It reads like a script for a Hollywood movie—a poor protagonist happens upon an opportunity that has the potential of bestowing riches, but an evil curse threatens to spoil it all.
Unfortunately, it’s not a movie script. The scenario plays out repeatedly in many parts of the real world all the time. For many developing countries, managing natural resources and the increased revenues they bring is a tough haul.
Cue the extensive literature on the “resource curse” and the lack of consensus on how to run fiscal policy and manage budgets in resource-rich countries.
In some respects, this is like the “all-too-similar” sequel, because the tribulations associated with how to best manage natural resources, such as oil, minerals, and gas, seem to endure so that resource-rich developing countries are never quite free of them.
The “resource curse” and fiscal policy
High commodity prices and the discovery of new reserves offer the potential for much needed revenue in many developing countries—revenues that should help promote economic and social development, build human capital, and reduce infrastructure gaps in resource-rich countries. In a new study, my co-authors and I look at how to manage fiscal policy to achieve those goals while avoiding previous pitfalls.
The design of fiscal policy frameworks for resource-rich developing countries is beset by trade-offs and tensions. In fact, the volatility, uncertainty, and exhaustibility of revenues earned from resources have to be taken into account when formulating a scaling up of public spending.
- How to ensure short-term macroeconomic and fiscal stability?
- How to achieve long-term fiscal sustainability and adequate savings for future generations while allocating sufficient resources to meet development needs?
- How to address absorption capacity constraints that could limit the quality and effectiveness of scaled-up spending?
These are important questions that many politicians, policymakers, and economists face in such countries.
Recent academic and empirical work has enhanced the debate on this issue. On the one hand, such work has brought to the fore the need to avoid rigid policy formulations that would force countries with substantial development needs to keep the consumption of their resource wealth at a constant level over time (that is, borrowing at the beginning, saving when income is high, and lowering the rate of saving as income tapers off).
While persuasive, such work hasn’t offered practical approaches to managing fiscal policy in those countries and overemphasizes the role of resource funds, for example.
So, how could fiscal frameworks for resource-rich countries be made more flexible in practice? In our study, we analyze this question from a practitioner’s perspective, proposing specific options to effectively anchor fiscal policy while allowing for a sustainable scaling up of spending in the context of increased resource revenue.
In laying out the options, our study emphasizes that there is not a “one size fits all” approach since each country has its own set of economic and institutional circumstances to balance, such as resource revenue dependency, how long the reserves will last, and the country’s development needs. Furthermore, the large volatility of revenues earned from natural resources and the difficulty to predict those swings would call for prudence and gradualism in scaling up spending and for flexible fiscal rules to adapt to new information and changing circumstances.
Accordingly, we propose the following principles to guide the formulation of fiscal policy frameworks in resource-rich developing countries:
- The framework should reflect country-specific characteristics like revenue dependency and volatility as well as how long the resource revenue stream is expected to last—all of which may change over time.
- It should ensure the sustainability of fiscal policy. Depending on how many years the natural resource is expected to last before it is depleted, benchmarks of sustainability can be derived from simple constant consumption approaches—particularly for countries with short-lasting reserves—or from a broader focus on stabilizing government net wealth (not now, but over the long run).
- Policymakers can choose alternative fiscal anchors, either primarily addressing fiscal sustainability concerns (for example, permanently constant non-oil balance deficit rules) or focusing more on short-term demand management (such as a price-based or structural balance rule). Country characteristics should guide the choice of the appropriate fiscal anchor (see table below).
- Frameworks should be sufficiently flexible to enable the scaling up of growth-enhancing expenditure (for example, public investment to tackle existing infrastructure gaps), especially in low-income countries.
- In countries with large absorption constraints, the pace of scaling up may have to be gradual, while public financial management systems are reinforced and domestic supply constraints softened.
- The volatility and uncertainty of resource revenue is critical for the design of fiscal frameworks, and having sufficient precautionary fiscal buffers is critical. A strong revenue forecasting framework needs to be developed and spending plans framed in a medium-term perspective.
- The credibility and transparency of the framework can be supported by a well-designed natural resource fund. But the fund cannot be a substitute for an appropriate policy framework nor a panacea that obviates the need to strengthen overall fiscal management capacity. Funds need to be fully integrated with the budget and the fiscal framework.
The complete framework would comprise three elements:
- Fiscal policy indicators–the best analytical measures of the actual stance of fiscal policy.
- Fiscal sustainability benchmarks–provide a way to assess fiscal policy with a longer-term perspective.
- Fiscal policy anchors–the rules or guidelines that would better fit resource-rich countries and their specific characteristics.
The table below illustrates the more appropriate rules possible along two specific dimensions: the horizon of their resource reserves and the relative scarcity of capital.
This post originally appeared at iMFdirect and is posted with permission.