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Harnessing Windfall Revenues in Developing Economies: Sovereign Wealth Funds and Optimal Tradeoffs Between Citizen Dividends, Public Infrastructure and Debt Reduction

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  • van der Ploeg, Frederick
  • Venables, Anthony J.

Abstract

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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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 6954.

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Date of creation: Sep 2008
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Handle: RePEc:cpr:ceprdp:6954

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Keywords: asset holding subsidy; credit constraints; debt management; developing economies; optimal fiscal policy; private investment; public infrastructure; risk premium on foreign debt; Sovereign Wealth Fund; windfall public revenues;

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References

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  1. Stephanie Schmitt-Grohe & Martin Uribe, 2001. "Closing Small Open Economy Models," Departmental Working Papers 200115, Rutgers University, Department of Economics.
  2. Olivier Basdevant, 2008. "Are Diamonds Forever? Using the Permanent Income Hypothesis to Analyze Botswana's Relianceon Diamond Revenue," IMF Working Papers 08/80, International Monetary Fund.
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  5. Jan-Peter Olters, 2007. "Old Curses, New Approaches? Fiscal Benchmarks for Oil-Producing Countries in Sub-Saharan Africa," IMF Working Papers 07/107, International Monetary Fund.
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  10. Roel M.W.J. Beetsma & Frederick van der Ploeg, 2007. "Partisan Public Investment and Debt: The Case for Fiscal Restrictions," Economics Working Papers ECO2007/37, European University Institute.
  11. Jan-Peter Olters & Daniel Leigh, 2006. "Natural-Resource Depletion, Habit Formation, and Sustainable Fiscal Policy," IMF Working Papers 06/193, International Monetary Fund.
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Cited by:
  1. Paulo A. Medas & Daria Zakharova, 2009. "A Primeron Fiscal Analysis in Oil-Producing Countries," IMF Working Papers 09/56, International Monetary Fund.
  2. Pablo Lopez Murphy & Mauricio Villafuerte & Rolando Ossowski, 2010. "Riding the Roller Coaster," IMF Working Papers 10/251, International Monetary Fund.
  3. S. M. Ali Abbas & Kenji Moriyama & Abdul Naseer, 2010. "Fiscal Adjustment in Sudan," IMF Working Papers 10/79, International Monetary Fund.

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