Avoiding the Resource Curse

In few years from now, Eritrea will probably become an exporter of mineral resources such as gold and copper. In light of this development, it is appropriate to discuss about the prospects and challenges for an economy that will likely depend heavily on resource revenues.

The discovery of natural resources represents an addition to the wealth of a nation and should normally be welcomed. So why should one worry about it? Well, as experience of resource-rich countries shows, resource abundance may not always be good news. To be specific, on average an abundance of natural resources tends to slowdown overall economic growth, a phenomenon referred to as the "resource curse," and even worsen income inequality.

One obvious cause of resource curse is mismanagement by resource owners (usually governments). Another is that, with the discovery of natural resources, some of the productive inputs (labor and capital) are shifted away from the manufacturing sector, which is the source of long-term growth. Moreover, higher mineral wealth leads to an appreciation of the real exchange rate, which in turn hurts export competitiveness of the economy (so called Dutch disease). Add to these the fact that prices of natural resources are highly volatile with substantial uncertainties about export revenues.

To begin with, mineral wealth represents a collective windfall for a nation's citizens, in some way analogous to an individual winning a lottery worth millions of Nakfa. Naturally, we would expect the individual to spend part of it for current consumption and save the rest. But that is where the analogy ends because collective ownership of natural resources involves solving problems much more complex than those facing an individual.

Of course, Eritrea can avoid the resource curse by taking appropriate measures and learning from success stories such as Norway. One of these measures involves the creation and management of a national fund.

Creation of a national fund: a commitment by the people and the government to create a national fund for saving and investing part of the resource income. In particular, this requires goodwill on the part of the government backed by specific actions.

Independence: setting up an independent professional body for managing the fund. This would prevent misuse of the fund for political purposes and ensures the growth and sustainability of the fund. For example, Norway followed this path by letting its central bank, which is independent by law, manage its "Petroleum Fund." Central banks are the natural choice because they are the authorities responsible for managing reserves of gold and foreign exchange and therefore they have the necessary expertise.

Diversification: the fund is diversified across asset classes and geographical regions, ensuring a balanced risk-return profile. There maybe a temptation for actively managing the fund, that is, frequently moving funds in and out of certain categories of stocks or bonds. However, active management should not be a priority as it relies on speculation and can result in large capital losses.

Intergenerational equity: although the fund should help insulate the economy from unexpected shocks in the short-run, fund managers should take a long-term perspective in order to ensure the equitable distribution of wealth across generations. Intergenerational equity can also be the rationale for limiting active management of the fund.