Oil and other sectors

Could Guyana escape the natural resource curse?

Part 6

The previous column explored how the lack of economic research capacity might have contributed to the lopsided contract in favour of ExxonMobil. One misconception that is often expressed in various Guyanese quarters is observers like yours truly never worked in the oil industry, therefore, we do not know about negotiating a PSA-type oil contract. Indeed, some politicians have also expressed this viewpoint. This criticism, however, misses the context of negotiation. Negotiation requires information. Information is created by researchers using and generating raw data.

I think the fault rests not so much with the critics, but more so with the political leaders who have not asked the right questions. Asking the right questions and processing raw data to create information requires broad training and diverse perspectives. On a parallel topic, the University of Guyana also from time to time gets criticized for not teaching relevant subjects for the private sector. But UG offers several programmes that mould a rounded human being with technical skills. I am not saying there is no room for improvement, but the problem also rests with the bosses in the private sector who often don’t ask the right questions. The task of a university is not necessarily to job train – which is the task of the Government Technical Institute – but to shape rounded and nimble humans with skills, including quantitative ones, which can be quickly deployed to various questions and problems facing the country.

This column examines another initial condition that is a prevalent feature of the Guyanese economy. We are observing initial conditions because we want to make a reasonable prediction – itself a perilous task – of how well Guyana is likely to utilize its coming oil revenues so that the resource curse is not a hindrance to development. Last week we looked at economic research capability as an initial condition. Certainly other research in agriculture, chemistry, biology, physics, management, healthcare, etc, are equally important. But the purpose was to demonstrate how economic research could have produced a better outcome for Guyana if the negotiators were well-equipped with the information. In this column, I will look at production structure as an initial condition.

The idea that the structure of production matters for higher living standard is an old one and is associated with structuralist economists. The idea of structure was recently applied to Guyana’s oil and gas prospects by Professor Jay Mandle in a 2016 paper ‘Guyana’s future as a petroleum exporting state’ that was presented at a conference at the Central Bank of Barbados. Mandle used a recent innovation in the structuralist literature, an idea known as the product space. It is a measurement of how related one export product is to another. Advanced economies with high living standards export products which are tightly related in the space. In other words, one export success breeds another, a classic favourable spill-over scenario. Less developed countries export products that are unrelated. Think about sugar, bauxite, timber, gold, rice and rum. Except for rum and raw sugar, the others are unrelated.

Mandle uses Trinidad and Tobago as a plausible counterfactual to predict how well Guyana will do with its soon to be realized financial inflows. In spite of just over a century of experience in oil production, Trinidad and Tobago still exports products that are largely unrelated in the product space measurement. In other words, after 100 plus years, the economy there is not diversified enough with a network of sophisticated interconnected exports, compared with, for example, Singapore. Interconnected exports also signal superior technological spill-overs and greater opportunities for technology diffusion. Product relatedness might also shape culture and who knows have long-term implication for aggressive and heinous crimes. However, we do know that the relatedness of products is important for a vibrant entrepreneurial class.

The only large industry in Guyana that results in production application elsewhere in the economy is GuySuCo. Sugarcane makes molasses that also gives rum, world class ones at that. GuySuCo also provides a public good known as drainage. Sugarcane can also give biomass for cogeneration. In the right scale, sugarcane could also be used for sweets and ethanol. While these are all old technologies, they still require a certain degree of ingenuity, industrial activity and planning to link them all up across an economy. The misunderstood free market would not get it done. Management will.

Another way to think about structure is to consider how much Guyana’s exports rise as the income of trading partners increases by 1 per cent. The country wants to be in a position in which a 1 per cent increase in the incomes of people living in our export markets will generate a more than 1 per cent rise in Guyana’s exports. This is one way to secure a stable economy in the future.

On the other hand, we can expect that the new oil revenues will result in an increase in average Guyanese income. The increase will likely not be shared equitably, but on average we can expect incomes to rise. Therefore, we want to be aware of how much will Guyana’s imports grow for every 1 per cent rise in average income. If this higher income induces a more than proportionate increase in imports, we can expect trouble. In other words, if higher incomes mean the country will move from consuming bora and catahar to broccoli and Brussel sprouts or from Banks beer to expensive French cognac, you can expect that Guyana will be knocking at the IMF’s door around 2030.

The point I am making is the structure of production matters for the export and import composition and how likely the country will steer clear of balance of payments problems. The goods Guyana presently exports are not high income elasticity products, meaning exports do not grow faster than the incomes of foreign countries. However, over the long term, Guyana’s imports grow faster than the growth of Guyanese income. This is mainly because the country imports energy-based products such as oils and gas and chemicals. Crude oil incidentally has a lower income elasticity than the downstream derivatives such as jet fuels, gasoline, lubricants, asphalt, LPG, etc.

From 2020 Guyana will be exporting crude oil and importing relatively high income elasticity downstream derivatives such as those listed above. The country cannot escape this initial condition or adverse structure immediately. One private investor indicated that a micro refinery can be built for US$100 million. Although I remain sceptical that it can be done with US$100 million, I wish private enterprise would get into downstream production as soon as possible. With proper management, structural change that secures stable and sustained growth without balance of payments crises is possible.

It will not occur overnight and an astute government will have to direct structural change. A developmental civil service will be needed because the free market does not exist in reality, only in one chapter of all microeconomics textbooks. If ExxonMobil indeed scales up production to 500,000 barrels per day, Guyana will realize US$150 million per year in royalty, assuming US$50 a barrel. However, the mysterious average cost number adds much uncertainty to expected revenues from profit share. I will address this in a later column. Suffice to say, a scaling up to 500,000 per day will provide enough revenues for a comprehensive renewable energy industrial strategy. The newly announced Department of Energy will only be responsible for energy derived from fossil fuel.

Comments: tkhemraj@ncf.edu

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