Addressing the natural resource curse: An illustration from Nigeria

TL;DR: In PPP terms, Nigeria's per capita GDP was $1113 in 1970 and is estimated to have remained at $1084 in 2000, placing Nigeria among the 15 poorest nations in the world for which such data are available as mentioned in this paper.

Abstract: Nigeria has been a disastrous development experience. On just about every conceivable metric, Nigeria’s performance since independence has been dismal. In PPP terms, Nigeria’s per capita GDP was $1113 in 1970 and is estimated to have remained at $1084 in 2000. The latter figure places Nigeria amongst the 15 poorest nations in the world for which such data are available.

Summary

Introduction

• Some natural resources – oil and minerals in particular – exert a negative and nonlinear impact on growth via their deleterious impact on institutional quality.
• Between 1970 and 2000, the poverty rate, measured as the share of the population subsisting on less than US$1 per day increased from close to 36 percent to just under 70 percent (Chart 1A).
• Third, and perhaps more importantly, their core results are subject to a greater degree of robustness checks than in the paper by Isham et. al. (2003).

Econometric specification

• As discussed earlier, three channels of influence from natural resources to growth have been identified in the literature: the impact through terms of trade volatility, overvaluation of the real exchange rate, and institutional quality.
• But to ensure that their choice is not selective or biased, the authors check the robustness of their results to inclusion of all of the other 12 covariates identified by Sala-i-Martin et. al. (2003).
• Hence, the only variable the authors instrument for is institutions.
• This specification and estimation strategy yields implicitly a second equation that the authors estimate which will be very important for their analysis.

Data description and sources

• Following Rodrik, Subramanian, and Trebbi (2002) and Easterly and Levine (2003), the institutional quality measure the authors use is due to Kaufmann, Kraay, and Zoido-Lobaton (2002).
• This is a composite indicator of a number of elements that capture the protection afforded to property rights as well as the strength of the rule of law.
• The authors enlarge this to include (i) the share of the exports of four types of natural resources—fuel, ores and metals, agricultural raw materials, and food—in GDP and total exports; (ii) the share of the exports of all natural resources in total exports; and (iii) a dummy for oil producing countries.
• To address this concern, the authors use initial period 4.

Results

• The results for the growth and institution equations are presented in Tables 2–9. natural resources in the institution equation).
• Table 5 checks whether the results are sensitive to the list of the conditioning variables.
• The core result relating to the detrimental impact of fuel and minerals on institutions remains robust—even the magnitude of the coefficients is stable.
• The coefficient on the fuel and minerals variable drops in the institution equation drops to -1.9, but the overall impact remains broadly unchanged because the coefficient of the institution variable in the growth equation goes up from 1.2 to 1.57.

The evidence on waste

• Chart 4 provides a growth decomposition of Nigeria’s performance since 1965.
• A substantial part of the increase was accounted for by public capital spending financed by the surging oil revenues.
• In other words, twothirds of the investment in manufacturing by the government is consistently wasted.
• Based on the estimates in column (1), poor institutional quality in Nigeria has contributed to lower long-run growth of 0.5 percent per year.
• This, in many ways, is the real legacy of oil in Nigeria.

Relative Prices and the role of Dutch Disease

• In most accounts of Nigerian economic history, the impact of the oil windfall on the economy via its effect in raising the relative prices of nontradables to tradables occupies a central role in explaining poor economic performance.
• In Charts 6A and 6B, the authors plot four indicators for the relative price of tradables to nontradables: the first two might be called the external relative price and the latter two the internal relative price.
• Specifically, the two internal price indicators suggest that, in fact, relative prices started moving in favor of tradables from 1970 onwards.
• The resulting reduction in the size of the rural labor force led to a sharp decline in agricultural production and a rise in food prices.
• The correlation between oil prices and the two real exchange rate indices between 1968 and 2000 is -0.05 and -0.11, respectively: correctly signed but very weakly related (indeed statistically insignificant).

Relative quantity movements

• The prime exhibit for the Dutch disease explanation of Nigerian economic decline are Charts 7A and 7B, which show a decline in the share of agriculture in GDP from 68 percent in 1965 to 35 percent in 1981.
• Starting from this premise, the logical conclusion is that the best way to deal with the problem is to transform Nigeria into a “non-oil” economy.
• This would replicate or simulate a situation in which the government has no easy access to natural resource revenue, just as governments in countries without natural resources.

1. Creating a Fund or distributing current revenues

• One possible response to managing revenue volatility is to create a Fund.
• The bestknown examples are Norway and Kuwait, although there are many others (see Davis et. al. 2001).
• Based on an analysis of a number of countries Davis e. al. (2001) conclude that, funds “are, however, not an easy—nor necessarily an appropriate—solution to the fiscal policy problems faced by these countries.”.
• If the problem with oil is, as demonstrated above, weak institutions and corruption, a fund is more likely to exacerbate the problem than address it.

2. Who should receive the revenues?

• An important question is who should receive the oil revenues.
• Of course the natural answer would be: all Nigerian citizens!.
• But when one thinks about this, some issues arise.
• If only adults should be entitled to the lump-sum transfer, the incentive to have more children would be lessened since the revenue associated with extra children would be postponed for eighteen years.
• It could also be argued that revenues should be distributed among women only.

3. Fiscal issues

• Another question is whether all the revenues should be distributed or whether a certain share should be retained because of the government having to provide certain essential services (public goods).
• One way to achieve or simulate this would be to distribute all the revenues to the people and require the government to rely on normal fiscal principles to determine appropriate levels of taxation and expenditure.
• One natural question that arises is whether regions or households in regions that are the victims of the environmental degradation caused by oil should be compensated in the form of greater revenues to reflect the marginal environmental cost.
• Ahmed and Singh (2003) argue that the current revenue sharing system is a key factor in predisposing the Nigerian intergovernmental arrangement to instability and inefficiency.
• The authors proposal would be in line with their proposals for a larger and more stable base for sub-federal levels, while at the same time obviating the need for the federal government to provide the stabilization function.

4. Implementation issues

• Implementing a system of transfer would no doubt raise huge administrative problems.
• The problems are very real and would have to be addressed.
• Nigeria could take advantage of the fact that it has just implemented a voter ID system and issued cards to all eligible voters.
• Indeed, requiring a bank account as a precondition for receiving revenues could encourage financial intermediation.
• In essence, the defaults between the current system and the one the authors are proposing would change: under the former, citizens rely on public officials and institutions for receiving the oil money indirectly through public services; under their proposal they would have an automatic—and justiciable—right to receive the proceeds directly.

5. Debt relief

• The authors proposal also offers a way out of the ongoing and sterile debate between international donors and Nigeria on the issue of debt relief.
• Nigerian officials and the public rightly wish to see the burden of external debt lifted, especially since a sizable part of the debt was “odious” (contracted by dictators) and in which there was a large degree of creditor complicity.
• But donors, even those who accept the economic and moral arguments, are wary about providing debt relief.
• They justifiably fear that any savings from relief may well be misused as other public resources have been, making them reticent about providing it despite the enormous pressure from within Nigeria and international civil society.
• Under their proposal, the “savings” from debt relief would also be distributed directly to the private sector, alleviating donor’s legitimate concerns and making them more amenable to granting debt relief.

6. Need for cooperation by foreign oil companies

• Implementing their proposal and minimizing the corruption and waste would require the cooperation of the foreign oil companies in a number of important respects.
• To prevent the government from under-stating the revenues it has available for distribution, oil companies should independently report the exact amounts they have paid to the government, which could be verified by independent audit.
• Information on their levels of production and the prices received would help in corroborating government figures.

8. Political economy

• The authors proposal is open to one fundamental criticism.
• If vested interests have been responsible for the squandering of oil revenues in the past, why would they allow their proposal, which would denude them of all money and power, acquiesce to it.
• The authors response is that in some ways radical change of the sort the authors are proposing might be easier to accomplish than incremental change.
• Waste and corruption are issues that resonate deeply with every Nigerian: one could even hazard that the average Nigerian considers this to be the fundamental problem in Nigeria.
• As argued above, this constitutional right can provide some scope for redress against inevitable abuse.

9. Macroeconomic consequences

• Finally, the proposal presented in this paper applies for Nigeria would apply to all countries that have a deep dependence on natural resources and that have suffered from the deteriorating institutions as a consequence.
• Share of natural resources in total exports (calculated as the sum of the shares of individual resources).

Figures

Table 1: Comparative Indicators

Table 2: Growth, Institutions and Natural Resources in Aggregate

Table 6: Growth, Institutions, and Natural Resources: Robustness to Alternative Measures of Institutions

Table 5: Growth, Institutions and Natural Resources: Robustness to Covariates

Table 9: Growth, Institutions, and Natural Resources: Is Nigeria Unusual?

Table 4: Institutions and Natural Resources: Monotonic or Non-monotonic Effects?

Table 8. Growth, Institutions, and Natural Resources: Maximizing Sample Size

Table 3: Growth, Institutions, and Individual Natural Resources

Table 7. Growth, Natural Resources, and Institutions: Robustness to Influential Observations, Regional Dummies, Sample, and Instrument for Institutions

Full text

NBER WORKING PAPER SERIES
ADDRESSING THE NATURAL RESOURCE CURSE:
AN ILLUSTRATION FROM NIGERIA
Xavier Sala-i-Martin
Arvind Subramanian
Working Paper 9804
http://www.nber.org/papers/w9804
NATIONAL BUREAU OF ECONOMIC RESEARCH
1050 Massachusetts Avenue
Cambridge, MA 02138
June 2003
We are grateful to Francesco Trebbi for valuable research assistance. Thanks are due to Doug Addison, Chris
Lane, and Dani Rodrik for helpful comments and discussions. Errors remain our own.The views expressed
herein are those of the authors and not necessarily those of the National Bureau of Economic Research.
©2003 by Xavier Sala-i-Martin and Arvind Subramanian. All rights reserved. Short sections of text not
to exceed two paragraphs, may be quoted without explicit permission provided that full credit including
© notice, is given to the source.

Addressing the Natural Resource Curse: An Illustration from Nigeria
Xavier Sala-i-Martin and Arvind Subramanian
NBER Working Paper No. 9804
June 2003
JEL No. O1, O4, O5, O55, O57, Q0
ABSTRACT
Some natural resources – oil and minerals in particular – exert a negative and nonlinear impact on
growth via their deleterious impact on institutional quality. We show this result to be very robust.
The Nigerian experience provides telling confirmation of this aspect of natural resources. Waste and
corruption from oil rather than Dutch disease has been responsible for its poor long run economic
performance. We propose a solution for addressing this resource curse which involves directly
distributing the oil revenues to the public. Even with all the difficulties of corruption and
inefficiency that will no doubt plague its actual implementation, our proposal will, at the least, be
vastly superior to the status quo. At best, however, it could fundamentally improve the quality of
public institutions and, as a result, transform economics and politics in Nigeria.
Xavier Sala-i-Martin Arvind Subramanian
Department of Economics International Monetary Fund
Columbia University 700 19
th
Street, NW
420 West 118
th
Street, 1005 Washington, DC 20431
New York, NY 10027
and NBER
xs23@coulmbia.edu

4
I. INTRODUCTION
Nigeria has been a disastrous development experience. On just about every
conceivable metric, Nigeria’s performance since independence has been dismal. In PPP
terms, Nigeria’s per capita GDP was US$1,113 in 1970 and is estimated to have remained at
US$1,084 in 2000. The latter figure places Nigeria amongst the 15 poorest nations in the
world for which such data are available.
Nigeria, unfortunately, fares much worse on measures of poverty and income
distribution. Between 1970 and 2000, the poverty rate, measured as the share of the
population subsisting on less than US$1 per day increased from close to 36 percent to just
under 70 percent (Chart 1A). This translates into an increase in the number of poor from
about US$19 million in 1970 to a staggering US$90 million in 2000 (Chart 1B).
1
Similarly, the income distribution also deteriorated very sharply. Chart 2 plots the
distribution of income for four years, 1970, 1980, 1990, and 2000. It is striking that over time
the two tails of the distribution have become fatter, signifying that more and more people
have been pushed towards poverty (the left hand side of the distribution) and towards
extreme wealth (the right hand side). To illustrate: whereas in 1970 the top 2 percent and the
bottom 17 percent of the population earned the same total amount of income, in 2000 the top
2 percent had the same income as the bottom 55 percent.
Table 1 reports the growth rate of GDP and its volatility for Nigeria. In terms of
growth since 1960, Nigeria fared worse than the average country but better than oil
producing countries. It is also noteworthy that Nigeria’s economy was substantially more
unstable—reflected in the standard deviation and coefficient of variation of growth rates—
than other countries, including other oil producing countries.
2
These developments, of course, coincided with the discovery of oil in Nigeria.
Chart 3 depicts the revenues that Nigeria has obtained from oil since1965. Over a 35-year
period Nigeria’s cumulative revenues from oil (after deducting the payments to the foreign
oil companies) have amounted to about US$350 billion at 1995 prices. In 1965, when oil
revenues per capita was about US$33, per capita GDP was US$245. In 2000, when oil
revenues were US$325 per capita, per capita GDP remained at the 1965 level. In other
words, all the oil revenues—US$350 billion in total—did not seem to add to the standard of
1
These calculations are based on Sala-i-Martin (2003). We use the original definition of
poverty line of the World Bank, which is one dollar a day in 1985 prices.
2
It turns out that the greater instability—relative to other oil producers—is not a
consequence of oil’s greater weight in GDP: in the sample, the share of oil in GDP for oil
producing countries was 9.5 percent compared with 8.1 percent for Nigeria.

living at all. Worse, however, it could actually have contributed to a decline in the standard
of living?
This paper has three objectives developed in three sections. First, in Section II we use
cross-section empirical analysis to demonstrate that stunted institutional development—a
catch-all for a range of related pathologies, including corruption, weak governance, rent-
seeking, plunder, etc.—is a problem intrinsic to countries that own natural resources such as
oil or minerals. The resulting drag on long-run growth from having resources can be
substantial. Second, in Section II we establish that Nigeria’s poor economic performance
stems largely from having wasted its resource income. Finally, in Section IV we propose a
solution for Nigeria to accelerate institutional change, which would involve distributing the
bulk of the oil revenues directly to the people. In the absence of measures to improve the
quality of institutions and avoid the problems created by oil rents, we remain deeply
pessimistic about Nigeria’s long-run prospects. The final section concludes.
II. THE NATURAL RESOURCE CURSE: REVISITING THE EMPIRICAL LITERATURE
Is the detrimental impact of oil on development unique to Nigeria or is it—the oft-
cited “natural resource curse”—a more general phenomenon? From a policy perspective,
while it is important to know if a curse exists, it is perhaps more important to know the
mechanism by which it casts its spell. Identifying the mechanism allows a better stab to be
made at prescription.
In the theoretical economics literature, three channels of causation from natural
resource abundance to lower growth have been identified.
3
First, natural resources generate
rents which leads to rapacious rent-seeking (the voracity effect), whose adverse manifestation
is felt through political economy effects as in Lane and Tornell (1995) and to increased
corruption (Mauro, 1995; and Leite and Weidmann, 1999) which adversely affects long-run
growth. We shall refer to this effect more broadly as the institutional impact of natural
resources.
Second, natural resource ownership exposes countries to volatility, particularly in
commodity prices, which could have an adverse impact on growth through an increase in
3
Isham et. al. (2003) provide an excellent summary of the mechanisms of causation
identified in the economics as well as in the political science literature. In the latter, emphasis
is placed on the “rentier” effects, whereby large revenues from natural resources allow
governments to mollify dissent and avoid accountability, insulating governments from
pressures for institutional reform; and “anti-modernization” effects, whereby governments
successfully thwart pressures for modernization and institutional reform because their
“budgetary revenues are derived from a small workforce that deploys sophisticated technical
skills that can only be acquired abroad.”

fertility. Finally, natural resource ownership makes countries susceptible to Dutch Disease—
the tendency for the real exchange rate to become overly appreciated in response to positive
shocks—which leads to a contraction of the tradable sector. This outcome, combined with
the (largely unproven) proposition that tradable (usually manufacturing) sectors are
“superior” because of learning-by-doing and other positive externalities, leads to the
conclusion that natural resource ownership exerts a drag on long-run growth.
Hausman and Rigobon (2002) state our understanding of the impact of natural
resources as follows: “The concern that natural resource wealth may somehow be
immiserating is a recurring theme in both policy discussions and in empirical analysis. The
empirical regularity seems to be in the data but understanding its causes has been a much
harder task.” This supposed empirical regularity derives originally from the work of Sachs
and Warner (1995), who showed, based on standard cross-section growth regressions, that
the curse of natural resource-ownership is substantial, manifested in such countries growing
slower, on average, by about 1 percent per year during the period 1970–89. Variations of this
basic results can be found in Leite and Weidmann (1999) and Bravo-Ortega and De Gregorio
(2001).
In their empirical work, Sachs and Warner (1995), and Leite and Weidemann (1999)
attempt to unravel the potential channel of causation, but without great success. Given the
Nigerian experience, we are particularly interested in exploring the channel that operates
through corruption and institutional quality. The recent work (Hall and Jones, 1999, and
Acemoglu et. al., 2001) on institutions provides another reason to revisit the natural resource
literature. Our key results, are in sharp contrast to the commonly-held view about the impact
of natural resources (especially Sachs and Warner, 1995), validating this revisiting of the
empirical literature.
More recently, Collier and Hoffler (2002) have shown that natural resources
considerably increase the chances of civil conflict in a country. According to their estimates,
the effect of natural resources on conflict is strong and non-linear. A country that has no
natural resources faces a probability of civil conflict of 0.5 percent, whereas a country with
natural resources-to-GDP share of 26 percent faces a probability of 23 percent. Civil conflict,
of course, is an extreme manifestation of institutional collapse and the work of Collier and
Hoffler (2002) is therefore suggestive of a role for natural resources in affecting institutional
quality more generally.
A recent paper by Isham et. al. (2003) tests the proposition that natural resources
affect economic growth through its adverse effect on economic institutions. Although our
paper focuses on Nigeria, we do test a similar proposition in section II. Our section II differs
from the Isham et al. (2003) paper in some respects. First, we employ a different basis for
measuring natural resources, which also allows us to test for nonlinear effects. Second, in
order to deal with the usual problem of what additional explanatory variables to include, we
use the robust variables identified by Sala-I-Martin, Doppelhoffer and Miller (2003). Third,
and perhaps more importantly, our core results are subject to a greater degree of robustness
checks than in the paper by Isham et. al. (2003).

Frequently asked questions

Q1. What are the contributions mentioned in the paper "Nber working paper series addressing the natural resource curse: an illustration from nigeria" ?

The authors show this result to be very robust. The Nigerian experience provides telling confirmation of this aspect of natural resources. The authors propose a solution for addressing this resource curse which involves directly distributing the oil revenues to the public. 

Q2. What is the main argument of Ahmed and Singh?

Ahmed and Singh (2003) argue that the current revenue sharing system is a key factor in predisposing the Nigerian intergovernmental arrangement to instability and inefficiency. 

Q3. What is the argument that the Nigerian government should be treated as if it were a?

The notion that fiscal issues, including those relating to fiscal federalism, should be addressed “as if” Nigeria were a normal non-oil economy would argue in favor of making households or individuals rather than states as the beneficiary of the revenues. 

Q4. What is the effect of the oil windfall on Nigeria's economy?

as Bevan et. al. (1998) note the oil windfall enabled the government to increase its expenditures and thus provide increased opportunity for kickbacks. 

Q5. What would be the way to smooth out the windfalls?

intertemporal consumption smoothing would require that a large portion of windfall gains be saved and that these savings be efficiently used. 

Q6. What is the role of the oil windfall in Nigeria's economic history?

In most accounts of Nigerian economic history, the impact of the oil windfall on the economy via its effect in raising the relative prices of nontradables to tradables occupies a central role in explaining poor economic performance. 

Q7. What is the telling piece of evidence about the quality of investment in Nigeria?

Another telling piece of evidence about the quality of investment comes from capacity utilization in manufacturing, a substantial portion of which is government-owned. 

Q8. What is the prime exhibit for the Dutch disease explanation of Nigerian economic decline?

The prime exhibit for the Dutch disease explanation of Nigerian economic decline are Charts 7A and 7B, which show a decline in the share of agriculture in GDP from 68 percent in 1965 to 35 percent in 1981. 

Q9. How many children would be eligible for the lump-sum transfer?

If only adults should be entitled to the lump-sum transfer, the incentive to have more children would be lessened since the revenue associated with extra children would be postponed for eighteen years. 

Q10. Why is the weak correlation between oil prices and the real exchange rate?

In fact, the weak correlation between oil prices and the real exchange rate reported earlier may have been stemmed precisely from the tendency of the government to keep the exchange rate appreciated during periods of low oil prices. 

Q11. What is the main reason why Nigeria has suffered from poor institutional quality?

In other words, Nigeria, like other oil and mineral producing countries, has suffered from poor institutional quality stemming from these resources. 

Q12. What is the point of distributing the money and getting it back?

Thus even though some would argue that the point of distributing the money and getting it back would essentially constitute an administrative waste, the authors believe that this waste would be justified by the radically altered incentives for governance.