Paul Collier’s ‘The Bottom Billion’ was one of my chosen summer books and an interesting, and thought changing view of natural resources caught my attention. Labelled as ‘The Natural Resource Trap’ chapter 6 of ‘The Bottom Billion’ describes how resources can act as a trap for developing countries trying to escape poverty.
A country with abundant natural resources, you may feel, is exceedingly lucky. Although on the face of it, large quantities of resources may seem to be a key and fundamental factor in economic development and growth, when you look into it, natural resources (in abundance) appear to be a greater hindrance in a free market economy, than they do of benefit. The first issue is that of foreign exchange. When goods and services are exported, they generate foreign exchange. That is, when a foreign importer demands the goods your country is exporting, they have to purchase these goods in your domestic currency (or at least, you later naturally exchange their currency for yours), thus they have to exchange a certain amount of their currency for yours on the exchange market. The result of such an exchange is that the demand for your currency rises, leading to an appreciation of your currency (your currency becomes more expensive/ stronger), and that there is a larger amount of foreign exchange domestically available. Now, exporters create foreign exchange and importers need this foreign exchange, in order to import goods/ services from abroad (because they too have to purchase the goods in the exporter’s currency).
So, what is the problem with this? Well, simply and firstly, with a stronger currency, imports become cheaper, or in other words, domestically produced goods become relatively more expensive. The result of such a situation is the diversion of demand from domestic markets to international markets. Not only that, but items that cannot be traded internationally also become more expensive relative to other goods (which can be traded internationally), therefore resources get diverted to producing these domestic goods (the allocative function of a free market). Therefore, resources get diverted away from industries which could export before and towards domestically focused markets. The issue with this is, exporters in infant industries (new underdeveloped industries), due to the appreciation of the currency, can no longer survive on the international market, and so, in developing stages of the economy, the discovery of natural resources can cause great harm. The economy becomes reliant upon the natural resources, in order to fund its imports, and future sustainable growth is greatly affected. The dutch disease theory suggests this, that appreciation caused by the discovery of natural resources (or aid for that matter) causes other, more sustainable and developing export industries to become uncompetitive, and thus fail to fully develop.
Secondly, as the former hinders growth greatly, a result is that entrepreneurial efforts in developing countries are far less successful and so, a reliance on developed countries (which import these resources) becomes greater and greater. The level of unemployment, if the resources are in capital intensive fields, may also rise substantially resulting in a demoralizing colonial psychology to the country as they rely on the developed countries. If these resources were only used domestically, then of course, the issue ceases to exist but in a perfectly free market economy, this would seldom occur. The situation would have to be unique in so far that the costs of extraction were such that when coupled with transport costs, it ceased to be profitable to export however when transported only domestically, they were sufficiently competitive with international markets (the world price of that resource).
Thirdly, the issue of inequality becomes even more significant. The distribution of wealth is usually, in resource rich countries, highly skewed to the few who own the resources. Equally, corruption becomes a far greater threat and the wealth of the few, is often greater due to it. A lack of regulation allows deals to be made discretely by public officials, without a fair auction. The threat and probability of civil war also becomes ever greater due to the increased inequality and, the ability to fund such wars with the capturing of the natural resources (and future financial prospects from setting up such deals).