The decision chain of natural resource management (II)

Paul Collier, Professor of Economics and Public Policy, Blavatnik School of Government, Oxford University

  1. What are the key policy decisions that governments must get right to successfully turn resource revenues into sustainable development?
  2. What makes good revenue management particularly challenging?

So where we left off, we’d got the revenues. Those revenues are the main product of resource extraction and the main opportunity from resource extraction. There’s a lot of fussing about adding value to iron ore or something like that. That, in my view, is a sideshow. The main issue is using the revenues from resource extraction well, and that is really difficult because that is the thing that has most commonly gone wrong. There are, there are two big reasons why things go wrong. The first is that the revenues are volatile, and they are not sustainable. They only last at best as long as the resource is still available.

So volatility and temporariness of the revenues. The second big difficulty is converting those revenues into assets that are as productive as possible. So let’s take those two issues in turn. First, the time profile of the revenues. So key feature is that they’re volatile. Commodity prices go up, commodity prices go down. That’s been true for a century, boom, bust. If you track public spending around revenues, then public spending will have booms and busts, and that is terribly inefficient. In fact during the supercycle, it was often much worse than that because what governments were tempted to do, often pushed into it, because they were accountable to citizens who didn’t understand the right issues. Governments were tempted to go and borrow on the strength of these revenues. And so public spending soared during the supercycle disastrously.

A country like Ghana went out into the world’s sovereign bond market, borrowed two billion dollars on the strength of an oil discovery. And then the government spent it. So we had a huge public spending boom. Precisely the opposite of what the government of Ghana should have been doing. The country that just got this right is Chile.

Chile had a big copper boom. It didn’t push public spending up like a rocket. It recognized that copper prices were temporarily high, and so quite a lot of the revenues needed to be parked. The only way to park them is temporarily to park them abroad in a parking fund, a stabilization account, which just smoothes public spending so that when the copper prices came down, the government of Chile was able to carry on spending at a sustained level.

So you had a phase where revenues were higher than spending, followed by a phase when spending was higher than revenues. You pulled down the money you parked in the fund. That’s very sensible, but it’s quite rare. It’s quite rare mainly because citizens don’t understand the issues properly and push governments to spend as much as possible, as fast as possible. And in order to win elections governments then try and do that. Governments that do that need to lose elections, not win them. So much for dealing with volatility. The other time-related feature of resource revenues is that they are fundamentally unsustainable. They are going to run out. There are two ways in which they run out. The most obvious one is that the physical supply of the resource can get exhausted. You got a small oil field, it’ll be extracted over the course of a couple of decades, and then there’s none left.

By about 2002, Zambia had run out of copper. It was very lucky that the copper price went up, and it discovered some more, deeper copper. But as of 2002, it looked as if that whole copper game in Zambia was over. So we’ve got the risks of exhausting the resource physically, we’ve got the risks, a second layer of risks of obsolescence.

For example, until 1920, half of Chile’s revenues, entire government revenues, half of them were provided by nitrates, the tax on nitrates. And then in 1920, a German scientist discovered how to make fertilizer synthetically, and that was over. The price of natural nitrates collapsed, and the rents disappeared. Half of government revenue disappeared overnight and never returned, because of technological obsolescence.

So that’s always a fear with natural resources. The revenues are fundamentally unsustainable. And so you cannot afford to spend them as if they were normal sustainable tax revenues. They’re not. So when you do, you have a much higher proportion of revenues devoted to assets, if the revenues are coming from natural resources. So that when the revenues run out, you’ve accumulated other assets, which can generate equivalent revenues.

And so you need a high rate of saving into assets, whether those assets are domestic investment or foreign assets. I call them savings, but savings in this case covers domestic investment. And it’s a tragedy that most poor resource rich countries have had very low savings rates from natural resource revenues. Indeed, during the supercycle, many poor countries, the government actually had a negative savings rate. It used the revenues to borrow, and then it spent the borrowed money on consumption. Ghana would be a good example. You borrow two billion, what you do with that two billion, you put up public sector wages 50%. And so people consume it. And people vote for that, because they don’t understand that what they’re doing is fundamentally undermining their children’s future.

The oil and the gold that were providing the revenue boom should have been used to build a better future for Ghana’s children. It should have gone into education, into infrastructure, into a whole range of assets. And it didn’t. Fundamentally that’s a fault of citizens, not of government, because citizens didn’t understand the issue. So we’ve dealt with volatility. We’ve dealt with the fact that the resource is fundamentally unsustainable and needs to be converted into assets.

And now we’re going to come to the question, what assets? And there’s a big glamorous temptation here which is Norway. Norway, the richest country in the world, has created a sovereign wealth fund into which it puts part of it’s oil money. And that sovereign wealth fund is invested in abroad in countries like China, Brazil, America, whatever.  That’s a very sensible thing for Norway to do, because Norway already has more domestically invested capital per person than any other country in the world. Norway is awash with infrastructure, with factories, with schools, with universities, all the things that invested capital buys that makes the future more productive. And having run out of good things to spend on, as investments within the country, it’s sensible for Norway to invest in China or Brazil or America. The typical poor country is absolutely not like that. The typical poor country is desperately short of domestic investment.

And so creating a sovereign wealth fund and putting the money abroad is really foolish. And yet the glamour of that Norwegian model has meant that, for example, Africa is the fastest-growing region for the creation of sovereign wealth funds, parking money abroad. There’s not much money parked there, because African governments haven’t tended to save very much. But to the extent that they’ve saved, they’ve saved abroad rather than domestic infrastructure. That’s the wrong thing to do. Poor countries desperately need electricity generation, better ports, better roads, better education systems, better health systems. All these investments. And so the priority is to first get a much higher savings rate out of resource revenues and then channel it into domestic investment. Finally, there is a big but. If you’re going to spend a lot of money on domestic investment, you need to build a capacity to do domestic investment well. And I call that, investing in investing.

Building the capacity to manage a domestic investment process. Otherwise what you get is glamorous white elephants that are useless. The president looks out of his limo and says, build a highway to my village. Build a cathedral here. I’ve been to Cincinnati, and they have a racetrack. Let’s build a racetrack. Stupid investments. And so you have to plan investments, select them correctly, implement them correctly and then evaluate them to see what investments turned out to be good and what investments turned out to be bad and then learn from failure.

The IMF’s got an index called The Public Investment Management Index, which is quite a useful way of just checking: how does your country seem to do on these public investment management processes? So just to wrap up, the biggest mistakes during the supercycle were in converting revenues into sustained prosperity. And instead, a lot of countries, the resource supercycle was used to throw a party.

Governments went out into sovereign bond markets, borrowed, and used the money to for something that was ice at the time, but has bequeathed debts to the future. And instead, what should have happened. First, build the capacity to invest domestically. Then, have a savings strategy where a lot of the revenues are devoted to investing in the future. Some of the revenues are used to smooth the commodity cycle, the booms and busts, and then certainly some of revenues can be used for consumption, but in a sustained way.

A few countries in Africa, Botswana’s an example, in Asia, Malaysia’s an example, have actually managed that process of using revenues for sustained consumption rather than throwing a party. And that’s why Botswana and Malaysia are both now upper-middle income, prosperous countries, unlike the countries they were 40 or 50 years ago. Thanks very much.