## An Alternative Explanation for the Resource Curse: The Income Effect Channel

_IMF Working Papers, May 1, 2009_

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## Bibliographic details
- Authors: Ali Alichi, Rabah Arezki
- Published: May 1, 2009
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451872590.001

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### Summary and main finding
- The paper provides an alternative explanation for the "resource curse" based on the income effect resulting from high government current spending in resource rich economies.
- Using a simple life cycle framework, the authors show that private investment in the non-resource sector is adversely affected if private agents expect extra government current spending financed through resource sector revenues in the future.
- This income channel of the resource curse is stronger for countries with lower degrees of openness and forward altruism.
- The authors empirically validate these findings by estimating non-hydrocarbon sector growth regressions using a panel of 25 oil-exporting countries over 1992-2005.

### Theoretical framework
- Model type: Simple life cycle framework.
- Mechanism: Expected future government current spending financed by resource revenues raises private agents' perceived lifetime incomes, which reduces private investment in the non-resource sector (income effect).
- Amplifying factors:
  - Lower degree of openness increases the strength of the income channel.
  - Lower forward altruism increases the strength of the income channel.

### Empirical validation
- Data: Panel of 25 oil-exporting countries.
- Sample period: 1992-2005.
- Estimation focus: Non-hydrocarbon sector growth regressions.
- Empirical result summary: The panel regressions validate the theoretical prediction that anticipated government current spending financed by resource revenues negatively affects non-resource private investment and growth.

### Policy implications and interpretation
- High government current spending financed by resource sector revenues can generate an income-effect channel that undermines private investment in non-resource sectors.
- Policies aimed at mitigating the income effect could consider:
  - Measures to reduce the volatility or predictability of government current spending tied to resource revenues.
  - Policies that increase economic openness.
  - Policies that affect intertemporal preferences or incentives for forward altruism.
- Fiscal policy design in resource-rich economies should account for the income effect on private sector incentives when using resource revenues for current spending.

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