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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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  • Frederick van der Ploeg
  • Anthony J Venables

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 resouce (or aid) booms. We analyse the optimal policy actions for countries in this positon and show that the usual permanent income hypothesis prescrition of engineering a permanent increase in consumption finance by borrowing ahead of the windfall and then accumulating a Soveriegn 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 inctricate dynamic trade-offs faced when using the windfall to pay off debt and possibly acumulate 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 Oxford Centre for the Analysis of Resource Rich Economies, University of Oxford in its series OxCarre Working Papers with number 009.

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Date of creation: 2008
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Handle: RePEc:oxf:oxcrwp:009

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

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  1. Schmitt-Grohe, Stephanie & Uribe, Martin, 2003. "Closing small open economy models," Journal of International Economics, Elsevier, vol. 61(1), pages 163-185, October.
  2. 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.
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  4. Jan-Peter Olters & Daniel Leigh, 2006. "Natural-Resource Depletion, Habit Formation, and Sustainable Fiscal Policy," IMF Working Papers 06/193, International Monetary Fund.
  5. Barro, Robert J, 1979. "On the Determination of the Public Debt," Journal of Political Economy, University of Chicago Press, vol. 87(5), pages 940-71, October.
  6. Paul Collier & Jan Willem Gunning, 2005. "Asset Policies During an Oil Windfall: Some Simple Analytics," The World Economy, Wiley Blackwell, vol. 28(10), pages 1401-1415, October.
  7. Alonso Segura, 2006. "Management of Oil Wealth Under the Permanent Income Hypothesis," IMF Working Papers 06/183, International Monetary Fund.
  8. 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.
  9. Philip R. Lane & Aaron Tornell, 1999. "The Voracity Effect," American Economic Review, American Economic Association, vol. 89(1), pages 22-46, March.
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Cited by:
  1. S. M. Ali Abbas & Kenji Moriyama & Abdul Naseer, 2010. "Fiscal Adjustment in Sudan," IMF Working Papers 10/79, International Monetary Fund.
  2. Paulo A. Medas & Daria Zakharova, 2009. "A Primeron Fiscal Analysis in Oil-Producing Countries," IMF Working Papers 09/56, International Monetary Fund.
  3. Pablo Lopez Murphy & Mauricio Villafuerte & Rolando Ossowski, 2010. "Riding the Roller Coaster," IMF Working Papers 10/251, International Monetary Fund.

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