7.3 Consume or Save?

consumption and saving for the long term. Policy makers need to strike a balance between spending today and saving for tomorrow. In practice, this is often less clearly a problem. Apart from the island of Nauru, no country has actually run out of mineral (or hydrocarbons) resources, although the Republic of Yemen comes close. 4. Undetermined ownership. Resource rents belong to the

“nation,” but what does that mean? Does it mean the government or municipalities in producing areas or something wider like “the people”? If the latter, what about unborn citizens? These questions go to the heart of the accountability problem and beyond questions of whether revenue should be shared among today’s citizens.

Responding to volatility

Policies have to be designed in ways that avoid transmitting volatility (which is outside the control of policy makers) to the macroeconomy. This is achievable by smoothing spending flows; promoting long-term fiscal sustainability and intergenerational equity; enforcing measures to mitigate Dutch Disease (see the discussion of overall resource policy in chapter 2 and section 4.2). In principle, decisions on current versus future consumption and on the form of investment can all be made using a model—but volatility is a complication.

Experience suggests that success is often elusive. One researcher notes, “Capital flows, fiscal policy, monetary policy, and sectoral allocation each tend to be more procyclical in commodity producing countries than economists’ models often assume. If anything, they tend to exacerbate booms and busts instead of moderating them” (Frankel 2011, 167). Formal fiscal rules and resource funds are not a panacea. A study of increased revenues from oil concluded, “Implementation of quantitative fiscal rules has proved very challenging, mainly due to the characteristics of oil revenue and political economy factors. . . . Many countries have had difficulty managing funds with rigid operational rules, as tensions have often surfaced in situations of significant exogenous changes or with shifting policy priorities” (IMF 2007b, 3). Large sovereign wealth funds can also be raided by future governments, who may also seek to divert resource rents outside the budget. For example, in the República Bolivariana de Venezuela, almost 70 percent of oil rent flows through funds that are outside the budget (Rodríguez, Morales, and Monaldi 2012). This undermines fiscal rules as well as transparency.

No option is free from risks. The basic question for a country facing the prospect of significant resource revenues is how it should plan the time path of spending and saving from this revenue flow (intertemporal optimization). How much of the resource wealth should a government consume and how much should it save?

■ If consumption is the priority, government has to make decisions about increasing public consumption or transferring funds to citizens. ■ If investment is the priority (and investment is the principal option for the use of savings), there are several choices: decisions can involve making domestic public investments or to invest abroad in financial assets (sovereign wealth funds).4 Investment in human capital can be done by training or education and in intellectual capital through investment in research and development. Rather than overseeing the investing itself, the government can offer investment incentives to private firms.

In either case, the choice could lead to waste and generate unfair outcomes. Whatever decision is made for the use of rents, it will be made under high levels of uncertainty about resource revenue flows. For example, sudden slumps in demand can follow euphoric booms, and the persistence of either is unknown.

Some kind of fiscal framework is required to address these issues. Given the inevitable fluctuations in revenues, it needs to smooth revenue flows and perhaps involve the use of stabilization funds. The fiscal framework may also wish to introduce an instrument called fiscal rules as a means of addressing stabilization or savings. This does not necessarily have a statutory basis.

Other factors and policy choices have to be taken into account in making such fiscal choices, including the factor of absorptive capacity and choices such as tax reduction, increases in expenditure, and debt reduction or savings of windfall revenues.

Fiscal rules

Fiscal rules are multiyear formal constraints on government spending or public debt accumulation. They rely on formal commitments to the achievement of certain numerical values for selected and targeted fiscal variables, such as the fiscal balance, public expenditure, or the public debt. The International Monetary Fund (IMF) has defined them as “institutional mechanisms that are

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intended to permanently shape fiscal policy design and implementation” (IMF 2007b, 17). Hence there is a tendency to enshrine them in legislation or even in a constitutional document. Some countries like Peru and Colombia have fiscal rules in this sense. Others like Trinidad and Tobago have preferred “ad hoc rules which may not have taken specific issues such as household welfare and fiscal stability, into account” (Primus 2016, 5). Those that do have them use various types of rules or combinations of them, but essentially a set of fiscal rules comprises numerical rules designed to guide and benchmark performance against quantitative indicators (such as the fiscal balance of debt) and procedural rules intended to establish transparency, coverage, and accountability requirements (IMF 2007b, 17). See table 7.1 for a recent list of countries and their fiscal rules.

The five kinds of fiscal rules found in practice are the following:5

1. The balanced budget rule. Sometimes called “hand to mouth,” in this rule all annual oil receipts are spent while the government’s overall financial position is kept in balance. For example, in Mongolia the structural deficit may not exceed more than 2 percent of gross domestic product (GDP). (The disadvantages are that it tends to privilege current over future generations in terms of their share of consumption of extractives wealth and it may subject governments to boom-and-bust cycles in the international markets.) 2. The debt rule. This sets a limit on public debt as a percentage of GDP. For example, in Indonesia there is a requirement that total and local government debt should not exceed 60 percent of GDP. Mongolia sets the ceiling of public debt at 40 percent of GDP. 3. The expenditure rule. This sets a limit on spending, in absolute terms or terms linked to the level of growth rate or percentage of GDP. For example, Botswana has a ceiling on the expenditure-to-GDP ratio of 40 percent, and

Peru has a statutory limit on real growth current expenditure of 4 percent. 4. The revenue rule. This sets a ceiling on the use of overall revenues or revenues from oil, gas, or minerals. For example, in Ghana a statutory limit is set on the amount of oil and gas revenues that may enter the budget; this may not exceed 70 percent of revenue averaged over a seven-year period. The rest of the revenue has to be saved in a stabilization fund or a fund for future generations. 5. The permanent income hypothesis (PIH) rule. With this rule, decisions on spending oil, gas, or mineral revenues

186 OIL, GAS, AND MINING Table 7.1 Country Fiscal Rules

Country Rule and date established

Botswana Expenditure rule (2003) Supranational rules—Central African Economic and Monetary Community (CEMAC) (2002, 2008)

Cameroon Budget balance rules (2002, 2008), Debt rule (2002)

Chad Supranational rules—CEMAC (2002, 2008)

Chile Budget balance rule (2001)

Colombia Budget balance rule (2012), Expenditure rule (2000)

Congo, Rep. of Supranational rules—CEMAC (2002, 2008)

Côte d’lvoire Supranational rules—West African Economic and Monetary Union (WAEMU), Budget balance rule (2000), Debt rule (2000)

Ecuador Expenditure rule (2010), Budget balance rule (2003), Debt rule (2003)

Equatorial Guinea Supranational rules—CEMAC (2002, 2008)

Gabon Supranational rules—CEMAC (2002, 2008)

Indonesia Budget balance rule (1967), Debt rule (2004)

Mali Supranational rules—WAEMU (2000)

Mexico Budget balance rule (2006), Expenditure rule (2013)

Mongolia Expenditure rule (2013), Budget balance rule (2013), Debt rule (2014)

Niger Supranational rules—WAEMU (2000)

Nigeria Budget balance rule (2007)

Norway Budget balance rule (2001)

Peru Budget balance rule (2000, 2003, 2009), Expenditure rule (2000, 2003, 2009, 2013)

Russian Federation Expenditure rule (2013)

Venezuela, RB Fiscal rules embedded in Organic Law for the Public Finances (2000)

Source: Adapted from IMF 2015a, 6, table 1.5.

in any given year are predicated only on the return on the assets already in hand. Only the interest income that accrues from accumulated revenues may be spent consistently over time. This “precautionary saving” is based on the idea that since these resources are nonrenewable it is not fair to future generations to consume them today. It may create social tensions, since public expenditure may be low while revenues are accumulated during production, and there may be a lost opportunity in terms of social and infrastructure spending in the early years in deference to future spending.

We may also note here the so-called bird-in-hand approach to resource revenue management, which suggests that resource revenue should be used to accumulate financial assets in a sovereign wealth fund; the government should limit its spending to only the interest accrued from these assets.

None of these rules is likely to prove sufficient in itself or in combination with others. There has been a robust debate about their benefits.6 For many years the PIH rule was influential, emphasizing the need to preserve resource wealth and avoid the instability that can arise from spending resource revenues (in other words, addressing the familiar challenges of exhaustibility and volatility characteristic of EI and discussed in chapter 2 of the Sourcebook). That view has been challenged by several leading economists taking a more development-oriented approach to fiscal rules (NRGI and CCSI 2014, 7). After all, resource revenues can be used beneficially to finance public investments in infrastructure, especially where such infrastructure has been physically damaged following conflict, or government institutions, where these are characterized by a weak civil service, for example. Even if no one-size-fits-all principle applies, and some fiscal rules may suit an advanced economy better than a capital-scarce resource-rich country, the existence of fiscal rules in one form or another “can provide helpful and transparent benchmarks for policy” (Gelb 2014, 23). They can play a role in providing robust checks and balances on public spending and at the same time factoring in the kind of uncertainty that will always be present in resource markets. However, fiscal rules are neither necessary nor sufficient for the achievement of sound fiscal outcomes. Arguably, this conclusion also applies to fiscal discipline at the subnational level (Ter-Minassian 2007). The decision to consume or save does not need a fiscal rule to be determined.

In the extractives sector, fiscal rules are less commonly used than the fund instrument (discussed in sections 7.4 and 7.6), at least in the oil-exporting countries. However, some funds, such as those in Chile, Ghana, Kazakhstan, and Norway, are governed by fiscal rules. The volatility of revenues in the EI sector plays a large part in the variation in approaches. Some fiscal rules target overall or primary balances or particular debt-to-GDP ratios, but they can transmit oil fluctuations to expenditure and the non-oil balance.

Experience has shown the difficulties of implementing effective and durable rules, partly due to design weaknesses and political economy factors (IMF 2007b). Essentially, the rules, often resulting from fiscal policies oriented to shortterm constraints, can be too rigid to adapt to economic fluctuations and lack reliable support among political elites. During a boom, liquidity pressures can ease and governments may find it very difficult to contain spending pressures.

There is no shortage of examples of fiscal rules being weakened over time or ignored. Equatorial Guinea has an expenditure rule, which requires current spending not to exceed non-oil revenue; it has been repeatedly breached and even interpreted as a medium-term goal. Expenditure in this case has even grown substantially faster than EI revenue, rendering the fiscal rule largely irrelevant as an instrument to benchmark fiscal policy (IMF 2007b, 19). By contrast, Chile changed the target for its structural balance to permit slightly more expansive spending when copper prices and the reserves in the stabilization fund were high. The benefit of this approach is that the spending adjustment, while significant in the longer run if maintained, is gradual. This reduces pressure for a more radical change in the rules.

The considerable successes of Botswana and Chile with resource revenue management are well known. In both cases, the fiscal rules have considerable flexibility, in contrast to those in some other countries. They have achieved stable macroeconomic environments and high growth rates. Given the importance of their natural resource sectors (mainly diamonds in Botswana and copper in Chile), and their use of fiscal rules, they present worthwhile lessons for petroleum-producing countries. This is explained in box 7.1.

While fiscal rules have been useful to the conduct of sound fiscal policies in Botswana and Chile operationally, the evidence suggests that they were not critical elements— the keys have been political commitment and good institutions. Both countries’ economic success mostly points to strong overall institutional quality, willingness to adopt key structural reforms, and political commitment to ensure fiscal discipline.7 According to World Bank and

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