After Peak Oil: Who Escapes the Resource Curse?*

Given the discovery of resource wealth, which factors account for future economic success and which factors hinder success? This case study compares two countries which discovered oil wealth in the late 1960s: Ecuador and Norway. The analysis gives the economic and political context and then compares three bodies of resource curse literature that relate to economic success. The study ultimately concludes that resource sale is the largest contributor to economic success. In the past “resource winners” have been praised for policies and economic outcomes only to have those policies deemed ineffective in retrospect. Norway is the current outlier in resource curse literature and is often cited as the most successful example of resource wealth management. However, projections indicate that Norway has started to show symptoms of economic decline now that it has reached peak oil. A final implication from this study suggests that resource curse literature should focus on whether the economic trajectories of resource winners can ever be sustained resource reserves expire. * I am grateful to Dr. Chris Butler and Dr. Mark Peceny for their enduring guidance. Introduction This case study applies resource curse literature to two case studies. By focusing on two specific cases this study shows that perhaps the division between “resource winners” and “resource losers” may be far more blurred than scholars suggest. Ecuador and Norway both discovered oil in the years that lead up to the oil price shocks that were suppose to have given oil exporting countries enormous economic clout. In the 1960s Ecuador was a developing nation that discovered small oil reserves. Conversely, Norway was a highly developed nation that found huge oil reserves. According to resource curse literature Ecuador was faced with a “bad situation” (in terms of overcoming the resource curse) and today, it is not considered a “resource winner.” Norway, however, began production in a “good situation.” Norway developed unique policies and is frequently considered a “resource winner.” Yet, Ecuador did as well as Norway for fourteen years (in terms of GDP per capita) until it reached peak oil. Furthermore, since reaching peak oil Ecuador has maintained steady growth both economically and in terms of human development. Norway reached its peak oil only this year (2010). The question then is: will resource curse literature continue to consider Norway as a “winner” in the decades that follow its peak oil? Literature Review Resource curse literature grapples with two broad topics. The first topic is why resource rich countries frequently perform poorly compared to their resource poor counterparts. The second topic focuses on why among resource rich countries some succeed and others do not. Resource rich countries are both some of the richest and some of the poorest countries on earth. Terry Karl (1997) summarizes the phenomenon as it relates to developing countries in her book the Paradox of Plenty. She asks "after benefiting from the largest transfer of wealth ever to occur without war, why have most oil-exporting developing countries suffered from economic deterioration and political decay?”(p. xv). In other words, why have developing countries been unable to use their resources to improve their economies? Karl (1997) proposes that Petro-states are unlike other states. Petro-states are frequently resources losers because institutions favor rent seeking activities, and this is particularly true in countries where the discovery of oil wealth coincided with modern state-building. Karl theorizes that dependence on petrodollars produces a distinct institutional situation. This is because the initial bargaining situations between oil companies seeking to secure access to crude and local rules who want to consolidate their support results in centralize political power, strong links between public and private actors, poor development practices, and the replacement of domestic taxation with petrodollar influxes. Other studies, like Mehlum et al. (2006), find that the quality of institutions can affect growth rates for the country. Mehlum et al. (2006) describe three ways in which resources interact with institutions. The first way is when the quality of institutions is hurt by resource wealth. A second way where institutions do not play an important role, and a third way where resource wealth is appropriated in relation to the quality of the institution. Additionally, Persson et al. (2008) find that the because presidential regimes imply less incentives for legislative participation and more separation of powers, a presidential system endowed with resources will redistribute wealth towards powerful minorities and invest less in public goods. Conversely, parliamentarian governments redistribute wealth toward a majority and invest more in public goods. For the purposes of this study the most important findings on resource wealth and institutions comes from Michael Ross and his article “Does Oil hinder Democracy?” Ross (2001) shows that oil does, in fact, impede democracy. Moreover, Ross (2001) finds that oil deteriorates democracy more in poor countries than in rich ones. Finally, Ross (2001) finds that this phenomenon is not limited to the Middle East. Sachs and Warner (1997) suggest that regardless of institutional type or quality, resource rich states tend to overspend during the onset of the natural resource wealth. Using a Ramsey growth model, Sachs and Warner display the convergence towards the natural steady state equilibrium which they conclude accounts for the negative growth seen in the resource curse literature. Another explanation for why resource rich countries perform poorly is the Dutch Disease. The Dutch Disease proposes that exporting resources deteriorates the manufacturing sector. This is because the cash inflow from the international market makes the exporting country's currency stronger. A stronger currency makes the products manufactured within the country cost more in the international market and so decreases the exportability of these manufactured products. This may explain why resource abundant countries like Nigeria, Zambia, Sierra Leone, Angola, Saudi Arabia, and Venezuela experienced lower growth rates than resource poor countries like the Asian tigers: Korea, Taiwan, Hong Kong, and Singapore. However, the Dutch Disease fails to explain why there is such growth variation between resource rich countries. Botswana, Canada, Australia, the United Arab Emirates and Norway are all examples of resource rich countries that have seen the rapid growth of their economies. For both the United Arab Emirates and Norway, their growth is linked specifically to their oil exporting activities. To explain the difference between resource winners and losers Ding and Field (2004) use World Bank data on national capital stocks to find that countries with resource endowments have positive economic growth, while countries that are resource dependent experience negative impacts on growth. This paper links the above factors of the broader resource curse literature specifically to the economic success of two petroleum exporting countries which ultimately seem to emphasize the importance of economics over policy. Research Design In terms of gross domestic product (GDP) Norway far outranks Ecuador. Both before and after the discovery of oil Norway had a higher GDP (by orders of magnitudes) and grew at a faster rate than Ecuador did. The two countries are clearly diverse in terms of development. The following graph shows the GDP in constant 2000 USD from 1960 to 2008. An important aspect of this graph is that both countries demonstrate steady growth rates. Most importantly, it is clear that Norway had and continued to drastically outperform Ecuador economically. This should not surprise anyone familiar with international economies. What should surprise the reader is what is found in the following graph. The following graph attempts to control for prior economic performance and country size, while displaying the growth trend since the discovery of oil. For these reasons the dependent variable Gross Domestic Product per capita is used. The World Bank defines Gross Domestic Product per capita as follows: “GDP per capita is gross domestic product divided by midyear population. GDP is the sum of gross value added by all resident producers in the economy plus any product taxes and minus any subsidies not included in the value of the products. It is calculated without making deductions for depreciation of fabricated assets or for depletion and degradation of natural resources.” The GDP per capita used in this analysis is taken from World Bank national accounts data, and OECD National Accounts data files. It is measured in Constant 2000 United States dollars. The following graph shows a comparison of growth rates between the two countries based on gross domestic product per capita data. The above graph was normalized using the base year: year of discovery. The year of discovery for Norway is 1969 and is 1967 for Ecuador. Normalizing has the effect of eliminating differences of prior economic performance allowing the graph above to display a comparison of growth rates in relation to their respective oil discovery dates. What is quite shocking here is that Ecuador actually models the Norwegian growth trajectory until the 14th year after Ecuador’s oil discovery. This is the year Ecuador reached its peak oil. According to Ding and Field (2004) a resource dependent Ecuador should not have modeled the growth rates for the resource endowed Norway. Ecuador had less oil, was more resource dependent, and had a low income economy. All these economic indicators should suggest negative growth or, at least, low growth but instead, we see the above performances. Why might this be the case? After justifying the case selection, the remainder of this paper will attempt to determine what produces this similarity among such dissimilar countries. Case Selection This paper uses the method of agreement as prescribed by John Stuart Mill (1843) to compare the selected cases of oil discovery. The method of agreement looks for a common factor in all the cases where the effect occurs. For this study the factors are oil discovery, year of discovery, the international price of oil, economic development prior to and during oil exporting years, regime type, and production model. The effect is GDP per capita growth. The subjects of this study are Ecuador and Norway. Criteria One: Resource Impact and Economic Performance The cases selected are vastly different, but they have several features in common that make them comparable. Stevens (2003) identifies 55 countries in which resource export revenues exceed 30% of merchandise exports. Both Norway and Ecuador make this list. Stevens identifies Norway as one of seven countries which have beaten the resource curse; Ecuador is not identified as a winner. Yet, both countries have had more stable growth as compared to other oil exporting countries. In addition, increases in growth are more notably related to oil. For comparison, the following graph shows the gross domestic product of four well-known oil exporters. Oil onset is marked by a short vertical line. For both Venezuela and UAE oil discovery was made before the data begins. Karl’s theory seems to play out in these two cases, where long standing traditions of the interaction between oil wealth and institutions have created precarious economic situations. On the other hand, both stability and increases in growth as it relates to onset of oil wealth, is visible for Norway and Ecuador. It is obvious from the above graph that this study investigates the extremities of the rich and poor among resource impacted countries. The following three criteria do not relate to rich and poor and offer more evidence that the comparison can and should be made between Ecuador and Norway. Criteria Two: Oil Prices The two countries discovered their oil in the late 1960s just before the first major spikes in oil prices and began producing and exporting their crude in the early 1970s during the price increases. The international petroleum market is a very complex market. Economic policies of countries worldwide affect the international price, different grades of crude demand different prices, and conflict (both international and domestic) is also a huge factor in international oil price. It is for these reasons that the same time frame must be used to analyze the effects of petroleum income on a country. The timing of discovery and development policies will greatly affect how much revenue a country can extract from their natural resource. The Yom Kippur war of 1973 and the Arab oil embargo spiked the international price for oil right after the two countries began to sell their oil on the international markets. The following is a graph of the average oil price over time. The graph shows a large upshot in oil price in 1973. This is a product of the Arab oil embargo. The Arab oil embargo was a result of the decisions made by the Organization of the Petroleum Exporting Countries (OPEC) which was established by Iran, Iraq, Kuwait, Saudi Arabia and Venezuela in 1960. One year before the 1973 oil embargo, in 1972, Ecuador began producing oil. Norway began producing in 1970 but would not become a top producer until 1975. Karl (1997) explains that during the 1970s industrialized countries, which were faced with the first energy crisis as a result of the embargo, feared the wealth and power oil exporters were acquiring would alter power structures and allow the exporters (OPEC in particular) to become the bankers of the world. The result has not been nearly as dramatic. The Arab oil embargo had ended by 1974 but the embargo left the price at new high which all two countries enjoyed during their early exporting years. Embargoes cause artificial price increases for all exporting nations because the supply shortage increases the price on the international market. From 1970 to 1974 government revenues of OPEC nations on average grew eleven times over (Karl, 1997, p.2). Norway was not a member of OPEC. Ecuador joined in 1973 only to withdrawal in 1992 over membership dues.1 However, regardless of OPEC membership status the price shocks provided additional revenue for all oil exporting countries. Unfortunately for OPEC nations and oil-exporting developing countries alike, dreams of utilizing that enormous transfer of wealth to significantly alter their economic trajectories had failed even before the price plunges of 1983 (p.3). Criteria Three: No domestic experience Prior to the late 1960s, Ecuador and Norway had no known oil reserves and no oil exporting experience. The importance of these criteria cannot be understated, at least in terms of policy decisions. This criteria is used to separate incremental policy development from deliberate policy planning done at time of discovery. In other words, countries like the United States, Mexico, Venezuela and Middle Eastern producers who had discovered oil reserves in the early 1900s have incrementally developed their oil policies over the past century often unaware of the effects such a resource would produce. The theory of the paradox of plenty (Karl, 1997) is most applicable in these cases, where state building and the creation of institutions coincided with incremental 1As of 2007 it has rejoined OPEC. Source: OPEC: Brief History discoveries of oil. Such an early discovery meant that these countries developed demarcated production models that encourage poor practices like giving too much autonomy to multinational production companies, faulty investment strategies, or overspending. By1970s, the world’s dependence on oil would be well known. Because of this knowledge Ecuador and Norway were presented with the opportunity to alter course and deliberately choose a policy more beneficial to the country. They were provided the opportunity to gather knowledge about oil exportation and its effects from countries that had produced oil for extended periods of time. Because they had no known oil reserves, Ecuador and Norway had no exporting experience. Exporting experience means two things: first, experience with the relationship between government and production companies and second, national human capital that could be employed to produce the country's oil. Both countries were faced with immediate deliberate decisions about how to control oil reserve development and how to incorporate the resource rents into their national economies. This deliberate decision-making was not available to the countries which discovered their oil deposits early and incrementally. Criteria Four: Independence Finally, at the time of discovery each country was independent. This is important because many oil exporting countries discovered their oil under colonial rule and therefore had their initial oil development policies dictated to them. In some cases countries with early discoveries had their policies decided for them by the great powers of the early twentieth century. One example is Venezuela. When oil was discovered in 1922, Venezuela's dictator, General Juan Vicente Gomez, allowed the oil companies of the United States to dominate the decisions regarding Venezuelan petroleum laws. Yergin (1991) says General Gomez used Venezuela’s oil wealth for his own personal enrichment. In1935 when General Gomez died and the ruling party (which was born out of the “Generation of 1928” activists) renegotiated the oil policy. Their renegotiations resulted in “fifty-fifty” principal. Government would take equal percent of the profits the companies made from Venezuela oil. In effect they were equal partners and the country was able to regain some control. In 1943 it was considered a landmark event, but it took over twenty years for Venezuela to regain control of its own resource. Mexico which discovered oil in 1901 is another example of an incremental process of policy development, and Libya, whose oil exploration was led by British efforts in the 1950s, is yet another example. This paper will discuss how the independence of the three countries allowed them to choose their own production models and in the case of Norway: invent a new one. The Qualitative Analysis: Compare and Contrast Ecuador History Throughout the twentieth century Ecuador became very familiar with the booms and busts of maintaining a large exporting sector volatile to the international markets. In the beginning of the century Ecuador was reliant on a powerful cacao exporting sector. By the 1950s Ecuador had replaced cacao exports with banana exports. As a result of the export dependent economy the banking system expanded. In 1970s oil dominated the Ecuadorian economy as the primary export. Ecuador was a country prone to political instability. Between 1925 and 1947 twenty-three governments cycled through the Ecuadorian capital. In 1970, two years after the discovery of oil in Ecuador, the ruling president, Velasco Ibarra, declared a dictatorship. In 1972 Ibarra was removed by a military coup. The military government was self-described as the “revolutionary nationalist” government and General Guillermo Rodriguez Lara presided. Ecuador would draft seventeen constitutions by the time the military would turn the government back over to democratic civilian rule in 1979 just two years before Ecuador reached its peak oil. In Latin America, during the 1960s and 1970s, military dictatorships were not uncommon. Ecuador (with Peru) would eventually be among the earliest of the Latin American countries to democratize but the Ecuadorian oil boom years were administered by the military dictatorship. The following graph demonstrated Ecuador’s GDP per capita as compared to other middle income countries from 1960 to 2008.