Reverse Dutch disease from reverse resource curse

The problem

Shekhar Gupta and Swaminathan S. A. Aiyar have pointed out that our domestic policy logjam is leading to the import of natural resources which are amply present in mines in India. This is giving a bigger current account deficit and a weak rupee.



I feel this is not such a bad thing. Many countries have been afflicted by the resource curse and many countries have been afflicted by Dutch disease. We are blessed with reverse resource curse and reverse Dutch disease. Here's the argument.

Reverse resource curse

The idea of the resource curse runs like this:

For many years, economists have been puzzled at the way things have gone wrong in countries where natural resources were discovered. In 1993, the economist Richard M. Auty coined the phrase `Resource curse' to convey the extent to which natural resource finds are a curse and not a blessing. But the idea had been kicking around well before that. I suppose it was an obvious conjecture after watching the failures of the Middle East, where trillions of dollars of oil revenues were squandered by not one but many countries.



In the 1970s, when oil was discovered in Venezuela, former Oil Minister and OPEC co-founder Juan Pablo Perez Alfonzo said: "Ten years from now, 20 years from now, you will see, oil will bring us ruin." His phrase for oil was: "the devil's excrement."



Why are resources a curse? In a country blessed with no natural resources (think Japan), the only way forward for the ruling elite is the slow hard work of building public goods, so that GDP builds up, which then feeds back into the power and importance and utility of the ruling elite. When the ruling elite gets their wealth for free, without having to do the hard work of building public goods and thus GDP of the country, the rulers emphasise the wrong issues. That's how Venezuela ended up with Hugo Chavez.



On one hand, rulers get focused on finding ways to maximise their rent from the underlying resource flow, without developing the knowledge about how to build a State that delivers public goods. In parallel, competition between politicians becomes an unpleasant process of trying to grab the riches by means fair or foul, rather than a process of competing in doing better on public goods. If there are XX billion dollars to be grabbed by becoming head of state, fairly unpleasant tactics get used by rivals aiming for that job.

Source: Why does Bombay have abysmal governance, 6 November 2010, on this blog.



And, you may like to also see: Resource curse - comparing India and Russia, 21 February 2007 and The resource curse of land ownership, 12 January 2012.



For many years, resources in India were a messy business. Now, we have started getting push back in terms of greater scrutiny and medium-grade enforcement. This has exerted a sharp negative impact on this business.



This is not such a bad thing. A country that lacks good institutions is better off without natural resources! If we hide the natural resources into the ground for 25 years, while we build good institutions, that is a good deal. It is far better to do this than to face the destruction of institutions which comes from natural resources impacting upon a badly constructed political system.



If we were advising a tin pot dictator who has just found oil, what's the best advice we could give? We would say: Burn all the documents about this oil find, and build the rule of law for the next 25 years. It is an achievement of Indian democracy and institutions that the reduced form outcome is one of restraint rather than exploitation of these natural resources. If this restraint had not come about, it would have distorted the trajectory of Indian politics, possibly with disastrous consequences for our future.

Reverse Dutch disease

At present, the exchange rate in Sri Lanka reflects a combination of competitiveness of the tradeables sector and financial considerations. Suppose there is a great oil find there. A surge of oil exports from Sri Lanka would then commence. This would exert pressure for the exchange rate to appreciate. This would damage the development of the tradeables sector which would not be able to compete at that distorted exchange rate. This has been termed `Dutch Disease' as it was first described in the context of the impact of North Sea oil.



We in India are getting the reverse. Excessive imports of natural resources, of even the things that are found under the ground in India, is exerting pressure on the exchange rate in favour of excessive depreciation. This will foster the tradeables sector. Reverse Dutch disease is not such a bad thing.

Conclusion

It is curious and remarkable that India is importing things that are found under the ground in India, owing the domestic institutional logjam. But we should resist calls to cut the Gordian knot and debottleneck the resources business in messy ways. It is much better for us to dig in and build good institutions, rather than find short cuts through which natural resource exploitation can hurriedly take place. This will surely take a long time. In the meantime, this will generate currency weakness. This is not such a bad thing.