There’s this somewhat understandable idea that because Malaysia is rich in natural resources, we are…well, rich. Or at least we should be, if the government had handled things properly.
If only we could harness our reserves of oil and gas and minerals effectively and efficiently…
If only we had invested in and boosted the productivity of our agricultural sector…
If only we managed our forests and bio-diversity for sustainable development…
If only natural resource extraction wasn’t subject to leakages and corruption…
If only, if only…
But there’s a slight problem with this mindset – the empirical evidence suggests that natural resources alone do not beget wealth or prosperity, that focusing on developing such assets actually undermines the foundation of long term growth and prosperity. In fact, in development circles, it’s more common to speak of natural resources as a “curse”, not a blessing.
The reasons why natural resources can be a curse are generally counterintuitive, which explains how so many people tend to somewhat naturally hold the opposite view. I mean, if we start off with a bigger endowment of resources than others then we should at least do as well or better, right? If Korea or Taiwan or Singapore can reach high income status without any natural resources to speak of, Malaysia should at least do as well or better, right?
There are various versions of the natural resource curse, including Dutch disease (investment in oil extraction diverted investment from manufacturing, thus reducing the ability to process raw materials into finished goods, which in turn reduced GDP growth).
But I want to focus on two particular aspects of the problem with having a large natural resource endowment.
The first is within the context of development theory, where structural changes in the economy springboard the economy from primarily agrarian- or mineral-based to industrial-based. The second aspect is the impact of volatility of income and income growth for producers of commodities.
Development economics continues to be in a state of flux, with continued debate over theoretical constructs and dispute over empirical evidence. Nevertheless, there is general agreement over some stylised facts about development, bearing in mind the 2-3 centuries worth of historical experience of development beginning with the Industrial Revolution.
One primary observation is this – growth and development occurs in conjunction with, or is caused by, an increase in the intensity of capital on primary industries leading to a movement of resources (labour and capital) away from natural resource exploitation and into secondary (manufacturing) and tertiary (services) sectors.
Let me repeat that…development doesn’t come from having natural resources, but in investing in sectors that use natural resources (whether local or otherwise) and combine them into products that people want. Having lots of oil is not enough, having lots of tin or rubber or palm oil are not enough and are in fact not necessary. It’s only through processing these items into things that people value, that growth really starts to take-off.
The point in investing in agriculture and mineral extraction isn’t so much to produce and sell more of the stuff, but to be able to do so efficiently and shift labour from low value added activities to higher value added activities. The point of raising agriculture productivity isn’t really about producing more food, but to produce as much or more with less people, so more people could do things that are more productive and make things that are valued by others.
After all, what’s GDP but an aggregation of profit across an economy? And what is profit, but an aggregation of value-adding to raw materials? Who makes the most income – the miner who digs copper and tin and tungsten and rare earths, or the one who designs and puts together all these materials and more into a smartphone?
Now at this juncture somebody might bring up the Middle East, and how those countries became rich in a generation from selling oil…at least, those that actually had oil. These leads me to my next point – volatility kills.
In 1980, the UAE had a per capita income 327% higher than the United States in nominal USD terms; Kuwait was at 171%, while Saudi Arabia was at 144%. Even Libya boasted a per capita income level at par with the US.
But in 1981, Fed Chairman Paul Volcker put the brakes on US monetary base growth, and slew the 1970s stagflation dragon. The consequences were far reaching – the US dollar zoomed, interest rates rose around the world, commodity prices crashed, and global trade contracted.
Within a decade, both the UAE and Kuwait had lost more than 70% of their relative income levels, to just 90% and 51% of US per capita income; Libya and Iran saw similar relative income losses. Saudi Arabia lost comparatively more ground, with a nearly 80% drop to just over a third of US incomes.
Most commodity producers suffered similar income collapses, particularly in Latin America where commodity price troubles were compounded by a sovereign debt crisis. In East Asia, Thailand and Malaysia lost a third (though Thailand subsequently recovered by the end of the decade), while Indonesia fell back 50%.
Fast forward to today, none of the Middle Eastern oil producers have revisited their 1980 income peaks. The UAE, as rich as they are now, are still 60% below; Libya, Kuwait and Saudi Arabia are between 75% to 50% below.
If that isn’t enough evidence, Australia has a decently diversified economy but was and still is a big producer of both agricultural and mineral commodities. In 1981, Australian per capita income was 92% of the US level. It took more than 25 years – until 2007 – before that peak was surpassed, a period which encompassed a drop to just 53% of the US income level (in 2001).
By contrast most industrial economies with few natural resources, such as Taiwan, Korea and Japan, barely missed a beat in the 1980s; while commodity producing countries with better diversified economies (such as Australia and Brazil) tended to suffer less or did nearly as well:
Per capita income relative to the US (gain/loss from 1980-1989)
|Hong Kong|| |
|Saudi Arabia|| |
|United Arab Emirates|| |
Note that forex movements don’t explain much of the changes in income differentials, for while the major currencies were free floating, smaller countries tended to have explicit or implicit pegs against the USD.
Having natural resources guarantees nothing, and in fact can function as a big drag on growth. Low global commodity prices can hammer income levels, never mind growth. Beyond price volatility, concentrating on commodity production leaches capital and labour from higher value added activities.
Let’s take a more concrete example: Say you’re an estate owner with your own refineries selling crude palm oil. You produce 1,000 tons of CPO every month, and manage to increase productivity 1% per annum. I’m going to use the monthly price data from the IMF’s primary commodity price database (link).
Here’s what your annual revenue stream looks like, in USD:
I’ve included the inflation adjusted figures for a better idea of the actual purchasing power of income you’d have gotten. Prices rose until the mid 1980s, but subsequently crashed and were low for nearly a decade. There was another price boom in the late 1990s that lasted until about 1999, before another retreat until the commodity bubble of the last decade. However in inflation adjusted terms, revenue didn’t recover to early 1980s levels until 2010!
Remember, I’ve also factored in a 1% annual productivity improvement, which in this case means that by 2012 production was 37% higher in 2012. Take that away, and 2012 revenue would still not have revisited the early 1980s peaks. In fact the recent peak of 2011 would be 11% below 1980.
Here’s a different perspective (click on the graphs for a closer look):
On average, revenue grew 3.1% every year, with the median growth at 9.8%. But the standard deviation is 28.1%, which if the distribution is standard normal means that 95% of the time your revenue could go up or down more than 50% in any given year. But the distribution isn’t standard normal and in actuality is skewed towards the negative side, which suggests sharp changes in revenue growth are skewed towards the downside. Again, this little example assumes constant annual productivity increases, which means I’ve deliberately slanted the results towards positive revenue growth.
Who says having natural resources means we should be rich?
In Malaysia’s case, it’s probably more pertinent – and accurate – to wonder not why we aren’t rich when we have abundant natural resources, but rather how Malaysia has managed to grow so far and so fast despite the handicap of having abundant natural resources.