Diamonds May Be Forever, Natural Resource Wealth Is Not

Imagine a low-income country in the developing world suddenly discovering a large endowment of natural resources within its borders. Perhaps a large oil reserve is found just offshore, or a deposit of valuable natural minerals is uncovered just below the earth's surface. Surely, such a discovery would be a blessing, as it would expand the country's total stock of capital. In the short-term, especially if commodity prices are high, this additional source of richness would help lift per capita GDP. In the long-term, the rents from these discoveries could help generate wealth for future generations, both through investments in produced capital such as machinery and infrastructure, and through intangible capital such as improved education, stronger institutions, and better governance.

However, history has shown that things don't always work so smoothly. In fact, it has been argued for several decades that large endowments of natural resources may actually be more of a curse than a blessing for poor countries. Instead of transforming natural capital into other forms of productive wealth, weak governance and poor policies have in some cases led to stagnating economic growth, income regression, and redistributive struggles. At its worst, just think of the conflict between North and South Sudan over control of oil-producing regions, or the violence in the Democratic Republic of the Congo over access to vast natural resources such as gold, diamonds, tin, copper, cobalt, and oil.

Over the years there has been much scholarship on what has been termed the "natural resource curse" -- a paradoxical situation, where natural resource wealth does more harm than good. In the past, research on the topic has had to rely on proxies for measuring natural resource wealth, such as the ratio of natural resource exports to GDP. However, doubts remain about the accuracy of estimates of natural resource wealth. This gap has now started to be filled, as a new data series produced by the World Bank on national wealth is beginning to shed more light on natural and other forms of capital.

As you might expect, the data show that the levels and composition of natural capital vary widely between counties. In 2005, for example, natural capital such as agricultural land, protected areas, forests, minerals, and energy resources, contributed to 30 percent of total wealth in low-income countries but only 2 percent in high-income OECD countries. Typically, as countries move up the income ladder, there is a common process in which natural capital declines as a percentage of national wealth, while produced and intangible capital begin to comprise the majority of a country's wealth. In the U.S. and Japan, for example, natural capital accounts for 1.9 and 0.4 percent of national wealth, respectively, with the vast majority in the form of produced and intangible capital. However, this is not to say that natural capital does not remain a significant component of national wealth in all high income countries. In resource-rich Norway, for instance, natural capital comprises 12.8 percent of total national wealth, and remains a key driver of savings and investment in produced and intangible capital.

Against this background, the most recent edition to the Economic Premise series looks at some of the data and revisits some of the conclusions reached in past literature on the relationship between natural resource abundance and economic growth. In "Natural Capital and the Resource Curse," we found that there is no clear deterministic evidence of natural resource abundance as a curse or blessing. Rather, we found that the effects depend on determinants at the country level.

As we and others have argued in the past, the misallocation and mismanagement of natural resource wealth are often associated with weak governance at the domestic level. For instance, resources can shift into unproductive and rent-seeking activities when patronage networks are strengthened with their appropriation of natural resource rents.

As this week's Economic Premise posits, a number of policies can be put into place to ensure that low-income countries get the most "bang from their natural resource buck." First, high transparency and strengthened checks-and-balances in all phases of the extraction and sale of natural resources will minimize the risk of rent-capture by patronage networks. Second, adopting fiscal rules to ensure that certain investments are made from the proceeds of natural resources can help accumulate national wealth as countries move up the income ladder. Last, reforms to increase public sector capacity -- through public investment management, monitoring and evaluation, and budget processes -- are essential to transform today's natural resources wealth into long-term opportunities for future generations.