Problems Of Industrial Diversification Economics Essay

The economic development of the natural resource-rich states may frequently look counter-intuitive. Blessed with such great natural gifts, how have many of these states failed to initialize sustainable growing in a scope of industrial sectors? This paper begins by reexamining the cardinal theoretical literature, covering the constructs of ‘Dutch disease ‘ , the ‘resource expletive ‘ and the ‘rentier province ‘ in peculiar. The realization of these theories is so assessed in the context of industrialization and structural alteration in Iran.

2. Dutch disease

A cardinal theory to the argument on the economic jobs associated with resource copiousness is that of ‘Dutch Disease ‘ ( ‘DD ‘ afterlife ) , a term foremost used in the 1970s by ‘The Economist ‘ ( 1977 ) to denote The Netherlands ‘ worsening fabrication sector following the find of extended gas Fieldss.

The construct is outlined by Corden and Neary ( 1982 ) in an effort to explicate the fact that de-industrialisation had occurred in many states developing an ‘extractive ‘ industry. The basic theoretical account assumes two traded sectors – energy ( e.g. oil ) and fabricating aboard one non-traded sector ( ‘services ‘ ) , and that labor is the merely nomadic factor of production. The comparative monetary value of traded goods is determined in the universe market but the existent exchange rate – comparative monetary value of non-traded to traded goods – is flexible. Wagess are assumed to be wholly flexible and full employment is ever maintained.

Figure 1 shows the labour demand agendas for the three sectors. A technological promotion or reserve find in the energy sector sees the demand for labor in energy displacement out ( LT to LT ‘ ) , increasing rewards to w1 ; this brings about a ‘resource displacement ‘ from fabricating to traded sector, as labor demanded in fabricating falls to OTM ‘ , i.e. direct de-industrialisation. Give the higher pay and associated higher incomes, the monetary value of services has to lift to clear extra demand for services ( LS becomes LS ‘ ) , a ‘spending consequence ‘ . As entire domestic end product is fixed ( full employment assumed ) , the non-traded sector ( s ) must increase rewards to pull labor from traded sector ( s ) , while the traded demand spread is met by increasing imports. The exchange rate appreciates as the domestic-world monetary value ratio additions ( justification in Annex A ) and the domestic non-traded sector ( s ) hence expand at the disbursal of traded sectors. The demand for labor in the energy sector so shifts upwards to fit the wage/price of services ( w2 ) , squeezing/’crowding out ‘ fabricating further to M ” , or ‘indirect industrialization. ‘ In the instance of oil economic systems, negligible employment ( i.e. factor input ) in the energy sector can intend that the ‘resource displacement ‘ is absent, therefore the ‘spending consequence ‘ may probably rule.

Figure 1: Dutch Disease ( Corden and Neary 1982 )

Leting for capital motion between sectors can do the impact of the energy sector roar on other sectors becomes more equivocal ( Heckscher-Ohlin manner theoretical account ) , though given the limited, domestic capital market development during the constitution of many oil sectors this consideration may non be important to the apprehension of the oil provinces ‘ development. Further premises are challenged in the instance survey.

The DD can besides be presented in footings of monetary values and exchange rates ( adapted from Bresser Pereira 2000 ) . See two exchange rates: the market/’current ‘ rate Iµc and the ‘industrial exchange rate ‘ , Iµi, at which the trade good draws the ‘necessary ‘ monetary value to do the state ‘s tradable exports competitory. In the instance of DD, the trade good market monetary value ‘pm ‘ ( driven by fringy cost ) is far below this necessary monetary value ‘pn ‘ due to high productiveness in the sector. The spread between ‘market ‘ and ‘necessary ‘ monetary values delivers Ricardian rents and the ‘current ‘ exchange rate appreciates relative to the ‘industrial exchange rate ‘ – Iµc & lt ; Iµi ( e.g. 4000rial/ $ & lt ; 5000rial/ $ ) The grade of DD can be defined as:

dh = 1 – ( pm/pn ) *100

For illustration in a state where the market monetary value constitutes 40 % of the necessary monetary value, dh will be 60 % . The grade of DD will so increase ( worsen ) with an addition in the trade good monetary value, as the spread between autopsy and pn ( and Iµc: Iµi ) will widen. The Ricardian rents in this instance are ‘enjoyed ‘ ( in the short tally earlier longer term amendss accrue ) by the domestic society in the signifier of inexpensive tradable goods and the state of affairs can therefore stand for a market failure, with monetary values non reflecting the fringy, societal cost of their production. This construct is continued in the ‘rentier province ‘ treatment.

A state enduring from DD will therefore typically have the “ symptoms ” of ( I ) decelerate fabrication growing ; ( two ) rapid enlargement of the services sector ; ( three ) high rewards ( unless domestic labor supply is abundant ) ; and ( four ) important unemployment ( Oomes and Kalcheva 2007 ) .

The standard ‘DD ‘ theory hence provides one ground why resource-rich economic systems may fight to farther industrialization and so why they may go progressively dependent on the natural resource sector. Using a gravitation theoretical account of trade for 1970-1997, Stijns ( 2003 ) concludes that a 1 % addition in net energy exports decreases a state ‘s fabrication exports by 8 % on norm ; the less supportive consequences of predating writers are attributed to their deficiency of appropriate trial. Davis ( 1995 ) suggests that the predicted fabrication diminution could suppress longer term growing by gnawing a state ‘s comparative advantage, fabrication directors could lift up against the energy sector and the progressively specialized economic system would be more open to external dazes.

On the other manus, while Fardmanesh ( 1991 ) notes that agricultural traded sectors did by and large worsen following the 1970s oil roar, he finds fabricating traded sectors by and large grew during this clip. This is confirmed through empirical observation with informations from Algeria, Venezuela and Nigeria from 1966-86 and similar consequences are found in our instance survey of Iran. However as noted already the ‘resource displacement ‘ may probably non be in the instance of oil, though even the disbursement consequence entirely would be expected to herd out both traded sectors. The spread outing fabrication sector is eventually explained one time the theoretical account takes history for the many limitations to free trade, doing manufactured goods ‘semi-traded ‘ and warranting additions in their monetary value and end product.

Neutralizing Dutch Disease

Though some have advocated depreciations of the nominal exchange rate to restrict existent grasp and therefore redress DD ( see Bresser Pereira 2000 ) , it is evident that such actions tend to increase non-traded rewards farther ( to vie with the dining export sector ) , change by reversaling the devaluation ‘s initial consequence ; the domestic value of the oil grosss besides rises. Thus Bresser Pereira argues that a revenue enhancement on the resource production should be levied, to switch the supply curve upwards to the industrial equilibrium, with grosss collected in an international fund to avoid re-appreciating the currency. In order to eliminate DD and hence equate Iµc and Iµi, the revenue enhancement rate, ‘m ‘ demands to be set at:

m = dh/ ( Iµc/Iµi )

In our illustration where Iµc/Iµi = 0.4 and dh = 0.6, the revenue enhancement rate would hence be 67 % . Bresser Pereira ( 2000 ) finds that UAE ‘s scene of a 98 % revenue enhancement rate on oil production has allowed the state to set up other, tradable service industries e.g. in finance and touristry. States have besides employed alternate steps ; Al Mutawa ( 1996 ) shows that UAE ‘s fabrication subsidies to counter the effects of DD may really be justified on the evidences that this sector can present strong productiveness additions through ‘learning by making ‘ outwardnesss.

3. The resource expletive?

It would be alluring to reason that natural resource copiousness flatly implies hapless economic results, a alleged ‘curse of natural resources ‘ . For illustration Sachs and Warner ( 2001 ) present a negative and extremely statistically important relationship between GDP growing and natural resource copiousness, which holds even one time other geographical and climatic conditions are controlled for. However such empirical observations do non turn out causality from resource copiousness to economic ruin. Indeed Wright and Czelusta ( 2004 ) emphasise that resource copiousness need non connote a ‘curse ‘ , with the mineral sector offering chances to develop ‘non-renewable ‘ resources in the signifier of accomplishments, cognition and technological promotion. The following subdivision therefore considers other factors that could explicate the oft-poor economic results of resource-abundant states.

4. The rentier province

The ‘rentier province ‘ literature addresses a figure of of import considerations excluded from predating theories. Economic rent can be defined as the difference between a return made on an plus and the return required to maintain the plus in its current usage ( Bannock et al 2003 ) . In the context of oil, economic rents can hence be seen as the difference between and its extraction and production costs – the chance cost, which could be spent on an alternate chase such as an investing in substructure – and the gross gained from selling a barrel of oil in the market ( Richards and Waterbury ( 2008 ) . Historically, this spread has been highly broad for MENA states, leting the states to harvest big economic rents ( Griffin and Teece 1982 ) ; this form still mostly holds true, with production costs of $ 6 – $ 28 per barrel in MENA oilfields for 2008 ( IEA 2008 ) and mean market monetary values for rough oil of about $ 100 for this twelvemonth ( OECD 2011 ) .

A ‘rentier province ‘ can be characterised by an economic system having big flows of economic rent from abroad ( Mahdavi 1978 ) , with a little fraction of society actively engaged in production but with the wages for pull outing the natural resource accruing to the state at big, the ‘rentiers ‘ ( Beblawi 1987 ) . Such traits seem to keep strong for the oil-producing economic systems in MENA, where 2008 oil rents[ 1 ]made up 64 % , 60 % and 40 % GDP in Saudi Arabia, Kuwait and Iran severally ( World Bank ) ; likewise the full excavation sector employs less than 2 % of the work force in these states ( ILO LABORSTA 2008 ) .

Beblawi ( ibid ) finds that the steady flow of immense rents from oil in Arab provinces typically supports the development of a really big public sector, with a weak work moral principle.[ 2 ]Similarly really low revenue enhancement can do citizens less demanding in footings of political engagement, leting for a important convergence between authorities and major concern. Using informations from 113 states, Ross ( 2012 ) concludes that oil has a “ strong antidemocratic consequence ” given the limited force per unit areas for greater answerability.

The big rent watercourses can besides let provinces to avoid doing tough ( but necessary ) development determinations, while sustained, unequal land term of office systems, urban prejudices and DD can all lend to weak domestic supply responses ( Richards and Waterbury 2008 ) , potentially clogging structural alteration. Davis ( 1995 ) warns of authoritiess going complacent with the entrance grosss, ensuing in inordinate adoption. The likely rise of income inequality is besides predicted, with the authorities ‘s focal point switching from societal results to rent-seeking. The likely rent-seeking and corruptness can be seen as a signifier of herding out of entrepreneurial/innovative activities ( Sachs and Warner 2001 ) .

5. The instance of Iran

With the 3rd largest proved oil militias in the universe ( OPEC 2011 ) and a sustained, high economic dependence on this sector, Iran provides an illuminating instance survey of the resource-rich rentier economic system. In some ways Iran was in an advantageous place in which to get down industrialization, with entree to capital ( and hence no force per unit area to pull excess from agribusiness as in many developing states ) , a strong desire of the ( Shah ‘s ) province to industrialize, plentiful agricultural and mineral militias and a big domestic market ; 34 million in 1976 ( Halliday 1979 ) . Yet industrial productiveness has been low ( Mahdavi 1978 ) and while Turkey ‘s existent GDP per capita more than doubled and the portion of fabrication in exports bit by bit rose to 80 % 1960-2000, Iran ‘s existent GDP in 2000 was at pre-Revolution degrees and its fabrication portion remained in individual figures ( Karshenas and Hakimian 2005 ) .

Dutch Disease and Iran

The grounds of DD in Iran is assorted. On the one manus, the services sector did spread out quickly, more than duplicating in value added footings during the 1970s ( World Bank ) and with its portion in GDP lifting from 31 % to around 40 % 1969-1974 ( Halliday 1979 ) and transcending 50 % by 1980 ( World Bank ) . In add-on, existent rewards in the building sector tripled 1962-77[ 3 ]( Hakimian 1999 ) and there was a downward tendency in the current history balance ( i.e. from net exporter to net importer ; a possible mark of DD ) 1976-1989[ 4 ], though the extra effects of the Iran-Iraq war, early US countenances and post-Revolution convulsion would besides hold affected this index.

On the other manus, fabricating value added ( in changeless 2000 US $ ) increased threefold from 1965 to 1976, and overall industries ‘ portion in GDP increased from 30 to 55 % over the period ( World Bank ) ; some possible accounts for this have already been outlined ( Fardmanesh 1991 ) . Karshenas ( 1990 ) points out that oil grosss can cut down constrictions to industrial and fabrication and productiveness growing by supplying a beginning of foreign exchange and by hiking domestic demand ; it is argued that this contributed to Iran ‘s strong 1959-72 growing public presentation.

Similarly, certain premises behind the DD theoretical accounts may non keep for Iran. We have already shown that trade limitations may render ‘traded ‘ goods ‘semi-traded ‘ ; countenances placed on Iran since 1979 could do this more likely and can forestall the theory ‘s predicted results. Second, the cardinal premise of full employment – which squeezes labour out of fabricating – is unrealistic. Official estimations suggest double-digit unemployment since the first records ( 14 % in 1986, World Bank ) and a high petroleum birth rate ( 40-50 per 1000 1966-86 ; see Annex A ) has quickly inflated the working age population ( Aghajanian 1995 ) . Furthermore, imperfect information, hapless substructure, social/family norms and limited ( rhenium ) preparation chances can keep inter-sectoral labour mobility. Finally the premise that engineering degrees are exogenously given is likely flawed, with oil grosss supplying entree to new engineerings ; this could increase productiveness in other sectors ( ‘spillovers ‘ ) , though linkage restrictions are discussed below.

The DD theoretical accounts hence seem to supply a limited account for structural alteration in Iran ; alternate models are now considered.

Persia: ‘rentier province ‘ and political economic system

The theory subdivision already identified Iran as a likely rentier province, with a high fraction of oil rents in GDP, low employment in this sector and a big public sector, but we test this now in more item.

The historical patterned advance of the political economic system in Iran sets the context for industrialization policies and results in the 2nd half of the 20th century. Iran ‘s integrating to the universe economic system occurred at a clip when parts were governed by tribal chiefs/provisional swayers and the population was dominated by an inactive peasantry ( Karshenas 1990 ) . As a consequence imperialist powers were able to vie for economic power, sabotaging the limited power of the cardinal province and puting a case in point of weak domestic establishments and hapless substructure. This set the way for the rise of Reza Shah ‘s autocratic government ( ibid ) and Iran ‘s initial industrialization hence occurred under a big, elite-controlled province.

It is so unsurprising that grosss were frequently non channelled into the most productive activities, an experience typical to the ‘rentier province ‘ . For illustration during the 1970s the defense mechanism budget increased several crease, transcending industrial investings ( Halliday 1979 ) , while Karshenas ( 1990 ) highlights an “ inept and inexperient bureaucratism. ”

While the sudden bead in oil grosss during nationalization ( 1950-3 ) forced Iran to replace domestic merchandises for imports and to spread out non-oil oil exports ( Mahdavi 1987 ) , the immense and turning oil grosss and institutional conditions shortly after allowed the authorities to ‘complacently ‘ addition outgo ( ibid ) without keeping the ingestion of the top income groups. This resulted in high income inequality ( informations in Annex A ) and unsustainable, “ perverse ” growing forms ( Karshenas 1990 ) . The domestic demand besides became skewed, with an enlargement of luxury imports for the rich minority instead than of merchandises for mass ingestion ( ibid ) . Ultimately, Reza Shah ‘s “ failure to utilize Iran ‘s crude oil rents for structural accommodation ” and associated inequalities strongly influenced his death ( Richards and Waterbury 2008 ) .

The 1979 Revolution aimed to change by reversal these inequalities and the trust on oil ; so the First Plan ( 1989-93 ) temporarily succeeded in developing non-oil exports ( Hakimian 1999 ) . However Figure 2 shows that the tendency correlativity between oil gross and GDP growing rates really increased following the Revolution, potentially due to the “ [ Islamic Republic ‘s ] impression of economic independenceaˆ¦with insularity and autarchy instead than a managed, active and diversified patternaˆ¦of interactions with the outside universe. ” ( ibid ) Likewise Iran has engaged in the unsustainable and oil-dependence-fuelling subsidization of labor-intensive industries ( Karshenas and Hakimian 2005 ) instead than hiking competition and invention through serious reform.

Figure 2 ; Hakimian ( 1999 )

Others have argued that structural alteration in Iran was hampered by jobs built-in to oil. The industry by and large provides weak backward linkages given hapless occupation creative activity potency ( Karshenas 1990 ) and given most capital and engineering came from abroad ; likewise forward linkages are limited as most of the rough merchandise is straight exported ( Halliday 1979 ) . On top of this, Halliday ( ibid ) concludes that oil can add extra economic “ obstructions ” to the long-run development procedure, including rising prices and uncompetitive industries, which tend to switch resources from investing to ingestion.

In order to counter Iran ‘s sustained oil dependence, gross misdirection and rent-seeking province, Karshenas and Hakimian ( 2005 ) propose that oil gross direction should be devolved/decentralised to regional authoritiess, traveling important public disbursement determinations from centralised involvement groups to those with a clearer sense of local precedences. The writers besides conclude that this would increase transparence in policymaking, a deficiency of which presently sustains the “ rampant rent-seeking. ”

6. Decisions

Dutch Disease provides a utile get downing model against which to see the economic effects of a big resource gift, though this paper showed that several of its premises and anticipations did non ever use in world, for illustration in the instance of Iran. Furthermore it is clear that political economic system factors such as rent-seeking, inequalities, authorities rawness, avoided political transparence and political precedences have to a great extent restricted the state ‘s ability to develop and diversify its industrial base.

While it was shown that oil industries can supply dissatisfactory linkages to the remainder of the economic system and can let authoritiess to defy transparence and reforms, reasonable direction can allow states to avoid the ‘resource expletive ‘ prognostication.

ANNEX A – Background information

Real exchange rate ( vitamin E ) = P ( domestic ) / ( P ( universe ) *E ) , where E = Official exchange rate per $ ; under drifting exchange rates the grasp happens automatically through an autumn ( grasp ) in E, as demand for domestic currency additions.

Beblawi ( ibid ) besides finds a figure of secondary beginnings of rents originating in oil economic systems, including sustained belongings bubbles[ 5 ]and the trading of citizenship rights to move as patron ( U?U?USU„ ) of exile activities.

The birthrate rates fell somewhat in the seventiess with household be aftering enterprises, but remained above 40 per 1000. The entire population about doubled between 1966 and 1986 ( Aghajanian 1995 )

Iran ‘s Gini coefficient was 0.47 even by 1986 ( World Bank )