The paradox of wealth: East Timor’s coming struggle with the resource curse 31/10/00 By Lee Seymour

Researcher North-South Institute Ottawa, Ontario CANADA

lseymour@nsi-ins.ca Tel: 1 613 241-3535 x 266 Fax: 1 613 241-7435

Last week in Dili, delegates from the Australian government and the United Nations Transitional Administration in East Timor (UNTAET) opened negotiations on the division of royalties from oil and gas revenues from the Timor Sea Zone of Cooperation.

Oil is being regarded as a panacea for Timor’s woes. For a poor, subsistence economy facing inflation, shortages of basic consumer goods, 70 per cent unemployment, a ruined infrastructure and dependent on the handouts of international donors, a potential windfall oil income of $150 million per year within a decade has raised already high expectations. And for aid and development agencies that expected to be permanently engaged in Timor, petroleum reserves present an opportunity to transform the country into a model of self-sustaining, small-state development.

Amidst such optimism, however, there has been a short-sighted lack of attention to the paradoxical danger that, far from being a blessing, oil revenues are a potential curse on the fledgling country’s economic, social and political development. Resource abundance is consistently and persuasively associated with low levels of economic and human development, the aggravation of social tensions, poor governance and an increased likelihood of violent conflict.

The perils of the resource curse are by no means inevitable. But if East Timor is to avoid the fate of countless other states for which resource wealth has been associated with a host of ills (think Angola, Sierra Leone, Equatorial Guinea, Nigeria and Venezuela…), the current nation building exercise must give forethought to the challenges of the coming oil bonanza.

In order to understand the dangers ahead, consider some of the hazards associated with oil-dependent development and resource abundance more generally. The economics of the “resource curse” are simple, if counter-intuitive. “Dutch disease” is a term used by development economists to diagnose an all too familiar set of inter-related symptoms: rapid inflows of foreign exchange appreciate the country’s exchange rate, erode the competitiveness of industries subject to international competition and promote current account deficits, accelerate inflation, distort investment and policy patterns, and generally link the economy to fluctuations in commodity prices (or, as in present-day Mozambique and to a lesser extent East Timor, the whims of aid donors who infuse large amounts of capital into devastated economies). Thus, rather than generating prosperity, resource revenues have the perverse effect of stunting broad-based and sustainable development.

Oil-led growth also tends to exacerbate social cleavages. Income inequality is often associated with resource dependence, and such economies also have much lower levels of “social capital”, or the productive social cohension that facilitates sustainable social and economic development. Rising, and often unfounded, expectations for the better days of “black gold” are seldom met.

In the political realm, the corrupting effects of wealth can weaken fragile institutions. Elites succumb to the temptations of gross corruption and patrimonialism perverts political systems in ways that erode the quality of governance. And even where intentions remain pure and structures exist to promote the transparent allocation of the oil rent, public pressures link government spending and investment to the highest oil prices. When prices inevitably fall, governments run deficits, and expensive investments must be abandoned and their costs sunk into growing public debt.

Perhaps most worrying for East Timor is recent research linking resource dependence to not only underdevelopment, but violent conflict. Countries with large numbers of unemployed young males, little education, and large levels of resources ­ three factors prominent in East Timor ­ are especially prone to conflict.

This gloomy picture raises the question of whether or not Timor can escape the resource curse. Here, there are no clear answers. Timor is clearly insulated against some of the risks of its coming oil windfall. Use of the US dollar mitigates against currency appreciation (but raises a whole other set of constraints…) A wracked infrastructure and low-levels of human capital imply that the economy can absorb relatively high levels of productive investment. Further, the agricultural sector is set for strong recovery and, along with the promotion of tourism and support for small and medium enterprises, will support economic diversification.

Ominously, however, ethno-religious tensions are high. Sometimes violent factionalism within the former resistance movement is stunting the development of a pacific civil society. Unemployment will persist into the foreseeable future. Understandably, the Timorese are restless and expect both UNTAET and its successor East Timor government to provide immediate, tangible improvements that may not be forthcoming.

Despite the ambiguity surrounding Timor’s future, Timor’s capacity to manage oil-led development can be enhanced if present policies are explicitly framed with the risks of resource dependence in mind. Pending resolution of negotiations between Australia and UNTAET to determine revenue sharing, long-term planning must begin to determine the allocation of a budget surplus that could reach $90m if anticipated royalties reach $150m per year by 2010. Here, emphasis should be placed on a stabilization fund to guard against oil price volatility, support for the private sector, as well as investments with high social returns, particularly those in infrastructure and human capital, with emphasis on health and education. In addition to prudent economic management, support for democratic, accountable governance is imperative. UNTAET’s efforts with the Timorese to build capacity in public administration, promote the rule of law and encourage a healthy civil society will help put checks in place against the corrupt politics that accompany rapid financial inflows.

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