Oil, Government Take & Spending: Navigating Guyana’s Development Challenges – 21

Introduction

A number of readers have indicated to me I should have placed much more emphasis on the great extent to which the Permanent Income Hypothesis (PIH) fiscal rule for natural resources revenue management,no longer finds favour, even among its most ardent initial supporters. The International Monetary Fund (IMF) is a good example of this. I felt I had done enough through emphasising that this evaluation holds true, forcefully, for capital-scarce economies like Guyana. I suspect, though, readers feel strongly that with the negative and almost daily media onslaught on Guyana’s coming petroleum sector, there prevails a deep misunderstanding of the full implications of a Natural Resources Fund (NRF).

I remain convinced that, holding Guyana’s resources’ earnings in a Fund dedicated to invest these earnings externally, given all our pressing development needs, requires very careful calculation! Blind belief in the dogma that the only outcome would be theft by the political class is very naïve. The experience is private bankers and investors who have “agency” over similar funds have been exposed as no more “moral.” Malaysia today is an excellent example of Fund theft.

Expectations Management

However, in the interest of moving the series forward, today’s column treats with the management of expectations as a development challenge. Spending Guyana’s Government Take from its petroleum wealth (and other natural resources revenue) has to navigate this challenge. Regrettably, it appears persons underestimate the importance of this ninth challenge. 

To begin, it is no overstatement to claim: “the central difference between economics and natural sciences lies in the forward-looking decisions economic agents routinely make” (Evans & Honkapohja, Existential Social Theory, 2001). Indeed, I further argue: “expectations are a basic building block of economic theories” (ibid). Evidence of this is widely revealed in all forms of economic modelling. Here, expectations substantially impact on the behaviour of all economic agents, whether they are individuals, households, businesses or governments.

Definition

All standard definitions of expectations recognise 1) a common set of assumptions that economic agents employ about the future, and 2) based on this, the forecasts they make about the future and, 3) the impact of 1 and 2 on their decision-making. The Economic Glossary defines expectations as: “What people or businesses anticipate will happen.” This is true, especially in terms of markets. Expectations constitute one of the five demand determinants as well as one of the five supply determinants, which are assumed constant, when demand and supply curves are constructed. Changes in expectations therefore, cause shifts of the demand and supply curves.

To take an example, the PIH as a fiscal rule is predicated on the substantial impact expectations have on consumption behaviour. In other words, the role of expected future incomes and not only income changes at the margin (that is, the marginal propensity to consume).

Rational Expectations

Pertinently, the most standard assumption in economic modelling is rational expectations. For modellers, this resolves the conundrum where, on the one hand, expectations influence the time path of economic events and on the other, the time path of economic events influences expectations. Rational expectations theory rests on the foundation that, as a rule “people are self-interested and try to make correct guesses about what will happen” (N. Robinson, Bizfluent, September 2017). While there are likely to be many poor guesses, in aggregate these cancel out and the more or less “right guesses” emerge in the aggregate.

Indeed, over the long term it is demonstrated that actual events do not contradict average expectations. This vital conclusion allows many economists to claim “in a very real sense, economics is the study of how people make decisions. Expectations about what will happen in the future lie at the heart of every choice, so they are the heart of economics as a discipline” (ibid).

Relatedly, there is what is termed in economics as rational choice theory. This theory assumes that “individuals always make prudent and logical decisions.” They do so for the selfish purpose that acting in this way maximises their personal benefit or gain. Indeed, if given a choice, everybody acts this way (that is rationally for their own benefit). By so doing, competitive markets provide the best overall outcomes for society; efficiency and effectiveness.

While I acknowledge the above can be considered the mainstream organising principle which governs economic modelling, there are strong criticisms of this approach. This column, however, is not the place to pursue such theoretical issues. I mention, though, one critique, which as I shall argue has had a strong bearing on managing expectations. That critique comes from those economists who observe economic agents most frequently do not have all the information required to input into optimal decision-making. Their rationality is therefore, bounded by this reality. This makes irrational decisions likely outcomes. For more information on this topic, readers can google the theory of bounded rationality.

Windfall Revenues

Managing expectations in Guyana in the context of 1) its planned NRF and 2) the imminent emergence (2020) of a petroleum sector involve two notions, both having been developed in resources economics. These are: the notion of windfall revenues, and the lottery-syndrome. The former speaks to unexpected rapid inflows of revenues to the Government (Government Take). And, the latter speaks to the stereo-typical non-rational behaviour of some lottery winners and the disastrous management of their good fortune (winnings).

Since the search for petroleum wealth in Guyana has been on-going for several decades, finding it (as an event) cannot be literally treated as unexpected, even if the timing could not have been foretold. In my view, therefore, a more acceptable description of windfall revenues is the emergence of a new unprecedented source of significant Government revenues. New sources (oil and gas) emerge and/or exceptionally favourable market adjustments in the traditional natural resources could similarly lead to windfall revenues (gold).

Of course, windfall revenues give rise to the response of windfall taxation. However, I shall not pursue this topic in today’s column. On the other hand, the lottery-syndrome highlights non-rational behaviour of lottery winners, who, through a mixture of considerations, including poor planning, end up even poorer than before their winnings!

Conclusion

Next week, I shall continue this discussion on “managing expectations.” After completing this topic, I shall turn to address the final (tenth) item from my list of top-10 developmental challenges, spending Guyana’s Government Take from its petroleum wealth has to navigate.  

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