van der Ploeg, F & Poelhekke, S (2008) ‘Volatility and the Natural Resource Curse'

Precept 10 says that resource revenues can be used by governments to facilitate private investment. A question arises over whether this investment should be steered toward diversifying the economy or exploiting opportunities in the domestic resource sector. The paper by Van der Ploeg and Poelhekke suggests the former. The authors find that an excessive level of natural resource dependence exposes the economy to volatility.

 

Precept 8 states that revenue volatility ought to be addressed through gradually and smoothly building up domestic expenditure and investment from resource revenues. The paper supports the fundamental premise of the Precept through providing evidence that resource dependent economies experience growth volatility. Furthermore, the paper draws out measures on how to address such volatility.

 

The paper investigates the link between natural resources and volatility in economic growth. The authors find that the indirect effect of natural resources on growth, via volatility, is negative. The case is made hereby that poor growth performance and volatility are strongly related to resource dependence, as well as the absence of a sophisticated financial system. However, when controlling for volatility, natural resources can have a positive direct effect upon growth. Reducing volatility through, for instance, a financial system able to cope with sudden resource income fluctuations therefore also reduces the negative effects of resource dependence.

 

With regards to general investments it is crucial to improve the business environment and the productivity of the private sector as a whole. For such reforms the paper provides a specific recommendation, demonstrating that a well functioning capital market can reduce the effect of shocks in the resource share on volatility. This also allows for funding of new activities, thereby fostering a responsive and flexible business environment, which is essential for increased private investment. 

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