Boom town: This Google Earth image demonstrates the spectacular town growth over the last decade.

A decade or so ago, Kathu in South Africa’s Northern Cape province was little more than a quaint mining town with a fantastic golf course. Supported almost entirely by the nearby Sishen iron ore mine, no one had expected that the town would change remarkably in the coming decade. But a surge in the global price of steel encouraged Anglo American, the majority owner of Kumba Iron Ore, to expand production, rapidly increasing employment. The town boomed. House prices went through the roof, further strengthened by a lump sum bonus to all employees in 2011. (Not all investments were sensible, though: one story goes that upon receiving the bonus, an employee drove to a neighbouring town to purchase a new luxury car, only to crash it on the way back.) The people of Kathu saw their disposable incomes and living standards increase. Two new malls opened in a town with less than 15000 people.

And then it all came tumbling down. A few weeks ago, Anglo announced that, based on weak prospects in China and the low price of steel, it will cut around 4000 jobs at the Sishen mine. House prices are falling and those new developments that rose like mushrooms are going unsold. Stores are likely to close their doors soon, cutting more jobs. The future for the former quaint mining town looks bleak.

Kathu is a microcosm of the problem with development based on natural resources. Oxford University economist Anthony Venables investigates this conundrum in the most recent edition of the Journal of Economic Perspectives, asking ‘Using Natural Resources for Development: Why Has It Proven So Difficult?’. Venables explains that the successful use of natural resources requires multiple stages. First the deposits have to be discovered and extracted. Then the revenues need to be divided between the government, investors and other claimants (like the local community). What is important is how these revenues are split between the different claimants, and what it is used for. Finally, the indirect, negative effects to the rest of the economy must be allayed.

Dividing what can often be large gains can be difficult. Discovery and extraction licenses are typically awarded to encourage the most efficient mining companies to operate, but can result in corrupt practices. To avoid this, auctions provide one mechanism to ensure the government maximise revenue. Auctions do not work everywhere, though: in Botswana, the government instead negotiated with the dominant De Beers to ensure a larger share of the gains from diamonds.

Once gains have been divided, deciding how to spend it can be even more difficult. Often, Venables argues, there is pressure to spend on current expenditure instead of investing in infrastructure, for example. These pressures are magnified by patronage politics, which favours spending on groups or individuals allied to the government. The worst a government can do is to use the revenues to increase its chances of staying in power, for example, by hiring supporters as public sector employees.

But even if revenues are divided fairly and invested effectively, resource exports can cause what is known as ‘Dutch disease’: an appreciation of the exchange rate that hurts other exports. (The term ‘Dutch disease’ was coined after the 1959 discovery of gas fields in the Netherlands hurt the Dutch manufacturing industry.) A country that only exports one resource can become dependent on a single but volatile source of income, which can destabilise the economy during bad times. Just ask Angolans or Nigerians. Or the mayor of Kathu.

The future for natural resources dependent economies will not get better soon. Resource prices, notably oil, are unlikely to rise rapidly in the face of continued weak demand combined with the growing popularity of alternative energy sources, from fracking to renewables. That means that resource-rich countries, like many African countries including South Africa, will have to come to terms with the negative shocks on its public finances and balance of payments. The silver lining is that this may stimulate economic activity in other, more sustainable sectors of an economy. But even then, political pressure to protect the status quo may cause additional pain.

Perhaps Kathu will revive the golf course to its former glory, attracting tourists who want to enjoy affordable Kalahari hospitality, and allow the town to develop at a more sustainable rate. But not before many of its inhabitants have suffered the consequences of the natural resource curse.

*This article first appeared in Finweek magazine of 3 March.