Efficient Spending

Efficient Spending Efficient Spending

Oil prices are falling at terrific speed. This may be good news for consumers in the importing nations, but not for the handful of countries that use oil export revenues to fund national budgets. Countries that projected prices on the lower side should be able to manage without having to adjust their 2015 budgets. Iran can survive low prices, at least for some time, but a protracted downturn would hurt the budget.

Most Mideast countries are endowed with large quantities of petroleum resources. In recent years, they have benefited from high oil prices. But they often face the 'resource curse' resulting from the unpredictability, exhaustibility and uncertainty of the resources. As these resources are systemically developed and exploited, states face critical fiscal and macroeconomic challenges. For example, what type of fiscal framework should be used in the face of revenue unpredictability and exhaustibility? How can these proceeds best be used to achieve sustainable and equitable growth and at the same time ensure macroeconomic stability and fiscal sustainability?

Recently it has become popular among oil-producing countries to establish resource funds, which go by such names as sovereign wealth funds, oil stabilization funds, funds for future generations, or the National Development Fund of Iran. Therefore, when revenues are higher than budgeted, they should be saved. It is believed that such institutional arrangements help stabilize the economy when in need and provide inter-generational redistribution of oil wealth. But oil funds also are and should be subject to institutional capacity, such as transparency and accountability plus strict operational rules.

One venue to protect against variability is to set aside oil earnings and spend the returns generated from the special funds. Norway is a well-known model, the government budget every year gets about 4 percent of the value of the saved oil revenues. The approach has done well for Norway, but would not necessarily be optimal for a developing country such as ours with a huge population and equally large development needs.

Another option is to use the oil wealth to buy physical assets, improve the social safety net and educate the people (to augment human capital). In countries with massive infrastructure and human capital needs, the rate of return of productive public expenditures is expected to be significantly higher than the rate of return on financial assets. If the government uses resource revenues for quality public investment projects, economic growth is likely to increase, thereby leading to an increase in non-resource revenues.

Of course, this outcome demands effective public spending. If expenditure is poorly allocated the nation and its future generations will be worse off. This highlights the importance of close public and social dialogue about how to decide public projects and how that would affect growth and non-resource revenues.