The Natural Resource Curse

CEP macro program member Francesco Caselli uses variation in oil output among Brazilian municipalities to investigate the effects of resource windfalls. They find muted effects of oil through market channels: offshore oil has no effect on municipal non-oil GDP or its composition, while onshore oil has only modest effects on non-oil GDP composition. However, oil abundance causes municipal revenues and reported spending to increase as a result of royalties paid by Petrobras, while survey based measures suggest little contribution to the improvement to local living standards. To explain this, they use data from the Brazilian media and federal police to document that very large oil output increases alleged instances of illegal activities associated with mayors.

Meanwhile, CEP macro program members Francesco Caselli and Tom Cunningham discuss political economy mechanisms which explain why an increase in the size of resource rents causes a decrease in the economy’s total value added. They find that resource abundance may either induce greater investment by the leader in assets that favour growth, or alter incentives which leads to a potentially catastrophic drop in such activities, leading to a resource curse.

Resource windfalls result in higher revenues which both increase the value of staying in power and increase the likelihood that the leader will face a challenge for his political control. There are two broad scenarios under which an increase in the value of staying in power can lead to a resource curse. In the case of a binding budget or time constraint, the leader substitutes away from productive activities into activities that preserve him in power. If the leader is unconstrained, activities undertaken by the leader to stay in power can have a negative spillover on the private sector and can also lead to a fall in living standards.

An increase in the likelihood of a challenge for political control from more aggressive and motivated opponents will shorten the leader’s horizon, and hence his perceived returns from developing the non-resource economy. This effect can be exacerbated if the leader responds to the greater probability of a challenge by shifting more resources into wasteful self-preservation schemes.

To read more about the natural resource curse see:

• "Do Oil Windfalls Improve Living Standards? Evidence from Brazil" [Full document in Adobe PDF] (Francesco Caselli and Guy Michaels), CEP Discussion Paper 0960, December 2009
  
  
• "Leader Behavior and the Natural Resource Curse" [Full document in Adobe PDF] (Francesco Caselli and Tom Cunningham), CEP Discussion Paper 0913, March 2009