Are Developing Countries Better Off Spending Their Oil Wealth Upfront?

IMF Working Papers, August 1, 2004

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The paper questions the conventional view that it is optimal for government to maintain a stable level of spending out of oil wealth.
It compares the conventional policy recommendation with a policy where government spends all of its oil revenues upfront, at the same rate as oil is extracted.
Using a neoclassical growth model with positive external effects of public spending on consumption and productivity, the authors find:
- If the economy is growing along the steady-state balanced path, the conventional view is validated.
- If the economy starts with a lower capital stock, the welfare ranking across the two policies can be reversed.

Model type: neoclassical growth model.
Key model feature: positive external effects of public spending on consumption and productivity.
Policy scenarios compared:
- Conventional policy: maintain a stable level of spending out of oil wealth (annuity policy).
- Upfront-spending policy: spend all oil revenues upfront, at the same rate as oil is extracted.

The optimality of maintaining stable spending out of oil wealth depends on the initial capital stock and the economy’s position relative to the steady-state balanced path.
For economies on the steady-state balanced path, policymakers are supported in following the conventional annuity/stable-spending approach.
For economies with a lower initial capital stock, spending oil revenues upfront can produce a superior welfare outcome according to the model’s results.