metadata: authors: 0: author: Toto Same,Achille C. S.
count: Africa
docna: 0: docna: Transforming natural resource wealth into
            sustained growth and poverty reduction : a conceptual
            framework for Sub-Saharan African oil exporting countries
docty: Policy Research Working Paper
subtopic: Economic Theory & Research,Industrial Economics,Construction Industry,Common Carriers Industry,Food & Beverage Industry,General Manufacturing,Pulp & Paper Industry,Plastics & Rubber Industry,Economic Development,Economic Growth,Business Cycles and Stabilization Policies,Inequality,Global Environment
teratopic: Macroeconomics and Economic Growth,Finance and Financial Sector Development
abstracts: cdata!: Oil and mineral revenues raise national
            savings and hence facilitate investment, capital
            accumulation, and sustained growth; thus, there are benefits
            of owning large natural resources. There can be a
            significant spillover effect from the oil sector to the
            non-oil sector particularly if governments are committed to
            bridge the infrastructure gap and promote the non-oil
            economy and foremost the non-oil tradable sector.
            Consequently, the capacity for coordinated policy
            formulation and execution is fundamental as well as sound
            windfall management mechanisms and institutions. This
            conceptual framework uses the case of Indonesia and the
            example of Norway to argue that the resource paradox is
            avoidable. Abundance should not be a curse, but rather a
            blessing for Sub-Saharan Africa's oil and mineral
            exporting countries. The country context and political
            economy matter a great deal but should not be the main
            driving forces behind windfall management, to avoid
            excessive rent-seeking activities, inefficiency, and
            wasteful spending. The EITI++ implementation can contribute
            to make a difference, mostly through capacity building,
            implementation assistance, and coordination support.
repnme: repnme: Transforming natural resource wealth into
            sustained growth and poverty reduction : a conceptual
            framework for Sub-Saharan African oil exporting countries
display_title: Transforming natural resource wealth
            into sustained growth and poverty reduction : a conceptual
            framework for Sub-Saharan African oil exporting countries
listing_relative_url: /research/2009/03/10315412/transforming-natural-resource-wealth-sustained-growth-poverty-reduction-conceptual-framework-sub-saharan-african-oil-exporting-countries
topicv3: Economic Growth m1326241 471,Manufacturing Sectors m1326521 1281,Poverty m1326687 695,Environment, Natural Resources and Blue
            Economy m1327391 566,Dutch Disease m1583679 4708
publishtoextweb_dt: 2010-07-01T00:00:00Z
historic_topic: Macroeconomics and Economic Growth,Finance and Financial Sector Development
no_of_pages: 44
author_keys: 0: author_key: 646958
model_extractions: WPS4852 Policy ReseaRch WoRking PaPeR 4852 Transforming Natural Resource Wealth into Sustained Growth and Poverty Reduction A Conceptual Framework for Sub-Saharan African Oil Exporting Countries _Achille Toto Same_ The World Bank Africa Region Poverty Reduction and Economic Management Division March 2009
Policy ReseaRch WoRking PaPeR 4852

# **Abstract**

Oil and mineral revenues raise national savings and hence facilitate investment, capital accumulation, and sustained growth; thus, there are benefits of owning large natural resources. There can be a significant spillover effect from the oil sector to the non-oil sector particularly if governments are committed to bridge the infrastructure gap and promote the non-oil economy and foremost the non-oil tradable sector. Consequently, the capacity for coordinated policy formulation and execution is fundamental as well as sound windfall management mechanisms and institutions. This conceptual framework uses the case of Indonesia and the example of Norway to argue that the resource paradox is avoidable. Abundance should not be a curse, but rather a blessing for Sub-Saharan Africa’s oil and mineral exporting countries. The country context and political economy matter a great deal but should not be the main driving forces behind windfall management, to avoid excessive rent-seeking activities, inefficiency, and wasteful spending. The EITI++ implementation can contribute to make a difference, mostly through capacity building, implementation assistance, and coordination support.

This paper—a product of the a product of the Poverty Reduction and Economic Management Division, Africa Region—is part of a larger effort in the department to help African Oil Producing Countries, manage and transform their natural resource wealth into long-term economic growth that spreads the benefits more fairly among their people for an effective poverty reduction. Policy Research Working Papers are also posted on the Web at http://econ.worldbank.org. The author may be contacted at Atotosame@worldbank.org.

_The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent._ Produced by the Research Support Team
# **Transforming Natural Resource Wealth into Sustained Growth and Poverty Reduction:**

A Conceptual Framework for Sub-Saharan African Oil Exporting Countries _Achille Toto Same_
# **Table of Contents**

|I – Introduction ............................................................................................................... 3|
|---|
|II – Sub-Saharan Africa’s Oil Exporting Countries’ Sustained Growth Path: Setting the|
|Stage................................................................................................................................ 6|
|III – Back to the Main Resource-Rich Macroeconomic Impediment: The Dutch|
|Disease.......................................................................................................................... 13|
|IV – Effectively Managing Boom and Bust Cycles...................................................... 23|
|V – Addressing Institutional Issues: Avoiding the Rent-Seeking-Disease in Sub-|
|Saharan Africa’s Oil Exporting Countries.................................................................... 26|
|VI – Transforming Oil and Mineral Rents into a Sustained Growth-Path and Durable|
|Poverty Reduction in SSA ............................................................................................ 30|
|VII – Conclusion........................................................................................................... 39|
|VIII. References.......................................................................................................... 41|

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# **I – Introduction**

The enormous body of literature on the Resource Curse provides several explanations for the detrimental effects of natural resources particularly on growth. Among the persistent and rather robust explanations is the negative effect of real effective exchange rate appreciation due to the spending effect and subsequently the resources reallocation effect and its impact on the tradable sector.

The curse is a clear probability and a number of examples, in Sub-Saharan Africa and elsewhere, clearly indicate that context conditions have to be added to the equation when studying the exact mechanisms and transmission channels of the “curse”. The curse does not strike in the same way in a country with sound institutions and good leadership as in a country with poor institutions and slack political economy environment. These contexts and conditions deserve differentiation and it is important to make a distinction between the pre-resource extraction conditions and environment, such as the general level of development and the political system and resource specific conditions, and their magnitude and relations between identity groups.

The theoretical challenge of a contextually sensitive study of the political economy of natural resources should capture complexity. This applies to dynamics and interplays between the context conditions as well as the direction and nature of the relationship. This calls for precise concepts; carefully formulated hypotheses that integrate complexity rather than simplify relationships. The political economy and the political dynamics seem to be as important as the Dutch Disease and probably in the context of Sub-Saharan Africa that is what matters the most, given their influence on the decision underlying the utilization of windfalls.

The resource curse or resource paradox is not unavoidable; a sound resource-led development strategy and well articulated and efficient public investment program (PIP) along with sound public finance management (PFM) will contribute to make a difference. In the context of an oil boom or other mineral boom, the structure of the economy is fundamentally transformed; these changes, together with the revenues from oil exports, 3
could set the stage for a sustained growth-path and economic development. Natural resource endowments have helped many countries (Norway, Malaysia, Botswana, Finland and Indonesia) to grow and diversify, in part by providing a basis for developing associated technologies and capital goods industries.

The governance aspect is equally important. Actually, fiscal and tax regimes, in other words, government’s take on oil and mineral exploitation in Africa, are by no means uniform. A multitude of revenue extraction instruments or systems are currently in place in different countries in Africa from the government side to capture some of the benefits for the state and the public. It is therefore critical to understand the environment in the very beginning and early stages of the rent production or revenue chain by assessing the arrangements in place to eventually improve transparency throughout the revenue chain and by the same token improve efficiency and revenue allocation.

Once oil and mineral resources are secured, the next challenge is to ensure efficiency and sound allocation to promote the development process in general and poverty reduction in particular. This is done essentially through the national budget. The budget is the main vehicle and an active policy instrument in the hands of governments to promote their development strategy and poverty reduction programs through efficient allocation of resources to implement their medium-term development vision.

The immediate challenge often facing the authorities is to prepare a comprehensive development strategy to reduce poverty and foster broad-based economic growth. A well formulated and prioritized budget is critical in this regard. With substantial oil and mineral wealth, mineral-rich countries should be able to make rapid progress toward the development process and poverty reduction. Windfalls or oil and mineral rents are in principle channeled through the national budget, and should be integrated into the budget; therefore, the quality of budget execution matters. Nonetheless, the quality of budget execution depends on the quality of budget preparation.

4
As a matter of improving the overall development performance of mineral-rich developing countries, the World Bank recently launched (on April 2008) the Extractive Industries Transparency Initiative Plus Plus (EITI++) initiative, which aims at helping developing countries, particularly African countries, manage and transform their natural resource wealth into long-term economic growth that spreads the benefits in the country. The initiative is the perfect framework for mineral rich countries in Africa, provided that the initiative is successfully carried out.

The EITI++ in addition to improving transparency and accountability will rightly focus on the resource chain, including managing revenues and promoting sustainable and efficient utilization of natural-resource wealth. It could provide governments with a range of options including technical assistance and capacity building for improving the management of natural-resource-related wealth for the benefit of the overall economy and notably the implementation of good policies to promote sustained growth and poverty reduction.

The purpose of this conceptual framework is an attempt to provide a comprehensive approach that could contribute to address the resource paradox and promote sustained growth and hence durable poverty reduction in Sub-Saharan Africa (SSA). It aims to draw from international experience, country specificities, SSA’s context, and the very nature of natural-resource abundance. This could eventually support the EITI++ implementation.

5
<!-- Start of picture text --> Global Annual Average Oil prices per barrel<br>1986- 2008<br>120<br>100<br>3/<br>+80<br>bs)<br>a<br>5 60<br>a<br>a 40<br>2<br>20<br>0<br>© g\ a © © oS ob &® of & © ol DAM OW dm OO cl<br>FILLDEB? LPIOd” O_O?PGDD?PIAH PIAD MMOPSSOVOSLTOA SLOMSe<br><!-- End of picture text -->
<!-- Start of picture text --> SSA's Oil Exporting Countries: Real Per Capita GDP<br>1997-2008<br>5000<br>4500 aed —__— — -_<-<br>“ 4000<br>2<br>& 3500 — es ——Angola<br>==> 3000 | —@— Cameroun<br>24~co tie1500 ae ———t— Congo,Chad Rep<br>as x<br>1000 2 = i—_—— —— FOG<br>500 t SS —@®— Gabon<br>ié) ee a EEE ESS<br>a<br>Sb = Nigeria<br>PF LF LF Lf<br>ae SF > 9 se Sp<br>aw&<br><!-- End of picture text -->
<!-- Start of picture text --> Oil Exporting Countries' Government Revenue (Excluding Grant)<br>1997-2008<br>60<br>0. 50<br>2v 30 —OE ——————<br>= 20 —_—___ ==<br>Ey<br>a 945 —<br>fe)<br>1997-2002 2003 2004 2005 2006 2007 2008<br>—Angola —TM—Cameroun —te=—Chad —— Congo, Rep<br>——EQG —®— Gabon = Nigeria<br><!-- End of picture text -->
<!-- Start of picture text --> Domestic Saving Rate SSA's Countries vs SSA's Middle Income Countries<br>100<br>9080 Oe<br>a 70<br>52ie60 SS ae —"<br>2& 40 ed OEE—_—_<br>g pe ee<br>2 30 ee a<br>10<br>0<br>1997-2002 2003 2004 2005 2006 2007<br>—@— Angola —*— Cameroun<br>—— Chad —— Congo, Rep<br>—@—EQG = Gabon<br>—Nigera —— SSA's Middle income Countries<br><!-- End of picture text -->
Investment is the centerpiece of growth; consequently ensuring an adequate level of saving<sup>8</sup> should remain a central policy concern, particularly for SSA economies, where foreign investors seem reluctant to invest beyond investment in extractive industries. Traditional development theory since WWII has emphasized the very fact that the longrun rate of economic growth is largely dependent on the saving rate. Saving determines investment, and they reinforce each other—technological change is implicitly taken as a function of investment—and thus, the rate of capital accumulation, which is the basic determinant of long-run growth (Chakravarty 1993; Marglin and Schor 1990). The notion that raising the investment rate is a key parameter to increasing long-run growth or sustained growth has been at the heart of growth thinking since David Ricardo.

Correlatively, a comfortable level of exports is critical in developing countries to sustain an adequate level of necessary imports. It is indispensable to import basic technology to break the supply side constraint and to modernize the structure of production. This is more so in SSA, which is characterized by a narrow export base and weak export performance. Thanks to oil exploitation in SSA’s oil exporting countries, the level of exports to GDP is more than comfortable. In SSA’s good oil exporting countries, overall export performance proportionally to GDP is an additional substantive advantage for their development financing toward a sustained growth path.

Industrial productivity in Tanzania, for example, was hampered by the weak capacity to export (Ndulu 1986; Devarajan, Easterly, and Pack 1999). At Tanzania’s independence, more than 80 percent of the manufactured goods consumed in the country were imported, and the manufacturing sector accounted for only 4 percent of GDP. A succession of government plans placed heavy emphasis on import-substituting industrial investments for basic consumer goods, construction, and related capital goods. Between 1965 and 1980, real investment in manufacturing grew by 21 percent a year. And in 1986–90, investment rose to the remarkable level of more than 100 percent of manufacturing value added. Despite this massive expansion, output per worker fell as

> 8 Regardless of whether saving is the main force driving growth, ensuring adequate levels of saving is fundamental to provide sufficient financing for investment and to avoid balance-of-payments disequilibria and unnecessary debt burden.

10
<!-- Start of picture text --> SSA's Oil Exporting Countries: Exports of Goods and Services<br>1997-2008<br>120<br>100 TT<br>a2<br>8<br>oO 80 . . a<br>*ro) a as<br>&~ 660 _—$<$<<—— a —— =<br>2 40<br>ov<br>oe 20 eeie<br>0<br>1997-2002 2003 2004 2005 2006 2007 2008<br>—eAngola —TMCameroon —t—Chad —<Congo, Rep ——-EQG —@®—Gabon -—-—Nigeria<br><!-- End of picture text -->
<!-- Start of picture text --> SSA's Exporting Countries: Real Non-Oil GDP Growth<br>(Percent)<br>12<br>= Li<br>Se ae,<br>= — ==<br>;<br>1997-2002 2003 2004 2005 2006 2007 2008<br>—@ Angola —TM—Cameroon —te—Chad —— Congo, Rep<br>——EQG —®— Gabon —— Nigeria<br><!-- End of picture text -->
<!-- Start of picture text --> SSA's Overall Government Fiscal Balance Comparison<br>(percent of GDP)<br>15<br>10<br>a<br>tds) 5<br>—<br>= fe)<br>=<br>= -5<br>aw<br>-10<br>-15<br>aDSSv aS‘e] aS& asS$9 aaSS&S =S<\ aSHS<br>?4<br>@ SSA’s Oil Exporting Countries @ M-Income Countries<br>m Low-Income Countries m Fragile Countries<br><!-- End of picture text -->
natural resource exports on growth, which they attributed to Dutch Disease. Acemoglu et al. (2001, 2002 and 2004) found that the nature of institutions is more important than resources. Lederman and Mahoney (2007) query both results and argue that natural resource rents boost economic growth.

The Dutch Disease can be a real disease and a source of persistent slow growth, if there is something special about the sources of growth in manufacturing (decline in leading technological-knowledge sector) with production externalities or the learning-bydoing stressed by Matsuyama (1992) where he assumed that there are increasing returns to scale in manufacturing, but not in the resource sector. Hence an abundance of natural resource makes the economy specialize in the less dynamic sector of the economy; thus the economy loses the benefits of increasing returns to scale in manufacturing, which leads to a decline in growth.

In principle the Dutch Disease<sup>10</sup> can be seen as a matter of one sector benefiting partly at the expense of others, therefore it is not an impediment _per se_ ; however the disease is potentially harmful if there is something special about the reallocation of resources between sectors, for example from high-tech service industries to low primary production (Gylfason 2001). The oil boom would therefore induce a decline in a technologically leading sector of the economy with adverse consequences for long-term growth. The resource shift can then become a true disease (Sachs 2007).

The paradox effect of natural resource abundance on the economy is commonly described as an economy experiencing an export boom, and divided into three sectors: (a) the booming export sector; (b) the lagging export sector – traditional exports - as the two traded good sectors; and (c) the non-traded goods sector, which essentially supplies domestic residents and might include retail trade, services and construction. In the presence of the Dutch Disease, the traditional export sector gets crowded out by the other two sectors (Corden and Neary in 1982).

> 10 The Dutch disease is a matter of concerns mainly because of its potentially deleterious consequence for economic growth.

14
Abundant mineral resource-led exports lead to an appreciation of the real exchange rate by shifting production inputs ( _capital and labor - resource movement effect_<sup>11</sup> ) to the booming mineral sector and non-tradable sector (retail trade, service, and construction), thereby reducing the competitiveness of the non-booming sector (mostly agriculture and manufacturing) and hence participating in their collapse. The shift to the non-tradable sector accelerates domestic inflation<sup>12</sup> ( _the spending effect_ of the boom does increase the price of non-traded goods due to increased demand), which is responsible for the real exchange rate appreciation. These short-term macro-adjustment problems result in long-term effects on growth by reducing the country’s economic diversity and increasing its reliance on exports from its natural resource sector.

Without discounting the robustness of the Dutch Disease transmission mechanisms above explained, it is however useful to go back to the original context of Dutch Disease and eventually to see how far the concept could possibly explain SSA’s oil exporting countries’ development impasse. Indeed, the term Dutch Disease refers to the fears of de-industrialization that gripped the Netherlands as a result of the appreciation of the Dutch currency that followed the discovery of natural gas deposits. The appreciation of the Dutch currency that followed the gas export boom reduced the profitability of manufacturing and service exports<sup>13</sup> . Total exports decreased markedly to GDP during the 1960s. Expansion of petroleum exports in the 1960s not only crowded out other exports, actually reduced other exports disproportionately and fueled the fears of dire consequences for Dutch manufacturing.

In fact based on existing data, SSA’s oil exporting countries’ manufacturing sector almost does not exist and where it does, like it is case of Nigeria, it is neither knowledge-driven nor globally competitive. It does not perform significantly better than the natural resources sector; therefore, the positive effects of linkages are negligible. This

> 11 The marginal productivity of labor in the booming industry will increase and attract labor away from the non-booming industry. This change in the sectoral composition of labor is called the resources movement effect of the boom (Corden, 1982).  - Managing Oil Wealth: The Case of Azerbaijan. IMF, 2004. 12 As the matter of fact, the non-tradable sector supply is inelastic in the short term so, when demand expands and resources move into the non-tradable sector, this causes prices to increase thereby induces real exchange rate appreciation.

> 13 Thorvaldur Gylfason. Lessons from the Dutch Disease: Causes, Treatment, and Cures - Institute of Economic Studies - University of Iceland. August 2001.

15
is clearly what I found in the case of Equatorial Guinea<sup>14</sup> and Chad, and it is the case of other oil exporting countries in Africa, where the manufacturing sector is yet to be developed, to provide these countries with the much needed employment. Building on this simple observation, a convincing<sup>15</sup> case remains to be made if the Dutch Disease could possibly be the main factor explaining the poor development performance of SubSaharan Africa’s oil exporting countries.

Besides the simple observation above mentioned, it is not inevitable that existing natural resources prevent the emergence of a dynamic economy or that the discovery of such resource acts to dampen an already developed economy. Natural resources can be a blessing rather than a curse. Norway is a case in point. Norway is one of the leading oil exporters in the world, the country as yet to show clear symptoms of the Dutch disease. On the contrary, growth has thus far remained stubbornly high (Thorvaldur Gylfason 2001). Norway was already a developed country when oil was discovered in the 1970s.

Natural resource income may raise national savings and hence facilitate capital accumulation and growth; hence, there are benefits of owning large natural resources. Oil exporting economies have averaged twice the savings rate of non-oil exporters globally from 1960 to 1998 (Hausmann and Rigobon 2002). The position of a country before and during the influx of wealth is often a factor among the many different variables ranging from the political system in that economy to the status of other industries, if any, at the time of resource exportation. The applicability of Dutch Disease is therefore limited in context, particularly in the case of Africa, given the overall development level of these countries and the structure of their economy.

Indonesia, besides Norway, is another success story account and the country was similar to SSA’s oil exporting countries in the early 1970s. With a per capita income of only $200 in 1974, Indonesia was the poorest country in the world to receive a substantial

> 14 Achille Toto Same; Mineral-Rich Countries and Dutch Disease: Understanding the Macroeconomic Implication of Windfalls and the Development Prospects. The Case of Equatorial Guinea. - World Bank’s Policy Research Working Paper, 4595.

> 15 For more accuracy, Sachs and Warner (2001) empirically found that extremely resources-abundant countries such as Nigeria, or Mexico and Venezuela, have not experienced sustained rapid economic growth, in addition, empirical growth studies tend to confirm this casual evidence. But to which extent it is due to Dutch Disease in the case of Nigeria, remains an open question.

16
<!-- Start of picture text --> Indonesia: Structure of Exports<br>1970-1990<br>120<br>100<br>ao 80<br>a<br>es)<br>+ 60<br>=<br>=<br>= 40<br>=<br>20<br>0<br>QO AV ake AO Adv QD Gh gh © gb<br>QP PP PP PS PP PS SS<br>@Non-oilexports Oil-exports<br><!-- End of picture text -->
<!-- Start of picture text --> Indonesia<br>15<br>40<br>5<br>0<br>5<br>-10<br>45<br>1982 1992 2002<br>Scale: Units<br><!-- End of picture text -->
<!-- Start of picture text --> Indonesia<br>50<br>40 ene<br>30<br>20<br>10<br>0<br>1982 1987 1992 1997 2002 2007<br>Agriculture, value added (22 of GDP)<br>——— Industry, value added (2: of GDP)<br>Scale: Units<br><!-- End of picture text -->
<!-- Start of picture text --> Nigeria<br>15<br>10<br>5<br>0<br>5<br>10<br>45<br>1982 1992 2002<br>Scale: Units<br><!-- End of picture text -->
<!-- Start of picture text --> Nigeria: Federal Budget 1970- 1984<br>(percentage of GDP)<br>120<br>100<br>a<br>&<br>S 80 @ Capital Exp.<br>2 60<br>& = Current Exp.<br>5<br>5 40 ® Non-oil Revenue<br>ae<br>20 @ Total revenue<br>0<br>i=)~ aff Ni mnFr tT& EEwy oO.& ~~ coBR oaBe OoCO alBO NO mmCO st<br>co) Co) fo) fon) a co) oy fea) fon) fea] cea) fon) co) fon] co)<br>a a a oo a a a a a a a a a a 4<br><!-- End of picture text -->
1975, started declining very quickly, to about 50 percent in 1983. Since the mid-1980s, capacity utilization has never exceeded 40 percent, and has languished at around 35 percent. In other words, two-thirds of the investment in manufacturing by the government is consistently wasted.

As Bevan et al (1998) noted, the oil windfalls enabled the government to substantially increase its expenditure and thus provided increased opportunity for kickbacks. In fundamental ways, the politics of Nigeria has been shaped by getting access to the revenues from oil. Successive military dictatorships have plundered oil wealth and created a huge civil service. Oil revenues financed the building of the famous Ajakouta steel complex in the 1970s, which is yet to produce a commercial ton of steel. To appease regional rivalries; steel-production capacity was divided among several locations of the country. However the decision behind the steel industry was noble as it was a specific manifestation of the drive for modernization and industrial self-reliance.

The Nigerian explanation shows that the complexity of country context matters in Africa therefore should imperatively be taken into account, instead of quickly jumping to conclusion using the Dutch Disease cliché as the main explanation of the poor development performance of SSA’s oil exporting countries; if we are to efficiently address the resource paradox issue and help Sub-Saharan African oil exporting countries, manage and transform their natural resource wealth into long-term economic growth that spreads the benefits into the country.

The political economy and the political dynamics seem to be more important than the Dutch Disease causality explanations and probably in the context of Sub-Saharan Africa that is what matters the most, given their influence on the decisions underlying the utilization of windfalls. Transparency and accountability in the management of oil revenues are therefore critical as well as good economic policies, if these countries are to transform oil and minerals revenue into sustained growth-path and poverty reduction.

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# **IV – Effectively Managing Boom and Bust Cycles**

Besides the Dutch Disease, an alternative explanation of the curse puts the emphasis on volatility. Natural resources rents tend to be very volatile and volatility has been shown to be bad for growth, investment, income distribution, and poverty reduction<sup>20</sup> . Managing this volatility is challenging, much of the gain made in a boom unravels in the bust that follows; if not well managed boom and bust cycles can disrupt government development programs and poverty reduction spending.

Boom and bust cycles plague oil exporting<sup>21</sup> countries, given the importance of oil in the overall economy and in government revenues. The economic impact includes unpredictable revenue streams because widely fluctuating export revenues lead to fluctuating levels in overall government revenues (Mikesell 1997). These frequent upward or downward adjustments of fiscal expenditures are costly because they simultaneously discourage private investment and destabilize the government’s budget, therefore impeding its ability to sustain investment and social provision and service deliveries (Katz et al. 2004). In addition, once expenditures become entrenched, it is harder for governments to make budget cuts; rather than reversing their spending patterns during busts, they often opt to borrow, and hence, risk incurring huge debt burdens.

Nigeria is a case in point, since the collapse of oil prices in the early 1980s. Nigeria<sup>22</sup> experienced rapid external debt buildup and exhausted foreign reserves. Public and publicly guaranteed external debt increased from $4.3 billion to $11.2 billion, while foreign exchange reserves were almost exhausted, from $10 billion to $1.23 billion, all between 1981 and 1983. In early 1980s Nigeria was borrowing heavily from commercial banks, mostly at floating interest rates. During 1984-1993, the public debt to GDP ratio increased substantially and reached a staggering 140 percent of GDP. The consistent

> 20 Also see Gavin and Hausmann (1996), Ramey and Ramey (1995), Aizenman and Marion (1999); and Caballero (2000).

> 21 Although market volatility is a problem for all exporters of primary commodities, the phenomena is acute for oil exporting countries given the importance of oil in the overall economy.

> 22 Nigeria’s Growth Record: Dutch Disease or Debt Overhang? World Bank Policy Research Working Paper 4256, June 2007.

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record of repeated rescheduling<sup>23</sup> and continuing arrears since early 1980s have effectively shut Nigeria out from international market for most of the past two decades.

Fiscal policy has been the major factor behind the debt expansion during the period of oil price collapse and the subsequent collapse of the real GDP growth rate in 1981 – 1983 (Fig. 11). While the non-oil deficit was reduced substantially as a result of the sizeable public expenditure cuts (Fig. 12), the drop in oil revenue as a result of the oil price collapse was much larger. Consequently, the average annual non-oil deficit for the period exceeded the average oil revenues by more than 50 percent of non-oil GDP. The resulting large fiscal deficits translated in large current account deficits, which amounted to $18 billion cumulatively over 1981-1983, in turn led to rapid buildup of unsustainable external debt Budina, Pang and Van Wijnbergen (2007), A country with large revenues derived from exploiting a nonrenewable resource such as oil, typically faces two main problems: (i) the revenue stream is uncertain and volatile because it depends on the world oil prices, and (ii) that revenue will eventually dry up. Nonrenewable Resource Funds (NRFs) are proposed to deal with both problems. First, a fund may be seen as able to stabilize budgetary revenues. When oil price is high, the fund would receive excess resources, which would then allocate to the budget when the price is low and therefore revenues. Second, a fund may be seen as a way to save some of the revenue generated by exploiting the finite stock of the resource, which can then provide income after it has been depleted. Funds may also be set up for other reasons such as to counteract the spending effect leading to the real exchange rate volatility and Dutch Disease, for liquidity and political economy purposes, and to enhance governance and transparency (Jeffrey Davis et al. 2001).

Norway, for example, has charted a long-run-oriented, tax-based and reasonably market friendly approach to the management of its oil resources. The oil revenue is

> 23 In 1982 and 1983, Nigeria accumulated commercial debt arrears for the first time and has been running arrears on its external debt ever since. Nigeria’s arrears on external debt have been rescheduled in successive agreements with the London Club (1984, 1987, 1989 and 1992) and the Paris Club (1986, 1989, 1991, and 2000). The last Paris Club debt reduction agreement was reached in October 2005.

24
deposited in the Norwegian Petroleum Fund<sup>24</sup> , which is being built up and invested mostly in foreign securities for the benefit of the current generation of Norwegians when the reach old age as well as for the future generations, and also in order to shield the domestic economy from overheating and possible waste. At the same time, however, a variable proportion of each year’s net oil-tax revenue is transferred from the government’s Petroleum Fund to the fiscal budget, essentially to cover the non-oil budget deficit<sup>25</sup> . Norway example constitutes the state of the art in term of fiscal management rules; transparency and predictability in the management of oil windfalls utilization.

At end-2006, the fund’s assets were worth 114 percent of GDP and currently it manages around US$350 billion. Other countries are using Norway’s standards as models for their own Funds. Fiscal policy in Norway is anchored by a guideline that the government’s structural non-oil deficit is supposed not to exceed 4 percent of the total financial assets of the pension fund. The rationale for this guideline is that the long-run real return on these assets is assumed to be 4 percent, which is about the equivalent of the real return of the fund – the annual net real return has been 41⁄2 percent since 1997Clausen (2008). The non-oil deficit benchmark helps make the dependence on revenues from natural resources more transparent, hence contributes to a more long-term-oriented fiscal policy. Only the permanent part of Norway’s oil revenue is being consumed with this fiscal rule. This ensures a permanent and predictable availability of revenues provided that Norway keeps its non-oil deficit under the 41⁄2 percent of the total financial assets of the fund.

Government spending however contains both an investment and a consumption component; it could ultimately benefit the current generation as well as the future<sup>26</sup> generation. Taking into account the investment impact on productivity and the incentives it creates for private capital accumulation, countries with low capital stocks such as it is the case of SSA’s oil exporting countries, benefit most if the government spends the

> 24 The Fund recently became Government Pension Fund.

> 25 Thorvadur Gylfason. The Paradox of Plenty – For the Statoil-Econ conference volume – Lessons from the Dutch Disease: Causes, Treatment, and Cures. March 2001.

> 26 Some countries have considered, or turned to the use of savings funds, which seek to create a store of wealth for future generation. This would allow the latter to benefit from part of the revenue arising from the depletion of exhaustible natural resources in the current period.

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bulk<sup>27</sup> of accruing oil revenues with the aim at increasing the return to private investment and raising the country growth rate, Takizawa, Gardner and Ueda (2004). This result does not simply follow from the fact that marginal return on investment spending in these countries would be higher than the return on external financial assets. When the initial capital stock is low and government spending has positive externalities on production, the country would be better off spending more of its oil revenue upfront by increasing both return to private investment and the country’s rate of growth. Hence, if oil revenue investment lead to long-term benefits (e.g.; health, education and infrastructure), then spending can permanently raise income, thus minimizing the tradeoff between current and future generations.

Managing revenue volatility is a tricky task; nevertheless, strengthening the fiscal<sup>28</sup> management, adopting clear rules of the game upfront, and improving transparency and accountability can help smooth the problem during the bust cycle. Managing the bust cycle might be less an issue if revenues are well-managed during the boom period; therefore improving public finance management (PFM) should be a priority. Investing in the economy to the extent of the absorptive capacity could be a wise decision, to spread the natural resource wealth into the country and in other to increase the standard of living. Building up assets should also be a serious alternative depending of the magnitude of oil revenues and country absorptive capacities.

# **V – Addressing Institutional Issues: Avoiding the Rent-Seeking-Disease in Sub-Saharan Africa’s Oil Exporting Countries**

Existing empirical evidence seems to demonstrate without exception that countries that have managed to circumvent the resource curse demonstrate superior organizational settings with sound institutions or good leadership able to insulate windfalls from political interferences: Norway for example is one of the perfect illustrations for that matter. With natural resource wealth such as oil, there is so wealth

> 27 Provided that there is not absorptive capacity issue or it is taken into account in SSA’s oil exporting countries.

> 28 Also see Achille Toto Same; Windfall Management for poverty Reduction: Improving Public Finance Management. The Case of Chad. World Bank‘s Policy Research Working Paper 4596. April 2008.

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floating around the government that it is easier to engage in unproductive rent-seeking activities to appropriate that wealth rather than in creating more wealth. Weak institutions may lead to wasteful spending or distorted allocation. It is widely recognized that the quality of political and economic institutions such as the type of property rights arrangements and the quality of state bureaucracy determines to a great deal whether natural resource rents will be managed to the benefit of the economy and society, this is clearly negatively evidenced by the disappointing case of Nigeria, in many regards.

Acemoglu, Johnson, and Robinson (2003), demonstrate that, although the geography hypothesis emphasizes forces of nature as a primary factor in the poverty or prosperity of nations, the institutions hypothesis is about manmade influences. According to this view, some societies are organized in a way that upholds the rule of law; encourages investment in machinery, human capital, and better technologies; facilitates broad-based participation in economic and political life by the citizens; and supports market transactions.

Three crucial elements of these organizational settings of good institutions are as follows: (i) Enforcement of property rights for a broad cross-section of society, so that a variety of individuals have incentives to invest and take part in economic life; (ii) Constraints on the actions of elites, politicians, and other powerful groups so that these people cannot expropriate the incomes and investment of others in the society or create a highly uneven playing field; (iii) Providing some degree of equal opportunity for broad segments of the society, so that they can make investments, especially in human capital, and participate in productive economic activities Acemoglu, Johnson, and Robinson (2004) and Rodrik, Subramanian, and Trebbi (2002) further demonstrated that economic institutions matter for economic growth because they shape the incentives of the key economic actors in society. In particular, they influence investments in physical and human capital and technology, as well as the organization of production. Although cultural and geographical factors may also matter for economic performance, differences in economic institutions are the major source of 27
cross-country differences in economic growth and prosperity.<sup>29</sup> Economic institutions determine not only the aggregate economic growth potential of the economy but also an array of economic outcomes, including the distribution of resources in the future. That means they not only influence the size of the aggregate pie, but how this pie is divided among different groups and individuals in society. Therefore, the quality of leadership in SSA’s oil exporting countries is critical to positively influence the rule of the game toward a sustained-growth-path, and poverty reduction; because political power—hence, country’s leadership—determines economic institutions and policies.

There is now an international consensus on the critical necessity to strengthen governance, transparency, and accountability in oil and mineral rich countries for poverty reduction. Evidence has shown that with good institutions, large revenues generated from extractive industries enjoyed by some SSA countries can foster economic growth and reduce poverty; similarly, efficient management of government revenues and spending— public expenditure management—can have a profound impact on poverty reduction. Ensuring sound and transparent institutions to adequately managing natural resource and more so in Sub-Saharan African’s oil and mineral exporting countries is fundamental given their overall disappointing development performance in spite of their resource endowments.

The EITI++ initiative aims at addressing this critical issue. Further to improving transparency and accountability, the EITI++ is rightly focusing on the resource chain including managing revenues, and promoting sustainable and efficient utilization of natural-resource wealth. In fact, fiscal and tax regimes, in other words, governments’ takes on oil and mineral exploitation in Africa are by no means uniform. A multitude of revenue extraction instruments or systems are currently in place in different countries in Africa from the government side to capture some of the benefits for the state and the public. It is therefore critical to understand the resource chain in the very beginning and early stages of rent production by assessing the arrangements in place to eventually

> 29 For a detailed framework, please see Acemoglu, Johnson, and Robinson (2004).

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improve transparency throughout the revenue chain and by the same token improve efficiency and revenue allocation for sustained growth and poverty reduction.

This conceptual framework suggests and promotes the review of all mechanisms and management arrangements related to oil and mineral revenues in every stage of the resource chain. However, to avoid political complications and given the sensitivity of the subject and to make the process more manageable, this framework suggests to stay away from contract negotiations process between government and international private oil companies, as well as from the adjudication of rights to extraction. Instead, it suggests to focus on assessing the overall oil and mineral wealth governance and management arrangements in place from the collection of taxes and royalties to sound and sustainable projects, including possibly project monitoring, hence addressing the resource paradox.

For example what is the structure of governments’ rents? Is there any direct or indirect taxation on international oil and mineral companies? Any corporate taxes? What is the level of royalties if there are any? Is there any production sharing arrangement? Is there any state equity fractional ownership? Are there any special mineral taxes regulations?<sup>30</sup> The objective is to help SSA’s oil exporting countries to adequately manage their windfalls in a manner that spreads the benefits to the economy for sustained growth and poverty reduction, while avoiding undermining legitimate private corporate interests. This will require capacity building, economic policy advice and technical assistance.

The immediate challenge often facing authorities is to prepare a comprehensive development strategy to reduce poverty and foster broad-based economic growth. A well formulated and prioritized budget is critical in this regard. With substantial oil and mineral wealth, mineral-rich countries should be able to make rapid progress toward a sustained-growth-path and poverty reduction. In general the budget is the financial mirror of government policy. The preparation process is a powerful tool for coherence. The budget is both an instrument of economic management and an implicit policy statement, as it sets relative levels of spending and priorities for different programs and activities. In

> 30 The purpose here is to secure the source of revenues and to improve transparency in the revenue chain.

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principle, the starting points for expenditure programming are: (i) a realistic assessment of resources likely to be available to the government; and (ii) the establishment of fiscal objectives. The capacity to translate policy priorities into the budget, and then to ensure conformity of actual expenditures with the budget, depends in large part on the soundness revenue forecasts for oil exporting countries.

This backdrop calls for a budget formulation and execution strengthening. What are the budget preparation structures and procedures in place? Are they properly working? On the capital budget side or the investment budget formulation: is there any efficient public investment system to support the PIP? The overall assessment of expenditure framework to improve transparency and accountability is also needed. What are the budget execution and monitoring mechanisms and procedures in place? This aspect is critically important.

As is well known, most of corruption activities and mismanagement are happening around the budget execution stages, where most of the cash is susceptible to floating around; therefore, it is fundamental to ensure that the principles of transparency and accountability are well observed. What are the safeguard and mechanisms currently in place? What are the financial control institutions in place? Are they working properly? Is there any need to improve the flow of funds during the budget execution? Good governance, sound institutions and abundance of revenue are necessary and indispensable however not sufficient by themselves for a sustained growth and durable poverty reduction: There is also a need to implement good economic policies.

# **VI – Transforming Oil and Mineral Rents into a Sustained Growth-Path and Durable Poverty Reduction in SSA**

In the context of globalization, it is widely recognized that the rate at which a country grows is substantially determined by three factors: (a) the country’s ability to integrate in the global economy through trade, investment and innovation (technological change); (b) its capacity to maintain sustainable government finances and a sound monetary policy; and (c) the country’s ability to put in place an institutional environment in which contracts can be enforced and property rights can be established. In addition, in 30
the context of developing countries, like is the case of SSA oil exporting countries; because the country wealth is generated from the country economic structure, other things being equal _,_ substantial additional income can be derived only from expanding the very structure of their economy<sup>31</sup> as productivity is improved. In other words, the pure consumption<sup>32</sup> of abundant oil and mineral resources cannot expand the production base needed for a sustained-growth-path, as no added value is created in the country, through the simple and pure consumption of oil windfalls.

It is critically important for SSA’s oil exporting countries to start the process of climbing the value-chain ladder and progressively move into more manufacturing activities. This can be done by adopting and adapting existing technologies (abundant oil revenue can help) while adjusting to the global demand and international trade to limit their dependency on oil revenue, hence paving the way for a sustained growth, job creation and durable poverty reduction. The oil sector creates very few jobs; therefore the bulk of employment is inevitably from the non-oil economy. A rentier developing country which does not expand the structure of its economy condemns itself to an unsustainable permanent welfare society, unemployment and poverty circle.

The recent global food crisis for example demonstrates the vulnerability and the dependency of SSA countries on imported foods. Food constitutes by far the largest single item of household consumption in general. Oil proceeds can be invested in raising the productivity of farmers by financing improved seed variety for local production toward food security. This could also fuel job creation in rural areas.

In spite of its existing abundant-oil-wealth, Indonesia consistently invested in the food crop sector to promote technical changes in the food sector, which oil revenues helped to accelerate by financing the diffusion of improved techniques. Indonesia’s pattern of growth and its economic performance stands out as being successful in many accounts and is considered today as a successful emerging economy, partly because of

> 31 Oil exploitation will create a temporally growth surge as the rent is spent. But this type of growth can only be short-lived if the non-oil economy is not developed; it could just be like manna from heaven and will generate inflation and high costs, which will make the situation even worst.

> 32 Particularly in the context of a depletable resource the overall situation may even be worse than the exante situation preceding the establishment of a “rentier” economy, once resources are depleted.

31
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<!-- Start of picture text --> Cameroon<br>40<br>|, “Se<br>=<br>20 3 O_o<br>10<br>0<br>1982 1987 1992 1997 2002 2007<br>eee Agriculture, value added (% of GDP)<br>—-— Industry,value added (% of GDP)<br>Scale: Units<br><!-- End of picture text -->
<!-- Start of picture text --> Cameroon<br>4000<br>400<br>600)<br>400<br>200<br>0<br>1984 1986 1991 4996 2001 2006<br>TE OP pe capita contr 200)<br>Seale: Units<br><!-- End of picture text --> <!-- Start of picture text --> Indonesia<br>1200)<br>1000)<br>800<br>600<br>400<br>00<br>0<br>1981 1986 1991 1996 2004 2006<br>EN GOP per capita constant2000 US<br>Seale: Units<br><!-- End of picture text --> <!-- Start of picture text --> Chad<br>60<br>20<br>0<br>1982 1987 1992 1997 2002 2007<br>= Agriculture, value added (% ofGDP)<br>—-— Industry, value added (% ofGDP)<br>Scale: Units<br><!-- End of picture text -->
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population<sup>36</sup> constitutes a significant advantage in terms of market potential and possible labor to drive the manufacturing development hence, further employment.

Nigeria’s experience shows that the solution is not simply to spend but to spend wisely and in a coordinated manner. Hundreds of billions of dollars have accrued from the oil sector in recent decades but unfortunately there is little to show for it in terms of poverty reduction and improved standards of living. Spending of oil receipts resulted in a short-term boom in growth (Fig. 11) but this was followed by low or even negative growth and massive accumulation of debt. Put differently, Nigeria saw a harmful pattern of boom and bust that locked its economy into a _low-growth path_ . In the presence of mounting savings from the very recent oil boom, pressures are building up, particularly by state governments, to spend more given the tremendous existing needs for a stronger public infrastructure, particularly power, to support a growing private sector and to reduce poverty. Carefully crafted economy policy is essential to avoid past mistakes. This also holds for the other SSA oil and mineral exporting countries.

SSA oil exporting countries should be better off with a flexible capital expenditure program every five years, together with strict implementation monitoring made possible through an improved PFM/PEM system. This requires excellent budget preparation, execution, and monitoring. The flexible development planning will be done in such a manner that the countries could integrate the volatility of oil revenues. The proposed flexible capital expenditure program can be done, using the lowest oil priceper-barrel forecast as a baseline scenario. In the worst-case scenario, these countries could nevertheless implement the flexible capital expenditure program. And in the case where the prices forecast per barrel are more favorable, additional revenues generated will be carefully invested in priority sectors or transparently set aside.

The very recent oil boom presents these countries with a unique opportunity to invest massively and qualitatively to promote the non-oil sector necessary to catalyze the sustained growth process for a durable poverty reduction and more so for Nigeria because

> 36 A small population also means that the country is in a position to make rapid progress toward a full employment and durable poverty reduction, through wise absorption and investment of windfalls in the economy.

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of its production sharing agreement contract<sup>37</sup> basis. It is time for SSA oil exporting countries like Gabon, Congo Republic and Cameroon to reorient their development policy and understand that oil revenues are an exceptional opportunity and not a renewable source of development financing. Therefore, they should take full advantage of that favorable situation to strengthen their public finance management in general, and their public expenditure management in particular and promote the non-oil economy for Jobs creation and sustained-growth. They may also wish to plan their development process effectively and improve the efficiency of their public investment system.

> 37 The production sharing agreement contract is more sensitive to oil volatility and could possibly provide the government with significant revenues during the boom period.

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# **VII – Conclusion**

The purpose of this conceptual framework has been to put together a comprehensive approach that could contribute to address the resource paradox issue in oil and mineral exporting countries in Africa, while suggesting the strengthening of windfall management mechanisms and institutions, and the implementation of good economic policies toward a sustained growth-path and hence, job creation and durable poverty reduction in Sub-Saharan African oil and mineral exporting countries; drawing from the international experience, country specificities, SSA’s context and the very nature of natural-resource abundance.

This conceptual-framework supports the World Bank’s EITI++ initiative, which aims at helping developing countries, particularly African countries, manage and transform their natural resource wealth into long-term economic growth that spreads the wealth among the people. The World Bank’s initiative is a much needed instrument and support for mineral rich countries in Africa, as it plans to provide governments with a range of options including technical assistance and capacity building for improving the management of natural-resource-related wealth for the benefit of the overall economy and notably the implementation of good policies to promote sustained growth and poverty reduction.

This conceptual framework demonstrates on one hand, through the case of Indonesia and the example of Norway that the resource paradox is avoidable and the abundance should not be a curse rather a blessing for SSA oil exporting countries. On the other hand, focusing on Nigeria, the conceptual framework equally emphasizes what not to do, and what went wrong in Nigeria although the desire to promote the country’s development was persistent. Nigeria demonstrates to perfection that hasty spending and poor coordination, no matter how many billion of dollars are spent, is not the optimum solution: the quantity is useful but the quality of spending is crucial. Spending for the sake of spending is squandering valuable non renewable resources.

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The oil sector directly generates very few jobs, the bulk of employment is consequently from the non-oil economy and the non-oil tradable sector; therefore good economic policies matter to transform rents into sustained-growth, hence job creation and durable poverty reduction. The capacity of policy formulation and execution in a coordinated way is thus fundamental. This has been clearly one of the missing pillars in the case of Nigeria. The country context and political economy matter a great deal but should not be the main driving forces behind windfall management, to avoid excessive rent-seeking activities, inefficiency and wasteful spending; Norway is a case in point. The EITI++ implementation can contribute to make a difference, particularly through capacity building, implementation and coordination assistance.

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