Public Investment in Resource-Abundant Developing Countries

Abstract

Natural resource revenues provide a valuable source to finance public investment in developing countries, which frequently face borrowing constraints and tax mobilization problems. This paper develops a dynamic stochastic model to analyze the macroeconomic effects of investing resource revenues, making explicit the role of public investment inefficiency, absorptive capacity constraints, Dutch disease, and financing needs to sustain capital. Revenue exhaustibility raises medium-term issues of how to sustain capital built during a windfall, while revenue volatility raises short-term concerns about macroeconomic instability. Using the model, country applications show how combining public investment with a resource fund-a sustainable investing approach-can address the problems associated with exhaustibility and n

Optimal fiscal management of commodity price shocks

“…The Dutch disease effect is mitigated over time, as the increase in public capital benefits the supply side. The latter result is consistent with other studies-such as Agénor et al (2008) in the context of aid, and Berg et al (2013) in the context of resource price shocks-that have emphasized the productivity effects of infrastructure. In the present model, however, the transmission process is more complex, given that there are a number of additional channels through which public capital affects the economy.…”

“…19 By contrast, in Berg et al (2013) and related contributions, the efficiency parameter is subject to a threshold effect related to the level of public investment. An alternative approach, as in van der Ploeg (2012) and van den Bremer and van der Ploeg (2013), would be to assume that public investment is subject to adjustment costs, which fall with the amount invested.…”

“…The parameter that measures the strength of adjustment costs to private capital are set at a high level,  = 25, to match a slow response of private investment to shocks. This is the same value used in Berg et al (2013) and follow-up studies. The direct complementarity effect of public capital on private investment is assumed to be initially strong; accordingly,…”

“…A number of analytical contributions, including Takizawa et al (2004), Matsen and Torvik (2005), Venables (2010), van der Ploeg (2011van der Ploeg ( , 2012, van der Ploeg andVenables (2011, 2013), Dagher et al (2012), Araujo et al (2013), Berg et al (2013), Richmond et al (2013), and van den Bremer and van der Ploeg (2013), have attempted to address these issues. Several of these contributions bring together elements of the literature on the optimal management of resource windfalls and the literature on the Dutch disease, which considers more broadly the macroeconomic consequences of large inflows of capital (in the form of aid, remittances, or private capital flows, rather than government-related flows only).…”

“…But compared to the PIH prescription (holding the entire windfall in for-eign assets) it may be optimal to place less revenue in offshore funds in the long run, because of the need to finance higher public investment, but more in the short run, because of absorption constraints. Dagher et al (2012), Berg et al (2013), and Richmond et al (2013) develop closely related, three-sector dynamic stochastic general equilibrium (DSGE) models with a financial side to discuss both fiscal and monetary policy responses to natural resource price shocks. In these models, to capture absorptive capacity constraints, the efficiency of public investment is negatively related to the level of investment itself.…”