price volatility and the political economy of the resource...

Price Volatility and The Political Economyof the Resource Curse

Thierry Verdier(PSE and CEPR)

Introduction (I)• An old standing question :

Natural Resources & Economic Performances: blessing or curse ?

• Prior to late 80s: conventional wisdom : a blessing ! Economic historians / Industrial revolution : USA, Britain, Australia (Viner 1952, Lewis 1955, Rostow 1961, Krueger 1980)




• After the 80s: Presumption of a Curse !




- Case studies : Gelb (1988), Karl (1997), Auty (2001), Ross (1999, 2001), Sala-i-Martin and Subramanian (2003), Eifert et al. (2003)

• After the 80s: Presumption of a Curse !- Cross country empirical work : Sachs and Warner (1995, 1999),

Bushy, Isham, Pritchett, Woolcock (2003)Bannon and Collier 2003; Davis et al.2003Mehlum, Moene and Torvik (2006),

Introduction (II)

• In fact : great variety of outcomes (even in LDCs) : Botswana, Chile, Malaysia, Oman and Thailand (Abidin 2001)Algeria, Ecuador, Mexico, Nigeria, Trinidad &Tobago, Venezuela, Zambia

Introduction (II)

• In fact : great variety of outcomes (even in LDCs) : Botswana, Chile, Malaysia, Oman and Thailand (Abidin 2001)Algeria, Ecuador, Mexico, Nigeria, Trinidad &Tobago, Venezuela, Zambia

• Skepticism/controversies about existence of Resource CursePbs of statistical robustness / generalizations / endogeneity:

Manzano and Rigobon (2001), Ding and Field (2005), Alexeev and Conrad (2009), Brunnschweiler and Bulte (2008), van der Ploeg and Poelhekke (2010)

Collier and Goderis (2007); Butkiewisz and Yanikkaya (2010)

1) Explaining diversity of outcomes and mechanisms : «Why some resource-abundant countries succeed while others do not? »

Introduction (III)

• Shifts in literature from « average effects » of resources to:


Introduction (III)

Mehlum, Moene and Torvik (2006), Iimi 2007, Kolstad (2009) : Quality of institutionsAndersen and Aslaksen (2008): Presidentialism vs Parliamentary democraciesArezki and van der Ploeg (2007) : Trade policies/openness


role of institutions and policies:


Introduction (III)

Mehlum, Moene and Torvik (2006), Iimi (2007), Kolstad (2009) : Quality of institutionsAndersen and Aslaksen (2008): Presidentialism vs Parliamentary democraciesArezki and van der Ploeg (2007) : Trade policies/openness

political economy dimensions


role of institutions and policies:

2)Volatility curse : volatility of prices/policies

• Volatility and growth : - Aizenman and Marion (1991)- Ramey and Ramey (1995)- Aghion, Angeletos, Banerjee, Manova (2005) - Aghion, Bachetta, Rancière and Rogoff (2006)

Introduction (IV)

2)Volatility curse : volatility of prices/policies

• Volatility and growth : - Aizenman and Marion (1991)- Ramey and Ramey (1995)- Aghion, Angeletos, Banerjee, Manova (2005) - Aghion, Bachetta, Rancière and Rogoff (2006)

• Volatility curse : Haussman and Rigobon (2002): reinforcing effects: specialization in non tradables /

financial frictions/ RER volatilityvan der Ploeg and Poelhekke (2010) : direct positive effect of resource on growth

indirect negative effect through volatility

Bleaney and Halland (2009): negative effect of resources on growththrough fiscal volatility

Leong and Mohaddes (2011) : volatility curse /mitigating role of institutions

Introduction (IV)

In this talk… (I)

• Political economy dimensions / volatility curse

In this talk… (I)

• Political economy channel :- «Bad policy » induced by Resource rents- Dysfunctional state behavior \ large public sectors \

Inefficient redistributive policies \(Gelb (1988), Gavin (1993), Karl (1997), Auty (2001), Ross (2012))


In this talk… (I)

• Political economy channel for resource curse- «Bad policy » induced by Resource rents- Dysfunctional state behavior \ large public sectors \

Inefficient redistributive policies \(Gelb (1988), Gavin (1993), Karl (1997), Auty (2001), Ross (2012))

Interactions between political incentives / price shocksvolatility

• How Resource Booms / volatility affect the extent of inefficient redistribution ?


In this talk…(II)

• Political models of resource extraction with price volatility

- Probabilistic voting Model (Lindbeck-Weibull 1993)incumbent politician\ resource extraction

In this talk… (II)



- Inefficient redistribution : clientelism \ patronage : system of political exchange with votersPublic employment: redistribution of rents (Auty 2001)

Way to gain political support(Robinson and Verdier (2012))

Two sided credibility: patron\votersExclusivity of patron: social network

In this talk… (II)



Price shocksVolatility

Political support.Incumbent’s incentivesPublic Policies

Resource Curse

- Inefficient redistribution : clientelism \ patronage : system of political exchange with votersPublic employment: redistribution of rents (Auty 2001)

Way to gain political support(Robinson and Verdier (2012))

Two sided credibility: patron\votersExclusivity of patron: social network

Main Insights (I)

• Over extraction of natural resources

• Permanent resource boom: improves efficiency of extraction

• Permanent resource boom: increase resource misallocationin the rest of the economy

• Impact of resource boom : depends on nature of political institutions

Resource booms create underdevelopmentnot because of inefficiency in the rate of resource extraction But because of what politicians do with the resource rents.

Deterministic price shocks (Robinson, Torvik, Verdier 2006)

Main Results (II)

Extension to Stochastic Resource Prices and Volatility

- Value of staying in power (for risk averse politicians)

Volatility

- Political support / turnover (fiscal volatility for risk averse voters)

Main Insights (II)

Extension to Stochastic Resource Prices and Volatility

Higher resourcevolatility

- Value of staying in power (for risk averse politicians)

• When incumbent’s constituency « more sensitive » to fiscal shocksthan rest of population :

Magnification of over extraction of natural resources

Inefficient Patronage policiesCrowding out of public investment

More so under « weak » institutions

Volatility

- Political support / turnover (fiscal volatility for risk averse voters)

Roadmap

1) Political Economy models of the resource curse

2) A simple model of clientelism, price shocks and resource curse

3) Political clientelism under price volatility

4) Political clientelism, public investment and price volatility

5) Resource extraction under price volatility

6) Conclusions

Economic /Political models of the resource curse (I)

• «Dutch Disease » literature: Corden and Neary (1982), van Wijnbergen (1984), Krugman (1987), Matsuyama (1992), Sachs and Warner (1995), Gylfason et al. (1999), Torvik (2001), Matsen and Torvik (2005), van der Ploeg and Venables (2011)Haussman and Rigobon (2002)

Surveys: van der Ploeg (2010), Deacon (2011), Frankel (2012).

Economic /Political models of the resource curse (I)

• «Dutch Disease » literature: Corden and Neary (1982), van Wijnbergen (1984), Krugman (1987), Matsuyama (1992), Sachs and Warner (1995), Gylfason et al. (1999), Torvik (2001), Matsen and Torvik (2005), van der Ploeg and Venables (2011)Haussman and Rigobon (2002)

• « Rent-Seeking » Literature : Tornell and Lane (1999): « Voracity Effect »

Baland and François (2000) Torvik (2002), Hodler (2006)

- Need for some negative multiplier /externality/ increasing returns effect: not internalized by political system decentralized

- No explicit role for political/institutional parameters

Surveys: van der Ploeg (2010), Deacon (2011), Frankel (2012).

Occupational choices

Political/ Economic models of the resource curse (II)

- Political theories of the « rentier » state: North and Thomas (1973)Karl (1997), Ross (1999, 2001)

• Political Economy Models of the resource curse

Political/ Economic models of the resource curse (II)

- Political theories of the « rentier » state: North and Thomas (1973)Karl (1997), Ross (1999, 2001)

• Political Economy Models of the resource curse

- Civil conflicts : Collier and Hoeffler (2004): Rebels’ incentives and capacityAslaksen and Torvik (2006): violent vs democratic competition

- Incumbency distortions and lobbying: Acemoglu, Robinson and Verdier (2006): Elite’s behaviorDamania and Bulte (2003): Lobbying incentivesCaselli and Cunnigham (2009): leader’s incentives/ non monotonic effects

survival function

- Public sector distortions: Robinson, Torvik and Verdier (2006) : public employment /clientelismRobinson and Torvik (2005) : « white elephants »Smith (2008) : Selectorate theory / windfalls / composition of public goods

A Simple Political Economy Model (I)

• Two-period probabilistic voting model : periods 1 and 2 • Two parties \ politicians: incumbent A and challenger B.

• Mass of voters normalized to 1

• Stock of natural resources: prices ,

• Election is at the end of period 1

2p1p

(Robinson, Torvik and Verdier 2006)

• Resource extracted in period 1: ein period 2 : R(e) with R’(e) < 0 and R’’(e) < 0

• After election, political winner consumes remaining resource rents.

• No commitment to policies

A Simple Political Economy Model (II)

• Resource income can be used in two possible ways: - Consumption by the incumbent - Distribution as patronage: public jobs / influence election outcome- No taxes

• Incumbent politician: clientelism / offers public jobs: LP < 1public wage: W > H

H : productivity in private sector

• Re-election probability: Π=Π(LP) with Π′ > 0

• The incumbent decides policy before the election: Resource extraction e and public sector employment LP

A Simple Political Economy Model (III)

maxe,LP p1e − WLP LPp2Re − WLP




p1 LPp2R′e 0

−1 LPW ′p2Re − WLP 0

e

LP

),,( 21 ppLe P

),( 2peLP

E

Equilibrium Policies




p1 LPp2R′e 0

−1 LPW ′p2Re − WLP 0

)(21 eRpep +• Efficient extraction path : e

(F): 0)('21 =+ eRpp

Max

e e f

• Resources are inefficiently over-extracted : e e f

Price Shocks and Extractive Efficiency (I)

• Resources are inefficiently over-extracted :

• Comparative statics on price shocks : 21 , pp

i) permanent resource boom: p

dpp

dpp

dp==

2

2

1

1

e e f





dpp

dpp

dp==

2

2

1

1

- reduces extraction rate and increases efficiency

e e f





dpp

dpp

dp==

2

2

1

1

- reduces extraction rate and increases efficiency

Intuition: - value of staying in power: - more incentives to bias political competition- probability of staying in power : - politician is less myopic

e e f


e

LP

0>∆p

),,( 21 ppLe P

),( 2peLP

EE ’

Permanent resource boom

ii) temporary resource boom: 00 21 => dpanddp

iii) anticipated future resource boom: 00 21 >= dpanddp



- increases extraction rate and reduces efficiency if


0)(''' ≥eR

- equilibrium extraction path changeEndogenous effect of clientelism: increases myopia


e

E

E ’

Temporary resource boom

01 >∆p

),,( 21 ppLe P

),( 2peLP

LP




0)(''' ≥eR

- equilibrium extraction path changeendogenous effect of clientelism: increases myopia




- reduces extraction rate and increases efficiency if


0)(''' ≥eR

0)(''' ≥eR

- equilibrium extraction path changeendogenous effect of clientelism: increases myopia

- equilibrium extraction path changeendogenous effect of clientelism: decreases myopia


e02 >∆p

E

E ’

Future anticipated resource boom

02 >∆p

),( 2peLP

),,( 21 ppLe P

LP

permanent resource boom: p

dpp

dpp

dp==

2

2

1

1

- public sector employment

Resource booms and resource allocation (I)

- Private sector employment

permanent resource boom: p

dpp

dpp

dp==

2

2

1

1

- public sector employment

Resource booms and resource allocation (I)

- Private sector employment

Resource Booms lead to politically motivated expansions of the public sector :

- Gelb (1988): Nigeria

- Gavin (1993): Oil Boom in Nigeria from 1973 to 1987 and expansion of public employment

- Auty (1999) : Trinidad and Tobago

- Gelb (1988): Ecuador and Venezuela

- Bates and Colliers (1993), Gelb, Knight and Sabot (1991): Zambia

• Opposite extraction path effect and labor misallocation effect :

• ex: permanent boom: - efficiency of extraction rate increases- more labor in public sector

• Impact of resource booms on total income: ambiguous

Y 21 − LPH p1e p2Re

Resource curse ? (I)

• Opposite extraction path effect and labor misallocation effect :

• ex: permanent boom: - efficiency of extraction rate increases- more labor in public sector

• Impact of resource booms on total income: ambiguous

+

- -

-Positive extraction patheffect

Negative reallocationeffect

+

Y 21 − LPH p1e p2Re

dYdp/p p1e p2R p1 p2R ′ de

dp/p − 2H dLPdp/p

Resource curse ? (I)

Resource valueincrease

Resource booms and resource allocation (II)

• Negative reallocation effect stronger on public sectorwhen politician has more ability to influence political processthrough « patronage » redistribution

• Importance of institutions for resource curse :



• Importance of institutions for resource curse :

Resource curseWeak institutions: (subject to clientelism)

•

• No resource curse Strong institutions


Positive effects of Resources on growth when institutions are goodConsistent with Mehlum et al. (2006), Iimi (2007), Kolstad (2009) :


Price Volatility and Political Economy (I)

• Exogenous natural resource endowment: Z

(deterministic) p1 p1 0

• Intertemporal path of prices (p1 , p2) :

p2 p2 (stochastic)ε: random variable defined on [-a,a]

p2 0

E 0 var 2

• Microfoundations of political competition (probabilistic voting):

2 groups of individuals A and B: size 1/2.

2 politicians: incumbent from group A / challenger from group B

- Different preferences: private good/ group specific public good

voters of type A : uACt,Gt Ct − A G−Gt2

2

voters of type B : uBCt C t

G 0A 0

- concave public good utility: risk aversion for fiscal volatility- group specific public good: fiscal volatility affects political turnover- quadratic specification : “certainty equivalent” forms

• Each politician cares about his own utility:

VtA Rt

A − A G−Gt2

2

VtB Rt

B Rti : politician's private good consumption

Price Volatility and Political Economy (II)

• Productivity in private sector: H• Productivity in public sector: 0, wage W

• : public sector workers decided by incumbent in period 1credible commitment for incumbent in period 2

PL

• Per-period Gvt budget constraints (no taxes):

(political patronage / clientelistic social networks)No commitment for challenger (Robinson and Verdier 2012)

G1 R1A p1Z − WLP

G2A R2B p2Z − WLP

G2B R2B p2Z

Price Volatility and Political Economy (III)

• Probabilistic voting model : )()( BUAU it

iit >++ θσ

iσ : « idiosyncratic component » uniformly distributed on

θ : incumbent specific popularity uniformly distributed on

− 12s , 1

2s

− 12h , 1

2h

Price Volatility and Political Economy (IV)

• Probabilistic voting model : )()( BUAU it

iit >++ θσ

iσ : uniformly distributed on

θ : uniformly distributed on

• Timing:- period 1: - Incumbent chooses:

- winner implements ex post optimal rent- realization of the price shock ε- production, consumption and public good provision

( )AP RGL 11 ,,

- period 2: - political competition: ( )ARAG 22 ),(( )BRBG 22 ),(

- production, consumption

− 12s , 1

2s − 1

2h , 12h

2R

Price Volatility and Political Economy (IV)

• Credible policies: backward induction

Equilibrium Policies in period 2 (I)

- If politician of type B is elected : Period 2:

G 2B 0No public jobsconsume all the rent p2Z

• Credible policies: backward induction

Equilibrium Policies in period 2 (I)

- If politician of type B is elected : Period 2:

G 2B 0No public jobsconsume all the rent p2Z

- For incumbent of type A:

G 2A max p2Z − R2A − WLP;0

Public jobs: LP

maxR2A R2

A − AE G−G2A2

2

We will consider only regimes where G2(A) > 0 for all realizations of p2

Choice of R2A :

maxR2A R2

A − A G−EG2A2

2 − A 2

2 Z2

• Incumbent of type A maximizes expected utility:

EG2AA p2Z − R2

A −WLPwith

Equilibrium Policies in period 2 (II)

maxR2A R2

A − A G−EG2A2

2 − A 2

2 Z2

EG2AA p2Z − R2

A −WLPwith

- Optimal level of incumbent's rent :

- Provision of the public good A :

R2A p2Z − WLP 1

A − G

G2A p2 − p2Z G − 1A


• Incumbent of type A maximizes expected utility:

maxR2A R2

A − A G−EG2A2

2 − A 2

2 Z2

• For incumbent of type A:

EG2AA p2Z − R2

A −WLPwith

- Optimal level of incumbent's rent :

- Provision of the public good A :

R2A p2Z − WLP 1

A − G

G2A p2 − p2Z G − 1A

• Assumptions for an interior solution: R2A 0 and 0 G2A G

aZ min 1A ;G − 1

A

p2Z − W2 G − 1

A

0 G 2A G

R2A 0


Equilibrium Voters Utilities (I)

• Voters of type A: - Utility benefit of average public good provision

• Period 2 expected utility of private sector voters:

U2AA H − 1

2A −A2

2 Z2 and U 2AB H − A

2 G 2

U2BB U 2

BA H

A

2 G 2 − 12A 0

- Fiscal volatility cost related to fluctuations of resource income p2Z

− A2

2 Z2

• Assume volatillity not too high : U 2AA U2

AB

• Expected utility for public employees in group A :

U 2LA W − 1

2A −A2

2 Z2 and U2LB H − A

2 G 2

• Again when volatility not too high : U 2LA U2

LB

Equilibrium Voters Utilities (II)

Election probability (I)

• group B voters:- Post-election income independent of election outcome:

- Support incumbent A:

⎟⎠⎞

⎜⎝⎛ += θsN B 2

121

0>+ θσ i

Election probability (I)

• group B voters:- Post-election income independent of election outcome:

- Support incumbent A:

⎟⎠⎞

⎜⎝⎛ += θsN B 2

121

0>+ θσ i

• Group A voters:U 2

AA si U 2AB- private employees:

[ ]( )⎟⎠⎞

⎜⎝⎛ −++−= )()(

21)1( 22 BUAUsLN AA

PHA θ

- public workers:

[ ]( )⎟⎠⎞

⎜⎝⎛ −++= )()(

21

22 BUAUsLN LLP

PA θ

• Election probability of incumbent: ⎭⎬⎫

⎩⎨⎧ ≥++=Π

21Pr L

APAB NNN

Pr A

2 G 2 − 1A 2 −

2Z2 W − HLP ≥ 0

Election probability (II)

LP, 2 12 h A

4 G 2 − 1A 2 −

2Z2 W − HLP

• Election probability of incumbent: ⎭⎬⎫

⎩⎨⎧ ≥++=Π

21Pr L

APAB NNN

Pr A

2 G 2 − 1A 2 −

2Z2 W − HLP ≥ 0

• Depends positively on public employment LP

Election probability (III)

LP, 2 12 h A

4 G 2 − 1A 2 −

2Z2 W − HLP

Clientelism influences probability to stay in power

• Relection probability of incumbent: ⎭⎬⎫

⎩⎨⎧ ≥++=Π

21Pr L

APAB NNN

Pr A

2 G 2 − 1A 2 −

2Z2 W − HLP ≥ 0

• Depends negatively on volatility of the resource price

- Type A voters suffer from fiscal volatility when incumbent reelected - Reduces political support of these voters.- Economic volatility translates into political instability- (asymmetry between incumbent/challenger is crucial)

Election probability (IV)

LP, 2 12 h A

4 G 2 − 1A 2 −

2Z2 W − HLP

Equilibrium patronage and Price Volatility (I)

• Period 1 problem of the incumbent:

maxR1

A ,G1 ,LP

R1A − A G − G 1

2

2 LP, 2 p2Z − WLP 12A − G − A2

2 Z2

1 − LP, 2 −A

2 G 2

G 1 R1A p1Z − WLPunder budget constraint :

Equilibrium patronage and Price Volatility (I)

• Period 1 problem of the incumbent:

maxR1

A ,G1 ,LP

R1A − A G − G 1

2

2 LP, 2 p2Z − WLP 12A − G − A2

2 Z2

1 − LP, 2 −A

2 G 2

G 1 R1A p1Z − WLPunder budget constraint :

Equilibrium level of public employment (patronage) :

L′ p2Z − WLP 1

2A − G − A2

2 Z2 A

2 G 2 − W1 0

Marginal benefit of patronage Marginal costof patronage

Equilibrium patronage and Price Volatility (II)

• Effect of price volatility on patronage :

• Volatility reduces value to stay in power (marginal benefit) :

Vpower p2Z − WLP 12A − G − A2

2 Z2 A

2 G 2

Reduces political patronage LP


- in general : ambiguous




2 Z2 A

2 G 2




• Volatility reduces proba of reelection / expected cost of public jobs

Increases political patronage LP


• Effect of price volatility :



2 Z2 A

2 G 2




• Volatility reduces proba of reelection / expected cost of public jobs

Increases political patronage LP

• For our parametric specification: LP with volatilitywhen public wages are not too high (ie. W/H < 2)

/ Politician not too risk averse

2

Resource Curse and Volatility (I)

• Total expected wealth :

Y 2H p1Z p2Z − 1 LPLPH

Expected resource cost of politicalpatronage

Resource Curse and Volatility (I)

• Total expected wealth :

Y 2H p1Z p2Z − 1 LPLPH

Expected resource cost of politicalpatronage

Price volatility leads to a resource cursewhen political patronage increases

Moreover when average resource income is large enough, Negative effect is stronger, the weaker the institutions

(ie. )L′

p2Z

Public Investment and Political Patronage (I)

• Extend the model to public investment/growth

- Curse not only through clientelistic policies but also through crowding out of public investments (infrastructures/education)(Caselli (2006), Caselli and Cuningham 2010).

• Productivity of private sector : H 1 H ; H2I H I 0

• Government can tax private sector at the tax rate τ > 0

LP, I min 12 h A

4 G2 − 1A 2 −

2Z2 W − H2I1 − LP ;1

• Prb of reelection :

Rent depends negatively on I-+

Public Investment and Political Patronage (II)

∂2∂LP∂I

0

Public investment reduces the effectivenessof political clientelism

Political patronage increases the cost of public investment on re-election proba

• First period problem of the incumbent :

maxR1

A ,G1 ,LP,IR1

A − A G − G12

2

LP, I H2I1 − LP p2Z − WLP 1A − G − A2

2 Z2

1 − LP, I −A

2 G 2

under the constraint : G 1 R1A H 11 − LP p1Z − WLP − I

Public Investment and Political Patronage (III)

−W H 1 − W H2 L′ Vpower 0

−1 I′ Vpower 1 − LP 0

Vpower H21 − LP p2Z − WLP 1A − G − A2

2 Z2 A

2 G 2

LPI

ILP

Where :

Marginal cost

Marginal cost

Marginal benefit

Marginal benefit

value to stay in power

Public Investment and Political Patronage (IV)

−W H 1 − W H2 L′ Vpower 0 LPI

Marginal cost Marginal benefit

Public Investment and Political Patronage (V)

• How is patronage affected by public investment ?

I

−W H 1 − W H2 L′ Vpower 0 LPI


I - +

LPLP



−W H 1 − W H2 L′ Vpower 0

LPI


I - + +-

• Large enough value of resource income p2Z• Patronage and public investment are strategic substitutes

LPLPLP LP



−1 I′ Vpower 1 − LP 0 ILP


Public Investment and Political Patronage (VI)

+LP - -+

II II

• Large enough value of resource income p2Z

• How is public investment affected by patronage ?

ILP

I

LP

E

Public Investment and Political Patronage

ILP

LPI

• Effect of price volatility : 2

Public Investment and Political Patronage (VII)


- Political patronage LPI

2

1) Political turnover Expected cost of public jobs LP

2) Fiscal volatility Value to stay in power LP



- Political patronage LPI

2

1) Political turnover Expected cost of public jobs LP

2) Fiscal volatility Value to stay in power LP

- Public investment ILP

cost on expected gains to stay in power

2) Fiscal volatility I

1) Political turnover horizon for public Investment

I


• When public wage/sector not too large / politician not too risk averse

Public Investment, Political patronageAnd the resource curse

increases with price volatility

political turnover effect dominates

LPI

ILP decreases with price volatility

• Volatility leads to resource curse : magnification effects of interaction between public investment

and patronage

I

LP

E

Public Investment, Political Patronage and Price Volatility

ILP

LPI

E’

Δ2 0

Δ2 0

Rent extraction, Politics and Price volatility (I)

• Extension with rent extraction: Z1 e Z2 Re

R ′ 0 and R′′ 0

• No public investment I : H 1 H2 H• No taxation τ =0

• Extension with rent extraction: Z1 e Z2 Re

R ′ 0 and R′′ 0

• No public investment I : H 1 H2 H• No taxation τ =0

• Proba of incumbent’s election:

• Proba of reelection increases with extraction rate e : Utility cost for voters of type A of price volatilityis reduced with lower stock of the resource in period 2.

Rent extraction, Politics and Price volatility (I)

LP,e 12 h A

4 G 2 − 1A 2 −

2Re2 W − HLP

Rent extraction, Politics and Price volatility (II)

• The effect of e on stronger when volatility parameter σ² larger :

e2

" −h A

2 ReR′e 0


e2

" −h A

2 ReR′e 0

• period 1 problem of incumbent:

maxR1

A,G1A ,LP ,e

R1A − A G − G1

A 2

2 LP, e p2Re − WLP 12A − G − A2

2 Re2

1 − LP, e − A

2 G 2

• Equilibrium extraction in case without patronage (ie. LP=0) :

p1 p2R ′e eVpowere,LP − A2ReR′e 0



e2

" −h A

2 ReR′e 0

• period 1 problem of incumbent:

maxR1

A,G1A ,LP ,e

R1A − A G − G1

A 2

2 LP, e p2Re − WLP 12A − G − A2

2 Re2

1 − LP, e − A

2 G 2

• Equilibrium extraction in case without patronage (ie. LP=0) :


Political turnovereffect

Fiscal volatilityeffect

Average priceeffects


Rent extraction, Politics and Price Volatility (III)

• Comparative statics on extraction rate e: ∂e∗∂p1

0


0

(when price volatility not too high) ∂e∗∂p2

0



0

• Effect of :2




0


0

• Effect of :2


1) Increased political myopia e*



0


0

• Effect of :2


2) Increased politicalturnover effect

e*



0


0

• Effect of :2


3) Reduced value to stay in power

e*



0

Rent extraction, Politics and Price Volatility


0

• Effect of :2


4) Increased fiscal volatilityeffect

e*



0


0

• Effect of :2


4) Increased fiscal volatility effect

3) Reduced value to stay in power

2) Increased political turnover effect

1) Increased political myopia ++

+-

Price volatility not too strong


e∗


0

Rent extraction, Politics and Price Volatility (IV)

• More agressive extraction in context of price volatility

Van der Ploeg (2010) : social planner’s context /modified optimal Hotelling ruleSocial optimum extraction path brought forward by future price volatility

• More agressive extraction in context of price volatility

Van der Ploeg (2010) : social planner’s context /modified optimal Hotelling ruleSocial optimum extraction path brought forward by future price volatility

• Here social utilitarian optimum : max S X1 1

2 uAC1A,G 1

A 12 uBC 1

B

E X2 12 uAC 2

A,G2A 1

2 uBC2B

X1 G1A p1e X2 G2

A p2Re

p1 p2R ′e − A

2 2ReR′e 0

Optimum extraction brought forward by price volatility

Rent extraction, Politics and Price Volatility (IV)

Rent extraction, Politics and Price Volatility (V)

p1 p2R ′e − A

2 2ReR′e 0 (social optimum)

p1 p2R ′e eVpowere,LP − A2ReR′e 0 (political eq.)

p1 p2R ′e − A






p1 p2R ′e − A





Over extraction of the resource under price volatilityInefficiency likely to increase with 2

Expected total wealth : Y 2H p1e p2Re

Resource curse associated to higher 2


Rent extraction, Politics and Price Volatility (VI)

• Analysis can be extended to positive political patronage (ie. LP > 0)

−1 W L′ Vpower 0

p1 eVpower p2 − A2ReR′e 0

LPe

eLP

Vpower p2Re − WLP 12A − G − A2

2 Re2 A

2 GWith:

e

LP

E


LPe

eLP

LPeshifted up with 2

eLP• Effect of volatility:

Rent extraction, Politics and Price Volatility (VI)

e

LP

E


LPe

eLP

Δ2 0

Δ2 0 E’

Rent extraction, Politics and Price Volatility (VII)

• At least one of the two policy variables: e* ; L* P

with price volatility

• Negative impact of price/fiscal volatility on incomewhen both variables increase :- over extraction / inefficient public employment

LPeshifted up with 2

eLP• Effect of volatility:

Conclusions (I)

• Political-economy models of the resource curse : How political incentives interact with price shocks/volatility

• Incumbent’s asymmetric capacity:- Clientelism: inefficient redistribution through public jobs

tool for influencing people's political behavior.

• Resource booms create underdevelopmentnot because of inefficiency in rate of resource extraction But because of political redistribution of the rents.

• Political-economy models of the resource curse : How political incentives interact with price shocks/volatility

• Incumbent’s asymmetric capacity:- Clientelism: inefficient redistribution through public jobs

tool for influencing people's political behavior.

• Resource booms create underdevelopmentnot because of inefficiency in rate of resource extraction But because of political redistribution of the rents.

Public policy volatilityvoters’ perceptions political turnover

• Resource volatility

Incumbent’sPublic policies

Resource allocationRedistribution

Conclusions (I)

- Limited public instruments : risk shifting to voters- Asymmetric effects on constituencies between incumbent/challenger

Conclusions (II)


« bad » incumbent’s policiespolitical channel for volatility cursevolatility

Conclusions (II)

• Extensions: - The role of Liquidity constraints/ Financial frictions- Debt policy

- Other public policies

- Nontraded\ traded goods: « Political » Dutch disease ?


Conclusions (II)

« bad » incumbent’s policiespolitical channel for volatility cursevolatility

price volatility and the political economy of the resource...

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