## Saturday, August 24, 2013

### The problem

Shekhar Gupta and Swaminathan S. A. Aiyar have pointed out that our domestic policy logjam is leading to the import of natural resources which are amply present in mines in India. This is giving a bigger current account deficit and a weak rupee.

I feel this is not such a bad thing. Many countries have been afflicted by the resource curse and many countries have been afflicted by Dutch disease. We are blessed with reverse resource curse and reverse Dutch disease. Here's the argument.

### Reverse resource curse

The idea of the resource curse runs like this:
For many years, economists have been puzzled at the way things have gone wrong in countries where natural resources were discovered. In 1993, the economist Richard M. Auty coined the phrase Resource curse' to convey the extent to which natural resource finds are a curse and not a blessing. But the idea had been kicking around well before that. I suppose it was an obvious conjecture after watching the failures of the Middle East, where trillions of dollars of oil revenues were squandered by not one but many countries.

In the 1970s, when oil was discovered in Venezuela, former Oil Minister and OPEC co-founder Juan Pablo Perez Alfonzo said: "Ten years from now, 20 years from now, you will see, oil will bring us ruin." His phrase for oil was: "the devil's excrement."

Why are resources a curse? In a country blessed with no natural resources (think Japan), the only way forward for the ruling elite is the slow hard work of building public goods, so that GDP builds up, which then feeds back into the power and importance and utility of the ruling elite. When the ruling elite gets their wealth for free, without having to do the hard work of building public goods and thus GDP of the country, the rulers emphasise the wrong issues. That's how Venezuela ended up with Hugo Chavez.

On one hand, rulers get focused on finding ways to maximise their rent from the underlying resource flow, without developing the knowledge about how to build a State that delivers public goods. In parallel, competition between politicians becomes an unpleasant process of trying to grab the riches by means fair or foul, rather than a process of competing in doing better on public goods. If there are XX billion dollars to be grabbed by becoming head of state, fairly unpleasant tactics get used by rivals aiming for that job.
Source: Why does Bombay have abysmal governance, 6 November 2010, on this blog.

And, you may like to also see: Resource curse - comparing India and Russia, 21 February 2007 and The resource curse of land ownership, 12 January 2012.

For many years, resources in India were a messy business. Now, we have started getting push back in terms of greater scrutiny and medium-grade enforcement. This has exerted a sharp negative impact on this business.

This is not such a bad thing. A country that lacks good institutions is better off without natural resources! If we hide the natural resources into the ground for 25 years, while we build good institutions, that is a good deal. It is far better to do this than to face the destruction of institutions which comes from natural resources impacting upon a badly constructed political system.

If we were advising a tin pot dictator who has just found oil, what's the best advice we could give? We would say: Burn all the documents about this oil find, and build the rule of law for the next 25 years. It is an achievement of Indian democracy and institutions that the reduced form outcome is one of restraint rather than exploitation of these natural resources. If this restraint had not come about, it would have distorted the trajectory of Indian politics, possibly with disastrous consequences for our future.

### Reverse Dutch disease

At present, the exchange rate in Sri Lanka reflects a combination of competitiveness of the tradeables sector and financial considerations. Suppose there is a great oil find there. A surge of oil exports from Sri Lanka would then commence. This would exert pressure for the exchange rate to appreciate. This would damage the development of the tradeables sector which would not be able to compete at that distorted exchange rate. This has been termed Dutch Disease' as it was first described in the context of the impact of North Sea oil.

We in India are getting the reverse. Excessive imports of natural resources, of even the things that are found under the ground in India, is exerting pressure on the exchange rate in favour of excessive depreciation. This will foster the tradeables sector. Reverse Dutch disease is not such a bad thing.

### Conclusion

It is curious and remarkable that India is importing things that are found under the ground in India, owing the domestic institutional logjam. But we should resist calls to cut the Gordian knot and debottleneck the resources business in messy ways. It is much better for us to dig in and build good institutions, rather than find short cuts through which natural resource exploitation can hurriedly take place. This will surely take a long time. In the meantime, this will generate currency weakness. This is not such a bad thing.

1. Most natural resources are virtually certain to be in shorter supply twenty years from now than today. To that extent, we are better off hoarding on our own reserves and depleting what other people own. Instead of crying about the rupee depreciation we will be better off if we use the opportunity to boost exports.

2. Shekhar Gupta wasn't simplistically mourning the non-mining of resources; he was implicitly criticising the lack of institutionalisation of appropriate extraction and utilisation of these resources. The only disease really is the misallocation of capital, be that from the crowding out of domestic industry from overinvestment in resource exports, or the overdependence on imported resources, hence crowding out domestic investment and its multipliers. If we are able to arrive at the true cost of local resources, accounting for land rights , compensation, environment and such, and compare it with imports also facotring, at the very least, being short a (political) put to our suppliers, then we can have an enlightened argument about whether we should dig in our backyard or not.

3. I loved your arguments. For the first time I'm feeling a little bit happy about what is happening in my country. But it also makes me realize all the more strongly that I will not get a good standard of living in this life in this country. So, I'll have to consider options for emigrating. Don't tell me that I should stay back to build institutions. Even if I had the capability, which I don't think I do, my impact would be weakened by the multiplicity of power centers in our country.

One argument that will go against you is that India's tendency to hoard has always made it attractive for marauders from abroad. Whether it is the gold in our temples or the coal in our mines, it's not clear if we as ordinary people will ever enjoy the benefits of our thrifty nature. When the time comes to mine our hoarded resources will we be powerful enough to protect ourselves?

4. a) In 25 years we might not need the natural resources we are hoarding. b) There is no surety that corruption can be avoided due to well developed institutions, as the flood of money can overrun any regulation system, as is seen in developed economies today. c) Often, the incumbents, once they have the power, will push for good institutions. In other words, I think its better to let the private sector have rights to natural resources, with or without crony capitalism/resource raj problems. And, in a generation or two, the companies will typically squander their rights and lead eventually to a decent quality capitalistic system. Surely, the next generation of Ambanis are going to squander their wealth away. Its better than govt control, because govt control doesn't ever end. d) There are some middle east countries like say Saudi Arabia/Qatar which haven't done too badly with the resource curse. Sure, they aren't great countries, but they are probably better off than without the resource advantage.

1. Speaking for me, I would much rather live in India than in Saudi Arabia or Qatar -- EVEN if I was one of the ruling elite there.

Every country must do 3 modernisations -- social, political and economic. Qatar or Saudi Arabia have failed on all three. India is meandering with all three. I think that if there had been no natural resources in Qatar, they would have made some progress down these 3 routes.

2. I agree, which is why I was sure to point out that they aren't great places. I would prefer India to KSA too.

I made the point mainly for two reasons: one was the stability of the oil contracts. There haven't really been any conflicts or corruption or politics for resources in KSA (at least not after the initial power structures were established). Secondly, maybe KSA would have turned out like Somalia without oil - mired in tribal conflicts, which would be even worse. So, I wasn't saying that things are great in KSA/Qatar, but that they could have been worse, without resources.

On second thoughts, my point was weak one that was merely put up to play devil's advocate. On my first reason, conflicts on resource control aren't the only issue. The loss of imperative is the main factor. Also, KSA has the opposite problem of monopolies. And, without the imperative to modernize, maybe these countries are still vulnerable to becoming another Somalia if the monarchy was to fall and/or if oil prices were to come down a lot.

3. I am the Anonymous at 9.53 pm.

I agree with the Anonymous here. What if solar energy becomes cheap and plentiful so that coal is no longer needed. There is no guarantee that the institutions we build will stay strong when the time to use of resources come up.

We in India seem to love doing everything in the opposite way. Korea did not need to wait for building institutions. Economic growth took care of a lot of things. The same is happening in the Middle East with prosperity, education and now a growing fear of losing it all propelling people to seek their rights. Indians living on empty stomachs are not in a position to do that. So we cannot expect any revolution (or even peaceful change) in the next two generations at least.

5. Well said Ajay. Surely, we Indians are great at breast-beating and damning ourselves. What we need is a sustainable institutional framework to be put in place. We have mined our resources and acquired land for that and more, without proper institutional accountability and without a long-term vision on how to avoid becoming like vast tracts of Africa, South America and Arabia. We have caused the Maoist situation, we have built an inter-institutional distrust, with the CAG, the judiciary and the blundering executive all forming trenchant opinion because of the sheer lack of proper institution-and-capacity building in the hurry to get things off the ground.

6. This is an interesting thought Ajay. While in theory, the depreciation in rupee should boost tradeables, the problem is that the industry is not able to make use of this opportunity in India due to infrastructure bottlenecks and difficulty of doing business. The government needs to do 'investing in investing' as Paul Collier says. The issue is that the same forces that are blocking exploitation of natural resources are also blocking the boost in tradeables which is resulting in a total logjam in manufacturing sector.

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