Fighting the resource curse

Only sound macroeconomic policy can save Lebanon from its own oil and gas

It's not all roses

This article is part of Executive’s special report on the oil and gas sector. Read more stories as they’re published here, or pick up October’s issue at newsstands in Lebanon.

 

“Ten years from now, 20 years from now, you will see: oil will bring us ruin … Oil is the Devil’s excrement.” This statement from Juan Pablo Pérez Alfonso, an OPEC founder, illustrates a common phenomenon linked to the discovery of hydrocarbon resources, coined the ‘resource curse’. In a nutshell, this concept links the increased exploitation and reliance on natural resources with the systematic decline in other economic sectors, specifically agriculture and manufacturing. The economy will be geared toward one sector which absorbs all the resources, labor and attention of policymakers, which would eventually reduce investments in other sectors of the economy. These symptoms are even more dangerous in countries with poorly run and corrupt institutions, non-democratic regimes and weak financial systems. Several countries with abundant resources, such as Nigeria, Angola and Chad, experience rampant poverty and widespread economic failures to this day, despite their riches. It is precisely this gloomy condition that Lebanon should try to avoid.

A set of reform policies needed

The discovery and extraction of oil and gas off the shores of Lebanon would ultimately translate into a boom in revenues for the government, which under the current conditions of poor fiscal planning could easily translate into an uncontrolled expansionary budget policy. If these revenues are spent with no oversight and proper planning, we might end up having large streams of cash that make limited contributions to economic development.

Although the oil and gas law enacted a couple of years ago by parliament stipulates the creation of a sovereign wealth fund to manage these resources, it left the details of this fund and its spending parameters to a future law, and placed these expenditure decisions in the hands of the parliament. With the existing track record of our politicians in mismanaging current revenues, there are serious doubts about its capacity to manage additional revenues.

But the ‘resource curse’ could be avoided if appropriate policy adjustments are implemented in conjunction with the development of offshore hydrocarbon resources. The successful experiences of a few resource rich countries like Norway have been largely attributed to their success in managing resource wealth and its associated risks. The optimal response that takes advantage of the boom while mitigating its potential negative implications includes a set of fiscal, monetary, exchange rate and structural reform policies.

Two principal decisions need to be made when designing a fiscal policy response to the resource curse: first, how much should a government spend from its resource revenues across time? And second, on what should the government spend its resource revenues? Adopting a revenue sterilization policy — whereby foreign exchange reserves are accumulated — can constrain the spending effect and as a result curb a currency appreciation. In that respect, the government must resist the pressure to enjoy all the additional revenues in the short run and recklessly expand its budget expenditure. On the contrary, it must commit to saving part of the revenue proceeds in order to attain a permanent wealth increase.

As for how the windfall revenues should be allocated, the government must be careful not to spend the wealth in a way that would increase the domestic aggregate demand for non-tradable goods and services which would consequently appreciate the real exchange rate. In that respect, the government must direct its spending toward the non-resource tradables sectors through subsidies or by investing in physical and human capital to enhance the productivity in these sectors.

Moreover, the discovered hydrocarbon resources can be helpful if, and only if, there is an energy substitution strategy away from costly imported oil, which includes (a) the renewal of existing energy production facilities; (b) connecting pipelines with offshore and onshore facilities in an integrated energy demand and consumption framework; and (c) respecting the environment and urban fabric around electricity production sites.

Such steps will be complicated and require a detailed level of design and execution. But without such an integrated, overarching plan of action, Lebanon will not be able to escape the very real dangers of ‘the Devil’s excrement.’ No one wants that to happen — not in 10 years, 20 years or ever.

Jad Chaaban

Jad Chaaban is an associate professor of economics at the American University of Beirut and the lead author of the UNDP’s Arab Human Development Report 2015

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