Structural Challenges to Sustainable Investing in Developing Economies

Resource-Based Economies and Dutch Disease

A natural resource–based economy is one in which natural resource endowments drive a large share of the country’s gross national product or gross domestic product. A production surge in natural resources can reduce internal incentives to produce, and reduce the international competitiveness of domestically produced non-resource tradable goods. This structural economic problem is known as 'Dutch Disease,' a term coined by The Economist in 1977 to describe the Netherlands’ economic challenges from deindustrialization after a natural gas boom. Several resource-rich developed countries faced similar issues during the 1970s and 1980s.

In more recent times, developing countries are encountering the same challenges as they embark on industrialization. Without credible signals, long-term financing for industrial development struggles to materialize. Through my consulting project with the Central Bank of Armenia (CBA), I observed this sequencing problem firsthand. Our team analyzed Armenia’s sustainable finance landscape and found that while the government had ambitious aspirations for green industrial upgrading, the financial sector lacked consistent incentives, reporting standards, and market signals needed to mobilize private capital. Similar to many developing economies, Armenia faced a policy–implementation gap: incentives for sustainable investment existed in principle, but mechanisms to ensure market integrity, reduce compliance costs, and reward green issuers and investors remained fragmented. This experience reinforced the importance of aligning financial system reforms with long-term industrial objectives.

Characteristics of Financial Systems in Resource-Based Developing Economies

Resource-based developing economies often operate with narrow fiscal space. Commodity revenues fluctuate sharply with global prices, making fiscal planning reactive rather than strategic. These limited fiscal buffers constrain governments’ ability to invest in long-term infrastructure, industrial policy, and human capital development - each essential for reducing resource dependence. Much of the existing fiscal space is further absorbed by politically sensitive expenditures, such as high energy subsidies, which inhibit necessary structural transformation.

These economies also remain heavily dependent on unprocessed, low–value-added natural resource exports. Extraction generates revenue but contributes little to domestic technological development or ecosystem strengthening. Industrialization progresses slowly, leaving the economy vulnerable to commodity price volatility and displaying symptoms of Dutch Disease: an appreciating exchange rate and a narrow productive base.

The investment environment is further shaped by short-term political dynamics. Policy changes can signal weak long-term commitment to industrial policy, which concerns investors operating on 20–30-year horizons. Such gaps directly translate into execution risks for extractives, infrastructure, and industrial projects. In Armenia’s case, strengthening rule enforcement and improving the reliability of green taxonomies were identified as essential steps for expanding the pipeline of investable sustainable finance projects. Similar issues in other resource-dependent economies reduce investor confidence and raise the cost of capital.

Sustainable Investment Practices

Coordinated stakeholders must aim for a systemic industrialization agenda through sustainable investing practices. A system undergoes real transformation when its core structures are reshaped - often through new rules and overarching norms. These shifts can lay the groundwork for new, sustainable systems to emerge, enabling them to eventually replace entrenched, unsustainable regimes (Schot, Kanger, & Urmetzer, 2019).

Investors capable of deploying long-term capital, such as sovereign wealth funds (SWFs) and pension funds, are well suited for capital-intensive projects like clean energy infrastructure. Additionally, long-term policy commitment and early risk-sharing - supported by constructive dialogue with regulators - raise expectations for quality and help establish norms for responsible investment. These practices support the creation of new markets that would not emerge organically, especially for developing economies seeking to move up global value chains.

For natural resource sectors, industrial development requires shifts toward refining, processing, and manufacturing, instead of exporting raw materials. This approach enables countries to capture more domestic value and generate wider multiplier effects.

Conclusion and Reflection

I learned that the investment ecosystem should align closely with country-specific resources and industrial priorities. Investment decisions must support long-term structural transformation rather than reinforce cyclicality tied to commodity markets. This requires clarity of purpose, long-term commitment, coordinated stakeholder management, and disciplined separation between political cycles and investment strategy.

Embedding ESG principles and transparent reporting is essential for building global credibility and securing co-investment from reputable partners. For investors aiming to build alpha-generating portfolios, certain ESG strategies have been shown to deliver market-rate or even superior returns, particularly for those with long-term horizons such as sovereign wealth funds. These strategies also offer downside protection during periods of economic or social instability - conditions typical in developing economies (Atz, van Holt, Liu, & Whelan, 2021). The consulting project, along with the SIRI faculty, enabled me and my team to analyze symptoms at a system level, revealing root causes that prompt immediate action and shape interactions between investment stakeholders.

References

Behrendt, S. (2010). Sovereign wealth funds: Governance and legitimacy. Bertelsmann Stiftung. https://www.jstor.org/stable/resrep13033

Schot, J., Kanger, L., & Urmetzer, S. (2019). Deep transitions: A theory of socio-spatial change for the Anthropocene. Working Paper 1, Deep Transitions Project / Transformative Innovation Policy Consortium (TIPC). https://deeptransitions.net/wp-content/uploads/2019/06/DT-Report-No1-Web.pdf

Atz, U., van Holt, T., Liu, Z., & Whelan, T. (2021). ESG and financial performance: Uncovering the relationship by aggregating evidence from 1,000+ studies published between 2015–2020.

NYU Stern Center for Sustainable Business & Rockefeller Asset Management. https://doi.org/10.2139/ssrn.3897249