Skewed Development: How Oil Discovery impacts growth in LEDC's

Many countries across the world have access to natural resources which have the potential to economically benefit the GDP (Gross Domestic Product) and population of that country. Despite the popular belief that those blessed with natural resources experience higher standards of living and economic growth, repeated historical and current economic failures show this isn’t always the case. This essay will examine why some countries can successfully transfer their wealth from natural resources to benefit their population, while other countries become plagued with corruption and experience negative economic growth.

The phenomenon of natural resources causing economic hardship is sometimes referred to as ‘The Dutch Disease’. It was first identified after the discovery of natural gas off the Dutch coast and the subsequent decline in non-resource industries. The discovery of natural gas led to non-resource sectors losing their competitive advantage as the native currency, the Guilder, increased in value, making their exported goods more expensive relative to their international competition, further reducing demand for their goods and services. This all came about because initially the Dutch Government's spending was diverted to help build up the gas industry at the expense of the other domestic industries because the Dutch Government believed that the profitable gas industry would generate greater tax revenue in the short term. However, as the Dutch gas companies sold their product in US dollars, British pounds and German marks, this relatively rapid inflow of foreign currency increased demand for the Dutch Guilder and therefore caused a significant currency appreciation.

Such a strong domestic currency was disastrous for the Dutch non-resource industries as it meant their products for export were significantly more expensive in comparison to their international competitors. This sudden decrease in demand for non-resource sector goods now meant the Dutch economy‘s health and domestic tax collection placed a disproportionate reliance on the natural gas Holland was exporting, and the economy was now heavily dependent on the unpredictable price of natural gas. This sequence of events became a recurring pattern for resource-rich developing countries as they attempted to successfully transition into developed economies by exploiting their wealth of domestic resources and reinvest the profits into their economy to improve their population’s standard of living. Subsequently, ‘The Dutch Disease’ became a catchphrase for the negative consequences that can follow the discovery of natural resources and the spike in the value of a nation’s currency.

Both Norway and Nigeria have abundant oil reserves and rank 22nd and 10th in global oil reserves respectively. Yet despite the similarities in the size of their oil reserves, Norway ranked 1st in the Human Development Index (HDI) in 2019, whilst Nigeria ranked 161st. This once again begs the question of whether or not the discovery of natural resources equates to guaranteed development for global economies.

Upon the discovery of oil in the late 1970s Norway, aware of the risks to the economy from the Dutch Disease phenomenon, worked to find a long-term solution to sustainably generate future revenue from its oil supplies, without the risk of volatile prices of the commodities hampering the economic performance of the country. It did this by creating a Sovereign Wealth Fund (SWF). This had the aim of transferring the profits from Norway’s oil reserves into an investment portfolio that held assets in global equities, fixed income and real estate. Today, this SWF manages assets valued at $1.35 trillion and holds 1.4% of all the world's listed companies. The consequence of the Norwegian Government’s Sovereign Wealth Fund was that it successfully eliminated the volatile income from oil revenue, as it had a constant alternative supply of revenue-generating investments at its disposal to spend on improving the economy. Additionally, it limited the impacts of fluctuating surpluses on government spending, to further help stabilise the economy.

Although the Norwegian economy had been initially built on oil extraction, it is slowly diversifying its economy to wean itself off the country’s reliance on oil, using the SWF. The fund is under the management of the Norges Bank and is governed by a fiscal framework of rules that limit the Government to only spending the equivalent of the real return on the fund, in order to safeguard the preservation of the initial value of the fund for the benefit of future generations. This fiscal framework insulates the Government’s budget from short-term fluctuations in petroleum revenue. Moreover, it is a significant factor in allowing the Government to both plan long-term State sponsored growth projects for the economy, as well as provide a secure stable economy to attract both domestic and international investment.

In contrast, after the discovery of oil in Nigeria in 1956 by Shell-BP, Nigeria joined OPEC (Organisation of Petroleum Exporting Countries) in 1971 and nationalised the oil industry through the Nigerian National Petroleum Company (NNPC). The discovery of oil drastically changed the distribution of wealth in the country, as oil became the most valuable source of domestic wealth (contributing 90% of the economy). The Government attempted to collect most of the oil revenue from oil-producing regions and, in theory, share the collected income equally. Instead of uniting the Nigerian states and creating a program of socio-economic development, the growth of oil revenue caused issues regarding revenue allocation and created imbalances as well as distortions in national and regional development. Heavily populated states gained more revenue and socioeconomic benefits at the expense of minority states which suffered deprivation, neglect and first-hand experience of environmental degradation. This illustrates the fact that oil rents are a corrupting influence in Nigeria, creating and exacerbating regional imbalances, heightening ethnic minority mistrust in central government and the unequal distribution of wealth. In the year 2000, the top 2% of the Nigerian population held the same amount of wealth as the bottom 55%.

The discovery of oil has also led to the decline of other sectors of the Nigerian economy such as cacao, timber and palm oil. Exacerbated by the enticing revenues of oil, the Nigerian economy has not diversified its economy and as a result, has become entirely dependent upon oil – a classic example of the Dutch Disease phenomenon.

Due to the extreme wealth flowing unevenly through the country, reliance on oil means that control over oil resources equates to control over the nation’s economic power. Since the state controls natural resource revenues, the state itself has become a desirable resource to capture. This has led to a pandemic of corruption plaguing the country, where the ruling elite has lined their pockets with the revenue from oil extraction whilst using this to buy influence at local levels between tribes where oil is extracted. The Government has been unable to resolve this corruption and failed in its attempts to reinvest the proceeds of the oil sales into a fund for the future benefit of the country’s citizens. The Nigerian state oil company is estimated to have received US$300 billion over the past 25 years (in contrast, Norway received $727 billion) and it is estimated that 75% of this was embezzled by individuals due to corruption and inefficiency.

The two very different outcomes for these countries are a clear demonstration that the fundamental importance of a robust, enforceable legal system, a strong governance framework and a culture of transparency is vital in determining whether natural resources are a curse or a blessing.

In the case of Norway, the implementation of high standards of fiscal regulations and environmental laws that have been administered through a robust, transparent Sovereign Wealth fund in partnership with the Central Bank has led to the optimisation of the long-term benefits of oil for the population, economy and environment. Overall oil has been a blessing for Norway. In glaring contrast, the discovery of oil in Nigeria has been a socio-economic and environmental disaster, causing irreversible levels of corruption. The oil extraction process has led to the degradation of the environment, and the wealth distribution is amongst the most extreme in the world, making oil a curse for Nigeria.