John Hoffmire: Why do countries with oil reserves often do worse than they should?
Nabil al-Jurani, Associated Press
Imagine that you are online and all of the sudden you have the urge to participate in a lottery. A day later, you discover that you have won $100 million. You now have it made, right? Actually, according to the National Endowment for Financial Education, up to 70 percent of people who unexpectedly gained large fortunes will lose everything by the seventh year following their windfalls. This figure, while focused on individuals, speaks volumes about how a poor country could end up with much less than it expected after discovering oil.
According to Dr. Terry Karl from Stanford University, countries without oil grew four times faster than those with oil. This could be related to the fact that governments of countries that possess large deposits of oil often lose their interest in developing their economies Moreover, oil-rich countries tend to have a mediocre Gross National Product per capita and high inequality as measured by the GINI index (the higher the GINI index, the higher the economic inequality). Countries such as these are encircled in green below.
Countries encircled in orange are those that, in terms of GNP and inequality, managed to do as well as those without oil such as the U.K., France and South Korea. That is, they have a decent GNP and low inequality. More interestingly though, is the blue oval which encircles countries which produce very little or no oil — except Norway. They did remarkably better than oil-endowed states. As one of the outliers, the U.S. has a high GNP but it has high inequality. Qatar, with a remarkably high GNP per capita, has high inequality. Norway is the country that managed oil wealth in a way that drove low inequality.
If one can believe World Bank figures, the most well-endowed 10 percent in Nigeria controls 38.2 percent of wealth, whereas the bottom 10 percent controls only 1.8 percent. The real statistics, if they could be collected, are probably more skewed toward the top 10 percent controlling an even more dominant portion of the wealth.
Oil-rich countries often show severe lags in terms of life expectancy, educational attainment and income. This information is captured by the Human Development Index, according to which, Venezuela ranks 71, Mexico 61, Kuwait 53, Saudi Arabia 57, Russia 55 and Nigeria 153. Considering how oil-rich these countries are, they should have done better.
Many economic analyses have been offered to explain the poor outcomes found for people in many oil-rich countries. The first is the Dutch Disease explanation which posits that when a country finds oil, its exchange rate appreciates (the value of the local currency increases in comparison with foreign currencies). This works against a country’s export sector since it is more expensive for foreigners to buy local goods. For those who are wondering about the name, in 1959, the Netherlands discovered natural gas within its borders and the manufacturing sector fairly quickly was influenced in a negative way.
Also, oil-dependent countries have found that oil prices are quite volatile. As a result, they very rarely have the opportunity to plan ahead effectively. Also, oil-dependent countries often fail to diversify their economies away from oil. With this, other industries and agriculture are frequently not prioritized. In addition, having more money in circulation as a result of an oil-based economy can foster inflation.
Some oil-rich countries regularly charge little or no taxes to its citizens, this makes rulers less accountable. In such situations, transparency is often scarce and institutions are frequently weak. Hence, many resources are stolen by corrupt managers and politicians.
In the end, oil’s presence is not a curse on its own. More likely, it is mismanagement and the economic factors mentioned above that cause lackluster performance. In the meantime, many countries are wishing they might win the lottery.
John Hoffmire is director of the Impact Bond Fund at Saïd Business School at Oxford University and directs the School of Business and Poverty at the Wisconsin School of Business at UW-Madison. He runs Progress Through Business, a nonprofit group promoting economic development. Mario Mercado, Hoffmire’s colleague at Progress Through Business, did the research for this article.
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