Volatility, rather than abundance per se, drives the "resource curse" paradox

Commodity Price Volatility and the Sources of Growth. By Tiago V. de V. Cavalcanti, Kamiar Mohaddes, and Mehdi Raissi
IMF Working Paper No. 12/12
http://www.imfbookstore.org/ProdDetails.asp?ID=WPIEA2012012

Summary

This paper studies the impact of the level and volatility of the commodity terms of trade on economic growth, as well as on the three main growth channels: total factor productivity, physical capital accumulation, and human capital acquisition. We use the standard system GMM approach as well as a cross-sectionally augmented version of the pooled mean group (CPMG) methodology of Pesaran et al. (1999) for estimation. The latter takes account of cross-country heterogeneity and cross-sectional dependence, while the former controls for biases associated with simultaneity and unobserved country-specific effects. Using both annual data for 1970-2007 and five-year non-overlapping observations, we find that while commodity terms of trade growth enhances real output per capita, volatility exerts a negative impact on economic growth operating mainly through lower accumulation of physical capital. Our results indicate that the negative growth effects of commodity terms of trade volatility offset the positive impact of commodity booms; and export diversification of primary commodity abundant countries contribute to faster growth. Therefore, we argue that volatility, rather than abundance per se, drives the "resource curse" paradox.


Excerpts

I. INTRODUCTION

Finally, while the resource curse hypothesis predicts a negative effect of commodity booms on long-run growth, our empirical findings (in line with the results reported in Cavalcanti et al.  (2011a) and elsewhere in the literature) show quite the contrary: a higher level of commodity terms of trade significantly raises growth. Therefore, we argue that it is volatility, rather than abundance per se, that drives the "resource curse" paradox. Indeed, our results confirm that the negative growth effects of CTOT volatility offset the positive impact of commodity booms on real GDP per capita.

VI. CONCLUDING REMARKS

This paper examined empirically the effects of commodity price booms and terms of trade volatility on GDP per capita growth and its sources using two econometric techniques. First, we employed a system GMM dynamic panel estimator to deal with the problems of simultaneity and omitted variables bias, derived from unobserved country-specific effects.  Second, we created an annual panel dataset to exploit the time-series nature of the data and used a cross-sectionally augmented pooled mean group (PMG) estimator to account for both cross-country heterogeneity and cross-sectional dependence which arise from unobserved common factors. The maintained hypothesis was that commodity terms of trade volatility affects output growth negatively, operating mainly through the capital accumulation channel.  This hypothesis is shown to be largely validated by our time series panel data method, as well as by the system GMM technique used, suggesting the importance of volatility in explaining the under-performance of primary commodity abundant countries.

While the resource curse hypothesis postulates a negative effect of resource abundance (proxied by commodity booms) on output growth, the empirical results presented in this paper show the contrary: commodity terms of trade growth seems to have affected primary-product exporters positively. Since the negative impact of CTOT volatility on GDP per capita is larger than the growth-enhancing effects of commodity booms, we argue that volatility, rather than abundance per se, drives the resource curse paradox.

An important contribution of our paper was to stress the importance of the overall negative impact of CTOT volatility on economic growth, and to investigate the channels through which this effect operates. We illustrated that commodity price uncertainty mainly lowers the accumulation of physical capital. The GMM results also implied that CTOT volatility adversely affects human capital formation. However, this latter effect was not robust when we used an alternate GARCH methodology to calculate CTOT volatility. Therefore, an important research and policy agenda is to determine how countries can offset the negative effects of commodity price uncertainty on physical and human capital investment.

Another notable aspect of our results was to show the asymmetric effects of commodity terms of trade volatility on GDP per capita growth in the two country groups considered. While CTOT instability created a significant negative effect on output growth in the sample of 62 primary product exporters, in the case of the remaining 56 countries (or even in the full sample of 118 countries) the same pattern was not observed. One explanation for this observation is that the latter group of countries, with more diversified export structure, were better able to insure against price volatility than a sample of primary product exporters.  Finally, we offered some empirical evidence on growth-enhancing effects of export diversification, especially for countries whose GDP is highly dependent on revenues from just a handful of primary products.

The empirical results presented here have strong policy implications. Improvements in the conduct of macroeconomic policy, better management of resource income volatility through sovereign wealth funds (SWF) as well as stabilization funds, a suitable exchange rate regime, and export diversification can all have beneficial growth effects. Moreover, recent academic research has placed emphasis on institutional reform. By establishing the right institutions, one can ensure the proper conduct of macroeconomic policy and better use of resource income revenues, thereby increasing the potential for growth. We await better data on institutional quality to test this hypothesis. Clearly, fully articulated structural models are needed to properly investigate the channels through which the negative growth effects of volatility could be attenuated. This remains an important challenge for future research.