The Resource Curse: The Problem with Commodity Dependence

A large number of developing countries across the world are dependent upon commodities. About 135 of these developing countries were surveyed, and it turned out that more than 94 of these countries are commodity dependent. This means that primary commodities like food grains, oil, etc. account for more than 60% of their total exports. Prima facie, this does not seem like an issue.

However, over a period of time, economists have started correlating commodity dependence with poverty and financial turmoil. There are too many resource-rich countries which are suffering from poverty. Hence, the “resource curse” cannot just be ignored.

In this article, we will have a closer look at why commodity dependence is not such a good strategy for developing nations.

Impact On Government Revenue

Generally, when the industry of a nation is in turmoil, the government is expected to bail out the industry. However, in countries which have a high degree of commodity dependence, the government and the industries are both dependent on the commodity prices.

For instance, consider the case of Australia. Even though it is a well-developed economy, Australia is still reliant on the export of iron ore. China has been importing iron ore from Australia in vast quantities.

However, if for some reason the price of iron ore falls even $10, the result will be a massive shortfall of $3.4 billion for the Australian government. This is because many of the biggest industries in Australia are dependent on iron ore.

If the price of iron ore falls, so does the profit of these companies. Finally, less profit means fewer taxes for the government. As a result, the Australian economy would be facing a double whammy in such situations. Both the industry and the government will not be in a position to deal with this crisis.

Volatile Economy

Commodity prices are not really stable. They are extremely volatile in the short run. In the long run, they tend to be reduced. Consider the case of oil, whose price has been very volatile in the short run and has gone down in the long run.

If most of the economic activity of a nation is based on commodities, then the entire economy becomes volatile. Consider the case of the economy of Venezuela. The country was largely dependent upon its oil exports. They assumed that the prices of oil would never fall. Hence, they started funding welfare programs from the oil revenues that they derived. However, the price of oil has almost halved over a period of five years.

Now, the Venezuelan government finds itself unable to meet its debt obligations. Similar cases have happened in other economies as well. Venezuela is not the only nation that has faced the oil shock.

The economy of Saudi Arabia is also in shambles thanks to the rapid decline in commodity prices. It is just that Saudi Arabia had some reserves to weather the storm. However, they have realized that commodity dependence is a bad strategy.

As a result, the new Saudi prince wants to follow in the footsteps of Dubai and create a state which is not dependent upon oil prices for its survival. This has become the central objective of Saudi government policy and all plans are being drawn in order to meet this objective.

Harms Other Exports

It is not only the downturn the rise in the commodity business also harms other sectors of the economy. For instance, if a country has too much oil, they will have to export it. This means that they will receive revenue in dollars and their currency will become stronger.

Once the currency becomes strong, exports in other sectors become more expensive. Hence, a large number of commodity exports makes the other exports uncompetitive. They create a vicious cycle wherein the country’s dependence on commodities in amplified during the process.

Political Instability

If the economy of a country is dependent upon a single commodity, the wealth distribution in that country depends upon who controls that commodity. As a result, political instability is common in such countries.

Studies have shown that political instability and commodity dependence follow a nonlinear relationship. This means that as commodity dependence increases, so does political instability. However, this happens only till a particular tipping point. Post that, the commodity becomes so abundant that fights do not occur.

Consider the case of Iraq for instance. Because the country is mainly dependent on oil and everyone wants control of that oil, several wars have been fought in the nation.

The same is also true of African countries like Sierra Leone which are rich in diamonds. Mercenaries and war-mongers are commonplace because of high commodity dependence. Over a period of time, this leads to poverty and economic turmoil.

To sum it up, having a very high degree of dependence on commodities can be called a “Resource Curse.” It is ironic that all the countries that have been mentioned in the examples above have many resources but are not developed. On the other hand, nations like Singapore and Hong Kong have become economic superpowers even without any resources.