Avoiding the Resource Curse

1. Avoiding the Resource Curse Topic 5 (2): Natural Resources: Blessing or Curse? National Graduate Institute For Policy Studies IDPTP Fall 2012 John Page

2. Avoiding the Resource Curse • Because outcomes are mixed, the impact of natural resources on growth and poverty is a consequence of policy decisions. • In virtually all countries (except the United States) subsurface rights are the exclusive property of the state. • That means that the state plays a central role in decision making. • It also means that the state must inevitably play a large role in the economy.

3. Avoiding the Resource Curse • The sequence of choices for governments related to resource extraction can be thought of as a decision chain. • The decision to extract • Getting a good deal • Collecting revenues • Save or spend • Managing volatility • Investing for growth • The outcome of these decisions should be to obtain the maximum social and economic value for the resource

4. Avoiding the Resource CurseThe decision to extract • For low income countries the reality will be that exploration and extraction will be done by private (most often foreign) investors • Two important considerations govern the country investor relationship: • Property rights and transactions costs • Information asymmetries • Governments must be able to make credible commitments of property rights to investors. • But they also lack information on the resource. • Competition (auctions) can reduce the impact of the informational disadvantage of governments versus companies and identify those who most value opportunities.

5. Avoiding the Resource CurseThe decision to extract • State provision of geological information is a key enabler of competition. • A pre-requisite to successful competition for prospecting licenses or auctions for exploration and development rights is to provide sufficient information to the market so that those with the capability and interest are present and compete. • In general the more geological information is available the better for promoting competition, but this must be balanced against the cost of obtaining it. • Donors have an important role in supporting the discovery and provision of geologic information by providing funding and capability from their own national geological services.

6. Avoiding the Resource CurseGetting a Good Deal • To attract investors while securing full value for the country's resources requires carefully designed fiscal and licensing policies or contractual terms. • Well-designed fiscal regimes should allow the government to share in profitability and to have some minimum revenue stream in all production periods. • a royalty linked to production • a charge linked with profitability • use of production sharing arrangements

7. Avoiding the Resource CurseGetting a Good Deal • Fiscal Stability and Changing Circumstances • Investments are long-term and capital-intensive • Reasonable stability is needed • investors need to be protected from confiscatory government action • Social and Environmental Impacts. • Historically neglected • Local communities matter • Allocation of Risk • investors are the best party to bear operational or market risk • governments should bear political risks

8. Avoiding the Resource CurseGetting a Good Deal • Clear Rules and Transparency • rules applicable to all investors in similar circumstances • ensure that operators know that treatment is non-discriminatory, • reduce opportunities for corruption, • may reduce the demand by individual investors for special treatment • Policies, rules and contracts for new projects should reflect current government priorities and lessons learned • Enforceability • contracts and regimes need to have flexible mechanisms for resolving disputes and adjusting for changed circumstances • governments and investors need to have clear legal remedies • access to international arbitration

9. Avoiding the Resource CurseCollecting Revenues • Government may be at an informational disadvantage • know relatively little about technical details • little or no experience in complex negotiations • Auctions are generally the preferred mode, both on grounds of transparency and of securing maximum value • Competition between firms that are technically and financially competent has the potential to deliver maximum value to a government • well-designed auctions can reduce opportunities for discretion by government officials • Sequential auctions can secure greater value for governments. (reveal privately held information about the true value of neighboring plots)

10. Avoiding the Resource CurseCollecting Revenues • Bidding should take place over observable or verifiable bid variables • delivery on bid variables can be monitored and enforced • Competition need not simply be on price, but competition on too many variables erodes transparency, increases administrative • government-to-government deals for infrastructure which require that the host government give preferential access to the other country’s companies usually lack transparency and are difficult to value • Unbundling the contract into separate parts • Governments need not allocate extraction rights prior to obtaining exploration information • Incumbency rights of those who have carried out prospecting or supplied geological information should be clear • Competition in downstream activities and procurement of upstream services is also important • avoiding the allocation of resource outputs to the domestic market at a value lower than the international price • transparency, open access and fair competition in procurement processes • Competitive rules should apply equally to private and state-owned companies.

11. Avoiding the Resource CurseCollecting Revenues • The role of national resource companies (NRCs) • National Resource Companies (NRCs) can build expertise and professionalism in the resource sector. • They can also be a locus of corruption and fiscal losses. • Investments in NRCs can limit diversification and increase a country’s reliance on the resource sector. • NRCs can be successful, efficient, revenue-generating operations. • Structuring companies so that decisions are transparent and subject to market tests • Ownership through a commercial relationship such as shareholdings • NRCs should not conduct regulatory functions.

12. Avoiding the Resource CurseSave or Spend? • Revenues from resource extraction are intrinsically limited. • Most natural assets will be depleted. • For sustained growth this means that the natural asset must be replaced by another type of asset. • This implies the need for a high share of savings from natural resource revenues.

13. Avoiding the Resource CurseSave or Spend? • But the question is how much should be saved? • Early rules emphasized the need to provide for future generations (permanent income rule; “future generation funds”) • But poor economies have pressing immediate needs • physical infrastructure • human capital—e.g. education and healthcare • poverty reduction • better public administration • A significant increase in public revenues creates the opportunity to break the trap of low private investment • These considerations suggest that a substantial portion of revenues should be saved and invested (but not necessarily 100 percent)

14. Avoiding the Resource CurseManaging Volatility • Resource revenues can fluctuate dramatically. • Efficient use of revenues requires that expenditure be smooth and that investment build up over time (absorption constraints). • In budgeting, it is critical to take account of volatility of commodity prices and revenue flows. • This can be achieved by saving a portion of revenues during high revenue periods, holding the surplus in a “stabilization fund", and then drawing down the saved revenues during low revenue periods. • Smoothing can also be enhanced by limited foreign borrowing. • Assets held for the purposes of stabilization have a different function than longer term, “future generations” assets. • Amounts paid into the fund should be held in international financial assets

15. Avoiding the Resource CurseManaging Public Investment • For low income countries, domestic investments are preferable to overseas investments (provided they have adequate social returns). • Expenditure programs need to be formulated with prudence • volatility of resource revenues • expenditures are typically hard to reverse. • Expenditure and savings plans and execution should be fully transparent, reviewed and approved by legislatures, and understood and supported by the public. • A role for scrutiny mechanisms (external standards).

16. Avoiding the Resource CurseManaging Public Investment • If public spending has been properly prioritized, extra spending will be less valuable—in efficiency and equity terms—than existing spending. • A substantial increase in public spending is an opportunity for innovation in spending systems. • It may be politically easier to introduce improved, tougher management for new spending than to reform existing spending. • Innovation in public spending systems should meet two objectives: • integrity—avoiding misallocation and minimizing the opportunities for corruption • quality—the efficiency and equity of spending.

17. Avoiding the Resource CurseManaging Public Investment • Elements of an effective system: • A medium term expenditure framework • Published budgets and independent audit. • Cost-benefit analysis. • Ex post evaluation both for accountability and for learning. • Where to invest? • Investments in competitiveness (dealing with Dutch disease). • Investments that raise the return to private investment. • Investments that promote diversification. • “Investing to Invest”

18. Investing to Diversify:Chile and Malaysia • Chile and Malaysia – show quite different but successful patterns of structural change and growth based on natural resources. • The diversification pattern of each country reflects the types of public policies pursued by their governments. • Malaysia: spatial and industrial policies for manufactured exports • Chile: knowledge and coordination policies for agr-industry

19. Diversification in AfricaInvesting in agriculture • Agricultural yields have stagnated or declined for 40 years. • Crop yield losses range from modest to significant, depending on crop, soil type, climate and production systems. • Asia's productivity has increased threefold during the same time period • If current productivity levels are maintained, Africa will probably have lost global competitiveness in all of its main agricultural products by 2050

20. Investing in agriculture: Some elements of a strategy • Funding and certifying the use of new technologies appropriate to their agro climatic conditions • Introducing intensive agriculture through consolidation of holdings and commercialization • Clarifying the nature and duration of land rights claims; formalizing the terms of deeds, contracts and registration; and improving ways to document and uphold claims • Developing national programs for soil management • Rehabilitating agricultural innovation systems • Entering global value chains for processed agricultural and agro-industrial products.

21. Diversification in AfricaInvesting in knowledge • Natural resource activities generate opportunities for idiosyncratic knowledge – Norway and oil • Natural resource exporters can use revenues to generate knowledge in unrelated sectors – Chile and salmon • Sector specific knowledge can be used to develop ancillary industries – Qatar and pollution • Knowledge generation can be linked to spatial policies – Malaysia and electronics

22. Investingin knowledge:Some elements of a strategy • Building up the geology and engineering departments of universities • Developing service and supply industries to the resource extraction sector • Existing domestic firms often lack the technical and quality control capacity to deliver to international standards • Coordination mechanisms – perhaps in the form of public-private partnerships - may be required to achieve critical mass

23. Investing in knowledge:Some elements of a strategy • Generating knowledge relevant to new exports in agriculture or services, such as tourism, where geography or other endowments provide a comparative advantage • Linking knowledge with geography • investing in the quality of technical and university education in areas where existing agglomerations exist or in proposed regional SEZs • generating specific practical technical and management knowledge that it would provide as a public good to investors in regional economic zones.

24. “Investing to Invest” • In many countries construction is a key bottleneck. • High marginal costs reduce the “investment outcomes” obtained from a given amount of investment effort (real versus nominal expenditure). • Resource booms have a particularly sharp impact on construction costs.

25. “Investing to Invest”

26. “Investing to Invest” • Public policies can be used to “flatten” the marginal cost curve for construction. • This is Investing to Invest (Collier). • Possible areas of action: • Identifying bottlenecks • Removing restrictions • Improving logistics • Investing in construction skills • Opening to immigration

27. Summing Up • Because they are the owners of the resource governments must play an active and constructive role in managing natural resources for development. • Avoiding the resource curse is about making good public policy choices. • These choices can be viewed as a sequence of decisions ranging from exploration to public investment. • In low income countries there is a high potential pay-off to investing resource revenues in the future competitiveness of the economy • This requires a focus on investments that raise the return to efficient private investments.

28. Summing Up • Efficient public investment requires: • A medium term perspective (MTEF) • integrity—avoiding misallocation and minimizing the opportunities for corruption • quality—the efficiency and equity of spending • This in turn requires minimum standards of accountability and transparency.