue his economic and social strategy, which included funding social programmes.

Roe says: “Chavez started with very good intentions and socialists even today might call him a hero. His social programmes were generous, but if there are  social programmes that are over-generous, given the country’s fiscal capacities, there is always a problem. When you combine that with the mismanagement of the national oil company, you get the tragedy that we see today.”

Now Venezuela has an economy in crisis, with the mismanagement of its oil inflows at the centre of its problems. Current President Nicolás Maduro is in the midst of a bitter power struggle and in 2020, the UN accused his government of using corrupt practices as a way to govern through fear.

Rodriguez says: “Corruption is something that we inherited, and, unfortunately, it is very difficult to dissipate, because it has to be done with the importance of giving to the masses to have a better society.”

The Venezuela of 2021 stands in sharp contrast to the country in the immediate aftermath of its oil journey in 1922, and it begs the question how other resource-rich nations have avoided, or indeed reversed, the negative side effects of the 'resource curse'.

Breaking the 'resource curse'

Objectively, when does foreign direct investment (FDI) regarding raw materials go right for resource-rich countries? The answer to that is complex and changes depending on the perspective.

For the investing corporations, it works well when there is a return on that investment, workers are safe and business can continue without interruption from political and economic instability.

Chile's minister of finance stood up against the other politicians and said: ‘We will lock up much of this money into sovereign wealth or reserve funds.’ Alan Roe

From a government perspective, many are happy to accept the capital inflows brought about by the initial investment, but this is essentially where the pivotal point of the ‘resource curse’ occurs. It is flaws in governance that often inflame the downfall of mining-dependent economies.

If leadership is approached like asset management, as Rodriguez describes, and there are smart fiscal policies, and ethical laws and regulations, then FDI into commodities can indeed be utilised to enhance these countries economically and socially.

Botswana, Canada, Chile and Norway are all widely regarded to have handled their resource riches well. For example, the Botswana government undertook a joint venture with DeBeers that had its roots in revenue transparency and a solid strategy to develop the country using the capital gained.

Despite the president of Botswana’s province holding all of the diamonds, the wealth was distributed across the country. There were laws put in place to regulate this and capital was reinvested into other sectors such as agriculture to promote a more diverse economy. As a result, the country is currently one of the world's fastest-growing economies with a view to becoming a middle-income country by 2036.

Roe highlights Chile as another positive example. “Chile was brave during the super-cycle period [between 2000 and 2012]. Its minister of finance stood up against the other politicians and said: ‘We will lock up much of this money into sovereign wealth or reserve funds’.

“This strategy wasn’t initially popular in Chilean politics, but the benefit came during the global financial crisis when other countries were having to scale back their economies and Chile didn't have to. Indeed, Chile was able to ride that recession much more effectively than other countries. So this management of volatility is possible.”

So, it would appear that simply being resource-rich isn’t enough to enact the dreaded curse, and instead it boils down to a lack of ethical and thoughtful governance.

Hope for mining-dependent economies?

So, for mining-dependent economies such as Venezuela and Suriname is there hope for a more ethical future?

Roe is optimistic, believing there are now two types of mining-dependent economies. “Having worked on this set of issues for the past 20 years or so, I have seen much change for the better," he says. "There are really two types of low-income extractive countries with ongoing problems. There are those that have genuine problems still with their technical capacities to effectively run and regulate their extractive industries. They have got all the systems in place, the proper laws and regulations, but not the depth of capacity to profit fully from them. They can, however, benefit from well-designed external support from institutions such as the World Bank .”

“Then you have got other countries that have some of the same technical deficiencies but also fail on the ethical side, and are still prone – often through autocratic governments – to use these resources as ways to enrich a few narrow elites.”

To effectively address the issues surrounding these mining economies requires a reasonably competent government and resources, be they through FDI or fiscal policy. However, the key to resolving these issues is part of a much larger and systemic issue – corruption.

Discovering a source of raw materials does not have to be the kiss of death for a country. As long as that resource is in the hands of an unethical or misguided government, however, the curse will continue to plague these nations.

Ruth Strachan

Ruth Strachan

Senior reporter

Ruth Strachan is a senior reporter at Investment Monitor, focusing on manufacturing, mining and commodities.