Volatility, Financial Development and the Natural Resource Curse

Abstract

Cross-country evidence is presented on resource dependence and the link between volatility and growth. First, growth depends negatively on volatility of unanticipated output growth independent of initial income per capita, the average investment share, initial human capital, trade openness, the national income share of natural resource exports and population growth. Second, the adverse effect of resources on growth operates primarily through higher volatility. The positive effect of resources on growth is positive, but can be swamped by the indirect negative effect through volatility. Third, with well developed financial sectors, the resource curse is less pronounced. Fourth, landlocked countries with ethnic tensions have higher volatility and lower growth. Fifth, restrictions on the current account lead to higher volatility and lower growth, but capital account restrictions lower volatility and boost growth. These effects are especially strong in resource-rich countries. We also present IV-estimates to correct for the endogenous nature of investment rates and panel estimates to allow for possible changes in explanatory variables over time. Our key message is that the volatility is a quintessential feature of the resource curse.

Keywords: ethnic tensions, financial development, growth, landlocked, openness, resource curse, restrictions on current and capital account, volatility

JEL Classification: C12, C21, C23, F43, G20, O11, O41, Q32