Developing countries that are well endowed with natural resources should use the revenues to increase wages and employment, boost private and public sector investment and so bring forward economic development. They should ignore those who advise using all the revenues to build a stock of foreign assets to provide dividend income for future generations.
These are the key conclusions of research by Professors Rick van der Ploeg and Tony Venables, published in the March 2011 issue of the Economic Journal. They argue that current poverty levels in developing countries mean that it is appropriate to skew the consumption benefits of windfall revenues towards the current generation rather than passing them on to future generations, who will in any case be richer.
Many countries have made a mess of managing their natural resource revenues. The ''resource curse'' is the term usually used to express the fact that countries that are well endowed with natural resources – particularly oil – have on average had worse economic performance than resource-poor countries.
There are many reasons for the resource curse: some countries have failed to capture resource revenues; others have dissipated them in rent-seeking, corruption or conflict; many have suffered the adverse effects of price and revenue volatility; and many have saved and invested too little of the revenue.
This study addresses the question of how resource revenues should be managed. What should be the balance between consumption and saving? How should savings be invested? And how can public and private sector actions be made to fit together?
For a high-income country, the choices between consumption, savings and investment are relatively straightforward. Resource revenues (at least from an exhaustible resource such as oil) flow for a limited period of time, but the consumption benefits should be spread over the present generation (in retirement as well as in work) and future generations.
So for such countries, the response should be to set up a sovereign wealth fund, such as Norway''s Pension Fund. Revenues are deposited in the fund and current distribution is limited to income from the fund.
For a developing country the choice is harder. Current poverty levels mean that it is appropriate to skew consumption benefits towards the current generation rather than passing them on to future generations, who will in any case be richer.
Capital scarcity in developing countries means that saving should, where possible, be invested in increasing human and physical capital in the domestic economy rather than in foreign investment funds. So while it is important that developing countries save more of their resource revenues, advice that it should all be saved in foreign funds is inappropriate.
The researchers outline how the balance between consumption and domestic investment should be managed to ensure maximum impact on economic growth and development. Central to this is securing an increase in private sector investment: resource revenues can be used to remove obstacles to investment by reducing taxes and improving infrastructure.
Policy in developing countries should therefore typically follow a profile of measures to increase public and private sector investment, accompanied by some initial increases in consumption (perhaps achieved through tax reductions or conditional cash transfers).
The objective should be to use resource revenues to increase wages and employment and so bring forward economic development in the country, not to build a stock of foreign assets to provide dividend income for future generations.
''Harnessing Windfall Revenues: Optimal Policies for Resource-Rich Developing Economies'' by Rick van der Ploeg and Tony Venables is published in the March 2011 issue of the Economic Journal.
