Harnessing Windfall Revenues in Developing Economies: Sovereign Wealth Funds and Optimal Tradeoffs Between Citizen Dividends, Public Infrastructure and Debt Reduction
A windfall of foreign aid or natural resource revenue faces government with choices of how to manage public borrowing, public asset accumulation, and the distribution of funds to households (across time and household types), particularly when the windfall is both anticipated and temporary. These choices are acute if some households do not have access to credit markets and are unable to smooth consumption, and if the country as a whole is not a price-taker in international capital markets - both reasonable descriptions of many developing countries experiencing resource (or aid) booms. We analyse the optimal policy actions for countries in this position and show that the usual permanent income hypothesis prescription of engineering a permanent increase in consumption financed by borrowing ahead of the windfall and then accumulating a Sovereign Wealth Fund (SWF) is not optimal. Heavily indebted countries with a small windfall should both increase current consumption and accumulate capital to accelerate their development. Only if the windfall is large relative to initial debt is it optimal to build a SWF. We study the intricate dynamic trade-offs faced when using the windfall to pay off debt and possibly accumulate a SWF, build public infrastructure and hand out citizen dividends. Finally, we show that a more sophisticated range of instruments (e.g., an asset holding subsidy) makes the trade-offs easier.
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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number
6954.
Find related papers by JEL classification: E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General F34 - International Economics - - International Finance - - - International Lending and Debt Problems F35 - International Economics - - International Finance - - - Foreign Aid F43 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Economic Growth of Open Economies H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management O11 - Economic Development, Technological Change, and Growth - - Economic Development - - - Macroeconomic Analyses of Economic Development Q33 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Nonrenewable Resources and Conservation - - - Resource Booms (Dutch Disease)
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Aaron Tornell & Philip R. Lane, 1999.
"The Voracity Effect,"
American Economic Review,
American Economic Association, vol. 89(1), pages 22-46, March.
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