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Reversing the ‘Resources Curse’: Investing in Resource Driven Economies

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published
20 January 2014

The amount of investment needed in oil and gas or mining is set to climb, and the proportion destined for lower-income countries could significantly increase with the potential of lifting over 540 million people out of poverty before 2030, according to leading research group, McKinsey Global Institute.

There are no guarantees that resource prices are set to rise but all evidence suggests that whether demand for resources increase or even remains the same, more money is going to have to be invested in future to get these commodities out of the ground and ready for use.

“Under any different scenario,” said Fraser Thompson, a Senior Fellow at McKinsey Global Institute (MGI), “there’s going to be a huge amount of new investment needed.”

 

 

“This represents a huge opportunity for low-income countries,” he added, “90 percent of historical resource investment has been in upper-middle-income or high-income countries. Going forward, we think the share going to low-income countries could potentially double.”

 

To meet existing demand for many mined commodities or fossil fuels, extractive industries are going to need to spend more money. Deposits in existing projects are dwindling and some of the most easily exploited reserves of oil or metals are already depleted, pushing up supply costs as companies move into more difficult terrain.

“A higher share of a much larger share of total investment,” said Dr Thompson, “could potentially be heading to lower-income countries. The amount of investment we’re talking about could be as much as three-times the amount of ODA, Overseas Development Assistance, going into these countries.”

“When you look at that and how it could translate into poverty impact, we see the potential – if these countries get it right – to take more than 540 million people out of poverty by 2030.”

According to Dr Thompson, “getting it right’ needs to involve both government and private sector responsibility towards equitable and sustainable growth, for instance by promoting transparency in fiscal contributions through efficient tax systems and anti corruption structures, environmental preservation, job creation and skill building, infrastructure investment and social and community benefits.

 

 

Please also visit the Extractive Industries Transparency Initiative website. The Extractive Industries Transparency Initiative (EITI) is a global coalition of governments, companies and civil society working together to improve openness and accountable management of revenues from natural resources. As the main donor, the EU is making efforts to help developing countries mobilise their internal resources by promoting political dialogue with partner countries on the reform of their tax systems and the efficient use of revenues. Domestic revenue mobilisation is also one of the key topics in current discussions on the post-2015 development agenda.

 

MGI is the economic research arm of McKinsey & Company, the global consultancy.  MGI’s recent study, ‘Resource Revolution: Tracking global commodity markets’, available online, lays out some of the rising extraction costs that will drive this shift in investment.

For example, the average cost of bringing an oil well online doubled between 2000 and 2010, according to MGI. Not only that but much of the oil being extracted today is not the high-quality, easily refined sort preferred by oil companies, but deep-sea or tar-filled deposits previously overlooked for being too costly to extract and process.

The story is similar in the mining sector, said MGI. While demand from emerging markets has pushed up metal prices since 2000, the McKinsey Basic Materials Institute also finds that geological challenges and the rising cost of inputs, notably energy, have boosted metal prices too.

So how can big aid donors, like the European Commission, best harness these changes? According to Dr Thompson, the question donors have to ask is how they can best work with the private sector to make this potential poverty alleviation a reality. But changes already taking place in the private sector could make this a happy alliance.

The private sector “are undergoing a fundamental transformation themselves,” said Dr Thompson. “There really is a shift that’s ongoing from an extractive mindset to a more development mindset in these companies.”

Extractive companies are increasingly working in developing regions, where their activities might make up a high proportion of national economic activity and can make them a visible and notable player in national economies. 

Add to this recent record-breaking volatile resource prices, which can quickly fuel resentment if one or both parties feels they are not getting a ‘good deal’, and companies are under a lot of pressure to change how they operate, said Dr Thompson.

“To deal with this changing landscape we really think there needs to be a reorientation of the approach of these extractive companies and really become a lot more sophisticated and scientific about how they meet the expectations of local stakeholders,” said Dr Thompson.

Reverse the Curse

Historically, abundant natural resources have not come hand in hand with development. In the 1980s, economists coined the term the ‘resource curse’, or ‘paradox of plenty’- an idea that linked resource-wealth, especially non-renewable resources like oil, with under-performing economies and in some cases, internal conflict and strife.

Even the low-income resource-rich countries that have in recent years notched up impressive economic growth rates, have often failed to grow in an inclusive manner. Take Zambia for example – poverty levels actually increased despite relatively strong economic growth.

“There’s a lot of focus at the moment saying, can developing countries adopt the Asian Tiger growth model?” he added. “But we don’t think that model is fit for purpose for these kind of economies. We think they need a new kind of model to ensure that they have inclusive, sustainable growth, which we dub the ‘Resource Tiger’ growth model”

In a new report, ‘Reverse the curse: Maximizing the potential of resource-driven economies’released on 5 December, McKinsey warn resource-rich developing countries they need to take action to avert squandering this opportunity.

Dr Thompson chaired a ‘Lab’ or special session at the 2013 EU Dev Days in Brussels, where he introduced some of the key findings of the report. You can listen to a podcast of this event online. 

If developing countries can get it right and successfully utilize this investment windfall, if they can reverse the resource curse, global development could have a significant boost. 

“If these countries get it right,” said Dr Thompson, “this could be a fundamental, transformational story in the world’s fight against poverty.” 

 

Reversing the Curse: Key Points

Economic strategies need to be reframed around three key imperatives: i) effectively developing their resource sector, ii) capturing value from it, and iii) transforming that value into long-term prosperity.

The report also explores best practices on six fronts:

  • building the resource sector's institutions and governance

  • developing infrastructure

  • ensuring robust fiscal policy and competitiveness

  • supporting local content

  • deciding how to spend resource windfalls wisely

  • and transforming resource wealth into broader economic development

 

This collaborative piece was drafted by Sarah Simpson with input from Maria Inmaculada Montero-Luque and Dr Fraser Thompson, and support from the capacity4dev.eu Coordination Team

DISCLAIMER: This information is provided in the interests of knowledge sharing and capacity development and should not be interpreted as the official view of the European Commission, or any other organisation.

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