This volume brings together papers that deal with a wide range of macroeconomic
and fiscal issues in oil-producing countries, and aims at providing policy
recommendations drawing on theory and country experience. The scope of the
essays reflects the significant operational involvement of the IMF with oil
producers, particularly in terms of surveillance, program work, and technical
assistance. This work has highlighted the difficult challenges that confront
policymakers in these countries, and the possibilities in several areas for
improved practice.
The volatility of oil prices in recent years has brought these major challenges
into sharper focus. Over a period of just a few years, oil prices plunged
to around US$12 per barrel in late 1998, surged to US$30 per barrel in late
2000—only to fall back to US$20 per barrel in early 2002 (Figure 1.1).
This volatility can translate into significant fluctuations in fiscal revenue.
A case in point is Venezuela, where public sector oil revenues fell from
27 percent of GDP in 1996 to less than 13 percent of GDP in 1998 before rising
again to more than 22 percent of GDP in 2000. At the same time, oil is an
exhaustible resource, which poses difficult intergenerational equity questions.
While it may be a distant concern for some producers, for others the reality
of a post-oil period is approaching. And, since oil revenue largely originates
from abroad, its fiscal use can have significant effects on the domestic
economy.
Many oil producers have had difficulties designing and implementing policies
in this context. Studies have shown that resource-dependent economies tend
to grow more slowly than nonresource-dependent ones at comparable levels
of development. Poverty is still widespread in a number of oil-producing
countries. Downturns in oil prices have in a number of cases led to external
and fiscal crises. And a pattern of fluctuating fiscal expenditures associated
with oil volatility has entailed significant economic and social costs for
a number of oil producers.
Oil-producing countries, however, do not form a homogenous group. First,
there is significant variation in the extent of oil dependence. In some countries,
oil accounts for the vast majority of fiscal revenue and exports, while in
others it is less significant for the economy. Second, oil sectors are at
different stages of development. There are several new or soon-to-be producers
where the oil sector is being developed, and oil revenues can be expected
to grow substantially over the next few years. At the other end of the spectrum,
some oil producers like Yemen face the prospect of depleting their oil resources
in the not-too-distant future. Third, governments' financial positions also
vary substantially. Some governments have accumulated sizable financial assets,
while for others public debt is a major concern. This has implications for
the options and constraints in responding to fluctuations in oil prices.
And finally, the ownership of the oil sector also differs across countries.
In countries such as Venezuela and Mexico, the oil sector is dominated by
a state-owned producer. In other countries, the oil industry is largely in
private hands.
Moreover, the way oil revenues are collected and used is not just an economic
issue. Importantly, policies are framed within specific political and institutional
frameworks. These frameworks—including their governance, transparency,
and accountability characteristics—tend to vary among countries. Several
papers in this volume incorporate wider institutional issues specifically
into their analysis.
This book is structured around four broad sets of topics. The papers included
in Part I examine fundamental macroeconomic and fiscal issues and institutional
factors associated with the formulation and implementation of fiscal policy
in oil-producing countries. Part II looks at more specific oil revenue issues,
in particular the taxation and organization of the oil sector, national oil
companies, and oil revenue and fiscal federalism. Institutional arrangements
to deal with oil revenue instability, including oil funds and the use of
oil risk markets, are the focus of the papers in Part III. Finally, the papers
included in Part IV discuss domestic petroleum and energy-pricing issues.
Determining Fiscal Policy in Oil-Producing Countries
Countries with large oil resources can benefit substantially from them,
and the government has an important role to play in how these resources are
used. At the same time, the economic performance of many oil exporters has
been disappointing, even to the extent of prompting some observers to ask
whether oil is a blessing or a curse. The papers in this section address
analytical and operational issues in the formulation of fiscal policy in
oil-producing countries, as well as the political and institutional factors
that may affect the design and execution of policy.
In Chapter 2, Hausmann and Rigobon introduce an innovative analytical approach
to explain the "resource curse." Their model relates the poor growth
performance of many oil-dependent countries to the interaction of government
spending of oil income, specialization in nontradables, and financial market
imperfections. Both the level and volatility of government expenditure contribute
to lack of diversification, which, according to empirical evidence, exacerbates
the resource curse. The main policy conclusions are that welfare and macroeconomic
performance can be improved by reducing the volatility, and in some cases
the level, of government spending; improving budget institutions, debt management,
and policy credibility; and enhancing the efficiency of domestic financial
markets.
Barnett and Ossowski address operational issues in formulating and assessing
fiscal policy in oil-producing countries in Chapter 3. They put forward operational
guidelines based on lessons drawn from the experience of many oil producers.
First, the non-oil fiscal balance should be given greater attention as an
indicator of fiscal policy, and should figure prominently in the budget and
in fiscal analysis. Second, the non-oil balance, and expenditure in particular,
should be adjusted gradually, which requires decoupling, to the extent possible,
government spending from oil revenue volatility. Third, the government should
strive to accumulate substantial financial assets over the period of oil
production, on both sustainability and intergenerational equity grounds.
Fourth, while many oil producers can afford to run sizable non-oil deficits,
there are strong precautionary motives that would justify fiscal prudence.
Fifth, in setting fiscal policy, consideration needs to be given to supporting
the broader macroeconomic objectives. Finally, a number of oil producers
should pursue strategies aimed at breaking procyclical fiscal responses to
volatile oil prices and ensuring that the government's financial position
is strong enough to weather downturns in oil prices.
Eifert, Gelb, and Tallroth (Chapter 4) provide an analysis of the underlying
political and institutional determinants of the economic performance of oil
exporters. Drawing on concepts from the comparative institutionalist tradition
in political science, their paper develops a generalized typology of political
states, which is used to analyze the political economy of fiscal and economic
management in oil-exporting countries with widely differing political systems.
Country experiences point to the key role played by constituencies for the
sound use of oil rents, the importance of transparent political processes
and financial management, and the value of getting the political debate to
span longer time horizons.
Understanding the statistical properties of oil prices is important for
fiscal policy formulation in oil-producing countries. In particular, whether
oil price shocks are deemed to be temporary or persistent has implications
for government wealth (including oil wealth)—a key input for assessing
the sustainability of fiscal policy. In Chapter 5, Barnett and Vivanco test
empirically the statistical properties of oil prices. Accepting that there
are periodic permanent oil shocks (such as in 1973), their evidence suggests
that most oil price movements are transitory. This implies that many year-to-year
oil price fluctuations have only a minor impact on government wealth. For
the most part, therefore—and looking only at sustainability considerations—governments
should not adjust expenditure significantly in response to oil price changes.
Dealing with Oil Revenue
The papers included in Part II of this book address three sets of oil revenue
issues. First, oil extraction plays a crucial fiscal role in generating tax
and other revenue for the government in oil-producing countries. Therefore,
the proper design of the fiscal regime for the oil sector is of key fiscal
importance. Second, there is a need to look at the performance of national
oil companies—including transparency and governance issues—since
in many cases these enterprises play a major macroeconomic and fiscal role.
Finally, three papers are devoted to fiscal federalism topics, as important
questions arise over the assignment of oil revenues to various levels of
government.
Sunley, Baunsgaard, and Simard argue in Chapter 6 that the fiscal regime
must be properly designed to ensure that the state, as resource owner, receives
an appropriate share of oil rent. Competing demands arise between the government
and oil companies over sharing risk and reward from oil investments—where
both aim at maximizing reward while shifting risk as much as possible to
the other party. Abalance also needs to be struck between the desire to maximize
short-term revenue against any deterrent effects this may have on investment
in the oil sector. The paper surveys various fiscal regimes to collect revenue
from the oil sector; cross-country evidence suggests that good fiscal regimes
should guarantee some up-front revenue with sufficient progressivity to provide
the government with an adequate share of economic rent.
In Chapter 7, a paper by McPherson on national oil companies covers an important
area where previous work has been limited. The author argues that the performance
of national oil companies is generally poor, as these enterprises are often
plagued by lack of competition, the assignment of noncommercial objectives,
weak governance, limited transparency and accountability, lack of oversight,
and conflicts of interest. These ills may be addressed by setting performance
standards, increasing competition in the oil sector, divesting noncore assets,
transferring noncommercial activities to the government, and conducting (and
publishing) independent audits on a regular basis. The reform of national
oil companies, however, faces formidable obstacles, including political opposition
and entrenched vested interests. To be successful, reform programs need support
from the highest political levels as well as from a wide range of public
opinion.
The assignment of oil revenues to various levels of government raises a
number of extremely complex issues in oil-producing countries. These include
whether subnational regions should have the right to raise revenues from
natural resources; the ability of subnational governments to cope with oil
revenue volatility given their expenditure assignments; the implications
of various intergovernmental fiscal frameworks for the maintenance of overall
fiscal control by central governments; interjurisdictional equity and redistribution
issues; and environmental and social concerns.
In Chapter 8, McLure provides a conceptual framework for analyzing the assignment
of revenues from the taxation of oil to various levels of government in multilayer
systems. The paper focuses, in particular, on whether subnational governments
should have the power to tax oil, why, and (if so) how. Most of the considerations
examined in the paper suggest that revenues from oil should be reserved for
national governments. There may be overriding legal and political economy
considerations, however, that may lead to the assignment of power to tax
oil to subnational governments.
The next two papers also see the centralization of revenues as the best
solution. Reflecting the complexity of the issues, however, their authors
reach different conclusions regarding second-best policies.
Ahmad and Mottu present a topology of existing oil revenue assignments in
Chapter 9. While recognizing that the centralization of oil revenue is preferable,
they conclude that a second-best solution would be to assign oil taxation
bases with stable elements (such as production excises) to subnational governments,
supplemented by stable transfers from the central government. This would
allow subnational governments to finance a stable level of public services.
The least preferred solution would be oil revenue sharing, which complicates
macroeconomic management, does not provide stable financing of local public
services, and may not diffuse separatist tendencies (oil-producing regions
would still be better off by keeping their oil revenues in full).
Brosio also notes that a growing trend toward sharing of oil revenue with
subnational governments bears out the principle that optimal policies (oil
revenue centralization) often have to give way to second-best solutions (Chapter
10). Based on a review of various types of tax assignments and equalization
mechanisms, he concludes that revenue sharing (including an equalization
mechanism to limit regional disparities in revenues) should be preferred
over the assignment of local taxes on oil. The main reasons are that oil
is typically concentrated in a few regions; oil revenue is highly volatile
and thus difficult for subnational governments to manage; oil taxes are complex
and difficult to administer; and energy policy is a national responsibility.
Institutional Arrangements for Dealing with Oil Revenue Instability
Fiscal policymakers in oil-producing countries need to decide how expenditure
can be insulated from oil revenue shocks, and the extent to which resources
should be saved for future generations. The papers in this section discuss
two institutional mechanisms that have been proposed to promote better fiscal
management. First, oil funds have been suggested as an institutional response
to stabilization and savings concerns, particularly when there are strong
political pressures to increase spending. This is a topic where judgments
on political economy issues can lead to different views, as reflected in
the papers included in this section. Second, a potential way to deal with
the oil price risks that affect the public finances of oil producers is to
use oil risk markets.
Davis, Ossowski, Daniel, and Barnett look at the effectiveness of oil funds
from both a theoretical and an empirical perspective (Chapter 11). The main
types of funds include stabilization funds, savings funds, and financing
("Norwegian") funds. The objective of stabilization funds is to
minimize the transmission of oil price volatility to fiscal policy by smoothing
budgetary oil revenue. Savings funds aim at addressing intergenerational
concerns. Oil funds other than financing funds, however, ignore the fungibility
of resources, and therefore do not effectively constrain expenditure. Moreover,
these funds often do little to improve the conduct of fiscal policy and entail
certain risks, including fragmenting fiscal policy and asset management,
creating a dual budget, and reducing transparency and accountability. Econometric
evidence and country experiences generally raise questions as to the effectiveness
of oil funds.
In Chapter 12, Skancke describes the Norwegian Petroleum Fund. The fund,
which is viewed as a tool to enhance transparency in the use of oil wealth,
is fully integrated into the budget and has flexible operating rules, thereby
avoiding the problems discussed in the previous paper. Since the budget targets
a non-oil deficit that is financed from the fund, the accumulation of resources
in the fund corresponds to net financial public savings. A large-scale buildup
of public financial resources, however, requires a high degree of consensus,
transparency, and accountability—traditionally present in Norway—and
therefore the Norwegian model may not be easily "exported" to many
other oil-producing countries.
Wakeman-Linn, Mathieu, and van Selm note in Chapter 13 that despite the
ambiguous track record of oil funds in other countries, Azerbaijan and Kazakhstan
have created funds to assist them in managing their new petroleum wealth.
The decision to establish funds in these countries was motivated by the serious
challenge posed by an unfinished transition from planned to market economy
in the context of an oil boom, which in the view of the authorities argued
for the separation of oil revenues from other revenues. Given the recent
history of these countries' oil funds, only preliminary conclusions can be
drawn on how they have performed relative to their stated objectives. According
to the authors, on balance these funds, if operated in accordance with existing
rules, should contribute to better management of oil wealth and improved
transparency. However, a further strengthening of these funds is urgently
needed for their potential to be fully realized.
Hedging represents a possible way to reduce oil revenue volatility and limit
oil price risk, as Daniel argues in Chapter 14. Hedging may allow for more
realistic and certain budgeting, provide insurance against declines in oil
prices, and lessen the chances of oil price falls forcing costly fiscal adjustments.
As oil risk markets have matured in the last decade, their range and depth
could allow many oil producers to hedge oil price risk. At the same time,
concerns about the potential political costs of hedging (particularly the
failure to benefit from upturns in prices), institutional capacity constraints,
financial costs, and the depth of the market have discouraged many governments
from actively using hedging. In many cases these concerns could be overcome,
however, and the author encourages governments to explore the scope for hedging
oil price risk.
Designing Policies for Domestic Petroleum Pricing
In oil-producing as well as oil-importing countries, domestic petroleum
product prices are often heavily regulated. Many governments keep prices
below international levels, resulting in the implicit or explicit subsidization
of oil consumption. The quasi-fiscal costs and appropriateness of setting
domestic prices at below-market rates, as well as the potential social consequences
of price reform, are contentious and deeply political issues in many countries.
Gupta, Clements, Fletcher, and Inchauste (Chapter 15) argue that the subsidization
of petroleum products in oil-producing countries does not appear to be a
wise use of resources. Petroleum subsidies are inefficient and inequitable,
implying substantial opportunity costs in terms of foregone revenue or productive
expenditure, and procyclical, thus complicating macroeconomic management.
Moreover, as these subsidies are typically not recorded in government budgets
as expenditures, their economic cost, as well as the incidence on different
income classes, is often poorly understood. Despite the substantial costs
of implicit petroleum subsidies, reform is often difficult, as there is typically
strong popular opposition to their elimination. Support for subsidy reform
can be promoted through countervailing measures and publicity campaigns.
Undertaking poverty and social impact analyses and establishing social safety
nets can mitigate the adverse social and political effects of reforming energy
subsidies.
In Chapter 16, Espinasa provides a simple accounting model to analyze the
distribution of the cost of domestic petroleum subsidies between the government
and the national oil company. It is found that the fiscal incidence of this
cost depends on the fiscal regime in place. Some tax regimes shift the burden
of subsidies to the state oil company, thus hampering its ability to invest
and hence to provide the government with revenues over the medium term. In
addition, estimates of the implicit subsidies should take into account domestic
distribution and retail costs, which typically represent a sizable share
of the final retail price.
In Chapter 17, Federico, Daniel, and Bingham examine the case for smoothing
retail petroleum prices in countries where these prices are regulated by
the government. The authors contend that full and automatic pass-through
of international price changes to domestic retail prices is the first-best
solution in a competitive market economy, as it allows for correct price
signals and does not expose the government to undue fiscal risk as a result
of volatile oil prices. However, most developing countries that regulate
petroleum prices follow a discretionary approach to adjusting them, which
suggests that from a political economy perspective full-cost pass-through
is not a robust policy option. The paper therefore explores the case for
government-managed retail price smoothing. It concludes that there is a sharp
trade-off between the degree of price smoothing and government fiscal stability.
Since many pricing rules would leave the government overexposed to oil price
risk, only limited price smoothing is likely to be fiscally sustainable.
Energy sector operations often lead to quasi-fiscal activities. Petri, Taube,
and Tsyvinski stress in Chapter 18 that this is the case in many of the countries
of the former Soviet Union. Their study provides an analysis of quasi-fiscal activities arising from the mispricing of energy and the toleration of payment arrears. In addition to information on various countries of the former Soviet Union, the paper presents detailed case studies on Ukraine (a net energy importer) and Azerbaijan (an energy-rich country). The main policy recommendations in the paper focus on the need to adjust inappropriately low energy tariffs and improve financial discipline in order to reduce energy consumption and waste and streamline untargeted energy subsidies; to supplement these reforms with the provision of explicit and better targeted subsidies to needy population groups; to include estimates of quasi-fiscal activities in the reported fiscal positions; and to enhance the scrutiny of these activities and promote fiscal transparency.
|