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The Day After Tomorrow: Commodities And Uncomfortable Natural Riches

Commodity prices are experiencing a lot of volatility right now, with food and oil prices nearing record highs. But what about the medium-term? The answer is fundamental for developing countries as commodity prices will be the key external variable for them to watch -- perhaps even more than interest rates. Commodity prices are expected to stay high until at least 2015, before supply responses and lower relative demand by a burgeoning global middle-class moderate them. And while commodity dependence has been declining for decades, exports and fiscal revenues will remain dominated by natural resources in many developing countries.

Is this commodity price increase good news? The literature on whether commodity wealth is a "curse" is as vast as it is ambivalent -- as we show it in The Day After Tomorrow: A Handbook on the Future of Economic Policy in the Developing World (World Bank Publications, Washington D.C.). What is certain from empirical evidence is that good policies and good governance are necessary, but not sufficient, conditions for natural riches (especially oil and minerals) to support development. For that to happen, it is necessary to solve five main problems associated with those riches: (a) "Dutch Disease" (non-commodity exports becoming less competitive), (b) price volatility (complicating investment decisions), (c) over-borrowing (lenders are less stringent with governments that expect to collect lots of cash), (d) sustainability (the amount of the natural wealth to preserve for future generations), and (e) corruption (the larger the rent, the more voracious the rent-seeking).

Given these five challenges, what are "good" policies and what does "good" governance entail? Will the developing world succeed now where it mostly failed in the past? This time, the odds are higher in favor of better development outcomes stemming from high commodity prices. With important differences across countries, democratization has, on average, enhanced citizens' demand for transparency and has improved institutional checks and balances. In parallel, natural resource funds have become more common and the technology to administer them has improved. Public investment processes, from identification to evaluation, are also better than before.

More generally, fiscal policy is more robust, backed by more rules, better coordinated with other agencies of the state (notably, central banks), and more acquainted with techniques for results-based management. Monetary anchors are stronger (scores of countries follow and meet inflation targets). And while we are still far away from a broad acceptance of the prudent "permanent income rule" (that is, from spending only the annuity value of our natural wealth), there is a general sense among policymakers and voters that consumption binges financed by commodity revenues tend to end in tears.

Of course, not all developing countries are improving their natural resource management at the same speed, and a few are actually moving in the opposite direction. But the overall trend is more promising than it has ever been. The more rich nations undergo painful fiscal adjustments and austerity, the more support politicians in emerging markets will have for prudence in saving and using commodity wealth. It may sound overly optimistic, but sound fiscal management will begin to be perceived as a political asset.

This blog was originally posted on the World Bank Insititute Growth and Crisis website.

Otaviano Canuto is the World Bank's Vice President for Poverty Reduction and Economic Management, and Marcelo Giugale is the Sector Director of Poverty Reduction and Economic Management for the Africa Region. They are both the coeditors of The Day After Tomorrow: A Handbook on the Future of Economic Policy in the Developing World.

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