The opportunities for sustained growth that are created by a large increase in public expenditure, such as that made feasible by new resource revenues, require effective allocation and control of spending. Government should pay careful attention to the macroeconomic impacts on other sectors of the economy.
Governments facing increased public revenues from resource extraction must pay special attention to the problem of the quality of public spending. If public spending has been properly prioritized, extra spending will be less valuable—in efficiency and equity terms—than existing spending. Deterioration in the quality of spending may also occur as a result of political economy pressures: once lobby groups know that public spending will increase, they will increase their efforts to capture it for their own advantage; ‘rent-seeking’. If the quality of extra public spending is low, then the resource revenues cannot be transformed into substantially higher living standards.
The solution to the problem of low-quality public spending is to recognize that a substantial increase in public spending is also an opportunity for innovation in spending systems. In countries with low institutional capacity it may be politically easier to introduce improved, tougher management for new spending than to reform existing spending.
Innovation in public spending systems is needed to ensure two distinct objectives are met: (i) integrity—avoiding misallocation and minimizing the opportunities for corruption; (ii) quality—the efficiency and equity of spending.
As when pursuing integrity and quality in resource extraction contractual regimes, competition can be an effective instrument. The institutional equivalent of an auction for the sale of extraction rights is to require competitive tendering for all public procurement.
In addition to competitive tendering there are some systems which are primarily designed to ensure integrity. The decisions to approve expenditures should be made transparent through published budgets. Once expenditures have been incurred they should be subject to the scrutiny of independent audit. Other systems are primarily for efficiency purposes. Prior to approval, the costs of major expenditures should be compared to their likely benefits (cost-benefit analysis). After completion, such expenditures should be evaluated, the results being used both for accountability and for learning.
Large increases in spending financed from resource export earnings have macroeconomic repercussions which can damage sectors indirectly in competition with resource export. Firms that produce other types of exports can be hurt by changes in exchange rates that make their exports less competitive. Firms which produce tradable goods for the domestic market, such as manufactures, can be hurt because labor and other costs may be bid up by demands from the resource sector. Together, these effects are known as ‘ Dutch Disease’.
The solution to Dutch disease is, in part, to offset the damage done to producers of other exports and import substitutes by lowering their costs. The way to do this on a sustainable basis is not through subsidies but through choosing public investments that are ‘general purpose’, such as health, education, and infrastructure, which will benefit essentially all sectors of the economy and all regions of the country.
Dutch disease can also be reduced by smoothing peaks and troughs of commodity price fluctuations. However, even with such smoothing the economy will need to adjust to periodic external shocks. This has implications for the design of economic policies that might appear unrelated to resource extraction. A key economic characteristic that appears to improve the ability of resource-rich economies to weather shocks is labor market flexibility. Since resource-rich economies are exposed to particular types of shocks they should prioritize such flexibility accordingly. This implies that policies for social protection might need to be distinctive in such economies, with greater focus on direct help to households and assisted job mobility, rather than on the protection of existing jobs.
