Does Oil and Gas Wealth Eat Up Total Wealth? Analyzing the Resource Curse With Measures of Sustainable Wealth

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1 HHL Working Paper No. 116 January 2013 Does Oil and Gas Wealth Eat Up Total Wealth? Analyzing the Resource Curse With Measures of Sustainable Wealth Wilhelm Althammer a, Martin Schneider b a Prof. Dr. Wilhelm Althammer is Holder of the Chair of Macroeconomics at HHL Leipzig Graduate School of Management. wilhelm.althammer@hhl.de b Dr. Martin Schneider was doctoral candidate at HHL Leipzig Graduate School of Management. martin.schneider@hhl.de Abstract The findings of empirical studies on the question whether endowments with natural resources are a curse or a blessing are ambiguous. The majority of studies found that resource rich countries grow slower than their resource scarce counterparts ( resource curse ). In recent studies, this negative effect on economic performance has been questioned; the effect of resources seems to depend on how resource wealth is measured. While most of these studies use the growth of GDP, a flow variable, as the dependent variable, we propose to use the growth of real total wealth, a stock variable. By this, the idea of sustainable development is taken into account. Using this measure in a cross-sectional analysis, we find strong evidence of a resource curse for oil and gas rich countries. The higher the share of oil and gas wealth in total wealth per capita in 1995, the worse the growth in total wealth per capita a decade later.

2 1 Introduction Countries rich in natural resources tend to grow slower than their resource scarce counterparts ( resource curse ). However, there are notable exceptions to this assumed growth trajectory such as Australia, Botswana, Canada, Norway and the United States; thus, there exists no deterministic relationship between resource richness and economic growth. Existing studies discuss conceptualities with regard to the measurement of resource abundance (resource endowment versus resource dependence) as an independent variable. A common feature in most of these studies is that economic growth is measured by real GDP growth per capita. This traditional indicator of economic progress imposes a problem for resource rich countries: The depletion of natural resources increases GDP and contributes to growth, but this may not be sustainable. Therefore, a natural extension of the analysis is whether the growth of resource rich countries is sustainable, and how this growth is related to resource abundance. In this article, we measure the sustainability of economic development by the Hartwick rule (see Hartwick 1977, Solow 1986). 1 It states that the rents from extracting nonrenewable resources should be invested into other forms of capital. Using wealth estimates provided by the World Bank (World Bank 2006, 2011), the study shows that oil and gas rich countries are losing wealth relatively to others. This provides new insights into the resource curse debate by introducing aspects of sustainable development. 2 Are natural resources a curse or a blessing? Empirical cross-country studies on the relationship between natural resources and economic growth reveal twofold results; in particular, outcomes are dependent on the measurement of natural resources as independent variables. Furthermore, endogeneity (e.g. through omitted variables) and heterogeneity in the sample composition pose challenges to the generalization of results to a single country scale. 1 Sustainable development is defined as maintaining the value of a capital stock over time, where capital encompasses natural, manufactured, human and institutional capital. If one assumes perfect substitutability between natural and other forms of capital, the maintenance of an aggregate capital stock is a necessary and sufficient condition for weak sustainable development. See e.g. Turner (1999), pp

3 Until the late 1980s, the majority of research considered natural resources to be a blessing rather than a curse, e.g. Lewis (1955). However, this point of view was turned upside down over the next decade, e.g. by Gelb (1988) and the seminal work of Sachs and Warner (1995; 1997a; 1997b; 2001). Sachs and Warner found out that countries with a high share of primary exports tend to grow at a lower rate than their counterparts with scarce resources. The negative and significant relation persists even when controlled for, among others, initial GDP, openness, capital accumulation, rule of law and global commodity price shocks. Further empirical evidence of an adverse relationship was also found by, among others, Sala-I-Martin (1997), Gylfason et al. (1999), Auty (2001), Gylfason (2004) and Mehlum et al. (2006b). However, more recent studies reveal that the results are not stable with respect to the measure of resource abundance. According to Rosser (2006), earlier approaches did not provided a precise definition and yardstick for resource abundance. Recent research distinguishes between resource endowment and resource dependence. 2 Resource endowment measured as natural capital per capita is a stock variable, calculated as the present value of returns from proven reserves. 3. Conversely, resource dependence, as applied by Sachs and Warner (1997b), is a flow variable that provides information on the intensity of resource exports relative to an output variable (total exports or GDP), but does not provide information on domestic resource depletion. Hence, the latter is more a measurement of the sectoral importance of the primary product sector in terms of exports or GDP. By this, a country with a high proportion of primary exports would be characterized as resource rich, but it is possible for a resource-abundant country such as the United States to have a small primary sector, whereas a resource-poor country (Tanzania, Burundi) can be heavily dependent on the primary sector. 4 Brunnschweiler (2008), Brunnschweiler and Bulte (2008) and Ning and Field (2005) identified a positive relationship between resource endowment and economic growth, thus challenging the resource curse view.. 5 Table 1 provides a summary of selected studies and their underlying variable specifications. All studies, with the exception of Alexeev and Conrad (2009), use real GDP See e.g. Peretto and Valente (2010), Karabegović (2009), Brunnschweiler and Bulte (2006, 2009), Brunnschweiler (2008), Ning and Field (2005), Stijns (2005). See World Bank (2006) for further details. See Ning and Field (2005), p Nonetheless, it seems that those countries are rather an exception and that the level of development plays the decisive role. Alexeev and Conrad (2009) used different endowment measures and derived similar results. However, Gylfason (2001b) has shown that the share of natural capital in national wealth (but not in per capita terms) is inversely related to annual growth of GNP per capita. 2

4 growth per capita over a certain period of time as the endogenous variable. Alexeev and Conrad (2009) used GDP in its level as dependent variable. There is significantly greater difference in the measurement of the exogenous natural resource variable. Two categories of classification can be derived: first, natural resource exports/gdp (denoted as resource dependence) and second, natural capital per capita (described as resource endowment). In terms of the controlling variables, the initial income, openness, rule of law (a measure of a country s institutional quality), enrolment rates, and investments were found to play a significant role in such growth regressions. In conclusion, the current research status with regard to cross-country studies indicates that resource dependence has an adverse effect on economic growth, whereas the effect seems to be reversed if resource endowment is used. However, heterogeneity between the countries under scrutiny raises questions as to how the findings should be interpreted on a sound commensurable basis. It is obvious that not every resource-rich country is seriously affected by the resource curse, e.g. Australia, Botswana, Canada, Malaysia, New Zealand, Norway, Thailand, and the United States. 6 According to Bulte and Damania (2008, p.4), no one-sizefits-all situation appears to exist. Hence, there is no univariate relationship between resource richness and economic growth. As Gylfason summarized his review of resource rich countries, they ( ) vary so greatly from one another ( ), that it could be regarded as highly questionable whether all of them ( ) should be grouped together for drawing general conclusions. (Gylfason 2001c, p.585). In addition, the studies compare different sets of resources (e.g. oil, cropland, minerals). Therefore, Torvik (2009, p.248) concludes that it is improbable to assume that all types of resources have a similar effect on economic growth. The question whether resources are a curse or a blessing cannot be answered universally: ( ) what matters most is what countries do with their natural resources (Stijns 2005, p.126), or how they manage the wealth See, for example, Acemoglu, et al. (2003), Iimi (2006), and Sarraf and Jiwanji (2001). See Auty (2007), p. 630, Pesaran (1984), p. 265, and van der Ploeg (2010). 3

5 Table 1: Selective overview of studies and their corresponding variable specification Author Dependent variable Independent variables Results Average annual real GDP Natural resource variable (primary products exports/gnp), Sachs and Warner (1997b) growth divided by the economically active population initial GDP, openness, investment rates, human capital accumulation rates, changes in external terms of trade, government expenditure ratios, terms of trade volatility, Resource Curse ( ) efficiency of government institutions Natural resource variable (natural resource exports/gdp) in Sachs and Warner (2001) Real GDP growth per capita ( ) 1970, initial GDP, openness, interaction variable(openness*initial GDP), % Land w/in 100 km coast, km to closest port, % land in geographical tropics, Resource curse falciparam malaria index 1966 Gylfason (2001b) Real GNP growth per capita ( ) Natural resource variable (share of natural capital in national wealth, 1994), enrolment rate, investment, initial income Resource curse Real GDP growth per Natural resource variable (natural resource capital per Ning and Field (2005) capita capita), initial GDP, investment rates, openness, rule of law, Resource blessing ( ) changes in external terms of trade Mehlum et al. (2006b) Real GDP growth per capita ( ) Natural resource variable (primary exports/gnp in 1970), initial income, openness, investments, institutional quality, interaction term (natural resource variable*institutional quality), secondary school enrolment rate, ethnic fractionalization, language fractionalization Resource curse only in countries with inferior institutions Brunnschweiler (2008) Real GDP growth per capita ( ) Natural resource variables [1. average total natural capital per capita in 1994 and 2000 (USD), 2. Average subsoil wealth per capita in 1994 and 2000 (USD)], initial income, rule of law/government effectiveness, geography (regions) Resource blessing Natural resource variables [1.hydrocarbon deposits, 2. value Alexeev and Conrad (2009) GDP per capita (PPP) 2000 of oil output, 3. oil/gdp ratio], ethnolinguistic fractionalization, European population, Latin America, East Resource blessing Asia, rule of law 4

6 3 Transmission channels as explanations for the inferior performance of resource-dependent countries The reasons why some resource dependent countries perform worse are multifarious, see Sachs and Warner (2001, p.833). However, four main transmission channels have been described in literature: 8 Dutch disease 9, volatility of commodity prices 10, neglect of the human resource base 11 and rent-seeking behavior 12. A large dependence on natural resources may cause a certain transmission channel to appear, which will then tend to slow down economic growth. The phenomenon of Dutch disease (DD) states that a boom in a country s tradable natural resource sector leads to de-industrialization in terms of a shrinking manufacturing sector, factor reallocation and real exchange rate (RER) appreciation. It was labeled Dutch disease by The Economist (1977) because of the adverse performance of the manufacturing sector in the Netherlands during the 1970s as a consequence of the natural gas discovery and extraction in the North Sea during the 1960s. The phenomenon of DD was also observed, among others, in Great Britain (North Sea oil), in Columbia (coffee) and in Australia (minerals). Dutch Disease may improve welfare due to a rise in wages and income; however, it comes at the expense of the manufacturing sector. Given that the manufacturing sector uses labor and non-tradables as input factors, its international competitiveness on world markets decreases. 13 If the manufacturing sector is more conducive to economic prosperity (e.g. through technological progress, learning by doing, increasing returns to scale, positive spillovers) than the resource and non-tradable sector, any decline will in the long term impede economic growth. 14 A further reason for the adverse performance of some resource dependent countries is price volatility of the exported commodity. 15 Nominal and real prices, e.g. of oil, are volatile This is a non-exhaustive list of reasons. There is no universal theory that explains the resource curse. Furthermore, the resource curse does not presuppose that every phenomenon will be manifest. See, among others, Sachs and Warner (1995). Referable to van der Ploeg and Poelhekke (2009). See, among others, Gylfason (2001b), and Asea and Lahiri (1999). See, among others, Gelb (1988), and Tornell and Lane (1999). See Kronenberg (2004), p See, for example, Matsuyama (1992) and van Wijnbergen (1984a). See, for example, van der Ploeg and Poelhekke (2009) and Deaton (1999). 5

7 and subject to random fluctuations. In the period between 1970 and 2009, the annual percentage OPEC nominal oil price volatility (standard deviation) amounts to 46%, the annual OPEC real oil price (base 1973) volatility is equal to 40%, the annual BP nominal oil price (Brent) volatility comes in at 49% and the BP real oil price (base 2009) volatility is 43%. From a statistical perspective, the oil price can be modeled approximately by a random walk. 16 This implies for an oil dependent country that a substantial part of the economy is founded on a randomly proceeding cash flow, thus leading to some serious ramifications, ranging from incalculable government budgeting to future uncertainties in general. Volatility has serious repercussions. It creates uncertainty, derogates private investments through imposing welfare costs for risk-averse individuals, abates the accumulation of human capital and decreases FDI. 17 Overall, volatility has an adverse effect on economic growth. 18 Among other things, well-developed financial sectors, economic diversification and stabilization funds serve to reduce volatility. 19 A further transmission channel is the disregard of human capital accumulation. 20 Resource-intensive countries tend to neglect investments in the human resource base due to a high level of non-wage income, for example dividends or social spending. 21 In resourceintensive countries, unskilled workers are mainly employed in sectors not exposed to competition, such as the government sector. An increase in wages for unskilled workers relative to skilled worker, e.g. due to job subsidization or excessive public salaries, increases the individual opportunity costs of accumulating human capital. 22 Governments may fail to invest in education because the benefits from spending on education are accrued with a time lag of more than a decade, so immediate results are not visible. 23 A further reason, in particular in non-democratic states, is that governments invest insufficient amounts, as higher education levels may lead to tendencies for an increased participation of the public in the government. Accordingly, there may be a target conflict between education spending and maintaining political power. In addition, resource-rich countries may rely too much on foreign See, for example, Hamilton (2009). See Narayan and Narayan (2007), p. 6549, Ferdere (1996), Loayza, et al. (2007), Flug, et al. (1998). See, among others, Ramey and Ramey (1995), Mobarak (2005), Blattman, et al. (2007), and Imbs (2007). See van der Ploeg and Poelhekke (2009). Mobarak (2005) further emphasizes the role of democracy in reducing volatility. Regarding the importance of human capital for economic growth and development, see, among others, Lucas (1993), Barro (2001), and Galor and Moav (2004). See Gylfason (2001a), p. 7. See, for example, Asea and Lahiri (1999). See Kronenberg (2004), p

8 labor for basic work (such as building of infrastructure) and specialized work (such as engineering). In both cases, this may reduce incentives for local citizens to develop particular skills. According to Gylfason (2001b), an increase in the natural capital share by five percentage points is associated with a ten percentage points decrease in secondary school enrolment rates across countries. Finally, resource dependence may prompt rent-seeking behavior. According to the definition of Meadowcroft (2007a, p.103), rent seeking describes the attempt to gain income or wealth by manipulating the political process rather than by productive activity in the marketplace. In the context of resource rich countries, this means that people are concerned with tapping parts of the resource revenue, rather than personal engagement in productive participation. Although not restricted to this, it may be prevalent in the form of political lobbying. Resource rich countries can often be characterized as rentier states, since rents fall to the government as the principle owner of the resource. 24 Rent seeking has serious ramifications. It induces improper fiscal redistribution 25, imposes avoidable costs on socially valueless and unproductive activities 26 and crowds out innovation 27. For instance, an excess share of public sector labor can be seen as a consequence of lobbying for high wage/rent employment; the larger the public sector, the greater the wastage in lobbying for jobs yielding high rents. 28 Accordingly, the price of labor is high relative to the productivity provided. 29 Some governments tend to imitate Western consumption and spending patterns instead of investing in productive activities that will provide a long-term pay-off. 30 In some cases, resource rents can induce corruption 31, thus obstructing economic growth, reducing competition and lowering per capita income levels. 32 In extreme cases, civil According to Beblawi (1990) a state can be termed a rentier state if it displays the following characteristics: (1) Rent situation predominate, (2) Economy relies on substantial external rent and can therefore survive without a strong domestic productive sector, (3) Limited numbers of protagonists are engaged in the creation of the rent, while the rest are occupied with the distributing and exploiting of the rent, (4) The government is the principal recipient of the external rent. See Gylfason and Zoega (2006), p See Jomo (2003), p See, for example, Papyrakis and Gerlagh (2007). See Gelb, et al. (1991), p See Auty (1997), p See Kronenberg (2004), p Oechslin (2010) highlights the relationship between government revenues and growth promoting public spending in weakly institutionalized countries. He underlines an inverse u- shape, implying that both, high and low revenues may be detrimental to economic growth. See, for example, Ades and Di Tella (1999) and Vicente (2010). Bhattacharyya and Hodler (2010) discovered the same relationship if the quality of democratic institutions is relatively poor. 7

9 shown. 33 Rent seeking behavior, corruption and the negligence of the human resource base all unrest or even civil war may ensue, as the situation with blood diamonds in Africa has tend to seek their channels through institutions; thus, the institutional apparatus and especially the quality of institutions are decisive for the relationship between natural resources and economic growth. 34 Tornell and Lane (1999) discovered that if an economy lacks a strong legal-political institutional infrastructure, a terms of trade windfall (e.g. oil boom) will generate a voracity effect that ultimately reduces growth. In general, high quality institutions, on hand when resources are discovered and exploited, exert a positive influence on economic prosperity, while low-quality institutions tend to obstruct economic growth. 35 By and large, however, having a real and functioning institutional apparatus on hand is more the exception than the rule in current high resource-dependent countries; it appears that the emergence of suitable institutions will take a considerable length of time. 36 Further, the supposed causality between resource wealth and lack of democracy does not effectively contribute to alleviating this problem. 37 As Tsui (2011) estimated, the discovery of 100 billion barrels of oil will reduce a country s democracy level by 20 percentage points within three decades, when compared with prevalent trends. Collier and Hoeffler (2009) argue that resource-rich countries need a distinct form of democracy with strong checks and balances which withstand resource rents. 4 Model Specification Unlike existing research that examined the effect of resource endowment or dependence on economic growth, this paper varies the specification of the dependent variable. Thus, the two variables of interest, namely resource wealth and wealth performance, are comparable with regard to their measurement levels. Wealth estimates provide accounts for See, among others, Mauro (1995), Ehrlich and Lui (1999), Leite and Weidmann (1999), Bardhan (1997), Mo (2001), Blackburn, et al. (2006) and, Emerson (2006) See Gylfason (2004), p. 9. Regarding civil wars and oil, see Ross (2006). See, for example, Mehlum, et al. (2006b), Robinson, et al. (2006), Spinesi (2009), Bhattacharyya and Hodler (2010), and Cabrales and Hauk (2011). For a proof of the positive relationship between institutional quality and long-run growth see, among others, Scully (1988) and Sachs and Warner (1997a). Complementary, Smith (2004) examined that oil wealth has increased regime survival. See, among others, Ross (2001), Tsui (2011) and Barro (1999). 8

10 the depletion in natural resources, while GDP does not provide indications of the liquidation in natural wealth. Indeed, extraction will contribute positively to a country s GDP, but not necessarily to a country s wealth. To refer to the sustainability of growth, we use total real wealth per capita growth (TWG) as the endogenous variable. We use the wealth estimates by the World Bank, covering 122 individual countries from The World Bank calculates total wealth as the present value of the current level of consumption (kept constant) over 25 years (one generation), discounted at the pure rate of time preference (1.5%). Separate estimates are provided for net foreign assets (total assets less total liabilities), produced capital (sum of physical capital and urban land), natural capital (sum of crop, pasture land, timber, non-timber forests, protected areas, oil, natural gas, coal and minerals). Given these estimates, intangible capital is calculated as the residual of total wealth and net foreign assets, produced capital and natural capital. Intangible capital includes for example human and institutional capital as well as total factor productivity. The natural resource wealth variable is defined to make it comparable to the abundance measures used in previous studies. However, there are two crucial differences to other studies that measured resource abundance, as described in table 1. First, our paper addresses on the one hand oil and gas wealth (regression 1 to 4) and on the other hand subsoil assets (including coal and minerals) per capita (regression 5), and not total natural capital per capita (including crop land, pasture land, timber, nontimber forest resources and protected areas). It is argued that oil and gas, along with minerals, have special properties (e.g. nonrenewable resources, volatile pricing) and that this wealth, once exploited, is easier to convert into hard currency and to misallocate. Second, oil/gas wealth and subsoil wealth are measured relative to total wealth. By this, it shows the extent to which natural resources contribute to a nation s total wealth. The independent variable SOGT is therefore specified as the share of oil and gas wealth in total wealth per capita as per In addition, control variables are included to account for any influence on the relationship between SOGT and TWG. These variables are initial total wealth per capita in 1995 (IW), rule of law (RL) in 1996, population growth (POG) from 1995 to 2005 and average tariffs (TAR) from 1995 to 2005 (see Appendix 1 for a description of all variables). The rule of law is used as a proxy for the institutional framework, while tariffs are used as a 38 All comparative figures are in 2005 USD. See Appendix 2 for the list of countries. For more details of wealth calculation, see The World Bank (2011) 9

11 negative proxy for a country s openness. Both variables were found to be important in crosscountry studies on resource affluence. 39 Accordingly, we model total wealth per capita growth (TWG) as a linear function of the share of oil and gas wealth (SOGT), initial wealth (IW), rule of law (RL), population growth (POG) and tariffs (TAR): TWG 0 1SOGT 2 IW 3RL 4POG 5TAR In order to measure the effect of subsoil assets (SST) on wealth performance, minerals and coals are added to the oil and gas share and an additional regression is conducted: TWG 0 1SST 2IW 3RL 4POG 5TAR 5 Empirical analysis Figure 1 shows a negative relation ( 0.41) of oil and gas wealth and subsequent wealth growth, indicating that countries rich in oil and gas in 1995 experienced an inferior or even negative development in total wealth per capita over the subsequent period. Indeed, multiple regression analysis confirms this negative correlation. Table 2 shows the corresponding regression results. In addition to the variable of interest share of oil and gas wealth in total wealth, the first regression lends consideration to absolute initial wealth as per Oil and gas wealth have a strong negative effect on wealth performance. The second regression considers as an additional factor the rule of law. Inclusion of this institutional proxy variable goes some way towards absorbing the pronounced effects seen in the first regression. Rule of law has a strong positive effect on wealth growth. Initial wealth as a further controlling variable changes sign and becomes negative, indicating wealth convergence across countries. All variables are significant at the 1% level, and the explanatory power increases to 0.29, from just 0.17 in the first regression. 39 See e.g. Mehlum et al (2006a, 2006b). 10

12 Figure 1: Oil/gas wealth (1995) and wealth growth ( ) wealth growth per capita ( ) Share of oil and gas wealth as percentage of total wealth per capita 1995 Source: own illustration and calculation, data based on World Bank Wealth Estimates. The third regression adds population growth ( ). However, population growth does not produce any significant effect, and the explanatory power remains almost unaffected. Finally, the fourth regression adds average tariffs as a proxy for a country s openness over the period. It increases the adjusted R 2 only slightly and is insignificant. Regression five examines whether the negative relationship between resource wealth and wealth growth also holds for the aggregated group of subsoil assets (including minerals and coals). Indeed, the regression does reveal that the results are transferable to subsoil assets. The coefficients are almost the same. A pronounced negative effect of natural wealth on wealth performance persists, while rule of law has a pronounced positive effect. 11

13 Table 2: Effect of oil/gas and subsoil wealth per capita (1995) on total wealth per capita ( ) OLS: Dependent variable: total wealth growth per capita ( ) Variable Regression 1 Regression 2 Regression 3 Regression 4 Regression 5 Constant 18.21*** (7.28) 24.29*** (9.90) 26.77*** (6.30) 26.50*** (4.03) Share of oil and gas in -0.99*** -0.86*** -0.82*** -0.83*** total wealth, per capita (-5.85) (-5.47) (-4.17) (-4.18) Share of subsoil wealth in total wealth, per capita Initial wealth 0.00* -0.00*** -0.00*** -0.00*** (1.66) (-3.65) (-3.01) (-2.82) Rule of law 12.78*** 12.07*** 12.55*** (4.85) (4.09) (4.00) Pop-growth (-0.72) (-0.80) Tariffs 0.12 (0.37) 28.31*** (4.39) (-0.86)*** (-4.41) -0.00*** (-3.00) 12.32*** (3.95) (-0.92) 0.08 (0.24) Observations Adjusted R The numbers in brackets are t-values. ***denotes significant at 1% level, * at 10% level A Ramsey Reset test shows that the estimated regression models are robust with respect to misspecification. As heteroskedasticity appears in regression one and two (at 5% respectively 10% level), both are estimated using White heteroskedasticity consistent standard errors. Further robustness analysis shows that the regression result remains unaffected when oil and gas wealth is applied in terms of absolute figures. Using absolute oil and gas wealth in 1995 (in constant 2005 USD) instead of the share of oil and gas wealth in total wealth (SOGT) does not alter the result of a negative impact of SOGT. This contrasts with results of Ning and Field (2005) and Brunnschweiler (2008), who showed that natural capital per capita (resource abundance), respectively subsoil wealth per capita, have positive effects on real GDP per capita growth (resource blessing). Furthermore, additional explanatory variables that other studies have found to be relevant for the relationship between resource wealth and growth did not improve the regression fit. Secondary school enrolment, ethnic fractionalization (Alesina et al. 2003) and arable land were added to the final system of variables (regression 4). Moreover, an interaction term, as used in Mehlum et al. (2006b), that accounts for the moderating influence between institutions and resource wealth (SOGT*RL) 12

14 was added. However, the additional variables are neither statistically significant, nor do they add to the explanatory power. 6 Discussion of the results Countries that were rich in oil and gas in 1995 saw their wealth dissipate over the following decade and failed to accumulate new prosperity. Table 3 shows a set of 14 countries which had an oil and gas per capita share larger than 10% in Their corresponding wealth performance from 1995 to 2005 is highlighted in the third column of the table. Overall, oil and gas rich countries performed unsatisfactorily. There are only three oil and gas rich countries (Trinidad and Tobago, Iran, Ecuador) that could increase per capita wealth. The remaining eleven countries forfeited per capita wealth. Brunei, Kuwait, and Algeria performed worst in this group. However, it is important to mention that total wealth per capita growth includes the growth of oil and gas wealth per capita, e.g. by the discovery of new reserves. This might explain the wealth performance of the three wealth winners (Trinidad and Tobago, Iran, Ecuador), in which a positive wealth growth may stem from new discoveries of oil and gas resources. Indeed, as column four of Table 3 shows, all oil and gas rich countries increased their resource share from 1995 to 2005, whereas the share of intangible and produced capital as well as net foreign assets per capita dwindled away (see column five). 40 Interestingly, real GDP growth per capita was mostly positive in these resource rich countries over the period of interest. For example, Algeria s real per capita GDP growth was 27.4% from 1995 to 2005, while total wealth per capita declined by 16%. This and other examples of oil and gas rich countries show that some economies grew at the expense of total wealth. From that it can be concluded that too much of the resource wealth was consumed (e.g. distributed through social spending or white elephant projects), and that the countries did not substitute their natural wealth adequately. This poses a severe problem once oil and gas reserves run short. If the countries had invested their resource revenues according to the Hartwick (1977) rule of sustainable development (stating that non-declining wealth per capita indefinitely requires that the rents from the depletion of non-renewable 40 Nigeria was the only country among this group with an increase in the accumulation of intangible and produced capital as well as net foreign assets from 1995 to However, its total wealth per capita loss was attributable to a deterioration in cropland wealth. 13

15 resources are invested in reproducible capital such as financial assets, produced capital or intangible capital such as human capital) then they would have accumulated more wealth. Table 3: Oil and gas rich wealth winners and losers and their corresponding real economic growth performance Wealth performance Wealth of intangible+ Real GDP growth Oil and gas share performance per Oil and gas share Country produced capital+ per capita per capita (1995) capita per capita (2005) net foreign assets ( ) ( ) ( ) Trinidad and Tobago Iran Ecuador Oman Syrian Bahrain Saudi Arabia Gabon Venezuela United Arab Emirates Nigeria * Algeria Kuwait Brunei All numbers are in percentage. * Wealth loss due to tremendous loss in cropland wealth Source: own calculation, World Bank: Wealth Estimates and World Development Indicators. 7 Concluding remarks Summing up, if an alternative approach of variable specification is applied, there is once more evidence of a worse performance of resource rich countries. The higher the share of oil and gas wealth in total wealth per capita in 1995, the worse the growth in total wealth per capita a decade later. The result is robust under applied controls for initial wealth, institutional conditions, population growth and openness. A detailed consideration of oil and gas rich countries revealed that there are only few countries that performed satisfactorily in terms of wealth growth per capita. However, most of these countries wealth increase was attributable to newly discovered oil and gas wealth. Interestingly, real GDP growth per capita was positive in some of these resource rich countries over the course of time ( ). That is probably consistent with the view that the countries consumed too much of their wealth. Hence, on average, natural resource rich countries did not substitute their natural wealth 14

16 adequately. and failed to adopt the Hartwick (1977) rule for sustainable development. While it is not clear how much of the resource rents should be invested into different kinds of capital, it is vital that the aggregate capital stock is passed on to future generations. For a country as Norway, the use of sovereign wealth funds is a suitable vehicle. This may not be necessarily appropriate for countries such as Algeria or Venezuela, in which basic investment in infrastructure and human capital may show a higher real rate of return for future generations. Future research could adopt case study approaches to examine how countries have developed their resource wealth in a sustainable manner, including the analysis of transmission channels that existing literature found to be important for the relationship between resource wealth and development. 15

17 Appendix Appendix 1: Definition and Source of variables Variable Definition and Source Total wealth growth per Total wealth per capita in 2005/ total wealth per capita in 1995; World Bank: Wealth Estimates capita (TWG) Share of oil and gas in total Oil and gas wealth per capita in 1995/ total wealth per capita in 1995; World Bank: Wealth Estimates wealth, per capita (SOGT) Share of subsoil wealth in Subsoil wealth includes oil, gas, coal, and minerals. Subsoil wealth per capita in 1995/total wealth per capita in total wealth, per capita (SST) 1995; World Bank: Wealth Estimates Initial wealth (IW) Total wealth per capita in 1995; World Bank: Wealth Estimates Rule of law (RL) Rule of Law captures perceptions of the extent to which agents have confidence in and abide by the rules of society, and in particular the quality of contract enforcement, property rights, the police, and the courts, as well as the likelihood of crime and violence. Estimate gives the country's score on the aggregate indicator, in units of a standard normal distribution, i.e. ranging from approximately -2.5 to 2.5 Source: World Wide Government Indicators by Kaufmann et al. (2010). Pop.-growth (POG) Population growth ; World Bank: World Development Indicators Tariffs (TAR) Tariff rate, applied, simple mean, all products (%); World Bank: World Development Indicators Appendix 2: List of countries Country Algeria Colombia Guatemala Lesotho Norway Swaziland Argentina Comoros Guinea Luxembourg Oman Sweden Australia Congo Dem. Rep. Guinea-Bissau Macao, China Pakistan Switzerland Austria Costa Rica Guyana Madagascar Panama Syrian Bahrain Côte d Ivoire Haiti Malawi Papua New Guinea Thailand Bangladesh Denmark Honduras Malaysia Peru Togo Belgium Dominica Hong Kong, China Mali Philippines Tonga Belize Dominican Republic Hungary Malta Portugal Trinidad and Tobago Benin Ecuador Iceland Mauritania Rwanda Tunisia Bhutan Egypt India Mauritius Saudi Arabia Uganda Bolivia El Salvador Indonesia Mexico Senegal United Arab Emirates Botswana Ethiopia Iran Mongolia Seychelles United Kingdom Brazil Fiji Ireland Morocco Sierra Leone United States Brunei Darussalam Finland Israel Mozambique Singapore Uruguay Burkina Faso France Italy Namibia South Africa Venezuela Burundi Gabon Jamaica Nepal Spain Zambia Cameroon Gambia Japan Netherlands Sri Lanka Zimbabwe Canada Germany Jordan New Zealand St. Kitts and Nevis Central African Rep. Ghana Kenya Nicaragua St. Lucia Chad Greece Korea, Rep. Niger St. Vincent and the Grenadines Chile Grenada Kuwait Nigeria Sudan 16

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