The effects of changes in the price and availability of natural resources have dominated the world economy in the last decade. Oil- and other resource-based booms have administered severe shocks to the economies of both resource-poor and resource-rich countries. Economic theory has correctly predicted the effects of these booms, argued Programme Director J Peter Neary at a lunchtime talk on April 14. Neary emphasized that a country's economic performance following a resource boom is not pre- ordained: it also depends to a considerable extent on the policies followed by its government. Even small economies, Neary stressed, have considerable influence over their own economic performance. But much of the evidence suggests that governments have rarely exercised this influence wisely.

The lunchtime meeting marked the publication of CEPR's latest book, Natural Resources and the Macroeconomy, edited by Neary and CEPR Research Fellow Sweder van Wijnbergen, a Senior Economist at the World Bank. The volume is the result of a June 1985 conference organized by the Centre, with the support of the Ford Foundation. The conference brought together academic economists and policy-makers with experience of the effects of resource- based booms and attempted to combine the insights provided by the theoretical models of the Dutch Disease with the evidence available from case studies of particular countries during the last fifteen years.

Neary first outlined some of the issues of particular interest to policy-makers which were addressed in Natural Resources and the Macroeconomy.

Can economic theory predict the effects of resource-based booms? Yes, argue Neary and van Wijnbergen in the book's introductory survey. The theory predicts that oil discoveries and other resource-based booms will lead to exchange rate appreciation and 'deindustrialization', the so-called 'Dutch Disease'. This theoretical prediction is broadly consistent with recent experience.

Neary and van Wijnbergen point out that a resource boom can affect the structure of the economy in two ways. The first is the 'spending effect': higher domestic incomes as a result of the boom lead to extra expenditure on both traded and non-traded goods. The resulting increase in the price of non-traded (relative to traded) goods causes the output of the traded-goods sector to decline. A second effect emerges if the booming sector shares domestic factors of production with other sectors, so that the boom bids up the price of these factors. The resulting 'resource-movement effect' reinforces the tendency towards appreciation of the real exchange rate (defined as the relative price of non-traded to traded goods). The result is a squeeze on the tradeable goods sector. These predictions are common to most models of the Dutch Disease and have been observed in a variety of countries.

In addition to its effect on sectoral structure, a booming resource sector has often been identified as one of the causes of unsatisfactory macroeconomic performance. Neary and van Wijnbergen examine how this can arise through real or nominal rigidities in the economy. They conclude that unemployment could be avoided through a moderately expansionary monetary policy which provides enough liquidity to accommodate the boom.

How do developing countries' governments react to resource windfalls? Alan Gelb (The World Bank) discusses this question in the light of the 1970s experiences of resource-rich developing countries. Their windfall revenue gains amounted to 25% of non- oil GDP and accrued mainly to governments. The revenues were used mainly to finance domestic and public capital formation, and this propensity to devote a large proportion of their resource revenues to investment, especially in downstream activities such as refining and petrochemicals, tended to offset the Dutch Disease symptoms predicted by the theory. The investment, however, was plagued with problems and contributed very little to growth in the non-oil economy. The evidence suggested to Gelb that these countries could have obtained more benefits if they had limited domestic investment and instead invested a higher proportion of the windfall abroad.

Did developed countries fare differently? Countries such as the Netherlands and the United Kingdom appeared better able to cope with the disruptive effects of the development and exploitation of natural resource discoveries, partly because oil and gas played a relatively modest role in these economies. The evidence presented in the book suggested that during the resource booms other factors were already present which tended to increase wage costs and reduce competitiveness: the booming resource sector only reinforced this tendency. Jeroen Kremers (Nuffield College, Oxford) argued, for example, that the government's use of the windfall revenues was crucial to the course of the Dutch disease in the Netherlands. Increased government revenues from gas merely reinforced an existing trend towards increased public consumption and transfer payments. During the 1970s (as theory would predict) there was a squeeze on profitability in the Dutch traded-goods sector, due to the strong guilder, upward wage pressure and increasing energy prices. Profit margins absorbed the pressure at first, but significant reductions in output and employment followed. Government subsidies were provided to industries in the traded-goods sector. Some of these industries now appear to have a healthy future: to this extent the policies were successful. The decline in the traded-goods sector had also contributed to a sharp rise in unemployment, but government policies to alleviate this had been less effective.

In another chapter, Peter Forsyth (Australian National University) compared the effects of the UK oil boom and the minerals boom in Australia. In the United Kingdom the 'spending effects' dominated, while in Australia the resource movement was more important. The effects of the boom on government revenue have been important for the United Kingdom but less so for Australia. Forsyth concluded that the theoretically optimal response to such a revenue windfall would involve increased public investment, a lowering of other taxes and perhaps a rise in public consumption. Macroeconomic factors make it difficult to judge whether the UK government's response to its increased revenues approximated to the optimal one, but it seemed likely that not enough of the revenues had been invested.

Neary noted in his talk that Natural Resources and the Macroeconomy deals with the unsatisfactory performance of oil- exporting economies following the oil price hikes of 1973 and 1979. Yet the lessons of the book are equally relevant today, when oil prices are falling, he argued.

The evidence in the book suggests that government behaviour is a key determinant of an economy's response to a boom. Neary observed that perhaps surprisingly the key issue is not whether the additional government revenues were devoted to consumption or investment. The increased share of public consumption and transfer payments in the Netherlands was indeed a major contributory factor to the Dutch Disease on its home ground. But even less satisfactory economic performance was exhibited by a representative sample of less developed countries, in which over 75% of the post-1973 oil windfall was devoted to public investment! Unfortunately, the capacity of these countries to absorb such massive shifts in investment patterns seems to have been limited. The outcome was a dismal record of cost overruns, missed completion dates and a failure of the projects to contribute to continued growth in GNP.

The other key lesson of many of the contributions to the book was the importance of flexibility of factor markets and industrial structure. Inflexibility in public investment planning was again a major problem: many development programmes initiated in the mid-1970s ran into trouble before the second oil price boom of 1979, and the subsequent oil price slump and world recession has proved disastrous for them. Public subsidies to oil consumption led to increased rather than reduced dependence on energy. They have proved expensive to maintain but difficult to discontinue as oil prices fell.

Neary concluded his talk with a discussion of the implications of the analysis for a world with oil at $10 per barrel. Can oil exporters now expect to benefit from a 'Dutch Cure'? His short answer was no. At worst, the Dutch Disease was a lost opportunity, at best the recent fall in oil prices must lower the real income of net oil exporters. Neary predicted that nevertheless, some sectors will benefit even in the most oil- dependent countries. Slack labour markets and softening exchange rates would be observed. This would reflect a deterioration in overall economic performance but might also encourage a pro- industrialization mini-boom. The one sector sure to suffer, according to Neary, is the public sector, and much depends on how governments respond to their worsening budgetary situation. Only by adapting to the changed environment and encouraging (or not discouraging) flexibility in the private sector can they hope to minimize the harmful consequences of the third oil shock.

Natural Resources and the Macroeconomy, edited by J Peter Neary and Sweder van Wijnbergen, is published by Basil Blackwell at #29.50 (ISBN 0631 150870). It is published in the United States by MIT Press, and is available for $35.00. It contains the proceedings of a conference on the structural and macroeconomic consequences of resource-based booms, held at the Centre for Economic Policy Research, London, in June 1985 with the support of the Ford Foundation.