Precept 10

October 3, 2013

Abstract:Are natural resources a "curse" or a "blessing"? The empirical evidence suggests that either outcome is possible. This paper surveys a variety of hypotheses and supporting evidence for why some countries benefit and others lose from the presence of natural resources. These include that a resource bonanza induces appreciation of the real exchange rate, deindustrialization, and bad growth prospects, and that these adverse effects are more severe in volatile countries with bad institutions and lack of rule of law, corruption, presidential democracies, and underdeveloped financial systems. Another hypothesis is that a resource boom reinforces rent grabbing and civil conflict especially if institutions are bad, induces corruption especially in nondemocratic countries, and keeps in place bad policies. Finally, resource rich developing economies seem unable to successfully convert their depleting exhaustible resources into other productive assets. The survey also offers some welfare-based fiscal rules for harnessing resource windfalls in developed and developing economies.Access the article here

October 3, 2013

Abstract:

The permanent income rule is seldom the optimal response to a windfall of foreign exchange, such as that from a resource discovery. Absorptive capacity constraints require domestic investment, and investment in structures requires non-traded inputs the supply of which is constrained by the initial capital stock. This, particularly when combined with intra-sectoral capital immobility, delays adjustment and creates short run ‘Dutch disease’ symptoms as the real exchange rate sharply appreciates and overshoots its long run value. Optimal revenue management requires investing in the domestic non-traded goods sector and a slow build up of consumption. Accumulation of foreign assets adjusts to accommodate the time-paths of domestic consumption and investment.

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April 2, 2013

Precept 10 says that resource revenues can be used by governments to facilitate private investment. A question arises over whether this investment should be steered toward diversifying the economy or exploiting opportunities in the domestic resource sector. The paper by Van der Ploeg and Poelhekke suggests the former. The authors find that an excessive level of natural resource dependence exposes the economy to volatility.

 

Precept 8 states that revenue volatility ought to be addressed through gradually and smoothly building up domestic expenditure and investment from resource revenues. The paper supports the fundamental premise of the Precept through providing evidence that resource dependent economies experience growth volatility. Furthermore, the paper draws out measures on how to address such volatility.

 

The paper investigates the link between natural resources and volatility in economic growth. The authors find that the indirect effect of natural resources on growth, via volatility, is negative. The case is made hereby that poor growth performance and volatility are strongly related to resource dependence, as well as the absence of a sophisticated financial system. However, when controlling for volatility, natural resources can have a positive direct effect upon growth. Reducing volatility through, for instance, a financial system able to cope with sudden resource income fluctuations therefore also reduces the negative effects of resource dependence.

 

With regards to general investments it is crucial to improve the business environment and the productivity of the private sector as a whole. For such reforms the paper provides a specific recommendation, demonstrating that a well functioning capital market can reduce the effect of shocks in the resource share on volatility. This also allows for funding of new activities, thereby fostering a responsive and flexible business environment, which is essential for increased private investment. 

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April 2, 2013

In facilitating private sector investment for a diversified economy and exploiting added value at a domestic level, a major objective of Precept 10 lies with supporting resource-linked development. New sources of demand, such as for labor services and goods, can be met by local sources. The report provides a number of insights on a successful case of adding domestic value through local content policies.

 

Recognising that resource projects can have both negative and positive local economic, environmental and social effects, Precept 5 outlines the internationally accepted frameworks governing resource extraction.  The report provides insight on some of the measures which can be taken by mining companies to mitigate adverse effects and contribute to development. In addition, the case study demonstrates the importance of early community consultations.

 

Through a case study of the Lao PDR the report provides support for adopting local content policies. The two mines in the country have had a significant contribution to local development through a number of local content projects. These have focused primarily around four areas: employment generation, procurement of local goods and services, training programmes and enterprise development. For both mines, 35% of employees come from local districts and 50% of goods and services are procured nationally. Since 2011 these policies have led to a significant improvement in mortality rates, 14% higher literacy rate than at national level, five fold total village income increase and a seven fold per capita income increase. These figures come from biennial surveys, which are conducted to monitor social, economic and health status of local communities and serve as a basis for programme prioritization.

 

The authors find however that such success it highly contingent upon the mine’s ability to work with and understand the local community actors and streamline the companies policies with government institutions at local and national level.  It is also noted that the most important mechanism for wealth generation is through the consumption linkage, which arises from spending on goods and services and also the multiplier effect from employees spending their wages.

 Access the report here.

April 2, 2013

Precept 10 states that resource revenues can be used by governments to facilitate private investment for diversification as well as exploiting opportunities for increased domestic value added. The report supports the underlying statement of Precept 10, that increasing growth of the domestic economy requires a significant increase of private sector investment. In addition the report provides a number of general points specifically for resource rich countries.

Precept 9 recommends that government use resource wealth for increasing efficiency and equity in public spending. In doing so the government is required to raise the capacity for spending. As resource rich countries have a large concentration of revenues accumulating to government, the government must be able to spend that money effectively. The report provides a number of guideline recommendations on public spending.

Precept 7 states that resource revenues must foster continued high levels of domestic investment if those revenues are to promote sustainable and inclusive economic growth. A general principle of the Precept is that once it has been decided to invest, investment in public capital is particularly beneficial. The report supports this principle and places emphasis upon infrastructure investment.

The Growth Commission report analyses 13 economies which experienced sustained high growth rates for 25 years or longer. In doing so it identifies some of the characteristics of high growth economies and considers how these can be replicated. The underlying statement of the report is that growth is a necessary, albeit insufficient, condition for broader development. It is found that no country achieved sustained growth without also maintaining high rates of public investment. Such investment furthermore crowds in private investment and allows new industries to emerge. Public investment is however affected by the availability of savings, the report finding that high income economies often have a saving rate of between 20-25%. One sector which has been neglected and which the report highly recommends for public investment to reach is infrastructure.

The report also directly addresses growth in resource rich countries. The Dutch disease and fluctuating commodity prices, whilst presenting a challenge, are not insurmountable. They have not been handled well by many governments however. Extraction rights are sold too cheaply and taxation is too low whilst money accrued is stolen or wasted. As a response to these challenges the report suggests government begin by deciding how to allocate exploration and development rights and an accompanying tax regime. Once revenue is collected, government should aim to invest between 5-7% of GDP in the domestic economy. Remaining revenue ought to be invested in a politically insulated savings fund.

Access the report here.

April 2, 2013

Precept 10 states that resource revenues can be used by governments to facilitate private investment for diversification as well as exploiting opportunities for domestic value added. The strategy chosen for doing so can significantly affect growth of the domestic economy. The paper by Collier and Goderis provides a number of insights on some of the potential transmission channels through which growth can be negatively affected as a result of natural resource booms.

 

Precept 8 states that revenue volatility ought to be addressed through gradually and smoothly building up domestic expenditure and investment from resource revenues. The paper by Collier and Goderis provides evidence on resource volatility. Supporting Precept 8, it is found that resource booms have short term positive effects but long term negative effects which need to be mitigated, through, for instance, establishing a stabilization fund.

 

Paper begins with the finding that whilst the literature predicts negative effect of commodity booms upon growth, evidence has been shown that such booms significantly raise growth. These findings could be short lasting however. The paper therefore examines data from 1963 to 2003 to consider short and long run effects of commodity prices on growth. In doing so they investigate all the potential causes of the resource curse proposed in the literature. The authors find that no single transmission channel determines whether resources are a curse. However, a combination of private and public consumption, total investment and exchange rate overvaluation accounts for a substantial part (p. 3). They also find that commodity booms have positive short-term but adverse long-term effects. The results support the view that such booms provide incentives for non-productive activities such as rent seeking and lobbying. The authors note, however, that the existence of strong institutions and good government can mitigate the curse and enable positive growth for resource rich countries.

Access the paper here.

April 2, 2013

To maintain high levels of growth private sector investment needs to be increased. Precept 10 shows that government ought to have the objective of making ‘general purpose’ investments and diversifying the economy. The paper supports both these objectives, providing guidelines on how this can be achieved through industrial policy.

 

Rodrik begins with the recognition that employment and sectoral production are less concentrated and more diversified in rich countries. In order to diversify the economy Rodrik puts forward an industrial policy framework. A fundamental element of this is the challenge of how government can expedite private sector investment.  According to the paper this challenge ought to be tackled through a collaborative approach between private sector and government, whereby focus is placed as much on the exchange of information regarding significant externalities as it is on implementing the right policies

 

In achieving diversification Rodrik makes the case for an industrial policy in which strategic cooperation between the private and public sector occurs. However, such cooperation ought to be guided by a number of industrial policy design principles. These include, but are not limited to:

      - First, as not all investments will pay off there ought to be clear benchmarks for success and failure – ideally dependent upon productivity.

     - Second, government needs to target activities rather than sectors, thereby supporting the correction of specific market failures.

     - Third, a built-in sunset clause would ensure that resources do not remain stuck with activities that do not pay off.

     - Fourth, subsidized activities ought to have the potential of providing spillovers and demonstration effects

     - Fifth, government agencies promoting industrial policy ought to maintain channels of communication with the private sector, thereby allowing public officials to have good information on business realities.

     - Sixth, in adopting a strategy of picking winners, mistakes will be made. These should be allowed but minimized where possible.

Access the report here.

April 2, 2013

Precept 9 recommends that government use resource wealth for increasing efficiency and equity in public spending. In doing so the government is required to raise the capacity for spending. As resource rich countries have a large concentration of revenues accumulating to government, the government must be able to spend that money effectively.

 

The paper analyses the effectiveness of aid projects in post conflict situations using data on World Bank projects. The authors find that whilst aid ought to be particularly effective in the immediate post-conflict setting, this tends to be offset by the limit to absorptive capacity in such a context. It is found that the supervision of projects is a crucial determinant in the success of projects. This is particularly relevant evidence for the implementation of public investment projects, suggesting that international development agencies could act as partners in projects due to their experience in supervision.

Accesss the report here.

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