13
appendix 2). However, if production of traded goods requires natural resources as factor input,
a higher world price of natural resources leads to depreciation of the real exchange rate and a
lower capital intensity in the production of non-traded goods which accentuates the fall in
traded sector employment and throttles learning by doing and growth even more.
To illustrate how a resource boom affects relative productivity growth of the traded
and non-traded sector, the adverse effects of the Dutch disease on growth are illustrated with a
dynamic two-sector economy without capital accumulation, absence of current account
dynamics and balanced trade (Torvik, 2001). Both traded and non-traded sectors contribute to
learning. A foreign exchange windfall arising from resource exports then leads to appreciation
of the real exchange rate in the short run, but real depreciation in the long run. To illustrate,
allow productivity growth in each sector to increase with the number employed in that sector
and suppose that learning by doing is more substantial in the traded than non-traded sector.
Suppose also that the elasticity of substitution between traded and non-traded goods in
consumption ε is less than unity. A fall in relative productivity of the traded sector H≡HT/HN
induces real depreciation (lower P) and, given ε < 1, a smaller non-traded sector (lower LN).
After an increase in QE the economy gradually converges to the lower steady-state value of H,
so over time productivity of the traded sector declines relative to that of the non-traded sector.
We have already seen in section 3.1 that higher natural resource exports lead initially
to real appreciation and expansion of the non-traded sector (the shift from A to A' in fig. 2).
Over time relative productivity of the traded relative to that of the non-traded sector H
declines gradually. This induces gradual depreciations of the real exchange rate and falls in
labour use in the non-traded sector, and corresponds to the movement from A' to A" and
eventually B in fig. 2. In the end this completely chokes off the initial expansion of the non-
traded sector and eliminates the boom of the traded sector through gradual depreciation of the
real exchange rate. The new steady-state level of production has also moved in favour of the
non-traded sector, not due to reallocation of labour, but due to the relative fall in the
productivity of the traded sector.
Empirical evidence for negative effect of natural resources on economic growth
The pioneering study on the empirical cross-country evidence shows that resource rich
countries indeed grow on average about one percentage point less during 1970-89 even after
controlling for initial income per capita, investments during the period, openness and rule of
law (Sachs and Warner, 1995). The revised cross-country regressions explaining average
growth in real GDP per capita during 1970-90 are reported in the first regression of Table 1.
5 Similarly, giving aid to developing countries may lead to appreciation of the real exchange rate and
decline of manufacturing (Adam and Bevan, 1999, 2006; Adam and Connell, 2004).