Madrid and the resource curse (18-4-2020)

Written by: Jan Luiten van Zanden

Bianca asked me this week why the huge wealth the Spanish Habsburgs extracted from their American colonies does not show up more clearly in buildings and monuments of Madrid, the capital city. This raises a number of issues, I think.

First of all, there are other places in Spain where you do see some of this wealth, for example in the towns of Extramadura (Caceres, Trujillo) where you can find the wealthy palaces of the families of the Conquistadores who conquered the Americas. And Madrid may be not particularly charming and impressive (but was a bit the ‘Brasilia’ of the 16^th century), but Salamanca, which had its golden age in the 16^th century, definitely is, and it has the most beautiful square of the world.

The other part of the answer is that the silver and gold of the Americas did not make Spain wealthy. There was hardly any economic growth (the long term trend was in fact downward), and income levels remained much below those of Italy and the Low Countries (according to the Maddison project, but this is entirely based on estimates made by Spanish colleagues). The Spanish state, which received most of the wealth, used it to fight expensive wars – against the Turks and the Dutch, amongst others – for conspicuous consumption (such as building the El Escorial), and to strengthen its already quite powerful position (it did not have to bargain so hard anymore with the estates and the cities of Spain). Most of the silver was indirectly used to import commodities from the more industrial parts of Europe – in particular the Low Countries – who in fact may have profited much more from the inflow. Nuno Palma is his dissertation has shown that if you test econometrically the link between silver mining in the Americas and economic growth in Europe, you get a significant positive impact of silver on GDP growth in Holland and England, but no effect at all for Spain and Portugal!

This phenomenon that it is often not very helpful to have access to free resources – such as silver in the 16^th century, and oil in the 20th/21^st centuries – has been called the ‘resource curse’ (also known as the Dutch disease, as it was first established for the Netherlands in the 1970s, when we ‘profited’ a lot from the Groningen natural gas reserves). There are two mechanisms. Firstly, free resources that are an easy source of income for a small (state)elite, are bad for institutions, for democracy and for investments in education. Corrupt regimes are often based on such a source of income (think of Putin, Madura, many states in the Middle East), and the inflow of silver made it possible for Filip II to become an absolutist ruler. The second mechanism is that easy exports of these free resources ‘crowd out’ other exports. This was the effect noticed in the 1970s in the Netherlands: industrial exports were being replaced by exports of natural gas, which meant a loss of employment and of long-term growth potential. Therefore, easy money resulting form easy resources are bad for the long term prospects of an economy.

This ‘curse’ also works in other ways. We have, for example, huge savings in the form of our pension funds. You would expect that this would give the Netherlands more flexibility in years of crisis – a rainy day fund – but the effect is quite the opposite. During a crisis, such as after 2008, we do not spend these savings to stabilize our consumption, but we are forced to save more, as the ‘dekkingsgraad’ (cover ratio, the ratio between the total value of savings and future commitments) has collapsed during the downturn (the stock market has gone down and interest rates have fallen). So we deepen the crisis because we want to stabilize the value of our savings – instead of using these savings to stabilize consumption. In an upswing the reverse happens: the savings increase disproportionally in value, due to booming stock markets, making it possible to save less and to spend more. The pension system is therefore a strong pro-cyclical force in the Dutch economy. It is a rather ironic way to punish the kind of frugal behaviour we are so proud of.

There is another aspect of this discussion which brings us back to the sights of Salamanca, and of Venice, Florence and Rome. These wonderful cities of art and beauty can also be seen as free resources, that attract huge crowds of tourists (or at least used to attract them), crowding out all other activities. But as all other free resources, it creates a lazy, uninnovative economy. With the Uffizi in your back garden you simply can count on the flocks of tourists increasing every year, spending their high incomes on the ice cream and café latte that you serve. Tourism is like oil, a source of easy growth, and there is probably some truth in the Calvinist idea that you have to work for your living. The good thing about the present crisis, perhaps, is that this trend of Europe becoming the open-air museum of the world, has now abruptly come to an end. And it will take quite some time before in particular mass tourism will return to normal, I assume. A good time-out to reconsider?

Continue reading: The Calimero Effect and Original Sin (21-4-2020)

Sources:

Nuno Palma, Harbingers of modernity: monetary injections and European economic growth, 1492–1790, European Review of Economic History, Volume 21, Issue 4, November 2017, Pages 435–436, https://doi.org/10.1093/ereh/hex025

Venables, Anthony J. (February 2016). “Using Natural Resources for Development: Why Has It Proven So Difficult?”. Journal of Economic Perspectives. 30 (1): 161–184. doi:10.1257/jep.30.1.161

I thought that tourism as a resource curse was an original idea, but there are already a few papers discussing this hypothesis, for example Deng, T., Ma, M., & Cao, J. (2014). Tourism Resource Development and Long-Term Economic Growth: A Resource Curse Hypothesis Approach. Tourism Economics, 20(5), 923–938. https://doi.org/10.5367/te.2013.0325