Oil, Government Take & Spending: Navigating Guyana’s Developmental Challenges – 2

Introduction

Today’s column considers the second topic in my list of the top ten developmental challenges, which the spending of Guyana’s significant estimated Government Take from the petroleum sector must navigate. That is the Resource Curse. Before tackling this topic, I shall briefly wrap-up last week’s discussion of the first challenge, the Dutch Disease threat.

As noted, at the economic core of the Dutch Disease phenomenon lies two economic traits; namely, a tendency towards nominal and real exchange rate appreciation plus the growing global loss of competitiveness in the affected economy. Experience suggests the implementation of three policies. These are: 1) policies directed at slowing the rate of exchange rate appreciation 2) re-engineering the non-oil sectors (especially traditional exports) along with the domestic sectors producing goods and services for the domestic market, and 3) creating a Sovereign Wealth Fund (SWF), which invests in international assets markets. In effect, the creation of a SWF seeks to increase government savings. This modulates rapid inflows of foreign exchange and stems the consequential rise of national spending.

The observation, however, which I wish to add here in order to close the discussion is that the increase in national savings does not have to come only from the state sector through a SWF. The evidence shows that mechanisms designed to increase savings from other sectors (such as households and domestic business) can produce the same policy effect for navigating the Dutch Disease.

Resource Curse: Paradox of Plenty

Like the Dutch Disease, the Resource Curse is colourful language for economics, long known as the dismal science! Like the Dutch Disease, the Resource Curse also derives from a description of an observed correlation. In the case of the Resource Curse, the identified correlation is for developing countries (or small and middle income ones based on global classifications) that are natural resource abundant (especially petroleum) correlates with weaker macroeconomic performance, lesser economic growth, lesser broad-based development, greater democratic governance challenges, and more stunted institutional support systems, when they are compared to similar countries without abundant natural resources.

For those readers with limited knowledge of statistical theory, the first scientific rule of analytical statistics is that correlation is not the same as causation. Correlation is not a cause and effect statistic. Indeed, the two correlated sets of items listed above could well have been simultaneously caused or determined by some other consideration. Moreover, it is in recognition of this that the Resource Curse thesis has been the subject of intense controversy in economics.

It is widely recognized that the correlation identified in the Resource Curse is, without a doubt, counter-intuitive. One would better expect that, everything being equal, those countries with abundant natural wealth to perform better than those without! This has led some economists to term this phenomenon: the paradox of plenty.

Oil Lottery

In the interrogation of this phenomenon, several economists have drawn analogies to situations where individuals who win large lotteries and yet end up poor and/or bankrupt. Typically, the cause of this is that those individuals who won lack experience on how to manage their sudden large increases in wealth. Consequently, some may turn to untrustworthy financial managers who effectively enrich themselves, at the expense of their clients. Other winners, who used the lottery winnings on their own, and who lack the requisite skills to do so, might end up losing much, if not all of their winnings. Of course, the risk of the lottery loss (curse) is greater, the less it has been pre-conceived and/or pre-planned for by the winners. Readers would be familiar with the demeaning articles in the foreign press, which dismiss Guyana as a “winner of the oil lottery!”

Causation: Governance

Some analysts have tried to research whether the correlation indicated in the Resource Curse thesis represents causation. Thus, they have sought to determine if resource wealth always leads to two important economic outcomes. First, there is an adverse effect on governance; that is, fostering corruption and/or the looting of national resources for private gain and not public benefit. One empirical observation, which is very pertinent to Guyana, is the greater likelihood of “regime entrenchment.”

Such entrenchment refers to the observed phenomenon, where the Government in power wins the “lottery” of the resource coming into production and export during its stewardship. The tremendously enhanced flow of revenue into the State’s coffers leads to regime spending on benefits to its supporters (constituents, party members, cronies, and the ruling political elite itself). In this way, public wealth does not result in careful spending on considered plans and programmes, but is instead wasted on “buying” support for the ruling regime.

Causation: Rent-seeking Behaviour

The second economic outcome economists identify is rent-seeking behaviour. Such behaviour is profoundly anti-development, inefficient, and, fatally damaging to resource allocation in market economies, like Guyana. Formally, textbooks refer to this phenomenon as behaviour, which “seeks to increase the share of existing wealth for economic agents, without their generating new/additional wealth themselves.” This makes for reduced wealth creation and economic inefficiencies in a market environment. Indeed, it misallocates resources because the behaviour of economic agents is economically irrational. Further, this process can foster income inequality alongside reduced national income and public revenues.

More generally, “economic rent” is that amount of income or resources any productive factor receives, which is above that which it would require to remain productively utilized. It is in other words, the extraction of uncompensated value without a commensurate contribution to productivity. Rent seeking behaviour embodies corrupt practices (bribery, fraud, extortion).

Other Studies

There are several excellent recent reviews and research on the observed correlation between resource abundance and poorer economic outcomes. In particular, several of these have challenged the empirical validity of earlier studies. These studies extend both the country case study coverage and the historical frame of analysis. The result is that the original earlier claim of a Resource Curse is no longer, by any measure, universally accepted. Today, studies have shown why a Resource Curse might emerge and where now, not infrequently, resource abundance becomes a blessing!

No one up-to-date with the economic literature can make a serious claim that it indicates Guyana’s recently found petroleum wealth would inexorably lead to the Resource Curse. This would be utter nonsense of the highest order.

Conclusion

Next week I shall conclude my consideration of the Resource Curse thesis and then consider the third of the listed top ten development challenges oil will bring forth, the Governance Curse.

 

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