39734 No. 3 Petroleum Sector Briefing Note May 2007 Avoiding the Resource Curse Many resource-rich countries have fallen prey to the natural resource curse [1]. But a handful of developing countries have managed to escape it. This note examines four resource-rich countries and the policies they have followed since the beginning of the 1970s. One, Nigeria, is a well-publicized case of oil wealth impoverishing rather than enriching the economy. The other three--Indonesia, Malaysia, and Botswana--have achieved impressive economic gains despite their resource abundance. H ow have some resource-rich countries man substantially larger state revenues, the government ini- aged to avoid the resource curse? Nigeria and tially tried to save excess income. But this attempt at Indonesiamakeaninterestingcomparison.They saving was short-lived.As the size of the new oil wealth exported comparable amounts of oil in the first half of became widely known, political pressures to spend all the 1980s. Both have large populations and regional and of it at home mounted and the government soon accel- ethnic tensions. Yet Nigeria, despite being the world's erated spending as if the high oil prices were perma- sixth largest oil exporter in 2005, has one of the poorest nent. Budget deficits grew, and, encouraged by projec- populations in sub-SaharaAfrica and come to epitomize tions of continually rising oil prices, the government what can go wrong with oil wealth, while economic began to borrow abroad. These foreign debts soon be- growth in Indonesia until 1996 has won praise.And this came unsustainable. enormous difference in outcome is not because Indone- sia had inherent advantages over Nigeria before the first During 1975­1980, the government gave priorities to oil boom of 1973­74. In fact, the initial conditions in In- infrastructure (transport and communications); mining donesia were anything but favorable: a military regime and manufacturing; agriculture and water supply; and that came into power in 1966, a low adult literacy rate, health, education, and housing, in that order. Spending high levels of ethnic and linguistic diversity which can on primary education was greatly increased, and one lead to conflicts (see [1] for the impact of oil wealth on major achievement was the use of oil income to fund civil strife), and pervasive corruption. almost universal primary education.Although self-suf- ficiency in agriculture was the desired goal, investment This note describes and contrasts some of the policies in agriculture declined. In other areas, many projects implemented by Nigeria, Indonesia, Malaysia, and were quickly started without due attention to their eco- Botswana in response to large inflows of resource rev- nomic viability, coordination, or sequencing, and with enues, and their consequences. few safeguards against waste and corruption. Nigeria The second oil boom of 1979­80 prompted another spending spree, giving rise to higher salaries and new In 1970, Nigeria had an active private sector and a large investment projects, including construction of the new laborforce,holdinggreatpromisetobecometheregion's inland capital,Abuja. The lion's share of investment in economic power house. Successive governments have agriculture and industry went to a few large, high-cost embraced three common objectives: economic growth, projects such as steel, irrigation, and fertilizer produc- greater domestic participation in both the oil and non- tion. The policy of maintaining a relatively low interest oil sectors, and more equitable distribution of income rate, combined with rising wages and the appreciating across ethnic groups and regions. exchange rate (see [1] for a discussion on Dutch dis- As the first oil boom of 1973­74 began to generate ease), encouraged capital-intensive industries based on 2 Petroleum Sector Briefing Note May 2007 imported inputs. These distortions and inefficiencies in clarityinlandownershiprights;publicspendingtargeting the economy slowed down competitive industrialization urban rather than rural infrastructure; cheap food im- and the share of industry in gross domestic product ports thanks to the stronger exchange rate; loss of skilled (GDP) actually fell from 19 percent in 1974 to 10 per- workforce to migration to urban areas; and inefficiency cent in 1994. in the distribution of domestic inputs and technical sup- port contributed to this disappointing outcome. After 1980, oil revenues collapsed and real income per person fell sharply. The income from oil exports in Ni- The quality of economic policy in Nigeria progressively geria was among the most volatile on account of fluc- deteriorated after 1990. Business activity was affected tuating oil production--exports more than halved be- by personal ties and endemic corruption. Some suspect tween 1979 and 1983--in addition to oil price volatility, General Abacha alone of having stolen an estimated plummeting from a high of US$25 billion in 1980 to a US$2.2 billion of government revenue during his presi- low of $6 billion in 1986. During the oil booms, the Ni- dency between 1993 and 1998 [3] gerian currency appreciated and agricultural exports halved. Poor policy choices amplified the adverse ef- Nigeria returned to civilian rule following the elections fects of oil revenue volatility, making the investment of 1999 and has been making concerted efforts to tackle climate extremely unattractive. corruption and accelerate development. In 2004 an Eco- nomic and Financial Crimes Commission was estab- In the face of mounting economic difficulties, the new lished, which began trying people for corruption in a military government that came into power in 1983 im- civil court for the first time. The government has adopted posed a program of fiscal austerity, including across- an oil-price-based fiscal rule that mandates saving ex- the-board budget cuts, reduced imports, and foreign cess oil income when world oil prices rise above a ref- exchange rationing. The wage bill could not be reduced erence price. for political reasons, and budget cuts resulted in many unfinished projects. Continuing deficits and emerging Allowing corruption to fester for decades, Nigeria has debt-servicing problems led the government to adopt a not found it easy to root it out. Oil still provides some 85 structural adjustment program in 1986. But downsizing percent of the government's revenue and continues to the public sector and improving fiscal administration be a source of strife and mismanagement. Nigeria has again proved politically difficult. The third oil boom of publicly demonstrated its commitment to revenue trans- 1990 led to more public spending [2]. parency by launching the Nigeria Extractive Industries Transparency Initiative, which will be discussed in fu- Like many large oil exporters, Nigeria has historically ture briefing notes. subsidized fuel prices. This has not only carried an enor- mous cost, but led to a widespread black market, smug- Indonesia gling of subsidized fuels to neighboring countries, inad- equate financing to maintain and modernize domestic In the mid-1960s, Indonesia was one of the poorest refineries, and frequent fuel shortages coupled with countries in the world, with large government deficits price spikes that hurt consumers and especially the ru- and hyper-inflation nearing 1,500 percent a year at one ral poor. Cheap fuels have also encouraged non-essen- point. President Suharto came into power in 1966. De- tial and inefficient fuel consumption. Increasing fuel use, spite being a military one with high concentration of together with smuggling, raise "apparent" domestic power in the president, the Suharto government gave demand--fuels smuggled out of the country are not priority to economic growth, emphasizing infrastructure, actually consumed on the domestic market but appear education, capital-intensive industry, and, above all, ag- in the statistics as domestic consumption--and cut oil riculture to which an unusually high proportion of gov- exports, reducing revenue to the government. ernment spending was allocated. Agricultural performance in the 1970s and 1980s fell far President Suharto appointed a team of five economic short of the goal of self-sufficiency. Despite efforts un- advisers, all academics drawn from the Faculty of Eco- der the "Operation Feed the Nation" in the 1970s, Nige- nomics at the University of Indonesia. They were tech- ria--once a modest exporter of farm products--became nocrats, well educated and competent, and exerted a large net importer of food by the early 1980s.Alack of considerable influence. Focusing on macroeconomic May 2007 Petroleum Sector Briefing Note 3 stability and tight control over inflation and budget defi- in Nigeria. The financial crisis of 1997­98 affected In- cits, the government brought down inflation drastically donesia more than other Asian economies, and some by 1969. President Suharto's 31-year grip on power, analysts argue that the way the country's rapid growth which could have led to economic failure, enabled a interacted with weak institutions contributed to the se- long-term view and continuity in policy-making. verity of the crisis [4]. Nevertheless, Indonesia illus- trates how a major oil producer has overcome unfa- Agriculture, which accounted for three-quarters of to- vorable initial conditions and temptations to squander tal employment in the early 1960s, played a key role in oil windfalls to achieve impressive economic gains. the country's growth and poverty reduction. During the first oil boom, the government allocated about 20 per- Malaysia cent of its investment expenditure to agriculture, com- pared to only 2 percent in Nigeria. The government Malaysia is endowed with diversified natural resources gave large subsidies to inputs (fertilizers, pesticides); that include oil, rubber, tin, and palm. Like Indonesia invested in irrigation, roads, and schools in rural areas; and Nigeria, Malaysia faced ethnic tensions, but the and helped stabilize rice prices. Fortunately for Indo- government deliberately pursued a policy of improving nesia, the timing of these policies coincided with the the welfare of the majority group, Buminputeras, who Green Revolution, which introduced high-yielding crop were rural and poorer than other groups. varieties. Oil revenues funded fertilizer subsidies and spread of high-yielding varieties. These helped raise A critical element of success was the high savings rate rice yields in the late 1970s and early 1980s and Indo- that made capital available for investment. Households nesia turned from having to import almost a third of the were frugal by nature, and in addition workers were world's traded rice in some years to self-sufficiency by required to contribute to a compulsory savings scheme. 1985, a goal earlier considered unattainable by many. Government expenditures favored education, housing, and health, and achieved a geographically balanced dis- The country was also "helped" by Pertamina's finan- tribution. cial scandal of 1975. Pertamina, Indonesia's national oil company, failed to repay its loans in 1975 after mak- Malaysia promoted export-oriented manufacturing from ing extensive and diverse business investments and the early 1970s. One unsuccessful policy was use of accumulating some US$10.5 billion in debt, equivalent oil income in the early 1980s to launch heavy and chemi- to almost 30 percent of Indonesia's GDP. This scandal cal industries (vehicles, steel, and cement) by public- greatly diminished Pertamina's reputation and political sector companies enjoying government protection. This influence, delayed overly ambitious and risky invest- policy led to economic difficulties. The size of the pub- ments in the oil sector (and when oil prices fell in the lic sector doubled between 1966 and 1981. The reces- 1980s, there was still time to cancel the planned sion of the mid-1980s returned the country to private- projects), and strengthened the hand of reformers. sector-led economic development. When oil prices fell in the early 1980s, the government Instead of import substitution, Malaysia pursued eco- reacted swiftly with a series of measures that com- nomic diversification and export-oriented industrializa- bined expenditure reduction, exchange rate devalua- tion. Sensible economic policies were formulated and tion in 1983 and 1986, and economic reform. The re- implemented by professional civil servants, academics, sponse was dramatic. Between 1983 and 1992, the share and technocrats. In the early stage of development, the of manufactures in total merchandise exports rose from government focused on labor-intensive industrialization 7 percent to nearly 50 percent. Some officials have utilizing workers from rural areas. Fortunately, around even come to regard the collapse of world oil prices as that time, multinational companies were relocating a blessing in disguise. manufacturing to developing countries where wages were lower. To supply skilled workers to the rapidly This is not to say that all economic policies were sound. expanding manufacturing sector, the government allo- The government has maintained large fuel price subsi- cated a substantial portion of the budget to education. dies (prices were more than doubled in 2005, but the As a first step, the government provided free primary total subsidy bill in 2006 is still an estimated US$7 bil- education. Secondary education was expanded in line lion) and this has had similar negative effects to those with progress made in primary education, and the en- 4 Petroleum Sector Briefing Note May 2007 rollment tripled from 1960 to 1990 [5]. corruption according to a perception index compiled by Botswana Transparency International. In addition to the countries surveyed in this note, Saudi Arabia--the world's larg- At the time of independence in 1966, Botswana was est oil exporter--and Iceland--perceived to be the least extremely poor. Botswana is not an oil producer but is corrupt--are included for comparison. the world's largest producer of gem-quality diamonds. A small country, Botswana ranks among the most suc- Conclusions cessful resource-rich countries, thanks to prudent fis- cal policies toward managing revenue generated from Until recently, the economic trajectory of Nigeria re- diamond mining. Much of the diamond income has been flected many policy errors and deteriorating governance spent on infrastructural development, education, health, generally considered responsible for the natural resource and agriculture, and little on "prestige" projects. curse: large expenditures on dubious prestige projects, a growing public sector that is not able to contract in To assess its fiscal performance, the government has times of low oil prices, and outright thefts of oil rev- constructed an index called the budget sustainability enue, to mention a few. In contrast, Indonesia has man- ratio. It is the ratio of non-investment spending (that is, aged to achieve a four-fold increase in GDP per per- consumption) to non-mineral revenue. A ratio greater sonthroughpoliticalstability,goodeconomicpolicy,rapid than unity indicates that the government is using min- productivity improvement in agriculture, poverty-fo- eral revenues to finance consumption, which is unsus- cused policies, and an effective response to large oil tainable in the long run. revenue volatility. Indonesia, Malaysia, and Botswana have all relied on highly trained technocrats and given In 1972, in the same year the commercial production of them relative autonomy to run the economy. These diamonds began, the government established a fund to examples illustrate that the resource curse is not inevi- save excess revenues abroad to finance budget defi- table, but also that a strong political will and commit- cits in times of need, and introduced an incomes policy ment to sound economic policies, sustained over many specifically designed to prevent mining wages from years, are needed to avoid it. pullingupgeneralwages.Consensuspoliticshasevolved and taken hold in Botswana, leading to a high level of References transparency in public revenue collection and expendi- ture. The ruling elite has left technocrats and profes- [1] World Bank. 2007. "Oil and Gas:ABlessing orA sional civil servants (who were among the best edu- Curse?" Petroleum Sector Briefing Note No. 2. cated) alone to implement sensible policies. [2] Amuzegar, Jahangir. 1999. Managing the Oil Wealth: OPEC's Windfalls and Pitfalls. New The government has historically had a reputation for York: I.B. Tauris Publishers. being relatively clean, but a number of scandals broke [3] Pan, Esther. 2005. "The Pernicious Effects of out in the early 1990s. In response, the government Oil." Council on Foreign Relations. www.cfr.org/ established a Directorate of Corruption and Economic publications/8996/pernicious_effects_of_oil.html. Crime in 1994 to good effect. Corruption has remained [4] Temple, Jonathan. 2001. "Growing into trouble: well below levels seen in most other developing coun- Indonesia after 1966." http://ksghome. tries. Table 1 ranks countries in order of increasing harvard.edu/~drodrik/Growth%20volume/ Table 1: 2005 Transparency International Corruption Temple-Indo.pdf. Perception Index [5] Auty, R.M. Resource Abundance and Economic Development. 2001. Oxford: Oxford University Rank Country Score Press. 1 Iceland 9.7 32 Botswana 5.9 For more information contact: 39 Malaysia 5.1 Mr. Bun Veasna 70 Saudi Arabia 3.5 Infrastructure Officer 137 Indonesia 2.2 Email: vbun@worldbank.org 152 Nigeria 1.9 or Source: http://ww1.transparency.org/cpi/2005/cpi2005 Masami Kojima infocus.html. Lead Energy Specialist Email: mkojima@worldbank.org