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Natural Resources and Economic Growth: The Role of Investment Thorvaldur Gylfason and Gylfi Zoega

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Sources of growth: Investment and education ++ + denotes a positive effect in the direction shown

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++ + Adam Smith knew this, and more, as did Arthur Lewis Sources of growth: Investment and education Solow raised doubts on long- run linkages Nelson and Phelps on education

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More sources of growth + + + denotes a positive effect in the direction shown + Arthur Lewis: x is trade, stable politics, good weather But Solow carried the day: long-run growth is exogenous

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Enter initial income + + + – + denotes a positive effect in the direction shown – denotes a negative effect in the direction shown ? Conditional convergence

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Asolute convergence? Do poor countries catch up? r = -0.09 Botswana China Korea Nicaragua Thailand Indonesia No sign that poor countries grow faster than rich 85 countries r = rank correlation

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Enter natural resources + + + –– + denotes a positive effect in the direction shown – denotes a negative effect in the direction shown ? Endogenous growth: x can be almost anything! Dutch disease and rent seeking

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+ + + –– – More on natural resources ? Recent papers: Natural resource abundance reduces high- skill labor intensity, thus hurting growth

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+ + + –– – – More on natural resources ? Natural resource abundance reduces investment and hence also growth This paper: Natural resource abundance reduces investment and hence also growth

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Aims and overview natural resource intensity, saving, and investment Explore the relationship between natural resource intensity, saving, and investment in theory as well as empirically across countries since 1965 saving, investment, and economic growth Explore also the linkages among saving, investment, and economic growth across countries since 1965 Hypothesis: Resource abundance reduces growth Hypothesis: Resource abundance reduces growth via investment

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Outline 1.Introduction 2.Preview 3.Literature 4.Norway 5.Theory 6.Correlations 7.Regressions 8.Conclusion

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Natural resource abundance and economic structure Resource poor, resource dependent (Chad, Mali) Resource rich, resource dependent (OPEC) Resource rich, resource free (Canada, USA) Resource poor, resource free (Jordan, Panama) Resource dependence, b Resource abundance, N

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Natural capital and economic growth 85 countries What is the empirical evidence? r = rank correlation An increase in the natural capital share by 8% goes along with a decrease in per capita growth by 1% per year. r = -0.64 8 African countries I/Y = 0.05 8 Asian countries I/Y = 0.32 Notice two clusters A new measure of natural resource abundance A new measure of natural resource abundance Confirms results based on other measures Confirms results based on other measures Venezuela Australia

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Recent literature Four main linkages: 1.Dutch disease Hurts level or composition of exports 2.Rent seeking Protectionism, corruption 3.Education 4.False sense of security Poor quality of policies and institutions 5. Investment But Norway is, so far at least, an exception Foreign capital Social capital Human capital Real capital Natural capital tends to crowd out

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Theory: Optimal saving Ramsey Golden Rule

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Implications for optimal saving An increase in the share of natural resources in national output reduces the marginal productivity of capital and the real interest rate, and reduces thereby also the optimal saving rate and economic growth Natural capital crowds out physical capital An increase in the natural capital share may also hamper financial development

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More theory: Endogenous growth Ramsey rule

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More theory: Endogenous growth Discrepancy between privately and socially optimal growth varies directly with the share of natural resources in national income Privatelyoptimal Socially optimal Extent of market failure varies directly with the share of natural resources in national income

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Empirical research strategy Study 85 industrial and developing countries from 1965 to 1998 cross-country patterns Look for cross-country patterns in data from the World Bank Investment and natural resources genuine saving Investment, genuine saving, gross saving Investment and growth Financial depth regression analysis Dig deeper through regression analysis

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Natural capital and investment 85 countries An increase in the natural capital share by 10% is associated with a decrease in investment by 2% of GDP. r = -0.38 Congo Sierra Leone Mali

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Investment and economic growth 85 countries r = 0.65 An increase in investment by 4% of GDP is associated with an increase in per capita growth by 1% per year. Congo Chad Nicaragua

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From gross investment to genuine saving quality Gross investment does not take quality into account Genuine domestic saving Genuine domestic saving is adjusted for quality, and is defined as Gross domestic saving minus Depreciation of physical capital plus Expenditure on education minus Depreciation of natural capital Energy, minerals, forests, carbon dioxide

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Natural capital and genuine saving 85 countries An increase in the natural capital share by 10% is associated with a decrease in genuine saving by 4% of GDP. r = -0.53 Japan Botswana Mauritania

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Genuine saving and economic growth 85 countries An increase in genuine saving by 6% of GDP goes along with an increase in per capita growth by 1% per year. r = 0.72 Mauritania Mozambique Cote d’Ivoire China

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Natural capital and gross saving 85 countries An increase in the natural capital share by 10% is associated with a decrease in gross saving by 4% of GDP. r = -0.40 Botswana China Zambia Niger

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Gross saving and economic growth 85 countries r = 0.73 An increase in gross saving by 6-7% of GDP goes along with an increase in per capita growth by 1% per year. Mozambique Venezuela Thailand Zambia

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Summary of results We have seen that, across countries: 1.Economic growth varies directly with three different measures of saving and investment 2.The three measures of saving and investment are all inversely related to natural capital 3.Economic growth varies inversely with natural capital

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Summary of results Growth Investment Growth Resources Investment + =

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Financial depth Resource-abundant nations may feel they have less need for finance Smooth out consumption over time by adjusting the pace of resource extraction If so, a high natural capital share may go along with limited financial depth, low investment, and slow growth

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Natural capital and financial depth 85 countries r = -0.68 Italy Portugal New Zealand

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Financial depth and economic growth 85 countries r = 0.66 Jordan Switzerland JapanIndonesia

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Regression results Note: 85 observations. Method of estimation is SUR. t-statistics are shown within parentheses. Dependent variable Constant Natural capital Initial income Enrol- ment rate Invest- ment rate R2R2R2R2 Economic growth 10.1 (6.0)-0.06 (4.6) -1.54 (7.3) 0.05 (5.5) 0.10 (3.5) 0.67 Enrolment rate -103.7 (7.5) -0.75 (4.2) 19.9 (12.4) 0.72 Investment rate 22.5 (29.3) -0.20 (4.1) 0.16 Recursive system

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Regression results Note: 85 observations. Method of estimation is SUR. t-statistics are shown within parentheses. Dependent variable Constant Natural capital Initial income Enrol- ment rate Invest- ment rate R2R2R2R2 Economic growth 10.1 (6.0)-0.06 (4.6) -1.54 (7.3) 0.05 (5.5) 0.10 (3.5) 0.67 Enrolment rate -103.7 (7.5) -0.75 (4.2) 19.9 (12.4) 0.72 Investment rate 22.5 (29.3) -0.20 (4.1) 0.16 Recursive system Direct effect of natural capital on growth is -0.06

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Regression results Note: 85 observations. Method of estimation is SUR. t-statistics are shown within parentheses. Dependent variable Constant Natural capital Initial income Enrol- ment rate Invest- ment rate R2R2R2R2 Economic growth 10.1 (6.0)-0.06 (4.6) -1.54 (7.3) 0.05 (5.5) 0.10 (3.5) 0.67 Enrolment rate -103.7 (7.5) -0.75 (4.2) 19.9 (12.4) 0.72 Investment rate 22.5 (29.3) -0.20 (4.1) 0.16 Recursive system

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Regression results Note: 85 observations. Method of estimation is SUR. t-statistics are shown within parentheses. Dependent variable Constant Natural capital Initial income Enrol- ment rate Invest- ment rate R2R2R2R2 Economic growth 10.1 (6.0)-0.06 (4.6) -1.54 (7.3) 0.05 (5.5) 0.10 (3.5) 0.67 Enrolment rate -103.7 (7.5) -0.75 (4.2) 19.9 (12.4) 0.72 Investment rate 22.5 (29.3) -0.20 (4.1) 0.16 Recursive system Indirect effect through education is -0.75·0.05 -0.04

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Regression results Note: 85 observations. Method of estimation is SUR. t-statistics are shown within parentheses. Dependent variable Constant Natural capital Initial income Enrol- ment rate Invest- ment rate R2R2R2R2 Economic growth 10.1(6.0)-0.06(4.6)-1.54(7.3)0.05(5.5)0.10(3.5)0.67 Enrolment rate -103.7(7.5)-0.75(4.2)19.9(12.4)0.72 Investment rate 22.5(29.3)-0.20(4.1)0.16 Recursive system

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Regression results Note: 85 observations. Method of estimation is SUR. t-statistics are shown within parentheses. Dependent variable Constant Natural capital Initial income Enrol- ment rate Invest- ment rate R2R2R2R2 Economic growth 10.1(6.0)-0.06(4.6)-1.54(7.3)0.05(5.5)0.10(3.5)0.67 Enrolment rate -103.7(7.5)-0.75(4.2)19.9(12.4)0.72 Investment rate 22.5(29.3)-0.20(4.1)0.16 Recursive system Indirect effect through investment is -0.20·0.10 = -0.02

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Regression results Note: 85 observations. Method of estimation is SUR. t-statistics are shown within parentheses. Dependent variable Constant Natural capital Initial income Enrol- ment rate Invest- ment rate R2R2R2R2 Economic growth 10.1(6.0)-0.06(4.6)-1.54(7.3)0.05(5.5)0.10(3.5)0.67 Enrolment rate -103.7(7.5)-0.75(4.2)19.9(12.4)0.72 Investment rate 22.5(29.3)-0.20(4.1)0.16 Recursive system Total effect is -0.06 + (-0.75)·0.05 + (-0.20)·0.10 -0.12

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Summary of results 10 An increase in the natural capital share by 10 percentage points reduces growth directly by 0.6 points reduces enrolment by 8 points, lowering the growth rate further by 0.4 points reduces investment by 2% of GDP, lowering growth further by 0.2 points 1.2 So, the total effect on growth is -1.2 percentage points – not small at all!

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More regression results Dependent variable Natural capital Initial income Enrol- ment rate Gross saving rate Financial depth R2R2R2R2 Economic growth -0.06(5.2)-1.64(9.2)0.04(5.4)0.09(6.4)0.74 Enrolment rate -0.90(5.2)16.0(10.1)0.70 Gross saving rate -0.26(2.5)4.95(3.0)0.28 Financial depth -0.03(7.4)0.39 Note: 85 observations. Method of estimation is SUR. t-statistics are shown within parentheses. Suppress constants

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More regression results Dependent variable Natural capital Initial income Enrol- ment rate Gross saving rate Financial depth R2R2R2R2 Economic growth -0.06(5.2)-1.64(9.2)0.04(5.4)0.09(6.4)0.74 Enrolment rate -0.90(5.2)16.0(10.1)0.70 Gross saving rate -0.26(2.5)4.95(3.0)0.28 Financial depth -0.03(7.4)0.39 Note: 85 observations. Method of estimation is SUR. t-statistics are shown within parentheses.

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More regression results Dependent variable Natural capital Initial income Enrol- ment rate Gross saving rate Financial depth R2R2R2R2 Economic growth -0.06(5.2)-1.64(9.2)0.04(5.4)0.09(6.4)0.74 Enrolment rate -0.90(5.2)16.0(10.1)0.70 Gross saving rate -0.26(2.5)4.95(3.0)0.28 Financial depth -0.03(7.4)0.39 Note: 85 observations. Method of estimation is SUR. t-statistics are shown within parentheses.

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More regression results Dependent variable Natural capital Initial income Enrol- ment rate Gross saving rate Financial depth R2R2R2R2 Economic growth -0.06(5.2)-1.64(9.2)0.04(5.4)0.09(6.4)0.74 Enrolment rate -0.90(5.2)16.0(10.1)0.70 Gross saving rate -0.26(2.5)4.95(3.0)0.28 Financial depth -0.03(7.4)0.39 Note: 85 observations. Method of estimation is SUR. t-statistics are shown within parentheses. Total effect is -0.06 + (-0.90)·0.04 + (-0.26)·0.09 + (-0.03)·4.95·0.09 -0.13

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Bottom line The End Natural resource intensity impedes economic growth by reducing or corroding 1.social capital through rent seeking, etc. through rent seeking, etc. 2.human capital through neglect of education through neglect of education 3.physical capital through blunted incentives to save and invest as well as financial immaturity through blunted incentives to save and invest as well as financial immaturity These slides can be viewed on my website: www.hi.is/~gylfason

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