© 2018 by Daniel Anthes

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Natural resource exporters' dilemma: How to manage revenues?

Extractive resources are non-renewable natural resources and therefore exhaustible, which is why revenues generated from depletion are finite and hereby intrinsically temporary. Also, particularly in the developing world, they account for a large share of several country's overall export structure and often generate the bulk of total government revenues. These challenges said, how to best manage revenues?

Volatility, uncertainty and exhaustibility of particular oil revenues pose enormous challenges to the resource-rich country with regard to the design of appropriate policy frameworks. In this context the government should ask itself: How to ensure short-term macroeconomic and fiscal stability? How to achieve long-term fiscal sustainability and adequate savings for future generations, while at the same time allocating sufficient revenues to meet urgent development needs? How to address absorption capacity constraints that could limit the quality and effectiveness of increased public investment?

 

Distinctiveness of natural resource revenues 

 

Most of the political and economic problems that eventually lead to the resource curse can be traced back to the distinct characteristics of natural resource revenues. However, extractive resources and oil in particular have some unusual properties. The literature points to three distinct characteristics of revenues that are often held responsible for the bulk of resource-rich countries not being able to turn their enormous resource wealth into an unmitigated blessing: (a) their temporariness due to the finite nature of causal resources, (b) their massive scale, and (c) their extreme volatility.

 

First of all extractive resources are non-renewable and thus exhaustible, meaning that their revenues are intrinsically temporary. Of course, the duration of inflowing revenues varies from country to country according to one’s natural resource wealth, but since every extractive resource runs out after a certain time, revenues will eventually stop accruing to the particular country. For example, Venezuela is likely to receive oil revenues for more than another hundred years, whereas Equatorial Guinea will probably run out of oil within the next twenty years (British Petroleum 2012).

 

Secondly, rents from non-renewable natural resources can provide governments with large fiscal revenues, since in almost all countries policy leaders have the right to appropriate a share of those rents. This is first and foremost caused by the fact that the costs of extraction normally are way below the amount of revenues that can be fetched on commodity markets, eventually leading to “super-normal profits” (Barma et al. 2011: 14), particularly during times of commodity price booms. For example, in Saudi Arabia it costs 2 US-Dollar to lift a barrel of oil out of the ground, given the current oil price of over 100 US-Dollar per barrel leading to extremely high rents (see Fig. 1).

 

Fig. 1: Extraction costs and rents per barrel in selected countries, 2008 (Ross 2012: 36 adapted by author)

 

Oil revenues often amount to a high percentage points of national income, and thus a large proportion of government revenues. In comparison to other industries, the oil industry generates far more government revenues, which is why oil-rich states have relatively large governments. In fact, as Ross (2012: 30) points out, oil abundant countries have governments that are larger by 45 percent compared to their oil-scarce coun-terparts (see Tab. 1).

 

Tab. 1: Government revenues as a percentage of GDP, 2003 (Ross 2012: 30)

 

Also, the richer a country is in oil, the less reliant it is on taxes since it earns more non-tax revenues. This leads to the fact that oil-rich countries are, on average, about 30 percent less dependent on taxes (see Tab. 2). As a consequence, governments in oil-rich countries would be even larger if they would keep their tax rates at comparably “normal” levels, rather than lowering their taxes because of large oil revenues (Ross 2012: 31).

 

Tab. 2: Taxes on goods and services, 2002 (Ross 2012: 31)

 

Thirdly, revenues derived from natural resources are highly uncertain and fluctuating due to the high volatility of commodity prices (Jacks et al. 2011; Brown & Crawford 2008). Since prices of extractive resources on commodity markets are difficult to forecast, the government’s management of revenues and corresponding macroeconomic and fiscal policy frameworks are noticeably affected by changes in the market. As a result, the proper management of boom-bust-cycles becomes a key success factor for managing resource revenues. As Ruta & Venables (2012: 8) highlight in their studies, “volatility has reached new highs across fuels, minerals, and agricultural commodities” – fuel prices jumped 234 percent during 2003-2008, while mining products rose 178 percent. The slump of the 1970s and 1980s was followed by a sustained buoyancy of commodity prices from 2000 onwards. For the last decade, prices have risen dramatically, except for a short period induced by the global financial crisis in 2008 (see Fig. 2).

 

Fig. 2: Selected commodity annual price indices, 1960-2012 (World Bank 2013 adapted by author)

 

Thus oil exporters that are heavily dependent on revenues from oil exports are confronted with severe challenges due to high commodity volatility and thus the unpredictability of their revenues. For example, in the case of Nigeria a price fluctuation of 50 US-Dollar per barrel would be equivalent to a difference of 50 percent in its GDP (Gelb & Grasmann 2010: 4). The fundamental reason for extractive resources’ high volatility can be credited to their low short-run price elasticity, particularly in the case of oil – that is when changes in commodity prices have relatively small effect on the quantity of resources demanded, and on resources supplied (Carter et al. 2011). This is why relatively small shocks, both on the supply and demand side (e.g. because of political instabilities in the context of an oil embargo) imme-diately lead to large price changes that are necessary to balance out the market (Frankel 2012: 7; Ruta & Venables 2012: 8).

 

Fiscal policies for allocating natural resource revenues

 

Clearly, the optimal fiscal policy framework for resource-rich developing countries has to balance several objectives at the same time. Fig. 3 presents a simple decision tree, which helps to weigh these objectives across the entire spectrum of resource-rich countries (so both developing and developed countries). In this context both the size and the duration of the windfall of revenues flowing into the country, as well as the economy’s capital accumulation at the stage of discovery are of decisive importance for the general design of the fiscal framework.

 

Fig. 3: Decision tree to determine fiscal framework priorities (author’s own illustration after Baunsgaard et al. 2012: 7; Van der Ploeg et al. 2012: 3)*

 

Ghana at this point is exemplarily confronted with Saudi Arabia as an oil-producing country where revenues from export activities are both larger and more permanent than in Ghana. In fact, Ghana on the contrary can expect a relatively small and temporary windfall of oil revenues, which given its capital scarcity is why it should focus on speeding up economic development and providing for future generations.

 

This is in contrast to countries that face large and long-lasting windfalls, for those that are capital scarce meaning they have to pay particular attention to price volatility and thus macroeconomic stability (such as Libya, Nigeria or Gabon). Since those countries are advised to invest domestically they also have to focus on managing absorption constraints and preventing inequality and corruption.

 

On the other hand are countries that are capital abundant and whose framework should be centered on managing volatility and achieving macro-fiscal stability, as well as safeguarding recurrent spending on things like government jobs (such as Saudi Arabia and Kuwait). In countries where resource revenues are temporary, but which have ample capital, the key issue should be to accumulate sufficient financial savings for future generations (e.g. Norway).

 

Of course, the country classification here is not cast in stone and can change over time, hence the respective fiscal framework and its primary objective might also have to be modified. The most likely reason for this would refer to changing resource reserves estimates. As a matter of fact, many developing countries, particularly in SSA, enjoy significant potential for discovering further resources, which could extend their reserve horizons. However, future prices, costs, technology, as well as the policy environment will all affect the potential and the extent to which new reserves can be economically developed (Baunsgaard et al. 2012: 7 f.).

 

A holistic approach for managing natural resource revenues

 

To sum it up: It becomes clear that the distinct characteristics of natural resource revenues and concomitant different fiscal policies for allocating pose several challenges - at least from a financial perspective - to a government in order to manage it natural resource wealth properly. So how much should a country spend and how much should a country save?

 

With good reason Cherif & Hasanov (2012) speak about the “oil ex-porter’s dilemma” in the context of either spending or saving revenues. Finding out that the average oil exporter saves more than he invests, they plausibly ask themselves “Should they not invest more to grow faster, promote development, and have alternative industries when oil runs out?” (Cherif & Hasanov 2012: 3). However, this approach alone would neglect significant challenges in respect of sustainably managing revenues and therefore oversimplifies the problem.

 

Not just because of the high uncertainty and volatility of commodity prices and consequently revenues derived from export activities (particularly in the context of oil), but also addressing issues such as transferring wealth and ensuring intergenerational equity while at the same time tackling potential development needs, the government in charge has to grapple with a lot of balancing capabilities. 

 

Ideally, revenues should be managed so that they secure macroeconomic stability and fiscal sustainability, hereby particularly for countries with temporary revenue windfalls. Moreover, they ought to allow for growth enhancing expenditures that help raising the economy’s competitiveness, as well as diversifying the country’s economic structure, while at the same time avoiding absorption and institutional constraints. In addition they should ensure a sufficient accumulation of savings for precautionary, as well as intergenerational equity purposes. Hereby the precise weight of these fiscal framework objectives should reflect the country’s specific characteristics.

 

Of course, in this context there is no one-size-fits-all approach for how to best manage revenues from natural resources. In each case specific country characteristics require an appropriately adapted approach so that natural resource wealth and related revenues do not cause any dilemma.

 

 

References:

 

Foto: Money - Andrew Magill (taken from flickr)

 

*Setting up specific thresholds in this context will necessarily somewhat be arbitrary, but in order to undertake more general classifications there are helpful indicative thresholds. In fact, with regard to the windfall size and accordant revenue dependency an indicative threshold could be in the range of 20 to 25 percent of total fiscal revenue. A threshold for the revenue horizon could be set up at 30 to 35 years, basically equaling one generation. Besides there is a country’s accumulation of capital, relating to de-velopment needs, as well as absorptive and institutional capacities that are decisive in the context of spending revenues (see Baunsgaard et al. 2012: 6; Van der Ploeg et al. 2012: 4).

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