Laws and codes for the resource curse.

• Author: Collier, Paul

The international community assigns a high priority to helping impoverished societies, yet its efforts are currently lopsided. While it spends around U.S. $ 100 billion on aid and provides over 100,000 UN peacekeepers, to date it has largely neglected the potential of international codes and laws to raise standards of economic governance. This Essay analyzes the potential contribution of such codes and laws to increase the development impact of natural resource revenues. The current commodity booms make this a critical opportunity for assistance. This Essay reviews the evidence on the resource curse and its causes, including a prognosis for the long term consequences of the present commodity booms, concluding that where behavior patterns to stay unaltered the present booms would be a missed opportunity of quite staggering proportions. The Essay then anatomizes the decision process by which valuable natural resources in the territory of the society are harnessed for economic growth that benefits the society, delineating five key decisions and considering, for each, whether past failures were predominantly due to mistakes or to misaligned incentives. Next, the Essay turns to the scope for new international voluntary codes and discusses the potential need for new laws, the national promulgation of which would be coordinated across the OECD analogous to anti-bribery legislation. Such laws are difficult to introduce and so are a last-resort approach for the realignment of incentives.

1. INTRODUCTION

   The international community assigns a high priority to helping impoverished societies, yet its efforts are currently lopsided. While it spends around U.S. $100 billion on aid and the UN provides over 100,000 peacekeeping personnel, to date it has largely neglected the potential of international codes and laws to raise standards of economic governance.(1) This Essay analyzes the potential contribution of such codes and laws to increase the development impact of natural resource revenues. The current commodity booms make this a critical opportunity for assistance.

   Developing countries that export resources are currently experiencing booms unmatched since the 1970s. Many of these countries have been impoverished and economically stagnant for decades and the booms constitute extraordinary opportunities for development. The revenues are often large enough to finance transformation, dwarfing aid flows. However, the last global commodity boom of the 1970s largely failed to deliver transformational development. On the contrary, its long-term economic consequences were highly adverse. The failure to harness the booms of the 1970s was the result of poor-governmental decision-making. In many cases, the decision-makers would have arrived at different decisions had they realized their consequences. But these decisions also reflected divergences between the interests of the society and of the decision-maker: the incentives facing the decision-maker were misaligned with the social interest that the decision-maker was empowered to represent. This distinction between mistakes and misaligned incentives is fundamental. It is a guide to the actions that can prevent history from repeating itself. Mistakes are to an extent self-correcting through learning, whereas misaligned incentives require changed incentives. Codes may be helpful in correcting both mistakes and misaligned incentives.

   First, where past decisions were mistakes, international codes can be helpful. The typical low-income commodity exporter has remained prone to mistakes in economic policy because the cadre of well-trained decision-makers within the society is still tiny. Adult populations are small, few people get international graduate education, and few that do return to their country; globalization is accelerating the emigration of the highly skilled. Even among this limited pool, few are in positions of influence; the salaries of senior civil servants have been radically eroded. Further, because the adverse consequences of mistakes in managing commodity booms occur only long after the decisions, it is easy for a society to misdiagnose its problems. The typical mistake of the 1970s' booms was to intensify these problems by borrowing and then consuming the proceeds. When commodity prices crashed, this led to a phase of crisis management termed "structural adjustment." Nigerians, for example, generally see the boom period as the "good times," and blame their current poverty on "structural adjustment." Thus, the process of learning from mistakes can usefully be complemented by external guidance. This is where international codes can be helpful. They get noticed, and they are official status signals that they have been subject to a reasonably rigorous process of scrutiny and assessment and so should be taken seriously. Even when such codes are entirely voluntary, they can change behavior by speeding learning.

   Where wrong decisions were the result of misaligned incentives rather than mistakes, the incentives have to be changed. Although in principle, incentives can be changed both by penalties and rewards, in the case of decisions appertaining to resource revenues, the key changes are likely to come from new penalties. This is because the private rewards for socially costly decisions are usually too high to be countered by even higher rewards for good decisions. The terrain of penalties opens up a role for the law. Legal process is not the only means by which penalties can be introduced, but it is likely to be a critical part of solutions.

   In Part II, I review the evidence on the resource curse and its causes, including a prognosis for the long-term consequences of the present commodity booms should patterns of behavior stay unchanged. The key conclusion from this section is that, 'were behavior patterns to stay unaltered, the present booms would be a missed opportunity of quite staggering proportions. The issue under discussion is undoubtedly the single most important issue for the development of the countries now stuck at the bottom of the global economy: the "bottom billion." In Part III, I anatomize the decision process by which valuable natural resources are harnessed for economic growth that benefits that resource-rich society. I delineate five key decisions. For each I consider whether past failures were predominantly due to mistakes or to misaligned incentives. In Part IV, I turn to the scope for new international voluntary codes. Primarily, these address those errors due to mistakes although they can also help to realign incentives. In Part V, I turn to the potential need for new laws, the national promulgation of which would be coordinated across the Organization for Economic Co-operation and Development ("OECD") analogous to antibribery legislation. Such laws are difficult to introduce and so are a last-resort approach for the realignment of incentives.

2. THE RESOURCE CURSE AND ITS CAUSES: THE EVIDENCE

   The "resource curse" refers to the tendency for many low-income commodity exporters to experience slower economic growth than countries that are less well-endowed with resources. The resource curse is evident from particular situations, such as Nigeria since the discovery of oil; but as a general proposition about commodity-exporting countries it has been more controversial. (2) Counterexamples to Nigeria, such as the rapid growth of Botswana since the discovery of diamonds, demonstrate that the resource curse is not inevitable. Despite being landlocked and largely a desert, Botswana has had one of the most rapidly growing economies in the world. (3) Further, there was an apparent discrepancy between two different types of general (that is, statistical) evidence on the resource curse. The main general evidence came from a study by Sachs and Warner, which showed, using cross-section comparisons, that resource riches were damaging. (4) Cross-sections essentially compare the overall experience of one country with another. Economists have, however, come to doubt such evidence where it is used to investigate processes that occur over time, because it is easy to misattribute to temporal processes what are in reality underlying differences between countries. (5) Evidently, the resource curse is such a country-specific process: resources are discovered and this produces various changes, which eventually damage the economy. These ubiquitous suspicions of cross-section analysis appeared to be confirmed in the case of the resource curse through time series analyses by Deaton and Miller (6) and Raddatz. (7) Time series analysis relies upon before-and-after situations in each country and so is therefore better suited to temporal processes such as the resource curse. They found that the consequences of a commodity boom looked on average to be entirely benign on various economic criteria. (8) However, an acknowledged limitation of their method was that it could only investigate the first few years following a boom. My own recent work with Benedikt Goderis has reconciled this apparently conflicting evidence. (9) Using the statistical technique of co-integration we are able to analyze both the short-term and the long-term effects of commodity booms using data for virtually every country in the world, and spanning the period 1970-2003. Our results confirm that in the first few years, price booms benefit the overall economy. (10) However, after about twenty years the effects are often highly adverse. Simulating the current commodity booms in the fourteen major African commodity exporters, we find that the long-term effect is a reduction in output relative to the counterfactual by around twenty-five percent. (11) The resource curse is a reality.

   The adverse long-term effects are confined to price booms in nonagricultural commodities. One explanation for this is that agricultural booms accrue predominantly to farmers who usually use their windfalls sensibly. In contrast...