Risk of an 'oil curse' to Brazil is exaggerated

By Michael Alexeev and Robert Conrad

After Brazil’s recent large oil discoveries that may easily propel the country into the world’s top 10 by reserves, some economists and other commentators may have a stark warning for Brazilians: be afraid, be very afraid. The oil curse is coming to Brasilia, and it will result in lower economic growth, corruption, political instability and a soaring real.

These warnings may be premature and, we believe, misleading. While the oil curse may have become accepted wisdom in some academic and political circles, it is not in line with recent economic research, including our own, and reasonably interpreted facts.

For instance a simple correlation between national per capita (real) income and the value of oil production in recent decades is positive and almost 0.5. If we exclude Europe and rich, English-speaking countries (i.e., the US, Canada, Australia, and New Zealand), the correlation is even stronger, exceeding 0.7. Even these correlations are misleadingly low, because they include many countries that do not produce any oil. When the sample is further restricted to nations that produce some oil, the correlation exceeds 0.9. Simply stated, per capita income is higher on average for countries with oil and the more oil the higher the income.

The proponents of the oil curse also claim that oil producing countries suffer from corruption and weak institutions in general. As it turns out, the correlation between oil output and the World Bank’s “Control of Corruption” index is (again excluding Europe and the rich English-speaking nations) about 0.2, rising to 0.7 if we confine our attention to oil producers.

Only in the case of governmental accountability to their population, as measured by World Bank’s “Voice and Accountability” index, are the correlations negative, -.17 and -.07, respectively. This result does not imply, however, that the governments of oil-producing nations ignore their populations’ needs. For example, the correlations between per capita oil output and the share of educational expenditure in national income are again positive. Correlations are also positive between oil and life expectancy and negative between oil and infant mortality.

Finally, one purported result of the oil curse is Dutch Disease, where exchange rates rise in response to oil discoveries or to oil price changes. True, such changes harm traditional exports and may make diversification within the tradeable sectors more difficult.

The benefit, however, is that the exchange rate increase itself may be caused by the increase in real income resulting from the oil discovery and production. An increase in the real exchange rate may be an indicator that real wages have increased and that overall economic welfare has increased (witness China). In sum, while there are some costs associated with oil wealth, the evidence is that on balance oil benefits countries endowed with it.

How then does the oil curse idea arise? How did those economists who have tested and confirmed the oil curse theory get it wrong? In our view, the main shortcoming of the research supporting the oil curse lies in the statistical approach that skews the analysis.

When economists try to establish a relationship between oil and some economic or institutional indicator, they control for per capita gross domestic product, without accounting for the fact that oil increases GDP. This seemingly innocuous control biases the results in favour of finding an oil curse.

For example, Kuwait’s per capita GDP is greater than that of France, but Kuwait’s institutions are worse. If we control for GDP, we might conclude that it is the oil wealth that causes Kuwait to have relatively weak institutions. But the correct conclusion is more likely to be that oil wealth has raised Kuwait’s GDP, without simultaneously improving its institutions to the French level. Even here, however, it is worth noting that Kuwait’s institutions appear to be generally better (according to World Bank’s institutional quality measures) than in, say, Syria, Egypt, or Jordan, countries that have much less or no oil. Finally, consider three former Soviet republics: Russia, Belarus, and Ukraine. These countries have similar Slavic cultures and Soviet legacies. Also, they all have had a chance to rebuild their institutions after the breakup of the USSR. One big difference between Russia and the other two countries is Russia’s oil wealth. Has Russia been cursed relative to Belarus and Ukraine? Certainly not in terms of per capita GDP; even with respect to institutional quality, these countries are pretty similar.

We do not want to downplay either the real costs associated with natural resource wealth, including the need to accommodate risk and to diversify the economy, or the institutional problems associated with converting oil wealth into other types of reproducible and human capital. In fact we, jointly and individually, have worked with governments, international organisations and civil society to develop better and more transparent fiscal systems for natural resources. One of us is a participant in drafting the Natural Resource Charter, which is a set of precepts designed to enhance transparency accountability and better use of mineral resources. That experience, however, has taught us that there are gains as well as costs to resource ownership and that, on balance, the benefits have outweighed the costs in most countries. In short, the rumours of an oil curse have been greatly exaggerated.

Our views are based in part on our paper “The Elusive Curse of Oil” published in the Review of Economics and Statistics, vol. 91, no. 3, pp. 599-616, August 2009.

Michael Alexeev is professor of economics at Indiana University. Robert Conrad is associate professor of public policy studies and economics at Duke University.

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