Combating the Rise of Inequality

Benedict Clements, co-editor of an IMF book on Inequality, discusses “one of the defining issues of our time”

Inequality is at the forefront of the economic policy debate today in much of the world

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How is the IMF contributing to the debate about rising income inequality?  

On many fronts. First, we are doing new research on the causes of inequality and its macroeconomic implications. Second, we are doing studies on how economic policies and reforms can help countries achieve their equity goals. Our book on Inequality andFiscal Policy is an example of this kind of research.  Third, we are deepening our work on individual countries in the context of our annual consultations with them. 

What’s the importance of this work?

In many countries, achieving more “inclusive” growth—the kind that creates a high number of jobs and does not increase inequality—is a priority.  In this context, policymakers are eager to know the effects of economic policies on inequality and the effects of these policies on economic growth.  As an advisor to countries on macroeconomic and fiscal policies, the IMF has an important role.  In our book, we look at the evidence and provide guidance for policymakers and Fund staff on these issues.  The good news is that there are many reforms that both reduce inequality and boost growth.  Greater use of property taxes to raise revenues and the reform of energy subsidies are two such examples.     

How much has French economist Thomas Piketty’s book fueled this debate?

Piketty’s work has helped draw attention to the issue.  This is just one of many excellent studies that have documented the rise in inequality.  Of equal importance is the work that examines what countries can do to address it.

In your own case, what attracted you to economics and in particular to fiscal issues?

During my college years, I took a trip to Latin America with the Maryknoll Fathers, who work with the poor.  That trip helped show me that economics really matters when it comes to poverty and inequality. I’ve been interested ever since.

Benedict Clements is a division chief in the Fiscal Affairs Department of the IMF. He has worked in the IMF since 1991 and has published extensively on public finance and macroeconomic issues.

Understanding Global Recessions and Recoveries

The world is still recovering from the most recent global recession—dubbed the Great Recession because of its scale and global reach— and the likelihood of another downturn has never left the news as the world economy remains under the long shadow of a persistently weak recovery. The bankruptcy of Lehman Brothers, one of the largest U.S. investment banks, in 2008, pushed the world economy and financial system to the brink of collapse and the resulting recession had dire and extreme consequences.

 What began in the subprime mortgage market in the United States spiraled into a series of interlinked global events that scythed through the international financial and corporate sectors, slashed stock values and household wealth, made millions unemployed and triggered a huge rise in the debt of nations. Growing financial worries triggered a well-documented decline in the birth rate during and immediately after the 2008-9 recession in the United States, where vasectomy and suicide rates rose.

The 2009 recession ricocheted through Europe, left continued scars on the Japanese economy, and has also caused subsequent downturns in emerging market economies. The developing world has paid too with the subsequent sharp decline in commodity prices. A significant side effect has been the continued increase in inequality, particularly in advanced economies, where the wealthiest have advanced and middle classes stagnated.

But, despite the huge scale of the crisis, what’s clear is that we don’t really fully understand what triggers a global recession and how we can successfully stimulate a lasting recovery.

This book tracks the global business cycle through the destruction of a global recession to the uptick of recovery, drawing on four major episodes in the past half century, in 1975, 1982, 1991, and 2009. It defines key terms, document the main features of a recession and recovery, and describe the events that take place around these episodes.

Authors Ayhan Kose, now a leading economist at the World Bank, and Marco Terrones, a prominent researcher at the IMF, put the latest global recession and ongoing recovery in perspective and make a valuable contribution to the expanding literature on business cycles.

A companion website and DVD provide several unique tools to help readers understand the basics: interactive timelines of the four episodes, videos of author interviews explaining the context, several reports looking at the regional impact of the collapse, as well as coverage of the Lehman Brothers bankruptcy, and a commentary by Larry Summers.

As Nicholas Bloom, Professor of Economics at Stanford University, remarks: “Finally, a clear and insightful guide to global recessions and recoveries. And just in time, with the world trying to recover from its worst economic beating since the Great Depression. This book, written by two leading economists operating in the heart of Washington, will become the bible on global growth and collapse.”

See Trailer: http://www.imf.org/external/mmedia/view.aspx?vid=4138312282001

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"This is a landmark book that will have a profound influence on how scholars and policy economists think about booms and busts for many years to come. Pioneers in the field of analyzing and defining global recessions, Kose and Terrones argue that it no longer makes any sense to analyze national downturns as if they always occur in isolation. Particularly interesting and original is their emphasis on the asynchronous nature of recoveries. After 2009, for example, advanced economies experienced their slowest post-war recovery, yet for several years emerging markets experienced their fastest. Kose and Terrones analysis underscores why one needs to think differently about recessions and recoveries in today s globalized world" - Kenneth Rogoff, Thomas D. Cabot Professor of Public Policy and Professor of Economics, Harvard University.

"This is super cool stuff!”   Ugo Panizza, Pictet Chair in Finance and Development, The Graduate Institute, Geneva

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Tackling Climate Change Through Prices

This is an important year for galvanizing action on climate change. “Getting prices right” is convenient shorthand for the idea of using fiscal instruments to ensure that the prices that firms and consumers pay for fuel reflect the full costs to society of their use, which requires adjusting market prices by an appropriate set of “corrective” taxes.

In practice, many countries, far from charging for environmental damage, actually subsidize the use of fossil fuels. For many others, energy taxes—if currently implemented at all—are often not well targeted at sources of environmental harm, nor set at levels that appropriately reflect environmental damage. Clearly there is much scope for policy reform in this area, but there are also huge challenges, both practical and analytical.

From a practical perspective, higher energy prices burden households and firms and, even with well-intentioned compensation schemes, can be fiercely resisted. These challenges—not to understate them—are largely beyond the scope of this book; however, a complementary volume (Clements and others, 2013) distills lessons to be drawn from case studies of energy price reforms. Moreover, getting energy prices right need not increase the overall tax burden; higher fuel taxes could partially replace broader taxes on income or consumption (or environmentally blunt taxes on energy), broadening support for the policy. Where new revenue sources might be needed, corrective energy taxes are an especially attractive option because, unlike most other options, they improve economic efficiency by addressing a market failure.

The main focus here is on assessing the analytical challenges, that is, the pricing that needs to be put into practice. For the vast majority of countries, there has been no attempt to measure the magnitude of environmental damage across fossil fuel products—yet these measures are critical for actionable guidance to be given on how countries can get energy prices right.

The corrective energy tax estimates presented in this book should be treated with a good deal of caution, given data gaps, and controversies—for example, about the valuation of climate damage and the link between air quality and mortality risk. Nonetheless, the estimates provide a valuable starting point for dialogue about policy reform, scrutiny of the key uncertainties, and cross-country comparisons estimated on a consistent basis.

Moreover, the impact of alternative assumptions on corrective tax estimates can be derived from accompanying spreadsheets. Although tax assessments may change significantly as evidence evolves and data improve, the basic findings—most notably, the strong case for substantially higher taxes on coal and motor fuels in many countries—are likely to remain robust.

Main Findings

The main policy messages include the following:

• Coal use is pervasively undercharged, not only for carbon emissions, but also for the health costs of local air pollution. 
• Air pollution damage from natural gas is modest relative to that from coal, but significant tax increases are still needed to reflect carbon emissions. 
• Higher taxes on motor fuels are warranted in many countries, though more to reflect the costs of traffic congestion and accidents than carbon emissions and local air pollution. 
• Corrective taxes can yield substantial reductions in pollution-related deaths and in CO₂emissions, and large revenue gains:
• ▪ Fuel tax reform can reduce worldwide deaths from outdoor, fossil fuel, air pollution by 63 percent. 
• ▪ Tax reforms could reduce CO₂emissions by 23 percent globally. 
• ▪ Potential revenue from implementing corrective taxes averages 2.6 percent of GDP globally. 
• ▪ In short, the case for substantially higher energy taxes does not rest on climate change alone. Decisive action need not wait on global coordination.

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CDG event with IMF Managing Director Christine Lagarde

Comments from Nancy Birsall

Review on Energy Matters

Overcoming the Legacy of Japan's Lost Decades

With much at stake and multiple goals, Japan clearly needs a comprehensive and coordinated set of reforms. This recognition lies at the heart of Abenomics --the set of economic policies advocated by Shinzō Abe to revive Japan-- and the chapters in this book offer detailed recommendations in the areas of monetary policy, fiscal adjustment, and structural and financial sector reforms to make Abenomics a success for Japan and the rest of the world.

The various recommendations in this book are presented as a package and, ideally, one would like to see progress on all three arrows of Abenomics equally and simultaneously, not least because they create mutual synergies. However, there is a clear recognition that the amount of emphasis on each policy area needs to be state-dependent. This was evident, for example, around the time of the consumption tax increase to 8 percent in April 2014. Faced with weak demand and a possible reversal of actual and expected inflation, the Bank of Japan significantly further scaled up its asset-purchase program in October 2014. The authorities also decided to delay the second consumption tax increase to 10 percent and adopt further fiscal stimulus while placing greater emphasis on formulating a medium-term consolidation plan to maintain fiscal credibility. The key take away from this experience is that most, if not all, of the agenda for Abenomics laid out in this book will likely have to be implemented for Japan’s efforts to be successful, but the reader should remain mindful that priorities need to be recalibrated at times depending on how economic conditions unfold.

Four interrelated issues lie at the heart of Japan’s economic challenge: ending deflation, raising growth, securing fiscal sustainability, and maintaining financial stability. These objectives need to be achieved against the background of Japan’s rapidly aging society, entrenched deflationary expectations, and a global economy that remains mired in subdued growth.

Most readers will be familiar with the following striking statistic: in 2013, Japan’s level of nominal GDP was about 6 percent lower than it was in the mid-1990s. There can be little doubt that this in part is caused by persistent deflation. Nonetheless, it remains a challenge to quantify exactly how much of the slow growth was due to deflation rather than the typical post-bubble blues, population aging, and the waning effects of technological convergence. As a result, it is also difficult to measure how much living standards will improve from a successful reflationary effort and whether these potential gains are lower now than they would have been in the 1990s. Compared to other advanced countries, Japan has fared relatively well in terms of productivity growth, suggesting that the biggest bang for the buck will likely come from greater capital accumulation (domestic investment rather than outsourcing) and providing additional, high-quality, employment opportunities (rather than increasing part-time work with lower wages and less investment in human capital). The Bank of Japan’s quantitative and qualitative easing measures should lead to greater portfolio rebalancing and financial risk taking, raise inflation expectations, and support aggregate demand, which, together with complementary fiscal and structural measures, should help greatly to revive Japan’s economy and decisively end deflation.

Another striking statistic—unprecedented among advanced economies—is the debt-to-GDP ratio, which now tops 240 percent and has risen by 50 percentage points in the last five years. Restoring fiscal sustainability by putting the debt ratio on a firm downward path is a priority for Japan’s future. Although bond yields in Japan have remained very low despite ever increasing government debt, this is partly due to special factors, including a marked home bias of Japanese investors. None of these special factors can be taken for granted in the future especially with the prospect of higher yields as the Bank of Japan exits from its quantitative easing policies after achieving its two percent inflation target. Indeed, managing the normalization of interest rates along all asset classes and maturities in a way that maintains economic and financial stability will depend, in no small part, on the credibility of the government’s fiscal adjustment strategy.

Ambitious structural reforms are pivotal for lasting success of Abenomics. Ending deflation and eliminating the government debt overhang will be good for potential growth, but these efforts themselves depend a great deal on the economy’s expected growth rate in the future. Specifically, ambitious labor market reforms would strengthen the monetary policy transmission channel and accelerate the attainment of the Bank of Japan’s inflation target by enhancing the pass through of rising inflation expectations into higher wages. Ambitious structural reforms will support demand in the near term as expectations of permanent income rise. As we have seen recently in Europe, fiscal consolidation without faster growth is unlikely to succeed. A more dynamic Japan is also key from a multilateral perspective, by preventing excessive reliance on monetary and fiscal easing and an undue weakening of the exchange rate.

As David Lipton says in his Foreword: "This is not just a book about Japan. The main message that policymakers should use all policy levers at their disposal in a coordinated manner when faced with persistently weak demand and high public and private balance sheet vulnerabilities extends to other important parts of today’s global economic landscape. As such, policymakers around the world have much to learn from Japan’s experience and from the analyses presented in this volume."

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Review in The Diplomat

Blog: Can Abenomics Succeed? Overcoming the Legacy of the Lost Decades

Frontier Economies -- The New Darlings

For some time now, emerging markets have played an ever more important role on the global

economic stage. Today they account for half of the world’s GDP and are a key driver of global growth. 

At the same time, a new group of countries is getting more and more attention, including from global investors. These are fast-growing low-income countries often referred to as frontier economies. Work on frontier economies is in its infancy and publications on the subject are limited. This book aims to fill part of this void. It relies on cross-country analytical work and draws on experience in today’s emerging market economies to provide insights and make recommendations relevant for policymakers, think tanks, and academics.

Although there is no formal definition, frontier economies are increasingly regarded as a separate group of low-income countries that warrants special attention. Compared with other low-income countries, they tend to be dynamic economies that have experienced rapid growth and, in most cases, demonstrated a fair degree of macroeconomic stability over an extended period of time. Given their strong growth, the question arises whether they can become the next generation of emerging market economies and show the way to other low-income countries striving to improve living standards.

Within Asia, this group includes countries such as Bangladesh, Cambodia, Mongolia, and Vietnam. They are located in the world’s fastest-growing region and benefit from favorable population dynamics.
Similar problems and challenges

Many of these economies face similar macroeconomic and institutional challenges. Will they follow the success of other Asian emerging markets? What are the policy lessons that might be relevant for other low-income countries? This book addresses these questions, based on the IMF’s experience of working with Asia’s emerging, frontier, and developing economies over many years.

This book highlights that continued structural transformation and increased emphasis on inclusive growth will be critical to achieve the full potential of these countries. Also, drawing on the success of today’s emerging markets, high growth and rapid structural transformation needs to be complemented by increased investment in “soft” infrastructure to avoid crises down the road. In particular, to realize the strong potential of frontier and developing Asia, upgrading of monetary and fiscal policy frameworks and continued strengthening of financial sector regulation and supervision will be critical.

Editor Alfred Schipke discusses the book:

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Conference: Frontier and Developing Asia

Tracking a Budgetary Revolution

Public financial management (PFM)—the fine art of budgeting, spending, and managing public monies—has undergone a “revolution” since the late 1980s. This uniquely interdisciplinary combination of economics, political science, public administration, and accounting has seen an influx of innovative ideas and reforms that have sought to address some of the perennial challenges of managing public finances.

To constrain the likely temptation to increase expenditure and spend, rather than save, in times of plenty, countries have introduced fiscal rules and fiscal responsibility laws. To understand and plan for the impact of today’s policy choices on finances in the years ahead, governments have adopted medium-term budget frameworks. To help guard against over-optimistic economic and budgetary estimates, some countries have established independent fiscal councils. To shift the focus of decision making from how much money programs receive to the results they can achieve, many governments have introduced performance budgeting and management initiatives. To better understand the true state of public finances and underlying risks, some governments have sought to increase the comprehensiveness and coverage of fiscal reporting and accounting and have introduced risk management techniques.

This profound wave of change in the ways public spending is managed largely started in Australia, New Zealand, and the United Kingdom and has since then passed through virtually all advanced economies, and to some extent, has also reached emerging market economies and low-income countries.

Dramatic change

While the field of PFM has changed dramatically over the last two decades, very little has been written about this revolution, with the exception of a few specialized articles. In filling this gap in the literature, this book takes advantage of the unique perspectives provided by IMF public financial management experts, who, over the last two decades, have gained practical experience with many if not all of these reforms and are well placed to draw lessons, make sense of the PFM revolution, and share their cross-country experiences of what has worked in practice and what has not.

The book poses critical questions about these reforms and evaluates what they have accomplished and the issues and challenges they have encountered, including with the global financial and economic crisis.

Critical importance

The 2008-09 crisis highlighted the critical importance of a sound public financial management framework in ensuring that well-designed fiscal policies are effectively implemented. But it also demonstrated the underlying limitations of some countries’ PFM frameworks and the flawed design and weak implementation of some PFM innovations, as well as their failure to entrench themselves. Based on these experiences, this book draws general lessons to help guide reformers in their pursuit of the next generation of PFM reforms.

This publication can help countries, policymakers, and those interested in public finances meet the challenges of managing public finances in an increasingly complex and uncertain global environment.

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Testing the Soundness of Banks

The global financial crisis placed a spotlight on the stress testing of financial systems. Although weaknesses in stress tests were exposed by the devastating 2007-09 crisis, the recent experience of several countries has conversely provided a stark illustration of their potential benefit in examining the resilience of bank balance sheets when performed credibly and transparently. Nonetheless, the large menu of stress testing approaches, methods, and models raises questions about their appropriate application under different situations and, consequently, the comparability and reliability of the associated analyses.


The International Monetary Fund has had a long and detailed involvement in the stress testing of financial systems. Since the introduction of its Financial Sector Assessment Program more than a decade ago, IMF staff have conducted stress tests of banking sectors in over 120 countries, typically in close collaboration with country authorities.

Stress testing is also playing an increasingly important role in the IMF’s multilateral economic surveillance, through the analysis in its Global Financial Stability Report. Separately, member countries are increasingly requesting IMF technical assistance in stress testing as they develop their own expertise in this area. As a result, IMF economists have amassed a wealth of hands-on experience with stress testing techniques and their practical application.

Compendium of models

This book represents a compendium of stress testing methods, models, and tools developed or adapted by IMF staff over the years. Almost all the methods and models that are included in this volume have, at one time or another, been applied in its surveillance of, or technical assistance to, member countries. To guide users, each chapter offers a summary describing the application of a method or model, its strengths and weaknesses, and the data requirements. Where available, the stress testing tools or program codes are also provided for wider public use.

Although this volume will provide a valuable resource for policymakers, supervisors, academics, and private sector participants alike, caveats still apply. The crisis has underscored that stress tests, irrespective of their level of sophistication, are not fail-safe, stand-alone diagnostic tools.

Assessments of the soundness of any financial system cannot and should not be based solely on a “model” and must be complemented by other quantitative analyses, qualitative information, and, most important, expert judgment. Especially in light of evolving market practices, risks, and regulatory requirements, stress testing will necessarily continue to be art rather than science.

Ongoing work

Jose Vinals, head of the IMF's Monetary and Capital Markets Departments, says in a Foreword IMF staff are continually working to strengthen the analytical underpinnings of its stress testing, in ways that will help bolster its consistency and comparability and hence its credibility.

Key areas of focus, according to Vinals, include extending the analysis to better cover nonbank financial institutions and infrastructures; to take account of spillovers between institutions and across borders; to consider the interaction between liquidity and solvency risks; and to address data gaps. In addition, IMF economists are developing the policy-related aspects of stress testing, namely, “best practice” principles, concepts, and frameworks, to complement and strengthen the application of the models. "These efforts represent a challenging and exciting part of the IMF’s broader support of global efforts to improve financial surveillance and promote sound macroprudential frameworks," Vinals writes.

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Economics from The Simpsons

Joshua Hall, editor of the new book Homer Economicus, discusses how to teach economics via The Simpsons. Getting students to understand the economic way of thinking might be the most difficult aspect of a teaching economist's job. The counterintuitive nature of economics often makes it difficult to get the average student to think "like an economist." To this end, the need to keep students engaged and interested is essential when teaching economic principles and interdisciplinary approaches to engaging students are becoming increasingly common.

Professor Hall, from the University of West Virginia, extends this interdisciplinary approach to economic education by providing examples from the long-running animated television show The Simpsons that can be used to stimulate student discussion

and engagement in an introductory course in microeconomics. To create the book, Hall recruited 22 contributors, most of whom are professors of economics at universities such as George Mason and Baylor, allowing the reader to hear from several different voices as they unconventionally illustrate a wide range of economic topics.

The book is primarily meant to function as a teaching resource for students, but can also be a fun read for those who enjoy pop economics – and of course the Simpsons fanatics who buy anything related to the show.

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Listen to the author on Tom Woods radio show

Hall explains his approach in The Journal of Private Enterprise  and on the Stanford University Press blog

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Paper on Homer Economicus or Homer Sapiens? Behavioral Economics in The Simpsons by Jodi N. Beggs

Piketty Becomes Superstar Economics Author

Capital in the Twenty-First Century, already a best seller, is an invaluable contribution to how we understand inequality and its possible consequences.

Thomas Piketty—economist from the Paris School of Economics and ground-breaking researcher on income inequality--examines data from more than twenty countries spanning in some cases as far back as the 18th century to assess the dynamics of income and wealth distribution, with a particular focus on the role of capital ownership as a driver of long-run trends in income inequality. He argues that when the rate of return on capital exceeds the rate of economic growth, as it has for most of history, then rising income inequality becomes inevitable. He says that if this rising inequality is allowed to continue unchecked, the results could be deep political and social disruption.

While Piketty notes that inequality has different dimensions across countries, he concludes with a recommendation: significantly increase the progressivity of both income and wealth taxation. Given the extraordinarily globalized market for capital, he further argues that the reach of such taxes must be global as well.

Here"s a quick guide to the book from The Economist: Thomas Piketty’s “Capital”, summarised in four paragraphs

PBS Economics correspondent Paul Solman interviews Piketty for his take on why inequality of wealth has reverted to a lofty level last seen in 19th century Europe.




The Economic Policy Institute and the Washington Center for Equitable Growth host a presentation by Thomas Piketty:




The Guardian on What You Need to Know

CEPR and the Bank of England joint workshop (includes videos)

Reviews:

Paul Krugman, in the New York Review of Books

Larry Summers      Robert Solow        Brad DeLong    Jeffrey Frankel

Mervyn King, former Governor of the Bank of England

Why is it a bestseller?

Brad DeLong (again)    A critique from Daron Acemoglu and James Robinson

Dani Rodrik  "Piketty and the Zeitgeist"                    The Spectator magazine

Financial Times:Piketty’s Data Is Full of Errors     Piketty's Response

and Piketty's longer (10 page) response

NYT: Did Thomas Piketty Get His Math Wrong?

The Economist on Piketty's calculations

The view from France

An Alternative Easterly Road to Development

Over the past century, global poverty has largely been viewed as a technical problem that merely requires the right “expert” solutions. Yet all too often, experts recommend solutions that fix immediate problems without addressing the systemic political factors that created them in the first place. Further, they produce an accidental collusion with “benevolent autocrats,” leaving dictators with yet more power to violate the rights of the poor.

In The Tyranny of Experts, New York University economics professor William Easterly, bestselling author of The White Man’s Burden, traces the history of the fight against global poverty, showing not only how these tactics have trampled the individual freedom of the world’s poor, but how in doing so have suppressed a vital debate about an alternative approach to solving poverty: freedom.

 Presenting a wealth of cutting-edge economic research, Easterly argues that only a new model of development—one predicated on respect for the individual rights of people in developing countries, that understands that unchecked state power is the problem and not the solution —will be capable of ending global poverty once and for all.

Review in the Wall St Journal  by Sarah Chayes

"Mr. Easterly's alternative to the autocrat-driven, technocratic model of development is simple: Apply abroad what we know has worked at home—bottom-up solutions, a free flow of ideas leading to innovative experiments and democratic politics."

Review by Geoff Lamb (who works for the Bill and Melinda Gates Foundation)

"It’s an odd jumble of a book."

Review by David Roodman

"Through choice quotes, an Easterly trademark, the book dramatizes how rife is the “technocratic illusion” in the development business today. In particular, the technocratic illusion “would capture Bill Gates and Tony Blair” and World Bank president Jim Kim."

"In sum, I think this book, like its predecessor, gets tripped up in places by ill-defined abstractions. Just as searchers and planners are usually the same (when Steve Jobs’s told his people to create the iPad, was that top-down planning or “spontaneous” problem solving by a market actor?), the phraseology in “tyranny of experts” tends to blur distinct groups. There are autocrats who adopt with various degrees of sincerity the rhetoric of centrally planned development and then use it to rationalize human rights violations. There are foreign institutions that collaborate with them, sometimes for the best humanitarian reasons, sometimes out of geo-realpolitik. There are the less-powerful human beings within those institutions, who are seemingly the “experts” and “economists” in this book’s title. I think it is a mistake to simply tar one group with the sins of another."

Review by the Ethiopian news site ECADF

Hear it on Audible

Getting Beyond the "Curse" of Natural Resources

Countries that have an abundance of natural resources—and this includes many countries in sub-Saharan Africa—often show a record of relatively poor economic performance compared with non-resource-rich countries. 

The consensus in both academic and policy circles is that the presence of abundant natural resources poses a number of potential challenges to these countries. 

Six of them can be readily identified:

(i) a loss of competitiveness in potentially dynamic, non-natural resource sectors, (ii) a consequent narrowing of the production base,
(iii) excessive reliance on commodities for both government revenues and export earnings,
 (iv) high vulnerability to fluctuations in commodity prices,
 (v) macroeconomic and financial volatility, and
 (vi) rent-seeking behavior that can undermine governance and exacerbate the difficulty of building robust, growth-enabling institutions. 

The ideas in this book, "Beyond the Curse: Policies to Harness the Power of Natural Resources,"  were first presented at a seminar that was aimed primarily at policymakers in sub-Saharan Africa and brought together ministers, central bank governors, other senior policymakers, and well-known academics.The seminar focused on how to manage these challenges so as to reap the benefits of resource wealth while avoiding the pitfalls.

Diagnosis

Starting from a diagnosis of the wide range of challenges to macroeconomic management and financial policies that resource-rich countries face, the seminar sought to propose solutions that are context-specific, drawn from the most successful experiences, and capable of being implemented in Africa. Discussed at the 2010 seminar, therefore, were fiscal, monetary and exchange rate policies; savings policies; institutional arrangements to safeguard economies against volatility; economic diversification; and institution building.

The consensus among both speakers and participants at the seminar was that government revenues derived from natural resource extraction should be used conservatively in order to avoid excessive real appreciation and to safeguard inter- generational equity.

Preserving intergenerational equity requires saving and investing a large part of the proceeds to benefit future generations. At the same time, when investing these proceeds, it is not easy to make the choice between investing in external financial assets and investing in domestic physical and human capital (including infrastructure).

A deliberate and measured pace of domestic spending, carefully focused on absorptive capacity, can limit real appreciation and attenuate the negative consequences to the economy’s tradable sector. Moreover, history is replete with examples of large government spending programs that have been inefficient and wasteful.

Knowledgeable senior officials at the seminar from Norway, Chile, Botswana, and Mexico outlined the history of how their governments addressed the problems posed by the existence of natural resources. Their measures included conducting countercyclical fiscal policies and setting up institutions that limit rent-seeking behavior.

While seminar participants were cautious about spending policies, they recognized that populations in low-income countries have high expectations regarding higher public spending. Large resource windfalls often trigger political pressures to enlarge government spending, in particular in countries with vulnerable populations. Managing those expectations is an important task in all resource-rich countries, and particularly in those with recently discovered resources.

Better with the private sector

All countries with significant natural resources, especially those whose resources are recently discovered, must choose between putting the extraction activity in the hands of multinational companies or keeping it in the hands of state-owned companies.

The weight of country experiences worldwide tilts the balance in favor of leaving the extraction as much as possible to the private sector, provided that
  (i) the companies are selected on a competitive basis, and
  (ii) the government has the capacity to ensure that contract negotiations lead to a balanced deal where the short- and medium-term objectives of both parties are reconciled.

Indeed, such an “optimal contract” would ensure that the inherent time-inconsistency problem is addressed. In other words, governments in resource-rich countries should credibly commit not to expropriate for themselves foreign investments after they have been sunk in exploration and extraction. In this discussion, many countries around the table recognized their lack of capacity to negotiate such contracts and expressed a need for independent international advice and assistance in this crucial area.

Taxing natural resources

Taxes on rents are relatively efficient and less distorting. Therefore, higher levels of taxation in the natural resource sector make sense and facilitate lower taxes in other sectors. However, this usually leads to a structure of government revenues that is dependent on commodity prices and earnings and so can be highly volatile. There is therefore a need to establish medium-term spending plans, to decouple current spending from volatile government revenues, and to enact a strategy for countercyclical fiscal policy (especially because capital flows that also respond to current account strength, and thus commodity prices, can exacerbate cyclicality).

Fiscal institutions have proven to be instrumental in achieving such decoupling between spending programs and revenues. For countries that cannot establish institutional arrangements capable of credibly committing to countercyclical fiscal policies, the use of financial instruments—such as the Asian puts used to hedge government oil revenues in Mexico—are an effective second-best policy option.

Effect on exchange rate

Chile’s floating exchange rate coupled with an inflation-targeting regime has proved remarkably successful in recent years at sheltering the economy from external shocks. Many African countries are fearful of embarking on a fully flexible exchange rate regime, however. This is not the so-called “fear of floating” in the conventional sense—when a degree of fixity leads to foreign exchange liabilities that constitute a balance-sheet disincentive to floating—but simply a reluctance to embark on major institutional change based on a belief that the supportive institutional structure will take time to prepare.

It is clear that a more gradualist path to exchange-rate flexibility with inflation targeting will be pursued in many countries, with all the transitional difficulties that this will entail. In fact, the experience of Ghana, which adopted inflation targeting with limited exchange-rate flexibility in 2002-03, clearly illustrates this point.

The seminar stimulated much discussion about how to sterilize current account inflows (at times of high commodity prices) and the capital inflows that are correlated with these windfalls. Because their equilibrium domestic interest rates are almost always higher than those in advanced countries, in resource-rich countries the costs of sterilization can be significant and can create tensions between the fiscal authorities and the central bank. As the case of Botswana makes clear, however, insofar as periods of high commodity prices are also periods of large government surpluses held at the central bank, a properly managed countercyclical fiscal policy will provide a degree of automatic sterilization.

Diversifying away from dependence

Experiences with industrial policy around the world suggest that it is not a straightforward matter to design an appropriate incentive structure to help lay the groundwork for economic diversification in resource-rich countries. Seminar participants recognized that some government intervention is unavoidable but also stressed that such policies should be tailored to the context of each economy. It was also recognized that too-active industrial policies would open the door to corruption and thus risk undermining the broader institutional framework.

From the discussions certain things emerged that are clearly undesirable, such as commodity rents that are distributed through very high government salaries, which would have a detrimental effect on private sector development. On the other hand, low, predictable, and non-distorting tax rates on entrepreneurial activity could help foster diversification. Similarly, the use of commodity proceeds to establish a supportive physical and social infrastructure could raise returns and encourage private investment in other sectors.

INSTITUTIONAL ASPECTS

The existence of natural resources tends to distort the allocation of talent. Especially in countries with weak institutions, talent tends to shift out of private entrepreneurial activity and into more lucrative rent-seeking areas, with harmful implications for sustainable growth. Participants in the seminar spent a good deal of time focusing on how institutions should be designed to guard against such developments. For example, strong and reliable property rights can foster financial sector development, allowing the financial system to play a more active and significant role in mediating resources to help build small- and medium-size enterprises in the non-resource-rich sectors of the economy.

More generally, checks and balances and greater transparency in managing natural resource revenues can help counteract the misallocation of talent into unproductive activities. However, it was acknowledged that the problem was less difficult in countries with mature industrial economies than in those that were least developed when mineral resources were discovered. This, if anything, merely underscored the importance of a careful approach to institution building.

Foreign Policy review by Matthew Hulbert and Bas Percival 

VoxEU blog  "Beyond the curse: Policies to harness the power of natural resources"

iMFdirect blog on the escaping the "resource curse"

Barnes & Noble Nook version

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OIL WEALTH IN CENTRAL AFRICA 

Policies for Inclusive Growth 

Bernardin Akitoby and Sharmini Coorey 

Paperback · ISBN 978-1-61635-376-6 · Stock# OWCAEA 

Drawing on new research on managing oil wealth and central Africa’s oil exporters’ experiences, this 

book addresses the challenge of strengthening the management of oil wealth and promoting policies for 

inclusive growth. 

      Review in Foreign Policy

MANAGING THE OIL REVENUE BOOM 

THE ROLE OF FISCAL INSTITUTIONS

Rolando Ossowski, Mauricio Villafuerte, Paulo Medas, and Theo Thomas 

2008 · ISBN 978-158906-718-9 · Stock# S260EA · $30 

Increases in oil exports and revenues have revealed how governments manage fiscal 

policies in light of changing market conditions and the role of special fiscal institutions 

(SFIs). In this Occasional Paper, IMF experts examine the role of SFIs in fiscal 

management, review the experiences of selected countries, and draw general lessons. 

TAXATION OF PETROLEUM AND MINERALS 

PRINCIPLES, PROBLEMS, AND PRACTICE

Philip Daniel, Michael Keen, and Charles McPherson 

2011 · Paperback · ISBN 978-0-415-78138-1 · $38.95 

2010 · Hardback · ISBN 978-0-415-5692-7 · $150 

Copublished with Routledge. For more information, please visit www.routledge.com. 

“A timely and welcome guide to policymakers and advisors in the area of resource 

taxation, combining theoretical underpinnings and sound practical advice over a 

range of relevant topics, from tax design, through fiscal and financial modeling to 

tax administration.” 

Joseph Amoake-Tuffour 

Ministry of Finance and Economic Planning, Republic of Ghana 

COMMODITY PRICE VOLATILITY AND INCLUSIVE GROWTH 

Rabah Arezki, Catherine Pattillo, and Marc Quintyn 

Paperback · ISBN 978-61635-379-7 · Stock# CPVIEA 

This title discusses the challenges posed by commodity price volatility and discusses policies to promote 

growth that is inclusive of all the citizens in low-income countries. It also explores macroeconomic policy 

options and the building of fiscal institutions to prevent boom and bust cycles.

Seminar at the IMF on Commodity Price Volatility

Financial Crises and What to Do About Them

Financial Crises: Causes, Consequences, and Policy Responses, edited by Stijn Claessens, M. Ayhan Kose, Luc Laeven, Fabián Valencia, provides a comprehensive overview of research into financial crises and policy lessons learned. 

The book covers a wide range of crises, including banking, balance of payments, and sovereign debt crises. It begins with an overview of the various types of crises and introduces a comprehensive database of crises. 

Broad lessons on crisis prevention and management, as well as the short-term economic effects of crises, recessions, and recoveries are discussed. 

The medium-term effects of financial crises on economic growth, as well as policy measures to prevent booms, mitigate busts, and avoid crises are analyzed. Finally, policy measures for mitigating the adverse impact of crises and ways to restructure banks, households, and sovereigns are presented. 

The collection of research in this book provides an excellent overview of critical policy areas, with valuable lessons on how countries can better monitor their economies and financial systems. Read a blog by Stijn Claessens on the issue.

IMF eLibrary   IMF bookstore  Amazon Kindle version

RePEc -- Understanding Financial Crises