What should a government in a resource-rich state do about the gap between rich and poor populations (vertical inequality), and the gap between resource-rich and resource-poor regions (horizontal inequality)? Indeed, oil and gas exporters tend to have more varied outcomes than non-exporters: as the dependence of countries on oil, gas, and other mineral exports rises, so does the variation among states in development outcomes. Oil and gas revenues seem to magnify the ability of governments to do both good and bad things for their citizens (World Bank 2001).
One key to success is managing the impact that resource rents have on distribution of income – both the “vertical” (between rich and poor) and “horizontal” (across regions of a country) distributions of income. Both kinds of inequality can be harmful: high levels of vertical inequality may retard development and can reduce the poverty-alleviation of economic growth (Easterly 2002); horizontal inequality – and sudden changes in horizontal inequality – can lead to violent conflict (Stewart 2000).
Surprisingly little is known about the relationship between resource wealth and vertical income inequality. Using what is perhaps the most common measure of income inequality – the “Gini” coefficient – one finds that a country’s dependence on resource wealth appears to be uncorrelated with inequality. Resource-rich countries appear to be neither more nor less unequal, on average. Nonetheless, in fact there are good reasons not to draw strong conclusions from the lack of a simple relationship between inequality and resource wealth.
Vertical Inequality
The Problem
Resource booms have strong effects on the labour force; yet little is known about their impact on the vertical distribution of income. A resource boom can affect the labour force through two mechanism The first is the Dutch Disease: a sharp rise in resource exports will typically cause an appreciation in the real exchange rate, which in turn will reduce the international competitiveness of the country’s agricultural and manufacturing exports and may reduce employment in these sectors (Corden and Neary 1982; van Wijnberge 1984). Although governments can do much to offset the effects of the Dutch Disease, too frequently they do not. Nigeria’s economy, for example, suffered because of the government’s failure to act. A sharp rise in Nigeria’s petroleum exports in the 1960s and early 1970s led to an appreciation of the exchange rate. The higher exchange rate made it virtually impossible for firms in the agriculture and manufacturing sectors to sell their goods profitably abroad. Instead of devaluing the currency, the government kept it overvalued, for fear of inflation. The result was that booming oil exports crowded out agriculture and manufacturing exports, and hence, jobs in these sectors.
The shift in exports from agriculture and manufacturing to oil leads to a shift in the sectoral composition of the labour force (World Development Indicators 2005). Even though this sectoral shift is well understood by economies, it is unclear how it affects the distribution of income. In theory, the impact on employment levels should be neutral: if workers can easily move from one sector to another – for example, from agriculture to construction – then the sectoral shift could have modest effects on income distribution.
If there are limits on intersectoral labour mobility, however – meaning some types of workers in agriculture and manufacturing are unable to move into services – it could cause a rise in unemployment for these types and a shift in income distribution. This could affect the distribution of income between men and women: if there is a shift away from sectors where women have good job opportunities (manufacturing) to ones where they have poor or no job opportunities (construction), then gender inequality may rise. Similar problems could arise for older workers, low-skill workers and rural dwellers.
Resource booms have a second effect on the labour force, by generating new government jobs that are funded from resource revenues; this may have important consequences for income distribution. There is some evidence that inequality is lower in countries where a larger fraction of the labour force is employed by the government, since governments tend to compress the wages of their employees (Milanovic 2001). If this is true, an oil boom may reduce inequality – atleast in the middle quintiles of the income distribution – although policies intended to prevent a bloating of governments will attenuate this effect.
The Responses
It is difficult to predict how oil revenues will change the vertical distribution of income for any given country. Yet if the revenues have a strong pact, the social and economic consequences could be far reaching. A first implication is that any country that anticipates a substantial increase oil and gas revenues should commission research on how growth in the and gas sector will affect the distribution of income. Failing to anticipate these effects will likely make it more difficult to respond to growing inequality when it occurs.
If research suggests that oil revenues will widen the gap between rich and poor, governments can take three types of measures:
- First, they can try to offset the hardships in the agriculture and manufacturing sectors by promoting productivity and export growth;
- Second, they can provide new government jobs to displaced workers in these sectors;
- Third, they can target pro-poor policies.
Another way to promote equity is to distribute the extractives revenues directly to citizens, in the form of a cash payment. A uniform transfer to all citizens acts like a progressive tax (or more accurately a negative regressive tax) and produces a decline in the rich to poor income ratio and in this way reduces the level of vertical in equality.
There are, however, reasons to be sceptical about whether a direct distribution fund would work well in a developing country, such as Guyana. Governments in developing states tend to be less bound by the rule of law, have less institutional stability and are more susceptible to rent-seeking and corruption than in the advanced industrialised states. A direct distribution plan could work only if it were managed in ways that are uncharacteristic of most oil-rich developing country governments: with strict adherence to the law, intertemporal stability and immunity from political and rent seeking pressures. For many years, countries similar to Guyana have established other types of specialized commodity funds (for savings or stabilisation); in genera these funds have not functioned well (Davis et al. 2001).
Since the distributions would take the form of rents, a direct distribution plan could also encourage several types of rent-seeking. One danger could be rent-seeking through migration: new immigrants might enter the country until the rents available are largely dissipated. Another problem could be the growth of coercive rent-seeking organizations at the local level, such as protection rackets, shakedown operations by the police or military, for-profit rebel armies, and similar mafia-type associations.
There may be other drawbacks to having a direct distribution plan:
- It could create a parallel budget with its own revenues and disbursements, which would complicate fiscal policies.
- It may not be viable in countries that lack well-developed financial systems, where people lack the ability to manage large infusions of cash.
- It may be complex to administer, since it requires the state to maintain a large, reliable database of all of its citizens. While many states keep citizen lists for voting, people would have a much larger incentive to fraudulently manipulate a direct distribution list.
- It is unclear how it would affect regional grievances, since those who live closer to the resource’s origin would be likely to demand a large share of the funds.
If direct distribution functioned well, it would certainly allocate resource rent in an equitable way. However, there are reasons why it might not work well, and any government should proceed with caution when considering this option. States that adopt direct distribution plans should be ready to avert fraud and rent-seeking and may wish to consider using the distributions to encourage social goals to alleviate poverty.
Horizontal Inequality
The Problem
If the resource-producing region is concentrated in one or several parts of the country, a booming extractives sector may affect the geographical distribution of income. The strength of this effect depends on four factors:
- Initial incomes in the extractive region: if the region is poor, resource wealth can help close any gap with the rest of the country; if it is relatively rich, it can widen the gap.
- The difference between growth in the extractives sector and growth in the non-extractives sector.
- The strength of linkages between the extractive sectors and other economic activities.
- The ability of the subnational government to capture income from the extractives sector.
If the extractives sector operates as an enclave, and the regional government has no taxing authority, then a booming resources sector may have little or no impact on the region’s living standards. However, if the extractive sector is well linked to the local economy, or the local government can tax resources’ revenues directly or indirectly, an extractives boom can sharply boost employment and wages in the region.
While a rise in the region’s actual incomes may be good, a disproportionate rise in expected incomes may pose problems. People are dissatisfied with their income – no matter how large it is – if it falls short of their aspirations (Frey and Stutzer 2002).
The Response
Changes in horizontal inequalities are easier to anticipate than changes in vertical inequality. Direct distribution can also reduce horizontal inequality. Another strategy to offset any expected jump in regional inequality is to decentralize resource revenues.
Besides decentralization and direct distribution, governments can do much to narrow the gap between actual and expected incomes in the mineral-rich region. Options include:
- Giving extractives companies incentives to hire local workers and to purchase local products as part of their licensing agreement.
- Restricting the migration of workers into the extractive region. Resource booms often attract low-wage labourers from other parts of the country, or from other countries. Their presence can reduce the number of jobs for local peoples and introduce social tensions. Limiting migration-perhaps temporarily – can avert these tensions and raise the benefits of resource extraction for local peoples.
- Encouraging extractive firms to invest in local development.
- Encouraging nongovernmental organizations (NGOs) to mediate between local peoples and extractive firms. There is often a sharp divide between local citizens, who have complaints about the environmental, social and economic consequences of resource extraction and large foreign firms, who have little understanding of local concerns and conditions. NGOs that specialize in environmental protection, social justice and labour rights can help bridge this gap: they can help administer local development programs that are funded with resource revenues; monitor the activities of firms, government and other actors; convene adversarial parties, making them more transparent and accountable; and provide early warnings about impending conflicts.
- Promoting full transparency for all extractive revenues. Local peoples may develop inaccurate beliefs about the size and distribution of resource revenues when they lack accurate information, or when the government lacks credibility.
Finally, distributional issues are more likely to ignite violence when police or military forces engage in predatory behaviour. Extractive projects often attract police, military, and paramilitary organizations to use extortion too gain a share of the available rents, either directly from extractive firm and its contractors, or indirectly from the people who work with them. In some cases, military units have staged or facilitated attacks on extractive firms in order to extort funds. Local populations understandably resent such predatory behaviour, which helps widen the rift between their actual and excepted incomes from the extractive sectors. Both governments and firms can help curtail these activities. Applicable measure should include holding extensive consultations with local communities and NGOs since the early days of the project; developing a relocation agreement with a small village, which included plan for local hiring, restrictions on in-migration, sustainable economic development, cultural preservation and biodiversity conservation.
