Papyrakis and Gerlagh (2006) developed a simple mechanism to explain why resource windfalls are likely to lower income levels in the long run. They provided a theoretical justification to the empirical observation that resource-dependent countries generally do not reinvest resource rents in other forms. In that way, the decline in income may more than offset the increase in resource revenues, when we take account of the decrease in savings and the responsiveness of technology to investment. Their analysis focuses on the savings-investment transmission channel through which resource rents affect welfare. They use an overlapping generations (OLG) model to study the mechanism, where savings adjust downwards to income from natural resources, investments adjust to savings, and subsequently the level of overall productivity falls.

Natural resources are not harmful to growth or income per se but they tend to crowd out several income-supporting activities. Countries that maintain such activities are likely to convert the resource impact from a curse to a blessing. Norway, for instance, managed to catch up with its richer Scandinavian neighbors in the 1970s–1980s following its oil discoveries and maintained faster growth for most of the period thereafter (Røed Larsen, 2005). Usui (1997), on the other hand, claims that Mexico’s underperformance after its oil boom was related to the policy bias towards current spending rather than capital investment. Resource booms also reallocate factors of production from the manufacturing sector to the primary sector. Since it is often the manufacturing sector that is characterized by increasing returns to scale and positive externalities, this shift in production factors reduces productivity and profitability of investments (Sachs and Warner, 1995, 1999; Gillis et al., 1996).

As another mechanism, Atkinson and Hamilton (2003) show that governments often spend resource rents on public consumption. The few countries that use resource rents for public investment projects are those that have avoided the resource curse. Lange (2004), for example, claims that Namibia — and the majority of resource-abundant countries — liquidate rather than reinvest their resource revenues and therefore find themselves on a development path of declining welfare. On the other hand, in a few cases where a prudent investment of resource revenues takes place (as in the case of Botswana), people relish a higher level of wealth over time (Lange and Wright, 2004).

The first regression of Table 1 (taken from Papyrakis and Gerlagh, 2006) illustrates the negative relationship between natural resources and income for a sample of 82 countries. The dependent variable is the natural logarithm of GDP per capita in 2002 (LnY2002), while we use the share of natural capital in total wealth in 1994 (NatK94) as a proxy for resource abundance. There is a significant negative statistical association between the two variables. A 1 percent share of natural resources in the total capital stock is associated with a 7 percent lower income level. An increase in the natural capital share by a standard deviation (0.11) is associated with a decrease of the natural log of income by 0.84, which implies a decrease in income of 57 percent.

Table 1 depicts how natural capital is strongly and negatively associated with both savings and investment in physical capital. Regression (2) depicts the strong negative correlation between natural capital and savings. Regression (5) extends the correlation to investment. Indeed, countries that save less tend to invest less, as regressions (8) and (9) demonstrate. The former regression shows the positive correlation between investment and saving for the largest sample available of 141 countries, while the latter regression leaves out small countries with less than one million inhabitants. These small countries are atypical, as they need to be more open to foreign investments and often have a larger share of public investment in GDP to support basic infrastructure in telecommunications, airports, etc., which are needed irrespective of the size of the economy.

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