How is the natural resource curse related to startup investment in a country?

Have you ever wondered why natural resource-poor countries such as Singapore experienced higher economic growth in the contemporary world compared to their bigger, natural resource-rich countries such as Indonesia or, to a certain extent, the Philippines? 

And moreover, is there a connection between natural resources and a country’s rate of tech startup development?

Total Natural Resource Rents as a % of GDP (Source: World Bank)

According to the World Bank, in 2018, Singapore had a GDP per capita (US) of $64,582, whereas both Indonesia and Philippines had a GDP per capita (US) of $3,894 and $3,103 respectively. As unusual as it is when considering how endowed these countries are with natural resources, this paradox can be explained by the resource curse theory.

The theory states that countries with an abundance of natural resources tend to experience worse economic development compared to natural resource-poor countries. 

According to the IMF, of the 52 countries classified as “resource-rich”, 29 of them are classified as countries in the low to lower-middle income bracket. Among these 29 countries, they share similar characteristics such as an extreme dependence on natural resources as a source of fiscal revenue, poor overall growth performance and highly volatile natural resource derived revenue.

In addition, when we look at the Net Foreign Direct Investment (FDI) Inflow as a % of GDP in the same 3 countries as above, we similarly also observe that Singapore receives a significantly larger FDI as compared to Indonesia and the Philippines. 

FDI as a % of GDP (Source: World Bank)

So why do natural resource-rich countries tend to receive less FDI inflow? People tend to make guesses ranging from good/bad leaders to extortion from the colonial past. 

However, we believe that an analytical approach is needed to recognise the key reasons, in order to make informed investment decisions. 

We think there are 3 main reasons:

1. Dutch Disease

Dutch Disease refers to the causal relationship between the increase in one sector and a decrease in another sector. In the case of a natural resource-rich country, the discovery of a new natural resource endowment can result in a resource boom, leading to an appreciation of the local currency. This can cause the origin country’s non-natural resource exports to be less competitive at global prices. If the decrease in non-natural resource industries is larger than the increase in natural resource industries, this may lead to an overall decline in FDI due to its reduced attractiveness as a market.

2. High Volatility and Risk

Natural resources, in particular oil and gas, is notorious for its booms and busts, which can invariably lead to increased volatility in the exchange rates. In addition, many of these natural resource-rich countries are highly dependent on the trade of natural resources, which results in a lesser trade diversification, making them more vulnerable to external shocks. This combination of high exchange rate volatility and investment risk can reduce FDI. 

3. Poorly Regulated Institutions

Many natural resource-rich countries have weak institutions, with high corruption and unreliable legal systems. As much as this could merely be a correlation and not a causation with a country being natural resource-rich, we believe that a portion is attributed to the fact that competition over the control of these natural resources have caused governance weakness and overall sub-optimal policymaking. Weak political stability is a huge driver behind FDI, and would most definitely reduce FDI.

Of course, these are not universal. The resource curse theory is controversial and heavily debated. Countries like the US, Norway and Haiti are counterexamples of either categories. However, the above framework offers a useful factor to consider when you launch a business, or invest in one, in an emerging market. 

So how does this impact startups?

FDI brings about huge benefits for the host country, from encouraging economic stimulation to an increase in employment. This is especially so in the context of a developing economy, where FDI plays an important role in being a source of private external funding for future growth. 

In the context of startups, FDI promotes technological innovation and skilled labour among other factors that influence directly the efficiency of doing business, key ingredients to a fertile environment for startups to thrive.

Now you know how a country’s natural resource endowment can have second-order implications on the amount of FDI it receives, which ultimately affects how attractive it is as a country for enabling start-ups.

For VC investors, while the belief is that countries with large populations and growing consumption will naturally enjoy a boom, it is important to recognise the above. It determines how fast you can see the horizon of return on investment, as well as how many hoops and hurdles you need to jump through to reap these benefits.