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Special fiscal institutions for resource-rich developing economies

Research report

Written by Tove Strauss

Research report

Natural resources — defined as non-renewable resources such as hydrocarbons and minerals — are considered to be ‘gifts of nature’. If managed correctly, natural resources have the potential to transform a resource-rich developing economy by increasing the overall gross domestic product and reducing reliance on external assistance. However, there are special characteristics of natural resource wealth which make it challenging to manage. From a macroeconomic and budgetary perspective, these challenges include price volatility, the risk of ‘Dutch disease’ and extraction from a finite resource. From a political economy perspective, some of the challenges include increased likelihood of an undemocratic government, prevalence of a ‘rentier state’ (where the state is not accountable to citizens), pressures to spend within a short-term horizon to maintain support, and a greater likelihood of low-quality institutions being prevalent.                                

To address some of these challenges, there has been increasing interest in how institutional mechanisms that constrain the discretion of expenditure policies can promote fiscal discipline. Such mechanisms are referred to as special fiscal institutions (SFIs) and typically include fiscal rules, resource funds, fiscal responsibility laws, and fiscal advisory councils. In many cases, more than one SFI is implemented at a time. The countries considered to be most successful in implementing SFIs to manage natural resource wealth are Norway and Chile. However, as a number of developing economies—including fragile states—are making discoveries of natural resource wealth, there is an urgent need to consider the types of fiscal arrangements and institutional mechanisms that are appropriate in these environments.

In light of this, this paper considers the options available for resource-rich developing economies when deciding whether to implement SFIs to manage their natural resource wealth. In its conclusion, the paper does not recommend introducing SFIs as a single solution to the challenges of managing natural resource wealth, nor does it suggest that ‘best practices’ should be ‘carbon copied’ from other countries. Rather, the paper recognises the value in sharing experiences and for resource-rich developing economies to engage in discussions about what types of institutions would be most appropriate to their own political economy environment, given the formal and informal procedures that prevail. In this respect, policy-makers and advisors should consider the options available—no fiscal rule, a fiscal policy guideline, or a formal SFI—and assess their merits based on the overall fiscal policy framework and the incentives to introduce such mechanisms in the individual country context.

Natasha Sharma and Tove Strauss