Technical File with Grain Malunga: Resource Curse and Sovereign Wealth Fund

TECHNICAL FILE

by Grain Wyson Phillip Malunga FIMMM  Minerals, Geology, Environment & Corporate Affairs Consultant

Resource Curse and Sovereign Wealth Fund

Abstract

Resource curse and sovereign wealth funds are put into local context in order to guide their proper interpretation and how they can promote sustainable development through strategic determination of fiscal policies that influence effective national revenue management.

Introduction

Fiscal policies determine how governments benefit from profit sharing with resource companies. Government revenue expenditure determines how economic growth and poverty reduction benefit its people. Fiscal policy dilemmas include resource revenue planning for sustainable growth, intergeneration equity in case of non-renewable resources and fluctuating resource prices.

Problems related with poor fiscal policies and revenue management lead to resource curse. What is resource curse and how can it be mitigated against? This paper looks at how it is defined, its causes and how it can be mitigated against.

Resource Curse

Resource rich and mineral producing countries need to ensure that there is a fair benefit sharing with resource companies and that the benefits so realised are used for the benefit of its people and future generation. Resource curse comes in if these countries have its people continue leaving in abject poverty, illiteracy and poor health services. This is worsened by existence of poor and weak institutional set-up that manages the resource sectors. Poor accountability and political driven development agendas lead to misallocation of revenues.

Resource Endowment and Economic Development

Developing countries rely much on the extractive industries. These industries can serve as a source of economic prosperity and serve as link to the global economy through involvement of multi-national resource companies. Low income countries can reduce poverty if they properly understand and link national fiscal policy and wise revenue management with proper planning, development and utilisation of revenue into programmes that grow the economy such as vocational entrepreneurship, infrastructure development and rule of law.

It is also important to understand that taxation and rents are not significant channels for economic development. Attracting foreign investment and generating export earnings strengthen national economies. In resource rich countries, countries can benefit between 3 and 20 per cent of fiscal revenues while accounting for up to 90% of foreign direct investment (ICMM, 2015). The sector can contribute up to 60% of total exports in developing countries. This economic situation is misunderstood and results in disruptive tendencies in fostering consistent political decision making and bringing coherent positive social, economic and environmental consensus by all stakeholders.

Sovereign wealth Fund

Countries with trade surplus or windfall revenue from resource extraction invest those surpluses into foreign currency fixed deposits. These funds take also the form of Future Generation Funds, Stabilization Funds and Strategic Development Sovereign Wealth Funds. Middle Eastern Countries are expected to invest USD 9.0 trillion by 2020 arising from oil exports while China has accumulated USD 3.0 trillion for investment into real estate, infrastructure and state-owned businesses. The China – Africa Development Fund is one of its Sovereign Wealth Funds and is worth USD 5.0 billion.

Countries that create Sovereign Wealth Funds show a sign of fiscal discipline in that they have a limit to their budgeting philosophy and reserve the money for future generation and strategic investments that bring high income. Fiscal policies that bring sustainable development in resource extraction need to balance between spending on consumption e.g. direct cash transfer and investing for future generations through National Development Plans.

Mitigating Factors

Resource curse can be avoided if balanced fiscal policies and wise revenue management are adhered to. Fiscal policies should generate fair benefits to both government and resource companies with an effective tax rate within the range of 60 – 40 as universally agreed. Effective tax rate is the total revenue sharing between government and resource companies. Wise revenue management entails balancing government budget in such a way as addressing social development with supporting infrastructure development that grows the economy through private sector expansion while saving any trade surplus or surplus revenue in form of sovereign wealth fund.

Communities around resource extraction areas need to be engaged in benefit sharing in order to create economic opportunities. This should be through channelling of resources to community trusts that look into area development activities such as health, education, water, agriculture and infrastructure services in order to promote local content and other economic linkages.

Conclusion

A well-governed country is more likely to maximise the contribution of resource extraction by designing good fiscal policies for attracting resource companies’ investment and to build strong institutions that collect, manage and spend revenues wisely while creating an enabling environment to enhance employment and economic development.

Reference

  • ICMM (2007). Chile. The challenge of mineral wealth: using resource endowments to foster sustainable development. Country case study. March 2007. London: ICMM.
  • ICMM (2016). The role of mining in national economies (3rd edition). London: ICMM
  • Humphreys, M., et al, 2007. Introduction in “Escaping the Resource Curse”(Columbia University Press, 2007).
  • McMahon, G. 1997. The natural Resource Curse: Myth or reality? Economic Development Institute. World Bank, Washington, DC.

***

This piece was initially published in Malawi’s Mining & Trade Review Issue Number 61 (May 2018).

The full edition is available for download here. This monthly publication is edited by Marcel Chimwala.

 

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