Chapter

Foreword

Author(s):
Reda Cherif, Fuad Hasanov, and Min Zhu
Published Date:
April 2016
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Natural-resource-rich economies face a peculiar development dichotomy. The natural resource wealth helps increase living standards, both directly and indirectly, in the latter case via the additional government revenues that are transferred to the population in the form of social and infrastructure services, while avoiding, at least in part, the tax levies that are needed to provide those services in other economies. At the same time, these economies face the adverse development effects highlighted in a now extensive literature on the “Dutch disease,” giving rise to what has been called the “natural resource curse.”

Some of the adverse effects are institutional in character: the strong reliance on the state for income and employment discourages the risk taking necessary to develop new activities, and rather promotes “rent-seeking” behavior by entrepreneurs who can benefit from overtly generous government contracts—and in the worst case, from corruption. Others are of a distributional nature, and relate to how natural resource assets (land, mines, and oil and gas wells) are distributed and/or how the opportunities to access the natural resource revenues captured by the state are distributed across different social groups.

This book underscores, however, the strictly economic issues highlighted in the Dutch disease literature, particularly those associated with the difficulties of diversifying the production base into new high-technology activities. I would add the interlinked problems posed by the adverse effects on domestic production structures of commodity price booms. These effects can be called the structural and the cyclical dimensions of the Dutch disease.

The structural problems are related to the fact that the high profitability of natural resource sectors in these economies reduces the incentives to invest in other tradable sectors, including high-technology manufactures and services that are the clue to economic growth at high-middle-income levels and, even more, at high-income levels. This problem is reflected, in particular, in de-industrialization, lack of industrialization and, more generally, the reduced opportunities to develop the non-natural resource tradable sectors, which is structural in character but is enhanced by commodity price booms. This problem, it can be added, is particularly severe in high-income oil- and gas-rich countries, such as the Gulf countries, on which this book focuses.

This aspect of the problem is frequently linked with a phenomenon that has received significant attention in development debates in recent years: the “middle-income trap,” which in the case of the region this book looks at can be called the “resource-rich high-income trap.” The basic problem in this case is the incapacity to develop the higher-technology tradable sectors that are essential to continue to increase productivity at higher levels of development. I would add that this problem is compounded by the challenges faced by “latecomers” into any activity; entering into new activities to diversify the production structure is made more difficult by the entry costs associated with technological learning and the need to capture markets from other firms, most probably sacrificing profit margins. Smallness is a further complication—and most of the Gulf countries are small by international standards—when activities are characterized by scale economies and/or the external economies provided by the development of complementary activities, a typical problem in manufacturing activities.

The structural challenges are formidable in very rich natural resource economies. This is why the “leading hand of the state”—the editors’ terminology in this volume—is a sine qua non of any diversification strategy, and should focus on the development of “sophisticated tradables” that are critical for productivity growth at high-income levels. This involves an array of policy instruments, which, to quote from the concluding chapter of the volume, include “subsidies to support exporters and taxes on firms in the nontradables, access to financing and business support services through venture capital funds, development banks, and export promotion agencies, and the creation of special economic zones, industry clusters, research-and-development centers, and start-up incubators.” This is an excellent summary, not only of the different authors’ contribution to this volume, but of an extensive literature on industrial policies in emerging market and developing economies. This involves exploiting the forward and backward linkages of the commodity sectors, to use Albert Hirschman’s terminology, but also developing entirely different activities, which are essential for a strong diversification—vertical and horizontal diversification, in the terminology of this book. Skills and human capital are essential but, as some chapters in this volume point out, they can be created through the diversification process, indeed as part of the broader learning that successful development of alternative economic activities require.

Let me also underscore the cyclical dimensions associated with the management of commodity price cycles, and particularly those cycles of longer duration, such as that experienced with the commodity boom of the 1970s (including, in the case of oil, the two oil shocks) and the collapse, first for non-oil commodities in the early 1980s and later for oil in 1986, which lasted for almost two decades. The new boom started in 2003–04, lasted for about a decade, and came to an end—sharply so in the case of oil. Indeed, as both cycles show, one of their major features has been the tendency for oil prices to experience stronger booms, but also stronger busts.

The management of these cycles requires extraordinary countercyclical policies to avoid an excessive expansion of aggregate demand during booms, which would tend to increase the relative prices of nontradables, generating a real exchange rate appreciation that would hurt non-resource-based tradable activities, either for export or competing with imports. If the latter effect is strong, firms active in those tradable activities may go bankrupt during commodity booms, with lasting effects on structural diversification and productivity, to the extent that the latter is associated with production experience (that is, learning). Furthermore, unless there are explicit policies to diversify production activity, the incentives to do so during commodity booms would be very limited. In either case, the economy would destroy or fail to create the sectors that are likely to provide the growth engines when commodity prices weaken.

This means that the management of commodity booms must count, first of all, on strong instruments to increase savings, and keep them abroad. This is what natural-resource-rich countries have learned to do with the creation of sovereign wealth funds and the accumulation of massive foreign exchange reserves. However, in the case of the Gulf countries, these countercyclical savings were insufficient during the boom of the 1970s and early 1980s, leading to what the editors of this book call the “Greatest Depression”: the fact that per capita consumption fell by about 20 percent after the boom and did not recover to previous levels until the late 2000s. But, as pointed out in the previous paragraph, aside from savings there must be explicit policies to use the resources generated by the natural resource boom to promote new economic activities; otherwise the economy would lack growth engines when commodity prices collapse. Promoting new activities is, of course, a must during the periods of weak commodity prices, but the crisis conditions that then prevail and the reduced resources available may not be the best environment to promote new activities.

The Gulf economies, the focus of this book, have experienced these challenges in a remarkable way, as is reflected in the already mentioned “Greatest Depression” but also in the related fact that their per capita incomes relative to those of developed countries fell massively in the 1980s and 1990s before catching up only marginally during the recent commodity boom. Furthermore, efforts to diversify have only been partially successful in these economies. But the problem is broader, as the analysis of other regional experiences in this book indicates. The East Asian experience is the success story, as the review of the cases of Korea, Malaysia, and Singapore indicate, of which the latter two are more directly relevant to the Gulf countries, given that Malaysia is a commodity-rich country and Singapore is a small economy. As Chapter 6 describes, the Latin American experience is a less successful one, particularly during the era of market reforms that started in the 1980s (in the 1970s in a few countries), because the region has experienced “premature de-industrialization,” that is, de-industrialization at lower per capita income levels than those at which it started to take place in developed countries. This is despite some success stories in terms of designing policy instruments, such as the development bank of Brazil (BNDES), as explained in Chapter 9.

Related Country Data

Korea Country Report

Malaysia Country Report

Singapore Country Report

I congratulate the editors and authors of this book for their contribution to the analysis of these issues, which have become even more important because of the major challenges that all commodity-dependent economies now face as a result of the end of the 2004–2013 super-cycle of commodity prices. It should inspire the design of new policy frameworks, difficult as it may be to implement them under crisis conditions.

José Antonio Ocampo

Professor, Columbia University

Formerly Under-Secretary General of the United Nations for Economic and Social Affairs, Executive Secretary of the Economic Commission for Latin America and the Caribbean, and Minister of Finance and Minister of Agriculture of Colombia

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