Oil, Government Take & Spending: Navigating Guyana’s Development Challenge

Today’s column starts with a wrap-up of the discussion on intergenerational equity. Afterwards, I turn to address the budget rule for spending petroleum revenues or Government Take, known as the “permanent income hypothesis budget rule”.

Last week’s column had argued that, essentially, the term intergenerational equity seeks to convey the notion of “fairness across and not within generations”. Given this 1) the expected increasing cost to retrieve petroleum discoveries as well as their ultimately finite nature; 2) the environmental damage historically associated with petroleum; and, 3) Guyana’s Green State Development Vision, together combine to make this particular development challenge, especially acute. Environmental economics acknowledges two different ways of looking at the requirement to ensure future generations can supply their needs. These two ways are termed “weak” and “strong” sustainability. These are discussed below.

Weak Sustainability

Weak sustainability posits that, Guyana’s natural resources (or natural capital) should be available not only to the generation, which “discovers” these, but all future generations as well. Fairness requires future generations are compensated through providing for them, at the minimum, alternative sources of wealth creation derived from the use of natural resource discoveries. In this regard, environmental economics acknowledges both man-made capital (human capital) and natural capital (natural resources). Weak sustainability therefore, requires that human capital is substituted to its equivalent for natural capital, if this capital is depleted in any given generation.

Strong Sustainability

Strong sustainability however, diagnoses today’s environmental threat as dire. Human capital can no longer substitute for natural capital, because environmental degradation is too far advanced. In reality therefore, human capital and natural capital are complementary, but not interchangeable”.

Both notions of sustainability however, recognize that a country’s development potential resides in the availability of both types of capital. Therefore, Guyana’s goal of sustainable development is achievable if, and only if, it leaves the total stock of capital, at the very minimum, unchanged over generations. In essence, intergenerational equity requires “each following generation to have, at least, as much capital at its disposal as the preceding generation!”

I would be irresponsible if I did not alert readers to the fact that, the concept of intergenerational equity/sustainability, is “a theoretically contested one”. As the Australian Intergenerational Report (2002-3) has stated: “there are competing views about what it means, and what exactly it is that needs to be sustained into the next generation. And, consequently, there are competing views about what intergenerational obligations, if any, the goal of sustainability imposes on the current generation”.

That Report goes on to note: “our obligations to future generations can compete with our obligations of justice to contemporaries”. This raises the ridiculous spectre, which several economists object to, of treating these issues as a zero-sum game. That is one, where one generation’s benefit is another’s loss! I cite this here because of the naïve and under-researched views circulating, uncontested as orthodoxy, in Guyana’s debate on its coming time of oil production and export.

Budget Rule: PIH

For most of the 2000s and into the early 2010s, the Permanent Income Hypothesis (PIH) has been a leading fiscal benchmark or budget rule used to guide petroleum-rich, small, poor open economies’ spending of petroleum revenues or Government Take. I have identified this budget rule as one of “the top-ten development challenges”, which Guyana has to confront. I do so, because I am well aware that development agencies, along with our traditional donor partners have sought historically, to bias Government spending in favour of this specific budget rule. This remains true despite mounting evidence of its overly-conservative domestic spending bias and its overly-dependent promotion of external savings. The latter is typified in accompanying structured Sovereign Wealth Funds.

There are a number of options representing the major classes of fiscal rules used by the broad group of petroleumrich exporting countries. Revenue Watch Institute (RWI, 2014) indicates five such classes of fiscal rules. RWI describes a fiscal rule as “a multiyear constraint imposed on Government finances”. Typically, this is expressed in the form of determinative revenue, spending, or debt targets.

The chosen target represents a commitment, which successive governments work to attain. This commitment converts the target or budget rule into a long term standard for governing the nation’s public management of its petroleum revenues, supported by present and future governments. Such an approach is deemed necessary because of 1) the specific challenges, I have listed as the “top-ten” and 2) two intrinsic features of the petroleum industry; namely, its finite character, and its tendency to short to medium-uncyclical swings as well as decades-long boom and bust cycles. The explicit goal is to commit successive governments to “sound” macro-economic policies. This is considered to be a necessary, but not sufficient condition for the efficient and effective use of petroleum revenues.

The IMF and the RWI classifies existing budget or fiscal rules worldwide, into four broad categories. The existence of a “no-rule” situation is recognized. This therefore, allows for a “fifth” option. All options are listed below, and will be discussed more fully next week.

Options

The “no-rule” situation represents a circumstance in which “all oil revenues are spent in any given year”. This was highlighted in the IMF study of Uganda where it was revealed that the country’s draft legislation had created a Petroleum Fund, but did not specify “clear fiscal rules to determine how much oil revenues Uganda should save and how much should go to the budget … each year”. There was a failure therefore, to tie transfer of revenues in and out of the Fund to specific fiscal rules.

The Balanced Budget Rule, as typified by Chile and Mongolia is listed as the first rule in the classic RWI publication: Fiscal Rules for Natural Resource Funds, (2014). This is followed by the Debt Rule, as typified by Indonesia and Mongolia again. Next is the Expenditure Rule, as typified by Botswana, Peru and Mongolia yet again. Finally, there is the Revenue Rule as typified by Alaska, Ghana, Kazakhstan, Timor-Leste and Trinidad and Tobago.

Conclusion

Next week I shall develop the discussion of these fiscal (budget) rules. Last Update: 458.73 Current Update: 466.65 Movement: 1.73% YTD Movement: 58.56%