III A Framework for National Economic Management
Author:
Jahangir Amuzegar https://isni.org/isni/0000000404811396 International Monetary Fund

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Language:
English
Print Publication Date:
06 Apr 1983
Keywords:
OP; country; Oil exporting developing countries; Opec; world oil reserve; standard of living; physical capital; effective demand; OPEC countries oil export earnings flow; Oil exports; Oil; Oil prices; Global
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Abstract

Critical choices of development strategy facing the oil exporting developing countries revolve around the prospects for and limitations of their underlying economic structure as major oil exporters. On the positive side, these countries possess some fortuitous features not shared by other developing countries. Among these is a steady and effective demand for oil paid in foreign exchange, creating a sizable and virtually painless source of national savings that is capable of underwriting domestic development as well as foreign investment and assistance. On the negative side, these countries are plagued by certain growth-impeding factors such as insufficient infrastructure facilities, insufficient skilled labor, the lack of a commensurately developed bureaucracy, and a virtual absence of capital-based indigenous technology.

Critical choices of development strategy facing the oil exporting developing countries revolve around the prospects for and limitations of their underlying economic structure as major oil exporters. On the positive side, these countries possess some fortuitous features not shared by other developing countries. Among these is a steady and effective demand for oil paid in foreign exchange, creating a sizable and virtually painless source of national savings that is capable of underwriting domestic development as well as foreign investment and assistance. On the negative side, these countries are plagued by certain growth-impeding factors such as insufficient infrastructure facilities, insufficient skilled labor, the lack of a commensurately developed bureaucracy, and a virtual absence of capital-based indigenous technology.

These prospects and limitations influence, if not actually determine, the choice of national socioeconomic objectives, the formulation of domestic development strategies, and the direction of international cooperation. Accordingly, this chapter concentrates on three broad topics for inquiry: (1) a discussion of the fundamental differences between the oil exporting developing countries and the other developing countries as they relate to the choice of national socioeconomic agendas and development plans; (2) an analysis of oil exporting developing countries’ national priorities and oil revenue allocations; and (3) an examination of their specific development strategies.

Oil Exporters as Developing Countries

The oil exporting developing countries share some of the more common characteristics of all developing economies. With the exception of a few small, capital-surplus countries, they are among the middle-income or low-income nations as defined by the International Bank for Reconstruction and Development (World Bank); their adult literacy rate (with one or two exceptions) is about 60 per cent; life expectancy at birth for most of them is less than 55 years; their industrialization is at an early stage (as indicated by the low shares of manufactured goods in total production and exports); they suffer from a shortage of skilled labor; the rate of urban population to total inhabitants for some is 50 per cent or less; and their technology is mainly “borrowed.”

Shared Aspirations and Priorities

Although the oil exporting developing countries are not a homogeneous group, they share certain common objectives and priorities among themselves and with other developing countries. These goals are explicitly stated in their national plans, or implicitly followed in practice.

Rapid economic growth, together with relative price stability, is a principal objective of the oil exporting developing countries. The realization of this objective requires substantial improvements in existing infrastructure and is closely linked to high employment. Implied in this goal is an increasing recognition that a major constraint on development is the availability of skilled manpower to meet high productivity requirements. Hence, emphasis is being placed on the need to expand and improve the quality of educational and vocational training. The specific tasks of manpower development include an increase in the available workforce, an improvement in labor productivity in all sectors, the placement of workers in sectors with the greatest potential for growth and productivity, and a reduced dependence on foreign manpower.

Another major common objective is the diversification of the production base. Underlying this goal is the specific recognition that oil reserves are finite. The economy’s export base will thus have to be expanded through product diversification in order to make up for dwindling earnings from oil. Since most oil exporting developing countries are heavily dependent on petroleum as a source of government revenue and foreign exchange, they are particularly vulnerable to fluctuations in the global demand for oil, and hence its price. This vulnerability increases their need for financial security through product diversification. An additional incentive for diversification is the oil sector’s inability to generate production and consumption linkages with the other sectors of the economy and, thus, to create employment opportunities. Oil technology is highly capital intensive and skill intensive and has certain input requirements that are vastly different from the oil exporting developing countries’ domestic factor supplies. Lurking behind the emphasis on diversification are certain national security considerations and requirements.

Equity, social justice, and improvement in the distribution of income through improved productivity, or state assistance, constitute yet another important goal for these countries. While striving to improve the welfare of society, they seem mindful also of the need to provide for the wants of future generations by a conscious allocation of income between oil consumption and capital formation and by a deliberate production policy that takes into account the life span of existing oil reserves.

International economic cooperation is also a commonly shared goal. The economies of the oil exporting developing countries are heavily dependent on the rest of the world for trade, investment, transfer of technology, and flows of labor. At the same time, their oil production and pricing decisions directly affect the economic, social, and political structure of the oil consuming countries. In recognition of this interdependence and the need for cooperation, they seem anxious to avail themselves of the technological resources and experiences of others and to assist in the transfer of real resources to the oil importing developing nations in the interest of continued expansion of international trade and investment.

Implicit in the stated national objectives is the desire for a sustainable rise in real per capita income and the standard of living, increased access to modern and advanced technology in order to enhance national standing in the world scientific community, greater national self-sufficiency in basic consumption needs, and a substantial improvement in the level of scientific education, research, and development. Some of the corollaries of these basic objectives—often unstated—include strengthening of national defense, a narrowing of the real income gap and social amenities with the industrial countries, and the maintenance of solidarity with other developing countries in the North/South context.

Basic Differences

In some, and perhaps more important, respects, the oil exporting developing countries clearly differ from other developing countries that are dependent on single raw material exports. Two essential and two secondary differences may be singled out as distinguishing features. The two essential characteristics are economic dependence on a depletable resource and the public ownership of that resource. The secondary features are the unique properties of petroleum as a raw material and the characteristics of the world oil market.

The oil exporting developing countries differ from many other developing countries in their heavy dependence on a single commodity export—oil—which serves as the principal source of government revenues and foreign exchange receipts. The measures commonly used to assess dependence include the ratio of exports of the single commodity to total exports, the ratio of the single commodity export to gross domesic product (GDP), and the ratio of export revenues to total public revenues. By all these criteria, the oil exporting developing countries show a greater dependence on a single commodity than do the other developing countries (Table 2).

Table 2.

Oil Exporting Developing Countries: Alternative Measures of Dependence on Oil Exports and Oil Production, 1980

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Sources: International Monetary Fund, International Financial Statistics, and staff estimates.

1979/80.

1977.

1978/79.

Net oil exports.

1978.

Share of major single export commodity in exports or GDP.

An increasing number of developing countries (particularly those in the more advanced category), while traditionally dependent on agricultural exports, have now significantly diversified their economies, increased their export lines, and taken advantage of new opportunities for processing their raw materials (e.g., timber, wood, leather) for exports. Although their vulnerability to external changes in demand is not totally eliminated, and they also still have to overcome new foreign trade barriers, they are at least able to hedge their export earnings against a sudden decline in demand for a single export item. They have indeed found their export safety in numbers. Many oil exporters do not as yet enjoy such security.

The oil exporting developing countries are dependent on a single primary commodity export that is exhaustible. Many low-income or middle-income developing countries depend on exports for one fifth or more of GDP, and have their merchandise exports dominated by one or two commodities (for example, rice in Burma, cocoa in Ghana, coffee and cocoa in Ivory Coast, rubber in Malaysia, tea in Sri Lanka, and cotton in the Sudan). But dependence on these agricultural cash crops differs from that of the oil exporting developing countries because farm products are reproducible year after year (and even more frequently), while petroleum is depletable. A barrel of oil exported is a one-time transaction and a permanent parting, while the sale of a bale of cotton or a ton of jute can be an annual and continuous exercise.

Exhaustibility affects both the choice of domestic development strategy and the mode of participation in the international adjustment process. On the domestic scene, political leaders and economic planners want to make sure that any permanent loss in the nation’s stock of capital (i.e., national dissaving through the sale of a barrel of oil) is compensated by some other form of social utility. At the international level, such considerations as the safety of foreign outlays, the expected rate of return on foreign real or financial assets, and other nonbusiness risks may require that limits be placed on production or that special guarantees be demanded from foreign recipients of the oil surplus funds.

By custom, law, or ideology, the ownership and exploitation rights to petroleum deposits in the oil exporting developing countries belong to the state, not to individuals or private groups. Export earnings, too, accrue directly to the national treasuries. This institutional feature, like that of exhaustibility, has a significant bearing on both the scope and the direction of state intervention in the economy and on the economy’s overall response to the government’s initiatives and stimuli. When ownership and management of such national resources as petroleum are in private hands, the entrepreneurial decisions—factor mix, production rate, sales outlet, profit target, dividend distribution, earnings reinvestment, and the like—are as a rule made in and by the private sector according to consumer (or producer) preferences. These decisions—diffused and decentralized as they are—exert “impersonal” influences on a multitude of suppliers, workers, customers, and investors, with significant backward and forward linkages in the economy. Where the state is the sole owner/producer, the decision-making process is centralized in the bureaucracy, and the planners’ preferences replace those of independent consumers (or private producers). The substitution of state discretion and decisions for the “automatic” responses of the private sector—while leaving the fundamental necessity of internal and external adjustments unchanged—does lead to changes in both the character and the composition of GDP, as well as the tempo and direction of the economy’s development.

Petroleum has a number of rather special characteristics that are not usually found among other minerals. For example, several developing countries are in varying degrees dependent for their exports on one or two minerals (Chile and Zaire on copper, Peru on copper and zinc, Bolivia and Malaysia on tin, Botswana and the Dominican Republic on nickel, Suriname on aluminum, Morocco on phosphate, and Jamaica on bauxite). But none of these strategic minerals presently matches petroleum’s singular importance to the world economy. On no other mineral (with the possible exception of chromium) is the industrial world so heavily and so strategically dependent for the maintenance of its economic prowess, military strength, and high standards of living. For no other mineral is the average “economic rent” (i.e., the difference between average unit cost and the selling price) as large. No other strategic mineral deposits (again with the possible exception of chromium from Zaire and Southern Africa) are as heavily concentrated in a relatively small geographic region as petroleum is in the Middle East. There are few effective short-term substitutes for the flexible and versatile petroleum (particularly automobile fuel). Oil lends itself more easily to supply control and transshipment on short notice. And, the capital-intensive nature of the oil industry makes it immune to large worker layoffs in slack times, thus avoiding political pressure from labor groups for maintaining production levels.

The oil exporting developing countries are dissimilar to other one-commodity mineral exporters of strategic importance (e.g., chromium, copper, or bauxite) in that they are members of an organized commodity “club.” The world petroleum market is to a large extent influenced by 13 major oil exporters as members of OPEC. OPEC is often characterized by the press in some oil importing countries as a commodity “cartel”; but OPEC members until recently emphatically rejected this characterization and repeatedly pointed out the fundamental difference between their organization and a classical cartel. They emphasized the absence of compulsory production quotas, prorationing, market-sharing agreements, uniform pricing, et cetera, as the proof of their argument.16

Although OPEC may not have been a cohesive or homogeneous group, and not able to establish or enforce mandatory production quotas, it has been generally portrayed as a price-fixing association.17 Members have also voluntarily agreed from time to time to abide by certain collective decisions on pricing and output. (See below, page 27.) To this extent, then, the oil exporting developing countries ought to be considered in a class by themselves, and different from exporters of other “nonassociated” mineral sellers. In other words, the major petroleum exporters under OPEC’s umbrella have agreed to observe certain collective rules of behavior that set them apart from other mineral producers, some of whom (e.g., in phosphate and bauxite) have also tried to form similar producers’ associations.

At the same time, membership in OPEC, like the other differentiating features of the oil exporting developing countries, has its share of influence on internal and external adjustment policies. Internally, production (and to some extent price) policies have been formulated by some key members in close and direct reference (sometimes in conformity and other times in defiance) to the collective decisions. Internationally, members have also often adopted certain common positions with respect to foreign assistance or cooperation with international financial organizations.

In addition to these four basic differences, it should be re-emphasized that the particular attractiveness of oil as an energy source and the oil exporters’ ability to obtain high “rents” for petroleum places the oil exporting developing countries in a highly advantageous position compared with the other developing countries. To be sure, the availability of sizable revenues from oil exports in the form of “economic rent” facilitates the government’s development task by removing the necessity of mobilizing domestic savings and transforming them into foreign exchange through competitive exports.

National Priorities and Oil Revenue Allocation

Underlying the multidimensional national objectives in the oil exporting countries (and in fact in all “mineral economies”) is the concern with converting the predominant natural resource into a productive economic base and a skilled workforce capable of sustaining a viable and diversified economy. The achievement of this task (as with disposing of any windfall source of wealth or gift of nature) involves two essential decisions: the pattern for national consumption and saving, and the allocation of savings so as to equalize the marginal rates of return.18 Once the essential decision is made regarding the magnitude of oil output to be exchanged for current consumer goods and services, the subsequent options represent three investment alternatives, all of which are expected to further the development of the national economy: (i) oil can be left underground as a form of autoinvestment for future exploitation and use, (ii) the proceeds of oil exports (beyond current consumption) can be used for domestic capital formation, promising larger future flows of goods and services, and (iii) oil revenues not currently consumed or domestically invested can be placed in foreign capital assets (real or financial), bearing future returns in capital or consumer goods.

The level of public and private consumption, the magnitude of investment, and the appropriate sectoral priorities differ from one country to another because of variations in resource endowment and absorptive capacity. Hence, the strategy for development follows the special and distinguishing characteristics of the countries concerned.

An ideal discussion of appropriate long-term development strategies would require a country-by-country examination of the infrastructure and the institutional, political, and socioeconomic features of each. The following discussion will focus only on certain primary choices.

Principal Development Strategies

An oil exporting developing country’s national economic welfare will be maximized when the marginal rate of return in each of the “uses” of its oil reserves is equalized. Viewing petroleum reserves as capital assets, and assuming that equilibrium in financial markets will be reached when all assets of a given risk class earn the same rate of return, one may conclude that the value of a barrel of oil (i.e., the present discounted value of future sales minus extraction costs) must be expected to grow at a rate equal to the (market) rate of interest on competing assets.

This fundamental principle of the economics of exhaustible resources19 carries a number of implications, some obvious, some less so. To the extent that oil exporting developing countries expect the future rate of increase in the net world price of oil (i.e., nominal price minus extraction costs) to be higher than the rate of interest (either because the oil importing countries are not adopting policies that diminish their dependence on imported oil or because inflation and exchange rate depreciation reduce the effective yield on financial assets), they have good reason—other things being equal—to keep oil underground. Changes in the current price of oil will be dependent largely on changes in expectations about future market conditions, both for the supply of and demand for oil and prospective interest rates. Comparison of oil price movements with the rate of interest on financial assets as a rough guide to equilibrium price changes will be meaningful only if these interest rates are not (directly or indirectly) influenced by oil price changes.20 This is particularly relevant for rates of return on financial assets in foreign economies that are heavily dependent on oil. The dependence of extraction costs on the rate of production, the oligopolistic structure of the market, uncertainties about future demand and supply conditions for oil and oil substitutes, imperfections in world capital markets, lack of competitive futures markets, and foreign exchange constraints all combine to make the optimal extraction rate for oil very complicated. Thus, while quantitative techniques exist for identifying the optimal extraction rate over time for various objective functions and alternative constraints, in practice the assumptions involved are likely to be so arbitrary that the use of such techniques will be an exercise in spurious accuracy.

Current Consumption

In countries where current levels of consumption per capita are low by international standards, it is not hard to understand why large increases in the valuation of existing oil reserves should bring forth strong pressures for increased oil production and for immediate distribution of the proceeds for consumption. Indeed, it can be argued that, where current consumption is very low and expected future income from oil is high, additional current consumption will yield higher utility than consumption in the future. This arises simply from the application of the principle of diminishing marginal utility to intergenerational as well as intra-generational wealth transfers. The arguments would seem to carry greater weight for those oil exporting developing countries that have large oil reserves than for those that do not. The latter must already provide for a time, within their own generation, when oil revenues will no longer accrue, or will accrue in much smaller amounts. They will have more need to “carry forward” income-producing wealth, be it in the form of financial or real assets. The countries with large reserves have less need, on grounds of providing for future consumption levels, to defer current consumption.

Another, and more important, factor that has tended to promote current consumption in the oil exporting developing countries is the fact that the increase in oil revenues to such great magnitudes over the period 1973–80 has made it possible for substantial increases in consumption and investment to take place simultaneously, obscuring the fact that saving and investment come at the expense of current consumption. This has been particularly true for the surplus oil exporting countries, though data deficiencies and the rapidly changing structure of their economies make it difficult to convert nominal expenditures to real expenditures with precision. For the 13 OPEC members as a group, nominal investment expenditures during 1974–77 rose at an annual average rate of 44 per cent, while private and public consumption increased at average rates of 24 and 35 per cent, respectively. During the same period, the annual population increase was about 3 per cent, and inflation (as measured by the GDP deflator) averaged about 12 per cent.

Most of the arguments against consuming the bulk of present oil revenues include the adverse effects on diversification of the production and export base, the prospect of high inflation rates if absorption is pushed beyond the economy’s short-run capabilities, the potential for sociopolitical instability if consumption patterns and rapid development conflict with traditional values, and the adverse incentives for the formation and utilization of human capital that can result from the creation of a rentier society.

It is not surprising, therefore, to discover that savings rates in the oil exporting developing countries are higher than among other developing countries. A recent study has found that both gross savings rates and incremental savings rates in 15 oil exporting developing countries were over twice as high as in a sample of nonmineral developing countries in the 1973–76 period.21 What such an observation does not reveal is whether the higher savings rates of the oil exporting developing countries were sufficient to sustain desired rates of income growth, in view of the fact that a larger proportion of measured income is derived from wealth depletion and that the “savings” are largely “transformed assets.”

Oil Conservation

Keeping oil in the ground can be viewed as an investment whose real yield will be determined by changes in the future real net price of oil. The attractiveness of resource conservation as an investment is determined by the comparison of this real yield with that of the alternatives. In many oil exporting developing countries, conservation is encouraged not only by the view that oil prices will continue to rise in real terms but also by the perception of the costs of the alternative uses of oil reserves. Foreign financial investments are vulnerable to inflation, exchange rate variability, financial conditions, and political risks. A too rapid growth of domestic consumption from oil revenues can result in inflation, resource misallocation, disparity in urban/rural incomes, and an appreciation of the real exchange rate that inhibits product diversification. If one also views oil production as depleting the national wealth and reducing economic freedom of maneuver for the future, then conservation emerges as an attractive investment option. This position is apt to be reinforced where domestic oil consumption requirements for economic development are expected to be so large that their own use of oil is a preferred option. The same situation holds where factor endowments are such that resource-based industrialization (e.g., petrochemicals, energy-intensive manufacturing) is a viable long-run export strategy, so that oil can still be profitably used for export even if unforeseen technological developments sharply reduce the demand for crude oil.

While the foregoing considerations favor resource conservation over production, other factors suggest moving in the opposite direction. If the prospective value of financial assets is uncertain, so too may be the value of oil reserves. This uncertainty arises from potential developments on both the supply and demand sides of the world oil markets; it is, in part, a reflection of the fact that expectations play a dominant role in price determination in asset markets.22 This characteristic of the oil market is exacerbated by the apparent small short-run price elasticity of energy demand, which causes unforeseen supply changes to have a particularly marked effect on oil prices.

A further consideration for the oil exporting developing countries in contemplating a conservation strategy is the impact of their combined decisions on the economies of the oil importing countries. Energy use cannot be curtailed quickly, and sudden changes in the price or availability of oil could damage the economies of oil importing countries in ways that might incidentally adversely affect the value of financial claims held by the oil exporters. The point here is simply that the feasible upward range in real oil prices, given the stock of claims on oil importing countries, is much less than the hypothetical range, and that this constraint, in turn, may reduce the expected yield on oil resource conservation.23

Some oil exporting developing countries with considerable foreign indebtedness and with a need for further foreign capital inflows to finance industrialization (e.g., Algeria, Mexico) may feel that the increasing debt-servicing burden associated with conservation is more onerous than the potential losses from additional oil production. Finally, there is the foregone current development implied by holding back oil production. In fact, it is the very pressures for rapid development that have prompted some observers to characterize oil exporting developing countries’ past production policies, outside Saudi Arabia and Kuwait, as output maximization subject only to periodic cutbacks when there was a need to support world oil prices.

Investment in Domestic Real Assets

Investment in domestic real assets can be distinguished from the other options by the fact that the advantages are broader, but more difficult to measure. In addition to contributing to the goal of transferring income from the present to the future, investment in domestic real assets has some primary attractions for the oil exporting developing countries. It is the only channel by which these countries can ultimately diversify their production and export bases and thereby reduce their dependence on oil. In addition to the direct positive effects of such diversification, the pursuit of this objective implies other benefits (e.g., lower export instability, greater economic security). Domestic capital formation, to the extent that it occurs ouside the oil sector, has the advantage of promoting employment and hence checking the movement toward a rentier society. For this reason, a given direct yield from a domestic investment may well have greater social value than an equivalent monetary return from a foreign financial investment. A related benefit is that the labor and entrepreneurial skills acquired through “learning by doing” can make a substantial contribution to the longer-term growth of labor productivity in the economy as a whole. Thus, in addition to the direct real yield on domestic capital formation, it is necessary to add a number of ancillary (but largely nonquantifiable) returns, representing the external economies of product diversification.

The chief limitation on the pursuit of a domestic real investment strategy for some oil exporting developing countries is likely to be a shortage of investment opportunities. The availability of foreign exchange is only one requisite for viable domestic capital formation. Other complementary factors, such as raw materials, skilled labor, entrepreneurship, and construction capacity, are typically in short supply in many of these countries. These shortages can, of course, be alleviated as economic development advances, and with help from abroad. This process, however, is gradual, and effective only in proper sequence.24

If investment is too rapid, the benefits may be considerably diminished as a result of inflation, a deteriorating trade balance, wrong relative price signals for tradable goods production, and bottlenecks and shortages leading to waste.25 A further problem arises when the investment that is undertaken is of poor quality—something that is more likely in an environment of inadequate planning, inflation, and shortage of factors of production. Even where investment is in the traded goods sectors, the future output from present investments may prove hard to market—a particular danger if the size of the domestic market is not large enough to absorb this output.

Because of these limitations on the rate at which physical investment can be efficiently expanded, many oil exporting developing countries may want to consider, first and foremost, investing oil resources directly into human capital. The advantage of this kind of investment is that it provides relatively high adaptability and flexibility in development strategy, it is an investment with a rate of return that is typically little affected by external decisions and policies, and it may not produce the adverse inflation and relative price effects that can result from excessive investment in physical capital. Further, over the long run, investment in human capital offers the prospect that the state’s initially indispensable role in investment could be replaced by skilled private entrepreneurs who would assess the economy’s comparative advantage.26 The disadvantages of human capital investment are that the payback period can be long, the education infrastructure (of buildings and teachers) may take time to construct, and the particular disciplines, typically offered, may not closely correspond to the country’s immediate or long-term technical and professional needs.

Investment in Foreign Assets

Investment in foreign assets (real or financial) permits the oil exporting developing countries to take advantage of the current known price of oil while deferring the absorption of real goods and services. The preceding discussion anticipated the main advantages of this use of oil income. In countries where infrastructure is insufficiently developed to provide a broad range of investment opportunities (or where there are natural market or geographical limitations on product diversification), foreign investment, even when the real yield is low, may be superior to domestic capital formation that has gross returns that fall short of depreciation costs.

Foreign investment also avoids some of the incidental costs involved in a rapid increase in domestic spending. To the extent that oil export revenue is invested abroad rather than translated into public domestic expenditure, the induced inflation and relative price effects that can adversely affect the profitability and international competitiveness of non-oil exports are minimized. To the extent that it is in financial assets, foreign investment can be converted easily into real resources, when import needs increase. Thus, absorption can be more closely fitted to the economy’s absorptive capacity, including the constraint on labor availability (with its implications for the necessary scale of immigrant labor). Investment in financial assets also provides some of the “recycling” necessary for oil importing countries to adjust to changes in their current account induced by large changes in real oil prices. (See Chapter IV). Such investment, therefore, can be said to contribute to stability in the international monetary system as well to protecting the oil exporting developing countries’ existing overseas investment and their future markets for oil.

Not surprisingly, the foreign investment option also has serious drawbacks that limit its appeal as a vehicle for holding a large part of the oil exporting developing countries’ wealth. In the first place, the real rate of return may not be very attractive. In this crucial respect, the return to foreign financial holdings has not been particularly high during much of the 1970s. The major part of these countries’ current account surplus after 1973 was invested in bank deposits, government securities, and other assets in the industrial countries. Data on realized rates of return for money market instruments in the five major industrial countries indicate that average nominal rates of return were slightly over 9 per cent in 1973-82—a figure that is below the average recorded domestic inflation rates of the oil exporting developing countries in this same period, below the rise in import costs faced by them, and well below the annual increase in the real price of oil during the same period.27 (See Table 3.)

Table 3.

National and SDR Rates of Return on Money Market Investments in Specified National Currencies, 1973–82 1

(In per cent)

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Source: Fund staff estimates.

The yields on these investments are quarterly averages of yields on the same (or similar) instruments as those currently used by the Fund to determine the interest rate on the SDR. Since January 1981, the Fund has used the market yield (bond-equivalent basis) on three-month treasury bills in the United States and the United Kingdom, the three-month interbank deposit rate in the Federal Republic of Germany, the three-month interbank money rate against private paper in France, and the discount rate on two-month private bills in Japan. Principal and interest are assumed to be reinvested each quarter, with investments distributed evenly during each quarter. Interest is first realized on investments made during the second quarter of each year shown in the third quarter of that year. The amounts so accumulating in national currencies are converted to SDRs by use of the average quarterly SDR price per unit of national currency to obtain the equivalent SDR rates of return.

The fixed annual rate is shown which would have yielded the same as the actual growth of investment value from the beginning to the end of the period indicated.

The weights are 42 per cent for the U.S. dollar, 19 per cent for the deutsche mark, and 13 per cent each for the pound sterling, French franc, and Japanese yen. These weights are the same as those used to fix the national currency amounts in the present SDR basket when it was instituted at the start of 1981.

Since May 1981, the SDR interest rate set by the Fund can differ from the average rate shown only because of differences in timing and changes in weights.

Similar calculations by the Fund and the United Nations Conference on Trade and Development—UNCTAD—(Table 4) show how badly the oil exporting developing countries’ assets have fared during the 1970s, owing to accelerated world inflation. The average annual rate of return on money market investments (which comprised the bulk of OPEC’s assets) was 7.7 per cent during 1974-79. Investments in U.S. taxable bonds produced an average yearly return of about 7 per cent, and placements in equity shares (as indicated by the movement of the New York Stock Exchange composite index) yielded 7.9 per cent. In the same period, the annual increase in OPEC’s import index was 10.3 per cent. In contrast to such seemingly unfavorable returns on OPEC’s foreign placements, the real price of oil (measured by OPEC’s import index) rose by more than 10 per cent annually in the 1974–80 period, giving the return to oil kept underground an edge over such financial placements abroad, although the exact magnitude of losses cannot be determined without accurate information on the composition of OPEC’s portfolios.28

Table 4.

Rates of Return on Investments and Increase in Real Oil Price, 1974–80

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Sources: International Monetary Fund, staff estimates; and United Nations Conference on Trade and Development, Secretariat estimates.

First quarter of the year through first quarter of the subsequent year.

Second quarter of the year through the second quarter of the subsequent year.

Other drawbacks to the financial investment option include the risk, even if small, of repudiation or seizure by foreign monetary authorities, the risk that the visibility of certain foreign claims could lead to pressure from less favored countries for financial assistance on concessional terms, and the lack of skill development for the domestic labor force from such investment.

Time Pattern of Investments

Having outlined the range of policy options available to the oil exporting developing countries, it is worth pointing out that the mix of expenditures changes over time as absorptive capacity grows, domestic investment opportunities are expanded, and a wider range of consumption needs are met. The issue arises, therefore, as to the appropriate time pattern or “sequencing” of expenditure options. For example, should investment in foreign assets be emphasized in the early years of exploitation of oil reserves or should relatively greater investments in domestic sectors be the starting point? What considerations should bear on the decision?

All oil exporting developing countries accept the objective of a significant increase in real domestic capital formation, yet most lack the domestic resources to permit such an increase to take place both rapidly and efficiently. For countries with low per capita income and relatively large oil reserves, there is something to be said for expenditure patterns that permit a rapid increase in consumption in the short run. In other words, domestic consumption expenditures, combined with investment spending on infrastructure, may be a welfare-maximizing investment pattern. Then, as income levels rise to more “acceptable” levels, an increasing proportion of oil revenues can be devoted to income-generating investments.

Few oil exporting developing countries are, however, in the position of having low per capita incomes and large oil reserves. Where the ratio of reserves to consumption is lower, the case becomes more pressing for an expenditure strategy devoted to a rapid build-up in non-oil productive capacity. Even so, there will be an optimum speed at which this build-up can take place, which argues for initially devoting a relatively larger proportion of potential output to resource conservation, or investment in financial assets, and running this proportion down at a planned and gradual pace. The pace at which it is run down will depend on how fast the capacity to absorb production investment grows.

Although the issue of investment sequencing for oil exporting developing countries has not received due attention in the economic literature, some analysts have demonstrated how it can be dealt with formally as a matter of opimization under certain constraints.29 The basic rule of efficient resource allocation, which applies also to sequencing of investments, is that the marginal rate of return on resources employed should be the same in each use. With a perfectly functioning price system, this would involve equalizing the measured yield across different forms of resource investment. However, governments may have objectives that are not adequately captured by measured yield on investments, and oil exporting developing country economies may face constraints that mean prices are an inadequate guide to relative scarcity. For example, there may be situations in which these governments assign primary weight to the objective of building up domestic real capital while avoiding overseas indebtedness and in which the propensity to import is given. Such a scenario means that the true scarcity of foreign exchange will shift over time. When the foreign exchange constraint is nonbinding, it may be appropriate to focus on investments that most directly meet the objective of capital accumulation; when the foreign exchange constraint is binding, investments that earn or conserve foreign exchange should be favored.

Although there are limits on the extent to which the optimization problem can be discussed in the abstract, several qualitative points can be made. First, in aiming at equalizing returns in different investments, governments should take a dynamic view of costs and returns. For example, if foreign exchange is abundant in the present but likely to become scarcer as development gathers pace, the investment strategy should reflect the potentially rising price of foreign exchange. Specifically, countries whose foreign exchange situation, though currently strong, is likely to weaken, should engage in foreign exchange earnings (or savings) activities, even in some circumstances where the current measured return is less than in, say, nontraded goods. Second, in the early stages of development, a shortage of domestic investment opportunities in oil exporting developing countries is likely to mean that rates of return will fall quite sharply in response to attempts to expand capital spending. This implies that the acquisition of foreign assets is likely to be emphasized during the early stages of the investment sequence. A third observation is that the return on domestic real investmen may be subject to step-changes as bottlenecks are removed and complementary infrastructure is completed. Last, and following from the previous point, it is desirable to ensure a supply of necessary inputs before investment projects are undertaken within the domestic economy. Thus, high-technology, capital-intensive projects generally require prior investment in research and development, as well as highly trained manpower. Similarly, labor-intensive light manufacturing projects often depend crucially on ready supplies of agricultural inputs. If the prior investments in complementary outputs and in necessary inputs are not made, the result will be bottlenecks, delays in completing investment projects, price pressures, and recourse to imported goods and labor that would otherwise have been provided domestically.

National Characteristics and Specific Strategies

While the principal decisions on oil reserves (i.e., conservation versus consumption) and the potential uses of oil revenues (i.e., domestic real capital formation versus foreign direct or portfolio investments and bank deposits) have been presented as alternative strategies or options, they have in practice often been complementary. All oil exporting developing countries have in the past chosen a combination of these alternatives to satisfy what they felt to be their need for a higher standard of living, greater national security, and faster economic development.

The approach followed by the oil exporting developing countries within the context of their national characteristics and goals seems to be based on three main considerations: (1) national factor endowment and domestic absorptive capacity; (2) long-term competitive advantage; and (3) certain exogenous sociopolitical desiderata.

Factor Endowment and Domestic Capacity

In designing a framework for national economic management, oil exporting developing countries, like other developing countries, follow the dictates of their national resource priorities. But the major oil exporters show marked heterogeneities in resource endowment and absorptive capacity. There are presently some 28 developing countries that are net oil exporters. These countries differ widely in area, size of population, volume of oil reserves, degree of economic dependence on oil, availability of non-oil resources, gross national product (GNP) per capita, underlying balance of payments positions, and the extent of social development as measured by certain indicators. There are also notable differences among these countries in technological advancement, skills, and overall absorptive capacity for non-oil development.

As shown in Table 5, the oil exporting developing countries include some very small countries—Trinidad and Tobago, Kuwait, Qatar, and the United Arab Emirates—with areas of less than 100,000 square kilometers; some fairly sizable countries, such as Algeria, Indonesia, and Saudi Arabia, extending beyond two million square kilometers; and several other countries with between half a million and two million square kilometers. In terms of population, there are such relative giants as Indonesia, Mexico, and Nigeria (with 70 million to more than 140 million people) and Bahrain, Oman, Qatar, and the United Arab Emirates (with one million inhabitants or less).

Table 5.

Oil Exporting Developing Countries: Selected Data

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Sources: Oil and Gas Journal (Tulsa, Oklahoma), December 27, 1982; International Bank for Reconstruction and Development, World Development Report, 1982 (Washington, 1982); and Fund staff estimates.

Based on 1981 oil production.

1979.

1978.

In volume of proven oil reserves, the most richly endowed OPEC member, Saudi Arabia, has some 165 billion barrels, dwarfing Ecuador, Gabon, and Oman, which have 2.5 billion barrels or less. The life span of proven oil reserves, based on 1981 production, also varies from about three decades or less for Algeria, Ecuador, Gabon, Indonesia, Qatar, and Venezuela, among others, to more than a century for Iran and Kuwait. In terms of output, Saudi Arabia had an estimated average daily production of 9.6 million barrels during 1981, compared with only 147,000 barrels a day by Gabon and 200,000 by Ecuador—with Indonesia, Iran, Nigeria, and Venezuela in the range of 1.3 to 2 million barrels a day.

The oil exporting developing countries also differ from one another in the degree of dependence on petroleum for the bulk of foreign exchange earnings, budgetary revenues, and oil-related impetus to private sector activities, particularly in trade and distribution. Individual country dependence can be assessed by three main criteria: the ratio of oil exports to total exports, the ratio of oil exports to GDP, and the ratio of oil export revenues to total government revenues. In 1980, oil represented over 90 per cent of export earnings for each of the OPEC members except Ecuador, Gabon, and Indonesia, and averaged over 87 per cent for all of them (see Table 2).30 The ratio of oil exports to GDP in 1980 averaged 72 per cent for the six capital surplus countries (Iraq, Kuwait, the Libyan Arab Jamahiriya, Qatar, Saudi Arabia, and the United Arab Emirates) and 30 per cent for other OPEC members.31 The share of oil export revenues to total public revenues for the Gulf countries ranged between 85 and 95 per cent and for others, between 55 and 75 per cent; for the “net oil exporters,” the average was 37 per cent.

In addition to oil, several countries in the larger population group are endowed with other raw materials (Indonesia with wood, rubber, and tin; Iran with copper and chromium; Venezuela with iron ore; Nigeria with cocoa and coffee). There are those with a fairly large supply of agricultural land and water resources (Algeria, Indonesia, Iran, Iraq, Nigeria, and Venezuela), and there are a few with a moderately promising industrial base (Algeria, Iran, and Venezuela).

Per capital GNP (1980) ranges from $430 in Indonesia to $19,800 in Kuwait and $26,850 in the United Arab Emirates. Balance of payments positions are also quite different. During 1973–80, six countries—Iraq, Kuwait, the Libyan Arab Jamahiriya, Qatar, Saudi Arabia, and the United Arab Emirates—sustained substantial annual surpluses on current account; their cumulative surplus amounted to $330 billion, with Saudi Arabia and Kuwait accounting for $210 billion. Iran also recorded surpluses in the same period (except in 1978 and 1980) for a cumulative total of about $34 billion. Nigeria and Venezuela had much smaller cumulative surpluses, amounting to $6 billion and $5 billion, respectively.32 On the other hand, Indonesia had a cumulative surplus of only $0.2 million and Algeria a cumulative deficit of about $10 million. (See Tables 6 and 7.) Unlike the cumulative surpluses owned by the six surplus countries and their sizable investment income, other oil exporting developing countries (e.g., Algeria, Ecuador, Indonesia, Iran, Nigeria, and Venezuela) had a combined external public debt of about $76 billion at the beginning of 1980 and a debt service burden of $8.5 billion a year.33

Table 6.

Oil Exporting Developing Countries: Role of Oil in Current Account Balances, 1973–81

(In millions of U.S. dollars)

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Sources: International Monetary Fund, International Financial Statistics (IFS), and staff estimates.

As a surplus country prior to 1980, Iraq is classified as a low absorber in IFS. But in terms of productive capacity it should be treated as one of the high-absorbing oil exporting developing countries. See Tables 10–15.

Table 7.

Oil Exporting Developing Countries: Current Account Balances, 1973–80

(In millions of U.S. dollars)

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Source: Fund staff estimates.

See footnote to Table 6.

Owing to their particular resource endowments and export characteristics, the oil exporting developing countries face a number of rather special development problems requiring tailor-made strategies. Considerations based on the concept of oil reserves as assets (rather than income) are likely to emphasize the creation of viable, productive, non-oil wealth. Objectives favoring diversification (and in most instances, deliberate industrialization), in turn, require, initially at least, a substantial degree of government initiative, direction, and guidance. Different absorptive capacities for deliberate economic development also pose a number of serious economic, social, and political problems related to the tempo of progress and the nature of capital formation.34

Absorptive capacity is both a relative and a dynamic concept.35 All countries, if subjected to large and prolonged expansion of demand are likely to encounter supply bottlenecks of one type or another that may produce inflation, slow down the rate of growth, and worsen the balance of payments. All countries, too, given sufficient time and appropriate investments in infrastructure, human resources, and technological improvements are bound to reduce their absorptive constraints. This is particularly true for the initial shortage of skilled labor and the antiquated state of technology.

In discussing the oil exporting developing countries’ absorptive capacity, a distinction must at the outset be made between two groups. The first group—Kuwait, the Libyan Arab Jamahiriya, Qatar, Saudi Arabia, and the United Arab Emirates—is commonly referred to as “low absorbing” oil exporting developing countries. They are characterized by relatively small populations, large per capita GNPs, and large per capita oil reserves, but also by small farmlands, relatively few complementary resources, small markets, and an acute shortage of skilled manpower. The second group—Algeria, Iran, Venezuela, Nigeria, and Indonesia—is often referred to as “high-absorbing” countries. They have larger populations and relatively smaller per capita proven oil reserves, but have a larger skilled workforce, other minerals, some good agricultural land, relatively good water resources, and a generally more diversifiable economy.36

The essential differences in absorptive capacity are likely to affect the choice of domestic development strategy, particularly the rate of oil production, the level of current aggregate consumption, the magnitude of net domestic capital formation, the type of domestic investment project, and the size and direction of foreign investment.

In some respects, to be sure, the “high-absorbing” and the “low-absorbing” oil exporting developing countries share certain common fortunes and face certain common problems and choices. This universality of destiny, interests, and alternatives is rooted in the nature of oil. The phenomenon of exhaustibility, for example, presents the two groups of countries with the same thorny issue of the intergenerational comparison of utility (i.e., an increase in current income and consumption versus replacement of the depleting resource base for future generations through equivalent investment in financial or real assets). A similar welfare issue arises with respect to oil conservation (i.e., the rate of extraction and export). If, for instance, the rate of return on the proceeds of an additional barrel of oil export (in either domestic or foreign investment) should, for any reason, be below the discounted future value of oil underground, the rational alternative for both the high absorbers and low absorbers would be restraint in production. It makes no difference if one has little or much to invest if the return is negative.

The same uniformity exists with respect to the effect of “fiscal linkages” or public ownership of oil revenues. The very fact that in all OPEC countries oil export earnings flow directly to the national treasuries would place the responsibility for domestic disposition of oil income (the internal adjustment) or for its recycling (the external adjustment) squarely on the shoulders of national authorities in both the high absorbers and the low absorbers. In neither group will the extra oil receipts be automatically adjusted through larger induced imports or foreign investments; they will have to be appropriated by the authorities either directly on defense or development purchases abroad or indirectly through official transfers to the private sector. In both the high-aborbing and the low-absorbing economies, the government would allocate the new extra revenues from oil exports to competing alternatives at home or abroad. Investment decisions by the authorities in both groups would be subject to similar payback considerations, sociopolitical pressures, and other long-term national interests.

The same is not true, however, of the oil exporting developing countries’ other characteristics. The high and the low absorbers, for example, do not have the same degree of dependence on petroleum income. And the degree of dependence on oil revenues makes an enormous difference in the choice of domestic development strategy. The high absorbers that may also possess other non-oil export industries need not be overly concerned about additional import financing requirements for their new investment or other outlays. When there is a temporary drop in oil incomes, they can always rely on their other export proceeds. They enjoy greater freedom of choice not only in their investment decisions but also in their public consumption expenditures.

The high absorbers that have no supplementary foreign exchange receipts may have to be more cautious in their financial commitments at home or abroad. The current high absorbers, for example, have small proven deposits and a large capacity for agricultural and industrial development; they are in need of large quantities of capital goods imports, and they are often rather low in foreign exchange reserves in proportion to their import needs. For these high absorbers, whose development plans are frequently geared to an expected growth of oil incomes (in higher prices or increased output), any significant drop in foreign exchange earnings may become disruptive. Vulnerability to fluctuations in non-diversified export earnings in the early years of economic development can be a major problem for them. The risks of a future decline in exchange receipts naturally affect their choice of projects with a long gestation period, projects involving investment in human capital, allocation to nontradable goods, social welfare programs, et cetera.

Low-absorbing countries, whose oil revenues frequently exceed import finance needs, and whose liquid foreign exchange assets are comfortable, can afford to discount such uncertainties in their development planning. Most of the countries in this group, hedged in as they are by significant diversification constraints in terms of limited agricultural resources and native labor, are likely to choose oil-related capital-intensive industries (petrochemicals, gas liquification, etc.) or go into nontradable supporting and service industries (construction, banking, trades, etc.).

A widely different outcome may also be expected to emerge from exchange rate behavior. A sustained annual balance of payments surplus, not deliberately “sterilized” by the government, is bound to push the oil exporting country’s exchange rate upward—directly, if oil was priced in local currency and the local currency was floating; indirectly, if oil was paid in foreign exchange and the local currency was pegged. In the first instance, the nominal exchange rate would continue upward as long as current account surpluses persisted. In the second case, the real exchange rate would appreciate through increases in the domestic price level. An effective appreciation of the exchange rate would thus have a dampening influence on the international competitiveness of non-oil exports.37

For the low-absorbing countries that have little non-oil export potential, exchange rate appreciation may not be of major concern—at least until absorptive capacity is expanded. The higher exchange rate may in fact help the economy through lower import prices in terms of the local currency and lower inflation. But the high absorbers may find a unified overvalued currency as a major impediment to their export diversification, as well as to import substitution efforts.

Equally divergent results may be expected from each group of countries in the matter of oil “rent.” Since the rent is based on the effective price of crude oil in world markets, and the oil price is affected by world demand and supply for various forms of energy, there is always a significant measure of uncertainty about the continuity and magnitude of the rent itself. This uncertainty is bound to evoke different reactions from each oil exporting developing country.

The oil exporting countries with high production costs for crude (whether or not they are low or high absorbers and regardless of their petroleum reserves) will be more seriously affected in their net terms of trade than the low-cost producers, since the oil rent (i.e., the “windfall” gain) fluctuates with oil prices.

To the extent that expenditure and investment decisions are made more carefully or in a more relaxed fashion, depending on the nature of the “gains” from trade, the low-cost oil exporters may have an edge over the other group.

Development Strategy and International Comparative Advantage

For many years after World War II, the oil exporting countries seem to have been self-conscious, and clearly concerned, about the fact that their oil sector, as the main source of their material prosperity and modernization, was for the most part an alien sector. It was alien in its ownership, control, management, production, pricing, marketing, and downstream operations.38 Both the authorities and their political oppositions appear to have seen this alienation in the absence of forward and backward linkages between the oil industry and other sectors of the economy. In their view, the petroleum industry had in no way been meaningfully integrated into the national economies.

Integration has essentially meant an interlinking of the oil sector with the traditional segments of society. This popular strategy, in turn, has called for three specific paths: (i) a mandatory commitment by the oil industry to procure as much of its needs as possible from domestic sources; (ii) the maximum possible use of crude oil and gas as raw materials for domestically manufactured products (the so-called aspirin and nylon stockings path); and (iii) the maximum addition of domestic value to crude oil for export in “higher forms.” This integration strategy has required the use of crude oil in the manufacture of petrochemicals and fertilizers and in other nonenergy uses—under the “oil-is-not-for-burning” philosophy. It has also meant using flared natural (associated) gas as an energy source for the direct conversion process in metallurgical industries (aluminum refining and iron ore reduction).39

Although on the surface this strategy appears sensible on the grounds of comparative advantage and the feasibility of resource-based industrialization, its overall profitability, and universal applicability to all oil exporting developing countries, has been subject to question and qualification. In the countries with relatively small populations and workforces, inadequate farmlands and water supply, little or no non-oil resources and activities, and few services needed by the oil industry (e.g., Kuwait, the Libyan Arab Jamahiriya, Oman, Qatar, and the United Arab Emirates) the possibilities of backward or forward linkages would be limited. Severe shortages of skilled labor, the difficulties of adopting modern technology, and other internal market constraints would not make a large-scale use of petroleum for nonenergy production a viable short-run option. The maximization of domestic value-added in oil and gas manufacturing through further refining, processing, and petrochemical products would be possible for only a few capital-rich oil exporting developing countries (e.g., Saudi Arabia). Even where capital is relatively plentiful (e.g., Kuwait, Saudi Arabia, and the United Arab Emirates), the ultimate profitability of oil-based industries would depend (in addition to assured supplies of low-cost oil and gas) on the existence of a competitive edge in the costs of a number of other complementary variables (e.g., costs of transporting finished and semifinished products, capital construction costs, relative wages, costs of “borrowed” technology and management, financial costs, and the degree of capacity utilization).40 The successful pursuit of resource-based industrialization would thus demand comprehensive and careful planning, investment in higher education, advanced manpower training, and other requirements of capital-intensive, sophisticated technologies. A very long lease on “oil life” is needed, since these industries cannot, obviously, substitute for oil once petroleum reserves are exhausted; also required is a nonprotectionist world trading system.

From a general and purely common-sense viewpoint, an appropriate long-term strategy for the high-reserve countries with small populations and limited non-oil resources (e.g., Kuwait, the Libyan Arab Jamahiriya, Saudi Arabia, and the United Arab Emirates) would presumably lie in the petroleum-based, capital-intensive industries involved in oil refining and processing and related activities. For the nations with sizable populations and low per capita oil wealth but sufficient non-oil resources (e.g., Algeria, Indonesia, and Nigeria), a strategy that emphasizes agricultural development and the development of labor-intensive industries would seem more appropriate. Other “in-between” nations (Iran, Iraq, and Venezuela) could follow a combination of import-substituting industries and other domestic resource-based undertakings (including agriculture).

A more specific analysis of macroeconomic policy, however, must identify exactly where comparative national advantage lies, and whether and how it is likely to change over time. Broadly speaking, both trade theory and empirical work suggest that a country’s comparative advantage will be determined by its relative endowments of physical and human capital. Further, by investing in physical and human capital, a country can over time change its comparative advantage to some degree.41

Unfortunately, most of the empirical work on identifying and testing for comparative advantage has excluded the oil exporting developing countries, partly because of the difficulties associated with classifying and measuring the capital endowment represented by their oil reserves. A recent study has, however, addressed directly the comparative advantage issue for mineral exporting countries.42 Four measures or classification indices are considered for oil exporting developing countries. The first, and central one, is an index of long-run capital stock per capita, which has three components: (i) present physical capital stock per capita; (ii) the size of mineral reserves; and (iii) the long-run terms of trade (using World Bank projections for 1985). By adding present capital stock per capita to the value of mineral reserves per capita, the index of long-run capital stock per capita is obtained. Countries are then divided into high-, moderate-, and low-capital groups based on the value of this index. (See Table 8.) The countries in the high-capital group (e.g., Kuwait and Saudi Arabia, with more than $50,000 per capita) are judged to have much better prospects for oil-based exports and for capital-intensive resource-based industrialization than those in the low-capital group (e.g., Algeria, Ecuador, and Indonesia, with less than $10,000).

Table 8.

Selected Oil Exporting Developing Countries: Comparative

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Source: Gabind A. Nankani, “Development Problems of Mineral Exporting Countries,” World Bank Staff Working Paper, No. 354, International Bank for Reconstruction and Development (Washington, 1979).

See the qualifications referred to on page 25.

Skilled labor in the oil exporting developing countries is taken by Nankani to be best represented by the Harbison-Myers index of human-resource development.43 As updated in Harbison, Maruhnic, and Resnick, this index is the sum of the country’s unadjusted rate of enrollment in secondary schools plus an arbitrary weight of five times the rate of enrollment at university level. The higher this index, the greater the country’s potential for skilled, labor-intensive manufacturing.44

Agricultural potential, or availability of land, has as a proxy in the Nankani study an index of population density per square kilometer of agricultural land. Because this measure does not allow for quality differences in land and water availability, it is only a crude measure of agricultural potential and not always a useful one. While the index differentiates between those oil exporting developing countries with low agricultural potential (Saudi Arabia, the Libyan Arab Jamahiriya, Kuwait) and those with higher potential (Venezuela), it is perhaps inadvisably biased against others (Gabon) with moderate to good agricultural prospects.

The final classification index is domestic market size, which is measured by population. The larger the size of the domestic market, the less necessary it will be for the country to engage in international trade to reap economies of scale and to provide markets for its non-oil output.45 Again, as indicated in Table 8, the market size criterion helps to differentiate between the large oil exporting developing countries (like Indonesia, Nigeria, and Iran) and the smaller ones, but significant reservations about the identification of large populations with large effective demand still remain.

The next step in Nankani’s analysis is to use the various indices to group the oil exporting developing countries into several subgroups, where the countries in each subgroup share similar factor endowments and market sizes. More specifically, there is a small, high-capital group that includes Kuwait, Saudi Arabia, the Libyan Arab Jamahiriya, and Gabon. This group’s relatively high capital stock per capita indicates a strategy of resource-based, capital-intensive industrialization. Thus, this group’s long-term comparative advantage would be in processed oil-based exports, provided that investment is also made in research and development and education and training of the labor force.

The large, moderate-capital group includes such countries as Iran. This group’s capital endowment (oil reserves) is less favorable than that for the high-capital group, and its larger population implies a need to develop agriculture and small-scale enterprises along with resource-based industrialization in order to solve the employment problem. The larger domestic market also provides more scope for import substitution and for more broadly based industrialization.

Oil exporting developing countries like Venezuela and Iraq fall into the small, moderate-capital group. They have the same general relative factor endowments as the large, moderate-capital group but not the latter’s advantage of a large domestic market. They, therefore, have to be more export oriented.46 Also, they need to adopt a more diversified export structure, combining selective resource-based industries, labor-intensive manufacturing, and agricultural exports (where possible).47

The last two subgroups are the large, low-capital group (Algeria,48 Nigeria, Indonesia) and the small, low-capital group (Ecuador). These groups’ mineral reserves per capita are clearly too small to permit a strategy of relying on resource-based industrialization and on capital-intensive export products. Also, the relatively short-lived character of their oil reserves makes high savings rates more important than in other groups. Diversification is crucial in these countries, not only for providing export earnings when the oil runs out but also for providing employment for the domestic labor force. Labor-intensive manufacturing can play a particularly useful role in the smaller, more skill-abundant of these economies.

A broad picture of the types of industrial activities that are relatively labor intensive and that are relatively capital intensive is provided by Balassa (see footnote 41, above), showing that apparel and textile products, leather and leather products, and stone, clay, and glass products are relatively labor intensive. Capital-intensive industries include petroleum and coal products, paper and allied products, chemicals, and primary metals.

At least two important caveats should be kept in mind in appraising the conclusions of such a “two-factor” analysis of comparative advantage in oil exporting developing countries. Decisions taken over time are likely to have a subsequent and perhaps overriding impact on comparative advantage in, say, a decade from now. By making the right investments (e.g., in the educational system), a country can to some extent alter its comparative advantage. In the real world, factors of production are imperfect substitutes, and subject to greater or lesser mobility. Transportation, construction, and management costs can be important enough in certain resource-based industries to eliminate or greatly reduce the comparative advantage from relatively abundant supplies of capital. Similarly, financial capital may not confer the same comparative advantage in real economic activities as does physical capital; nor is imported labor likely to be a perfect substitute for an indigenous work force. Further, even if overall labor requirements in a capital-intensive industry are low, the required skill categories may be in such short supply that a medium-term bottleneck will occur. All of these factors operate in oil exporting developing countries to make the identification of “dynamic comparative advantage” more complicated and multidimensional than simply ranking industries by their capital-labor ratios (however defined).

Sociopolitical Desiderata

The policy mix chosen by individual oil exporting developing countries often transcends national economic and technical considerations. In addition to the fact that oil incomes in all these countries accrue to the government, and there is thus an intrinsic tendency for the size of the public sector to expand, the state’s clearly “interventionist” role in the economy (and to that extent, the choice of economic policies) also depends on the broad political ideology and economic structure adopted by each country. Two oil exporting developing countries, faced with the same domestic proprietary rights with respect to national oil reserves, and the same global oil demand and supply situation, may nevertheless have different political philosophies on public controls versus reliance on market forces. And the choice of particular decision-making mechanisms will determine the approach to economic development that each will follow. Basic political philosophy may thus sustain or override considerations based on factor endowments or comparative advantage.

Not infrequently, the fundamental stance of domestic development strategy is also affected by internal pressures of sociopolitical circumstances, by certain attitudes toward major oil importing countries, and, in OPEC countries, by certain collective commitments within the organization. Specific choices again differ from one oil exporter to another, but there are certain common features.

Domestic Constraints

The choice of development strategy does not always work out to be an optimization of returns on domestic investments. The common objective of sustainable growth is often tempered by such other notions as “balanced growth” or “social welfare,” however defined. For example, popular pressure in all oil exporting developing countries, and particularly in the capital-surplus group, demands that the largest possible percentage of the present population share in the benefits of oil. However, owing to the shortages of skills and experience needed for such wealth sharing by the majority, welfare-optimizing measures often translate into the free or below-cost supply of public services, or substantial public subsidies for food, housing, and fuels. These efforts, while perhaps morally laudable and certainly politically popular, may interfere with other national objectives. Significant attention to welfare via transfer payments, for example, may often result in the too familiar stifling of work incentives, and in the reduction of industrial competitiveness. Similarly, the concentration of oil-income expenditures in the government’s hands may result in “crowding out” the private sector in the areas in which the latter has a discernible superior efficiency (e.g., retailing and residential construction).

Again, while the continuation of public planning and allocation may be supported by the majority of the people in the short run, it is not certain whether long-term national interests and the welfare of future generations will be properly served. Furthermore, in the early stages of planning following sudden oil price increases and the resulting “revenue boom,” there may be hasty allocations of petroleum revenues to politically popular activities, “prestige” projects, or projects with inadequate feasibility studies. And such sociopolitically triggered, and “unavoidable,” investments, in turn, may fail the tests of competitive productivity. Still further, the tendency (commonly observed in almost all oil exporting developing countries) to keep domestic energy prices well below world market levels (largely for the overt purpose of keeping inflation down) may have the unfortunate consequence of misallocating productive factors into (subsidized) energy-intensive industries. Such misallocations, in addition to obstructing a balanced process of domestic industrialization, can lead to inefficient specializations and international trade conflicts.

Oil exporting developing countries are also torn between some inherently contradictory forces in the pursuit of their development strategies. On the one hand, there is a penchant toward participatory democracy—often explicitly advocated by the national leadership—requiring some degree of decentralization of authority. On the other hand, there is an urgent need for rapid capital accumulation in non-oil sectors—demanding a large measure of central planning and direction. Democratization and decentralized management are usually accompanied by significant social pressures in favor of income redistribution and rising consumption. The requirements of capital formation, by contrast, call for certain constraints on consumption and some initial tolerance of growing income gaps among major social groups (i.e., rural versus urban population). The reconciliation of these opposing forces is not easy.

External Considerations

The decision by many oil exporting developing countries regarding oil production versus conservation does not always follow domestic physical or financial needs; it also varies at different times and under different circumstances. Decisions based on the economic issues related to lengthening the life span of domestic proven oil reserves, supporting international oil prices, and protecting returns from foreign investments are familiar. Apart from these, however, other, noneconomic, considerations often loom large in domestic output policies. Among these considerations are an intelligent recognition and response to changes in the international political climate; a longer-term global energy perspective instead of short-term national self-interest in immediate oil export benefits;49 certain special military and diplomatic relationships with friends, allies, and trade partners; and adherence to certain collective positions (e.g., of pre-eminence or neutrality) within a regional or functional bloc.50

Foreign investment decisions, too, are based on a variety of objectives—not necessarily all economic or financial. Surpluses are kept in foreign private banking or financial institutions, not always under strict calculations of effective yields or predictable risks. Transactions often take place because of traditional ties with the recipient country, familiarity with the overseas country in question, personal contacts, or a middleman’s aggressive salesmanship. Those “noneconomic” attitudes and practices have sometimes resulted in financial losses to the national treasuries.

Collective Commitments

The major oil exporters do not constitute a cohesive or united bloc. They represent differences in ideology, political alliances, long-term national interests, and special ties with other countries. Nor are they collectively capable of sharing markets, or even exercising a firm production grip on unified pricing. For some countries, the role of petroleum in the global energy picture is more important than its price; for many, the reverse may be the case. Still others put more stock in ideology than in monetary gain. In short, a single unifying purpose holding the oil exporting developing countries together has always been somewhat tenuous and strained.

Yet, OPEC members—while never failing to emphasize their sovereign rights in the matter of production and pricing—nevertheless observe certain common, albeit voluntary, rules. With some notable exceptions in the oil-glut environment of 1982–83, they have refused to cut official prices below the established floor, even though such actions had long been advocated by oil importers and were perhaps economically rational for individual members’ national interests.51 In the consensus achieved among all OPEC members at the ministerial meeting of October 1981, some members agreed for the first time to lower their oil prices (and to adopt a range of price differentials) in order to serve the common purpose of reinstating a unified base price for crude (at US$34) after two years of multitier pricing.52 Some OPEC members have in recent years sought to establish a long-term price strategy under which future crude oil prices, once unified, would be linked to oil importing countries’ economic growth, inflation, and costs of developing alternative energy sources. While such a programmatic, disciplined, and gradual price increase may not be equally beneficial, a search for the mechanism of implementing such a strategy was unanimously approved at the ministerial meeting on May 24, 1981.53

Twelve of the 13 OPEC members agreed in May 1981 to voluntarily cut production in order to reduce the existing oil glut even though some poorer members (e.g., Nigeria) were in tight financial straits. In March 1982, they agreed on production ceilings for each member to support crude oil prices at existing levels. A continued sharp drop in industrial demand for OPEC oil, however, coupled with a larger than usual drawdown of world stock by the major oil companies in the 1982–83 winter, forced some financially drained members to increase output beyond allocated quotas and to deviate from previous production-sharing arrangements.

There are other examples of production and price decisions by OPEC members in the observance of their collective commitments. Some members, for example, participated in the 1973 collective oil embargo against certain Western countries on purely noneconomic grounds, and again out of solidarity with one another. In March 1982 when Nigeria was under pressure to lower its oil prices, some OPEC members threatened to cancel their crude oil supply contracts with those oil companies and to persuade other members to do the same. The pressure produced the intended effect. Finally, two major oil exporters—Mexico and Venezuela—agreed under the 1980 San José accord to defray the import costs of total petroleum consumption (i.e., 160,000 barrels a day) by nine Latin American and Caribbean countries on grounds of regional solidarity and cooperation.

16

See Abbas Alnasrawi, “OPEC: The Cartel That Is Not,” OPEC Bulletin, Vol. 12 (February 1981), pp. 1–7.

17

While this portrayal may be true to form, it has not always been correct in substance. There is a growing recognition by oil analysts that official OPEC prices have frequently followed the spot market, particularly on the upside and with some stickiness on the downside. Accordingly, the largest increases in crude prices have come as a result of politically inspired supply disruptions rather than specific pricing decisions by OPEC; and OPEC members have been able to raise prices only when market forces have permitted it.

18

Abstracting from philosophical considerations, the problem for the oil exporting developing countries (as for all others) is “wealth management” and “portfolio placement.” Differences in the allocation of depletable resources are largely dictated by sociopolitical or other national priorities.

19

See Harold Hotelling, “The Economics of Exhaustible Resources,” Journal of Political Economy, Vol. 39 (April 1931), pp. 137-75.

20

Empirically, mineral price changes have generally not been highly correlated with rates of interest; but for oil, the correlation, although indirect, cannot be assumed to have been totally absent. See Hendrick S. Houthakker, The Use and Management of North Sea Oil, Harvard Institute of Economic Research, Discussion Paper No. 697 (Cambridge, Massachusetts, April 1979).

21

See Gobind T. Nankani, “Development Problems of Mineral Exporting Countries,” World Bank Staff Working Paper, No. 354, International Bank for Reconstruction and Development (Washington, 1979).

22

Houthakker (pp. 24-25; cited in footnote 20) provides a succinct statement of the chief danger associated with the conservation strategy: “… excessive unanimity among speculators tends to be destabilizing because any disappointment in their price projections leads them to take corrective action more or less simultaneously. Concretely, if the world oil price fails to rise appreciably in real terms countries that have held back may suddenly decide they are missing the boat. Countries that let development take its course, on the other hand, may forego some additional returns if the price does go up sharply, but they are also less vulnerable to disappointment.” For a less pessimistic outcome, see Robert M. Solow, “The Economics of Resources and the Resources of Economics,” American Economic Review, Vol. 64 (May 1974), pp. 1-14.

23

To the extent that views about the future price of oil differ significantly between market participants, there is the opportunity for a futures market in oil to develop. Such a market would permit the oil exporting developing countries to eliminate the risk attached to future changes in the price of oil, though of course at the cost of accepting uncertainty about the future purchasing power of the means of payment for the oil. This latter kind of uncertainty could be avoided only if a futures market also existed in the products that the oil exporting developing countries wished to import. There have been examples of long-term contracts that link capital equipment to oil supplies, but these have not been common. More generally, where long-term contracts have been negotiated for oil, they have typically assured quantities rather than prices.

24

To take just the most obvious examples: importation of cement for construction will be very costly if it is undertaken before port and road facilities are in place, and university training is unlikely to provide the required skills unless there is adequate primary and secondary education; or, the large increase in the share of the service sector in many oil exporting developing countries, particularly in real estate and construction, may contribute little to diversifying the productive base of the economy or upgrading labor skills.

25

A typical manifestation of such wrong price signals is the temptation to counteract the adverse effects of currency appreciation on the competitiveness of the traded goods sector by keeping domestic energy prices deliberately low to encourage energy-intensive industrialization.

26

A recent review of the role of state intervention in the industrialization of developing countries concludes that there is a selective role to be played by both the state and the private sector in the process of industrialization, but also that many such countries have erred on the side of too much intervention. See Armeane M. Choksi, “State Intervention in Industrialization of Developing Countries: Selected Issues,” World Bank Staff Working Paper, No. 341, International Bank for Reconstruction and Development (Washington, 1979).

27

The real price of oil is defined as the average price per barrel received by the oil exporting developing countries divided by the average unit value of their imports.

28

It should also be noted that the base for the calculation of the “real” price of oil, as well as the methodology for measuring the real return on oil kept underground, are both subject to debate.

29

See Homa Motamen, “Economic Policy and Exhaustible Resources,” OPEC Review, Vol. 3 (March 1979), pp. 45-75, and Expenditure of Oil Revenue: An Optimal Control Approach with Application to the Iranian Economy (New York, 1980); see also Nankani (cited in footnote 21).

30

By contrast, the share of the major single commodity in the total exports of a sample of 41 non-oil developing countries averaged less than 51 per cent in 1978.

31

The corresponding 1980 ratio for other net oil exporters was 13 per cent and for the 41 non-oil developing countries, 17 per cent (1978).

32

Officials of the oil exporting countries generally take exception to the standard treatment of oil extraction as a “productive activity” generating added value, and thus to such international comparisons. Contending that oil extraction is simply a replacement of one capital asset by other assets, it is argued that comparisons of GNP per capita among countries are fundamentally flawed as long as the net “income content” of oil receipts is not properly distinguished from gross receipts; by the same token, it is held that external surpluses should not be treated as though they were surpluses on current account resulting from current production.

33

See “Oil: Myth and Reality,” OPEC Bulletin, Vol. 12 (April 1981), pp. 29–32.

34

The plight of the oil exporting developing countries in this respect is dubbed “the disease of the rich” and their problems as “golden ones,” making them essentially different from those of non-oil poor.

35

In the framework of this study, absorptive capacity refers only to the ability to absorb capital productively, that is, the possibility of rational and efficient real domestic investment in physical and human capital. It clearly excludes such notions as the “capacity” to import goods and services, or the “capacity” to spend oil revenues in one way or another. For this reason, some of the so-called low absorbers, who have contributed more to petrodollar recycling in the past several years than their opposite numbers (largely because of their relatively larger foreign expenditures), are still classified as “low absorbers” simply because of their underlying physical and resource conditions. For a more detailed discussion of this misconception, see El-Serafy (cited in footnote 14).

36

Iraq, despite its large potential for development, has been a “capital surplus” country for many years and thus sometimes is pictured, not quite accurately, as a “low absorber.” Oman, despite its meager non-oil resources, has been a capital deficit nation and thus by implication included among the “high absorbers.” (See Tables 6 and 7.)

37

The literature on the subject speaks of a “mineral rent cycle” during which the exchange rate would first rise, parallel to the rise in aggregate rent, and would later start declining along with the gradual depletion of the mineral base. But it offers no solution to the nonviability of other exports at early stages of rising mineral exports.

38

See Y.A. Sayigh, “A Second Look at Arab Oil,” Middle East Forum (January 1957).

39

A so-called need-oriented and self-reliant view of integration calls for a strategy that would attempt to (i) meet “basic national needs” of individual oil countries instead of imitating “Western” patterns of production and consumption; (ii) discourage oil production and export not needed for financing internal development; (iii) acquire “real” technological capability instead of borrowing it from abroad; (iv) eliminate dependence on expatriate workers; (v) reduce the income gap inside individual countries; and (vi) seek isolation of the domestic economy from the “menace” of “existing world order.” See Y.A. Sayigh, “Commentary,” in OPEC and Future Energy Markets, the Proceedings of the OPEC seminar held in Vienna, Austria, in October 1979 (London, 1980), pp. 182–88.

40

See Louis Turner and James Bedore, “The Trade Politics of Middle Eastern Industrialization,” Foreign Affairs, Vol. 57 (Winter 1978/79), pp. 306–22.

41

In a study of comparative advantage in 18 developed and 18 developing countries, it was concluded that: “the empirical estimates show that inter-country differences in the structure of exports are in large part explained by differences in physical and human capital endowments. The results lend support to the ‘stages’ approach to comparative advantage, according to which the structure of exports changes with the accumulation of physical and human capital.”—Bela A. Balassa, “A ‘Stages Approach’ to Comparative Advantage,” in Economic Growth and Resources, Vol. 4, Proceedings of the fifth world congress of the International Economic Association, Tokyo, Japan, 1977 (International Economic Association, London, 1979).

42

Nankani (cited in footnote 21). For the purpose of this paper, what is useful about Nankani’s results is the methodology employed rather than the precise country composition of the subgroups (which might be altered if more up-to-date data or alternative measures of capital and skilled labor were used).

43

See Frederick N. Harbison, Joan Maruhnic, and Jane R. Resnick, Quantitative Analyses of Modernization and Development (Princeton University, 1970).

44

Unfortunately, the latest available data for the Harbison-Myers index are for 1965; thus, the heavy investment in education undertaken by some Gulf countries after 1973 are not included in these figures. To the extent also that university education in most oil exporting developing countries is not carefully coordinated with national defense and development goals, the Harbison-Myers index substantially obscures the true picture.

45

Owing to the enormous gaps between per capita income in the oil exporting developing countries, the size of the market in terms of population, that is, actual or potential needs instead of effective demand, may not be considered a good index.

46

See Nankani (cited in footnote 21).

47

For those oil exporting developing countries that do have good agricultural potential, it is important to prevent inadequate producer prices, import protection for manufactures, urban bias in government spending, and real exchange rate appreciation from leading to excessive migration out of agriculture. In most such cases, a good argument can be made for increasing the share of oil revenues spent on the agricultural sector. See Alan H. Gelb, “Capital-Importing Oil Exporters: Adjustment Issues and Policy Choices,” World Bank Staff Working Paper, No. 475 (Washington, 1981).

48

If Algeria’s vast gas reserves were to be taken into account, however, the classification would be very different.

49

A prime example of such strategy is Saudi Arabia’s often stated policy of keeping oil prices stable over the years in order to cushion the international economy against detrimental difficulties in forecasting economic costs.

50

OPEC members have on more than one occasion declared their willingness to work with both the developed and developing countries in the search for new sources of oil and energy, although such cooperation could presumably help to break their own stronghold on the oil market.

51

A communiqué by the four African members of OPEC in June 1981 reaffirmed their determination not to lower their oil prices, and to respect the OPEC decision regarding the price freeze.

52

In the 1982–83 weak oil market, however, some members cut prices through discounts and other subtle means below the official level. In February 1983, Ecuador and Nigeria under severe financial pressures broke ranks with the other OPEC members, for the first time in the history of the organization, and refrained from observing OPEC’s official benchmark price.

53

For a discussion of this strategy, see Walter J. Levy, “Oil: An Agenda for the 1980s,” Foreign Affairs, Vol. 59 (Summer 1981), pp. 1079–1101.

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Cover Oil Exporters' Economic Development in an Interdependent World
Oil Exporters' Economic Development in an Interdependent World
ISBN:
9781557750785
ISSN:
0251-6365
Publication Date:
06 Apr 1983
Publisher:
International Monetary Fund
DOI:
https://doi.org/10.5089/9781557750785.084
Pages:
112

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