17 August 2020

Oil Wealth and Property Rights

In countries with significant oil wealth, economic and political power lies disproportionately with the oil elites. This has the effect of keeping property rights weak, which results in lower economic performance overall. The opposition is too weak to lead the way out of this “resource curse.” It is possible that international shocks, such as a pandemic, will tip the economic and political balance toward stronger property rights.

Key Issue

The “resource curse” literature suggests that natural resource wealth, especially oil wealth, has detrimental sociopolitical and economic effects, including low economic growth, poor governance, and political instability. However, the mechanisms through which these negative effects transpire are not yet fully understood. In particular, what is the role of market institutions as reflected in the protection of property rights, a fundamental prerequisite for sound markets and competition?

Approach and Methodology

This paper combines the “theory of the hierarchy and persistence of institutions” and “selectorate theory” to study how oil wealth affects property rights protection. It hypothesizes that higher levels of oil wealth lead to lower levels of property rights protection. This is because the oil elite will translate economic power gained from oil wealth into political power to push for weak property rights. In turn, weak property rights allow the elite to consolidate the existing status quo favorable to it by blocking potential challengers that would emerge due to competition and innovation under a regime characterized by strong property rights.

An empirical analysis of the relationship between oil and property rights uses a large sample of 156 countries between 1960 and 2014. Since weak property rights may also disincentivize innovation, competition, and long-term investment, thus “naturally” leading to a resource-extraction-heavy economy, instrumental-variable estimations using lagged oil reserves and unexpected oil discoveries as instruments are used to account for endogeneity.

Key Findings and Conclusions

The main result of this analysis is that higher levels of oil wealth result in weaker property rights. In line with theoretical predictions, it can also be shown that oil wealth leads to clientelistic policies favoring the selectorate, e.g., in the form of corrupt exchanges. This reflects the ways and extent to which the elite can buy off the selectorate. At the same time, those in opposition to the oil elite (the non-selectorate) are found to experience punitive policy reactions, e.g., in the form of exclusion from state jobs and business opportunities. Given the politico-economic advantages of self-interested elites favoring weak property rights, there are no easy solutions to overcome this variant of the “resource curse,” even though weak property rights will likely undermine overall macroeconomic performance.