Oil, Government Take & spending: Navigating Guyana’s Development Challenge - 8

Today’s column wraps-up my consideration of absorption capacity. This is the fourth on the list of top-ten development challenges, which spending Guyana’s expected significant Take (petroleum revenues) has to navigate in coming years in order to achieve sustained development. Following this, I introduce a discussion of the perils of an enclave economy. This is the next topic (fifth) on the top-ten listed development challenges.

Absorptive Capacity Wrap-up

Last week’s discussion ended with a brief reference to the output gap approach (also known as the GDP gap approach) used for estimating Guyana’s absorptive capacity. Careful measurement of this gap is essential for keeping track of the condition of this metric, if it is employed as the proxy for absorptive capacity. I readily admit on this matter that measurement is difficult. This is basically because all market–based economies operate with numerous “ups and downs” in their prevailing levels of economic activity.

These “ups and downs” are classified by economists as due to 1) seasonal factors (for example, more activity in the agricultural sector at the time of planting and reaping crops; 2) cyclical factors (for example, short-term swings in the flow of investment, consumption and government spending as the economic and business outlook changes); 3) random shocks (for example, natural factors like heavy rainfall, floods, drought); and 4) other exogenous factors (largely external). Good examples of these are changes in export and import prices, which are reflected in the terms of trade.

The task that statisticians face is how to isolate these regular and irregular “ups and downs” of economic activity, in order to identify the underlying trend in long-term growth. Such a measure is a gauge of Guyana’s productive capacity. In this sense, potential output/GDP is therefore the maximum amount of goods and services Guyana can produce at full capacity when it is most efficient. Further, just as actual GDP fluctuates upwards and downwards, so too does a country’s output gap.

Analogous to the output gap is the unemployment gap. This latter is estimated from the employment rate that is consistent with a constant rate of inflation. In technical language readers, this is referred to as “the non-accelerating inflation rate of unemployment (NAIRU), or the natural rate of employment.”

There are two standard statistical criticisms directed at these concepts and their use as a proxy for absorptive capacity. One is that there is an element of randomness in isolating the long-term trend from the short-term “ups and downs” induced by the elements that I indicated above. Second, this trend is harder to isolate the closer the analysis reaches present day. This difficulty is unfortunate, as typically this is the period (present day), from a policy point of view, which is the most crucial!

This concludes my comments on absorption capacity. In the following Section, I start discussion of the perils of “enclave economy” development in Guyana.

Origins of Enclave Economy

There are two preliminary observations, which I need to make before starting this discussion proper. First, the concept of an enclave economy, similar to others in the top-ten development challenges, has its origins not only in development economics (including political economy), but also in other social sciences disciplines. We observed this phenomenon in the previous discussion of “absorptive capacity.” As I revealed, this has an even earlier legacy in the administrative sciences/strategic management/ business behaviour literature, before being adopted by economists. So, too, does the enclave economy concept. This has origins in ethnic and multicultural studies, and even the geography of human settlements.

Secondly, way back in early 2017 (April), I had made some comments on this topic. On re-reading these comments, I cannot better them today, so I will base today’s comments largely on the notes taken from that occasion. To contextualise, at the earlier time I was discussing Guyana’s political economy of local content requirements (LCRs), bearing in mind the coming petroleum sector.

It is important therefore that I re-state the context of the previous discussion. I had argued earlier that: 1) the development rationale for LCRs in Guyana is rooted in the country’s historical experiences of extensive and intensive reliance on the fortunes and misfortunes of extractive industries export sales in world markets; and 2) these experiences have propelled Guyana’s economic growth and performance as well as its foreign exchange earnings, tax revenues, employment, and the environmental challenges it faces to its biodiversity.

Given this, Guyana has found itself over time (similar to other small, poor, open extractive industries-dependent economies) taking on traditional functional enclave features. Thus the companies that have dominated the economy bring a substantial proportion of their goods, services, equipment and critical staff they need from abroad. This limits spillovers to other domestic non-extractive sectors. And, in so doing, the potential for domestic growth and development, especially in the areas of agriculture, manufacturing and services is severely constrained.

However, the oil and gas sector is qualitatively very different. This is mainly because of: 1) the sector’s very high capital requirements; 2) its acute dependence on cutting edge technology; and 3) dependence on highly-trained operatives, and supervisory and managerial skills. Altogether, strong policy measures are required to foster spillovers and linkages to other sectors. Empirical data reveal that if left to spontaneous evolution, limited spillovers and linkages to domestic firms occur, and limited employment in the sector rules. This latter is, in the main, due to its sector’s high capital intensity, making the enclave characteristics in Guyana-type economies very prevalent in the petroleum sector!

In these circumstances, the goals and aims of LCRs are many and complex. I had highlighted seven of these in my earlier contributions. These were: 1) securing growth and development offsets for when oil and gas revenues peak (because depletion rates have also peaked); 2) leveraging oil and gas revenues in order to develop downstream value-added products; 3) consequent to this, promoting economic diversification, especially through non-extractive sector growth; 4) strengthening inter-industry linkages (backward and forward); 5) placing research development and innovation more centrally in Guyana’s productivity growth and development; 6) combatting environmental challenges (degradation, destruction, pollution) to our biodiversity; and 7) fostering economic, political and social stability.

Conclusion

Next week I conclude this discussion of the enclave economy.