Sunday, April 22, 2012

Why Are Governments of Developing Countries So Hung Up On Oil?

This is a million dollar question that every one should have to answer — because most of the answers floating around out there aren’t very good.

The first wrong answer is that developed economies are oil dependent. This is, at best, partially true. Developed countries use a lot of different energy sources, of which oil is just one. Further, developed country’s economies have also gotten less energy dependent with the passage of time: technology and services just don’t consume that much energy. And then there’s price: as economics majors you should all recognize that if we pay less for gas than we do for bottled water or Starbucks, that it just isn’t that scarce.

The second wrong answer is that oil reserves have made a lot of countries wealthy. Not so. Yes, there are places like Saudi Arabia and Kuwait. But, there are also one like Iraq and Venezuela where oil drilling has been going on for 75-100 years … without too much to show for it. The list of OPEC countries has some names you’ve probably never heard of — like Gabon — and places you wouldn’t normally think of as rich: like Nigeria and Ecuador. At the other end are places like the U.S., the U.K., Norway, and Canada, who are all rich and developed … but not from oil.

Once again, the reason has to do with explaining per capita income differences with capital, high tech, and low tech.

The exponents that the data suggests for the Cobb-Douglas indicate that technology is a lot more important than capital.

And … oil reserves are clearly not technology or labor, so they must be a form of capital.

High tech easily flows across borders, so it explains richness, but doesn’t do a good job explaining variation in richness.

Low tech does not easily flow across borders, and since technology is a bigger component than capital, this ends up being a big determinant of international differences in per capita incomes.

The thing is .. growth in low tech is hard for governments to pull off. Especially if your government is corrupt or authoritarian.

Which leaves capital growth as the way to get improvements in well-being. And what better way to grow your capital stock than to find it under the ground just waiting to be drilled.

So there you have it: the obsession with national oil reserves reflects a substitution away from low tech because the government lacks vision and capability. Many social scientists assert that it is resource exploitation that leads to government corruption. I’d turn that around: corrupt governments choose resource exploitation because it’s the only card they have to play.

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