Oil & public investments for Guyana’s overall development – not direct “citizen share”

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Oil earnings for an emerging economy such as Guyana should be turned into public investments rather than into increased private consumption. Most poor countries are severely constrained in their development by the under-provision of public goods.

Economic development, though undoubtedly requiring a predominance of the private sector in agriculture, industry, and services, also depends on core public goods. These are generally deficient, sometimes so much so that their absence impedes investments by the private sector and leaves countries in a poverty trap.

The poverty trap works as follows. The profitability of private investment depends on complementary public investments (in key infrastructure, health, education, etc.). Public investments, however, require budgetary outlays. In impoverished countries, those outlays are constrained by poverty itself. Typically, the government is not creditworthy, and therefore cannot borrow the needed investment funding from private capital markets. Thus, poverty leads to under investments in public goods, which in turn lead to under investments in the private sector, and poverty continues or worsens (e.g., because of continued population growth).

The causal chain and vicious circle are therefore as follows:

Oil earnings, at least in principle, allow countries to break out of this trap. The key is to use the oil earnings in a responsible manner to finance outlays on public goods that serve as the platform for private investment and long-term growth. When oil earnings rise and are successfully invested in public goods of various sorts, the resulting economic activity and stimulus to private investment should lead to higher incomes, improved budgetary resources including non-oil income, and therefore increased possibilities of financing public goods through an overall rise in economic activity. Even as oil resources are depleted, or diminished by declines in world oil prices, a strengthened private sector economy should be able to compensate (Humphreys, Sachs, Stiglitz 2007).

In this view, the popular idea of dividing the oil earnings into “citizen shares” and distributing the purchasing power to the public, as has been done in Alaska, is generally the wrong answer in poor countries, where public investment outlays rather than private consumption spending are typically needed to break out of a poverty trap. Even when increased private consumption is an urgent short-run objective for vulnerable groups (e.g., for the elderly or for people in extreme hunger), targeted public outlays rather than a general distribution of oil income preferable. Some of the outlays may be direct cash transfers (e.g., for the elderly), but more often they should be in the form of public services (such as health care) or the provision of inputs for private producers (such as fertilisers and improved seeds for smallholder farmers, or the extension of microcredit).

In any event, there is a strong case against transferring a depleting resource solely to the current generation, rather than spreading the benefits across the current and future generations. Intergenerational sharing is best accomplished through fiscal means. Norway, for example, invests its hydrocarbon income in the Government Pension Fund to spread consumption benefits to future generations, mainly by accumulating assets that will help indirectly to fund future pension benefits to be paid by the government’s social security system.

Therefore, A successful development strategy should include three components:

  1. A time path of public investments suited to the national circumstances.
  2. An economic policy framework to support private-sector economic activity.
  3. A political framework to ensure the rule of law and macroeconomic stability.

The detailed sequence of public investment must be of course based on the context of each country. For the poorest oil countries, the overriding goal is to use oil income to enable the economy to meet basic needs (food, safe drinking water, essential health services, basic education) and to put in place the infrastructure (power, irrigation, roads, ports, telecoms, the internet) for private-sector-led economic growth. For middle-income oil countries, the overriding goal is typically to promote the transition from a resource-based rural economy (including agriculture, oil and other mining) to a human-capital and knowledge-based urban economy. Key investments typically need to be made in knowledge creation and diffusion (higher education, scientific institutions) as well as in infrastructure in fast-growing urban areas. For high-income oil countries (e.g. Norway), which already have an extensive physical infrastructure in addition to well-endowed systems of higher education and science, a priority for oil earnings may be to support the budget burdens of social insurance (e.g., pensions, low-income support, public-sector insurance).

In the poorest oil-exporting countries, for example, Sao Tome and Principe and Nigeria, the prevailing conditions are characterized by a rural economy in extreme poverty and an absence of basic infrastructure (power, water and sanitation, roads, rail, telecoms, primary education, primary health care). Generally, these countries have long ago developed public investment strategies for each of these key sectors, but have been unable to fund those strategies because of a lack of fiscal resources and an inability to tap into private capital markets for project financing. A key priority for the poorest countries should be the power sector itself. Many impoverished oil economies export their oil and gas without developing their own modern energy system. Yet exporting the hydrocarbons without a strategy for expanding access to electricity and refined produces can be a major lost opportunity, one exemplified by the situation in Chad, which exported its limited oil reserves while depending for the vast majority of its energy needs on burning biomass. Other investment priorities are likely to include the construction of a road system, port facilities, access to safe drinking water and sanitation, a fibre optic network for telecoms and the Internet, primary schools, and primary health services (including community health workers, village-based dispensaries, local clinics, and hospitals).

The Sustainable Development Goals (SDGs), offer a useful “checklist” and organizing structure for public investments in poor countries. The SDGs call for decisive progress against extreme poverty in all its major dimensions – low income, high disease burden, hunger, lack of schooling, lack of safe childbirth (and attendant high maternal mortality), environmental degradation, and lack of access to basic amenities including safe drinking water and sanitation. Many middle-income countries are on track to achieve most or all of the SDGs (with maternal mortality and environmental goals being the most frequent exceptions), while the poorest countries are often far off course from achieving most or even any of the goals. Hence, emphasis should be centrally on increased public investments needed to achieve the SDGs, in key sectors including agriculture, education, health and infrastructure.

Distinctive Aspects of Development Strategies in Hydrocarbon Economies

Oil is different from other sources of national income, in that the preponderance of the income stream is a natural resource rent rather than the returns to reproducible capital (such as factories, machinery) or human capital (education, health). For this reason alone, it is easy for the state to appropriate the natural resource income (e.g., through nationalization), if it does not own the resource base in the first place. In fact, public ownership of hydrocarbon reserves is the norm. Major fields are often located on public lands or in public waters in the first place. Public ownership of hydrocarbon resources is often required by the national constitution. And where private owners are in control of oil fields, they often must transfer legal and illegitimate shares of oil earnings to governments and political leaders in order to maintain their share of the rents.

Treating the oil earnings as a simple rental income, however, is misleading in two important ways. First, a considerable investment of reproducible capital is required to produce the hydrocarbons, both for exploration and development of fields, and of course storage and transport. By “overtaxing” the oil flows, and thereby reducing or eliminating the returns to reproducible capital, the amount and value of the oil ultimately produced from a given field may be adversely affected. Second, since oil is a depleting commodity, the flow of oil income is, in fact, a conversion of natural capital (oil in the ground) into financial capital, and from there into consumption or into other kinds of capital such as human capital or reproducible physical capital. A sound investment strategy must take into account the time paths of oil production and depletion so that the time paths of investment and consumption will be smoothed over time.

Oil is distinctive for other reasons as well. The world price of oil is highly unpredictable and subject to large swings. Therefore, to the extent that the government relies on oil income for a significant part of budget revenues, policymakers must anticipate unpredictable and variable budgetary revenues. These pose enormous risks to macroeconomic stability. Three basic approaches have been taken to address these risks.

  • The first is hedging against future price changes (e.g., in the futures markets, but hedging possibilities are generally limited to the near term of a year or so).
  • The second is to budget based on estimates of “permanent” oil flows based on predictions of long-term average prices and quantities, rather than on short-term income based on current prices and current production levels.
  • The third is diversification, through privatization of public-sector holdings of oil, and investment of the cash value from privatization in a diversified portfolio. This third option depends on the ability of the government to carry out a privatization program that secures a market bid for the oil fields reflective of their actual present value.

As argued by Stiglitz (2007), such returns might be difficult if not impossible to achieve because of problems of asymmetric information and lack of enforcement of property rights subsequent to privatization (both of which lead prospective bidders to underbid the expected net present value of the oil income).

Another aspect of oil revenues is that they often can serve as a kind of collateral or security for international borrowing by the government. As a result, it is possible that following an oil boom (caused either by rising international prices or increased production) a government will be able to increase spending more than one for one with the increased oil earnings, by borrowing in international capital markets against the increased future flow of oil income. Many oil-exporting countries in the midst of an oil export boom have actually ended up deeply in debt since they spent more than 100 percent of the increased oil income. If future oil incomes were wholly predictable, borrowing against future oil earnings to raise public investment spending might indeed make good sense. Given the enormous uncertainties of oil income flows, however, borrowing against future oil earnings can be treacherous.

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