The news filtered around the international media recently that Ghana will start pumping its oil, estimated to be a minimum of 1 billion barrels in reserve. However, this news has been met with both joy and fear. Joy because this means Ghana now joins the league of oil producing countries, with the attendant streams of petrol Dollar in revenue.

There is the fear of the so-called oil resource ‘curse’ or the paradox of plenty - often used to describe a situation in which countries blessed with abundance of natural resources such as oil tend to have worse economic and development outcomes. This economic phenomenon is sometimes called the Dutch disease.

Macroeconomics traditionally offers some insights into how the ‘blessing’ of abundant natural resources might turned into a ‘curse’ overtime. This may occur when the revenue from oil exports initially leads to increase in real exchange rate and wages. This increase in turn will eventually damage the other productive or tradable sectors of the economy, such as the agriculture and manufacturing, as they become less competitive in world markets.

On the government front, the revenue from oil exports will more likely result in higher government spending (e.g. on education, health, etc.), but this is more likely to be financed through deficits in anticipation of higher oil revenue that are vulnerable to vagaries in world oil prices. Overtime, as the real sectors of the economy are exposed to international competition, the revenue from oil also becomes volatile due to exposure to global commodity market shocks, and this leaves the economy largely dependent on oil revenue.

Yet it would be very naďve to jump to the conclusion that all resource abundant countries are ‘cursed’. Whereas not all resource-rich countries have experienced the resource ‘curse’ phenomenon, one wonders why generally, the resource abundant countries (e.g. Nigeria, Sierra Leone, Angola, and Venezuela are all resource-rich) seem to lag behind countries with less resources (e.g. the Asian tigers: Hong Kong, Korea, and Singapore are all resource-poor) in economic growth and development.

These diverging experiences have been associated with the quality of a country’s institutions in managing the natural resource. The institutional explanation focuses on how a country’s institutional arrangement shapes the distribution of rents or the allocation of entrepreneurship between productive and rent-seeking activities (grabbing) in the country. An institutional arrangement can be producer friendly or a grabber friendly, depending on relationship between rent-seeking and productive activities
in the polity.

Rent-seeking relates to gains through manipulation or exploitation of the economic/political environment, rather than through economic transactions that genuinely increase wealth through entrepreneurship. Thus, an institutional arrangement is producer friendly when rent-seeking and entrepreneurial (productive) activities are complementary. This means that rent-seeking activities do not crowd out entrepreneurial activities.

It is a grabber friendly when these activities are competing. In this regard, unproductive activities are beneficial, for example due to a weak rule of law, ineffectual or malfunctioning bureaucracy, and the presence of unstable or corrupt institutions. Hence, people expend extra resource to gain access to the control of resources, which provides incentive to easily divert actual or expected revenue stream from oil exploration activities to unproductive activities.

With credible institutions however, resource abundance attracts entrepreneurial resources into productive activities, implying higher economic growth and development. In a grabber institutional environment, natural resources abundance push aggregate income down, which makes themajoring of the people worse off. More resources raise income and people are better off when institutions are producer friendly.

The institutional approach described above supports the evidence showing that the resource ‘curse’ phenomenon only occurs in countries with weak or ineffectual instittions, whereas this does not appear to be so in countries with credible institutional environment. Just as natural resources remain a blessing for countries such as Botswana, Canada, Australia, and Norway, the same cannot be said about countries such as Nigeria and Venezuela.

To date, the Economic Freedom of the World index (EFW) provided by the Fraser Institute, Canada, provides the most comprehensive, objective and accurate measure of a country’s quality of institutions. This is measured by the degree of economic freedom prevailing in the country, covering 141 countries of the world. The key components include security of property rights, size of government, legal structure, access to sound money, freedom to trade internationally as well as regulation of credit, labour
and business.

Each of these components are scored for each country to arrive at an overall EFW index (ranging between one worst to 10 best) and the associated rank of the country amongst 141 countries. The quality of institutions in Ghana has improved considerably in nearly three decades, with the overall EFX index increasing from 2.9 in 1980 to 7.0 in 2008, representing an increase of 141 per cent. In relative terms (relative to other countries), Ghana’s ranking has improved from the bottom 25th percentile (105 of 141) in 1980 to the top 50th percentile (70 of 141) in 2008.

These figures are consistent with the average performance in resource-rich but curse-free countries such as Botswana, Indonesia, Australia and Norway. Ghana openness to international trade has been a major contributor to this performance. Based on the evidence of Ghana’s performance in terms of quality of institutions in the last three decades or so, it is less likely that Ghana will suffer from resource ‘curse’, compared to countries such as Venezuela and Nigeria.

No doubt, the discovery of oil will put the Ghana’s institutional arrangements to test, which should be a key source of fear. This is the fear that the quality of existing institutions might become unsustainable as it happened in Venezuela, where the discovery of oil appears to have actually destroyed quality of her institutions overtime. Venezuela’s rank
declined from the top 10 per cent in 1980 to the bottom two per cent in 2008, ranking only better than Angola and Zimbabwe on the EFW ranking. Nevertheless, the cost of starting a business and associated bureaucracies is still high in Ghana relative to other resource rich but curse-free countries. Also, Ghana still ranks relatively lower (less than 5.0) in a few labour market indicators and the integrity of the legal system.

Thus, it is suggested that oil exploration should be matched with policies aimed at improving these low ranked areas, coupled with efforts to sustain the quality of existing institutions, including openness to international trade, labour, credit, and business regulations, and the size of government. In other words, for Ghana to escape the ‘curse’, its oil discovery should be matched with improving and sustaining the quality of its institutions.

Dr. Olajide is a Senior Research Fellow with Initiative for Public Policy Analysis, a public policy think tank in Lagos.