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The Effect of Natural Resources on Income Inequality

Byron Hewson

University of Queensland

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Introduction

Global Income Inequality – Gini Coefficients

Introduction

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Natural Resources

Wealth

Resource Sector Growth

Decline in Non-Resource Sectors

Inequality

Decline in Institutional

Quality

Policy Distortions and Myopia

Increased Corruption and Rent-Seeking

Introduction

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Natural Resources

Wealth

Resource Sector Growth

Decline in Non-Resource Sectors

Inequality

Decline in Institutional

Quality

Policy Distortions and Myopia

Increased Corruption and Rent-Seeking

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Introduction

Background

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1. What makes natural resources wealth different from other sources of wealth?

2. Why does income inequality matter?

Natural Resources

Defining “Natural Resources”:

● A subset of “natural capital” which includes subsoil assets, timber resources and protected areas.

“Subsoil Assets” or “Non-Rural Commodities” =

Mineral resources – e.g. copper, iron, gold

PLUS

Energy Resources – e.g. oil, coal gas

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Natural Resources

Distinct Characteristics of Natural Resources

1. High economic rents and relatively high volatility

2. Extracted and non-renewable

3. Cognitive impact in perception and treatment by state and non-state actors

4. High inequality in ownership and susceptibility to rent-seeking behaviour

Why is Inequality Important?

1. Inequality can impact on economic growth

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Why is Inequality Important?

2. Inequality is important for reducing poverty

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Growth and Inequality Elasticities of PovertyElasticities Comparative ratio

Growth (1) Inequality (2) Absolute (1)/(2)

Sub-Saharan Africa -1.51 1.56 0.97

Africa -1.82 2.16 0.91

East Asia and Pacific -2.48 3.49 0.71

Eastern Europe and Western Asia

-4.22 6.85 0.62

Latin America and Caribbean -3.08 5.00 0.62

Middle East and Central Asia

-2.75 3.91 0.70

South Asia -2.10 2.68 0.78

Source: Compiled from Fosu (2011).

Why is Inequality Important?

3. Inequality impacts on welfare

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Inequality

Discontent Crime Health

Data

Measures of Natural Resources:

1. Resource Rents (%GDP)

2. Subsoil Assets (log, per capita)

3. Resource Exports (%Total Merchandise Exports)

Instrument:

1. Value of resource stocks in 1970 (Norman, 2009)

2. Subsoil Assets

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Data

Measures of Natural Resources:

1. Resource Rents (%GDP)

2. Subsoil Assets (log, per capita)

3. Resource Exports (%Total Merchandise Exports)

Instrument:

1. Value of resource stocks in 1970 (Norman, 2009)

2. Subsoil Assets

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Data

Measure of Inequality:

● Gini Coefficients (UNU-WIDER)

Measure of Institutional Quality

1. Aggregate of six World Bank Governance Indicators

Voice and Accountability, Political Violence, Government Effectiveness, Regulatory Quality, Rule of Law, Control of Corruption

2. Economic Freedom of the World Index - EFW (Fraser Institute)

3. Corruption Perception Index – CPI (Transparency International)

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Data Coverage

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Econometric Specification

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Relevant features of the model:

1.Three equations and three jointly determined variables; income inequality (G), institutional quality (IQ), and per-capita income (Y).

2.Incorporates enough exclusion restrictions to guarantee identification of the equations - all of the equations are overidentified.

3.The vector of control variables in each equation contain a number of variables that exhibit endogeneity and correlation with the disturbances.

Econometric Specification

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Estimation Procedure – GMM-3SLS Estimator :

1.Jointly determined variables are regressed on all of the control variables included in the system, using a GMM estimator to instrument the endogenous controls in the reduced form equations.

2.Predicted values of the jointly determined variables generated from the reduced form equations are substituted into the structural equations. The endogenous controls in structural equations are instrumented using GMM.

3.Structural equations are jointly estimated using 3SLS.

Results – Preferred Measures

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Dep. Variable gini Dep. Variable govt_ind Dep. Variable logGDPpc

resource_rent 0.261*** resource_rent -0.299*** resource_rent 0.005

govt_ind -9.510*** gini -0.022*** govt_ind 0.317***

logGDPpc 3.325 logGDPpc 0.758*** gini -0.003

trade_open 0.024*** malaria -0.035 education 0.007***

polity2 0.466*** education -0.001 phys_capital -0.004

m2 0.007 aid -0.001** trade_open 0.001***

ethnic_frag 5.886*** ethnic_frag 0.317 coast 0.003

land_gini 0.138*** latitude 0.992*** malaria -0.463***

govt_spending 0.029 socialist_legal -0.749***

govt_system -5.957*** english_legal -0.107

resource_rent*govt_ind

0.209* french_legal -0.404***

german_legal -0.143**

Obs . 156 Obs . 156 Obs . 156

R-squared 0.664 R-squared 0.791 R-squared 0.785

Results – Alternative Measures of Institutional Quality

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Governance Indicators

● Political violence, voice and accountability, and the rule of law all have a significant negative effect on inequality

● Resource rents have a significant negative effect on each of the indicators, except control of corruption

Corruption Perception Index (CPI)

● There is no significant relationship between CPI and inequality and resource rent and CPI

Economic Freedom of the World (EFW)

● Resource rent has a significant negative effect on EFW and EFW has a significant positive effect on inequality

Results – Subsoil Assets and Resource Exports

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Dep. Variable gini gini Dep. Variable govt_ind govt_ind

subsoil_assets 1.869*** subsoil_assets 0.086***

resource_exports 0.053* resource_exports -0.003*

govt_ind -6.483*** -9.333*** gini -0.010 -0.027***

logGDPpc 2.553 3.200 logGDPpc 0.497*** 0.414***

trade_open 0.020* 0.035** education 0.004* 0.002

polity2 0.581** 0.329** aid -0.001 -0.001**

m2 0.032 0.009 ethnic_frag -0.155 0.152

ethnic_frag 7.622*** 3.486 latitude 1.880*** 1.286***

land_gini 0.170*** 0.187*** socialist_legal -0.851*** -0.793***

govt_spending 0.201 0.184 english_legal -0.066 -0.061

govt_system -5.608*** -5.245*** french_legal -0.341*** -0.242***

german_legal -0.226*** -0.088

Obs . 129 146 Obs . 129 146

R-squared 0.727 0.698 R-squared 0.794 0.771

Results – Summary

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1. Natural resource wealth, abundance, and intensity, consistently increases income inequality.

2. Both resource wealth and resource intensity decrease institutional quality. Conversely, resource abundance positively affects institutional quality.

3. The direct marginal impact of resource wealth and resource intensity on income inequality depends on the level of institutional quality.

4. The effect of resource wealth and resource intensity on inequality is robust to broader measures of natural resources

Policy Implications

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Policymakers must ensure that:

1. Resource wealth is not misappropriated

2. Benefits of resource wealth are shared both within society and across generations

Overall Aim: transforming non-renewable resource wealth into other forms of wealth which can

provide sustainable growth

Policy Implications

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Achieving inclusive growth

1. Taxation of natural resource wealth

2. Distribution and investment of natural resource wealth

Policy Implications

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Taxation of natural resource wealth

1. Efficient 2. Competitive 3. Stable and Transparent4. Flexible and Responsive

Policy Implications – Taxation

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1. Efficient

• Profit-based taxes encourage exploitation of lower grade ore and recognise risks in mining and mineral price fluctuations but are more difficult to administer than royalties

Policy Implications – Taxation

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2. Competitive

Policy Implications – Taxation

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3. Stable and Transparent

Policy Implications – Taxation

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4. Flexible and Responsive

Mining Cycle:

1. Exploration – Mineral Development Funds, carrying forward losses

2. Mine Development – depreciation allowance, low VAT and duties, tax deductions for

infrastructure

3. Production – tax changes with price fluctuations

4. Post-Mining – tax deductions for rehabilitation funds

Policy Implications – Distribution and Investment

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• Sovereign wealth fund (Norway)

• Direct Distribution (US, Canada)

• Tax Cuts (Australia)

• Public Goods (Indonesia)

• Infrastructure (PNG, DRC)

Conclusion

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• Natural resources increase income inequality

• Improved institutional quality decreases income inequality

• Resource wealth tends to decrease institutional quality, though resource abundance need not necessarily lead to a decline in institutional quality

• Resource policy must concentrate on limiting expropriation of resources

• Efficient and equitable taxation must be combined with long term resource utilisation strategies

• Political and social institutions are pivotal in determining the effect of natural resources

Thank you for listening

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