On the looting of nations

JEL Classification O 0 1 2 3 O 0 1 2 3 O 0 1 2 3 0 C. Meissner Department of Economics, University of California , Davis, CA 95616, USA 1 E. Bulte Department of Economics, Tilburg University and Wageningen University , P.O. Box 8130, 6700, EW Wageningen, The Netherlands 2 M. Sarr ( ) School of Economics and Environmental Economics Policy Research Unit, University of Cape Town , Private Bag, Rondebosch 7701, South Africa 3 T. Swanson Department of Economics and Faculty of Laws, University College London , London , WC1E 6BT, UK We develop a dynamic discrete choice model of an unchecked ruler making decisions regarding the development of a resource rich country. Resources serve as collateral and facilitate the acquisition of loans. The ruler chooses either to stay in power while facing the risk of being ousted, or loot the country's riches by liquefying the resources through lending. We show that unstructured lending from international credit markets can create incentives to loot the country; and an enhanced likelihood of looting causes greater political instability, and diminishes growth. Using a treatment effects model, we find evidence that supports our predictions. - so their assets always exceed their liabilities, which is the technical reason for bankruptcy. And thats very different from a company. Walter Wriston (Citicorp Chairman, 19701984) 1 Introduction An extensive literature documents that resource wealth can be a curse rather than a blessing for many countries (Sachs and Warner 1995). There are at least three different explanations for this so-called resource curse. Reduced growth in resource-rich countries has been associated with (i) increased indebtedness (Manzano and Rigobon 2001), (ii) domestic conflict and political instability (Collier and Hoeffler 2004), and with (iii) autocratic regimes and poor institutions (Ross 2001; Isham et al. 2005). Clearly there are political and institutional dimensions to resource-related development problems that need to be unraveled. This paper contributes to that ambitious objective, by combining institutional and economic factors in modeling resource-rich economies. It commences from the observation that many resource-rich countries hold these resources as national assets (rather than under systems of private property rights) and thus present a situation where the ruling party or person finds itself immediately endowed with substantial rights to the states resource wealth upon taking political control. Where such control is relatively unchecked, this presents the new rulers of such states with an immediate decision regarding the exploitation of its political position. Should political control be converted into immediately available wealth, or should it be retained to generate some other positive payoffs for the leadership in the future? This is akin to the voluntary liquidationor lootingoption first modeled by Akerlof and Romer (1994) and discussed in the context of African economies by Bates (2008). Autocratic leaders who stay and invest in the development of such countries must first make the decision not to engage in immediate looting (see also Overland et al. 2005). When the incentives to stay and invest are inadequate, centralized autocratic regimes translate control into little other than a series of looting incidents. Thus it is the incentives for looting (rather than investing) that turn resource-richness into economic disaster. States evidencing long-standing looting behavior include countries such as Nigeria or the Democratic Republic of Congo (DRC), in which the disastrous economic and political performance can be easily traced to the ongoing predatory behavior of a series of autocratic regimes. Many economic and political studies list examples of such resource-inspired looting-type behavior (e.g., Jayachandran and Kremer 2006; Bates 2008). We are not the first to point to the importance of institutions in the explanation of the resource curse. There is plenty of evidence suggesting that institutional quality is one of the main drivers of economic development in general (Acemoglu et al. 2001; Rodrik et al. 2004), and it has been argued that the fates of resource-rich economies in particular are influenced by the quality of their institutions (Robinson et al. 2006; Mehlum et al. 2006). Our point is more specific. We argue that it can be a particular sort of interaction between domestic institutional weaknesses (centralized governance and unchecked autocratic decision making) and international institutional weaknesses (unstructured lending conditions) that might explain looting behavior and provide a better understanding of the resource curse. Specifically we demonstrate here that there is one set of institutional failures that can combine to create irresistible incentives for the looting of nations. These are: a) the existence of relatively undeveloped domestic democratic institutions (an absence of checks on the current ruler); b) the presence of nationally held resource rights (centralized economies); and c) the availability of relatively unstructured international lending by banks to such rulers (unconditional conferment of liquidity). As indicated above, the international capital market plays a crucial role in our story. We wish to examine in particular how excessive resource-based lending by external financial institutions can induce debt, default and regime change in developing countries. This sort of moral hazard in the financial markets leading to excessive lending to sovereigns has been noted previously (Bulow 2002).1 A casual look at the data confirms some basic findings highlighted in the literature. Figure 1 shows the evolution of average lending and resource rents between 1970 and 2000. The lending curve mirrors the resource rents curve. This supports earlier claims that international financial markets lend money during commodity booms and restrict liquidity during busts. The evolution of these two indicators is indicative of the boom-based borrowing capacity highlighted by Usui (1997), and Manzano and Rigobon (2001). We also are not the first to highlight the roles of international lending and indebtedness in reduced growth. Manzano and Rigobon (2001) find that the resource curse vanishes when controlling for indebtedness. Their argument is that large credits offered on resource-based collateral in periods of commodity boom resulted in substantial debt overhang when commodity prices fell in the 1980s.2 We agree with their analysis, and develop ours to elaborate and expound upon the mechanisms by which resource-based lending goes bad. The most fundamental cause of this problem is moral hazard: the international creditors, private and official, perceive no downside risk to lending on the basis of resource-based collateral. This is because lenders see little reason to exercise restraint in lending to resource-rich states, since the resources (and liabilities) remain behind even when the r (...truncated)