Ronald H. Schmidt

English

Research Papers in Economics

FRBSF WEEKLY LETTER
March 23, 1990
Natural Resources and State Growth
Shares of District Output Percent
4
Rich endowment
The natural resource endowments in the West are
extensive. In 1986, the nine Twelfth District states
accounted for 18 percent of the nation's agricul-
tural output, 30 percent of forest products, 27
percent of mining output, and 15 percent of
energy production.
In terms of shares of state output, the importance
of these industries has fallen in recent years. As
shown in the Chart, the share of total western
output provided by resource industries has fallen
since 1964, with all resource industries except
energy losing share. Energy's share increased
after 1964 because of the discovery of oil in
Alaska, but barring major new discoveries,
production is expected to fall in the next decade.
2
Mining
Gl 1986
• 1964 3
Agriculture Lumber Energy
Natural resources make up a significant portion
of the western states' output, ranging from 34
percent in Alaska to two percent in Hawaii.
Idaho ranks fifth in the nation in agricultural
share of state output; Oregon, Idaho, and Wash-
ington have the largest shares of forest products;
Arizona, Utah, and Nevada aii rank in the top
five in non-fuel mining's share of state output;
and Alaska is near the top of the states in
energy's share of state output.
At the same time, dependence on natural re-
source industries continues to be associated with
severe regional economic cycles. The boom-bust
experience in Alaska and other oil states is well
known. Similarly, the 1981-82 recession brought
demand for lumber to a standstill and wreaked
havoc on the Oregon economy. A collapse of
mineral prices savaged the mining states, after
earlier price increases had boosted growth.
The evidence also reveals that gains in wealth
in the resource sector stimulated industrial di-
versification in the resource-dependent states.
Positive price shocks in resource industries have
contributed sharply to economic diversification
into non-resource industries. As a result, the
share of western output produced by natural
resource industries has fallen from 6.6 percent
in 1964 to 4.5 percent in 1986.
Natural resource industries played an important
role in the early development of many western
states. In most, agriculture provided the initial
impetus for development. Mining, particularly for
gold and silver, attracted people and investment
to parts of the West, and forest products provided
a strong export base for the Pacific Northwest.
Relatively recently, oil discoveries spurred
economic development in Alaska.
Many agree that natural resources have played
an important role in the varied fortunes of states'
economies; however, the ways in which natural
resources affect growth are not well understood.
This Letter compares the performance of re-
source-dependent and non-resource-dependent
states over the 1964-86 period, and finds that
the resource-dependent states outperformed the
non-resource-dependent states over this period.
The evidence suggests, however, that this supe-
rior performance can be traced to fortuitous price
increases in the resource industries during the
1970s, and suggests that resource-dependence
would slow economic growth in the absence
of positive price shocks.FRBSF
How resources affect growth
Differences in natural resource endowments
explain major variations in industrial structure
across regions. Not surprisingly, states that are
heavily endovved \vith natural resources have
larger-than-average sectors devoted to producing
those resources. This is consistent with the prin-
ciple of comparative advantage. A region with
an abundance of low-cost natural resources has
a readily available source of exports to other
regions, particularly when those other regions
lack the endowments to produce the resources
themselves. New England states, for example,
cannot become major oil producers because
they simply do not have the oil reserves.
Natural resources also provide an important
source of regional differences because natural
resource production often was a key element in
a region's early economic development. In many
cases, an abundance of such natural resources as
low-cost farm land, minerals, timber, or oil were
major attractions for settlers.
Over time, new industries emerged to support
the primary resource industries through the
provision of services or equipment. In many
cases unrelated industries also emerged to take
advantage of the infrastructure created to support
the resource industry. Eventually, most areas
developed strong industries unrelated to natural
resources. In fact, where other industries did
not develop, ghost towns appeared when the
resource base was exhausted. For those regions
that continued to grow, the natural tendency was
toward greater diversification, particularly away
from natural resource industries. As a result, this
historical source of regional specialization has
become less important.
Price effects
Beyond their influence on the industrial
--composition of a region, natural resources also
have had a profound effect on regional growth
through changes in relative income and wealth.
Sudden changes in resource prices directly affect
the income of the owners of the resource, many
ofwhom reside in the region. These income
changes tend to spillover into increased
demand for other goods and services in the
region. Natural resource price changes, therefore,
can significantly affect the wealth of the region
compared with that of non-resource-intensive
regions.
Price changes are particularly important in
extractive natural resource industries, such as
mining, energy, and forestry. Often, the resource
industry has little abiIity to expand or contract
production in the vvake of price movements. For
example, current oil production is largely the
result ofdrilling investments made years earlier;
current drilling adds little to the total. In fact,
even when oil prices rose 68 percent between
1979 and 1980, oil production in the United
States did not rise in the subsequent year. And
when oil prices dropped by half in 1986, pro-
duction fell only four percent in the next year.
Because production responds relatively little,
the impact of price movements is felt through
changes in profits.
Price effects work in three important ways. First,
a sudden increase in prices signals an increased
market value for that resource, and to the extent
it is expected to persist, this increase in value
raises the profitability of investing in that indus-
try. Consequently, price increases can be ex-
pected to boost investment and employment in
the resource sector and in resource processing,
thus providing a strong source of growth relative
to that in less resource-intensive regions.
Second, because an increase in resource prices
raises the incomes of those employed in the
resource industry and increases demand for
inputs needed by the resource sector, it also
boosts non-resource industry growth. Moreover,
since extractive resource production often is
limited in its ability to respond to rising prices,
gains in the wealth of resource-owners tend to
be invested in non-resource industries. When
resource prices are high, for example, resource
firms often diversify into non-resource pro-
duction through acquisitions.
Finally, sharp resource price movefll~flJ~h(1Y~ClI'1_
important effect in attracting or repelling labor
and capital from other regions. Price increases
often create a sense of optimism and opportunity
that attracts in-migrants and investment. Laborers
are attracted by the prospect of high-paying jobs.
Expectations of rapid growth often become self-
fulfilling, as investors pour in capital for new
businesses and residential construction.
By the same token, when resource prices drop,
in-migration slows dramatically, and investment
from outside the region becomes harder toRonald H. Schmidt
Senior Economist
This conclusion is even stronger when one
examines the separate contributions made by
the resource industries, resource processing
industries (such as food processing, pulp and
paper, stone, clay, and glass, and petroleum
refining), and other industries. The faster average
growth in resource-dependent states was a direct
result of faster growth in non-resource-related
production. Resource output grew at an average
annual rate just under one percent, and resource
processing industries grew at 2.4 percent. In
contrast, the other industries in the resource-
dependent states registered average annual
growth of 4.5 percent, considerably more rapid
than the 2.6 percent growth in non-resource
industry output registered by the non-resource-
dependent states.
Implications
The faster growth of non-resource-related
industries from 1964 to 1986 suggests a trend
away from resource dependence even in re-
source states. Although resource-dependent
states had faster growth during this period, that
growth largely can be attributed to fortuitous
price shocks in the resource industries. The his-
tory of resource pricing suggests that such gains
are not permanent.For example, recent declines
in oil and agricultural prices have reversed most
of the price increases in the 1970s.
cantly contribute to growth, and actually may
detract from that growth. Price movements, in
contrast, directly affect relative growth, with
positive movements boosting growth of resource-
dependent states, and negative movements slow-
ing growth. These results suggest that, in the
absence of favorable price movements, the
presence of a dominant resource sector probably
slowed a state's growth during this period.
The performance of the resource-dependent
states is not uniformly superior to that of non-
resource-dependent states throughout the
1964-1986 period, however. For the most part,
the resource-intensive states significantly out-
performed the rest of the states from 1973 to 1981,
but during the post-1981 period, the resource-
dependent states grew more slowly than the
other states.
This faster growth was found across nearly all
resource categories. The top five mining states
and the top five forestry states grew at average
annual real rates of 4.3 and 3.0 percent, respec-
tively, compared to 2.6 percent in the remaining
45 states. The top ten energy states had average
annual growth of 3.3 percent. Even in agricu 1-
ture, growth in the top ten agricultural states
matched the growth in the 40 less agricuIturally-
dependent states.
Performance
Gross State Product data over the period from
1964 to 1986 reveal some interesting relation-
ships between natural resource production and
state growth. First, natural-resource-dependent
economies tended to outperform the other states
over this period as a whole. The top ten resource-
dependent states (those with the largest shares of
state output held by the resource industries) had
average annual real growth of 3.4 percent, com-
pared to the 2.6 percent growth registered by the
other 40 states.
attract, as investors raise their assessment of
the risks of investing in the region.
The role of price movements
Shifts in the relative performance of resource-
dependent states are strongly correlated with
resource price movements. To separate the effect
of a region's dependence on its various resource
industries from the effect of relative price
changes in those industries, a simple econo-
metric model was estimated.
Thus, a large resource sector can be beneficial
to a region's growth when the industry experi-
ences positive price shocks that stimulate non-
resource production. But if prices fall or remain
unchanged, slow growth (or actual decline) in
Results suggest that price changes are an resource industry output can slow the overall
·impurtant facton~xptcri1)ingTelcttive-grnwth~in------wowthohesuQrce-=-etepem:renLstate-s-. ---.----
fact, after controlling for the effect of favorable
price movements, the model suggests that a
state's resource dependence does not signifi-
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San Francisco, or of the Board of Governors of the Federal Reserve System.
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Federal Reserve
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Natural resources and state growth

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