#1LSE FROM FISCAL STABILIZATION TO ECONOMIC DIVERSIFICATION: A DEVELOPMENTAL APPROACH TO MANAGING RESOURCE REVENUES Amir Lebdioui & Ha-Joon Chang 7 October 2020 Universidade Estadual de Campinas (Brazil)#2WORLD'S RICHEST LITTLE ISLE A speck in the Pacific. Nauru is running out of the source of its huge income. phosphate rock, and in the next 10 years, the island will be unlivable.#3WORLD'S RICHEST LITTLE ISLE A speck in the Pacific. Nauru is running out of the source of its huge income. phosphate rock, and in the next 10 years, the island will be unlivable. Welcom#4N O -> There will be many others 'Fritz Habers' to come.#58 6 Real GDP per capita relative to the U.S. 2 4 10 0 More reasons why resource dependence is problematic: Relative Income Decline 1970 1975 1980 1985 1990 1995 Year 2000 2005 2010 2015 Singapore UAE Saudi Arabia Kuwait Source: Cherif, R., & Hasanov, F. (2019). The Return of the Policy That Shall Not Be Named: Principles of Industrial Policy. IMF working paper 19/74.#6Financial Diversification (abroad) Taxonomy of Diversification strategies Backward production linkages Upstream Diversification Vertical Integration Consumption linkages Fiscal linkages Commodity Value Chain Transversal Capability Building Knowledge, Technological and organisational skills Forward production linkages Downstream Diversification Goods with wide application for other Infrastructure sectors Unrelated Horizontal Diversification (Degree of Relatedness) Lebdioui (2019c) Related#7Financial Diversification (abroad) Taxonomy of Diversification strategies Backward production linkages Upstream Diversification Vertical Integration Consumption linkages Fiscal linkages Commodity Value Chain Transversal Capability Building Knowledge, Technological and organisational skills Forward production linkages Downstream Diversification Goods with wide application for other Infrastructure sectors Unrelated Horizontal Diversification (Degree of Relatedness) Lebdioui (2019c) Related#8Role of Commodities: Source of Capital Financial Diversification (abroad) As products in a value chain Upstream Diversification Backward production linkages Vertical Integration Consumption linkages Source of production capabilities Fiscal linkages Commodity Value Chain Transversal Capability Building Knowledge, Technological and organisational skills Forward production linkages Downstream Diversification Goods with wide application for other Infrastructure sectors Unrelated Horizontal Diversification (Degree of Relatedness) Lebdioui (2019c) Related#9Role of Commodities: Source of Capital As products in a value chain WIDER Working Paper 2020/108 Financial Diversification (abroad) UNITED NATIONS UNIVERSITY UNU-WIDER Backward production linkages Upstream Diversification Vertical Integration Consumption linkages Source of production capabilities From fiscal stabilization to economic diversification A developmental approach to managing resource revenues. Fiscal linkages. Commodity Value Chain Transversal Capability Building Ha-Joon Chang and Amir Lebdioui Knowledge, Technological and August 2020 organisational skills United Nations University World Institute for Development Economics Rosearch wider.unu.edu Forward production linkages Downstream Diversification Goods with wide application for other Infrastructure sectors Unrelated Horizontal Diversification (Degree of Relatedness) Lebdioui (2019c) Related#10Real assets Options for resource revenue spending Investment Abroad Domestically e.g. acquisition of foreign companies, technology, infrastructure Public sector Resource rents Financial assets Domestically e.g. KWAN fund in Malaysia; Fonds de régulation des recettes in Algeria Private sector Abroad Public spending e.g. recurrent government expenditures Consumption Private spending Unconditional transfer e.g. citizen dividend schemes in Alaska or lowered taxes (MENA region and GCC countries) Conditional transfer e.g. consumption subsidies, transfers for specific purposes General capabilities e.g. Infrastructure, human capital, governance capabilities for investment efficiency Specific capabilities e.g. investments to promote the non resource tradable sector General e.g. bank landing or subsidised credit Targeted Conditional credit upon certain activities (e.g. non resource tradable sector) Safe assets Low-risk assets for savings purposes, e.g. bonds (as pursued by Botswana's Pula Fund, Chile's ESSF) High yielding assets Investments in strategic assets to generate high returns. (e.g. Qatar Investment Authority, Norwegian Pension Fund)#11Real assets Options for resource revenue spending Investment Abroad Domestically e.g. acquisition of foreign companies, technology, infrastructure Public sector Resource rents Financial assets Domestically e.g. KWAN fund in Malaysia; Fonds de régulation des recettes in Algeria Private sector Abroad Public spending e.g. recurrent government expenditures Consumption Private spending Unconditional transfer e.g. citizen dividend schemes in Alaska or lowered taxes (MENA region and GCC countries) Conditional transfer e.g. consumption subsidies, transfers for specific purposes General capabilities e.g. Infrastructure, human capital, governance capabilities for investment efficiency Specific capabilities e.g. investments to promote the non resource tradable sector General e.g. bank landing or subsidised credit Targeted Conditional credit upon certain activities (e.g. non resource tradable sector) Safe assets Low-risk assets for savings purposes, e.g. bonds (as pursued by Botswana's Pula Fund, Chile's ESSF) High yielding assets Investments in strategic assets to generate high returns. (e.g. Qatar Investment Authority, Norwegian Pension Fund) Neoclassical/Standard policy advice/ Permanent Income hypothesis Emphasis on fiscal stabilisation to mitigate the effect of commodity price vulnerability (e.g. Rainy day funds') Living like a pensioner (e.g. Norway or Qatar)#12Real assets FISCAL INSTABILITY ad e.g. acquisition of foreign companies, technology, infrastructure Public secto Options for resource revenue spending Investment MISJUDGING DURATION OF COMMODITY BOOM ELITE CAPTURE General capabilitie ific ABSORPTIVE CAPACITY es e.g. Infrastructure, human capital, governance capabilities for investment efficiency estme ote the non Source tradable sector Resource rents Consumption Financial assets Public spen FISCAL INSTABILITY POPULISM e.g. recurrent governme expenditures Domestically e.g. KWAN fund in Malaysia; Fonds de régulation des recettes in Algeria Private sector Abroad Unconditional transfer e.g. citizen dividend schemes in Alaska or lowered taxes (MENA region and GCC countries) Conditional transfer e.g. consumption subsidies, transfers for specific purposes eneral WASTEFUL ding or credit Targeted Conditional credit upon certain activities (e.g. non resource tradable sector) Safe assets Low-risk assets for savings purposes, e.g. bonds (as pursued by Botswana's Pula Fund, Chile's ESSF) High yielding assets Investments in strategic assets to generate high returns. (e.g. Qatar Investment Authority, Norwegian Pension Fund) Neoclassical/Standard policy advice/ Permanent Income hypothesis Emphasis on fiscal stabilisation to mitigate the effect of commodity price vulnerability (e.g. Rainy day funds') Living like a pensioner (e.g. Norway or Qatar)#13Real assets FISCAL INSTABILITY ad e.g. acquisition of foreign companies, technology, infrastructure Public secto Options for resource revenue spending Investment MISJUDGING DURATION OF COMMODITY BOOM ELITE CAPTURE Resource rents Consumption Needed to tackle deficit of O&M of existing capital stock FISCAL INSTABILITY Financial assets F e.g. recurre expenditures inme Domestically e.g. KWAN fund in Malaysia; Fonds de régulation des recettes in Algeria Abroad Private sector Unlikely to stimulate productive domestic transformation POPULISM Unconditional transfer e.g. citizen dividend scher in Alaska or lowered ta (MENA region and G countries) Conditional transfer e.g. consumption bsidies, transfers for cific purposes individuals may better invest revenues than government officials General capabilitie ABSORPTIVE CAPACITY ific es e.g. Infrastructure, WA human capital, governance capabilities for investment efficiency estme ote the non Source tradab sector Targeted Conditional credit upon certain tivities (e.g. non NEEDED TO STIMULATE urce tradable EXPORT DIVERSIFICATION.tor) short term fiscal stabilisation Low-rish savings pu e.g. bonds (a h yield sets investr asse re Pushes benefits too far pursued by into the future Fund, Chile's ESSF) Fun Botswana's Pula Neoclassical/Standard policy advice/ Permanent Income hypothesis#14Real assets Options for resource revenue spending Investment Abroad Domestically e.g. acquisition of foreign companies, technology, infrastructure Public secti Resource rents Financial assets Domestically e.g. KWAN fund in Malaysia; Fonds de régulation des recettes in Algeria Private sector Abroad Public spending e.g. recurrent government expenditures Consumption Private spending Unconditional transfer e.g. citizen dividend schemes in Alaska or lowered taxes (MENA region and GCC countries) Conditional transfer e.g. consumption subsidies, transfers for specific purposes General capabilities e.g. Infrastructure, human capital, governance capabilities for investment efficiency Specific capabilities e.g. investments to promote the non resource tradable sector General e.g. bank landing or subsidised credit Targeted Conditional credit upon certain activities (e.g. non resource tradable sector) Safe assets Low-risk assets for savings purposes, e.g. bonds (as pursued by Botswana's Pula Fund, Chile's ESSF) High yielding assets Investments in strategic assets to generate high returns. (e.g. Qatar Investment Authority, Norwegian Pension Fund) Chile and Botswana: the other side of the coin Kicking away the resource-based development ladder Long term export diversification Fiscal Stabilisation#15Various possible objectives of resource revenue management Fiscal stabilisation to smoothen government expenditure Domestic investment (specific) to promote economic diversification and reduce reliance on commodities for foreign exchange generation Objectives Domestic Investment (general) To increase human capital & infrastructure Boost private consumption by redistributing resource rents to citizens Saving for intergenerational equity#16Various possible objectives of resource revenue management Fiscal stabilisation to smoothen government expenditure Domestic investment (specific) to promote economic diversification and reduce reliance on commodities for foreign exchange generation Objectives Domestic Investment (general) To increase human capital & infrastructure Neoclassical models (the Permanent income hypothesis) Boost private consumption by redistributing resource rents to citizens Saving for intergenerational equity#17Various possible objectives of resource revenue management Fiscal stabilisation to smoothen government expenditure Domestic investment (specific) to promote economic diversification and reduce reliance on commodities for foreign exchange generation Objectives Domestic Investment (general) To increase human capital & infrastructure Neoclassical models (the Permanent income hypothesis) Structuralist and other models Boost private consumption by redistributing resource rents to citizens Saving for intergenerational equity#18Beyond the one-size-fits-all approach: Factors that influence the trade-offs between resource revenue management decisions Factors Degree of commodity dependence Savings rate to date Investment deficit Degree of resource exhausitibility and anticipated price fluctuations Institutional capacity to invest Degree of resource abundance per capita Explanation The more dependent a country is on a given commodity, the more urgent diversification becomes (e.g. Algeria, Angola, Saudi Arabia, Venezuela). Current savings rate contribute to the ability of the country to invest domestically as it is already “insured" in case of a commodity price collapse (e.g. Chile) Investment deficits (include low spending on human capital, education or R&D) increase the opportunity costs of resource revenue investments in financial assets overseas because funds would not be made available for domestic investment (e.g. Algeria, Botswana, Chile, Nigeria) If resources are to be depleted on the long term, or if their value is to decrease due to changes in consumer demand or technological innovations, the urgency to diversify sources of revenues through the transformation of domestic productive structures increases (e.g. fossil fuel dependent economies) A government's ability to spend revenues effectively is affected by the level of institutional development. The opportunity cost of investment in financial assets overseas are lower for very resource rich per capita countries (e.g. Kuwait, Qatar, UAE) than medium resource rich per capita countries (Algeria, Nigeria), where there is a need for employment generation outside of extractive sectors#19Way forward? • Beyond the "Norwegian solution" to managing resource revenues, which neglects the role of the diversification of productive structures. • There is a need for dynamic approach to the trade-off between various types of investment, across space & time.#20A different approach to managing resource revenues In order to overcome domestic structural constraints (such as low technological sophistication, limited areas of competitive advantage While mitigating economic risks associated with domestic investments of resource revenues (such as public investment inefficiency, absorptive capacity constraints, and Dutch disease), the approach in Chang and Lebdioui (2020) is based on the following two features: The gradual scaling-up of domestic investments in real assets The targeting of productivity enhancing assets for tradable sectors#21A different approach to managing resource revenues In order to overcome domestic structural constraints (such as low technological sophistication, limited areas of competitive advantage While mitigating economic risks associated with domestic investments of resource revenues (such as public investment inefficiency, absorptive capacity constraints, and Dutch disease), the approach in Chang and Lebdioui (2020) is based on the following two features: Share of resource revenues 100% 80% 60% 40% 20% 0% + The gradual scaling-up of domestic investments in real assets The targeting of productivity enhancing assets for tradable sectors to 8 t1 (Short commodity boom, <5 years) t2 t3 (Long commodity boom, >10 years) Domestic investments in general and specific capabilities Savings in financial assets overseas#2270 0 60 50 40 40 USD billion 30 A different approach to managing resource revenues 20 20 Short commodity boom 10 10 Long commodity boom 100 90 USD billion 20 2222222 ° 80 70 60 50 0 1 5 9 13 17 21 25 Years Stock of investments in financial assets (savings) Stock of investments in productivity-enhancing assets Non-renewable resource revenue income 1 5 9 13 Years 17 21 25#23A different approach to managing resource revenues In order to overcome domestic structural constraints (such as low technological sophistication, limited areas of competitive advantage While mitigating economic risks associated with domestic investments of resource revenues (such as public investment inefficiency, absorptive capacity constraints, and Dutch disease), the approach in Chang and Lebdioui (2020) is based on the following two features: The gradual scaling-up of domestic investments in real assets The targeting of productivity enhancing assets for tradable sectors ଓ This approach is dynamic over time because it enables the gradual shift between short-term fiscal stabilisation and long-term accumulation of productive capabilities. TIIT how certain It takes account patterns of resource-revenue investment can better contribute to increasing the institutional capacity to invest over time. It has several benefits, such as: •Reducing the cost of misjudging the duration of a commodity boom Taking into account the diminishing marginal utility of public spending and the issue of absorptive capacity •Explicitly considering the opportunity costs associated with over-insurance through overseas financial investment of resource revenues.#24Main takeaways Bringing structural transformation back into the resource revenue management debate The suitability of different resource revenue management strategies is highly context-dependent The standard policy advice has been dominated by short-termism and the lack of a perspective on economic development and structural transformation. Mainstream approaches have often addressed only the symptoms of commodity dependence (e.g. vulnerability to commodity price volatility) rather than its root causes (insufficiently diversified productive structures). The best fiscal stabilisation is economic diversification The state has a key role to play in shaping the accumulation of productive capabilities related to the emergence of new exports by reinvesting a share of resource revenues. • The failure to engage in creative imagination of alternative realities may inevitably lead to maintaining the status quo, where the risks are serious and tangible. The alternative resource revenue management model that we propose is more suited to the context of commodity-dependent developing countries. It also enables the alignment of the dual objectives of short-term stabilization and long-term diversification. The context of climate change and COVID-19: Reinvesting non-renewable resource revenues in green industries? Divestment from fossil fuels has started...Low carbon innovation is on its way. What will happen to fossil fuel economies if no serious action is taken? Fossil fuel-dependent economies need to undergo a sustainable structural transformation. Investing fossil fuel revenues in renewable energies leads to a “virtuous circle” of diversification. ⚫ Clean energy deployment is a necessity as demand will focus on goods with low carbon production processes.#25Commodity dependence and climate change Latin American exports are intrinsically linked to climate change because of a dependence: Agriculture (37 countries) Non-commodities 17% . on fossil fuels that are at risk of becoming stranded assets (87 countries) Energy 46% (32 countries) 17% Distribution of commodity-dependent and non-commodity-dependent states, 2013-17 20% Minerals (33 countries) Dependence on exports of agricultural products Dependence on energy exports Dependence on exports of minerals, ores and metals Non-commodity dependent countries Data not available or not included in the report . Agro-commodities, where productivity is vulnerable to fluctuations in temperature and precipitation (e.g. salmon farming in Chile, coffee in Colombia, and cacao in Ecuador). • So-called minerals of the future, that are still dominated by high levels of uncertainty and risks of technological disruption. Jamaica Saint Lucia, Trinidad and Tobago Gambia Sao Tome and Principe Qatar Maldives Comoros, Seychelles Fiji, Kiribati, Micronesia (Federated States of), Palau, Solomon Islands, Tonga, Vanuatu Nauru Source: UNCTAD#26Anticipating changes in sustainability standards Latin American firms will have to adapt as consumer demand shifts towards more sustainable products in key markets. • • Green Deal proposals in the USA & EU may bring regulatory changes that will reshape consumption patterns. Developing countries need to anticipate these "green" trade regulations by shifting their productive capabilities towards greener goods and services that will enjoy long-term access to the largest consumer markets. 6 CLIMATE NEUTRAL 050 GREEN NEW DEAL Eyevine#27Solar Renewable energy employment in 2018 (in thousand jobs) Photovoltaic Liquid Biofuels Hydropower Wind Energy Solar Heating/ Cooling Solid Biomass 2063 2054 1160 801 787 Biogas 334 Geothermal Energy 94 Municipal and industrial waste 41 CSP 34 IRENA International Renewable Energy Agency Tide, Wave and Ocean Energy 1 TT 3605 Off-grid solar for energy access 0 500 1000 1500 2000 2 500 3.000 3 500 Jobs (thousands) 4 000 In total, 11 million people were employed across the renewables sector in 2018 Source: IRENA jobs database. Note: Another 7600 jobs, not shown separately here, cannot readily be broken down by individual renewable energy technology. IRENA RENEWABLE ENERGY AND JOBS Annual Review 2019 International Renewable Energy Agency Source: IRENA (2019)#28Geographic distribution of renewable energy employment in 2018 China Jobs (thousands) EU United States of America 855 Brazil 1235 4078 Germany 291 India 267 719 North 1125 Africa Rest of 227 Africa 66 South Africa O IRENA International Renewable Energy Agency Source: IRENA jobs database. 11 million jobs in 2018 Disclaimer: Boundaries and names shown on this map do not imply any official endorsement or acceptance by IRENA Japan#29The case for a green recovery in post-COVID Latin America Growth and employment Green Recovery Resilience to health problems Achieve climate goals#300,5 0 (Low carbon) R&D levels remains very low The acquisition of innovative and productive capabilities requires skilled human capital and R&D support. The region's average R&D expenditure (as a share of GDP) is already amongst the lowest in the world, falling well below other regions (1/3 of the world average). 2000 1,5 1 2,5 2 3 Expenditure on Research and Development by World Region (%GDP) 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: WDI 2014 2015 2016 2017 World European Union -East Asia ▪Latin America -North America#31LSE THE LONDON SCHOOL OF ECONOMICS AND POLITICAL SCIENCE ☐ Canning House Towards Latin American Green Deals? Imperative High vulnerability to climate change as a result of export dependence on agriculture and fossil fuels High need for economic diversification across Latin America High inequality rates and the need for a alternative development model for decent jobs creation Anticipated shift in consumer demand towards sustainable products The current situation Very low R&D spending compared to other regions (1/3 of the world average), Lack of policy complementarity Regional clusters and supply chains? Low carbon innovation ecosystems A Latin American green new deal Opportunities & potential Increasing demand for electricity and renewable energy deployment, with potentially high socio-economic benefits Biodiversity endowment (Amazon region) Endowment in the 'minerals of the future' (e.g. lithium and copper) Future area of investigation Obstacles A considerable mobilisation of resources will be required. Political obstacles to regional integration Issues of regime continuity (regional vs national?) Countries starting from a different standpoint in terms of productive capabilities (Brazil vs the rest).#32WIDER Working Paper 2020/108 UNITED NATIONS UNIVERSITY UNU-WIDER From fiscal stabilization to economic diversification A developmental approach to managing resource revenues Ha-Joon Chang and Amir Lebdioui² August 2020 United Nations University World Institute Development Economics Research wider.unu.edu Thank you for your attention Contact me at: [email protected] COVID19 The case for a green recovery in post- COVID Latin America Access the full study on resource revenue management at: https://www.wider.unu.edu/sites/ default/files/Publications/Working- paper/PDF/wp2020-108.pdf Access the post on the green recovery in Latin America: English: https://blogs.lse.ac.uk/ latamcaribbean/2020/09/01/the-case-for-a- green-recovery-in-post-covid-latin-america/ Portuguese: https://blogs.lse.ac.uk/ latamcaribbean/2020/09/11/america-latina- precisa-de-uma-recuperacao-verde-apos- a-covid-19/ Updates on the Canning House Research Forum on the future of trade in Latin America: https://www.lse.ac.uk/lacc/ research/canning-house- research-forum