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Excessive Resource Specialization and Openness to Trade

Excessive Resource Specialization and Openness to Trade

Above, Saudi Arabia’s King Salman bin Abdulaziz Al Saud in conversation with Prime Minister Narendra Modi of India. Saudi Arabia has almost one-fifth of the world’s proven oil reserves and ranks as the largest producer and exporter of oil in the world.

 

In an era where global trade is powered by an insatiable thirst for primary resources, those in control of the lands blessed with the right fixes for the world’s addictions bear incredible influence on the futures of their own nations.  Add to the mix a lack of viable economic alternatives and the endowment of an abundant resource can serve as easy temptation for a country to overspecialize.  To a political leader, the allure of lining your nation’s coffers with the riches promised by a hefty resource endowment is hard not to give into.  And indeed, a valuable exportable asset is exactly that; valuable.  But what happens when country leadership goes full throttle with only one tradable resource?  How does this affect the overall trade outcomes of that country?  Throughout the process of overspecialization, the political elite of resource-dependent countries may look at their windfalls and be tempted to rest easily about the economic future of their nation, but data suggests that when it comes to overspecialization, it is typically the resources in control of the countries, not the other way around.

Looking into the issue of excessive resource specialization, there is no shortage of analysis connecting resource overdependence to poor governance outcomes and a host of economic maladies, yet very little is done to take the next step in connecting overspecialization to overall outcomes in trade specifically.  Considering this gap in research as well as the reliance of many resource-dependent economies on exports for their very economic existence, there is a compelling case to be made for us to explore just where embarking down a path of overspecialization leads, especially as it concerns a country’s overall, long-term trade outcomes.  To be sure, overspecialization can mean different things to different people.  Thus, this analysis  will focus on just the most extreme cases of specialization; from economies where one primary resource or resource sector (i.e., petroleum, refined petroleum and petroleum derivatives would be considered one ‘resource’) comprises or comprised at least 70% of exports, and/or at least 25% of national GDP.

Upon first glance, the main culprits of overspecialization demonstrate a few immediately identifiable commonalities.  The most dominant trait across the board is the dominance of mineral resources.  Though non-mineral, primary resource exports like bananas and coffee in some countries like Guatemala and Honduras make up significant percentages of government revenues, it would seem that no exportable asset wields the same potential to completely dominate a country’s export portfolio as raw mineral materials.  Secondly, these over-indulgers in mineral resources tend to be low to middle income economies.  In fact, according to a 2011 study, nearly “75% of all mineral-dependent countries are now low- and middle-income countries, while the number classed as mineral-dependent has increased by 33% since 1996 from 46 to 61 nations.”  The same study also finds a “strong negative correlation between non-fuel mineral dependence and GDP per capita,” suggesting that resource wealth actually aggravates, rather than alleviates, domestic inequality.  This means that we will be talking primarily about petroleum and oil exporters like Venezuela, Iraq, Azerbaijan, Angola and Equatorial Guinea, but also occasionally about exporters of other important commodities like the Democratic Republic of Congo, or Zambia, where copper reserves rake in over 77% of export wealth.  Additionally, given a lack of prior development in many overspecialized economies and the sheer abundance of the specialized resource, export capability tends to vastly overshadow domestic consumption capability, reflecting a domestic economy that is not industrialized enough to consume the abundant resource, further contributing to export concentration.

When it comes to the academic take on the effects of overspecialization, most scholars agree that there is a connection between singular resource wealth and the consolidation of authoritarian regimes and weakening of political and economic institutions.  Though there are disagreements about processes, the main hypotheses on this point can be summarized into three general points: 1) “easy resource revenues eliminate a critical link of accountability between government and citizens” 2) “[resource] revenues generate staggering wealth that facilitates corruption and patronage networks” and 3) “together, [these factors] consolidate the power of entrenched elites and regime supporters, sharpening income inequality and stifling political reform.”  The caveat here, however, is that not all countries that fit the scope of this investigation are officially autocratic, though many of these democracies on paper still indeed display indicators of weak institutions, such as corruption, uninterrupted political terms, as well extra-constitutional powers afforded to political figures.  Examples of these countries would be Azerbaijan, Zambia, DRC, Nigeria, Algeria and Venezuela, all ‘democracies’ given a rating below 45/100 on theOxford Policy Management economic and institutional development index, developed from the World Bank’s six world governance indicators.  These characteristics of resource-dependent states are particularly important to this investigation as they deal with the very policymakers steering a country’s economic vehicle and the economic climates that they operate in.

Implications for Trade

Foreign Direct Investment

At the outset of discovery, a given low-middle income resource overdependent nation typically does not possess the necessary capital, technology and expertise required to get a resource out of the ground and into the hands of consumers and industries the world round (and at a profit at that).  This paves a clear path for foreign MNCs with the right stature to assume the immense risks and costs associated with resource exploration. Thus, at first, there is a high incentive for host countries to embrace foreign access to their country’s resources.  Over the long term, however, governments tend to shed foreign ownership with time.  Today, foreign ownership varies from region to region, being the highest in the least developed countries.  According to a 2007 reportfrom the United Nations Conference on Trade and Development, the share of oil production by foreign firms was 57% for Sub-Saharan Africa, while it was a mere 18% for Latin America, 11% for middle income countries, 19% for all low income countries, and nonexistent for some countries like Kuwait and Saudi Arabia.  But even in these latter cases, initial foreign ownership has proven unavoidable, like in Saudi Arabia, where foreign partners were not completely bought out until 1988, a full fifty years after the discovery of oil.  These transitions make sense given the fortifying effect resource wealth can have on a regime’s grasp on power.  Despite these general patterns for oil producing countries, however, autocratic countries with poor institutions can still ostensibly exercise their domain over the export industry through their control of the enforceability of contracts and their final say on the issue of nationalization.  Furthermore, in some resource-rich sub-Saharan African countries for example, navigating bulky bureaucracies often means engaging in quid-pro-quo transactions that favor the established powers, serving as a tantalizing way to bypass red tape.  It is important to note here that a lack of transparency surrounding dealmaking in institutionally weak countries makes finding official figures notoriously difficult.

Foreign Reserve Usage

If FDI and exploration prove successful in developing a resource promise, host countries face the prospect of being on the receiving end of seemingly boundless sums of foreign reserves.  In autocratic regimes, these windfalls are concentrated in and directed by the hands of the powerful few, who may dispense of their wealth to ensure the continuation and enjoyment of their own entrenched political interests.  Thus, outcomes may be seen as depending disproportionately on the incentives of domestic leadership, and may be used to squander resource wealth just as they may be used to invest in future diversification and trade in other sectors, though the former seems to be more popular choice.  According to a 2015 report from the Natural Resource Governance Institute, “resource-rich governments have a tendency to overspend on government salaries, inefficient fuel subsidies and large monuments and to underspend on health, education and other social services.”  Securing popularity is not free, and in resource-rich autocratic regimes looking to preserve power, high on the list of priorities for the national budget is financing patronage networks that distribute jobs to political supporters and buying off opponents.  Perhaps most recklessly, foreign reserves may be also be blown on lavish personal endeavors.  Consider the ruling families of Equatorial Guinea, Gabon, and Republic of Congo; all nations that fit the confines of this investigation who have international investigations opened against them for embezzling millions of dollars worth of state money.

The implications these spending habits have for trade lie within their sustainability over the long term, and to what extent they direct or misdirect investment to/from industries outside of the resource sector.  This is because overspecialization subjects an economy to the fluctuations of international commodity prices, and when prices inevitably take a dip, if country leadership has not properly mitigated against this inherent risk, governments will likely have to stifle foreign exchange usage so that reserves don’t dry up.  This limits a country’s options for financing imports and is observable time and time again in developing, resource-dependent countries.  In 2015, Angola’s central bank had to request companies and citizens to cut foreign-exchange usage in half amid a dollar shortage caused by dwindling revenue from oil and diamond exports.  This year in Nigeria low international oil prices have devastated government earnings, causing rating agencies to downgrade the economy and President Muhammadu Buhari to slash his budget, reducing the country’s overall growth prospects.  This included ending Nigeria’s infamous fuel subsidies, for which the government this year alone spent over $5 billion trying to maintain.  According to experts, these subsidization policies, as part of government spending in an institutionally weak country, were corrupt and highly inefficient.  In Brunei, where oil windfalls in the sultanate have historically meant no income tax or sales tax for locals, as well as free university education and and subsidized housing, the government has recently had to make sweeping budget cuts in light of falling oil prices.  In Venezuela, where oil exports account for 95% of revenue, and imports account almost entirely for nationwide consumption, socialist leadership has historically diverted money from increasing productivity or ensuring production to building houses for the poor, distributing subsidised food to state-owned markets, and funding social programmes, neglecting not only alternative industries, but the oil producing sector as well.  Today, Venezuela’s economy lies in shambles and the availability of basic products is scarce, to say the least.  As a whole, in countries where transparency is low and institutions are weak, it can be assumed that low accountability for foreign reserve spending diminishes the probability that resource wealth is used responsibly.

Despite these doomsday predictions, however, as noted before, foreign reserves may indeed be used more sustainably, as observed in several Gulf Arab countries. In Saudi Arabia, for instance, serious dedication to attracting diverse foreign investment is corroborated by General Electric’s recent announcement of an investment of $1.4 billion in the country, creating a $400 million manufacturing facility as well as 2,000 new jobs for Saudi citizens.  This implies that nationwide investment in infrastructure (i.e., roads, electricity distribution, etc.) and alternate industries, enhances trade capabilities and widens overall domestic consumption capabilities.

Import & Export Restrictions

Excessive resource specialization can have a sway on leadership in some cases to pursue protectionist policies, such as import substitution, in a vain attempt at diversification.  In describing the political failures of Zambia in its pursuit of excessive resource specialization, Arne Bigsten notes that “during mineral booms, most governments behave as if the inflows of resources are permanent, embarking on new projects, including import substitution.”  Bigsten further describes that once “boom turns to bust,” it can be quite difficult to reverse economic policies as strong economic interest groups become entrenched by large initial investments.  In the case of Indonesia, high worldwide oil prices in the late 1970s brought Indonesia’s mining sector production composition ratio up to 25% by 1980.  Amidst this oil boom, Indonesia chose to overlook the role of foreign investment and pursue policies of import substitution, not switching to an export-oriented policy until oil prices plummeted in the 1980s.  Since 2015, Angola has also taken several import substitution measures to diversify its economy.  According to a report from the World Trade Organization, “customs tariff rates (especially those on agricultural products) have risen considerably and fall within a range of 2% to 50%, with an average of 10.9% (compared to 7.4% in 2005).  These cases reflect a desire to open up trade prospects, but in a way that relies too heavily on government directed-windfalls.

With regard to export restrictions, as described by a staff working paper from the World Trade Organization, “the need for export diversification of a resource rich economy can justify the use of export restrictions to promote domestic downstream production,” though “this strategy has a number of drawbacks.”  Other incentives also exist for export restrictions, such as is commonly seen amongst OPEC member nations, who are widely known for controlling world oil production supplies so as to secure a collective advantage in regulating  worldwide oil prices.  Forward thinking oil exporters may also limit output in the short term through production quotas so as to conserve resources for future, sustained exploitation.   

Conclusion

Ultimately, not every country shares the same story for how excessive specialization came to play such a dominant role in their economies.  In general, oil-dependent Gulf countries (Saudi Arabia, Kuwait, UAE) tend to reflect more positive trade outcomes than the rest of the countries in this investigation.  Noting that oil-exporting gulf countries congregate at the higher end of the previously cited economic and institutional development index, perhaps strong institutions, even under autocracies, can mitigate the negative economic forecast generally predicted by resource dependence, though this explanation still leaves the question of how these institutions became strong in the first place.  Other academics offer that the oil-rich countries of the Middle East have so far escaped some of the worst economic consequences of the resource curse due to a ratio of relatively small population to a vast amount of oil.  The question of what determines sustainable outcomes still remains largely unanswered.  

At the end of the day, however, it can be said with confidence that the incentive and initiative for which policies an overspecialized country will choose and why, ultimately fall on country leadership, according to the demands, strains, and opportunities available to them.  Thus, the connections that can be drawn between resource overspecialization and regime type, as well as economic conditions, are essential to bridging the broader relationship between excessive resource specialization and openness to trade. Certainly, external political and historical factors, as well as personal traits of individual leaders not addressed here wield their influence on trade outcomes, yet all of these factors seem to pale in comparison to the almighty resources themselves.  Ultimately, if a country chooses to devote itself to the riches and promises of one resource and one resource only, it must also accept the unbounding dominance that resource will have on its future.

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