Oil, Gov­ern­ment Take & Spend­ing: Nav­i­gat­ing Guyana’s De­vel­op­ment Chal­lenges - 20

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This week’s col­umn ad­dresses the Per­ma­nent In­come Hy­poth­e­sis (PIH) fis­cal rule as ap­plied to Nat­u­ral Re­sources Funds (NRFs). I have listed this topic at eighth on my top-10 list of de­vel­op­ment chal­lenges, which spend­ing Guyana’s Gov­ern­ment Take from its coming petroleum sec­tor will have to nav­i­gate. Thus far, this eighth topic has led to a rather ex­tended dis­cus­sion. This is ba­si­cally due to the fact that the Green Pa­per on Guyana’s NRF, pro­posed for 2019, in­cor­po­rates the fis­cal rules that will ap­ply to the com­pul­sory ex­ter­nally-held as­sets of Guyana’s NRF. Be­cause the Fund em­braces el­e­ments of the PIH fis­cal rule, I be­gin by re­spond­ing, in the next sec­tion, to the ques­tion: what is the PIH rule?

Per­ma­nent In­come Hy­poth­e­sis

The PIH rule is gen­er­ally ac­knowl­edged as one of the most widely adopted fis­cal rules em­ployed in nat­u­ral re­sources rev­enue man­age­ment. This is es­pe­cially true for petroleum, be­cause of its ex­cep­tional price volatil­ity. When ap­plied to Guyana, this rule ba­si­cally sets a limit to the spend­ing of Gov­ern­ment Take in any given year. That limit is the “in­ter­est ac­crued” from to­tal nat­u­ral re­sources wealth (in­clud­ing petroleum wealth); both ex­tracted and non-ex­tracted re­sources. This rule, in ef­fect, con­verts rev­enue from Guyana’s nat­u­ral re­sources wealth (in­clud­ing petroleum wealth) into a per­ma­nent in­come that can be main­tained in­def­i­nitely.

More for­mally, eco­nomic the­ory posits that: a coun­try with nat­u­ral re­sources rev­enue finds “its in­ter-tem­po­ral bud­get con­straint is sat­is­fied, when its yearly spend­ing (that is, the non-nat­u­ral re­sources pri­mary deficit) is lim­ited to the per­pe­tu­ity that can be sup­ported by the present value of the nat­u­ral re­sources wealth.” One may say, there­fore, that defini­tively this “fixes the high­est level of smoothed spend­ing over time that max­i­mizes Guyana’s wel­fare”.

Based on this for­mu­la­tion, it has been ar­gued that “the PIH is the rel­e­vant base to set a spend­ing tar­get that can be fol­lowed in nat­u­ral re­sources based coun­tries, in or­der to guar­an­tee: 1) long term avail­abil­ity of re­sources and, si­mul­ta­ne­ously 2) avoid sharp cuts in pub­lic spend­ing in the post nat­u­ral re­sources avail­abil­ity pe­riod” (Omgba & Dji­oloch, 2010, Jour­nal of Eco­nomic Lit­er­a­ture, Septem­ber, 2010).

How­ever, I read­ily ad­mit, this view has been strongly chal­lenged by a num­ber of econ­o­mists. They ar­gue along the fol­low­ing lines: de­vel­op­ing coun­tries, with scarce cap­i­tal like Guyana, (my em­pha­sis), might do bet­ter, by pri­or­i­tiz­ing do­mes­tic in­vest­ments in the early stages of their de­vel­op­ment; com­pared to the adop­tion of the PIH ap­proach.” The Eco­nomic Pol­icy Re­search Cen­tre (EPRC) has noted in ref­er­ence to Uganda that PIH pol­icy “fails to ad­dress con­cerns about cur­rent poor liv­ing con­di­tions and in­vest­ment needs in cap­i­tal-scarce low-in­come economies” (EPRC, 2015, Page 7).


Re­search re­veals that there are two dis­tinct trib­u­taries of the­ory and anal­y­sis, which flow into the PIH hy­poth­e­sis, as a fis­cal rule. One of these is based on the sem­i­nal work of Hotelling (1931). This work is on the eco­nom­i­cally ef­fi­cient man­age­ment of ex­haustible nat­u­ral re­sources in­ter­gen­er­a­tionally, along an “op­ti­mal ex­trac­tion path,” And, the other trib­u­tary flows from the equally sem­i­nal work of Mil­ton Fried­man (1957) con­cern­ing how “eco­nomic agents dis­trib­ute con­sump­tion over their life­time.” The lat­ter means how the con­sump­tion of eco­nomic agents is de­ter­mined not only by cur­rent in­come, but also fu­ture ex­pected in­come or in­deed the level of per­ma­nent in­come!

Mod­i­fied PIH Ex­ten­sion

The EPRC (2015) study, which I have cited above, refers to two mod­i­fi­ca­tions to the tra­di­tional PIH ap­proach. These are: 1) a “mod­i­fied” PIH ap­proach; and 2) a fis­cal sus­tain­abil­ity frame­work (FSF). This lat­ter is typ­i­fied in the one pro­posed in Guyana’s NRF Green Pa­per.

Last Up­date: 499.36 Cur­rent Up­date: 500.06

More specif­i­cally, the mod­i­fied PIH “al­lows for an ini­tial scal­ing up of spend­ing, al­ter­na­tively known as front­load­ing the spend­ing of Gov­ern­ment Take.” This is reg­u­larly com­bined with ex­ter­nal sav­ings in a Sov­er­eign Wealth Fund. How­ever, this ap­proach con­tin­ues to in­sist: “Fis­cal pol­icy re­mains an­chored in the long-term sus­tain­able use of nat­u­ral re­sources rev­enue. There­fore, while spend­ing Gov­ern­ment Take is front­loaded, spend­ing it is low­ered in fur­ther out years.”

Green Pa­per’s FSF

Al­ter­nately, the FSF ap­proach seeks to sta­bilise rev­enues over the very long-term. It thus al­lows for front-load­ing the spend­ing of Gov­ern­ment Take, in or­der to sta­bilise pub­lic spend­ing at a higher level in later years. This is be­cause (as the Green Pa­per in­deed as­serts) of ex­ist­ing in­fra­struc­ture and hu­man cap­i­tal gaps in cap­i­tal-scarce Guyana. The mod­i­fied PIH has been likened to the “Big Push” de­vel­op­ment strat­egy. And the FSH is likened to the “in­vest­ing to in­vest” de­vel­op­ment strat­egy. This lat­ter de­vel­op­ment strat­egy recog­nises the point that I made last week, which is, fu­ture gen­er­a­tions are go­ing to be richer than the present, if there are pos­i­tive real per per­son GDP in­creases gen­er­a­tionally.

Cri­tique of PIH

It is also widely rec­og­nized among sev­eral econ­o­mists that, as a fis­cal rule, the PIH is strongly con­ser­va­tive in re­gard to the spend­ing of Gov­ern­ment Take. It def­i­nitely seeks to re­strain Gov­ern­ment spend­ing to the equiv­a­lent of in­ter­est ac­crued on the net present value of Guyana’s nat­u­ral re­sources wealth; over the lifes­pan of these nat­u­ral re­sources.


This fo­cus re­duces to a sec­ond or­der pri­or­ity con­cerns about cur­rent liv­ing con­di­tions and in­vest­ment needs in a cap­i­talscarce econ­omy, like Guyana.

Im­por­tant in­ter­na­tional in­sti­tu­tions, like UNC­TAD and even the In­ter­na­tional Mone­tary Fund (al­though an early pro­po­nent of the PIH) have been urg­ing the reeval­u­a­tion of the PIH fis­cal rule (UNC­TAD, 2011 and IMF, 2012). There is grow­ing ac­knowl­edge­ment that pro­duc­tive gov­ern­ment spend­ing can do much bet­ter for growth, de­vel­op­ment, and em­ploy­ment (as a fis­cal path) in cred­it­con­strained and se­verely cap­i­tal scarce en­vi­ron­ments.

I urge read­ers to keep al­ways to the fore­front of their con­sid­er­a­tions that, nat­u­ral re­sources are fi­nite and even­tu­ally ex­haustible. The com­pelling logic of this cir­cum­stance is that this will ir­re­sistibly pro­duce pro­gres­sively bind­ing con­straints on nat­u­ral re­sources. Al­most cer­tainly rev­enues and prof­its from their sale will even­tu­ally peak and then dwin­dle. They, how­ever, dwin­dle be­cause re­sources are de­pleted. The con­se­quence is prof­its fall and unit costs rise. Unit costs rise, be­cause re­sources accessibility and/or qual­ity are re­duced over time.


Next week, I turn to eval­u­ate the penul­ti­mate (ninth) topic on my list of top-10 chal­lenges which spend­ing Guyana’s Gov­ern­ment Take will have to nav­i­gate. That is, man­ag­ing ex­pec­ta­tions. Al­though seem­ingly, not too tech­ni­cal (dif­fi­cult!) a task, this has fre­quently proven, in prac­tice, to be one of the most in­tractable in the top-10 de­vel­op­ment chal­lenges.

Com­ments can be cythomas77@ya­hoo.com

Move­ment: 0.14% YTD Move­ment: 69.91% sent

The Lucas Stock In­dex (LSI) rose 0.14 per cent dur­ing the first pe­riod of trad­ing in Novem­ber, 2018. The stocks of three com­pa­nies were traded, with 305,719 shares chang­ing hands. There was one Climber and one Tum­bler. The stocks of the Guyana Bank for Trade & In­dus­try (BTI) rose 9.37 per cent on the sale of 26 shares. On the other hand, the stocks of Banks DIH (DIH) de­clined 2.67 per cent on the sale of 305,560 shares. In the mean­while, the stocks of the De­mer­ara To­bacco Com­pany (DTC) re­mained un­changed on the sale of 133 shares. The LSI closed at 500.06. to

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