Why natural resource booms are a mixed blessing for local communities

The impact of natural resource wealth on macroeconomic outcomes is well researched, with the debate centered on whether resources are bad for development (i.e., the phenomenon of the resource curse). However, relatively little attention has been given to examining the effect on communities where those resources are located.

But interest in the local impact of resource abundance is growing, underpinning a nascent literature.  The focus of this research is on exploring whether extractive activities improve or harm welfare in adjoining regions, and how the benefits or costs are transmitted to the local population.  The answers to these questions can inform policy, leading to better outcomes, and may also help us understand the sources of regional and social tensions associated with extractive industries.

In a recent paper, we review the existing literature and develop a simple analytical framework to better understand how resource booms could benefit or harm local communities in developing countries.  There are at least three broad channels through which the local areas and regions may be affected:

• Local demand shock.  A resource boom can represent an increase in demand for locally supplied inputs, such as labor or intermediate materials.  This should raise wages and other incomes and increase employment opportunities in the non-extractive sector and generally improve local welfare and reduce poverty.  There could, however, also be some negative spillovers from this.  Often, the start of an extractive industry, say, the opening of a mine, will attract workers from other districts.  This could temper the rise in wages, put a strain on local services such as health and education, and raise the price of non-tradable goods and services such as housing and, therefore, actually reduce the real incomes of some local residents.  This represents the market-based transmission channels and possible outcomes of a natural resource boom.  The extent of the economic linkages of extractive activities would determine the size of the local demand shock.  It should be noted that strong backward linkages cannot be assumed in all developing country contexts.

• Local government revenue windfall.  Natural resources can be considered as a source of revenue for local governments, that is, a fiscal revenue windfall.  This windfall eases the hard budget constraint of local governments, and supports higher public spending.  The revenue windfall could have both positive and negative effects on economic welfare.  In so far as the windfall is used to improve the quantity or quality of local public goods and services, such as roads, hospital, schools, and housing, there would be the potential to improve human welfare outcomes, such as health and education outcomes.  Moreover, to the extent that public goods are productive inputs, or create positive spillovers, as in the case of transport infrastructure, a resource boom could also increase local income and growth.  The positive effect of revenue windfalls is underpinned by several assumptions: local politicians are responsive to the broad population, which requires well-functioning local institutions and a healthy degree of political competition; and local bureaucracies have the technical capacity to provide those public goods and services.  Lack of responsiveness of local politicians to demands from the broad population or lack of technical capacities of local bureaucrats, may undermine the positive effect of revenue windfalls on public good provision and local living conditions.
• Pollution.  Extractive industries, such as mining and oil extraction, have the potential to pollute the environment.  Environmental pollution creates several negative externalities especially in terms of human health outcomes, but also affects learning and cognitive outcomes.  Another potentially important pollution externality is the loss of agricultural productivity (Aragón and Rud 2014).  The loss of agricultural productivity can have a negative impact on agricultural output, and, through that channel, affect the income of farmers and the rural population.  This externality can be particularly relevant when extractive industries are located in the vicinity of rural areas, in which agriculture remains an important source of livelihood.

This framework has several implications for empirical analysis.  First, it suggests examining the effect of resource booms on indicators of human health, such as mortality and incidence of illness.  This can provide a better picture of the effect on human well-being than simply observing income or poverty outcomes.  Second, it points to other possible outcomes affected by resource booms such as workers’ productivity, labor supply, and agricultural output.  Finally, it highlights another channel, that is, loss of agricultural productivity, through which resource booms could negatively affect local income, especially in rural areas.

The framework also shows that the public sector channel can help local communities to benefit from growth in natural resources through: channeling the taxation of resource activity in increased spending on pro-poor services and infrastructure; and regulating any harmful environmental and health effects of extractive industries.  But translating resource wealth into sustained improvements in welfare is challenging in weak institutional contexts.  While empirical evidence is sparse, some studies (Brollo et al. 2013; Caselli and Michaels 2013) show that oil-based fiscal windfall in Brazil has provided little benefit to local communities, and has fueled patronage and political corruption.

This article was originally published on The World Bank’s Let’s Talk Development Blog. Publication does not imply endorsement of views by the World Economic Forum.

To keep up with the Agenda subscribe to our weekly newsletter.

Author: Punam Chuhan-Pole is Lead Economist in the Office of the Chief Economist of the Africa Region, World Bank. Fernando Aragon is an Assistant Professor of Economics at Simon Fraser University, Canada.

Image: A man points to the branch of a coffee tree. REUTERS/Henry Romero.