Today’s column starts my revisit of the Guyana Natural Resource Fund, NRF, alternatively termed Sovereign Wealth Fund, SWF. It addresses the topic from three unequally weighted perspectives. First. I revisit today the economic rationale behind these Funds. Second, in what follows I briefly address the transition from the NRF Act 2019 to the NRF Act 2021 and thirdly, I offer a critique of the very notion of such Funds.
NRF/SWF rationale!
Worldwide data clearly reveal that, oil and gas discoveries on the scale of Guyana’s invariably lead to impact booms in export and government revenues, thereby creating what economists term as “fiscal space”. That space is basically room in the national budget allowing government spending on its policies, projects, and programmes; without jeopardizing financial and/or macroeconomic stability. Because such spending may focus on items like infrastructure, health, education, social welfare, productivity enhancing products (hardware) and services (software), environmental sustainability, and so on, governments uniformly pounce on these revenues as a “golden opportunity” to exploit at the fullest.
Regrettably, empirical data also reveal that the “fiscal space” has turned out, all too often to be rather short-lived, if not illusory! Indeed, worldwide data further reveal that this plentitude of resources has led, far too frequently, to acute macroeconomic imbalances and vulnerabilities. Typically, deficits and gaps have rapidly emerged in the fiscal and monetary accounts, so that both internal imbalance (domestic investment and savings) and external imbalance (external trade and payments) characterize the macroeconomy. Further, unhealthy exchange rate changes, domestic inflation, and rising public indebtedness have come to typify economic conditions. The evidence of mis-managed, poorly-managed and corruptly-managed revenues from the extraction of hydrocarbon resources seems to have become all too frequent.
The Triad of Crises
Economists surveying these developments have found that in small, poor, and highly open economies with limited institutional and human capacities critical to development [ transparency, accountability, rule of law, and democratic governance] three crises frequently occur; namely: 1) the “Dutch disease;” 2) rigid pro-cyclical patterns of economic behavior; and 3) increasing dependence on the oil sector. Dutch Disease or the “curse of plenty” refers to booms in hydrocarbons export revenues that lead to rising wages and prices in the non-hydrocarbons sector; falling productivity in these sectors; appreciation of the exchange rate; consequential rises in the export price of non-hydrocarbons exports; weak internal sectoral linkages between the oil and natural gas sectors and other domestic sectors, both traded and non-traded; and, last but not least, negative outcomes caused by the low absorptive capacity of the non-oil and natural gas sectors in response to increased investment and public spending.
Rigid “pro-cyclical” patterns become imbedded in public spending in that, when there is a windfall in export revenues, governments reflexively spend. This may be political opportunism, but regrettably, spending when you have plenty, rather than saving for a rainy day has been regrettably the norm.
Increasing dependence on hydrocarbons rise as the size of discoveries increase, given the rate of depletion. As the peak of hydrocarbon resource extraction is approached, consequential declines in the depletion rate accentuate the natural boom and bust elements of commodity-based cycles.
Avoidance and Solution
It is in the context of the above dynamic that SWFs emerge as the best mechanism for avoiding/rectifying of such outcomes. From the analysis a SWF should accomplish, the following: 1) balanced management of oil revenues; 2) streamlined build-up of revenues fed into the national budget; 3) stability and predictability of government spending (including successive governments); 4) opportunities for saving some of the current revenue flows for future generations (inter-generational equity).
Further analysis
I wrap-up this discussion by expanding on two technical matters raised above namely, fiscal space and Dutch Disease, both central to a fuller understanding of the dynamic interplay between an oil and gas export boom and growth/development in small poor open economies like Guyana.
Fiscal Space
In Guyana-type economies, “fiscal space” in the national budget lets governments spend without jeopardizing fiscal and monetary stability. Specifically, increased public spending does not generate monetary/fiscal gaps. This is possible only if it is: 1) fully financed by taxation; 2) covered by external grants; 3) at the expense of lower priority Government spending; and 4) can be borrowed by Government from the banking system, without negative consequences for macroeconomic balances.
Dutch Disease
Dutch Disease/curse of plenty is a function of four sequential outcomes: first, rising wages and prices in sectors other than the booming oil sector; second, consequential declines in these sectors’ productivity; third, an appreciation of the exchange rate; and finally, price increases occur in the “other sectors,” which further reduce their competitiveness.
Guyana-type economies possess weak linkages between their booming oil and gas sectors and others, along with low absorption capacity. This weakness, compounds the difficulties, resulting in de-industrialization and de-agriculturalization of their economies.
This sequence, has been diagnosed by me as the causal link in Guyana-type economies, between their expanding oil and gas sectors and declines in other sectors, especially industry and agriculture. When interpreting, this causal link, oil and gas can be readily substituted for with: 1) any other commodity export; 2) massive inflows of foreign direct investment; and, 3) foreign aid.
The term Dutch Disease was coined as a description of this sequence in the Dutch economy in the 1960s and 1970s (following its natural gas “find”). Economists admit that economic policy can sever this causal link if the Authorities: 1) control/sterilize the transmission of increased export revenues into the domestic economy; and 2) prevent the loss of competitiveness in “other non-booming sectors”, by improving their absorptive capacity. It is essential, though, to recognize that expanding oil and gas revenues in such circumstances is usually both volatile and uncertain, reflecting the stark realities of the global hydrocarbons market.
Conclusion
Next week I continue as indicated above.
