Wednesday, November 13, 2013

Human development is the key to sustainable growth

Article by Ken Davies in China Daily, Hong Kong Edition on November 1, 2013

Some of the poorest countries in the world are sitting upon a fortune in natural resources. Instead of squandering these overnight in a failed development attempt, they should follow Hong Kong's -- and China's -- examples of diversification and investment in human capital.

In 1841, British Foreign Secretary Lord Palmerston dismissed Hong Kong as "a barren rock with nary a house upon it" that would never be "a mart for trade". How wrong he was. Unlike other British colonies, Hong Kong did indeed have no natural resources such as coal or gold. But it did, and still does, enjoy a tremendous locational advantage which subsequent generations of entrepreneurs exploited to the hilt. It has also educated its people. This is a good example for all countries, even those endowed with rich natural resources.

Several of what international institutions call the "least-developed countries" (LDCs) and "developing countries" possess a wealth of undeveloped energy and mineral resources: coal, oil, gold, diamonds, metal ores or rare earths. When foreign corporations offer to exploit these, governments are tempted to see this as a way of increasing revenues so they can improve infrastructure and raise incomes.

Jeffrey Sachs, at Columbia University's Earth Institute in New York, supported by his able and workaholic daughter Lisa Sachs, who heads the Vale Columbia Center under the Earth Institute (where I was Senior Economist in 2010-2011) strongly endorse this strategy, while seeking to minimize typical problems.

In his books and his public appearances, Jeff Sachs proposes solutions to the "resource curse", i.e. the process by which the foreign company, for example an oil major, retains most of the revenues from a large investment and leaves the local society largely untouched.

How to achieve this? He suggests that the companies be made to expand the facilities they create for their own use so that locals may also benefit from them.

The company needs to build a road to get its minerals to a port? Then let it build a wider and longer road that will allow farmers to expand their local market. The company builds a school for children of expatriate employees? Make it a bigger school that can educate local children.

This all sounds fine and dandy, but is it really the way to develop an economy and a society? I don't think so.

A major part of the resource curse is that resource-exploiting investments result in the smallest value-added for a poor country. They provide far fewer local jobs than the same dollar value of investments in manufacturing or services. The real money is in refining and processing, done overseas. And government revenues are often dwarfed by corrupt payments to leaders who put it into Swiss bank accounts.

So the "socially responsible" extras are mere crumbs off the table of foreign investors. And building bigger roads to ports benefits foreign economies more than local farmers.

More importantly, do you want a foreign company, which is not accountable to local voters, to decide your country's transport and education policies? Is that morally or politically acceptable? Do you know of any developed country that would allow this? Of course not. And who is to maintain the roads and run the schools when the oil has run out and the company is long gone?

Wholesale reliance on maximizing the offtake of natural resources is a recipe for environmental degradation, corruption, a wildly unbalanced economy, stagnation of potentially important industries when the currency appreciates as a result of massive resources exports (the "Dutch disease") -- and ultimate impoverishment when these resources have been exhausted.

So am I suggesting these countries should stay poor by leaving these valuable materials in the ground. Absolutely not. But I am saying they should not sit back and expect the drillers and diggers to develop their economies for them.

The most important investment any country can make is in its own people. It builds, or allows and encourages others to build, human capital by providing healthcare and education to all its inhabitants. A healthy, educated workforce will attract investment, both foreign and local, in a wide range of activities, not all of them predictable, and most of them providing more jobs than an oil well or an open-cast mine.

At the same time, governments should facilitate downstream investment in oil refineries, diamond cutting and similar processing operations, so that their countries can capture a higher share of value-added.

All this should be accomplished by positive means like retraining, competition policy and increasing investment openness, not by disastrous methods like central planning or industry policy, which destroy initiative and creativity -- just what a poor economy needs.

Environmental impact assessments of natural resource exploitation projects (whether by foreign or local firms) should be rigorous, transparent and accountable to minimize external diseconomies that subtract from the social value of such investments.

Let's take a look at China in comparison to Russia and India. In the 1980s its major export was crude oil, largely to Japan. It is now a net oil importer, but during the switchover its growth accelerated as it built up export manufacturing. Russia, with its over-reliance on energy exports, now has an economy built on sand. China developed earlier and faster than India largely because of the enormous expansion of education in earlier decades. Despite horrendous policy blunders in the 1950s and 1960s, China's overall development has so far been more successful than India's or Russia's.

Ken Davies was Senior Economist at the Vale Columbia Center on Sustainable International Investment under Columbia Law School and the Earth Institute at Columbia University in New York from 2010 to 2011. Before that, he was Chief Economist, Asia for the EIU in Hong Kong (1996-2001) and Head of Global Relations in the OECD's Investment Division in Paris (2002-2010).

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