The Resource Curse in the context of "Socialism of the 21st Century"

How Governance in Venezuela and Ecuador Influences the Transfer of National Resource Wealth into Economic Development

Bachelor Thesis, 2010

31 Pages, Grade: 1,33



Table of Contents

1) Introduction

2) Conceptual Framework and Country Introduction
2.1) The Resource Curse Phenomenon
2.2) Socio-Economic Situation in Ecuador and Venezuela

3) The Presence of the Resource Curse in Ecuador and Venezuela

4) Governance, and Natural Resource Policies: Exploring the Political Linkage between Wealth in Petroleum, and Failure of Socio-Economic Development
4.1) Conceptualizing Good Governance
4.2) Measuring Good Governance: Evaluating the two countries
4.3) Comparison: Latin-American Governance Pattern of “Socialism of the 21st Century”?

5) Conclusion: Trapped in the Vicious Circle

6) Bibliography

7) Appendix


Ecuador and Venezuela, two Latin American OPEC member states, experienced a socioeconomic upheaval with the windfall petroleum revenues beginning in the 1970s. The oil bonanzas, however, negatively affected the development in the two countries, which show minimal economic growth and political instability throughout the last thirty years. The paradoxical phenomenon can be explained with the resource curse theory. This paper starts with determining the extent of the resource curse and its forms of appearance in both countries. In a second step, it investigates good governance trends in Ecuador and Venezuela in recent years, using the World Bank indicators as guideline. This is done in order to test the hypothesis whether the current left-oriented governments are better able to tame the resource curse with their “innovative” political ideology. The findings display a downward development in good governance since presidents rule who advocate [J1]‘Socialism of the 21st century’. In fact, such an ideology is no remedy to the resource curse but tends to reinforce the negative economic situation, which in return is likely to deteriorate good governance even further. As the results are similar in both countries, one can possibly attribute the described trend to that form of governance in a more generalized manner.

1) Introduction

When thinking about the effects of petroleum abundance in a country, we are likely to have images of prosperous economies and societies in mind, reflected for instance in excessive Gulf States investments and vibrant places such as Dubai or Oslo. Possessing oil reserves is the jackpot for a country. Although this is the conventional idea, it is one of the most intriguing common misperceptions in the area of social sciences. Petroleum changed the trajectory of all countries with the fortune of being located on top of such enormous resource basins more significantly than social scientists could have imagined. In geographic terms, the Middle East has received most academic attention, and also singular African countries were examined thoroughly. This paper focuses on the case of Latin America, more specifically on its two OPEC members, Ecuador and Venezuela.

While a more comprehensive comparative analysis of the entire region may be worthwhile, two main reasons are in objection to this approach. First, the very heterogeneous character of Latin America requires far more extensive work. Simply lumping together countries as different as Haiti and Chile, for instance, is virtually impossible. Hence, the need for elaborating on the various characteristics inherent in that geographical area is inevitable, which would exceed the scope of this paper. Similarly, the limited extent of this work calls for a focus on only one natural resource. Petroleum is the most important internationally traded commodity as measured by volume and monetary value (Danielsen 1982). The difference to other mineral exports with regards to the magnitude and duration of their extraordinary rents is immense. Thus, I concentrate on this significant global resource.

Ecuador and Venezuela, both rich in oil resources, also share a political aspect which is interesting and demanding of academic research. The two states were governed for several years by left-oriented presidents. One central feature of their success was the notorious claim of a new, innovative form of governance: “Ahora es de todos” (“Now it is everybody’s”). Claiming to promote the inclusion of the entire society in the governance process would especially pertain to the fair extraction and distribution of natural resources. However, do the governments under scrutiny actually manage to achieve those objectives? Have the policies regarding extraction and distribution of natural resources changed in a manner favorable to the population so that development can be furthered? And finally, are the presidents and their rule of ‘Socialism of the 21st century’ a remedy to the so-called resource curse?

This essay will address these questions using a two-step approach. Following an introduction to the two countries and the theoretical framework of the resource curse phenomenon, I will evaluate the extent to which each country suffers from the resource curse, according to the main measurement tools suggested in the current literature. The context of the resource curse in the two countries is important and relevant for the second step of analysis, which deals with assessing the governance performance in the two states. The importance of the type of governance is often overlooked when analyzing the resource curse, as most of the hydrocarbon-rich countries have no democratic political system (Ross 2001). While Ecuador and Venezuela as defective democracies do not directly fall into this category, I will argue that they nonetheless display all major features of the resource curse, such that development, defined in its broadest sense, is impeded.

The seemingly paradoxical outcome of resource-abundance and poor development needs further governance-focused investigation. Successful management of the messy socio-economic problem, titled as resource curse, [J2]is undoubtably an important indicator of good governance. Consequently, I will investigate the link between national wealth in and subsequent exploitation of oil and gas, and its interaction with governance in the respective countries. The analysis is based on the theoretical concept of good governance defined as transparent framework of rules with a particular focus on institutional quality. Using the quantifiable good governance indicator provided by the World Bank, and recent policy examples as additional qualitative element, I will evaluate governance trends in the two countries.

In a final point, a comparative governance analysis will test the generalizability of the findings, that is, it will be shown whether there is an underlying Latin American pattern of ‘Socialism of the 21st century’, or whether country-specific factors prevail with regards to the explanation of the resource-related policies and governance taken. I will also address the question of causality and the complex interaction of resource wealth and governance performance, and the resultant difficulties in identifying the problem’s origin.

2) Conceptual Framework and Country Introduction

2.1) The Resource Curse Phenomenon

Despite skyrocketing oil prices, why has the majority of the oil-exporting countries not yet joined the league of the richest nations in the world? What Karl (1997) refers to as the Paradox of Plenty remains one of the greatest puzzles and most counter-intuitive phenomena of economics. Yet, the impact of the resource curse is undisputed, with nearly all resource-exploiting countries experiencing it or are suffering from its consequences. With regards to the theme of this paper, the potential dangers of natural resource abundance inevitably pose challenges for the countries’ governments. For Ecuador and Venezuela, both rich in oil and gas, I will evaluate the presence of the resource curse as well as the ‘innovative’ left-oriented government strategies taken in order to fight it. Therefore, a brief introduction into the complex topic of the resource curse is given here, upon which will be built in the later sections.

Numerous studies refer to the resource curse as the paradox that resource-rich countries typically develop more slowly, are less diversified, more corrupt, less transparent, subject to greater economic volatility, more oppressive and more prone to internal conflict than non-endowed countries at similar income levels (Sachs and Warner 2001; Collier and Banno 2003; Karl 1999; Wick and Bulte 2006). Meanwhile, the outsized revenues available to resource-rich governments allow them to pursue more radical policies than they would otherwise be able to support.

Stiglitz (2003) gives a brief, yet comprehensive explanation of the complex phenomenon of the resource curse. National resource riches invite rent-seeking, meaning that people try to get the biggest share of the revenue inflow they can. Weak state and judiciary institutions in the next step pave the way for corruption, bribery, and often armed conflicts. Governments also often stop taxing citizens, which decreases civil engagement, the accountability of incumbents, and the linkage between ruling elites and the people. Negative economic effects exacerbate these political difficulties. First, each country runs a risk of obtaining the so-called ‘Dutch disease’, which is an over-reliance on a single primary commodity export, and the adverse effect it has on exchange rates and productivity of other sectors (Birdsall and Subramanian 2004). Abundance of natural resources is likely to shift factors of productions away from industries and sectors which feature increasing returns to scale. Marginal spillover effects, that is, weak stimulating linkages of the oil industry to the rest of the economy, result in significant and persistent unemployment rates, while broad based development and growth do not take place (Torvik 2002). This, in return, creates even higher rent-seeking, dampened development, and a country that finds itself trapped in the resource curse.

Consequently, as previously stated, every national government ruling over territory with petroleum resources has to face the challenge of formulating policies that aim at self-sustaining development while averting the negative effects of the oil windfalls. There are, admittedly few, positive cases of successful natural resource management. Botswana, an example for a developing country, and Norway, being rich in petroleum, are the most often cited examples (Stevens 2003; Birdsall and Subramanian 2004). However, the evaluation of Ecuador and Venezuela is less straightforward, which calls for a short insight in both nations.

2.2) Socio-Economic Situation in Ecuador and Venezuela

Ecuador and Venezuela have more in common than just the Andes Mountains and Spanish colonial legacy. The purpose of the following country-features, however, is to show their distinct characteristics, which justifies a two-country analysis with a comparative perspective. Beginning with Ecuador, the second poorest nation in South America, figures indicate minimal economic growth and a constant GDP per capita of around $7000 over the last couple of years. Despite the poor economic performance and the unchanged high rate of poverty, the Human Development Index lists the country within “High Human Development” just behind Turkey (United Nations Development Program 2010). Ecuador gained independence almost 200 years ago, yet the overall political and institutional system is far from being consolidated. In the current political system established in 1979, the last three democratically elected presidents were forced to abdicate before their tenure, and today’s president, Rafael Correa, initiated the work for the twentieth constitution since gaining independence (Central Intelligence Agency 2010a). The lack of political stability negatively affects the general state of democracy reflected with the Freedom House rank of “Partly Free” (2010). Ecuador’s dependency on oil exports remains significantly high with petroleum products accounting for 63% of the total export earnings (United States Department of State 2009). In return, this subjects the entire economic performance to harsh international price fluctuations of that particular commodity.

This situation is shared with Venezuela[1], where the oil sector comprises roughly 30% of GDP, 90% of export earnings, and more than half of the central government's ordinary revenues (United States Department of State 2010). Windfall revenues from skyrocketing oil prices yielded an impressive domestic growth, ending with the global economic slowdown in 2009 (Central Intelligence Agency 2010b). Still, key indicators such as GDP per capita and HDI scores rank Venezuela in the same range as European Union countries, such as Romania and Bulgaria.

In a comparison with Ecuador, Venezuela has a significantly better economic situation. However, this is opposed to the worsened Venezuelan political situation after President Chávez seized power in 1999. Under Chávez, political and civil rights infringements, increasing corruption and crime, homicide rates twice as high as in Ecuador and roughly ten times the rate of Canada, led to an overall downward trend of the country and a lower Freedom House score than Ecuador (Philip 1999; United Nations Office on Drugs and Crime 2004a; Freedom House 2010).

3) The Presence of the Resource Curse in Ecuador and Venezuela

The economic aspects of exhaustible resources attracted extensive recent scholastic work, mainly due to its global relevance starting with the 1970s oil crises. However, as Robinson (1989) recalls, already in 1931 Harold Hotelling provided a summary of rich academic foundation from economists such as: Adam Smith, John Stuart Mill and Karl Marx. Based on existing literature, this section evaluates the presence of the resource curse in Venezuela and Ecuador through its most salient manifestations, with a historical timeframe starting with the 1970’s oil boom period lasting until today. The outcome is crucial for the validity and relevance of the second part of this paper, which looks at governance strategies taken with regards to petroleum. However, first one has to determine to which extent natural resources actually affect the overall economic performance of the two countries. Secondly, is it true that problems existed concerning the absorption of the impact of oil and gas in Ecuador and Venezuela, which would demand better governance strategies from current governments?

The indicators for determining the existence and extent of the resource curse are in line with suggestions from Karl (1999), Stiglitz (2003), and Torvik (2002), which yield four measurement dimensions. Although a causal relationship is difficult to prove, the Dutch disease is widely considered as a first manifestation. The interplay of an increase in natural resource revenues, the exchange rate’s development, and the decline in a lagging sector will be evaluated, as that results in weak competitiveness of domestic producers and a specific sector distribution pattern of the economy. Second, macro-economic volatility, a national economic dependency on oil price development is being examined. Furthermore, I will look at the important issue of rent seeking, using corruption tendencies as a proxy. Lastly, Karl (1997, 29) rightly identified a country’s debt situation as an important indicator, proving that resource curse affected countries are likely to live beyond their means and borrow faster than countries not dependent on oil revenues.

Karl (1997) and Hausmann (1997) argue that Venezuela possessed many of the prerequisites for withstanding the pitfalls of an oil boom, such as endorsement for industrialization and a sizeable educated middle class, framed in a comparatively pluralist democratic system. Life expectancy nearly doubled from the mid 1930s to 1980, in addition to decreasing rates of illiteracy and a fiscal income in the 1970s equal to that of West Germany’s (Astorga 2000, 228; Karl, 1997, 120). Yet, it became clear that such growth would not be feasible in the future. Shortly after the first oil bonanza the country suffered already from an overvalued currency which led to a decrease in competitiveness and, hence, to lower productivity of the manufacturing industry (Astorga 2000, 222; Auty 1990, 267ff.). When oil prices plunged in the mid 1980s, the bolívar devalued dramatically in return, leading to the worst national recession in the postwar period (Karl 1997, 176). The persistent currency devaluation, together with galloping inflation (nearly 100% in 1996) pressured President Chávez to introduce with the bolívar fuerte (VEF) a new currency on January 1, 2008 (OPEC 2008, 16). A comprehensive track of oil price and currency development is given in Figure 4 and 5. In short, it reveals that Venezuela has acquired the Dutch disease.

Secondly, there is striking evidence to the country, relying invariably on petroleum revenue windfalls for achieving national economic growth. Already during the 1970s boom, oil accounted for 90% of total exports, and 75% of fiscal receipts (Astorga 2000, 220; Bulmer-Thomas 1994, 342). Venezuela’s state-owned petroleum company, PDVSA, prospered a lot with the two oil shocks in that decade, appearing on Fortune magazine’s list of the world’s biggest firms (Bulmer-Thomas 1994, 355). When prices took a significant downswing in the 1980s, the entire nation, including the central economic actor PDVSA, faced a slash in oil revenues of 64.5%. The drop yielded a decrease of national income GNP in that period of ca. 25% (Karl 1997, 32). Petro-dependency has not been moderated since then. A vivid example was in 2002, when social-political conflict forced the stoppage of the oil industry, which directly led to a steep 26% drop in GDP (De Ferranti et al. 2003, 278).

Venezuela received more fiscal revenues in the five years period from 1974-78, than all the other Venezuelan governments since 1917 combined (Karl 1997, 116f.). Such money inflow is likely to get special attention, i.e. entails rent seeking. As Stiglitz (2003) describes, the powerful national elites preferred to divide the existing pie rather than to create a larger pie. The economic concentration of power is striking when one first glances at the following figures: in 1975, 9% of all industrial establishments accounted for three quarters of production value and 60% of employment (Karl 1997, 103). With Chávez’s nationalization tendencies, power concentration simply shifted to state authorities, but it has not been divided. Consequently, wealth was inefficiently administered and also unequally distributed, as two thirds of the population remains in poverty until today. Moreover, economists estimate moreover that Venezuela’s average GDP growth rate would rise more than 1% annually had it reduced its corruption to the level of Chile’s (Karl 2007, 20).[2]

Evaluating Venezuela’s public spending and debt situation reaffirms the previous findings. Already in the 1970s, public investment as share of total investment nearly tripled (Astorga 2000). Strikingly, the country absorbed virtually the entire windfall income from the hikes in oil price, and expanded its foreign debt as well, which accumulated to $26 billion by 1984 (Bulmer-Thomas 1994, 124). The enormous investments taken for financing the gigantismo (gigantism) of development planning continued albeit collapsing petroleum revenues in the 1980s. The general pattern that governments possessing oil windfalls aim at consolidating their position of power through investments in large public projects holds true also for Venezuela (Karl 1999, 35). Between 1982 and 1992, total government expenditures decupled, and foreign borrowing replaced oil rents which nearly led to national bankruptcy by 1989 (Karl 1997, 165). One should keep in mind that in the wake of this socio-economic petro-crisis young military officers attempted to overthrow the government on February 4, 1992, led by Hugo Chávez Frías (Karl 1997, 182). Despite the failure of this coup attempt, he entered the political state just a few years later as the elected president. In summary, and in accordance with Rodriguez and Sachs (1999), Venezuela clearly lived beyond its financial means with negative consequences. Poverty has nearly doubled since the late 1970s (Birdsall and Subramanian 2004, 82f.), and annual average GDP growth between 1965 and 1998 was -1% in Venezuela (Gylfason 2000) – figures that reflect the extent of the resource curse.

Equivalent to Venezuela, primary products account also in Ecuador for ca. 80% of national exports (Barton 2006, 139). As the fifth largest producer of petroleum in Latin America (Valdivia 2008, 457), Ecuador is “substantially dependent on its petroleum resources” (Central Intelligence Agency 2010a). Russi et al. (2008) note how the national currency’s development went out of control after the oil bonanza of the 1970s. Inflation reached a historical high of 75% in 1989, and, despite stabilization reforms also the 1990s, witnessed a similar trend. It was only through external help, i.e. the formal adoption of the US Dollar as legal tender in March 2000, that the high currency fluctuations came to an end (Central Intelligence Agency 2010a). As additional symptoms of the Dutch disease, Russi et al. (2008, 708) note the increasing material deficit in Ecuador, resulting in imports dominated by industrial products.

Since the second oil boom at the end of the 1970s, estimates account petroleum for 14.2% of the Ecuadorian GDP, including 41.2% of overall exports and 40.6% of the state budget (Valdivia 2008, 462). As Corbo (1992) reaffirms, the volatile oil prices in the 1980s shifted the emphasis of the political economy to petroleum. Ecuador’s economic well-being in the twenty-first century follows an oil-dependency pattern. The 6.5% growth rate in 2008 results from an unprecedented hike in oil prices. In return, the economy’s contraction in 2009 within the global recession has been exacerbated by the consequential drop of petroleum revenues (Central Intelligence Agency 2010a).

Evidence for rent-seeking tendencies was more difficult to recognize than in the Venezuelan case. However, the nationalization of subsurface elements in 1971, including oil and gas, declared to have better control of rents drawn from foreign investors reflects the interest of national elites to shift rent distribution internally (Valdivia 2008). During the 1980’s economic crisis, pressing adjustment policies were focused on short-term stabilization rather than structural change (Russi et al. 2008). No government dared to touch the rent-seeking system, as reforms might have had a negative effect on its basis of power. Current President Correa attempts to break the existing entanglement of political power and economic revenues, which is reflected in an improvement in the fight against corruption (World Bank 2009; see also Figure 2).

“Although Ecuador is one of the smallest countries in South America, in 2002 it ranked seventh in the region for external indebtedness […] and had the highest debt per capita” (Weinthal and Luong 2006, 36). The nation’s indebtedness is enormous and did not decrease over the last decades. Former governments approached international financial institutions such as the World Bank, the International Monetary Fund, and the Inter American Development Bank for loans (Corbo 1992). When Correa seized power, the country had already defaulted on its external debt. After he publicly raised doubts about the willingness to accept to pay for Ecuador’s bond liabilities, the country defaulted on over $3 billion in December 2008 (Central Intelligence Agency 2010a). The sustainability of such debt policies is yet unclear; however, they are evidence for the country’s appalling financial situation which began with petroleum extraction in the 1970s.


[1] See Figure 1 for a geographical overview of petroleum resources in the two countries

[2] Corruption Perception Indices by Transparency International for Venezuela and Ecuador over the last years are summarized in Figure 2. Herein, Venezuela has ranked in the lowest 20% of the Corruption Perception Index nearly consistently.

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The Resource Curse in the context of "Socialism of the 21st Century"
How Governance in Venezuela and Ecuador Influences the Transfer of National Resource Wealth into Economic Development
Jacobs University Bremen gGmbH
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