It’s often a curse to be blessed

-A +A

IN 1976, Stanford political science graduate student Terry Lynn Karl paid a visit to Juan Pablo Perez Alfonso, the founder of the Organization of Petroleum Exporting Countries (Opec).

Perez Alfonso’s home nation, Venezuela, was in the midst of an oil-fuelled boom that was partly Opec’s doing, but he wasn’t celebrating. He asked Karl to study what oil was doing to his country, then offered these parting words:

Ten years from now, twenty years from now, you will see. Oil will bring us ruin.

Perez Alfonso, who also called oil the “devil’s excrement,” was right about that, of course. He’s still right 39 years later, with Venezuela in the throes of perhaps its worst economic crisis yet.

It takes a special kind of misgovernance to mess things up as badly as Venezuela has — even before the current oil price slump began last summer, it had been running fiscal deficits of more than 10% of gross domestic product (GDP) for several years.

But with the price of oil and just about every other commodity slumping, lots of other commodity-exporting countries are finding themselves in a tough spot these days.

Saudi Arabia, Bloomberg’s Matthew Martin reports, is likely to run a budget deficit of almost 20% this year and is looking for outside advice on where to cut back.

In Ecuador, Clifford Krauss and Rick Gladstone write in the New York Times, oil revenue has fallen by almost half since last year and “tens of thousands of demonstrators pour into the streets every week, angered by the government’s economic policies”.

Political tensions are also running high in Iraq and Nigeria, and while Russian President Vladimir Putin still boasts high approval ratings his country’s economy is in a deep slump. Australia appears headed for its first recession in 25 years; Canada is probably already in one.

Some of this is inevitable. Any place that profits from a major commodity boom is going to suffer from a hangover when prices plummet. This is largely due to an economic phenomenon that has come to be called the “Dutch disease”, after the Dutch economy struggled in the wake of a big natural gas discovery in 1959. The problem is basically that money flowing into the commodity distorts the country’s economy, making it hard for other industries to stay internationally competitive.

Still, nobody thinks Australia or Canada is headed for economic disaster or political crisis. For that to happen, Karl — now a professor at Stanford — concluded in her classic 1997 book The Paradox of Plenty, the commodity needs to take over the political system.

In modern times the main commodity to do this has been oil, so Karl dubbed the phenomenon “petrolisation.” But she also described how gold and silver riches had pretty much the same effect on Spain in the 1500s.

As money poured into Spain then and the oil exporters in the 1970s, government spending boomed. That was understandable. Less so was the fact that these governments kept increasing spending even as commodity revenues peaked. They had become addicted.

Wrote Karl:

Spending becomes the norm for rulers because resources are available, at least initially, and because more difficult tasks like building administrative authority take time and provide few immediate rewards. Indeed, spending becomes seen as the primary mechanism of “stateness,” as money increasingly is substituted for authority.

The only Opec member that didn’t succumb to this petrolisation in the 1970s was Indonesia, and the main reason seemed to be that the country’s first president, Sukarno, had been such a profligate spender and borrower that the army general who ousted him in 1967, Suharto, became obsessed with keeping government spending in check and paying down foreign debt.

As oil prices subsequently skyrocketed, that obsession kept Indonesia’s economy relatively balanced. Economic austerity may often be a bad idea, but it turns out to be the perfect policy approach for a country experiencing a gigantic commodity boom.

In Norway, which started producing oil in 1971, the initial instinct of the country’s Labour government was to spend the riches.

By the time production peaked in the 1990s, though, political give and take and a couple of financial crises had led to a much more conservative approach of running big fiscal surpluses (Norway last ran a government deficit in 1993, according to the International Monetary Fund) and salting the extra money away in a sovereign wealth fund.

Norway made early mistakes similar to those of other oil exporters; it just had a strong and flexible enough political system that it was able to learn from and reverse them.

Nowadays, the lessons of Indonesia and Norway are widely known. Lots of resource-rich countries and other jurisdictions put commodity earnings aside in sovereign wealth funds. But the temptation of a commodities boom is still hard to resist, especially when it’s the first time.

Consider Ghana, which after more than a decade of strong economic growth found itself in need of an IMF bailout in April. The culprit was oil, which was discovered off the country’s coast in 2007 and began to be exported in late 2010. As Andrew Bauer and David Mihalyi of the Natural Resource Governance Institute explain:

While it saved slightly less than US$500 million (RM2.12 billion) in oil revenues in two sovereign wealth funds from 2012 to 2014, the government borrowed approximately US$7 billion on international financial markets, at interest rates approximately 5% higher than the rate of return on sovereign wealth fund assets. The Ghanaian experience highlights the dangers of over-exuberance when new discoveries are made.

For a country, a big commodity boom remains an extremely dangerous thing. It doesn’t have to end in ruin, but it takes hard work to avert that fate. — Bloomberg View

This article first appeared in digitaledge Daily, on August 27, 2015.