Commodity exporters can transform their resource curse into a blessing

By virtue of their rich natural resources, commodity-exporting developing economies ought to be able to manage their fiscal books comfortably. It’s true that gyrations in commodity prices can be difficult to handle, but having ample revenue-generating resources must surely be better than having none. 

The reality is quite different. The two-thirds of developing economies that rely on commodity exports are prone to crippling boom-bust cycles associated with sharp movements in commodity prices. Their fiscal policies can inflict additional damage, setting in motion a long-term deterioration in debt and budgetary balances. 

Swings in commodity prices often spur governments of commodity-exporting developing economies to adopt policies that exacerbate boom-bust cycles. These policies ramp up public spending when commodity prices rise and keep spending high even when prices and revenues fall. In other words, fiscal policy in these economies tends to be highly procyclical—expansionary in good times and contractionary in bad times. Over the past four decades, this procyclicality has been about 30 percent stronger in commodity-exporting developing economies than in others (Figure 1A). 

Fiscal policy also tends to be more volatile in commodity exporters than in commodity importers—about, on average, 40 percent more volatile (Figure 1B). Swings in commodity prices often result in large fluctuations in commodity-related fiscal revenues in these economies. This, in turn, leads to more volatile business cycles, which historically move in tandem with cycles in commodity prices. Not surprisingly, fiscal policy volatility ends up acting as a transmission channel for the “resource curse”—the notion that commodity abundance, if not managed properly, can damage overall growth.

Figure 1. Fiscal policy: more procyclical and more volatile in commodity-exporting developing economies

^{Sources: Arroyo Marioli and Végh (2023); Arroyo Marioli, Fatas, and Vasishtha (2023); International Monetary Fund; World Bank.} 

^{A. Bars show average correlation between the (HP-filtered) cyclical components of real GDP and real government spending within groups. The sample period is 1980–2020. The sample of commodity-exporting emerging market and developing economies (EMDEs) includes 38 agricultural, 21 metal, 31 energy exporters, and 59 commodity importers. The difference between the average correlation for commodity exporters, energy exporters, and commodity importers is statistically significant at the 10 percent level or better.}

^{B. Simple averages, by country group, of the standard deviations of the residuals obtained from regressing two dependent variables—log differences of real government consumption and real primary expenditures—on real GDP growth. Annual data for 148 EMDEs over 1990–2021.}

Procyclicality and volatility of fiscal policy can intensify boom-bust cycles and exert a chronic drag on economic growth in commodity exporters. Because of its procyclical nature, fiscal policy in the average commodity-exporting developing economy works to aggravate the impact of commodity-price shocks on output. 

This is precisely the opposite of what happens in commodity-exporting advanced economies— where fiscal policy tends to reduce the impact by reacting countercyclically. For example, over the 2003–08 commodity-price boom, more than three-fourths of the difference in growth between major commodity-exporting developing and advanced economies can be explained by the difference in the cyclicality of fiscal policy between the two groups of countries (Figure 2A). Fiscal policy volatility also reduces output growth by exacerbating macroeconomic volatility in commodity-exporting developing economies. 

Which policy interventions can help improve the quality of fiscal policy? Exchange-rate flexibility, the adoption of fiscal rules, and fewer constraints on international financial transactions can all help lower fiscal policy volatility. If the average commodity-exporting developing economy were to adopt the policies of an average advanced economy in these three areas, it could add about 1 percentage point in per capita growth every four to five years (Figure 2B). 

Figure 2. Procyclicality and volatility amplify business cycles and hurt growth

^{Sources: Arroyo Marioli and Végh (2023); International Monetary Fund; World Bank.}

^{Note: AE = advanced economy; EMDEs = emerging market and developing economies. The use of the terms “rain” and “pours” is based on the analogy of Kaminsky, Reinhart, and Vegh (2004).}

^{A. The orange bars (the “pours” component) represent the fraction of the change in GDP in response to a commodity price shock, explained by the reaction of fiscal policy to the shock, averaged at the aggregate level. The red bars (the “rain” component) show the direct effect of a commodity price shock on GDP.}

^{B. The middle column in the panel illustrates how applying the average advanced-economy policies along three dimensions (exchange rate regimes, capital account openness, and fiscal rules) impacts GDP per capita growth in the average commodity-exporting EMDE. The last column shows the total commodity-exporting EMDE growth with these advanced economy policies.} 

Over the past three decades, a growing number of developing economies—especially commodity exporters—have adopted fiscal rules and established sovereign wealth funds (SWFs) to help build buffers during commodity-price booms to prepare for any subsequent slump in prices (Figure 3A). Some have also adopted medium-term expenditure frameworks to improve fiscal discipline. These frameworks have been most effective in mitigating fiscal policy volatility and procyclicality when they are well-designed and supported by strong institutions. For example, Chile and Norway have successfully managed their commodity exposure due to their rigorous fiscal frameworks and strong institutions, offering lessons for other resource-dependent economies (Figure 3B).

Figure 3. Fiscal rules and sovereign wealth funds can mitigate boom-bust cycles

_{Sources: Arroyo Marioli and Végh (2023); Davoodi et al. (2022); International Monetary Fund; PRS Group (database); Sovereign Wealth Fund Institute; World Bank.}

_{Note: EMDEs = emerging market and developing economies.}

_{A. Number of emerging market and developing economies with fiscal rules and SWFs (sovereign wealth funds).}

_{B. The institutional quality indexes give higher scores to countries with better metrics. “EMDEs” shows the simple average of 68 commodity-exporting countries across the three indicators from 1990-2019. The correlation is calculated between the GDP and the real government expenditure of a country after using the Hodrick-Prescott filter to remove the trend component of the time series.} 

In the years ahead, the challenges associated with volatile and procyclical fiscal policies are likely to be compounded by sharp fluctuations in commodity prices as the impact of climate change on commodity markets becomes more pronounced. The persistence of procyclical and volatile fiscal policies would harm growth and impede progress in achieving development goals, including climate objectives. 

Possessing rich natural resources should not be a liability. Commodity-exporting developing economies have a full menu of options available to better manage their fiscal policies and enjoy stronger and more stable growth outcomes. They should make use of it.