Working Paper 320 - Hands Off Oil Revenues? Public Investment and Cash Transfers

Many resource-rich countries fare little better than their resource-poor counterparts because windfall income is often associated with misuses. We develop a small open-economy DSGE model to explore the policy response to oil windfall in Kenya, focusing on a scenario of transferring the resource revenues entirely to households versus two alternative fiscal rules: all-investing and sustainable investing. Our results show that transfers to households are welfare-improving while containing the pressure on public investment efficiency. However, the overall impact on the economy is negligible. The all-investing approach leads to positive yet volatile economic outcomes and pronounced absorptive capacity constraints. The sustainable investing approach—which involves jointly saving and investing—minimizes macroeconomic volatility, absorptive capacity constraints, and raises future investment efficiency. We find that it is socially optimal to use 60–80 percent of the oil windfall for transfers and investment spending and to save 20–40 percent. JEL classification:H54, F43, Q32