1. Lessons from the Dutch Disease: Causes, Treatment, and Cures Thorvaldur Gylfason

2. Overview of presentation 1.Origins and symptoms of the Dutch disease 2.Thinking about natural resources and economic growth 3.Interlude on OPEC 4.Empirical evidence on resources and growth around the world 5.The special case of Norway

3. Neither Dutch nor a disease Discovery of off-shore oil and gas in late 1950s, early 1960s Resulting upswing in exports of natural gas led to appreciation of Dutch guilder This hurt other exports for a while Threat of de-industrialization The problem proved short-lived But the name stuck 1

4. The Dutch disease: Some symptoms Overvaluation of the currency Exchange rate volatility Excessive wages Faroes, Greenland Centralized wage bargaining All this hurts the level or skews the composition of exports May also hurt FDI

5. Exports of goods and services 1960-1997 (% of GDP) What does experience show? Norway’s oil exports have crowded out non-oil exports krone for krone relative to GDP

6. Foreign direct investment 1975-1998 (% of GDP, ppp) In 1998, Norway attracted less FDI than the Netherlands, and also less than Sweden (23%) and Finland (36%)

7. Manufacturing exports 1980- 1998 (% of total exports) No growth in Norway’s manufacturing exports relative to total exports since 1980

8. Why these things may be important Exports and FDI are good for growth Openness to trade and investment stimulates imports of goods and services, technology, ideas, know-how Too much primary export dependence and too little manufacturing may hurt growth growth is key So, economic growth is key

9. Thinking about natural resources and growth Naturalresources Economicgrowth x 2

10. Naturalresources Economicgrowth x What is x ?

11. Five channels of transmission 1. The Dutch disease Exchange rates, wages, volatility Hurts level or composition of exports 2. Rent seeking Protectionism, cronyism, corruption 3. Overconfidence Poor quality of policies and institutions education 4. Neglect of education 5. Too little investment Social capital

12. Crowding out Put differently, natural capital may crowd out Social capital Human capital Physical capital Matter of taste whether these mechanisms are viewed as additional symptoms of the Dutch disease or as separate channels of transmission

13. Interlude: A quick look at OPEC Nigeria has been stagnant since independence in 1960: No growth Per capita growth 1965-1998 Iran and Venezuela: -1% per year Libya: -2% Iraq and Kuwait: -3% Qatar: -6% Why? 3

14. Background: A quick look at OPEC King Faisal of Saudi Arabia (1964- 1975) would hardly have been surprised: “In one generation we went from riding camels to riding Cadillacs. The way we are wasting money, I fear the next generation will be riding camels again.”

15. Increasing awareness that oil brings risks If... oil revenue is managed well, it can educate, heal and provide jobs for... the people. But oil brings risks as well as benefits. Rarely have developing countries used oil money to improve the lives of the majority of citizens or bring steady economic growth. More often, oil revenues have caused crippling economic distortions and been spent on showy projects, weapons and Paris shopping trips for government officials. New York Times, 1 August 2000.

16. Is OPEC an exception? No, this seems to be a general pattern. Of 65 natural resource abundant countries 1970-1998, only four had Investment of more than 25% of GDP Per capita GNP growth of more than 4% per year They are: Botswana, Indonesia, Malaysia, Thailand

17. But let’s be careful: Norway stands out The problem is not the existence of natural wealth as such... but rather the failure to avert the dangers that accompany the gifts of nature Norway is, so far, a success story Government takes in 80% of oil rent and invests it mostly in foreign securities No signs of damage to growth potential, at least not yet (more on this later)

18. Natural capital and growth: The evidence Review a few of the empirical findings of the new literature on natural resource abundance and growth Present cross-country evidence Individual historical case studies support the results Stress linkages between natural capital and various determinants of growth as well as growth itself 4

19. Economic growth and natural capital 85 countries What is the empirical evidence? A new measure of natural resource abundance Confirms results based on other measures r = rank correlation Norway r = -0.64 A ten percentage point increase in the natural capital share goes along with a decrease in per capita growth by 1% per year.

20. 91 countries A ten percentage point increase in the natural capital share goes along with a decrease in openness by 4% of GDP. Openness and natural capital Norway r = -0.33

21. 60 countries Corruption and natural capital A ten percentage point increase in the natural capital share goes along with an increase in corruption by 1.3 points. r = -0.52 Norway Natural capital crowds out social capital

22. Education and natural capital Now consider the relationship between natural resource abundance and two different measures of national commitment to education: 1. Public expenditure on education as percentage of GNP 2. Secondary-school enrolment as percentage of each cohort

23. Expenditure on education and natural capital An 18 percentage point increase in the natural capital share is associated with a decrease in public expenditure on education by 1% of GNP. 90 countries r = -0.32 Norway Norway is close to the top of the list of countries ranked by public expenditure on education

24. Expenditure on education and natural capital An 18 percentage point increase in the natural capital share is associated with a decrease in public expenditure on education by 1% of GNP. 90 countries r = -0.32 Norway Natural capital crowds out human capital

25. Secondary enrolment and natural capital A five percentage point increase in the natural capital share goes along with a decrease in secondary-school enrolment by almost 10 percentage points. 91 countries r = -0.66 College enrolment has risen from 26% in 1980 to 62% in 1997 Norway

26. Secondary enrolment and natural capital A five percentage point increase in the natural capital share goes along with a decrease in secondary-school enrolment by almost 10 percentage points. 91 countries r = -0.66 Norway Natural capital crowds out human capital

27. Economic growth and education 87 countries r = 0.69 Norway A 30 point increase in the secondary enrolment rate goes along with an increase in per capita growth by 1% per year. Education is good for growth and vice versa

28. Summary of results on education Growth Education Growth Resources Education + =

29. Summary of results on education We have seen that, across countries: 1.Public expenditure on and enrolment in education are both inversely related to natural resource abundance 2.Economic growth varies directly with education 3.Economic growth varies inversely with natural resource abundance

30. Interpretation of results high-skill labor high-quality capital Natural-resource-based industries are generally less high-skill labor intensive and less high-quality capital intensive than others, and so confer few external benefits distort comparative advantage impede learning by doing, technical advance, and economic growth

31. Investment and natural capital 85 countries r = -0.38 A ten point increase in the natural capital share goes along with a decrease in investment by 2% of GDP. Natural capital crowds out physical capital Norway

32. Economic growth and investment 85 countries r = 0.65 A five point increase in the natural capital share goes along with an increase in per capita growth by 1%. Norway Investment is good for growth and vice versa

33. Summary of results on investment Growth Investment Growth Resources Investment + =

34. Summary of results on investment We have seen that, across countries: 1.Investment is inversely related to natural resource abundance 2.Economic growth varies directly with investment 3.Economic growth varies inversely with natural resource abundance

35. The special case of Norway 5 Large petroleum sector Large petroleum sector Contributes 25% of GNP and almost 50% of exports (2000) Contributes 25% of GNP and almost 50% of exports (2000) Second largest oil exporter in the world Second largest oil exporter in the world Oil wealth is estimated at 50-250% of GNP Oil wealth is estimated at 50-250% of GNP State takes in about 80% of oil rent State takes in about 80% of oil rent Mostly through taxes and fees Mostly through taxes and fees The oil is a common property resource by law The oil is a common property resource by law Oil revenue is deposited in oil fund Oil revenue is deposited in oil fund Invested in foreign securities Invested in foreign securities

36. The oil fund: A fair and efficient strategy The purpose of the oil fund The purpose of the oil fund To share the wealth fairly across generations To share the wealth fairly across generations To shield domestic economy from overheating and possible waste To shield domestic economy from overheating and possible waste Fund will become huge... Fund will become huge... if Norwegians resist the temptation to use too much of the money to meet current needs

37. Why Norway has succeeded where OPEC failed Long tradition of democracy and market economy in Norway since before the advent of oil Long tradition of democracy and market economy in Norway since before the advent of oil Large-scale rent seeking was averted Large-scale rent seeking was averted Adequate investment performance Adequate investment performance Excellent education record Excellent education record Even so, Norway faces challenges Even so, Norway faces challenges Some (weak) signs of Dutch disease Some (weak) signs of Dutch disease Stagnant exports, sluggish FDI Stagnant exports, sluggish FDI

38. One last point Perhaps the main challenge is to make sure that the oil fund does not instill a false sense of security Perhaps the main challenge is to make sure that the oil fund does not instill a false sense of security May need to immunize the fund from political interference -- like the courts, media, even central banks May need to immunize the fund from political interference -- like the courts, media, even central banks This may require privatization This may require privatization But private sector is not infallible either But private sector is not infallible either So, best to adopt a mixed strategy So, best to adopt a mixed strategy

39. Good times demand strong discipline The End Natural resources bring risks Natural resources bring risks A false sense of security leads people to underrate or overlook the need for good policies and institutions, good education, and good investment A false sense of security leads people to underrate or overlook the need for good policies and institutions, good education, and good investment Awash in easy cash, they may find that hard choices perhaps can be avoided Awash in easy cash, they may find that hard choices perhaps can be avoided Awareness of these risks is perhaps the best insurance policy against them Awareness of these risks is perhaps the best insurance policy against them