Economic Research Forum (ERF)

Fiscal management of oil resources in booms and busts

943
To manage the volatility of commodity prices, resource-rich countries are typically advised to adopt a fiscal policy framework that can be operated counter-cyclically. Drawing on Norway’s experience, this column explains that a fiscal spending rule will not necessarily shelter the economy: if the constructed rule is too lax over the commodity price cycle, fiscal policy may even exacerbate the business cycle.

In a nutshell

Resource-rich countries should save revenue for future usage and adopt spending rules to stabilise the domestic economy.

But the adoption of fiscal spending rules will not necessarily shelter the economy from pro-cyclical fiscal spending.

For MENA countries, there is much to learn from Norway’s experience, both in terms of how to set up a sovereign wealth fund for rainy days and also how to implement a fiscal spending rule more flexibly to avoid pro-cyclical behaviour.

Sound resource management is crucial. There are huge costs associated with large and unpredictable swings in oil prices. If not well managed, the volatility can destabilise the domestic economy and undermine long-term growth. Resource-rich countries are therefore advised to adopt some type of fiscal policy framework (that is, a fiscal spending rule), which, if operated counter-cyclically, should shelter the economy from oil price fluctuations and prevent over-spending on the part of the government.

But the adoption of a fiscal rule does not in itself ensure that fiscal policy works to insulate the domestic economy from oil price fluctuations. In recent research, my colleagues and I show that the constructed fiscal rule may be too lax over the commodity price cycle: the actual conduct of fiscal policy might not be in accordance with the rule or fiscal policy may be conducted differently in booms and busts. Hence, what works in theory may not necessarily work in practice.

Norway’s experience

To illustrate the point, in Bjørnland and Thorsrud (2015), we analyse fiscal policy’s response in a resource-rich economy to oil price shocks over time and the extent to which this response has insulated the domestic economy from oil price fluctuations or, conversely, exacerbated their effect.

We focus on Norway, a country where the handling of its petroleum wealth has been described as exemplary. Unlike most oil exporters, Norway has adopted a fiscal framework in 2001, with a view to shielding the fiscal budget, and therefore also the domestic economy, from oil price fluctuations.

In particular, oil and gas revenue is first put in a Savings Fund, of which only the expected real return (4%) of the fund is drawn annually to finance public spending or tax cuts. Thus, in comparing how fiscal policy responds to oil price shocks before and after the rule’s implementation, our study provides a natural experiment for assessing fiscal policy over oil price cycles.

Global demand as a driver of oil prices

Analyses of fiscal pro-cyclicality in oil rich economies come with an important caveat: the price of oil has moved in tandem with global demand in recent decades. Hence, any changes in the response of fiscal policy to the oil price could be due to the role of global demand in the business cycles, and not necessarily the increase in the price of oil.

Thus, and in line with these findings, when analysing fiscal policy responses to oil price shocks, we control for shocks to global activity. Previous studies addressing the role of fiscal policy in resource-rich countries have typically ignored this issue. Furthermore, they have often found that fiscal policy is counter-cyclical in recent commodity booms.

Controlling for global activity, our study confirms that the counter-cyclical fiscal responses found in the recent oil price boom in these previous studies should be attributed to global activity shocks and their domestic propagation, rather than to the adopted fiscal framework (see Figure 1).

In particular, we find that in the wake of supply-driven oil price shocks, fiscal policy is pro-cyclical on impact and over response horizons. If anything, fiscal policy has been more (not less) pro-cyclical since the adoption of the fiscal policy rule in 2001. Hence, taking everything else as given and following an oil price shock, the adoption of the spending rule has not meant that fiscal policy effectively insulates the economy from an oil price shock.

MENA countries

In a more recent study (Bjørnland et al, 2017), rather than first identifying periods of booms and busts and then analysing fiscal policy behaviour in these periods, we identify and analyse fiscal regimes directly. Focusing on the 20 largest oil-exporting countries, many of them in the MENA region, we ask: in which periods is the probability of finding contractionary or expansionary fiscal policy regimes high? And are oil-exporting countries managing their resources well to minimise uncertainty?

We find that government expenditures seem correlated with business cycle fluctuations for many countries, independent of the adopted spending rule. Hence, there is evidence of pro-cyclical behaviour. Furthermore, fiscal policy seems particularly pro-cyclical in the booms. Still, there is large heterogeneity in volatility estimates across countries. Not all the countries are managing their natural resources so as to minimise uncertainty.

Concluding remarks

Although the fiscal rule has not managed to shelter the Norwegian economy from oil price fluctuations, the goal of saving resource revenue for future usage has been accomplished. By only using roughly 4% of the Savings Fund every year, the Norwegian sovereign wealth fund is today the largest in the world.

From a policy point of view, the implications of the findings are therefore of general interest since they highlight the strengths and weaknesses of the fiscal framework adopted in a resource-rich economy where the handling of resource wealth has been described as exemplary.

For MENA countries, there is much to learn from the Norwegian experience, both in terms of how to set up a sovereign wealth fund for rainy days and also how to implement a fiscal spending rule more flexibly to avoid pro-cyclical behaviour.

Further reading

Bjørnland, Hilde C., and Leif Anders Thorsrud (2015) ‘Commodity Prices and Fiscal Policy Design: Procyclical Despite a Rule’, Centre for Applied Macro- and Petroleum economics (CAMP) Working Paper No. 5/2015, BI Norwegian Business School.

Bjørnland, Hilde C., Roberto Casarin, Marco Lorusso and Francesco Ravazzolo (2017) ‘Oil and Fiscal Policy: Panel Regime-Switching Country Analysis’, mimeo.

Tags: , , , ,

Most read

Growth in the Middle East and North Africa

What is the economic outlook for the Middle East and North Africa? How is the current conflict centred in Gaza affecting economies in the region? What are the potential long-term effects of conflict on development? And which strategies can MENA countries adopt to accelerate economic growth? This column outlines the findings in the World Bank’s latest half-yearly MENA Economic Update, which answers these questions and more.

Trust in Lebanon’s public institutions: a challenge for the new leadership

Lebanon’s new leadership confronts daunting economic challenges amid geopolitical tensions across the wider region. As this column explains, understanding what has happened over the past decade to citizens’ trust in key public institutions – parliament, the government and the armed forces – will be a crucial part of the policy response.

Climate change: a growing threat to sustainable development in Tunisia

Tunisia’s vulnerability to extreme weather events is intensifying, placing immense pressure on vital sectors such as agriculture, energy and water resources, exacerbating inequalities and hindering social progress. This column explores the economic impacts of climate change on the country, its implications for achieving the sustainable development goals, and the urgent need for adaptive strategies and policy interventions.

Assessing Jordan’s progress on the sustainable development goals

Global, regional and national assessments of countries’ progress towards reaching the sustainable development goals do not always tell the same story. This column examines the case of Jordan, which is among the world’s leaders in statistical performance on the SDGs.

Small businesses in the Great Lockdown: lessons for crisis management

Understanding big economic shocks like Covid-19 and how firms respond to them is crucial for mitigating their negative effects and accelerating the post-crisis recovery. This column reports evidence on how small and medium-sized enterprises in Tunisia’s formal business sector adapted to the pandemic and the lockdown – and draws policy lessons for when the next crisis hits.

Unleashing the potential of Egyptian exports for sustainable development

Despite several waves of trade liberalisation, Egypt’s integration in the world economy has remained modest. In addition, the structure of its exports has not changed and remains largely dominated by traditional products. This column argues that the government should develop a new export strategy that is forward-looking by taking account not only of the country’s comparative advantage, but also how global demand evolves. The strategy should also be more inclusive and more supportive of sustainable development.

The threat of cybercrime in MENA economies

The MENA region’s increasing access to digital information and internet usage has led to an explosion in e-commerce and widespread interest in cryptocurrencies. At the same time, cybercrime, which includes hacking, malware, online fraud and harassment, has spread across digital networks. This column outlines the challenges.

Rising influence: women’s empowerment within Arab households

In 2016 and again in 2022, a reliable poll of public opinion in the Arab world asked respondents in seven countries whether they agreed with the statement that ‘a man should have final say in all decisions concerning the family’. As this column reports, the changing balance of responses between the two surveys gives an indication of whether there been progress in the distribution of decision-making within households towards greater empowerment of women.

Macroeconomic policy-making for sustainable development in Egypt

In recent years, economic policy in Egypt has been focused primarily on macroeconomic stabilisation to curb inflation, to reduce the fiscal deficit and the current account deficit, and to increase GDP growth. As this column explains, this has come at the expense of the country’s progress on the Sustainable Development Goals, which is rather modest compared with other economies in the region or at the same income level. Sustainable development needs to be more integrated with the conception and implementation of fiscal and monetary policies.

Qatarisation: playing the long game on workforce nationalisation

As national populations across the Gulf have grown and hydrocarbon reserves declined, most Gulf countries have sought to move to a more sustainable economic model underpinned by raising the share of citizens in the productive private sector. But, as this column explains, Qatar differs from its neighbours in several important ways that could render aggressive workforce nationalization policies counterproductive. In terms of such policies, the country should chart its own path.