Now or never - revisiting
some difficult choices Timor-Leste has to make
[1]Cosme
da Costa Araujo
Agree to disagree
Timor-Leste’s Parliament recently
approved a rectification budget for 2016. An additional $391 million was added
to the original budget, bringing the total expenditure for 2016 to $1.9
billion. Most of the rectification budget is destined to finance key
infrastructure projects.
The Government
argues that making such high return investments will provide the necessary
foundations for long-term sustainable private-sector-led development. Critics,
including Dili-based non-governmental organization Lao Hamutuk, disagree and counter that increase spending on
dubious physical infrastructure projects will not provide sufficient
benefits to current and future generations of Timorese people.
Both sides, without a doubt, have
the best intention for this country. Both want Timor-Leste to become a prosperous
country with a healthy and educated population and a strong and sustainable
non-oil-based economy led by the private sector. The question of how to achieve
it is where both sides disagree. And that should come as no surprise as
academics and practitioners have been for years disagreeing on how resource
rich countries should use the windfall to bring forward economic development. The
disagreement centers on the balance between ensuring long-term fiscal
sustainability so as to have adequate savings for future generations, while allocating
sufficient resources to meet the current and urgent needs for development. Unfortunately
there is no perfect answer and the disagreement indicates that there is no such
thing as a one size fits all solution. Every
country is unique and therefore requires a unique solution.
The PIH and its limitations
Setting up Petroleum Fund (PF) is
a milestone achievement for Timor-Leste in its quest for the wise management of
petroleum resources. It is an important political decision that many countries
before Timor-Leste are still struggling with. The PF contributes to sound
fiscal policy, where appropriate consideration and weight is given to the
long-term interest of Timor-Leste’s citizens.
The Estimated Sustainable Income
(ESI), calculated at 3% of the Petroleum Wealth, is a fiscal rule embedded in
the PF setup. It is a sustainable amount that can be withdrawn from the PF to
finance the state budget while leaving the Fund’s purchasing power intact. The
rationale behind the ESI rule is a derivation of the classic permanent-income
hypothesis (PIH). The theory, put forward by Milton Friedman in 1975, was
originally developed for individual
households. Since then it evolved and is applied to the country level. Under
this rule Timor-Leste spends only the 3 per cent of the ESI, which represents the implicit
investment return of
the Fund.
Despite its widespread
application, the PIH has been criticized by many including Paul Collier as
inappropriate or too rigid for a low-income country. A PIH-based rule does not
capture country characteristics well. In other words, the policy should reflect
national objectives and country circumstances.
Norway’s Sovereign Wealth Fund
provided the model for the management of Timor-Leste’s petroleum revenues.
Norway is a unique country and is certainly different from Timor-Leste in many
things. Despite
its Government
Pension Fund and the remaining petroleum revenues are considerable assets, the
activity in the
mainland economy is the primary basis for production, employment and income. Its
service sector as a whole accounted for approximately 59 per cent of GDP in
2012. Its modern infrastructures and skilled labor force and consequent high
productivity contribute to its high level of GDP per capita relative to the
upper half of the OECD countries.
In contrast Timor-Leste’s small,
developing economy is still dominated by the oil sector. The country has an acute
shortage of skilled labor. Its limited infrastructure mean that potential
sectors such as agriculture and tourism remain largely untapped and the efficient
movement of goods and people, which often results in high prices for ordinary
people.
It is clear now that in order to
diversify its economy, Timor-Leste needs to invest in productive sectors in
order to generate new sources of income and create jobs for its underemployed
and its expanding population. It also needs to increase the workforce’s skills
level and improve its infrastructures to increase its productivity. For all of
these reasons, rather than the PIH, capital expenditure needs to be scaled-up in
countries like Timor-Leste. Fortunately drafters of the PF Law knew the country’s
circumstances and accordingly allowed for excess withdrawal above the ESI,
provided that it is for the long-term interests of Timorese people.
Furthermore fiscal policy based
on a PIH rule would have assumed that everything remains constant
including population, economic development and public expenditure growth. Unfortunately
these assumptions do not hold in reality. With an annual population growth rate
of about 3 per cent, the demand for services increases, this in turn affects
public expenditure, not to mention the impact from introducing pensions for
public servants. The ESI now barely covers the recurrent expenditure. Spending only the ESI would require either
rationalization of expenditures or increasing the Fund’s base capital through
new oil and gas revenues. Spending
only the ESI
would entail stagnation of the non-oil economy, eternal dependence on the PF
and susceptibility of public expenditure to short-term fluctuation of the PF investment return. Not investing in core infrastructure
and human resources is in itself a risk. In addition, in order to ensure
spending only the permanent income – an equal amount that can be withdrawn
forever – the base of the PF needs to increase to account for inflation, thus,
maintaining the Fund’s purchasing power. Otherwise the PF’s value will shrink
in real terms.
“Front loading policy” and
its benefits
The Strategic Development Plan
(SDP) lays out a pathway for Timor-Leste in its journey towards achieving its
dream of becoming an upper-middle income country by 2030 with an educated, healthy
and prosperous people. It provides a solution to the development of the non-oil
economy with specific targets on developing agriculture, tourism and petroleum
industry.
Timor-Leste is blessed with many
natural resources, including oil and gas. While oil and gas has funded much of
the country’s growth since independence, it is time for Timor-Leste to realize
its potential in other areas by diversifying its economy and reducing dependence
on oil. This entails creating two important enabling environments – good
infrastructure and qualified human resources – to support and grow the
development of non-oil economy and facilitate private sector investments.
While other countries rely on
loans, foreign aid, remittances and so forth to develop their country and
economy, Timor-Leste is blessed with the PF. The front-loading policy allows
the government to fast-track the development of the country’s infrastructure
and human resources. The IMF, after relaxing its stance on implementing a rigid
fiscal rule for resource rich developing countries, now concurs that when the
initial capital of the economy, both physical and human is low, the
productivity gains of government social and capital spending of oil revenues
could exceed the financial returns from oil savings. The Fund
further adds that tilting investments towards relatively current poor
generations may be welfare-improving. The
benefits accrued from these investments should not be judged from a narrow
fiscal perspective but instead account for the time-lag. It takes time for these
benefits to materialize and be captured through formals channels such as taxes
or fees and charges.
It is wrong to argue that
investing in ports, roads, electricity, drainages, and human resources will not
provide sufficient benefits to current and future generations of Timorese
people. Tibar Bay Port will ease delays, which will certainly flow through to
more affordable prices for ordinary people. It will remove congestion; enhance
trading with Timor-Leste’s trading partners and could potentially serve as a
logistic hub for the region. A connected Timor-Leste, through roads, ports and
airports, will facilitate the efficient movement of goods and people within the
country and with other countries.
Apart from supporting employment
in construction and in the production of materials, these projects can build
the productive capacity of the economy through positively influencing the
productivity of the private sector and raising the return on private capital,
resulting in beneficial long-term effects. Moreover, increased spending by the
workers hired in these sectors can have positive ripple effects throughout the
economy. The benefits of investing in infrastructure are especially high when
there are underutilized resources in the economy. These projects benefit not
only the current generation, but also the future generation from the build-up of
capital in the form of better public services, improved living conditions and
enhanced human capital. Once all these basic foundations are in place that will
help stimulate economic growth, which in turn translates into higher domestic
revenues. Government spending can then revert back to the level consistent with
the ESI.
“Timing
the investment” – now or never
It is generally agreed that
Timor-Leste needs to diversify its economy. To do so it has to attract private
sectors to invest more in productive sectors. Our experience in the last few
years has shown that despite attractive tax rates and other incentives, private
investment, both local and international, has been very limited. The missing
link comes down to none other than the limited infrastructure and human
resources. When the private sector is reluctant to invest, it falls back onto
the government to shoulder the responsibility to kick start the development of
the country. And there is no better time to invest than now. Spending only the
ESI is in itself is a
risk. By not investing now simply means delaying or diverting the problems and
would only create new problems down the line. It makes future decisions more
difficult and more costly. Timor-Leste cannot afford to lose more opportunities
than it has forgone for last ten years. With countries around the world busy
dealing with excess capacity, investing now would be cheaper than in later
years. With Timor-Leste’s economy operating below its full capacity, investing
now would bring more benefits than costs. These are some difficult choices the
government has to make. They have to be made now or never.
Who
wants everything, loses everything
Everything in life involves making
choices. Giving up something now to get something more is what we call a
trade-off. The same principle applies in making political decisions for the
country. One cannot demand economic diversification to reduce the reliance on oil
and gas and at the same time resist the need to withdraw above the ESI to invest in infrastructures
and human resources, the two basic foundations for economic diversification. One
can have either but not both. Otherwise, those who want everything lose
everything (quem todo quer todo perde). It is the difficult choice that
Timor-Leste has to make. As with any investment we make in life, whatever
choice the country makes involves risk. But a well-rewarded risk is a risk
worth taking. The benefits from choosing to invest now are far greater than the
opportunity cost forgone for not investing at all.
But
be mindful of certain things
Petroleum revenues are a
transformation of oil and gas resources under the sea into financial assets. These
resources are finite. An optimal situation would be for non-oil revenues to
finance the state budget. The PF is a blessing to achieve this desired
situation.
The considerations on how much
and how fast public investment should be made is something we need to be
mindful of. In other words, when assessing the appropriate fiscal policy
consideration should be given to inter-generational equity, the economy’s
absorptive capacity and macroeconomic stabilization objectives. Failing to
factor-in these factors would lead to cost overruns, delays, inflation,
corruption and other inefficiencies.
Final
comments
In order to diversify its
economy, Timor-Leste needs to first have in place the basic foundations – good
quality, core infrastructure and qualified and skilled human resources. The
flexibility of the PF Law enables the government to front-load, withdrawing
above the ESI, to fast-track the development of the country. Not investing at
all or spending only the ESI is in itself is a risk. The benefits from
investing in these projects outweigh the opportunity costs of not investing at
all. And there is no better time to invest. It’s now or never.
But there are certain things that
we need to be mindful of.
· Public
investments need to consider the inter-generational equity, the economy’s
absorptive capacity and macroeconomic stabilization objectives.
· Public
financial management, budget execution and project implementation capacity need
to be strengthened and improved as well as developing a rigorous, independent
and transparent process for evaluating investment proposals.
· After
the first five years of its existence, the SDP might need a review to evaluate the
progress made to date and update some of its assumptions.
·
A
full and complete costing of a revised SDP might be needed to understand its
impact on the
PF.
· Borrowing
is one of the options to bypass the existing absorptive capacity of the
economy, but it should be done within an explicit limit and should be carefully
and comprehensively assessed.
· Economic
development needs to reach a balance between the need for quality products
provided by international companies versus the involvement of local players.
· A
two-tiered approach to the PF
management might need to be considered. A certain amount could be earmarked for
financing the current and urgent development needs of the country, while a
sizeable amount is saved for future generations and unexpected rainy days in a
saving fund.
Having the PF is one thing for
Timorese to be proud of. It is a very important achievement for the
country. But it is not enough. The
next important thing we need to do is to
have good planning and execution of the public sector budget so as to avoid the
resource curse found in so many petroleum producing countries. The
PF is a blessing. We
need to make sure that every investment that we make will turn this
blessing into more blessings.
References
ADB, (2015), A Private Sector Assessment for Timor-Leste.
Baungsgaard, T., Villafuerte, M.,
Poplawski-Ribeiro, M., & Richmon, C., (2012),
Fiscal
Framework for Resource Rich Developing Countries,
the IMF.
Lao Hamutuk, (2016), Submission to Timor-Leste National
Parliament on the Proposed Rectification of the 2016 State Budget, www.laohamutuk.org.
Ministry of Planning and Finance,
(2005), Establishing a Petroleum Fund for
Timor-Leste, Timor-Leste.
Norwegian Government, (2013), Norwegian Economy – Key Facts (access
at https://www.regjeringen.no/contentassets/455b1741a3814eb8823ce404fc0de3a0/norwegian_economy_2013.pdf,
access date 26 July 2016).
Segura, A., (2006), Managing of Oil Wealth under the Permanent
Income Hypothesis – The Case of São Tomé and Príncipe, the IMF.
The IMF, (2012), Macroeconomic Policy
Framework for Resource-Rich Developing Countries.
The White House, (2011), The Recent Examples of the Economic Benefits from Investing in
Infrastructure, (access at https://www.whitehouse.gov/sites/default/files/infrastructure_report_final_pdf_110211.pdf,
and access date 26 July 2016).
Van der Ploeg, R., & Venables, T.,
(2011), Harnessing Windfall Revenues:
Optimal Policies for Resource-Rich Developing Economies, Economic Jornal.
[1] The opinions
expressed in this article are the author’s own and do not reflect the view of
any entity or person that author works or associates with.
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