Precept 9

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

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 9 recommends that government use resource wealth for increasing efficiency and equity in public spending. This can be achieved through investing-in-investing, which in turn requires improved efficiency in recurrent public spending. The World Development Report (WDR) provides us with a framework for how this can be achieved.

 

The WDR begins with the premise that service provision often fails the poor but the fact that this is not always the case means failure is not inevitable. The report builds an analytical and practical framework for using resources more effectively. In understanding how services are delivered it is suggested service delivery be considered as a chain which can be unbundled into three actors and their relationships; these are policymakers, clients and providers. A fundamental explanatory factor in understanding service delivery failure is the accountability problem. Whilst in a market transaction a consumer can hold the provider directly to account, in government service provision this is not the case, occurring only via the long root of policymakers. Depending on whether a political system is pro poor, the clients are homogenous or heterogeneous and whether the output is hard or easy to monitor the paper provides a number of general lessons on making services more effective:

     - In a pro-poor political context services that are easy to monitor can be delivered by the public sector or financed by government and contracted out to the private sector.

     - When services are hard to monitor, politics are pro-poor and clients homogenous then the centralized public sector is most appropriate.

     - When preferences are heterogeneous local government ought to be involved in service delivery.

     - When politics are not pro poor and subject to capture it is best to strengthen the client’s power. 

Access the report here.

April 2, 2013

In seeking to use resource wealth for increasing efficiency and equity in public spending (a main objective of Precept 9) there is a need for good decision making over the entire process chain, from design through to implementation. The Precept provides guidelines on the different components of the public investment management process.

 

The IMF paper recognizes the importance of scaling up investment, specifically in physical and social infrastructure, for sustained growth. However, in most developing countries there have been low returns to public and private investment. This is in part due to poor selection and implementation of projects. In turn a result of limited information, a lack of technical expertise, and leakage and waste of resources. In addressing these challenges the paper provides an index of the “efficiency of the public investment management process” (p. 3). The quality and efficiency of the investment process is measured across each stage: project appraisal, selection, implementation and evaluation. This index provides a tool for conducting policy-relevant diagnostics and analysis as well as fostering accountability and transparency in the sector.

Access the report here.

April 2, 2013

Precept 9 recommends that government use resource wealth for increasing efficiency and equity in public spending. One hindrance to efficiency in both public and private investment is that in resource rich and low income countries the unit cost of capital goods is higher than global average.  According to Precept 9 a general principle that should be followed therefore is avoiding tariffs on capital goods. The paper by Collier and Venables provides support for this principle, finding that in resource rich economies, tariffs do not generate revenue.

 

The paper examines the fiscal consequence of tariffs for countries with large resource export and aid revenues. It is found that revenues generated by tariffs are “offset by unrecorded reductions in the real values of resource rents and aid flows, so that the apparent revenues are illusory” (p. 2). Import tariffs raise revenue whilst also reducing domestic purchasing power of revenues from resources or aid. As such, tariffs which appear to be providing government with revenue, often have no effect. They can however prevent export diversification and have a negative effect upon aggregate real income. The authors consider why such tariffs are still adopted; finding that either the true nature of tariffs is opaque or that the transfer of revenue between government accounts converts aid flows into tariff revenue and thus creates revenue free from donor conditionality. Although it is found that illusory revenues are particular to circumstances, the pertinence of the analysis to a particular context is the “sum of resource rents and aid relative to the value of imports” (p. 19).

Access the report here.

December 1, 2010

Over at the Guardian’s development blog, Madeline Bunting discusses the growing popularity of conditional cash transfers (CCTs) in emerging economies and the development community.

What does this have to do with natural resources? A great deal, it turns out. The use of CCTs in resource rich countries is illustrative of the importance of an over-arching view of the whole decision chain pertaining to natural resources – from exploration to expenditure – and the need for such a view to earn the support of an informed social consensus.

Governments with windfall revenues, for example from oil extraction, may be well positioned to develop innovative or ambitious programs of social protection or transfer. Indeed, governments should seek to maximise the benefits to its citizens of such resource wealth, and some form of direct transfer may be an effective means of doing so.

Take Mexico, for example, where government obtains 40% of its revenue from oil. In 2009 Mexico garnered $5bn from a hedge targeted at the oil price used in overall government budget estimates. Designed as an insurance mechanism, with Mexican officials careful to avoid gambling – or appearing to gamble - with the national patrimony, the amount dwarfed the expenditure ($3.6bn) on the country’s own CCT, a central component of its Oportunidades program. Oportunidades reduced the incidence of illness amongst 1-5 year olds in the 25% of Mexican families covered by the scheme by 12% and increased the mean growth rate of children between 12 and 36 months by 1cm.

It’s not merely the cash amounts that link successful hedging, or natural resource windfalls generally, to successful CCT schemes. Bunting points out that the success of Bolsa Familia in Brazil was bolstered by the legitimacy it achieved in the eyes of the majority of Brazilian taxpayers, mostly non-beneficiaries, both through the transparency of its administration and the fact that the economic pie as a whole has been growing over the years of the program’s operation. To this we might add the importance a stable as well as a growing ‘pie’: countries that have received a sudden natural resource windfall or are reliant on resource revenues can help avoid the zero-sum, short-term political economy inimical to successful cash transfer programs by using means such as the Mexican hedge, or other forms of smoothing, to counter price volatility. The hedge helps – both politically and economically - to guarantee the stream of revenues necessary to invest in human capital or meet urgent human needs.

It is relatively easy to recommend conditional cash transfer programs in states that are as developed as Mexico and Brazil. But what about countries that may lack existing, affordable channels for social transfers? It’s not necessarily the case that such innovations cannot be adapted to these environments. A new influx of revenues such as those associated with commodity price spikes or a new resource discovery provide an opportunity for innovating in previously poor institutional environments. Such opportunities are also the occasion for technical assistance from the developed world or the contracting out of certain functions to trusted partners of host governments. The infrastructure for a conditional cash transfer system can provide the basis for increasing the accessibility of everyday financial services of other kinds, with profound benefits to the private institutions of a developing economy, as well as the public fiscal balance. Technological innovation has reduced the cost of basic banking and communication services, whilst pilot schemes linking immunization drives to census recording and biometric identification hint at further positively reinforcing components of a virtuous cycle that can be sparked in previously unpromising environments.

It may be desirable to redistribute some natural resource revenues on a conditional basis and some on an unconditional basis (as with oil revenues in Alaska, for instance), and then – somewhat counterintuitively – tax back some of that distributed income. Many of the iniquitous consequences of the resource curse are the result of an overdependence of a gatekeeper state on resource revenues alone. Dividend-and-tax allows peoples not only to take ownership of their country’s natural resources, but of their own governments too.

The unconditional variant of CCTs, otherwise known as direct dividends, may be an appropriate tool in resource rich states, not least since citizens have a claim of ownership over resource rents. For more information on implementation of direct dividends see the Charter fact sheet and the recent paper by Paul Segal.

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