Problem Set 5

1. Natural Resources and Economic Outcomes

a) Define the natural resource curse. What is the linkage between resource abundance and institutions?

1. Natural Resources and Economic Outcomes

Explain the resource movement effect and the spending effect in the context of the Dutch Disease. How does the latter lead to indirect de-industrialization?

1. Natural Resources and Economic Outcomes

What may be the benefits of having a Sovereign Wealth Fund for a resource-rich country?

2. Institutions and the Resource Curse (Theoretical Model)

Consider the model of Mehlum, Moene, and Torvik (2006).1 Assume that there is one economy that consists of 𝑁 = 𝑛𝑃 + 𝑛𝑆 entrepreneurs, where 𝑃 and 𝑆 denote producers and rentseekers, respectively. Rent-seekers’ only source of income is the share of resources (𝑅) that they can appropriate and their payoff is given by 𝜋𝑆 = 𝛾 𝑅 / 𝑁 , where 𝛾 = 1 / (1−𝛼)+𝜆𝛼. The quality of institutions is reflected by 𝜆 ∈ [0,1], with a higher 𝜆 indicating that the economy is more producer-friendly. 𝛼 = 𝑛𝑃 / 𝑁 is the share of producers in the economy. In contrast to rentseekers, the payoff of producers is 𝜋𝑃 = 𝜋 + 𝜆𝛾 𝑅 / 𝑁.

a) Compare the individual payoffs to producers (𝜋𝑃) and to rent seekers (𝜋𝑆). Interpret the factor 𝛾.

2. Institutions and the Resource Curse (Theoretical Model)

Consider the model of Mehlum, Moene, and Torvik (2006).1 Assume that there is one economy that consists of 𝑁 = 𝑛𝑃 + 𝑛𝑆 entrepreneurs, where 𝑃 and 𝑆 denote producers and rentseekers, respectively. Rent-seekers’ only source of income is the share of resources (𝑅) that they can appropriate and their payoff is given by 𝜋𝑆 = 𝛾 𝑅 / 𝑁 , where 𝛾 = 1 / (1−𝛼)+𝜆𝛼. The quality of institutions is reflected by 𝜆 ∈ [0,1], with a higher 𝜆 indicating that the economy is more producer-friendly. 𝛼 = 𝑛𝑃 / 𝑁 is the share of producers in the economy. In contrast to rentseekers, the payoff of producers is 𝜋𝑃 = 𝜋 + 𝜆𝛾 𝑅 / 𝑁.

How does the payoff of rent-seekers depend on the quality of institutions (𝜆)? Briefly interpret your results.

2. Institutions and the Resource Curse (Theoretical Model)

Consider the model of Mehlum, Moene, and Torvik (2006).1 Assume that there is one economy that consists of 𝑁 = 𝑛𝑃 + 𝑛𝑆 entrepreneurs, where 𝑃 and 𝑆 denote producers and rentseekers, respectively. Rent-seekers’ only source of income is the share of resources (𝑅) that they can appropriate and their payoff is given by 𝜋𝑆 = 𝛾 𝑅 / 𝑁 , where 𝛾 = 1 / (1−𝛼)+𝜆𝛼. The quality of institutions is reflected by 𝜆 ∈ [0,1], with a higher 𝜆 indicating that the economy is more producer-friendly. 𝛼 = 𝑛𝑃 / 𝑁 is the share of producers in the economy. In contrast to rentseekers, the payoff of producers is 𝜋𝑃 = 𝜋 + 𝜆𝛾 𝑅 / 𝑁.

What is the effect of the quality of institutions (𝜆) on the profits of producers? How does their profit depend on the share of producers? Briefly explain the intuition of the results

2. Institutions and the Resource Curse (Theoretical Model)

Consider the model of Mehlum, Moene, and Torvik (2006).1 Assume that there is one economy that consists of 𝑁 = 𝑛𝑃 + 𝑛𝑆 entrepreneurs, where 𝑃 and 𝑆 denote producers and rentseekers, respectively. Rent-seekers’ only source of income is the share of resources (𝑅) that they can appropriate and their payoff is given by 𝜋𝑆 = 𝛾 𝑅 / 𝑁 , where 𝛾 = 1 / (1−𝛼)+𝜆𝛼. The quality of institutions is reflected by 𝜆 ∈ [0,1], with a higher 𝜆 indicating that the economy is more producer-friendly. 𝛼 = 𝑛𝑃 / 𝑁 is the share of producers in the economy. In contrast to rentseekers, the payoff of producers is 𝜋𝑃 = 𝜋 + 𝜆𝛾 𝑅 / 𝑁.

Calculate the equilibrium quality of institutions 𝜆∗, in which all entrepreneurs become producers.

2. Institutions and the Resource Curse (Theoretical Model)

Consider the model of Mehlum, Moene, and Torvik (2006).1 Assume that there is one economy that consists of 𝑁 = 𝑛𝑃 + 𝑛𝑆 entrepreneurs, where 𝑃 and 𝑆 denote producers and rentseekers, respectively. Rent-seekers’ only source of income is the share of resources (𝑅) that they can appropriate and their payoff is given by 𝜋𝑆 = 𝛾 𝑅 / 𝑁 , where 𝛾 = 1 / (1−𝛼)+𝜆𝛼. The quality of institutions is reflected by 𝜆 ∈ [0,1], with a higher 𝜆 indicating that the economy is more producer-friendly. 𝛼 = 𝑛𝑃 / 𝑁 is the share of producers in the economy. In contrast to rentseekers, the payoff of producers is 𝜋𝑃 = 𝜋 + 𝜆𝛾 𝑅 / 𝑁.

Assume that there is a scarcity of producing entrepreneurs and therefore some entrepreneurs will always decide to produce (𝜋(0) ≥ 𝑁𝑅). What are the possible equilibria with regards to the distribution of producers and rent-seekers?

2. Institutions and the Resource Curse (Theoretical Model)

Consider the model of Mehlum, Moene, and Torvik (2006).1 Assume that there is one economy that consists of 𝑁 = 𝑛𝑃 + 𝑛𝑆 entrepreneurs, where 𝑃 and 𝑆 denote producers and rentseekers, respectively. Rent-seekers’ only source of income is the share of resources (𝑅) that they can appropriate and their payoff is given by 𝜋𝑆 = 𝛾 𝑅 / 𝑁 , where 𝛾 = 1 / (1−𝛼)+𝜆𝛼. The quality of institutions is reflected by 𝜆 ∈ [0,1], with a higher 𝜆 indicating that the economy is more producer-friendly. 𝛼 = 𝑛𝑃 / 𝑁 is the share of producers in the economy. In contrast to rentseekers, the payoff of producers is 𝜋𝑃 = 𝜋 + 𝜆𝛾 𝑅 / 𝑁.

What conclusions can be drawn from the model? Critically discuss the presence of the resource curse in this model.

3. Institutions and the Resource Curse (Empirical Model)

Table 1 presents the results of the empirical model of Mehlum, Moene and Torvik (2006) that is based on the theoretical model discussed above. The authors attempt to measure the impact of natural resource abundance on GDP growth between the years 1965 and 1990, while controlling for initial income level (GDP in 1965), openness, and investments. The interaction term is an interaction between resource abundance and quality of institutions. Quality of institutions (𝜆) takes values from 0 to 1. The model is estimated by using the OLS method.

What is the relation between natural resource abundance and GDP growth according to the results of Regression 1 presented in Table 1? How does this relate to the idea of a resource curse?

3. Institutions and the Resource Curse (Empirical Model)

Table 1 presents the results of the empirical model of Mehlum, Moene and Torvik (2006) that is based on the theoretical model discussed above. The authors attempt to measure the impact of natural resource abundance on GDP growth between the years 1965 and 1990, while controlling for initial income level (GDP in 1965), openness, and investments. The interaction term is an interaction between resource abundance and quality of institutions. Quality of institutions (𝜆) takes values from 0 to 1. The model is estimated by using the OLS method.

How does Regression 4 differ from the other three models Explain the role of the interaction term (between resource abundance and institutional quality).

3. Institutions and the Resource Curse (Empirical Model)

Table 1 presents the results of the empirical model of Mehlum, Moene and Torvik (2006) that is based on the theoretical model discussed above. The authors attempt to measure the impact of natural resource abundance on GDP growth between the years 1965 and 1990, while controlling for initial income level (GDP in 1965), openness, and investments. The interaction term is an interaction between resource abundance and quality of institutions. Quality of institutions (𝜆) takes values from 0 to 1. The model is estimated by using the OLS method.

Calculate the critical level of institutional quality (𝜆∗) based on Regression 4. Would Italy (𝜆 = 0.82) benefit from a natural resource boom according to your results?

3. Institutions and the Resource Curse (Empirical Model)

Table 1 presents the results of the empirical model of Mehlum, Moene and Torvik (2006) that is based on the theoretical model discussed above. The authors attempt to measure the impact of natural resource abundance on GDP growth between the years 1965 and 1990, while controlling for initial income level (GDP in 1965), openness, and investments. The interaction term is an interaction between resource abundance and quality of institutions. Quality of institutions (𝜆) takes values from 0 to 1. The model is estimated by using the OLS method.

Mehlum et al. (2006) only use OLS and do not control for the possible endogeneity of institutions. Acemoglu, Johnson and Robinson (2001) found that the OLS coefficient of institutions is downward biased when related to economic performance. What implications does that finding have for the results presented in Table 1? Does the finding of Acemoglu et al. (2001) necessarily invalidate the results of Mehlum et al. (2006)? Discuss critically.