Price volatility and the political economy of the resource curse

Price Volatility and The Political Economy

of the Resource Curse

Thierry Verdier (PSE and CEPR)

Introduction (I)

• An old standing question :

Natural Resources & Economic Performances: blessing or curse ? • Prior to late 80s: conventional wisdom : a blessing !

Economic historians / Industrial revolution : USA, Britain, Australia (Viner 1952, Lewis 1955, Rostow 1961, Krueger 1980)

Introduction (I)

• An old standing question :

Natural Resources & Economic Performances: blessing or curse ? • Prior to late 80s: conventional wisdom : a blessing !

Economic historians / Industrial revolution : USA, Britain, Australia (Viner 1952, Lewis 1955, Rostow 1961, Krueger 1980)

Introduction (I)

• An old standing question :

Natural Resources & Economic Performances: blessing or curse ? • Prior to late 80s: conventional wisdom : a blessing !

Economic historians / Industrial revolution : USA, Britain, Australia (Viner 1952, Lewis 1955, Rostow 1961, Krueger 1980)

- Case studies : Gelb (1988), Karl (1997), Auty (2001), Ross (1999, 2001), Sala-i-Martin and Subramanian (2003), Eifert et al. (2003) • After the 80s: Presumption of a Curse !

- Cross country empirical work : Sachs and Warner (1995, 1999),

Bushy, Isham, Pritchett, Woolcock (2003) Bannon and Collier 2003; Davis et al.2003 Mehlum, Moene and Torvik (2006),

Introduction (II)

• In fact : great variety of outcomes (even in LDCs) : Botswana, Chile, Malaysia, Oman and Thailand (Abidin 2001)

Introduction (II)

• In fact : great variety of outcomes (even in LDCs) : Botswana, Chile, Malaysia, Oman and Thailand (Abidin 2001)

Algeria, Ecuador, Mexico, Nigeria, Trinidad &Tobago, Venezuela, Zambia

• Skepticism/controversies about existence of Resource Curse Pbs of statistical robustness / generalizations / endogeneity:

Manzano and Rigobon (2001), Ding and Field (2005), Alexeev and Conrad (2009), Brunnschweiler and Bulte (2008), van der Ploeg and Poelhekke (2010)

1) Explaining diversity of outcomes and mechanisms :

«Why some resource-abundant countries succeed while others do not? »

Introduction (III)

1) Explaining diversity of outcomes and mechanisms :

«Why some resource-abundant countries succeed while others do not? »

Introduction (III)

Mehlum, Moene and Torvik (2006), Iimi 2007, Kolstad (2009) : Quality of institutions

Andersen and Aslaksen (2008): Presidentialism vs Parliamentary democracies Arezki and van der Ploeg (2007) : Trade policies/openness

• Shifts in literature from « average effects » of resources to:

1) Explaining diversity of outcomes and mechanisms :

«Why some resource-abundant countries succeed while others do not? »

Introduction (III)

Mehlum, Moene and Torvik (2006), Iimi (2007), Kolstad (2009) : Quality of institutions

Andersen and Aslaksen (2008): Presidentialism vs Parliamentary democracies Arezki and van der Ploeg (2007) : Trade policies/openness

political economy dimensions • Shifts in literature from « average effects » of resources to:

2)Volatility curse : volatility of prices/policies • Volatility and growth : - Aizenman and Marion (1991)

- Ramey and Ramey (1995)

- Aghion, Angeletos, Banerjee, Manova (2005) - Aghion, Bachetta, Rancière and Rogoff (2006)

2)Volatility curse : volatility of prices/policies • Volatility and growth : - Aizenman and Marion (1991)

- Ramey and Ramey (1995)

- Aghion, Angeletos, Banerjee, Manova (2005) - Aghion, Bachetta, Rancière and Rogoff (2006)

• Volatility curse :

Haussman and Rigobon (2002): reinforcing effects: specialization in non tradables / financial frictions/ RER volatility van der Ploeg and Poelhekke (2010) : direct positive effect of resource on growth

indirect negative effect through volatility Bleaney and Halland (2009): negative effect of resources on growth

through fiscal volatility

Leong and Mohaddes (2011) : volatility curse /mitigating role of institutions

In this talk… (I)

In this talk… (I)

• Political economy channel :

- «Bad policy » induced by Resource rents

- Dysfunctional state behavior \ large public sectors \ Inefficient redistributive policies \

(Gelb (1988), Gavin (1993), Karl (1997), Auty (2001), Ross (2012))

In this talk… (I)

• Political economy channel for resource curse - «Bad policy » induced by Resource rents

- Dysfunctional state behavior \ large public sectors \ Inefficient redistributive policies \

(Gelb (1988), Gavin (1993), Karl (1997), Auty (2001), Ross (2012))

Interactions between political incentives / price shocks volatility • How Resource Booms / volatility affect the extent of

inefficient redistribution ?

In this talk…(II)

• Political models of resource extraction with price volatility - Probabilistic voting Model (Lindbeck-Weibull 1993)

In this talk… (II)

• Political models of resource extraction with price volatility - Probabilistic voting Model (Lindbeck-Weibull 1993)

incumbent politician\ resource extraction

- Inefficient redistribution : clientelism \ patronage : system of political exchange with voters

Public employment: redistribution of rents (Auty 2001)

Way to gain political support (Robinson and Verdier (2012)) Two sided credibility: patron\voters

In this talk… (II)

• Political models of resource extraction with price volatility - Probabilistic voting Model (Lindbeck-Weibull 1993)

incumbent politician\ resource extraction

Price shocks Volatility Political support. Incumbent’s incentives Public Policies Resource Curse - Inefficient redistribution : clientelism \ patronage :

system of political exchange with voters

Public employment: redistribution of rents (Auty 2001)

Way to gain political support (Robinson and Verdier (2012)) Two sided credibility: patron\voters

Main Insights (I)

• Over extraction of natural resources

• Permanent resource boom: improves efficiency of extraction • Permanent resource boom: increase resource misallocation

in the rest of the economy

• Impact of resource boom : depends on nature of political institutions

Resource booms create underdevelopment

not because of inefficiency in the rate of resource extraction But because of what politicians do with the resource rents.

Main Results (II)

Extension to Stochastic Resource Prices and Volatility

- Value of staying in power (for risk averse politicians) Volatility

- Political support / turnover

Main Insights (II)

Extension to Stochastic Resource Prices and Volatility

Higher resource volatility

- Value of staying in power (for risk averse politicians)

• When incumbent’s constituency « more sensitive » to fiscal shocks than rest of population :

Magnification of over extraction of natural resources

Inefficient Patronage policies

Crowding out of public investment

More so under « weak » institutions Volatility

- Political support / turnover

Roadmap

1) Political Economy models of the resource curse

2) A simple model of clientelism, price shocks and resource curse 3) Political clientelism under price volatility

4) Political clientelism, public investment and price volatility 5) Resource extraction under price volatility

Economic /Political models of the resource curse (I)

• «Dutch Disease » literature: Corden and Neary (1982), van Wijnbergen (1984), Krugman (1987), Matsuyama (1992),

Sachs and Warner (1995), Gylfason et al. (1999), Torvik (2001), Matsen and Torvik (2005),

van der Ploeg and Venables (2011) Haussman and Rigobon (2002)

Economic /Political models of the resource curse (I)

• «Dutch Disease » literature: Corden and Neary (1982), van Wijnbergen (1984), Krugman (1987), Matsuyama (1992),

Sachs and Warner (1995), Gylfason et al. (1999), Torvik (2001), Matsen and Torvik (2005),

van der Ploeg and Venables (2011) Haussman and Rigobon (2002)

• « Rent-Seeking » Literature : Tornell and Lane (1999): « Voracity Effect » Baland and François (2000)

Torvik (2002), Hodler (2006)

- Need for some negative multiplier /externality/ increasing returns effect: not internalized by political system decentralized

- No explicit role for political/institutional parameters

Surveys: van der Ploeg (2010), Deacon (2011), Frankel (2012).

Political/ Economic models of the resource curse (II)

- Political theories of the « rentier » state: North and Thomas (1973)

Karl (1997), Ross (1999, 2001)

Political/ Economic models of the resource curse (II)

- Political theories of the « rentier » state: North and Thomas (1973)

Karl (1997), Ross (1999, 2001)

• Political Economy Models of the resource curse

- Civil conflicts :

Collier and Hoeffler (2004): Rebels’ incentives and capacity Aslaksen and Torvik (2006): violent vs democratic competition

- Incumbency distortions and lobbying:

Acemoglu, Robinson and Verdier (2006): Elite’s behavior Damania and Bulte (2003): Lobbying incentives

Caselli and Cunnigham (2009): leader’s incentives/ non monotonic effects survival function

- Public sector distortions:

Robinson, Torvik and Verdier (2006) : public employment /clientelism Robinson and Torvik (2005) : « white elephants »

A Simple Political Economy Model (I)

• Two-period probabilistic voting model : periods 1 and 2 • Two parties \ politicians: incumbent A and challenger B.

• Mass of voters normalized to 1

• Stock of natural resources: prices , • Election is at the end of period 1

2

p

1

p

• Resource extracted in period 1: e in period 2 : R(e)

• After election, political winner consumes remaining resource rents. • No commitment to policies

A Simple Political Economy Model (II)

• Resource income can be used in two possible ways: - Consumption by the incumbent

- Distribution as patronage: public jobs / influence election outcome - No taxes

• Incumbent politician: clientelism / offers public jobs: L_P < 1 public wage: W > H H : productivity in private sector

• The incumbent decides policy before the election:

Resource extraction e and public sector employment L_P

A Simple Political Economy Model (III)

• The incumbent decides policy before the election:

Resource extraction e and public sector employment L_P

A Simple Political Economy Model (III)

max

p

e

− WL

 L

p

R

e − WL



p

 L

p

R

e  0

e L_P ) , , (L p₁ p₂ e _P ) , (e p₂ L_P E Equilibrium Policies

• The incumbent decides policy before the election:

Resource extraction e and public sector employment L_P

A Simple Political Economy Model (III)

max

p

e

− WL

 L

p

R

e − WL



p

 L

p

R

e  0

−1  L

W  

p

R

e − WL

  0

)

(

e

p

R

e

p

+

• Efficient extraction path : e (F):

p

+

p

R

'

(

e

)

=

0

Max

• Resources are inefficiently over-extracted :

_e

 e

• Resources are inefficiently over-extracted :

• Comparative statics on price shocks :

p

, p

p

dp

p

dp

p

dp

₌

₌

e

 e

• Resources are inefficiently over-extracted :

• Comparative statics on price shocks :

p

, p

p

dp

p

dp

p

dp

₌

₌

- reduces extraction rate and increases efficiency

e

 e

• Resources are inefficiently over-extracted :

• Comparative statics on price shocks :

p

, p

p

dp

p

dp

p

dp

₌

₌

- reduces extraction rate and increases efficiency

Intuition: - value of staying in power:

- more incentives to bias political competition - probability of staying in power :

- politician is less myopic

e

 e

e L_P 0 > ∆p ) , , (L p₁ p₂ e _P ) , (e p₂ L_P E E ’

ii) temporary resource boom:

_dp

_>

₀

_and

_dp

₌

₀

iii) anticipated future resource boom:

dp

=

0

and

dp

>

0

ii) temporary resource boom:

_dp

_>

₀

_and

_dp

₌

₀

iii) anticipated future resource boom:

dp

=

0

and

dp

>

0

0

)

(

''

'

e

≥

R

- equilibrium extraction path change

Endogenous effect of clientelism: increases myopia

e

E E ’

Temporary resource boom

0 1 > ∆p ) , , (L p₁ p₂ e _P ) , (e p₂ L_P L

ii) temporary resource boom:

_dp

_>

₀

_and

_dp

₌

₀

iii) anticipated future resource boom:

dp

=

0

and

dp

>

0

0

)

(

''

'

e

≥

R

- equilibrium extraction path change

endogenous effect of clientelism: increases myopia

ii) temporary resource boom:

_dp

_>

₀

_and

_dp

₌

₀

- reduces extraction rate and increases efficiency if

iii) anticipated future resource boom:

dp

=

0

and

dp

>

0

0

)

(

''

'

e

≥

R

0

)

(

''

'

e

≥

R

- equilibrium extraction path change

endogenous effect of clientelism: increases myopia

- equilibrium extraction path change

endogenous effect of clientelism: decreases myopia

e 0 2 > ∆p E E ’

Future anticipated resource boom

0 2 > ∆p ) , (e p₂ L_P ) , , (L p₁ p₂ e _P L_P

permanent resource boom: p dp p dp p dp _{= =} 2 2 1 1

- public sector employment

Resource booms and resource allocation (I)

permanent resource boom: p dp p dp p dp _{= =} 2 2 1 1

- public sector employment

Resource booms and resource allocation (I)

- Private sector employment

Resource Booms lead to politically motivated expansions of the public sector :

- Gelb (1988): Nigeria

- Gavin (1993): Oil Boom in Nigeria from 1973 to 1987 and expansion of public employment

- Auty (1999) : Trinidad and Tobago - Gelb (1988): Ecuador and Venezuela

• Opposite extraction path effect and labor misallocation effect : • ex: permanent boom: - efficiency of extraction rate increases

- more labor in public sector

• Impact of resource booms on total income: ambiguous

Y

 21 − L

H  p

e

 p

R

e

• Opposite extraction path effect and labor misallocation effect : • ex: permanent boom: - efficiency of extraction rate increases

- more labor in public sector

• Impact of resource booms on total income: ambiguous

+

-

-Positive extraction path effect Negative reallocation effect +

Y

 21 − L

H  p

e

 p

R

e

 p

e

 p

R

 p

 p

R

_

− 2H

Resource curse ? (I)

Resource value increase

Resource booms and resource allocation (II)

• Negative reallocation effect stronger on public sector

when politician has more ability to influence political process through « patronage » redistribution

• Importance of institutions for resource curse :

Resource booms and resource allocation (II)

• Negative reallocation effect stronger on public sector

when politician has more ability to influence political process through « patronage » redistribution

• Importance of institutions for resource curse : Resource curse Weak institutions:

(subject to clientelism)

•

• Strong institutions No resource curse

Resource booms and resource allocation (II)

Positive effects of Resources on growth when institutions are good Consistent with Mehlum et al. (2006), Iimi (2007), Kolstad (2009) : • Negative reallocation effect stronger on public sector

when politician has more ability to influence political process through « patronage » redistribution

Price Volatility and Political Economy (I)

• Exogenous natural resource endowment: Z

(deterministic) p1  p1  0

• Intertemporal path of prices (p₁ , p₂) :

p2  p2   (stochastic)

ε: random variable defined on [-a,a]

p2  0

E  0 var  2

• Microfoundations of political competition (probabilistic voting): 2 groups of individuals A and B: size 1/2.

2 politicians: incumbent from group A / challenger from group B - Different preferences: private good/ group specific public good

voters of type A : uACt, Gt  Ct − A G−G_t 2 2 voters of type B : uBCt  Ct G  0 A  0

- concave public good utility: risk aversion for fiscal volatility

- group specific public good: fiscal volatility affects political turnover - quadratic specification : “certainty equivalent” forms

• Each politician cares about his own utility:

V

 R

− 

2

2

V

 R

R

• Productivity in private sector: H

• Productivity in public sector: 0, wage W

• : public sector workers decided by incumbent in period 1 credible commitment for incumbent in period 2

P

L

• Per-period Gvt budget constraints (no taxes):

(political patronage / clientelistic social networks)

No commitment for challenger (Robinson and Verdier 2012)

G1  R₁A  p1Z − WLP

G2A  R₂B  p2Z − WLP

G2B  R₂B  p2Z

• Probabilistic voting model :

_U

₍

_A

₎

_U

₍

_B

₎

+

σ

+

θ

>

σ

θ

− 1 2s , 1 2s 

−

,



• Probabilistic voting model :

_U

₍

_A

₎

_U

₍

_B

₎

+

σ

+

θ

>

σ

θ

- period 1: - Incumbent chooses:

- winner implements ex post optimal rent - realization of the price shock ε

- production, consumption and public good provision

(

)

P

G

R

L

,

,

- period 2: - political competition:

(

)

R A G₂ ( ), ₂

(

)

−

,



R

• Credible policies: backward induction

Equilibrium Policies in period 2 (I)

- If politician of type B is elected : Period 2:

G₂B  0

No public jobs

• Credible policies: backward induction

Equilibrium Policies in period 2 (I)

- If politician of type B is elected : Period 2:

G₂B  0

No public jobs

consume all the rent p2Z

- For incumbent of type A:

G2A  max p2Z − R₂A − WLP;0 Public jobs: L_P

max

R

− 

E

We will consider only regimes where G₂(A) > 0 for all realizations of p₂ Choice of R₂A _:

max

R

− 

− 

Z

• Incumbent of type A maximizes expected utility:

EG₂AA  p2Z − R₂A −WLP

with

max

R

− 

− 

Z

- Optimal level of incumbent's rent : - Provision of the public good A :

R₂A  p2Z − WLP  1

A − G

G2A  p2 − p2Z  G − 1

A

Equilibrium Policies in period 2 (II)

max

R

− 

− 

Z

• For incumbent of type A:

EG₂AA  p2Z − R₂A −WLP

with

- Optimal level of incumbent's rent : - Provision of the public good A :

R₂A  p2Z − WLP  1

A − G

G2A  p2 − p2Z  G − 1

A

• Assumptions for an interior solution: R₂A  0 and 0  G₂A  G

aZ  min 1 A ;G − 1 A

p

Z

−

 G −

Equilibrium Voters Utilities (I)

• Voters of type A: - Utility benefit of average public good provision • Period 2 expected utility of private sector voters:

U₂AA  H − 1 2_A − A2 2 Z2 and U2AB  H − A 2 G 2 U₂BB  U₂BA  H A 2 G 2 − 1 2A  0

- Fiscal volatility cost related to fluctuations of resource income p₂Z

− A₂2 Z2

• Assume volatillity not too high : U₂AA  U

2

• Expected utility for public employees in group A :

U

A  W −

−

Z

and U

B  H −

G

• Again when volatility not too high :

_U

A  U

L

B

Election probability (I)

• group B voters:

- Post-election income independent of election outcome: - Support incumbent A: ⎟ ⎠ ⎞ ⎜ ⎝ ⎛ + = sθ N_B 2 1 2 1

0

>

+

θ

σ

Election probability (I)

• group B voters:

- Post-election income independent of election outcome: - Support incumbent A: ⎟ ⎠ ⎞ ⎜ ⎝ ⎛ + = sθ N_B 2 1 2 1

0

>

+

θ

σ

[

]

(

)

[

]

(

)

• Election probability of incumbent: ⎭ ⎬ ⎫ ⎩ ⎨ ⎧ _{+ + ≥} = Π 2 1 Pr L A P A B N N N   Pr   ₂A G2 − 1 A 2 −  2_Z2 _{ W − HL} P ≥ 0

Election probability (II)

 LP, 2  1₂  h A 4 G 2 − 1 A 2 −  2_Z2 _{ W − HLP}

• Election probability of incumbent: ⎭ ⎬ ⎫ ⎩ ⎨ ⎧ _{+ + ≥} = Π 2 1 Pr L A P A B N N N   Pr   ₂A G2 − 1 A 2 −  2_Z2 _{ W − HL} P ≥ 0

• Depends positively on public employment L_P

Election probability (III)

 LP, 2  1₂  h A 4 G 2 − 1 A 2 −  2_Z2 _{ W − HLP}

• Relection probability of incumbent: ⎭ ⎬ ⎫ ⎩ ⎨ ⎧ _{+ + ≥} = Π 2 1 Pr L A P A B N N N   Pr   ₂A G2 − 1 A 2 −  2_Z2 _{ W − HL} P ≥ 0

• Depends negatively on volatility of the resource price - Type A voters suffer from fiscal volatility when incumbent reelected - Reduces political support of these voters.

- Economic volatility translates into political instability - (asymmetry between incumbent/challenger is crucial)

Election probability (IV)

 LP, 2  1₂  h A 4 G 2 − 1 A 2 −  2_Z2 _{ W − HL} P

Equilibrium patronage and Price Volatility (I)

• Period 1 problem of the incumbent:

max R₁A,G₁,L_P R₁A − A G − G1 2 2   LP, 2 p2Z − WLP  1 2A − G −  A2 2 Z2  1 −  LP, 2  − A 2 G 2 G1  R₁A  p1Z − WLP

Equilibrium patronage and Price Volatility (I)

• Period 1 problem of the incumbent:

max R₁A,G₁,L_P R₁A − A G − G1 2 2   LP, 2 p2Z − WLP  1 2A − G −  A2 2 Z2  1 −  LP, 2  − A 2 G 2 G1  R₁A  p1Z − WLP

under budget constraint :

Equilibrium level of public employment (patronage) :

L′ p2Z − WLP  _21_A − G − A_2 2 Z2  A 2 G 2 − W1    0

Marginal benefit of patronage Marginal cost of patronage

Equilibrium patronage and Price Volatility (II)

• Volatility reduces value to stay in power (marginal benefit) : V_power  p₂Z − WL_P  1 2A − G − A_2 2 Z2  A 2 G 2

Reduces political patronage L_P

Equilibrium patronage and Price Volatility (II)

- in general : ambiguous

• Volatility reduces value to stay in power (marginal benefit) : V_power  p₂Z − WL_P  1 2A − G − A_2 2 Z2  A 2 G 2

Reduces political patronage L_P

Equilibrium patronage and Price Volatility (II)

- in general : ambiguous

• Volatility reduces proba of reelection / expected cost of public jobs Increases political patronage L

• Effect of price volatility :

• Volatility reduces value to stay in power (marginal benefit) :

V_power  p₂Z − WL_P  1 2A − G − A_2 2 Z2  A 2 G 2

Reduces political patronage L_P

Equilibrium patronage and Price Volatility (II)

- in general : ambiguous

• Volatility reduces proba of reelection / expected cost of public jobs Increases political patronage L_P

• For our parametric specification: L_P with volatility when public wages are not too high (ie. W/H < 2)

/ Politician not too risk averse

Resource Curse and Volatility (I)

• Total expected wealth :

Y

 2H  p

Z

 p

Z

− 1  L

L

H

Expected resource cost of political patronage

Resource Curse and Volatility (I)

• Total expected wealth :

Y

 2H  p

Z

 p

Z

− 1  L

L

H

Expected resource cost of political patronage

Price volatility leads to a resource curse when political patronage increases

Moreover when average resource income is large enough, Negative effect is stronger, the weaker the institutions

(ie. )L′

Public Investment and Political Patronage (I)

• Extend the model to public investment/growth

- Curse not only through clientelistic policies but also

through crowding out of public investments (infrastructures/education) (Caselli (2006), Caselli and Cuningham 2010).

• Productivity of private sector : H1  H ; H2I  H  I

  0

 LP, I  min 1₂  h A 4 G 2 − 1 A 2 −  2_Z2 _{ W − H} 2I1 − LP ;1 • Prb of reelection :

Rent depends negatively on I

-+

Public Investment and Political Patronage (II)

∂2

∂L_P∂I

 0

Public investment reduces the effectiveness of political clientelism

Political patronage increases the cost of public investment on re-election proba

• First period problem of the incumbent : max R₁A,G₁,L_P,I R₁A − A G − G1 2 2   LP, I H2I1 − LP  p2Z − WLP  1 A − G − A2 2 Z2  1 −  LP, I  −  A 2 G 2

under the constraint : _{G  R}A  H 1 − L   p _Z − WL − I

• First period problem of the incumbent : max R₁A,G₁,L_P,I R₁A − A G − G1 2 2   LP, I H2I1 − LP  p2Z − WLP  1 A − G − A2 2 Z2  1 −  LP, I  −  A 2 G 2

under the constraint : G1  R₁A  H11 − LP  p1Z − WLP − I

−W  H

 − W  H

  

V

  0

−1  

V

  1 − L

  0

value to stay in power

−W  H

 − W  H

  

V

  0

Marginal cost Marginal benefit

Public Investment and Political Patronage (V)

• How is patronage affected by public investment ?

−W  H

 − W  H

  

V

  0

Marginal cost Marginal benefit

I

- ₊

L_P L_P

Public Investment and Political Patronage (V)

−W  H

 − W  H

  

V

  0

L

I

Marginal cost Marginal benefit

I

- ₊

+

-• Large enough value of resource income

_p

_Z

• Patronage and public investment are strategic substitutes L_P

L_P

L_{P L}

P

Public Investment and Political Patronage (V)

−1  

V

  1 − L

  0

Public Investment and Political Patronage (VI)

+

L_P

- +

-I

I _{I I}

• Large enough value of resource income

_p

_Z

• How is public investment affected by patronage ?

I

L_P E

Public Investment and Political Patronage

ILP

• Effect of price volatility : 2

• Effect of price volatility : - Political patronage LPI

2

1) Political turnover Expected cost of public jobs L_P

2) Fiscal volatility Value to stay in power L_P

• Effect of price volatility : - Political patronage LPI

2

1) Political turnover Expected cost of public jobs L_P

2) Fiscal volatility Value to stay in power L_P

- Public investment ILP

cost on expected

gains to stay in power 2) Fiscal volatility

I 1) Political turnover horizon for

public Investment I

• When public wage/sector not too large / politician not too risk averse

Public Investment, Political patronage

And the resource curse

increases with price volatility

political turnover effect dominates

LPI

ILP decreases with price volatility

• Volatility leads to resource curse :

magnification effects of interaction between public investment and patronage

I

L E

Public Investment, Political Patronage and Price Volatility

ILP

LPI

E’

Δ2 _{ 0}

Rent extraction, Politics and Price volatility (I)

• Extension with rent extraction: Z1  e Z2  Re R′  0 and R′′  0

• No public investment I : H1  H2  H

• Extension with rent extraction: Z1  e Z2  Re R′  0 and R′′  0

• No public investment I : H1  H2  H

• No taxation τ =0

• Proba of incumbent’s election:

• Proba of reelection increases with extraction rate e : Utility cost for voters of type A of price volatility

is reduced with lower stock of the resource in period 2.

Rent extraction, Politics and Price volatility (I)

LP, e  1₂  h A 4 G 2 − 1 A 2 −  2_Re2 _{ W − HLP}

Rent extraction, Politics and Price volatility (II)

• The effect of e on stronger when volatility parameter σ² larger :



e2

" _{ −h} A

• The effect of e on stronger when volatility parameter σ² larger :



e2

" _{ −h} A

2 ReR′e  0

• period 1 problem of incumbent:

max R₁A,G₁A,L_P,e R₁A − A G − G1 A 2 2   LP, e p2Re − WLP  1 2A − G −  A2 2 Re2  1 − LP, e − A 2 G 2

• Equilibrium extraction in case without patronage (ie. L_P=0) :

p  p R′e   V e,L  − A2ReR′e  0

• The effect of e on stronger when volatility parameter σ² larger :



e2

" _{ −h} A

2 ReR′e  0

• period 1 problem of incumbent:

max R₁A,G₁A,L_P,e R₁A − A G − G1 A 2 2   LP, e p2Re − WLP  1 2A − G −  A2 2 Re2  1 − LP, e − A 2 G 2

• Equilibrium extraction in case without patronage (ie. L_P=0) :

p1  p2R′e  eV_powere,LP − A2ReR′e  0

Political turnover effect Fiscal volatility effect Average price effects

Rent extraction, Politics and Price Volatility (III)

• Comparative statics on extraction rate e:

∂e∗

• Comparative statics on extraction rate e:

∂e∗

∂p1

 0

(when price volatility not too high)

∂e∗

∂p₂

 0

• Comparative statics on extraction rate e:

∂e∗

∂p1

 0

• Effect of :



p  p R′e   V e,L  − A2_ReR′e  0

Rent extraction, Politics and Price Volatility (III)

(when price volatility not too high)

∂e∗

• Comparative statics on extraction rate e:

∂e∗

∂p1

 0

• Effect of :



p1  p2R′e  eVpowere,LP − A2ReR′e  0

1) Increased political myopia e*

Rent extraction, Politics and Price Volatility (III)

(when price volatility not too high)

∂e∗

• Comparative statics on extraction rate e:

∂e∗

∂p1

 0

• Effect of :



p1  p2R′e  eVpowere,LP − A2ReR′e  0

2) Increased political

turnover effect e *

Rent extraction, Politics and Price Volatility (III)

(when price volatility not too high)

∂e∗

• Comparative statics on extraction rate e:

∂e∗

∂p1

 0

• Effect of :



p1  p2R′e  eVpowere,LP − A2ReR′e  0

3) Reduced value to

stay in power e *

Rent extraction, Politics and Price Volatility (III)

(when price volatility not too high)

∂e∗

Rent extraction, Politics and Price Volatility

• Comparative statics on extraction rate e:

∂e∗

∂p1

 0

• Effect of :



p1  p2R′e  eVpowere,LP − A2ReR′e  0

4) Increased fiscal volatility

effect e

*

Rent extraction, Politics and Price Volatility (III)

(when price volatility not too high)

∂e∗

• Comparative statics on extraction rate e:

∂e∗

∂p1

 0

• Effect of :



p1  p2R′e  eV_powere,LP − A2ReR′e  0

4) Increased fiscal volatility effect 3) Reduced value to stay in power 2) Increased political turnover effect 1) Increased political myopia +

+

+

-Price volatility not too strong

Rent extraction, Politics and Price Volatility (III)

e

∗

(when price volatility not too high)

∂e∗

Rent extraction, Politics and Price Volatility (IV)

• More agressive extraction in context of price volatility Van der Ploeg (2010) : social planner’s context /

modified optimal Hotelling rule Social optimum extraction path brought

• More agressive extraction in context of price volatility Van der Ploeg (2010) : social planner’s context /

modified optimal Hotelling rule Social optimum extraction path brought

forward by future price volatility • Here social utilitarian optimum :

max S  X1  1 2 uAC1A, GA1  1₂ uBC1B  E X2  1 2 uAC2A, GA2  12 uBC2B X1  G₁A  p1e X2  G₂A  p2Re p1  p2R′e −  A 2 2ReR′e  0

Optimum extraction brought forward by price volatility

Rent extraction, Politics and Price Volatility (V)

p₁  p₂R′e − ₂A 2ReR′e  0 (social optimum)

p₁  p₂R′e − ₂A 2ReR′e  0 (social optimum)

p₁  p₂R′e  eV_powere,LP − A2_ReR′e  0 (political eq.)

Political turnover effect

Fiscal volatility effect

p₁  p₂R′e − ₂A 2ReR′e  0 (social optimum)

p₁  p₂R′e  eV_powere,LP − A2_ReR′e  0 (political eq.)

Political turnover effect

Fiscal volatility effect

Over extraction of the resource under price volatility Inefficiency likely to increase with



Expected total wealth : Y  2H  p1e  p2Re

Resource curse associated to higher



Rent extraction, Politics and Price Volatility (VI)

• Analysis can be extended to positive political patronage (ie. L_P > 0)

−1  W  L′ Vpower   0

p1  eV_power  p2 − A2ReR′e  0

L

e

e

L E

Rent extraction, Politics and Price Volatility

L

e

L

e

shifted up with



eLP

• Effect of volatility:

e

L E

Rent extraction, Politics and Price Volatility

L

e

eLP

Δ2 _{ 0}

Rent extraction, Politics and Price Volatility (VII)

• At least one of the two policy variables: e* _{; L}* P

with price volatility

• Negative impact of price/fiscal volatility on income when both variables increase :

- over extraction / inefficient public employment

L

e

shifted up with



eLP

Conclusions (I)

• Political-economy models of the resource curse :

How political incentives interact with price shocks/volatility • Incumbent’s asymmetric capacity:

- Clientelism: inefficient redistribution through public jobs tool for influencing people's political behavior. • Resource booms create underdevelopment

not because of inefficiency in rate of resource extraction But because of political redistribution of the rents.

• Political-economy models of the resource curse :

How political incentives interact with price shocks/volatility • Incumbent’s asymmetric capacity:

- Clientelism: inefficient redistribution through public jobs tool for influencing people's political behavior. • Resource booms create underdevelopment

not because of inefficiency in rate of resource extraction But because of political redistribution of the rents.

Public policy volatility voters’ perceptions political turnover • Resource volatility Incumbent’s Public policies Resource allocation Redistribution

Conclusions (I)

- Limited public instruments : risk shifting to voters

- Asymmetric effects on constituencies between incumbent/challenger

- Limited public instruments : risk shifting to voters

- Asymmetric effects on constituencies between incumbent/challenger

« bad » incumbent’s policies

political channel for volatility curse volatility

• Extensions: - The role of Liquidity constraints/ Financial frictions - Debt policy

- Other public policies

- Nontraded\ traded goods: « Political » Dutch disease ? - Limited public instruments : risk shifting to voters

- Asymmetric effects on constituencies between incumbent/challenger

Conclusions (II)

« bad » incumbent’s policies

political channel for volatility curse volatility