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 will 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 the nation’s physical infrastructure, and in education, health care, and social protection. The very fact that a country has urgent unmet needs across a wide range implies that there are many opportunities to increase growth across the economy. Broad-based growth increases jobs and household incomes and is the only route by which countries are able to sustainably reduce poverty. 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. Many resource rich countries have low levels of infrastructure, skills, and labor productivity. This in turn produces 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 lack of rural roads, irrigation or knowledge of appropriate technologies. A quantum 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 gearing up public investment with a private response.
However, precisely because the unmet needs are wide-ranging, the appropriate public investment takes many forms, some not even conventionally treated as investment. In addition to physical infrastructure, spending on human capital - education, health, and social protection – can all interact to improve the climate for investment.
For low-income countries, domestic investments are preferable to overseas investments. High income countries – such as Norway – may find it appropriate to build up sovereign wealth funds 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. This means that the return on appropriate domestic investment can be above what can be earned by investing on world markets.
The amount of investment which a country can absorb productively (its “absorptive capacity”) may at any time be limited by both its human capital and infrastructure. The sequencing of investment should address these limitations early to permit more rapid levels of future investment and hence 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.
While the key objective is sustained growth, the citizens of many resource-rich countries are poor. They are currently much poorer than they and their children are likely to be in the future and so it is appropriate to use part of resource revenues for an immediate increase in living standards, including through direct conditional or unconditional cash transfers or “dividend” payments. Direct transfers get around spending bottlenecks and capacity constraints. Such a dividend also demonstrates that citizens are the ultimate owners of the resource. Although frequently used as a way to distribute benefits, subsidizing the domestic price of the extracted commodity is the least desirable way to increase household consumption. The cost to the government budget can become prohibitive when world prices rise, the subsidies encourage smuggling and parallel markets, and they spur wasteful consumption which reduces the earning power of the resource.
Expenditure programs need to be formulated with prudence, and due attention to the volatility of resource revenues. They should also be developed within the context of a medium term expenditure framework that properly assesses their internal consistency and economic impact. (See Precept 8).
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