Ghana’s oil discovery: Lessons from Nigeria

Tuesday, January 18, 2010 

By Olajide Damilola

THE news filtered around the international media recently that Ghana will
start pumping its oil, estimated to be a minimum of 1 billion barrels in
reserve. However, this news has been met with both joy and fear. Joy
because this means Ghana now joins the league of oil producing countries,
with the attendant streams of petrol Dollar in revenue.

There is the fear of the so-called oil resource ‘curse’ or the paradox of
plenty – often used to describe a situation in which countries blessed
with abundance of natural resources such as oil tend to have worse
economic and development outcomes. This economic phenomenon is sometimes
called the Dutch disease.

Macroeconomics traditionally offers some insights into how the ‘blessing’
of abundant natural resources might turned into a ‘curse’ overtime. This
may occur when the revenue from oil exports initially leads to increase in
real exchange rate and wages. This increase in turn will eventually damage
the other productive or tradable sectors of the economy, such as the
agriculture and manufacturing, as they become less competitive in world

On the government front, the revenue from oil exports will more likely
result in higher government spending (e.g. on education, health, etc.),
but this is more likely to be financed through deficits in anticipation of
higher oil revenue that are vulnerable to vagaries in world oil prices.
Overtime, as the real sectors of the economy are exposed to international
competition, the revenue from oil also becomes volatile due to exposure to
global commodity market shocks, and this leaves the economy largely
dependent on oil revenue.

Yet it would be very naïve to jump to the conclusion that all resource
abundant countries are ‘cursed’. Whereas not all resource-rich countries
have experienced the resource ‘curse’ phenomenon, one wonders why
generally, the resource abundant countries (e.g. Nigeria, Sierra Leone,
Angola, and Venezuela are all resource-rich) seem to lag behind countries
with less resources (e.g. the Asian tigers: Hong Kong, Korea, and
Singapore are all resource-poor) in economic growth and development.

These diverging experiences have been associated with the quality of a
country’s institutions in managing the natural resource. The institutional
explanation focuses on how a country’s institutional arrangement shapes
the distribution of rents or the allocation of entrepreneurship between
productive and rent-seeking activities (grabbing) in the country. An
institutional arrangement can be producer friendly or a grabber friendly,
depending on relationship between rent-seeking and productive activities
in the polity.

Rent-seeking relates to gains through manipulation or exploitation of the
economic/political environment, rather than through economic transactions
that genuinely increase wealth through entrepreneurship. Thus, an
institutional arrangement is producer friendly when rent-seeking and
entrepreneurial (productive) activities are complementary. This means that
rent-seeking activities do not crowd out entrepreneurial activities.

It is a grabber friendly when these activities are competing. In this
regard, unproductive activities are beneficial, for example due to a weak
rule of law, ineffectual or malfunctioning bureaucracy, and the presence
of unstable or corrupt institutions. Hence, people expend extra resource
to gain access to the control of resources, which provides incentive to
easily divert actual or expected revenue stream from oil exploration
activities to unproductive activities.

With credible institutions however, resource abundance attracts
entrepreneurial resources into productive activities, implying higher
economic growth and development. In a grabber institutional environment,
natural resources abundance push aggregate income down, which makes
themajoring of the people worse off. More resources raise income and
people are better off when institutions are producer friendly.

The institutional approach described above supports the evidence showing
that the resource ‘curse’ phenomenon only occurs in countries with weak or
ineffectual institutions, whereas this does not appear to be so in
countries with credible institutional environment. Just as natural
resources remain a blessing for countries such as Botswana, Canada,
Australia, and Norway, the same cannot be said about countries such as
Nigeria and Venezuela.

To date, the Economic Freedom of the World index (EFW) provided by the
Fraser Institute, Canada, provides the most comprehensive, objective and
accurate measure of a country’s quality of institutions. This is measured
by the degree of economic freedom prevailing in the country, covering 141
countries of the world. The key components include security of property
rights, size of government, legal structure, access to sound money,
freedom to trade internationally as well as regulation of credit, labour
and business.

Each of these components are scored for each country to arrive at an
overall EFW index (ranging between one worst to 10 best) and the
associated rank of the country amongst 141 countries. The quality of
institutions in Ghana has improved considerably in nearly three decades,
with the overall EFX index increasing from 2.9 in 1980 to 7.0 in 2008,
representing an increase of 141 per cent. In relative terms (relative to
other countries), Ghana’s ranking has improved from the bottom 25th
percentile (105 of 141) in 1980 to the top 50th percentile (70 of 141) in

These figures are consistent with the average performance in resource-rich
but curse-free countries such as Botswana, Indonesia, Australia and
Norway. Ghana openness to international trade has been a major contributor
to this performance. Based on the evidence of Ghana’s performance in terms
of quality of institutions in the last three decades or so, it is less
likely that Ghana will suffer from resource ‘curse’, compared to countries
such as Venezuela and Nigeria.

No doubt, the discovery of oil will put the Ghana’s institutional
arrangements to test, which should be a key source of fear. This is the
fear that the quality of existing institutions might become unsustainable
as it happened in Venezuela, where the discovery of oil appears to have
actually destroyed quality of her institutions overtime. Venezuela’s rank
declined from the top 10 per cent in 1980 to the bottom two per cent in
2008, ranking only better than Angola and Zimbabwe on the EFW ranking.
Nevertheless, the cost of starting a business and associated bureaucracies
is still high in Ghana relative to other resource rich but curse-free
countries. Also, Ghana still ranks relatively lower (less than 5.0) in a
few labour market indicators and the integrity of the legal system.

Thus, it is suggested that oil exploration should be matched with policies
aimed at improving these low ranked areas, coupled with efforts to sustain
the quality of existing institutions, including openness to international
trade, labour, credit, and business regulations, and the size of
government. In other words, for Ghana to escape the ‘curse’, its oil
discovery should be matched with improving and sustaining the quality of
its institutions.

• Dr. Olajide is a Senior Research Fellow with Initiative for Public
Policy Analysis, a public policy think tank in Lagos.