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OIL AND GAS DISCOVERIES KICKSTART FOREIGN INVESTMENT BONANZA

  • Published Date: April 2017

‘Resource blessing’ as expectations of growth bring outside investors to developing countries

Countries that announce natural resource discoveries experience a boom in foreign direct investment (FDI), which can accelerate development even before the resources are extracted. That is the central finding of research by Gerhard Toews and Pierre-Louis Vézina, to be presented at the Royal Economic Society's annual conference at the University of Bristol in April 2017.

When discoveries of resources such as oil and gas are made, it takes five years on average before production starts. Much previous research has focused on adverse effects of the ‘resource curse’ of development, but the authors of the new study find that expectations of future growth in the economy following a discovery attracts investment from outside in manufacturing, business services, construction and retail, which drives the business cycle.

The research finds that, in these cases, the number of FDI projects increases by 37% and the number of jobs created increases by 68%. This FDI is also associated with transfers of technology, skills and higher wages. The authors add: ‘These new projects can diversify the economy, increase capabilities and hence provide a window of opportunity for a growth takeoff.’

More…

Giant oil and gas discoveries lead to foreign direct investment (FDI) bonanzas. FDI in non-extractive sectors increases by 73% in the two years following a giant discovery. These FDI waves are driven by new projects, in new sectors, from new source countries. What's more, the effect is stronger in poor countries with weak governance.

The natural resource price boom of the 2000s and the accompanying discoveries, many of them in sub-Saharan Africa, revived economists’ interest in the effects of resources on development. A recurrent theme in the research literature is that natural resources, notably oil, may be a curse rather than a blessing for developing countries.

While recent contributions have suggested that newfound resource wealth may lead to ‘Dutch Disease’ and premature deindustrialisation, this paper points to another mechanism at play in the short run in developing countries. As discoveries precede production by five years on average, they create expectations of future growth that can drive the business cycle notably via investment.

Giant oil and gas discoveries act as news shocks, creating expectations of future wealth and driving an influx of simultaneous investment in many sectors. The researchers find that the number of FDI projects increases by 37%, the number of sectors and source countries increase by around 20% and the number of jobs created increases by 68%.

Breaking down FDI by business activity, there are strong FDI effects in manufacturing, business services, construction and retail. These new projects can diversify the economy, increase capabilities, and hence provide a window of opportunity for a growth takeoff. This is because FDI is a key part of economic development. It is associated with transfers of technology, skills and higher wages, as well as with backward and forward linkages with local firms.

These results on FDI bonanzas shed new light on the research literature linking natural resources and development, especially since that work has mostly argued that newfound resource wealth may lead to premature deindustrialisation in developing countries.

In terms of policy implications, the research highlights that a giant resource discovery provides a growth opportunity via FDI diversification and this opportunity needs to be seized at the same time as the country prepares for future resource revenues.

The FDI bonanza of new projects, in new sectors, from new source countries is also an opportunity to avoid Dutch Disease pitfalls as it creates a more diversified economy.

Last but not least, it is worth keeping in mind that this bonanza is not permanent and capital flows can be volatile.

ENDS


‘Resource Discoveries and FDI Bonanzas’
Gerhard Toews & Pierre-Louis Vézina
OxCarre Working Papers 177, Oxford Centre for the Analysis of Resource Rich Economies, University of Oxford