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Development Based on Commodity Revenues: Theory and Russian Evidence Konstantin Sonin , New Economic School. February 18, 2011 Leontieff Center, St. Petersburg. Road map. B asic tradeoff: fantastic growth in Aze, Kaz, Rus, Tkm since 1999 volatility and a looming long run “resource curse”

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Development Based on Commodity Revenues:Theory and Russian EvidenceKonstantin Sonin,New Economic School

February 18, 2011

Leontieff Center, St. Petersburg


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Road map

  • Basic tradeoff:

    • fantastic growth in Aze, Kaz, Rus, Tkm since 1999

    • volatility and a looming long run “resource curse”

  • Economic Growth in Resource Rich Countries

    • theoretical arguments and empirical evidence.

  • Policy Goals and Policy Tools

    • development strategy for resource-rich countries

  • Diversification Policies in Resource Rich Countries

    • actual policy response of countries to resource riches

  • Assessment

    • How successful were they?


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Commodity boom underpinned growth...

  • Impressive growth records in oil and gas producing countries in the region

    • Turkmenistan, Azerbaijan, Kazakhstan, Russia

  • In particular in nominal (US dollar) terms


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… but at the expense of great risks

  • large growth corrections during crisis: macro volatility

  • Potential “resource curse” affecting long run growth


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Commodity rents and development

  • Commodity rents may be a blessing

    • developing countries fail to catch up because of an underdevelopment trap (fixed costs to investment; externalities across sectors): “big push” needed

    • commodity export revenues could finance such big push

  • Commodity rents might be a curse

    • depress long-run growth by causing macroeconomics distortions and excess volatility

    • have a negative effect on political institutions


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Commodity rents and investment

  • Reliance on commodity exports

    • leads to high terms-of-trade volatility

    • discourages investment, especially if financial systems are not sufficiently developed

    • affects human capital (uncertain returns)

  • Dutch disease

    • underinvestment in high learning by doing technologies (manufacturing), or technologies that are otherwise particularly beneficial for long run growth


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Macro lessons learned

  • in macro, little resembled petrostates of late 70s

  • fiscal conservatism (up until 2008)

    • budget control

    • debt repayment

    • stabilization funds, despite huge political pressure

  • mild political pressure on Central Bank (up until 2008)

  • control of ‘white elephants’ (up until 2007)

    • lesson “unlearned” by 2010


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“Resource curse 2.0”: Institutions

  • Commodity resources discourage investment in good institutions

    • good institutions limit rent seeking

    • flexibility to “seek” rents is more valuable to politicians in resource-rich environment

  • “Institutional Trap”

    • if institutions are bad to start with in a resource-rich economy, they are not likely to improve

  • Interactions with inequality

    • when the same amount of rents is appropriated by fewer members of the elite, rent-seeking strategy becomes even more attractive

    • in resource rich environment, inequality and poor institutions are mutually reinforcing

    • high inequality is bad for growth (particularly with imperfect capital markets. as poor with entrepreneurial skills have no access to capital)


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“Resource curse 2.0”: Evidence

  • Oil revenues have adverse impact :

    • on property rights (Guriev, Kolotilin, and Sonin, JLEO, 2011)

    • on corporate governance (Durnev and Guriev, 2009)

    • on media freedom (Egorov, Guriev, and Sonin, 2009)

    • on democracy (Ross, 2001, 2009)

    • on regulation and reforms to improve business climate in non-resource sectors (Amin and Djankov, 2009)

    • on political stability and likelihood of civil unrest (Ross, 2006)



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Why diversification

  • lowers vulnerability to external shocks

  • reduces relative size of resource rents and creates incentives to improve institutions (commitment device)


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Diversification Tools: Public Investment

  • “Vertical” policies: preferential treatment of specific non-resource industries

    • difficult to get right, especially in absence of good institutions

    • crowd out private investment

  • “Horizontal” policies: investment in education, infrastructure

    • more likely to complement private investment

    • again, less efficient in weak institutional environment


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Diversification Tools: Macro Policies

  • Sovereign wealth funds

    • prevent (in short-run) appreciation of currency or hikes in inflation, preserve (in short-run) competitiveness

    • smooth government expenditures over time

    • commitment device to prevent government’s pro-cyclical spending

    • could be used to finance development policies

  • Taxation of resource exports

    • per se cannot play a significant role in redirecting investment in an open economy (capital just flows to other countries, not to “right sectors”)


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Diversification Tools: Financial Development

  • helps to smooth effects of resource price volatility

  • benefits non-resource sectors, which are more dependent on external finance (cf. Rajan-Zingales)

    • works as a horizontal industrial policy

  • helps to match entrepreneurial ideas and funding

  • may help reduce (effects of) inequality

  • instruments:

    • improved regulation of banks and securities markets

    • deposit insurance

    • effective court systems


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Diversification Tools: Fighting Inequality

  • makes it easier to reform institutions in resource rich environments

  • instruments:

    • in developing countries typically implemented through government spending rather than taxation

    • ideally, through structural policies: labour mobility and education


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Examples of Substantial Progress

  • Diversification away from oil and gas is challenging, but there are examples of substantial progress

    • Chile: competitive agriculture and fishing (wine, salmon farming)

    • Malaysia: high-tech manufacturing integrated into South Asian and World production chains

    • Indonesia: medium-to-high-tech manufacturing, agriculture

    • Mexico: high-tech manufacturing based primarily on FDI by US firms


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Transition Countries

  • Russia and Kazakhstan made diversification cornerstone of development agenda

  • Public investment increased in all countries over commodity boom period

    • 3% to 4.5% of GDP in Russia;

    • 3% to 6% of GDP in Kazakhstan;

    • 2% to 10% of GDP in Azerbaijan.

  • Public spending on education:

    • 2.9 to 4% of GDP in Russia;

    • 3.3 to 4.2% of GDP in Kazakhstan


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Policies: Financial Development

  • Despite fast GDP growth (e.g., 8-fold in Russia in US$ nominal terms between 1998 and 2008) credit-to-GDP ratios have been growing rapidly


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Policies: Financial development

  • Rapid growth made possible due to entry of foreign banks

    • Especially in Kazakhstan

  • Loan-to-deposit ratios have been very high, well above regional average


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Policies: Financial Development

  • financial sector growth was facilitated by number of structural reforms

    • deposit insurance, credit bureaus, interest rates disclosure, revisions to legislation on collateral and bankruptcies

  • non-bank finance has also been growing, albeit at a lower pace

  • only in Russia reforms outpaced the non-oil-rich transition country average


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Policies: Sovereign wealth funds

  • Azerbaijan set up State Oil Fund in 1999

  • Kazakhstan established National Fund in 2000

    • Peaked at 30% of GDP (the largest in relative terms)

  • Russia: Stabilization Fund in 2004, subdivided into Reserve Fund and National Wealth Fund in 2008



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Assessment: Diversification

  • measures of structure of output / exports are distorted by oil price effects

    • directly (valuation)

    • indirectly (short-term incentives to produce and export)

  • Even Norway, Malaysia lost positions in UNIDO “Industrial Competitiveness” indices during the boom

  • compare oil / output structure at similar points in oil price cycle?


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Diversification in Russia: Comparison

  • Comparable periods in terms of average oil price:

    • Dec04-Apr05 and Dec08-Apr09

  • No evidence of diversification, there may be slight decline in manufacturing



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Structure of exports: Russia and Kazakhstan

  • exports structure suggests growing oil dependence in Kazakhstan and Azerbaijan

    • Partly reflects successful exploration, largely led by international firms (PSAs)

  • in Russia structure of exports was similar at similar points in the oil price cycle


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Structure of exports: Azerbaidzhan and non-oil countries

  • in other transition countries share of manufacturing exports has been increasing on average


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Assessment: Impact of Crisis

  • no clear link between commodity dependence and severity of the crisis on average (in terms of macro impact on growth)

    • indirect measure: deviation of 2009 forecast from the 1999-2008 average growth

    • if anything, the effect of commodity wealth is positive

  • all countries in the region drew on their fiscal and monetary reserves to finance sizable fiscal and monetary stimulus packages


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Assessment: Financial Development

  • Financial development supported real sector, but also exacerbated commodity cycle

    • very high leverage

    • rapid consumer credit growth

    • credit growth averaging 50%+, up to 115%, put strain on bank risk management and on supervisors

  • Overall, some cross-country evidence that while financial development softened the impact of crisis, excessively high loan-to-deposit ratios exacerbated it



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Assessment: Institutions

  • To look at diversification, compare export structures in 1991–92 and 2001–03 (oil at US$ 30-31 in 2008 prices)

  • Use share of food and higher-value-added manufacturing in exports (WTO data)

    • Technologically distanced from oil and gas

    • Bulk of developed countries’ exports (from 70% in Germany to 30% in Australia, but less than 10% in Rus, Kaz, Aze)


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Assessment: Institutions

  • export structures are generally “sticky” (correlation is 0.85)

  • oil rents suppress diversification, but this effect becomes insignificant when quality of institutions is included

  • quality of institutions is statistically and economically significant

  • one standard deviation improvement in the quality of institutions is associated with a 4 to 6 p.p. increase in share of higher-value-added manufacturing and food in merchandize exports

    • relationship is even stronger in the subsample of countries with weaker institutions (index below median)

    • result holds in a small subsample of countries where commodities accounted for 40%+ of merchandize exports at the start of the period

  • financial development per se or existence of sovereign wealth fund do not appear to have significant impact


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Assessment: Institutions

  • improving institutions remains a challenge



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A Russian problem…

Russia is 1.04st.dev. below the line;

Same if control for education, size, inequality etc…

Log GDP per capita, PPP, 2005


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Media freedom and Government Effectiveness

Replay

Egorov, Guriev, and Sonin (2009)


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Media freedom and Control of Corruption

Replay

Egorov, Guriev, and Sonin (2009)




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Conclusion

  • commodity revenues provide significant opportunities for financing investment but may also negatively affect growth

    • terms of trade volatility has negative impact on investment

    • structural shifts in accumulation/allocation of physical/human capital

    • incentives to engage in rent-seeking rather than improve institutions

  • diversification may be pursued via variety of strategies

    • direct investment in non-resource sectors

    • investment in education and infrastructure, fiscal redistribution

    • financial sector development

    • sovereign wealth funds


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Conclusion, ctd

  • diversification policies can be successful, but success crucially depends on institutions

    • democracy, media freedom, property rights, corporate governance, low tolerance for corruption

    • improving these institutions is a particularly challenging task in oil-rich societies

  • post-communist oil-rich countries have done well in terms of prudent macro policies

  • financial sector development

    • played an important role in supporting the real sector

    • extraordinary financial services boom fuelled by external borrowing in part amplified the effects of the commodity cycle


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Sources

  • Chapter 4 of the 2009 EBRD Transition Report

    • background paper “Development Based on Commodity Revenues”, with Sergei Guriev and Alexander Plekhanov

  • Own work on resource-dependence

    • Why Resource-Poor Dictators Allow Freer Media (with Georgy Egorov and Sergei Guriev), American Political Science Review, November 2009

    • Determinants of Nationalizations in the Oil Sector (with Sergei Guriev and Anton Kolotilin), Journal of Law, Economics, and Organization, 2011

  • Sergei Guriev and Ekaterina Zhuravskaya work

    • Why Russia is Not South Korea, Journal of International Affairs, 2010