Ensuring Guyana’s petroleum resources are a blessing and not a curse

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Whether the natural resources of a country will be a blessing or a curse, depends on various factors. The recent oil discoveries of Guyana can induce an appreciation of the real exchange rate, deindustrialisation and bad growth prospects, and these adverse effects are more severe in a volatile economy with bad institutions and lack of rule of law, corruption, presidential democracies and underdeveloped financial systems. Another supposition is that a resource boom reinforces rent grabbing and civil conflict especially if institutions are bad; induces corruption and keeps in place bad policies.

Therefore, for a resource rich economy such as Guyana, the fiscal and legal governance frameworks must ensure that the economy can successfully convert depleting exhaustible resources into other productive assets. Hence, there should be some welfare-based fiscal rules that will harness the resource windfall. Guyana must develop opportunities from which the petroleum resources will provide for economic growth and development and thus overcome the challenge of ensuring that natural resource wealth leads to sustained economic growth and development.

The best available empirical evidence suggests that countries with a large share of primary exports in Gross National Product (GNP) have bad growth records and high inequality, especially if quality of institutions, rule of law, and corruption are bad (van der Ploeg 2011). This potential curse is particularly severe for point-source resources such as minerals and precious metals. The resource curse is, however, not cast in stone. Nevertheless, for a resource rich country such as Guyana, it must ensure that over time, it develops better institutions, open more trade channels and increase investments in exploration technology. This could allow the economy to enjoy the fruits of its natural resources’ wealth.

On the other hand, Guyana could also become vulnerable to the notorious volatility of commodity prices, especially if its financial system is not well developed. Recent research, taking account of the endogeneity of resource dependence, suggests that volatility may be the quintessence of the resource curse. Of course, there is also cross country and panel-data econometric evidence that natural resource dependence may undermine the quality of institutions. And there is an interesting quasi-experimental which suggests that announcements of oil discoveries lead to corruption. Resource bonanzas also reinforce rent grabbing, especially if institutions are bad and keep in place bad policies (debt overhang, building a too generous welfare state, etc.). There is also evidence that dependence of point-source resources makes countries prone to civil conflict and war, although these results fail to convincingly take account of the effect of conflict on natural resource production.

However, from a normative perspective, Guyana should invest its natural resource rents into reproducible assets such as physical capital, human capital, infrastructure, or foreign assets. World Bank data suggest that resource rich economies do not fully reinvest their resource wealth and therefore have negative genuine saving rates. Whilst, resource rich countries may grow less simply because they save less than other countries. However, if Guyana anticipates a positive rate of increases in future resource prices or continual improvements in exploration technology, it may make sense to borrow. Rival factions competing for control of resources will speed up extraction and may well lead to overinvestment. Negative saving for the local economy can occur if there are insatiable resource extraction being associated with erosion of the legal system, inefficient rent seeking, investment in “white elephants,” and short-sighted policy makers. Therefore, for Guyana, it will be optimal to put part of the natural resource revenues in a sovereign wealth fund.

Some of the revenues garnered should be used to reduce the economy’s capital scarcity; in which case it is more appropriate to use part of the wind fall to pay off debt and lower interest rates to boost private and domestic capital accumulation and speed up the process of economic development. Many countries find it hard to absorb a substantial and prolonged windfall of foreign exchange since it takes time for the non-traded sectors to accumulate “home grown” capital. Whilst these Dutch disease bottlenecks are being resolved, it is optimal to park the windfall revenue abroad until there is enough capacity to sensibly invest in the domestic economy. Fear of the fund being raided should not allow for any illiquid investment, as effective legislations can protect the revenues.

Large oil and gas revenues for Guyana should promote economic development in at least two ways (Stevens and Dietsche 2007). First, large revenue inflows should provide opportunities to invest in projects and programmes that promote development. Second, inflows of foreign exchange can overcome the problems associated with ‘dual gap analysis’ (when improving saving rates to offset insufficient investment does not promote development because the saving is in local currency while development may require access to imports of capital goods for which foreign exchange is essential).

Unfortunately, these benefits will take some time to be materialized in reality in many cases. It has been widely recognized that it is a fact that most natural resource-abundant countries, particularly oil exporters, have not been able to utilize revenue from natural resource extraction for the general benefit of their societies. This has been dubbed the ‘resource curse’. Evidence has shown that resource-rich countries grew some three times slower than resource-poor countries and that fuel and mineral-rich countries performed even less well than the rest of the resource-rich group (Auty 2001). This poor outcome has allowed for apparent negative effects. The primary explanations of why oil exporters and exporters of other natural resources have suffered resource curse attacks, are; declining terms of trade between primary products and manufactured goods (Prebisch 1962), together with short-term price volatility (Sala-I-Martin and Subramanian 2003).

Moreover, Guyana’s economic principles should also concentrate on possible macroeconomic transmission mechanisms, for example Dutch disease; where overvalued real exchange rates undermine international competitiveness and reduce the size of the non-oil traded sector. Specifically, the manufacturing and service sectors can create more positive externalities than natural resources. Thus, a relative decline in manufacturing and services could depress economic growth (Matsuyama 1992). There are also identifiable microeconomic transmission mechanisms, including the argument that a dominant primary sector based on the extraction of natural resources crowds out investment in other economic sectors, and that high wages paid in the capital-intensive resource sector are transmitted to other sectors, undermining their competitiveness. It has also been suggested that resource-rich countries lack the incentive to invest in human capital (Birdsall et al 2001). In addition, economic focus should be on impact of oil and mineral exports on the exchange rate and finding the right mix between investment and consumption spending and on industrial and trade policies.

Further, Guyana must place greater emphasis on the political economy of oil and other natural resource exporters. This level of focus is necessary because many countries continuously failed to pursue the economic policy actions that has been identified for countering the various macroeconomic and microeconomic transmission mechanisms. One of the main reasons why countries would deliberately pursue poor policies is a political-economic explanation that has taken a rational agency perspective. It has been argued that those holding power in resource-abundant countries – typically politicians or bureaucrats – take personal advantage of their national resource wealth, engaging in rent seeking and corrupt political and business practices which rob their countries of the opportunities that the resource wealth could provide. For many, this is in fact the central issue in resource curse analysis. Thus, the most important result is that resource-rich countries suffer from low GS (genuine savings), but that they can improve their performance by fighting corruption, difficult as this may be (Neumayer, 2004).

Formal models constructed to explain the poor outcomes have employed basic economic arguments to political behaviour, starting out from the assumption that political and administrative power holders are rational self-maximising individuals with a narrow interest in exploiting their countries’ natural resource wealth for personal gain. Aggregating this rational individual behaviour results in collectively negative outcomes. This result should not come as a surprise nor should it be viewed as down to ‘policy failures’.

At first sight the policy conclusions of this line of argument would appear bleak. Domestic solutions are difficult to propose because normative appeals to politicians and bureaucrats to change their behaviour would be inconsistent with the basic assumptions of the argument. This dilemma points to external solutions. Not surprisingly, there have been many calls for international regimes to impose restraints upon countries to exploit their natural resource wealth or for internationally devised mechanisms to manage these countries’ resource revenue. At second sight, institutions have more recently been proposed as a possible solution to circumvent predatory state behaviour.

A popular political-economic explanation suggested by some has been based on the notion of rentier states or rentier societies (Isham et al 2002). The basic conjecture has been that the presence of oil and other mainly non-renewable natural resources provides structural incentives that impede the governments of such countries from building more democratic regimes. In rentier states the revenue generated by natural resource exploitation allows incumbent governments to diffuse pressure to democratise. Natural resource rents allow governments to keep domestic taxes low, which undermines political representation (Moore 2004). Governments can also undertake unproductive redistributive spending to satisfy political constituencies, and they can employ internal security to control domestic opponents. Thus, natural resource wealth tends to consolidate and conserve ‘bad’ political regimes and undermine the social and cultural changes that have facilitated democratic transitions and consolidations elsewhere. Furthermore, the domination of the state means there is less incentive to ‘form a healthy civil society, an independent middle class fails to develop, and technocratic and entrepreneurial talent remains captive of state largesse in terms of employment and advancement opportunities’ (Chaudry 1997). A variation on this theme is that political elites fear industrialisation and urbanization because they would weaken their grip on control of the resources (Acemoglu et al 2001).

Of course, this explanation of the lack of democracy has implied that democratic regimes would respond better to general public interests and redistribute more broadly the benefits of investments in the natural resource sector. The policy implications of this line of argument are equally bleak. If natural resource wealth has a structurally deterministic impact on the incentives and the interests of domestic political regimes, then there is little scope for change. The conclusion comes close to proposing that well-endowed countries leave their natural resources in the ground to prevent rent-seeking from taking place. A major challenge for both types of political-economic explanations has been that they have not been able to explain variance in outcomes across natural resource-abundant countries. While most natural resource-abundant countries, and in particular oil-rich countries, appear to have suffered from this type of resource curse, there are a few frequently cited examples of countries that seem to have avoided this outcome. These countries have typically included Chile and Botswana, which are of course mining countries. Arguably, the positive examples also include Malaysia and Indonesia and among industrialized countries Norway, the US, Australia and Canada. It would be beneficial for Guyana to look upon these countries to identify institutional features that distinguish them from the many others.

If the existence and causes of the resource curse are controversial, it is hardly surprising that cures or means of avoiding it are equally problematic. However, in terms of Guyana’s potential, if there is a strong probability of an attack of resource curse, or if the institutions for the development of positive linkages to the non-hydrocarbon sector are weak, then it would be suggested that depletion should be slowed in order to allow time for the necessary institutions to develop although, it is by no means obvious that such institutional development will simply occur spontaneously. Clearly, fears of an attack of the resource curse will play an important role in the decision of governments on whether or not to convert their below-ground assets of petroleum resources into above-ground assets of cash. However, also important is the issue of whether the above-ground assets of cash might be managed effectively in reserve funds.

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Bobby Gossai, Jr. recently completed his MSc (Econ) in Petroleum, Energy Economics and Finance from the University of Aberdeen. Mr. Gossai, Jr.’s professional experiences include being the head of the Guyana Oil and Gas Association, the senior policy analyst and advisor at the Ministry of Natural Resources and Environment, senior analyst at the Ministry of Agriculture, economist at the National Competitiveness Strategy Unit and a national accounts statistician at the Bureau of Statistics. Further, Mr. Gossai, Jr.’s earlier educational training includes attaining a BSc in Economics and a Post Graduate Diploma from the University of Guyana in 2005 and 2007, respectively. He obtained his first MSc in Economics from the University of West Indies, St. Augustine, Trinidad and Tobago in 2010.

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