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Natural resource dependence and human capital accumulation

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Natural resource curse” is a paradoxical phenomenon that was explored by Sachs and Warner (1995). It implies a negative relationship between economic growth and the abundance of natural resources. Since then the hypothesis has been subjected to ardent debate.
A country’s total wealth is the sum of its natural capital, physical capital and intangible capital, i.e., human capital. Since human capital induces economic growth, Dr. Zafar Mahmood ( Professor of Economics and Managing Editor, NUST Journal of Social Sciences and Humanities, S3H, NUST) and I sought to explore the relationship between human capital and dependence on natural capital using a political economy model (Cabrales and Hauk, 2011). This model generally concludes that countries with poor institutional quality choose policies that prevent human capital accumulation and hence growth. Therefore, if this condition prevails then the countries heavily endowed with natural resource wealth, on average, will exhibit lower growth rates than the resource poor countries.
The existing literature mostly takes into account resource rich countries, especially those that are rich in oil and natural gas, while studies focusing on regions focus on analyzing different counties and states of the same country. Our analysis deviates from the convention by splitting the sample of selected countries into Asian regions (SAARC and ASEAN) and considering the impact of differing natural resource wealth on human capital. The OPEC group is considered for the sake of comparison. SAARC, ASEAN and OPEC groups vary in natural resource endowments and degrees of natural resource dependence. Hence, we decided to focus on how human capital accumulation is influenced by natural resource dependence in these regions.
In Natural Resource Economics the term resource rents is used to refer to the economic rents generated by those resources. Resource rents are assumed to be the economy’s source of income. After using different proxies for naural resources and running a thorough empirical analysis we arrived at the following conclusions.
For SAARC natural resources are a blessing. Based on the threshold established for institutional quality Bangladesh, Nepal and Pakistan have poor institutions while India, Maldives and Sri Lanka have good institutions. Regardless of institutional quality the natural resource rent rates have a significantly positive impact on education in the SAARC region. However, natural resource rents in value terms show a significant impact only when institutional quality is good. Despite hybrid nature of democracies in the SAARC region, the degree of natural resource dependence is not large enough to be detrimental to education. This relationship is a good indicator and calls for increasing natural resource dependence. This would require efficient utilization of natural resources by the regional economies.
For OPEC natural resources are a curse. The OPEC group as compared to the SAARC region is another extreme. All countries in the sample are heavily dependent on natural resource rents. Based on the threshold Algeria, Iran, Libya and Venezuela have poor institutional quality while Kuwait, Qatar, Saudi Arabia and UAE have good institutional quality. Despite falling low on democracy index the authoritarian states exhibit good institutional quality. Looking at the empirical results the impact of natural resource dependence on education remains negative when natural resource rent rates and natural resource rents in value terms are used. Since in the model democracy is captured by institutional quality we can conclude that the model rightly predicts that when institutions are weak the incumbent government is likely to stay in power which then compromises on human capital accumulation to remain in power and reduce the chances of a revolution.
In the OPEC group even the democracies score low on the Democracy Index hence the difference between monarchies and democracies is blurred. This is why there is no difference in the relationship between human capital and natural resource dependence when monarchies are included and excluded. Since the institutional quality is also influenced by the element of governance, if the government is authoritarian in nature then even under good institutions the allocation of rents generated by the natural resources is influenced by the government. Also if the economy is highly dependent on natural resource rents as a source of income then those rents will be used to meet the economy’s expenditures. Hence, their contribution to human capital, which is often neglected, will most likely be negative. In comparison, SAARC and ASEAN are aware of the limited natural resource wealth they have and hence they do not rely on natural resource rents as a major source of income generation and instead consider them as a short-term bonus. This encourages them to invest these in human capital. Hence, lower degree of natural resource dependence encourages them to translate their natural capital rents into human capital which then helps the economy to generate income via other sectors.
For ASEAN natural resources can be a blessing or a curse depending on the measure of natural resources used. Cambodia and Lao PDR have poor institutional quality while all other countries including Indonesia, Malaysia, Philippines, Singapore, Thailand, and Vietnam have good political institutions including the monarchy, Brunei Darussalam. The impact of oil and gas rents as a percentage of GDP on ASEAN countries is positive regardless of institutional quality implying that rents from oil and gas enhance education in the ASEAN region. This can be explained by the model as when institutional quality is good the chances of the incumbent government to stay on will fall and the government’s interference in the appropriation of natural resource rents will be reduced. When a broader measure of natural resource rents as a percentage of GDP is used, regardless of the institutional quality natural resource dependence has a positive impact on education when Brunei Darussalam (monarchy) is included and the impact is negative when it is excluded. This shows that for ASEAN democracies natural resource dependence is a curse. Since despite strong institutions the limited natural resource dependence of ASEAN countries reveals detrimental impact on human capital accumulation it reflects a weakness in the measures of natural resource dependence being used. Currently, the measures of natural resources available are not broad enough to include each region’s endowments. Hence for ASEAN we can conclude that dependence on oil and gas rents (which is extremely minimal) is a blessing while natural resource dependence including a broader variety (reflecting higher level of dependence than on oil and gas rents only) prove to be a curse. This also signifies the need for policy making regarding development and management of natural resources in the region.
Based on the conclusions the following policy implications can be drawn:
(1) If natural resources have to be used for the benefit of society then the institutional quality must be strengthened
(2) Strengthening public sector education system will help dilute the negative effect of population growth on human capital. This will be especially helpful for SAARC region that has the highest population amongst all 3 regions.
(3) There is a need to develop a more inclusive measure of natural resource endowments. The current measures take into account the non-renewable fossil fuels (oil, gas, and coal) minerals, and forests. However, there is a variety of natural resources that remain unaccounted for like fisheries and rents generated using the renewables like hydropower, wind and solar energy. Since a country’s historic and cultural heritage and scenic beauty are natural endowments and attracts tourists, revenues generated by tourism should also be included in the measure of natural resources. Developing a more inclusive measure may change the results for SAARC and ASEAN regions since their natural resource endowments are different from OPEC’s natural resource endowments.
(4) Each region must aim to develop policies specifically targeting the development of their natural resource endowments. The policies must be four tiered with identification and quantification of natural resources – renewable and non-renewable, at the base; assessment of degree of renewability and determination of the lifetime of reserves at the second level; programming the development and exploitation process such that the productive and allocative efficiency is maximized at the third tier and the last tier must focus on reinvesting the rents earned from the liquidation of non-renewable assets such that they are converted into other assets so that the future generations in the region can also benefit from the natural resource endowments that their region was once blessed with. If such policies are developed by all countries in each regional organization and are compared, reviewed and implemented under the supervision of the regional organizations, the rents and efficiency derived from natural resources will not only be maximized but the exploitation of resources will also be able to lead to more sustainable levels of development in the long-run.
(5) Specifically, OPEC countries need to invest more in human capital development. They need to break free of the curse and this can be done only if they start developing their other industries and sectors and invest more in human capital accumulation. This will help them find alternative sources of income which is crucial for sustainable development. They must also focus on preservation of the revenues generated by their natural resources through investments in other assets.
(6) SAARC and ASEAN regions are both developing regions with ASEAN doing better in terms of income classification. While for SAARC natural resource dependence is a blessing according to our empirical results, for ASEAN it could be a curse or a blessing depending on the proxy being used. Therefore, countries in both regions must aim to develop their endowments of human capital and then aim to develop their natural resource sector such that sustainable development can be achieved.
Note: The article is derived from a Working Paper -“Natural Resource Dependence and Human Capital Accumulation – An Analysis for the Selected SAARC, ASEAN and OPEC Countries” by Rabia Qaiser and Dr. Zafar Mahmood published in S3H Working Paper Series, NUST.