Public Investment in Resource-Abundant Developing Countries

IMF Working Papers, November 15, 2012

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Public Investment in Resource-Abundant Developing Countries

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Bibliographic details

• Authors: Andrew Berg, Rafael A Portillo, Susan S. Yang, Luis-Felipe Zanna
• Published: November 15, 2012
• Series: IMF Working Papers
• DOI: https://doi.org/10.5089/9781475535563.001

Summary

• Natural resource revenues provide a valuable source to finance public investment in developing countries, which frequently face borrowing constraints and tax revenue mobilization problems.
• The paper develops a dynamic stochastic small open economy model to analyze the macroeconomic effects of investing natural resource revenues.
• The model makes explicit the role of pervasive features in these countries including:
  • public investment inefficiency,
  • absorptive capacity constraints,
  • Dutch disease,
  • financing needs to sustain capital.
• Two distinct policy challenges are highlighted:
  • Revenue exhaustibility raises medium-term issues of how to sustain capital built during a windfall.
  • Revenue volatility raises short-term concerns about macroeconomic instability.
• Combining public investment with a resource fund—a sustainable investing approach—can help address macroeconomic problems associated with both exhaustibility and volatility.

Model, Mechanisms, and Analytical Use

• Model type: dynamic stochastic small open economy model.
• Explicit mechanisms analyzed:
  • Investment efficiency and inefficiency in public projects.
  • Absorptive capacity constraints limiting effective scaling-up.
  • Dutch disease effects from resource revenue inflows.
  • Financing needs to sustain capital once built.
• The model is applied to country cases to:
  • Determine the appropriate magnitude of investment scaling-up (accounting for financing needs to sustain capital).
  • Determine the adequate size of a stabilization fund (buffer).

Key Findings from Country Applications

• A sustainable investing approach that combines public investment and a resource fund can mitigate:
  • Medium-term challenges due to revenue exhaustibility.
  • Short-term macroeconomic instability due to revenue volatility.
• The model provides guidance for:
  • The magnitude of investment scaling-up consistent with country-specific features.
  • The size of stabilization funds needed to buffer volatility.

Policy Recommendations and Implications

• Use natural resource revenues to finance public investment while explicitly accounting for:
  • Investment inefficiency,
  • Absorptive capacity constraints,
  • Dutch disease risks,
  • Ongoing financing needs to sustain capital.
• Adopt a sustainable investing approach that pairs investment scaling-up with a resource/stabilization fund to address both exhaustibility and volatility.
• Use model-based analysis to tailor:
  • The scale of investment expansion,
  • The appropriate buffer (stabilization fund) size.

Content in this bundle

• Appendix I: Equilibrium and Optimality Conditions
  • Appendix I: Equilibrium and Optimality Conditions (Markdown version)
  • Appendix I: Equilibrium and Optimality Conditions (PDF)