Opinion: Fossil-fuel wealth has costs

This week’s writer is Noah Smith, an assistant professor of finance at Stony Brook University and a freelance writer for finance and business publications.
The simplest kind of country, it seems to me, is one with just an army and a bunch of natural resources. The army guards the resources, and the resources fund the army. In today’s modern economy, energy is the most important commodity, so the easiest way to pull off this trick is by having large deposits of oil and/or natural gas. This is your basic petrostate.
Petrostates offer rulers some big advantages over a more industrialized development model. Industrial countries get their wealth from the hard work and skills of the humans who live within their borders, so they need to spend money educating their populace. They also need to establish courts, property rights, legal systems, police forces, roads, bridges, electrical grids and competent bureaucracies to manage all of this. Workers will demand things like pensions, health care and other government benefits. Corruption has to be kept in check, limiting the payouts that the friends of the ruler can extract. On the other hand, in a petrostate, the government — and the friends of the ruler — can get their money simply by taxing the state-run oil and gas companies.
As you might expect, skimping on public goods usually leads to a less efficient economy overall. That is a big reason for the “resource curse” — the observation that countries with large natural resource endowments are usually poorer than their more industrious peers. There are other reasons for the curse, of course — for example, exporting natural resources can push up the value of a country’s currency, making it more difficult to export higher-value-added products, a phenomenon known as the “Dutch disease.” Also, the huge stream of wealth accruing to the rulers of a petrostate make a tempting target for coups and revolutions; when the top dog has all the money, everyone wants to be the top dog. Instability and war, therefore, tend to afflict resource-dependent economies.
Nevertheless, in recent years there has been a lot of excitement in rich Western countries about oil, gas and other natural resources. In the U.S., this took the form of a boom in shale gas and tight oil, extraction of which has become much cheaper due to the development of hydraulic-fracturing technology. In Canada, the excitement is over the tar sands in the country’s western region. Australia, meanwhile, has become a major exporter of coal, iron ore and other resources, especiallyto China. These resource booms have helped to reduce trade and budget deficits, and they have probably given businesses a simple, compelling investment story that they can believe in.
But now that story is coming to an end, at least temporarily. The Western resource booms are going bust. A slump in global demand, combined with continued high crude production by Saudi Arabia, has lowered oil prices. In the U.S., that initially translated into plunging rig counts, and is finally filtering through to loweroil output. In Canada, major investors arefleeingthe tar sands, and the economy is rebalancingback toward manufacturing. Meanwhile, mining investment hasplummetedin Australia as China’s economy slows, and the Australian dollarhas fallentoo.
This is bound to cause much consternation among Western investors. The U.S. and Canada are not going to turn into petrostates after all, and Australia will probably have to diversify its economy as well. The abrupt reversal of the natural resource boom might be one reason the U.S. stock market has fallen recently, despite signs of overall healthin the economy. Certainly, peoplewho expectedresource booms to transfer wealth and power to America’s red states are going to be disappointed. 
But don’t worry. The flagging of the resource boom is a good thing. A petrostate is the last thing the U.S. should want to become.
Petrostates, after all, have bad governance. Some may think that rich, developed countries are immune from this aspect of the resource curse, but I wonder if this is true. In Canada, a country with very strong political institutions, some werebeginning to worrythat Prime Minister Stephen Harper, who was ousted in the recent election by Liberal Party candidate Justin Trudeau, was becoming increasingly illiberal. In the U.S. andAustralia, the political influence of fossil-fuel companies has suppressed action on climate change. This is a far cry from the autocracies that feed off of oil revenue in Saudi Arabia and Russia, but it’s hard to deny that natural resources give inordinate power to special interests.
Even more importantly, the dire situation in which petrostates are now finding themselves should be a stern cautionary tale. In Russia, falling oil prices areundoingyears of robust growth, as the country’s economyshrinksoutright. The situation isn’t much better in Iran. And Venezuela, the country with the world’s largest oil reserves, might bethe worstof all.
The U.S. is lucky that oil and gas are not yet a big enough part of the economy to threaten a similar crash. The smart thing, is to stick with promoting knowledge-based industries instead. Human ingenuity and industry will always be more valuable than lumps of material dug up out of the ground.

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