The revenues from resource extraction are intrinsically time limited; natural assets will be depleted. Hence, even where citizen needs are acute, if the resource revenues are consumed but not invested, the resulting increase in living standards may not be sustained. If the revenues are to be harnessed for a sustained increase in living standards, a substantial part of them must be invested outside the resource sector in physical, human and environmental infrastructure, including education, health care, roads, railways and ports. Low-income countries, particularly those faced with urgent unmet needs, are also likely to possess a wide range of opportunities to increase growth across the economy via domestic investment. Broad-based growth increases jobs and household incomes and is a necessary condition of sustainable poverty reduction. Growth also gradually generates the non-resource tax revenues that can sustain enhanced social spending.
To be effective and enduring such growth requires sustained high levels of investment over an extended period. The amount of investment which a country can absorb productively (its 'absorptive capacity') may at any time be limited by its human capital and administrative capacity as well as by its physical infrastructure. Many resource-rich countries have low levels of infrastructure, skills, and labor productivity. These in turn produce an unpromising climate for private investment. For example, private investment in electricity generation may be unprofitable because transport infrastructure is too poor to support the firms that would be reliable purchasers of power. Investment in agriculture may be low because of a lack of rural roads, irrigation or knowledge of appropriate technologies. A significant increase in public revenues creates the opportunity to break the trap of low private investment. By simultaneously increasing public investment across a wide range of needs, the return on private investment can be raised, thereby stimulating activity.
However, precisely because the unmet needs are wide ranging, appropriate public investment takes many forms, not all considered to be physical capital investment. In addition to physical infrastructure, spending on human capital—e.g. education and healthcare—and other complementary investments such as those in better public administration, may be worthwhile in themselves, delivering high social returns. However, they also serve the important function of improving the climate for investment and complementing private investments by raising the returns to capital.
For low income countries, domestic investments are preferable to overseas investments. High-income countries—such as Norway—may find it appropriate to build up SWFs to support future generations, but this strategy is inappropriate for low-income countries. Low-income countries are capital scarce, lacking vital infrastructure, public services and public goods, including health and education services. It is appropriate to remedy these deficiencies. The sequencing of investment should address these limitations early in order to permit more rapid levels of future investment and growth.
Countries which come into a commodity boom with high foreign debt levels can usefully apply some of the windfall to paying off outstanding debts. Debt reduction raises no domestic absorption issues, enhances the country’s credit standing and appeal to investors, and—most importantly—will reduce the cost of capital for the domestic private sector via its effect on interest rates.
While the key objective is sustained growth, the citizens of many resource-rich countries have urgent needs. They are currently much poorer than they and their children are likely to be in the future. Thus it is appropriate to use part of resource revenues for an immediate increase in living standards.
One mechanism for delivering the benefits associated with resource revenues to citizens may be via conditional or unconditional cash transfers or “dividend” payments. Direct transfers can help get around spending bottlenecks and capacity constraints and can also help overcome individual credit market constraints. Such a dividend also recognizes that citizens are the ultimate owners of the resource. Furthermore, transfers to citizens can increase accountability and generate public interest in the way revenues are spent. Direct transfers need not account for the full stream of resource revenues for these advantages to be realized. However, it should be noted that many resource-rich countries lack the public administration to cost-effectively distribute revenues to individuals. Doing so may incur high costs. Furthermore, individuals may be less able to make optimal investment decisions than governments on their behalf, perhaps due to market failures and volatility.
The mechanisms by which citizen transfers are made are critical, particularly where public administration and social security infrastructure may be underdeveloped. Recent research suggests that conditional cash transfers may be an effective channel to distribute money to households. One alternative type of distribution mechanism is the subsidizing of the domestic price of the extracted commodity, or its associated products such as petroleum. This is the least desirable way to increase household expenditure. Such mechanisms are widespread, however. The use of commodity subsidies spurs wasteful consumption and may encourage smuggling and the development of parallel markets. In times of high world prices the loss of export earnings and the macroeconomic burden of domestic subsidies can be unsustainable. Furthermore, the distributional targeting of such subsidies is typically absent or infeasible, leading to perverse distributional consequences, often at odds with wider government objectives such as poverty alleviation or redistribution. Some form of direct or targeted transfers may be preferable and less costly.
Expenditure programs need to be formulated with prudence, and due attention paid to the volatility of resource revenues and the fact that expenditures are typically hard to reverse. Any such programs should also be developed within the context of a Medium Term Expenditure Framework that properly assesses their internal consistency and economic impact. Expenditure and savings plans and their execution should be fully transparent, reviewed and approved by legislatures, and understood and supported by the public.
