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3.8. Natural resource wealth leads to unsustainable government policies
Natural resource wealth may encourage countries to engage in ‘excessive’ borrowing, which
harms the economy in the short and long run (Mansoorian, 1991). Heavy borrowing on the
world market induces depreciation of the real exchange rate in the long run. In an economy
with overlapping generations of households without a bequest motive, the generations alive at
the time of the exploitation of the resource borrow against future resource income and future
generations bear the burden of servicing the debt. The consequent fall of aggregate demand
causes depreciation of the real exchange rate in the long run. Others also find that resource
rich countries have an incentive to borrow excessively (Manzano and Rigobon, 2001).
In general, a sudden resource bonanza tends to erode critical faculties of politicians
and induce a false sense of security. This encourages them to invest in projects that are
unnecessary, keep bad policies in force, and dress up the welfare state so that it is impossible
to finance once natural resource revenues dry up. Politicians are likely to lose sight of growth-
promoting policies, free trade and ‘value for money’ management. For example, after the
discovery of natural gas in the Netherlands, the global oil price shocks during the 1970s and
1980s and the consequent sharp rise in unemployment, successive Dutch governments
responded irresponsibly. They expanded public employment and consumption, made
unemployment and disability benefits more generous, weakened eligibility conditions for
benefits, raised the minimum wage, and implemented protective labour market legislation
(Neary and van Wijnbergen, 1986). Starting in 1989, it has taken more than twenty years to
put the Dutch welfare state on a financially sustainable footing again.
Many developing countries erred by trying in vain to encourage industrialization
through prolonged import substitution using tariffs, import quota and subsidies for
manufacturing. Neo-Marxist policy makers in these countries but also many other economists
during the 1970s and 1980s found inspiration from the Prebisch-Singer hypothesis, namely
the secular decline of world prices of primary exports (Harvey et al., 2010), to attempt to
avoid resource dependency through state-led industrialization and import substitution. These
policies may also have been a reaction to the appreciation of the real exchange rate and the
decline of the traded manufacturing sectors caused by natural resource wealth. The substantial
resource wealth in many of those countries may thus have prolonged bad policies. Political
scientists have advanced several reasons why states have a proclivity to adopt and maintain
sub-optimal policies (e.g., Ross, 1999). Cognitive theories blame policy failures on short-
sightedness of state actors, who fail to take account of the adverse effects of their actions on
generations that come after the resource is exhausted, thus leading to myopic sloth and
exuberance. These cognitive theories also stress a get-quick-rich mentality among
businessmen and a boom-and-bust psychology among policy makers. Political scientists point
the finger at abuse of resource wealth by privileged classes, sectors, client networks and