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Opinions of Monday, 31 May 2010

Columnist: Adam, Mohammed Amin

How Oil Boom Becomes Oil Doom


Mohammed Amin Adam

Oil Coordinator – Publish What You Pay Ghana


Ghana’s oil find in commercial quantities has been an exciting story. However, judging by the way other resource rich countries managed their resources, there are serious doubts as to whether oil can be a window of development opportunity. Our country has faced significant economic challenges since independence. Even though we recorded our highest growth rate of 7.3% in 2008, this was at the expense of stability. Economic growth is important for a country’s development but growth does not necessarily lead to development. Ghana has therefore been faced with the growth-development paradox.
Ghana since the Economic Recovery Programme, through the Structural Adjustment Programme and then to the Poverty Reduction Strategy Support, has had an obsession for stabilization. The reason has been our inability to change the structure of the economy and therefore any signs of instability affect all sectors of the economy. The level of economic diversification has been negligible. It was therefore not surprising that the highest growth rate in our history also produced the highest fiscal deficit of more than 14% of GDP. This compelled Ghana which weaned itself from the IMF and raised about US$750 million from the capital market to go back begging the IMF and the World Bank for financial support.
The global financial crisis brought capital shortages in the global capital market whilst remittances to the country reduced by more than 40%. At the same time, our exports became cheaper due to the sharp depreciation of the local currency and therefore export receipts were negatively affected.
Furthermore, Ghana’s renewed romance with the international financial institutions following the global financial crisis has serious implications for debt vulnerability and there is strong likelihood of the country being drawn to unfavourable debt sustainability levels.
With oil revenues estimated at US$1 billion annually coming into the Ghanaian economy, the question that bothers many is whether these economic challenges the country continues to face will be surmounted. Will oil revenues and petroleum resources be a new window of development opportunity or a new hope of elusive opportunity? Terms like the ‘paradox of plenty’, the ‘devil’s excrement’, and ‘resource management curse’ have been used to describe how countries squandered their resource opportunities at the expense of their economic, social and environmental sustainability, thus the worry of the author – ‘How oil boom becomes oil doom’.

Since, the announcement of commercial oil discovery, Ghana has been inundated with expert visits prescribing different models of resource management. Anthony Venables prescribed the big push spending model during his visit to Ghana whilst William Ross prescribed direct distribution of oil revenues to citizens. Professor Amoaku Tuffour advised a mixture of spending and an oil fund to ensure expenditure smoothing and intergenerational equity, a view also held by Breisinger et al. But how do these prescriptions address the major challenges the country prepares to confront with its oil boom?

1. The ‘Big Push’ approach
First of all, the big push spending model is good for countries with acute capital shortage such as Ghana who cannot have the luxury of saving much needed development financing. We also must not forget that in addressing capital scarcity, there are serious implications for the economy where absorbtive capacity is weak. This has been the reason for the ‘target revenue’ argument which requires countries to produce oil in quantities that will earn revenues sufficient for the absorption of the economy and leave the rest underground for its value to increase in future, a phenomenon referred to as the theory of resource exhaustibility.
In countries with weak absorbtive capacity, high spending of oil revenues in the economy which is not appropriately absorbed by the productive sectors becomes wasteful spending and thereby introducing inflationary pressures as well as cause real local currency appreciation and the consequence is a weakened local economy (the popular ‘Dutch disease’).
Another dimension of the Dutch disease is the possibility of more experienced workers migrating to the oil sector because of ‘good salaries’ which then reduces productivity levels in the non-oil sectors. With a weak non-oil sector, unemployment increases since the oil sector, usually an enclave economy cannot be a good substitute for the traditional economies of manufacturing and agriculture in terms of job creation.
These same prescriptions were recommended for resource rich countries during the oil boom of the 1970s. Several countries overspent unproductively, invested in ‘big-projects’ most of which were later abandoned, and some even resorted to excessive borrowing against the boom. Therefore, problems such as collapsed agriculture, overvalued currencies, heavy indebtedness and massive unemployment, were the doom that the oil boom translated to in oil rich economies of those years.

2. Direct distribution to citizens
This appears very good for its transparency and accountability mechanisms. By paying a certain sum of money to citizens every year, all citizens are likely to know how oil resources have been spent. It has also been praised for its contribution to increasing aggregate demand in the economy and also creating a taxable opportunity for government to mobilize revenues from what is paid to citizens.
But to say this model will work for a developing country will be an attempt to deny Ghana the full benefits of oil revenues. Ghanaians may receive about US$50 per year from 2011 which may grow to US$100 by 2013 if we adopt this approach. While this may be popular to many poor Ghanaians and will also certainly be politically ideal, its little economic benefits seriously undermine its suitability for a developing country such as Ghana. .
One major problem is that the receipts by citizens annually will be insignificant and unsustainable considering the levels of reserves in the country. Such receipts will also likely fall below the taxable income in the country and may therefore defeat the purpose of the ‘taxable opportunity’ argument. Due to crude oil price volatility and declining production, payments to the citizens will not always be the same. It will rise and fall. Thus, the cyclical problems created by the rise and fall of payments undermine macroeconomic stability.
Further, citizens may spend the money unproductively or use it to patronize imported goods which will have no direct productive advantage for the economy. Such a situation only heightens the inflationary spiral. What is even more dangerous is the temptation to create a ‘rentier mentality’ where citizens sit back and expect to be paid every year from resources that are depletable. The adjustment cost to post oil economy is always higher than ever imagined when the oil revenues are no longer flowing to the citizens.

3. Fiscal Rules
In the area of oil funds for purposes of expenditure smoothing to address volatility concerns through a stabilization fund, and for intergenerational equity through a permanent income fund, both government and the citizens strongly find good reason to support it. If the oil resources of the country will be enjoyed by all citizens including future generations, then it is only an opportunist who will oppose such a move. Fortunately, most government officials who have made pronouncements on this proposal often refer to Norway. What most people do not know is that Norway did not start its petroleum resource management with an oil fund. Norway invested heavily in infrastructure, education, and industrialization with its oil revenues for more than 20 years before establishing an oil fund in 1995.
Furthermore, the establishment of stabilization funds for the purpose of smoothening expenditures is purely a macroeconomic measure. But oil shocks also create structural imbalances which require reallocation of resources rather than follow planned spending in the budget. This negatively affects growth, while the additional expenditures only add to increasing inflation without addressing the effects of volatility in crude prices. There has been a proposal for a growth fund to cushion the economy against the structural effects of volatility. While this may appear useful, multiplicity of funds creates institutional difficulties which may only add to the bureaucracies in the public sector with a huge cost on the economy. It is therefore possible to use stabilization funds to solve both cyclical and structural imbalances. Perhaps it may be safe to call such a fund a ‘liquidity fund’ as proposed by Anthony Venables. In this case, liquidity shortages are addressed by countercyclical and structural adjustment spending.
The case of intergenerational funds is even without any strong basis. Why should we save our oil revenues outside the country when we could have spent it in areas that could contribute to long term growth? Thus, investments in areas such as education and technology development could contribute to both current demand and future growth in the economy. We can therefore achieve intergenerational equity without saving the money abroad but by making strategic investments with long term development objectives. The use of strategic in this case is deliberate. That is, we do not just allocate money to education generally for instance, but rather to specific education programmes that have strong multiplier effects such as girl-child education, technology education, etc. Venezuela has the largest budget in education among resource rich countries, but the doom of oil has engulfed the country for several decades now because of untargeted resource allocation to the education sector.
On the issue of investment decisions, I have seen the proposals put out by the Ghanaian government which includes; institutional capacity building, law and order and public safety, agriculture and agro-business, human resource development, infrastructure, rural development, alternative energy sources, and forestry management and protection of water bodies. These are all very relevant to the Ghanaian economy and to Ghanaians. But such generalizations do not help and especially if they are largely speculative. It is important to analyse the economy-wide impact of any priority spending area before making any proposals for resource allocation. Investment in industrialization for instance will have different effects on the economy from agriculture. There is empirical evidence as exemplified by Malaysia and Indonesia that industrialization has fast growth potential with slow redistributive effect whiles agriculture has slow growth potential with fast redistributive effect. Thus such analysis on the effect of oil revenues on the economy modelled along the long term development agenda of the country will be more appropriate than mortgage such important decisions to speculations.


1. Economic Base line
While it is important to adopt international best practices for the management of our oil revenues, wholesale application of models of other countries is dangerous. It is important that before first oil in December 2010, the country’s economic managers should produce baseline economic report describing the state of the economy before oil revenues and also conduct simulations of different scenarios of oil revenue based investments. This will guide how revenues will be allocated and deployed into the economy. In the absence of such analysis, the following investment proposals which have been highly researched in Ghana in terms of their social and economic benefits to our country should engage our attention under our current circumstances. We don’t need to do big things. Big things have little impact.
I also do not support bulk and blanket allocation of oil revenues by sectors through the budget as the government proposes to do. Several years of budget support from donor funds have only come to maintain the status-quo and therefore, we have been unable to measure the impact on our economy of donor financing of our budget by more than 30%. Specific programme financing should be the rule. This does not only maximize the impact of programme financing but also ensure monitoring and accountability.

2. Investment areas
(i). Girl-child education – Girls of today will grow to become women, mothers, family managers, business people, etc. Therefore, spending on programmes that support girl child education, increased enrolment of girls, retention in school, scholarships for higher education, etc will enhance the nation’s capacity to develop faster.
(ii). Microfinance for women – Women have been proven to be good economists and financial managers even when they have no professional qualifications. Therefore, if they are economically empowered from oil revenues, it will not only double the size of the productive economy but their children are also raised well and soundly with appropriate emotional balance and confidence in themselves, which are essential ingredients for national development. In Brazil for example, such support for women is contingent on school attendance by their children.
(iii). Small scale industrial development – The small scale businesses have been the backbone upon which many economies have been built. In Ghana, the small scale sector contributes more to the economy than the big factories do. However, most of them are in the informal sector without access to capital. Most of them do not pay taxes and they have no proper records of their business transactions. It is important to target small scale businesses and support them with capital and training. They should also be organized and registered accordingly to formalize their operations. Apart from helping to grow the economy, this proposal will also facilitate mobilization of non-oil tax revenues to finance the budget.
(iv). Development of non-traditional exports – Ghana’s non-traditional exports have not grown significantly over the years. The export profile is therefore still dominated by the traditional commodities of cocoa, gold, and timber. Oil will be added soon. In the event of a ‘Dutch disease’ occurring through the injection of massive oil revenues to the economy, the traditional exports suffer more. These exports are more tied to global financial movement and are also patronized by most of the advanced countries whose currencies dominate the global market. Non-traditional exports are patronized more by regional neighbours and other developing countries that have no capacity for producing synthetic substitutes. By increasing the value of non-traditional exports through provision of capital, training and access to markets; and with falling values of traditional exports, the country will be pursuing the path of export diversification, an essential factor for accelerated economic development.
(iv). Infrastructure financing – These include energy production using the natural gas from our oil fields to power the industrial sector of the economy, roads and bridges to reduce business cost, and institutional infrastructure such as telecommunication to reduce transaction costs are also feasible.

3. Political economy
Most of the problems caused by resource management are attributed to weak political economy. Ghana must improve public financial management by reforming the public sector, reducing business cost through the inactions of public officials; involve citizens in decisions and providing accountability mechanisms including public and strong parliamentary oversight. The country also needs to legislate transparency and accountability initiatives such as the Freedom of information legislation, the EITI and actually embracing the EITI++, and ensuring greater transparency beyond the EITI by removing confidentiality and stabilization clauses in petroleum agreements.

4. Environmental Governance
The doom of most oil-rich countries have manifested in the environmental sector. Natural gas flaring, destruction to forest and community farms through pipe-laying and during on-shore oil production and pollution of water bodies as well as destroying marine life, thus endangering the livelihoods of communities, have been some of the examples of how oil boom has become a doom in some countries.
Strong environmental laws backed by strong institutions to implement the laws are urgently needed before first oil. The delay in the development of the Petroleum Regulatory Authority Bill ahead of first oil is a dangerous trend for the country. Most government officials have often referred to PNDC Laws 64 and 84 as the regulatory laws for the petroleum sector. But these laws were made during military dictatorship without public input and most of the provisions not backed by modern trends in the petroleum regulatory regimes. For instance, the government policy for gas flaring is zero tolerance, yet the current petroleum regulatory regime provides for gas flaring under some broad circumstances. Flaring for operational efficiency may be understood but how is the allowable flaring level determined. The sanctions regime is also insulting. For instance, under the current regulatory proposal, companies that flare gas of about 1000 cubic feet are sanctioned to pay 12 penalty units. The abuse of these sanctions is most likely as the cost is negligible. Let not forget that Newmont recently agreed to pay a fine of about US$7 million for cyanide spilling. But how can this money restore the health and environment of the communities affected. This same practice will continue in the oil sector. Therefore, we need preventive mechanisms which are more effective than sanctions regimes.


Ghana is on test as it prepares for oil production. But oil endowment itself is not a doom. How it is managed could make it a boom or a doom. While it requires a lot of sacrifice and patience to make the boom work for the economy, the country cannot equally ignore the higher price to pay if the oil resources are not managed well. Although Ghana’s oil reserves of 1.8 billion barrels is small relative to Nigeria’s almost 40 billion barrels, the proceeds from the oil could provide relief for financing the budget gap or the development financing gap which have been features of our economy over several decades. I trust the intelligence and innovativeness of the Ghanaian but these must reflect in the results from our test five or 10 years from now. We have no excuse to fail because our own experience in the mining sector and the experiences of our oil producing neighbours should spur us on to avoid the past mistakes. Can we do it? ‘Yes we can.’