The Curse of Natural Resources in Fractionalized Countries

This paper develops a model that can explain why natural resources are a curse for some countries, but not for others. In this model, natural resources cause fighting activities between rivalling groups. Fighting reduces productive activities and weakens property rights, making productive activities even less attractive. The aggregate production decrease exceeds the natural resources' direct positive income effect if and only if the number of rivalling groups is sufficiently large. The model thus predicts that natural resources lower incomes in fractionalized countries, but increase incomes in homogenous countries. Empirical evidence that supports this hypothesis is providedNatural resources; Fractionalization; Rent seeking

Industrial Policy in an Imperfect World

Theoretical analyses of industrial policy normally restrict the range of possible outcomes by abstracting from either market or government failures. This paper thus studies industrial policy and its effectiveness in a model that includes both market and government imperfections. We introduce a public agency responsible for industrial policy into the model of Hausmann and Rodrik (2003), and assume that this agency has limited information and is partly politically motivated. We further extend the model to allow the public agency to communicate with en- trepreneurs and the entrepreneurs to engage in rent seeking. We find that industrial policies are ineffective if the public agency is poorly informed, but that they are not necessarily ineffective if the public agency is highly politically motivated. Given a highly politically mo- tivated public agency, industrial policies are effective if and only if the institutional setting ensures that such policies are modest e.g. by re- stricting the public agency?s budget. Moreover, our model helps us to understand why the same industrial policies that have failed elsewhere have been relatively successful in South Korea and Taiwan.Industrial Policy,Market and Government Failures,Political Economy

Development (Paradigm) Failures

Over time the international development community has advocated various development paradigms, but countries following these paradigms have often performed poorly. I provide an explanation for this poor performance. In my model the political leader of a developing country chooses a policy and whether to implement it in an honest or corrupt manner. These choices affect domestic production and aid inflows. Production is high when productive capacity is high, and when the policy is appropriate in the country-specific circumstances and implemented honestly. Aid inflows are high when the policy is close to the paradigm. In equilibrium countries with low productive capacity and high corruption resulting from weak political institutions follow the paradigm more closely. Hence my model suggests that development paradigms have a tendency to fail because they are primarily followed by countries that would fail anyway.

Redistribution to Rent Seekers, Foreign Aid and Economic Growth

This paper analyzes the consequences of redistribution of public funds to rent seekers. Therefore, it introduces redistribution to rent seeking agents into Barro's (1990) endogenous growth model with a productive public sector. It shows that the growth rate decreases in the share of the public funds that is redistributed. The public sector's relative sizes that maximize growth and welfare become also smaller in presence of redistribution. Further, if foreign aid is added to the model, the relationship between aid and growth turns out to be inverted-U shaped under reasonable policy assumptions, which is consistent with the finding of an Aid Laffer Curve by some recent empirical studiesRent seeking; Growth; Foreign Aid; Fiscal Policy

How Fiscal Decentralization Flattens Progressive Taxes

We study the tension between fiscal decentralization and progressive taxation. We present a multi-community model in which the local income tax rate is determined by an exogenous progressive tax schedule and a tax shifter that can differ across communities. The progressivity of the tax schedule induces a self-sorting process that results in substantial though imperfect income sorting. Rich households are more likely to locate themselves in low tax communities than poor households. The actual tax structure is thus less progressive than the exogenous tax schedule. To investigate the quantitative implications of our model, we calibrate a fully-specified version to the largest metropolitan area in Switzerland. The equilibrium values of the simulation show the same pattern across communities as we observe in this area. The theoretical result is challenged by estimating the actual tax structure faced by the households in this area. We find that the actual tax structure is indeed substantially less progressive than the fixed tax schedule.Progressive Taxation, Fiscal Decentralization, Income Segregation

Do Natural Resource Revenues Hinder Financial Development? The Role of Political Institutions

We theoretically and empirically examine the relationship between natural resource revenues and financial development. In the theoretical part, we present a politico-economic model in which contract enforcement is low and decreasing in resource revenues when political institutions are poor, but high otherwise. As poor contract enforcement leads to low financial development, the model predicts that resource revenues hinder financial development in countries with poor political institutions, but not in countries with comparatively better political institutions. We test our theoretical predictions systematically using panel data covering the period 1970 to 2005 and 133 countries. Our estimates confirm our theoretical predictions. Our main results hold when we control country fixed effects, time varying common shocks, income and various additional covariates. They are also robust to alternative estimation techniques, various alternative measures of financial development and political institutions, as well as across different samples and data frequencies. We present further evidence using panel data covering the period 1870 to 1940 and 31 countries. --Natural resources,political institutions,financial development

Natural Resources, Democracy and Corruption

We study how natural resources can feed corruption and how this effect depends on the quality of the democratic institutions. Our game-theoretic model predicts that natural resources lead to an increase in corruption if the quality of the democratic institutions is relatively poor, but not otherwise. We use panel data covering the period 1980 to 2004 and 99 countries to test this theoretical prediction. Our estimates confirm that the relationship between resource abundance and corruption depends on the quality of the democratic institutions. In particular, resource abundance is positively associated with corruption only in countries that have endured a nondemocratic regime for more than 60 percent of the years since 1956. Our main results hold when we control for the effects of income, time varying common shocks, regional fixed effects and various additional covariates. They are also robust to various alternative measures of natural resources, corruption and the quality of the democratic institutions. These findings imply that democratization can be a powerful tool to reduce corruption in resource-rich countries.Natural resources; democracy; political institutions; corruption

All-pay war

We study a model of war in which the outcome is uncertain not because of luck on the battlefield (as in standard models), but because the involved countries lack information about their opponent. In our model their production and military technologies are common knowledge, but their resources are private information. Each country decides how to allocate its resources to production and warfare. The country with the stronger military wins and receives aggregate production. In equilibrium the country with a comparative advantage in warfare allocates all resources to warfare for low resource levels and follows a non-decreasing concave strategy thereafter. The opponent allocates a constant fraction of its resources to warfare for low resource levels and follows an increasing non-linear strategy thereafter. From an ex ante perspective the country with a comparative advantage in warfare is likely to win the war unless its military technology is much weaker than the opponent’s.Conflict; war; all-pay auction; private information

Do Natural Resource Revenues Hinder Financial Development? The Role of Political Institutions

We theoretically and empirically examine the relationship between natural resource revenues and financial development. In the theoretical part, we present a politico-economic model in which contract enforcement is low and decreasing in resource revenues when political institutions are poor, but high otherwise. As poor contract enforcement leads to low financial development, the model predicts that resource revenues hinder financial development in countries with poor political institutions, but not in countries with comparatively better political institutions. We test our theoretical predictions systematically using panel data covering the period 1970 to 2005 and 133 countries. Our estimates confirm our theoretical predictions. Our main results hold when we control country fixed effects, time varying common shocks, income and various additional covariates. They are also robust to alternative estimation techniques, various alternative measures of financial development and political institutions, as well as across different samples and data frequencies. We present further evidence using panel data covering the period 1870 to 1940 and 31 countries.Natural resources; political institutions; financial development

Foreign Aid and Enlightened Leaders

To study whether foreign aid fuels personal, regional and ethnic favoritism, we use satellite data on nighttime light for any region in any aid-recipient country, and we determine for each year and each country the region in which the current political leader was born. Having a panel with 22,850 regions in 91 aid recipient countries with yearly observations from 1992 to 2005, we compare the effect of foreign aid on nighttime light across regions. We find that in countries with poor political institutions, this effect is significantly higher in the region in which the current political leader was born than in other regions. This finding suggests that a disproportionate share of foreign aid ends up in the leader's birth region, and we argue that it supports the view that foreign aid fuels favoritism, broadly defined. We find no such difference in aid-recipient countries with sound political institutions.Foreign aid; Political leaders; Favoritism; Political institutions