Resource extraction can be harnessed to create employment and income in various sectors of the economy. Opportunities arise from the direct stimulus created by the resource sector, as well as from the availability of funds generated by resource revenues. This employment and income will be created largely by the private sector, but government has a role in ensuring that opportunities are taken up. It may be in resource related activity, in line with the view that the resource sector should yield direct benefits and local value added over and above tax and royalty payments. But countries will also want to ensure that non-resource sectors are enabled to grow.
The primary role of government is to create the investment climate and public goods that are complementary to private investment. First of all, this involves removal of obstacles to private investment. Since a resource boom brings about structural change in the economy it is particularly important that the business environment is supportive of new investments and flexible enough to allow redeployment of capital and labour across sectors of the economy. Potential bottlenecks – for example in the construction sector – can be identified and addressed. Openness to international trade helps to get around such bottlenecks.
Secondly, public investments can play a major role in raising the productivity of the economy and thereby stimulating private investment. In choosing public investments the government should prioritise those that are ‘general purpose’, such as health, education, and infrastructure which will benefit essentially all sectors of the economy and all regions.
Government may also choose to use incentives aimed at particular sectors or activities. Such policies carry risks, as witnessed by the numerous ‘white elephants’ left in many resource rich economies. If such policies are to be employed, then several design principles should be employed. The first principle is that investments should be credibly expected to attain long-run commercial viability. Investments that fail this test are likely to destroy rather than add value, and will be a continuing drain on public funds.
The case for government support for a new activity arises if there are ‘market failures’ which prevent firms from being able to undertake potentially high return investments. Many of these market failures can be removed by measures to improve the business environment, such as improving the financial sector, contract enforcement, and the system of regulation. Others are more deep-seated, and include spillover effects and coordination failures. The former arise when a firm creates benefits that accrue to other firms (such as training labour that then quits for another employer). The latter arises where inter-related private investments create a chicken and egg problem, with no private investor ready to make the first move.
Assessing the case for supporting particular sectors or investments requires careful analysis and diagnosis of the market failures that prevent the private sector from undertaking investments. When sector specific policies are employed several further principles should inform the design of any support package. The most important is that support should be linked to success not failure. Open-ended support packages should be avoided and support should involve credible criteria for termination in the case of continuing poor performance. Lobbying by interested parties is frequently an obstacle to this, so decisions should be taken at a high level and in consultation with a wide section of society, consumers and taxpayers as well as producer interests.
In selecting sectors for promotion there is a tension between building resource related sectors and diversifying the economy away from dependence on a narrow resource base. Choices here are country specific, but there are several guiding principles. The first is that if the resource is easily traded internationally (eg oil and high value minerals) then the best option is likely to be to export the resource and use the funds to invest in other sectors. It is only where the resource is less readily traded (eg gas, low value minerals) that the case for developing downstream sectors is strong. Choices should be based on assessment of countries’ capabilities and long-term comparative advantage. Is the country likely to attain world level efficiency in the sector? Do regional markets provide a long run basis for commercial viability? This assessment is difficult – the essence of economic development is that countries develop new capabilities and grow into new activities. Careful study of the experience of comparator countries is one way to form a judgement. Another is to identify areas where the private sector – international as well as domestic – displays an interest in investing.
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