Resource Curse and Institutions: Getting more specific  

In a few blogs over the last several weeks (herehere, here and here), we have argued that the empirical evidence suggests there is a “conditional resource curse” whose existence depends on the institutions of a society. Countries with bad institutions will find that resource abundance lowers their rate of economic growth, while the opposite applies to countries with good institutions.

Yet the bundle of institutions that appear in this literature is very large and encompasses many of the most central political and economic institutions in society. This is important to establish, but it also means that reform of such institutions will be very hard because, as we argue in Why Nations Fail, it is typically not a coincidence that societies have unaccountable political systems, lack the rule of law and have low capacity states all at the same time. In addition, improving the economic consequences of natural resource wealth is probably not the most important reason to reform such institutions now. Nor is it clear that such a focus is the best strategy for doing so.

A good place to start in reforming institutions is perhaps not the macro institutions of the whole society, but the nexus of institutions that surrounds natural resources like oil. After all these resources are owned, mining licenses allocated and the rents distributed in particular ways, all governed by institutions. Wouldn’t these institutions, obviously not picked up by macro measures of the rule of law or checks and balances, play an important role in determining the economic (and political?) consequences of natural resources?

The 2011 book by Pauline Jones-Luong and Erika Weinthal, Oil is Not a Curse: Ownership Structure and Institutions in Soviet Successor States, answers this question in the affirmative.

In 1991 the Soviet Union collapsed and broke up into a number of successor states. In Central Asia this included Azerbaijan, Kazakhstan, the Russian Federation, Turkmenistan, and Uzbekistan. These former Soviet Republics all inherited very similar and weak state institutions, and as they became independent all scored rather badly on the types of institutional measures discussed in the empirical literature on the conditional resource curse.

For example, the Soviet Union had no income tax system for these states to inherit, and many aspects of modern state institutions had to be built up from scratch. In addition to these commonalities of history, all five states were oil rich. Yet very different development paths emerged out of these apparently very similar initial conditions.

While Turkmenistan and Uzbekistan moved onto a classical resource curse type of trajectory, something very different happened in the other three cases. The former two countries expanded the public sector and engaged in grandiose national prestige projects. The latter three actually shrunk the size of the public sector relative to national income.

Jones-Luong and Weinthal argue that this divergence can be traced to the way in which the different countries differed in terms of the ownership structure of oil. They distinguish between four regimes that they argue are critical for determining the consequences of oil.

The first one is when the state owns and controls the oil sector (meaning that they own more than 50% of the shares in the petroleum secto) r. This regime typically involves very limited foreign involvement.

The second is state ownership without control where the proportion of shares owned is less than 50% and where there is more foreign involvement.

The third regime is private domestic ownership of the resource and firms that develop it.

The fourth regime is foreign ownership and control.

There are some simple theoretical relationships between these different regimes of ownership and control and state institutions. Jones-Luong and Weinthal’s main dependent variable is the strength of the fiscal regime and they argue that a weak fiscal regime is a situation where (1) the tax system is unstable, based largely on the natural resource sector and indirect taxation, (2) a system of expenditures which lacks stability and transparency.

A strong fiscal regime is one where the tax system is stable and broad based with a greater reliance on direct taxation and (2) expenditures emphasize budgetary stability and are transparent. The basic theoretical argument is that state elites do not have an incentive to set up strong institutions on their own, they have to be forced into doing so by society.

Different ownership structures of society alter the bargaining relationship between society and the state. For example, if natural resources are privately owned, then the private sector is empowered, and the change in property rights makes it more difficult for the state to just rely on natural resources as its sole tax base. Instead they must develop alternative fiscal resources. Moreover, the private sector can use its greater bargaining power to demand better fiscal institutions since they suffer from bad ones. Hence one would expect that the greater the extent of private ownership and control of resource wealth, the better the fiscal regime would be.

The regimes in the second and fourth categories are intermediate cases and their implications for the fiscal regime are more complex and depend on other factors. For instance, a general feature is that private ownership, by domestic or foreign investors, makes it more difficult for the state to finance itself from resource rents and hence would tend to encourage the development of a stronger stet of fiscal institutions. Yet foreign ownership differs from domestic ownership in that it may be easier for the state to hold up or renegotiate contracts with foreign companies and in the limit, expropriate, foreign companies (as has happened recently in Bolivia and Venezuela and in the past in a whole stream of countries, notably Chile, Iran and Mexico). Thus while one would expect the fourth regime to have better fiscal institutions than the first (state ownership and control), we might expect it on average to have worse fiscal institutions than the third regime.

Returning to the cases, it turns out that indeed Turkmenistan and Uzbekistan had state ownership and control of their oil sectors. Azerbaijan chose state ownership without control, Russia pursued private domestic ownership and finally Kazakhstan chose private foreign ownership. Thus this research suggests that one institution that is critical for certain aspects of the institutional consequences of oil wealth (and by logical implication other natural resource wealth) is the form of property rights and whether or not this is dominated by the state.

Such an argument also probably suggests much more fruitful lines of policy reform than blaming the resource curse on just weak “rule of law” or lack of “checks and balances” —- even though both statements are likely true.

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