For nations that heavily produce and export commodities such as food, oil and other minerals, those rents it receives are important source of national income. More importantly, if invested wisely, commodity rents can be a basis for future growth and prosperity.
|Economic rent “is an excess payment made to or for a factor of production over the amount required by the property owner to proceed with the deal (Investopedia; N.D.)”.|
However, over dependence on the commodity sector and miss-use of commodity rents can lead to worse economic outcomes – this is known as the paradox of plenty. This is because production capacity (capital, labour) is diverted into the industry leading the growth cycle, while its associated rents are not reinvested in a way that strengthens the economy more broadly (Natural Resource Charter, ND).
|Paradox of plenty “refers to the idea that resource-rich counties often have less economic growth compare with countries which have fewer natural resources (Natural Resource Charter, ND).|
Collier (2007) even finds that commodity rents are also “particularly unsuited” to democratic situations with autocracies out performing their democratic counter parts. This is for several reasons including, that:
- democratic governments are pressured by election cycles leading to short sighted investments;
- democratic governments use rents as ‘slush funds’ to influence election outcomes; and
- tax payers appear to be less concerned with the way revenues are spent because they have not been ‘earned.’
That is, governments and tax payers treat the revenues more like the winnings from a night at the casino!
More specifically, Giugale (2014) notes that there are five main problems associated with commodity growth cycles and include:
- Dutch Disease – where non-commodity exports become less competitive as the all the majority of economic production becomes focused on the resource sector due to high income and revenue associated with the sector. As this happens, the resource sector sucks in workers and production capacity from other sectors driving up prices;
- price volatility – complicating investments decisions often leading to short-term outcomes;
- over borrowing – lenders are more likely to provide greater debt access to governments that are expect to raise large amounts of revenue;
- sustainability – the amount of natural wealth to preserve for future generations; and
- corruption – the larger the rent, the ‘greedier’ a government and business can become leading to immoral and poor decisions.
While Collier (2007) adds that in developing nations two other problems include:
- a reduction in the implementation of democratic institutions – as government want to hold on to their power and wealth; and
- an increase in the likelihood of conflict – as a combination of the other problems destabilises growth, the government and society more generally.
The paradox of plenty is relevant to both developed and developing nations. Academics (Collier, 2007; Giugale, 2014) agree that resource rich societies must have good policies, institutions and governance to ensure strong economic outcomes. These include those that protect budgetary checks and balances, transparency of spending, and accountability mechanisms to ensure impacts that enhance citizen welfare (World Bank, 2016). An example is Norway’s Sovereign Wealth Fund, the world’s largest equity fund, set up to provide an autonomous investment mechanism to reinvest the surplus wealth produced by petroleum sector to provide alternative revenue streams that can be reinvested diversify the economy (McCarthy, 2017).
While there must be the right mechanisms, it is also imperative that there is greater awareness of the traps and mindfulness regarding the need to reinvest rents in long term initiatives that build capability and future growth potential. Otherwise, the alternative is that commodity rents can actually lead to a reduction in growth and development.
Until recently, the concept of commodity super-cycles had been widely discussed but never proven. In 2012 the UN (2012) claimed to have found evidence of commodity super-cycles which has now lead to wider agreement on their existence (Guigale, 2014).
|Commodity super-cycles are defined as “periods of about forty years when commodity prices steadily climb for a decade or two, only to fall slowly back to where they were” (Guigale, 2014).|
Super-cycles differ from business-cycles which are typically short-run and typically have micro-economic impacts. Super-cycles differ due to two main features, being:
- the presence of a “long wave” of growth of at least 10-35 years and the whole cycle taking 20-70 years; and
- the impact can be observed in a number of commodities across the economy (UN; 2012).
The key driver of a super-cycle is the “sudden rise in demand, often caused by technological innovation” and can lead to periods of increases in urbanisation and population. Increased demand associated with these factors drives long periods of growth in both prices and output before tapering and returning to pre-growth levels. Super-cycles also suffer from “acute capacity constraints” despite increased in production output and technology development (Guigale, 2014; (DeRooij, 2014). Whilst, tapering off within a cycle is driven from a number of factors including diminishing returns from technology, or, urbanisation and population growth steadying and the economy readjusting as a result.
Evidence suggests that in the last 150 years the world economy has experience at least three super-cycles, each over a period of four decades, each driving up commodity prices “20 and 40 percent” before returning to previous levels. Examples include Britain’s industrial revolution where prices for coal, cotton, sugar and tea increase as well as production (DeRooij, 2014).
From a government’s perspective, recognition of super-cycles is of “critical importance” to ensure the right decisions are made in regards to inflation, currency, balance of payments, and re-investment of rents. Businesses also need to identify super-cycles to ensure capital investments are used to fund long term production expansion and not be distracted by short-term price fluctuations (DeRooij, 2014).
We can now see that we are in a super-cycle or perhaps, we have just hit tipping point. This cycle was largely driven by China and India’s appetite for commodities. However, there may still be opportunities, as many people in South East Asia and other developing nations are still to transition to a more urbanised economy (DeRooij, 2014).
Thus, the question therefore is, are we to sit back and ride the wave out? Or do we ensure we maximise our future growth potential and extend the ride before through high impact re-investment?
Collier, P. (2007) The Bottom Billion: Why the Poorest Countries are Failing and What Can Be Done About. Oxford University Press: New York.
Giugale, M. (2014) Economic Development: What Everyone Needs to Know. Oxford University Press: New York.