Avoiding the Resource Curse: Nordic Approach to Economic Diversification

Avoiding the Resource Curse and Consequences for the Financial Sector MFW4A 2014 PARTNERSHIP FORUM Dakar, Senegal, 10-12 June 2014 Thorvaldur Gylfason

Natural Resources in Nordic Countries Finland, Iceland, Norway, and Sweden have all benefited from their natural resources Finland and Sweden outgrew their dependence on natural resources Norway has managed its oil exceptionally well Yet, what made the Nordics rich was not so much their natural resources as their use of human capital to harness their natural wealth Need to diversify by converting natural capital into human capital and social capital

Double Diversification Economic diversification Spurs growth by attracting economic activity from excessive reliance on primary production in agriculture or natural-resource-based industries Political diversification Spurs growth by redistributing political power from narrowly based ruling elites to the people, often replacing an extended monopoly of sometimes ill-gotten power by democracy Two sides of same coin: Diversity pays

Evidence: From Economic and Political Diversification to Growth From Diversification to Growth From Democracy to Growth 12 12 Log of GNI per capita 2012 (USD, ppp) 11 11 10 10 9 9 8 8 7 7 y = 5.5806x + 6.9028 R = 0.4668 y = 0.1365x + 8.6387 R = 0.3835 6 6 5 5 0 0.2 0.4 0.6 0.8 1 -12 -10 -8 -6 -4 -2 0 2 4 6 8 10 12 Export diversification index 1996-2012 Democracy 1960-2012 (from -10 to 10)

From Export Diversification to Growth Natural capital and diversification Export diversification and income 0.9 12 y = -0.0039x + 0.5508 R = 0.4908 Export diversification index 1996-2012 0.8 Log GNI per capita 2012 (USD, ppp) 11 0.7 10 0.6 9 0.5 0.4 8 0.3 7 0.2 y = 5.5806x + 6.9028 R = 0.4668 6 0.1 5 0.0 0 0.1 Export diversification index 1996-2012 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 0 20 40 60 80 100 Natural capital as % of tangible capital 2005

From Democracy to Growth Natural capital and democracy Democracy and income 12 12 10 Log GNI per capita 2012 (USD, ppp) Democracy 1960-2012 (from -10 to 10) 11 8 6 10 4 9 2 0 8 0 20 40 60 80 100 -2 y = -0.1216x + 7.792 R = 0.3516 7 -4 -6 y = 0.1365x + 8.6387 R = 0.3835 6 -8 5 -10 -12 -10 -8 -6 -4 -2 0 2 4 6 8 10 12 -12 Natural capital as % of tangible capital 2005 Democracy 1960-2012 (from -10 to 10)

Progress of Economic Diversification 80 Manufactures exports (% of total) 70 60 2012 50 40 1974 30 20 1962 10 0 Latin America & Caribbean (developing only) Sub-Saharan Africa (developing only) World

Progress of Political Diversification Europe 1943: Five democracies Now: Full house Africa 1960-1990: Five or less democracies Now: 17 democracies South America (Spanish or Portuguese) 1961: Three democracies out of ten Now: Eight out of ten

Photograph:Vladimir Putin, 2005. The Risks Are Real Resource-related rent seeking often results in conflict, corruption, economic stagnation, lack of democracy (clergy, military, royalty) Dutch disease through overvalued and volatile currencies tends to stifle exports like undervalued currencies simulate exports (e.g., China) False sense of security breeds neglect of human and social capital through education and institution building, including economic and political diversification

The Success Stories Are Real, Too Abundant natural wealth tends sometimes to attract the wrong sort of people to politics Could list many failures (e.g., Nigeria) Yet, several countries have done well, e.g., Botswana (diamonds) Malaysia (minerals, timber, gas) Mauritius (sugar) Norway (oil) Good governance, good institutions

Natural Resources and Human Rights Natural resources belong to the people A people s right to their natural resources is a human right proclaimed in international law, e.g., the International Covenant on Civil and Political Rights, and in many national constitutions Low taxes and generous transfers and subsidies, even if they amount to only a small fraction of each citizen s fair share of the nation s oil wealth, tend to weaken popular demand for democracy

Democracy and Good Governance Norway was a fully fledged democracy long before its oil discoveries Democrats are less likely than dictators to try to grab resources to consolidate their political power Norway s ten oil commandments, adopted before oil production began, lay down ethical guidelines for oil wealth management Good governance can be an effective remedy against rent seeking

Natural Resources May Undermine Finance Abundant natural resources may hamper the functioning of the financial system Dissaving through more rapid resource depletion Saving through less rapid depletion or more rapid renewal or deposits abroad Weaker links between domestic savers and investors distort allocation of capital Lack of financial depth deters efficiency and growth

Sovereign Wealth Funds From day one, Norway s oil and gas reserves were defined by law as common property resources, clearly establishing the legal rights of the Norwegian people to the resource rents On this legal basis, government has absorbed about 80% of the resource rent over the years Oil Fund (Pension Fund): nearly USD 900 billion Managed by independent Central Bank Norway resisted temptation to use too much of the money to meet current needs

Step by Step Developing countries with pressing economic and social needs cannot be expected to show the same patience as Norway No one-size-fits-all blueprint is available to guide resource-rich countries to a sustainable path of successful economic diversification Seek path of least resistance, doing easy things first, climbing the ladder rim by rim Boost education, infrastructure, and institution building, including good governance THE END