ENVIRONMENT t ~D E P A R T M E N T iW ~P A P E R SPAENOI ~~w X PAPER NO. X ENVIRONMENTAL ECONOMICS SERIES Beating the Resource Curse The Case of Botswana Maria Sarraf Moortaza Jiwanji October 2001 The World Bank O THE WORLD BANK ENVIRONMENT DEPARTMENT Beating the Resource Curse The Case of Botswana Maria Sarraf Moortaza Jiwanji October 2001 Papers in this series are not formal publications of the World Bank. They are circulated to encourage thought and discussion. The use and citation of this paper should take this into account. The views expressed are those of the authors and should not be attributed to the World Bank. Copies are available from the Environment Department, The World Bank, Room MC-5-126. Contents ABsTRAcr v ACKNOWLEDGMENTS Vii ABBREVIATIONS iX Chapter 1 Introduction 1 Chapter 2 The Resource Curse 3 Economic Explanations of the Resource Curse 4 The effect on non-boom tradable sectors and the Dutch Disease 4 Skill accumulation and the resource curse 5 The boom-sector: Low linkages with the rest of the economy 5 The Staple Trap Trajectory 6 Political Dimensions to the Resource Curse 6 Inappropriate economic management 6 Rent seeking 7 Policy Suggestions from the Literature 8 Chapter 3 The Case of Botswana 9 Development of the Mining Sector 9 Management of the Mineral Boom 10 Management of government's budget and accumulation of international reserves : Management of the exchange rate and economic diversification 13 Other Aspects of the Economy 14 Chapter 4 Conclusion 17 NoTEs 19 REFERENCES 21 Environmental Economics Series Beating the Resource Curse - The Case of Botswana FIGuREs 1. Revenue, expenditure, and development expenditure as a percent of GDP 12 2. Reserves in months of imports of goods and services 12 3. Formal employment by sector, 1989 14 TABLES 1. Comparison between Botswana and Sub-Saharan Africa for selected indicators 9 2. Contribution of the mining sector to GDP, government revenue, and export earnings in selected years 10 3. Government current revenue, expenditure, and surplus (million current pula) 11 4. Growth of output for selected groups of countries, 1970-1996 13 5. Gini index in Botswana 15 iv Environment Department Papers Abstract The endowment of natural resources has often on non-boom tradable sectors; inefficient been associated with disappointing economic investment beyond the absorptive capacity of development. This phenomenon is referred to in the country; and rent seeking behavior. By the literature as the "resource curse," which exploring the case of the mineral boom in hypothesizes that economies experiencing Botswana, this paper will demonstrate that the resource booms, either through price increases resource curse is not necessarily the fate of or new discoveries, will experience resource abundant countries. The adoption of unsustainable growth rates. There are various sound economic policies and the good mechanisms through which a resource-boom management of windfall gains have allowed can negatively impact on an economy. For Botswana to continuously manage growth and instance, it can lead to excessive government to become one of the great success stories of expenditure during the boom period and drastic developing countries. cuts when the boom ends; detrimental impacts Environmnental Economics Series V Acknowledgments For providing the original inspiration and for Aziz Bouzaher for reviewing various versions of guidance throughout, we are deeply grateful to this paper and providing valuable feedback. Kirk Hamilton. We would also like to thank Finally we acknowledge the assistance of Thor Gary McMahon, Richard Auty, Felix Remy, and Sigvaldason in helping to edit the paper. Environmental Econornics Series vii Abbreviations BT Booming Tradable Sector GDP Gross Domestic Product GNP Gross National Product HCI Heavy and Capital-Intensive Industry NBT Non-Boom Sector NT Non-Tradable Sector Environmental Economics Series ix 1 Introduction Let us start by asking a puzzling question: if countries that experience export booms is you suddenly inherit a pot of gold, will you be inherently linked with the fact that they are better or worse off in the long run? The obvious richly endowed in natural resources. reply is better off; few people would argue that Alternatively, might the symptoms of the curse more income is a bad thing. Standard economic be avoided through prudent economic theory asserts that one can never be made worse management? off by a positive wealth effect. The answer, however, is not always that straightforward. It In this paper, we will show that the natural depends on how you manage this unexpected resource curse is not necessarily the fate of gain. If you decide to quit your job, you might resource abundant countries. By exploring the spend the money over a couple of years or even case of Botswana, we will demonstrate how take up a loan based on your improved sound economic policies and good management circumstances. Once the pot of gold runs out, of windfall gains can lead to sustained you might not be able to get your old job back. economic growth. In the first section, we If you still have to service a loan, you may then describe the main dimensions for the resource end up worse off. If you decide to invest the curse, based on a survey of the current money wisely in assets that generate revenue literature. This discussion includes both pure each year for the rest of your life, you will economic explanations for the curse (such as probably be better off.' effects on the non-boom tradable sectors, effects on skill accumulation, and the low linkages of This simple example illustrates what can the boom sector) and more political dimensions happen when countries experience an export that manifest themselves via inappropriate boom. The discovery of new natural resources economic management and rent seeing (or a sudden increase in the price of an activities. The paper's second section describes exportable resource) may unexpectedly in detail the case of Botswana. This case study increases revenues. Unfortunately, many begins with a description of the economic countries have been unable to properly manage development of Botswana since its these windfall gains, ending up spending too independence, followed by a closer examination much, too quickly. This phenomenon has been of the development of the mining sector and its referred to in the literature as the "natural contribution to economic growth. Finally, it resource curse." A key question is whether the explores the means by which the Government under-performance of resource-abundant has managed the mineral boom. Environmental Economics Series 2/ The Resource Curse "We are in part to blame, but this is the curse of consensus on the measurement of resource being born with a copper spoon in our mouths." abundance. The various metrics include export - Keneth Kuanda, dependence (Sachs and Warner 1995), per former President of Zambia capita land area (Wood and Berge 1994), export orientation, and population size Throughout the 1980s and early 1990s many (Surquin and Chenery 1989). In fact Stijns Treougho abutdant countries have suffered from (2001) argues that the findings by Sachs and resource abundant countries have suffered from Waer(95aenorbutwnchgsae low growth. This phenomenon has been termed .me in9the are no natu resuce the "Resource Curse" by Auty (1993), whomaeithmasrofnualeorc thgues thaRresource Curse"abyutyan (199, w y abundance from trade-flows to reserves or arue tha reouc abnac seealroduction of natural resources. In contrast, associated with disappointing rates of economic Wooduand Berg1 argues ta thetbasic development. It should not be interpreted as an findings are not sensitive to these iron law, but rather as a strong recurrent classifications. tendency (Auty 1994a). Furthermore, it poses an interesting conceptual question as to why a The theory side of the resource curse literature "resource boom," either through an seeks to explain the relatively weak improvement in terms-of-trade or a resource performance of resource-abundant economies. discovery, does not lead to sustained economic Several explanations have been advanced, growth. The paradox of the resource curse is which offer a range of economic factors both that a resource boom provides valuable foreign internal and external to the economy. These exchange, attracts foreign investment, and include effects on production and investment provides raw material for production. structures within the economy and the price volatility of international primary goods Some studies, however, find that the resource markets (Auty 1998, Mikesell 1997). On the curse phenomenon is not widespread (Graham other hand, some authors argue that the root of 1995 in Mikesell 1997). On balance, however, the problem is political in that incorrect policy there is substantial evidence that supports the choice leads to the same outcomes and that resource curse hypothesis, ranging from resource booms inspire rent-seeking activities mineral rich to oil-exporting countries. Sachs (Auty 1998, McMahon 1997, Ross 1999). The and Warner (1995), for example, provide a fundamental question that arises from this substantive empirical investigation of 96 literature is whether or not resource countries, and find that economies with a high abundance is inherently a precondition for ratio of natural resource exports to GDP in poor economic performance (as the above 1971 (the base year) tended to have low quote by President Kuanda suggests), or growth rates during subsequent years (1971 to whether the curse could have been avoided 1989). Unfortunately, there is no clear with an appropriate set of policies? Environmental Economics Series 3 Beating the Resource Curse - The Case of Botswana Economic Explanations of the increased the relative export prices of non- Resource Curse boom tradable goods and subsequently damaged Peru's manufacturing and Export booms can cause major distortions in the a ged Peru's Mikesellg and economies of resource-abundant countries. agricultural sectors (Mikesel 1997). These distortions tend to affect the structure of One way to explain the apparent difficulties production and investment, and can persist long experienced in the manufacturing sector is to after the boom subsides. They increase domestic consider how governments reallocate windfall gains income, affect savings and investment, from the booming tradable (BT) sectors to non- government expenditures, and relative prices in tradable (NT) sectors (for example, different sectors of the economy. An export construction), and non-boom tradable (NBT) boom will typically involve a surge in foreign sectors (such as manufacturing). A typical exchange via increased exports of the affected products (and not other tradable sectors). This respnus ito a r oue-ois toaorb (the revenues into the domestic economy (that is, leads to an appreciation in the real exchange the NT sector), as was the case in Bolivia after rate. Changes in the real exchange rate reduce the mineral-boom of the 1970s (Auty and Evia the relative prices of tradable manufactured 2001). This "spending effect," as it is termed in products relative to non-tradable products, such the Dutch Disease literature (for example, Usui as construction and services (Mikesell 1997). For 1997), leads to movements of labor and capital instance, in Bolivia the real exchange rate towards the NT sectors (McMahon 1997). appreciated by 17 percent from 1973 to 1974, and then doubled between 1979 and 1983. As a One of the reasons for the movement of labor result non-mining activity was relatively un- and capital away from manufacturing was that competitive and its share of exports slumped to NBT goods became more expensive relative to 5.2 percent of total exports in 1985 (Auty and NT goods through the appreciation in real Evia 2001). However, there is no single reason exchange rates, as was the case in Bolivia for the resource curse and not all the during the early 1970s (Auty and Evia 2001). As suggestions in the literature apply to each a result it was quite common for mineral rents resource-abundant country'. to be used for the protection of the NBT sectors The effect on non-boom tradable sectors and the through subsidies and protectionist strategies. Dutch Disease However, the inadequate performance of the weakened NBT sectors during post-boom Many studies seeking to explain the resource downswings required levels of subsidy from the curse (such as Usui, 1997; Auty, 1998) place mining tradable sectors that were major emphasis on the failure of resource- unsustainable. This was the case in South abundant economies to promote a competitive America (Bolivia, Guyana, pre-Pinochet Chile) manufacturing sector, often termed the "Dutch and sub-Saharan Africa (Zambia, Zaire and Disease."2 The case of Peru, where GDP growth Nigeria) according to Auty (1994b). Another rates declined from 3.5 percent in 1970-1980 to reason for deficiencies in manufacturing sectors negative 0.5 percent in 1980-1993, provides an is that governments tend to "leap-frog" labor- adequate illustration of the damaging intensive manufacturing industries in favor of consequences for the manufacturing sector. heavy and capital-intensive (HCI) industries, as During the 1980s, Peru experienced a resource- was the case in Mexico and Brazil (Auty 1994a). boom through dramatic increases in the price of There is also some evidence to suggest that copper and other minerals. The resulting countries which leap-frogged the labor- appreciation of the real exchange rate intensive manufacturing sector displayed 4 Environment Department Papers The Resource Curse higher inequalities of income distribution Sachs (1996) models the incentives to invest in (Auty and Kiiski, 2001 referring to the education, by analyzing labor movements experience of southeast Asian countries). between the BT and NT sectors. Changes in resource-boom sectors, as explained above, In summary, it has been proposed in the push up the wages in the (unskilled) NT literature that the greater the natural resource sectors. Therefore, younger workers will work endowment, the higher the demand for NT in NT and they will be better off if they make goods, and, consequently, the smaller the no investment in education. Birdsall and others allocation of labor and capital to NBT sectors. (1997) found evidence for the differences in the incentives to invest in education between The~~ obiu.usini h xett hc resource-abundant and resource-deficient relative losses in NBT sectors can explain low couries.bHoever theresorif ical rates of overall economic growth. In terms of evidencestoHsuggest that natrl resouce the~~~~~~~ Duc Dies*fet h vdnehsbe evidence to suggest that natural resource the Dutch Dlsease effect, the evidence has been production has a negative impact on the inconclusive. In a survey of several empical manufacturing sector, learning-by-doing, and investigations, McMahon (1997) finds no ultimately economic growth (Stijns 2001). substantive evidence of the Dutch Disease effect. In contrast, Auty and Evia (2001) argue The boom-sector: Low linkages with the rest of that the Bolivian economy in the early 1970s the economy showed clear signs of Dutch Disease through low dversficaion,witha smllerthanPrimary goods are generally produced in an low diversification, with a smaller thanenlvwihfwbcaradfoad expected agricultural sector and protectedenlvwihfwbcaradfoad expefactduagricultua sector aundmptecitved linkages to the rest of the economy. They are manufacturing oetowth typically highly capital intensive, with a small international outputs. (albeit well paid) workforce, and inputs are Skill accumulation and the resource curse generally imported (Auty and Kiiski 2001). Hirschman (1958), Seers (1964) and Baldwin The manufacturing sector is often regarded as (1966) established these arguments more the principal source of technological progress, formally, by encouraging the view that and as a consequence there are educational linkages between the primary sector and the externalities associated with it. This externality rest of the economy are minimal (in Sachs and effect comes through the knowledge and skills Warner 1995). that are generated through the manufacturing Another implcation of weak linkages of the sector. As a result, Sachs and Warner (1995) primary goods sector is that the only way hypothesize that a shift in labor away from general benefits can be derived from a manufacturing will depress growth in labor resource-boom is through the taxation of productivity. Furthermore, a deterioration in resource rents. Therefore, in the face of widely the manufacturing sector could lead to a fluctuating export revenues, governments may reduction in the demand for education and find it diffict to promote economic growth. learning-by-doing and a commensurate fall in This disadvantage of low linkages was evident the long-term growth potential of an economy in Bolivia (Auty and Evia 2001). Furthermore, (Matsuyama 1992). In Matsyama's model, Mikesell (1997) found that governments forces that push the economy away from experienced widely fluctuating export manufacturing and towards agriculture (the revenues (Mikesell 1997), leading to boom sector) will lower the growth rate of the fluctuating levels in overall government economy (cited in Sachs and Warner 1995). revenues. Environnental Economics Series 5 Beating the Resource Curse - The Case of Botswana The Staple Trap Trajectory Political Dimensions to the Resource Curse Auty provides a more formal analysis of the The economic after-effects of resource-booms resource curse by specifying a model that have created hardship for resource-exporting describes the behavior and incentive structure nations. These hardships led to persistently of resource-abundant economies experiencing slow growth. Furthermore, there appear to have been active policies pursued by governments resource booms. He attributes the symptoms of be ciepfce use ygvnuet resource boom. Hthat exacerbated the effects of the resource curse the resource curse to a pattern of behavior he calls a "staple trap" trajectory. Countries on istuish bete policiesthtwr this trajectory tend to experience strong Dutch ingppropriteeo migided th at were inappropriate or misguided and those that were Disease effects, closed economies, few related to rent seeking. In either case, the root incentives for the development of capital, and cause was substantial increases in government high dependency on the boom sectors for revenues caused by the boom. foreign exchange and revenues. When the boom subsides, groups with vested interests Inappropriate economic management block the required adjustments to real Natural resource booms have often reinforced exchange and wage rates. or created inappropriate economic policies in resource-abundant countries (McMahon 1997). An example consistent with the staple trap Though there are a large number of studies on trajectory is that of Bolivia (Auty and Evia the implications of resource-abundant 2001). Bolivia was especially vulnerable to the economies, there is little consensus on which staple trap. It exhibited Dutch Disease effects, countries have under-performed as a result of which had already weakened the non-mining inadequate policy responses to a resource boom (Usui 1997). Nevertheless, there are some econoy. Ivestmnt eficincy ws lo andstriking examples of inappropriate economic the economy was not diversified. Most of the mangement. mineral windfall was not translated into investment and went into higher consumption. McMahon (1997) argues that one of the most Perhaps most significantly, the resource boom significant factors behind the negative impact of created incentives to relax market discipline. resource booms is the irreversibility of government In terms of macroeconomic policy, the expenditure. When the revenue streams from the government failed to sterilize the additional boom subsided, it was very difficult to adjust foreign exchange inflows and it used its expenditures down to levels on par with these hydrocarbon reserves as collateral for foreign smaller revenues. For instance, in Trinidad and borrowing, which increased to 78 percent of Tobago there was public pressure to share the GDP from 1975 to 1979 (Auty and Evia 2001). benefits of the boom, which led to large subsidies for food, fuel, utilites, and loss- making enterprises. By 1981, when the annual The resource curse thesis is merely a strong mkn nepie.B 91 hnteana thenresource curse tuch,exestisois n astron ligrowth rate of GDP was actually negative, there tenencradasch,excpto r lik, was considerable political difficulty in making More significantly, it has been suggested that cutbacks (McMahon 1997). Furthermore, these prudent policy can avoid pitfalls (Auty 1994a). increases in government expenditure The next section, therefore, illustrates how sometimes went towards the civil service by incorrect policy can perpetuate the resource way of an increase in the number of jobs and curse. pay levels. In Cote d'Ivoire, for example, the 6 Environment Department Papers The Resource Curse coffee and cocoa booms of 1976 to 1981 led to a They find evidence that increasing dependency 50 percent increase in expenditures on the civil on primary products is positively correlated service (McMahon 1997). with closed trade policy (cited in Auty and Kiiski, p14). Similarly, there are many examples of governments investing windfall gains In order to finance expansionary fiscal policies inefficiently. Unproductive investment booms and/or irreversible government expenditures, were evident in many countries. Lal and Myint, governments have been known to borrow on 1996 (cited in Auty and Kiiski 2001) find that the strength of their booms. Examples of boom- the efficiency of investment in resource- based borrowing include Jamaica and Nigeria abundant countries collapsed during the 1970s. (Cuddington 1989; cited in McMahon 1997). Furthermore, McMahon finds evidence in Mexico implemented a highly expansionary several countries of political pressure on fiscal policy aimed at rapid development, and government to spread investments towards spent its oil revenues in an imprudent way. failing industries. Governments tended to invest Together with the onslaught of capital flight, the windfalls in the NT sectors (for example, these led to a severe current account deficit, construction), or in projects with low rates of leading Mexico to an accumulation of short- return. Options for investment were not in term debt (Usui 1997). The example of Mexico abundance, given the undeveloped and stands in stark contrast to that of Indonesia constrained nature of financial sectors and where a conservative stance to foreign restriction on holding foreign assets (McMahon borrowing was adopted. 1997). However, the key mistake was that recurrent cost and capacity issues (such as skill Rent seeking requirements) were not taken into account. In Inappropriate economic management can also fact, the case of Botswana is exemplary of how be influenced by the effort of rent-seekers that to avoid these investment pitfalls (see below). are both within and outside of the public sector. For instance, in Brazil, rent-seeking Auty (1993) provides an interesting argument, groups bocked r ratwld have which attributes the low performance of rov ed reconmo the unoptive resource-abundant economies to their ability to rban-idutra preas Au 19) inc faptit postpoe refoms duesimplyto thelargeurban-industrial areas (Auty 1995). In fact, it postpone reforms due simply to the large revenues from the primary sector. In particular, has been noted that resource-abundant these large revenues reduced the incentives to economies are often more susceptible to rent- develop competitive manufacturing sectors. seeking behavior, due to the concentration of Rents are used to support long-standing import wealth either in the public sector or in the substitution strategies,3 as part of the hands of a small number of companies protectionism of non-booming tradable sectors (McMahon 1997). Auty (1998) argues that the (as already mentioned above), long after they existence of large resource rents distracts have been of benefit (Auty 1998). This attenton away from long-term economic prolonged protection of non-boom tradable development goals and towards rent seeking industries eventually reduces the activity. competitiveness of manufacturing sectors (Mikesell 1997). Sachs and Warner (1995b) Bates (1994 cited in McMahon 1997) argues hypothesize that governments seek to protect that the traditional functions of the state, in the manufacturing sectors (in fear of the Dutch light of a resource-boom, give way to the Disease) through protectionist trade policy. redistribution of revenues. As such, socio- Environmental Econornics Series 7 Beating the Resource Curse - The Case of Botswana economic development goals are pushed to the diversify is one important reason why side by rent seeking and patronage. Lane and many mineral economies experience such Tornell (1995 cited in McMahon 1997) contend disappointing rates of economic growth that a resource boom can lead to a "feeding (Auty 1994b) frenzy" in which rent seekers fight for the natural resource rents. * Macroeconomic related policies: Avoid large- scale debt; accumulate budget surpluses Policy Suggestions from the Literature (for example, Indonesia, Usui 1997); follow The resource curse literature, as a result of a prudent exchange rate management identifying the nature of the problem as well as policy by controlling the appreciation of analyzing success stories, is furnished with the exchange rate (Mikesell 1997); create a policy suggestions on how to avoid or mitigate stabilization fund to guard against the detrimental impact of the resource curse. commodity-price volatility (Seymour One caveat to these policy prescriptions is that 2000). they cannot be applied across all resource- abundant economies experiencing resource Other more specific policy suggestions include booms. Nevertheless, there are some general the promotion of autonomous fiscal and principles that arise out of the literature, which monetary authorities in response to the stand out in relation to the Botswana onslaught of rent seekers and special interest experience: groups (McMahon 1997), and the adoption of Environmental and Natural Resource * Investment strategy: Do not invest beyond Accounting (EARA) policies which provide a the absorptive capacity; consider all the rationale for the effective management of recurrent costs associated with new mineral windfalls to secure sustained rapid investment programs; only invest when the economic growth (Auty and Evia 2001). expected rate of return is considerably above that which can be earned in risk-less The above literature rview highlights several foreign assets; in fact some argue that it is channels of influence through which resource better to leave windfall gains in the hands booms have lead to negative effects in many of the private sector (Collier and Gunning resource-abundant economies. However, it is 1996 in McMahon, p38); pursue investments argued in this paper that being endowed with with high social rates of return, particularly natural resource wealth is not an inescapable those in human capital and infrastructure pre-condition for unsustainable economic (Seymour 2000) growth. From these theoretical and empirical investigations of the resource curse, a number of * Economic diversification: Improves policy suggestions have been put forward. The economic performance by increasing the following case study of Botswana demonstrates flexibility with which an economy can how the adoption of such policy suggestions respond to external or intemal shocks can lead to outcomes in contrast to the resource (Daniel 1992 in Auty 1994b). Failure to curse thesis. 8 Enviroranent Department Papers 3 The Case of Botswana "...we intend to conserve our resources wisely and income economy. Compared with other Sub- not destroy them. Those of us who happen to live in Saharan African countries, the economic growth Botswana in the 20th century are no more important of Botswana appears even more striking than our descendants in centuries to come." (Table 1). - Hon. Sir QKI Masire, former President of Botswana This rapid economic growth is not totally surprising given the discovery of large mineral Since its independence from Britain in 1966, deposits, mainly diamonds. What is remarkable Botswana has become one of the great success about Botswana is the way in which the mineral stories of developing countries. Between 1966 boom was managed. By avoiding common and 1989, it was the world's fastest growing pitfalls of mineral booms, such as the "Dutch economy. Botswana's Gross Domestic Product Disease," the Government was able to (GDP) grew at an average of 13.9 percent per continuously manage growth well. The purpose annum between 1965-80, at an average of 11.3 of this section is to explore the factors that led to percent between 1980-89, and at an average of such and extraordinary economic record, and to 4.75 percent between 1990-98 (The World Bank draw the lessons learned. 1991, 1998, and 2001). At independence, Development of the Mining Sector Botswana was among the twenty-five poorest countries in the world. Since then, the mineral The mining sector is largely dominated by the sector has grown significantly and is now a diamond industry and, to a lesser extent, by dominant part of Botswana's economy. By 1989 copper-nickel. The first diamond mine was the country was ranked as a lower-middle discovered in 1967 by De Beers in the region of income economy and in 1998, income per capita Orapa. Since then this mine has yielded more had reached $3,460 (in constant 1995 USD) and than 118 million carats of diamond. Today, Botswana was considered an upper-middle diamond mining is dominated by the Debswana Table 1. Comparison between Botswana and Sub-Saharan Africa for selected indicators Botswana |Sub-Saharan Africa 1965 1989 199841 1965 1989 1998 GNP per capita (constant 1995 USD) 379 2,84 3,460 529 581 539 Life expectancy at birth (years) 50 57 465 43 51 50 Infant mortality rate (per 1,000 live births) 108 55 58 149 101 94 Number of physician per 100,000 persons 4 19 20 3 5 Pupil to teacher ratio in primary school 40 32 25 42 42 41 Source: The World Bank 1991,1998, 2001. Environmental Econornics Series 9 Beating the Resource Curse - The Case of Botswana company which is jointly owned by Table 2. Contribution of the mining sector to GDP, government the government (more than 50 revenue, and export earnings in selected years percent) and by DeBeers. In 1994, Mineral share of Mineral share of Mineral share of the three main diamond mines in total GDP total revenues export earnings Botswana-Orapa, Letlhakane and Year (%) (%) (%) Jwaneng- produced 15.5 million 1967 1.6 0 1 carats of diamond. 1972 11 5 44 1976 14 27 57 Mineral development was the 1980 23 31 81 major contributor to the growth in 1981 22 33 65 Botswana's economy. The mining 1985 41 47 87 sector reached its peak in 1989, 1987 44 55 88 when it accounted for more than 50 1989 51 59 89 percent of GDP (Table 2). It was 1991 40 54 87 also a major generator of revenue 1993 33 40 82 for the government. The mineral 1995 33 51 76 share of government revenue grew Source: Central statistics office referred to in B. Gaolathe 1997, and in Harvey and Lewis from almost nothing at independence to about 60 percent followed by fast increase in government in 1989. It has since been oscillating around 50 spending, resulting in an overall increase in percent of total revenue. The contribution of domestic costs. Consequently, the diamonds and copper-nickel to total exports competitiveness of other tradable goods6 are varied between 75 percent and nearly 90 hlkely to be reduced creating a slowdown in the percent as of 1980 (except for 1981 when the growth of other sectors of the economy. Another diamond market was depressed). Despite its common problem resulting from export booms dominant role in economic production, is that, once the boom is over, governments find government revenue, and exports, the mining it very difficult to cut back on spending, sector is not a major employer. Due to its capital creating serious economic consequences and intensive structure, the sector only employed possibly a debt crisis. around 9 percent of the labor force in the early 1980s, and around 4 percent in 1989. Botswana has managed to avoid most of the economic problems associated with export booms by adopting appropriate macroeconomic In the 1970s, many countries experienced policies. Two main objectives guided Botswana's important export sector booms. Mexico and economic policies: avoid external debt and Nigeria benefited from large increases in oil stabilize growth on one hand, and encourage prices. Colombia, Cote d'Ivoire and Kenya economic diversification on the other (Hill and benefited from an increase in coffee prices in the Mokgethi 1989). mid-1970s, as well as from technological improvements in coffee production. However, The economic policies adopted by the in the years that followed, many of these government to achieve these objectives included countries suffered from balance of payment the following. To avoid excessive increases in problems and debt crises. As explained above, expenditure during boom periods, the one of the reasons underlying this effect is that government accumulated international reserves an increase in government revenues (resulting and ran budget surpluses earmarked for from a boom in the export sector), tends to be stability spending in leaner periods. This policy 10 Enviromnent Department Papers The Case of Botswana avoided having to drastically cut expenditures This ability to maintain expenditures in line during bad years and reduced inflationary with long term growth had been a strong pressures. A second central policy was to stabilizing force. manage the nominal exchange rate to avoid real appreciation of the local currency. This was Investment decisions: Given the high level of achieved largely through the accumulation of savings, the government had to decide how to intemational reserves. Preventing the local allocate its surpluses between international currency from appreciating allowed other reserves and domestic investment. A common tradable goods to maintain competitiveness on problem in countries where windfall gains world markets, and hence encouraged economic accrue principally to the government is that it diversification. will tend to invest in projects that have lower rates of return vis-a-vis the private sector. It is Management of government's budget and often argued, therefore, that a substantial part of accumulation of international reserves the windfall gains should be kept in the hand of As shown in Table 2, mineral revenues the private sector. However, the public constituted a major source of goverment allocations of the gains in the case of Botswana revenue. Consequently, any fluctuation in were done very wisely. diamond revenues would directly affect government revenue and hence spending. Table 3. Government current revenue, expenditure, In line with the above objectives, the and surplus (million current pula) government decided not to increase Current Current Current spending whenever revenue increased. Year revenue expenditure surplus Instead, it based expenditure levels on 1971 18 18 0 longer-term expectations of export 1972 28 20 7 earnings and government revenues. 1973 40 26 14 Despite considerable political pressure, the 1974 61 36 25 temptation to spend everything in the 1975 78 47 31 treasury was successfully avoided. 1976 70 63 6 Instead, any excess revenue was used to 1977 99 76 23 build up foreign exchange reserves at the 1978 209 137 72 Bank of Botswana. These reserves were 1980 266 179 88 thus available to be drawn on in years 1981 277 212 65 when revenues were low. 1982 343 270 73 1983 508 316 192 Control over expenditures: Government 1984 757 416 341 savings can be measured by the budget 1985 1,081 498 583 surplus. As can be seen in Table 3, the 1986 1,446 728 719 government saved a large fraction of 1987 1,707 963 745 revenues, avoided excessive increases in 1988 2,429 1,217 1 ,212 expenditure, and sustained high recurrent 1989 2,695 1,478 1 ,217 surpluses. Faced in 1981/82 and in 1994 1990 3,600 2,859 1,741 with a fall in diamond export earnings, 1992 4,505 2,618 1,887 surpluses declined while expenditure 1993 5,136 3,254 1,882 levels were maintained. The government 1994 4,393 3,274 1, 119 thus managed to avoid drastic cuts in 1995 5,383 3,986 1,397 expenditures when revenues decreased. Source: Statistical Information Management and Analysis, The World Bank. Envirornmental Econornics Series 11 Beating the Resource Curse - The Case of Botswana Domestic investments, as measured by revenues), they were intentionally kept well development expenditure, were based on below revenue levels. Avoiding over-investment expected intermediate and long term revenue also helped reign in inflationary pressures. flow, taking into account the recurrent expenditure iAvolved in each new development International investment: Between 1976 and project. Faced with a boom, countries often 1996, foreign exchange reserves increased from make investment decisions without proper US$75 million to US$5 billion. Once again, the account of the recurrent expenditures associated rationale to save windfall gains from mineral with each new investment. As a result, once the revenues for use when export receipts declined. boom is over countries are unable to cover the The part of the recurrent surpluses (Table 3) not recurrent costs of all the new investments, and invested domestically was used to accumulate projects often have to be abandoned before foreign reserves. By 1995, the government had completion. accumulated reserves equal to 25 months of import cover (Figure 2). If these reserves were In Botswana, however, the government astutely not accumulated during booms, the government avoided undertaking any new development would have had to either borrow or reduce projects if there was no provision to cover the long term recurrent costs. Thcoverthelongterm hasconsienty costs Figure 1. Revenue, expenditure, and development The government has consistentlyexndtrasapcntoGD produced National Development Plans expenditure as a percent of GDP that determined its spending. Once a 70 Reurent plan is voted into force by parliament, 60 revnue it is illegal to implement any X so expdiure additional public projects without - going back to parliament. This system % / has proven to be effective in 30 controlling spending, because it Z 20 - prevents the inception of a project for 1 0 - " - " " ' -. which no provision was made to cover the total costs over time. 0 AN A'3 ^p^\* ^ o o O 'q N"qA3Nq Moreover, decisions to invest domestically took into account the Source: Statistici Information Management and Analysis, The World Bank. absorptive capacity of the economy. Figure 2. Reserves in months of imports of goods and Since the availability of skilled services7 manpower was a large constraint in 30 Botswana, the government felt that 2S increasing development expenditure t beyond the capacity of the country 20 would result in a rate of return lower '8 is5 that what could have been earned on IO alternative assets (international I reserves in particular). With reference S to Figure 1, although development 0 spending could have been further 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 increased (given the huge inflow of Source: International Financial Statistics, International Monetary Fund. 12 Environment Department Papers The Case of Botswana imports when diamond revenues declined. exchange rates. A common problem in countries Instead of having to respond under pressure experiencing export booms is an appreciation of with drastic, fast acting policies, the the local currency leading to a reduction in the government had considerable leeway for more competitiveness of other sectors in the economy. thoughtful decision making. Another advantage By avoiding real appreciation of the pula, other of investing a part of the windfall gains in traded goods could continue to compete foreign exchange rather than domestically is successfully. Botswana's policy was, therefore, that it prevents the exchange rate from to use the exchange rate as a tool to promote excessively appreciating. economic diversification. The accumulation of When hit with the decline in diamond earnings foreign exchange reserves during boom periods in 1981/82, as mentioned above, the was consistent with this objective. However, government used some of the store of savings to even if economic diversification was a goal, the avoid any drastic decline in expenditures. government had also to worry about inflation. However, faced with uncertainty conceming the In times where the stability of domestic prices duration of the diamond crisis, the government dominated the diversification goal, the pula was took the precautionary measure of assuming allowed to appreciate. that it might be a long term crisis rather than a temporary one. As a result, it quickly adopted a The effort of the govemrnent to diversify the package of adjustment policies, which included economy can be seen in Table 4. Although the limiting increases in lending, increasing the share of manufacturing value added in GDP is prime lending rate, freezing wages and salaries and devaluing the pula.8 The rationale for very small (only 5 percent in 1995), its growth reacting quickly with a package of policies was has been very dynamic, especially when twofold. First, to spread a moderate impact on compared to the average growth of the the whole economy rather than making one manufacturing sector in Sub-Saharan African drastic change in a particular sector. Second, to countries or upper-middle income economies. take moderate measures before the situation The growth of the service sector was also very became too serious and more extreme actions important, far outweighing the growth in other might be required. similar countries. The agricultural sector, as discussed below, was the sector that did not Management of the exchange rate and economic succeed. It grew at a very slow, occasionally diversification negative rate, and its contribution to GDP fell The Government of Botswana paid close from 13 percent in 1980 to less than 4 percent in attention to the management of foreign 1995. Table 4. Growth of output for selected groups of countries, 1970-1996 (average annual growth rate, percentages) GDP Agriculture Industry9 Man acturin Services 70-80 80-90 90-96 70-80 80-90 90-96 70-80 80-90 90-96 70-80 80-90 90-96 1 70-80 80-90 90-96 Botswana 14.5 10.3 4.1 8.3 2.2 -1.2 17.6 11.1 1.8 22.9 8.8 2.6 14.8 11 7.1 Upper- 5.9 1.4 2.9 3.2 2.5 1.7 6.1 0.7 2.9 6.6 1.3 3.4 6.3 2.0 3.7 middle income Sub-Saharan 3.8 1.7 2.0 1.7 1.8 2.1 3.8 1.1 0.9 4.3 1.3 0.8 4.9 2.2 2.0 Africa Source: The World Bank 1995 and 1998. Environmental Economics Series 13 Beating the Resource Curse - The Case of Botswana Given that the employment potential of the Moreover, the legal framework to control mining sector is limited due to the capital environmental impacts of mining operations is intensive nature of its operation, the creation of well established.1 Examples of actions taken to jobs in other sectors of the economy was a major protect the environment during mining concern for the governnent. Even if the operations include: the incorporation of a sulfur government's overall strategy was to minimize reduction plant into the Selebi-Phikwe copper- intervention, it still adopted a few incentives to nickel smelter; the installation of power lines create jobs in the manufacturing and services underground to save the flamingo population sectors.10 Despite the small size of the near the Sua Pan soda ash company; and the manufacturing sector, it had great potential to suppression of coal dust by the wetting system create employment, especially in the in the coal mine of Moruplue Colliery (B. construction sector (Figure 3). Employment in Gaolathe 1997). Although diamond mines do manufacturing and services has grown not pose serious environmental hazards, tremendously during the past decades and in various measures were still taken to ensure that 1989 they represented 25 and 32 percent of diamond mining operations would be as formal employment respectively. Although environmentally friendly as possible. A major employment in agriculture only represents 4 aspect underlying Botswana's environmental percent of formal sector employment, it protection from mining activities is the prceuntsforthemajority of informal sector empinternalization of environmental costs, whereby accounts for the majority of informal sector prvt oprtr eerepnil o employment. It is important to note that in 'im et e measue ws Botswana formal sector employment only represents 30 percent of the total labor force. Other Aspects of the Economy The remaining 70 percent constitute the informal sector employment.11 In addition to the protection of the environment from mineral activities, Botswana is among the Not only has Botswana's government top ten countries in terms of preserving its successfully managed revenues from the mining natural environment; about 19 percent of its sector, it has also paid considerable attention to total land area is estimated to be nationally environmental protection in implementing protected (The World Bank 1998). This area mineral projects. Commitments to comprises national parks and game reserves, environmental protection were part of the some of them having gained interational fame concession agreements with mining companies. for their abundant wildlife (for example, the Central Kalahari Game reserve and the Figure 3. Formal employment by sector, 1989 12 Gemsbok National Park). Despite these accomplishments, it is fair to say that Botswana Agriculture has not solved all of its environimental 4% problems. Large shortcomings remain and need Manufacturing further efforts, such as deforestation from Government 25% overgrazing, soil erosion and water pollution. 35% t | l l lill Through many years of sustained growth, there have also been two main shortcomings which i 1 38 X 1 Mining contrast with the overall picture of economic 4% R B disuccess: the agricultural sector, and income distribution. Services 32% Source: Labor Statistics 1989, Gaborone, Republic of Botswana cited The agricultural sector: The poor performance in Perrings (1996). of the agricultural sector can be seen in Table 4. 14 Environment Department Papers The Case of Botswana Between 1980-90, while the industrial, inequality has neither improved nor worsened manufacturing and services sectors grew at an in urban areas and has barely improved in rural average rate of 11 percent, 23 percent and 11 areas. Table 5 presents the Gini14 index percent respectively, the agricultural sector calculated in each of the 3 surveys undertaken grew at only 2.2 percent. More recently, between in Botswana since independence. World Bank 1990-96, agricultural GDP contracted at an estimates of income distribution also suggest average of 1.2 percent. The decline in that very little improvement (almost none) has agricultural productivity is mainly the result of been made since independence. In 1970-75, it severe and prolonged periods of drought was estimated that the share of income accruing experienced by the country and the over- to the lowest 20 percent of the population was 4 utilization of rural resources. The evidence for percent, and the share of income accruing to the increasing pressure on scarce rural resources is top 20 percent of the population was 60 percent. visible through the depletion of water reserves By 1986 these numbers had changed to 3.6 available to villages, water pollution problems, percent and 58.9 percent respectively. overgrazing, rangeland degradation, and the depletion of wood around large settlements. Identifying the factors responsible for the lack of While the dependence of agricultural growth on improvement in income distribution in the sustainable use of agricultural resources has Botswana is a complex task. Nevertheless, two been recognized in Botswana, action to improve issues seem relevant. First, many authors the situation has been lacking. Given that recognize that long periods of drought are agriculture accounts for 70 percent of the labor generally associated with an increase in force, this is an issue of considerable concern. inequality. This occurs because large and rich As explained in paragraph 46, formal sector farmers with large reserves of livestock can employment constitutes only 30 percent of the better endure drought than poor ones. Second, it labor force, while the informal sector is also accepted that rapid economic growth and employment accounts for the remaining 70 resource-abundance usually results in percent, most of which is in the agricultural increasing inequality. In the context of the sector. Robust employment in the agricultural mineral development of Botswana, this view sector would have a very positive affect on the seems to be correct; the direct benefits were overall rate of unemployment, which is mainly restricted to a fortunate minority. currently quite high. Despite Botswana's bad performance in terms of income distribution, it is still favorably Income distribution: Unequal income comparable with other resource-abundant distribution in Botswana has always been countries, such as Brazil and Peru (Auty, recognized as a major problem. Many claim that personal communication). Nevertheless, the income inequality has been widening since Government's recognition of this problem has independence and that much of Table S. Gini index in Botswana the population Rural income Household income and Household income and did not benefit distribution survey expenditure survey expenditure survey from the overall 1974/75 1985186 1993194 growth in the Per capita urban 0.54 0.54 economy. Income areas distribution Per household 0.52 0.51 0.50 surveys indicate rural areas that income Source: Central Statistics Office, cited In Hudson and Wright 1997. Environmental Economics Series 15 Beating the Resource Curse - The Case of Botswana pushed it to invest in many social aspects of the educated population is one of serious economy, such as education and health. But the unemployment (estimated at 21.2 percent in problem that seems to be facing a now better 1994). 16 Environment Department Papers 4 Conclusion The "resource curse" literature shows, through resource abundant countries, and that prudent various channels of influence, how resource economic management can help avoid or booms can actually harm resource-abundant mitigate the detrimental effects of the resource economies. A review of the literature offers both curse. The discovery of large diamond deposits economic and political dimensions to the allowed Botswana to witness an important problems of resource-abundant economies. For export boom and the world's fastest growth in instance, an increase in copper prices in Peru GDP. The country moved from being the 25th lead to an appreciation of the real exchange rate poorest country in 1966 to an upper-middle which subsequently damaged the economy thirty years later. The most important manufacturing and agricultural sectors. In factor in Botswana's long term sustained Bolivia, low linkages of the booming mineral economic growth was its ability to avoid sector to the rest of the economy did not common problems associated with export promote sustainable economic development. In booms and the adoption of sound economic terms of political influences, Brazil's attempts to policies. Its main objectives were to avoid remove protection for uncompetitive sectors extemal debt, stabilize growth and to encourage were blocked by rent seeking groups. In short, economic diversification. This paper has the curse of resource booms is very real. explored the various economic policies adopted However, the question raised in this paper is by the Botswana government to achieve those whether or not resource-abundance and objectives. Even if the agricultural sector and subsequent resource-booms lead to inevitably income distribution have had a less successful low economic performance. fate, various lessons could be drawn from Botswana's capacity to manage the revenue of The case of Botswana illustrates how a natural the resource booms and to sustain long term resource curse is not necessarily the fate of all economic growth. Environmnental Economics Series 17 Notes 1. This example is drawn from a similar 8. For additional information please refer to example cited in McMahon (1997). Hill and Mokgethi (1989). 2. The Dutch Disease model is named after the 9. Industry includes mining. disappointing experience of the discovery of 10. For more information on this issue, please natural gas in the Netherlands. The term is refer to Siwawa-Nadi (1996). popularly used to refer to all economic 11. The size of the labor force estimate is based hardships associated with resource exports. on the projection of the population assumed Its more formal definition, however, to be economically active. Informal sector describes two effects of a resource boom: an employment is the difference between the appreciation of the real exchange rate; the estimated labor force and formal tendency to draw capital and labor away employment (Perrings 1996). from non-boom tradable sectors, making 12. Manufacturing includes: electricity, water, them more un-competitive (Ross 1999). and construction. Services include 3. Import substitution strategies were commerce, transport, and financial. promoted by the United Nations Economic 13. The legislation related to the environmental Commission, as part of the development impacts of mining operations include: The campaign of the 1960s and 1970s (cited in Atmospheric Pollution Prevention Act of Sachs and Wamer 1995). 1971; the Mining, Quarries, Works, and 4. 1998 or latest available year. Machinery Act of 1973; and the Mines and 5. The decrease in life expectancy since the Mineral Act of 1976. early nineties is mainly due to the high 14. A Gini index measures the extent to which incidence of HIV infection in Botswana. the distribution of income among 6. By other tradable goods, it is meant tradable individuals or households within an goods other than the one experiencing a economy deviates from a perfectly equal boom (such as minerals, in the case of distribution. A Gini index of 0 represents Botswana). perfect equality while an index of 100 7. 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