The impact of natural resources on economic welfare: Cross-country analysis with a focus on Indonesia

Abstract

The objective of this research is to provide empirical evidence regarding the nature of the relationship between natural resource rents and economic welfare. Firstly, this relationship is examined in 144 countries from 1996 to 2016; then the relationship is analysed for different groupings of these countries, based on their level of natural resource revenue as a share of total fiscal revenue and in terms of per capita income. Employing fixed-effect regression for panel data, three major auxiliary variables are included in the analysis—institutional quality, foreign direct investment (FDI) and industry value added (IVA). Due to their potential significance for the relationship between natural resource rents and economic welfare, these are analysed as both independent and moderator variables. The study is then extended to focus on one resource-rich country (RRC): Indonesia. Not only is Indonesia endowed with abundant natural resources, but it has also been posited as an example of a country that has overcome the ‘resource curse’—the failure of many RRCs to benefit fully from their natural resource wealth (Hanif & Bria, 2016; Rosser, 2004, 2007). Conversely, some studies claim that the resource curse does exist in Indonesia (see Hanafi & Martawardaya, 2015; Putra & Widodo, 2013). The analysis presented in this thesis comprises a time series regression analysis and a qualitative analysis based on primary data from key informant interviews. The results from the broad sample of countries suggest that, although rents generated from natural resource sectors have contributed positively to economic welfare, as measured by adjusted net saving (ANS), these rents have a conditional link to economic welfare. A focus on RRCs further demonstrates this ambiguous relationship; several models demonstrate no significant association. Following segregation of the RRCs according to per capita income levels, it became evident that a negative association between rents and economic welfare appears to exist in low and lower-middle income RRCs. In upper-middle income RRCs, natural resource rents are likely to have no association; and, in high-income RRCs, they appear to have a positive association with economic welfare. This study also found that IVA and some dimensions of institutional quality have significant positive effects on economic welfare and moderating effects on the relationship between natural resource rents and economic welfare. FDI was found to be significant only when treated as a moderator variable for the whole sample group and in the high-income RRCs; it had no effect in the remaining groups. These findings suggest that FDI, institutional quality and IVA do have an effect on the resource-welfare relationship. However, it is necessary to consider the particular characteristics of each country, such as natural resource productivity and income level. For Indonesia, the quantitative results indicate that it is difficult to determine the role of natural resource rents in relation to economic welfare; the estimated coefficient signs in the regression equations exhibited inconsistency. This ambivalent finding is supported by the qualitative results; interviewees suggested that the contribution of natural resources was beneficial in supporting economic growth, but not yet able to increase economic welfare. When treated as a moderator variable, FDI in Indonesia exhibits a weakening effect on the resource rents–economic welfare relationship. The qualitative results support this finding; some interviewees suggest that FDI generally favours only an exclusive group of people. The qualitative aspect of the research, comprising interviews with both government and non-government officials, suggests that strengthening the quality of institutions and encouraging the creation of increased IVA should be two key foci, if the Indonesian government is to guarantee that rent generated from the natural resource sector contributes to economic welfare. The key relevant dimensions of institutional quality are accountability, rule of law, control of corruption and regulatory quality, particularly in relation to contract transparency. In terms of creating increased IVA, current government policy regarding adding value to industry products must be maintained and improved, because this has a significant positive effect on the contribution of natural resource rents to economic welfare. This study also recommends that regulation relating to natural resources revenue-sharing must be improved, particularly in terms of the revenue-sharing allocation in the regional budget. This study recommends the formulation of new regulation to mandate natural resource revenue allocation for conservation and poverty alleviation activities, for those communities closest to resource exploitation source areas. Improvement in the natural resource revenue-sharing formula is also required to favour such areas.