Growth Week 2011: Ideas for Growth Session 9 - Climate Change, Environment, Natural Resources

Harnessing Oil Revenues in Ghana

Rick van der Ploeg, Radek Stefanski and Samuel Wills*

Oxford Centre for the Analysis of Resource Rich Economies (OxCarre)
Department of Economics, University of Oxford

www.oxcarre.ox.ac.uk

OxCarre Conference June 2011
1

Overview

Ghana has • Ghana has discovered oil with estimated reserves of
discovered oil between 780 and 4000 million barrels, but this is being
revised upwards frequently
• This is relatively modest on a global scale, though it will
still comprise a significant component of Ghana’s GDP
It is a small, • The oil windfall will also be temporary, so the issue is how
temporary and to spread the new found wealth between present and
volatile windfall
future generations.
• Ghana will also have to cope with the notorious volatility
of oil prices and the effects this will have on its budget and
economy.
• To make the most of this windfall Ghana must consider all
To harness the aspects of oil production, though our focus is on spending.
windfall they • Ghana should spend some of the income upfront to
should repay debt stimulate GDP growth, whilst considering inflation,
absorption and Dutch disease. This differs from typical
and invest in
recommendation of establishing a Sovereign Wealth Fund
capital, rather than
• Ghana should focus this spending on reducing foreign
a SWF debt and investing in domestic capital to promote
structural transformation of the economy

Harnessing Ghana’s Oil Windfall 2

Ghana has discovered oil with estimated reserves of between 780 and
4000 million barrels, but this is being revised frequently

Ghana has discovered oil commercial oil reserves in two These reserves amount to between 780 and 4000 million
licences off the eastern coast barrels
Total Ghana oil reserves at different probs, m barrels
1600 p
10%
1400
p
1200 50%

1000

800

600

400

200

0
Total Total DWT Total Total Other
Jubilee WCTP
(non-Jubilee)

Source: Tullow Oil 2010 full yr results

This places Ghana at approximately 50th in the world by proven oil
reserves, with significantly less oil than major producers

Ghana vs Top 20 countries by proven (90%) oil reserves, m barrels 2010

Source: CIA World Factbook, 2010 Harnessing Ghana’s Oil Windfall 4

The reserves are small relative to Ghana’s population, however they
may be significant as a proportion of GDP

Oil reserves/population, ‘000 barrels per person
45
40
35
30
With potentially 160 25
barrels/head Ghana is 20
15
small in terms of 10
reserves per capita 5
0

Oil reserves/GDP, barrels per dollar
1.2
1.0
However, Ghana could 0.8
be in the top 20
0.6
countries by
0.4
reserves/GDP if most
0.2
of its reserves are
accessible 0.0

Source: CIA World Factbook, 2010 Harnessing Ghana’s Oil Windfall 5

Current planned production from the Jubilee field is likely to be
temporary and last for ~20 years, peaking from 2012-2015

Predicted average oil output by year, m barrels

Source: World Bank, 2009, “Economy-wide impact of oil discovery in Ghana”

Ghana collects the revenue from this production through four
channels

Oil revenue has four
These four components combine reservesGhana’s total oil income
Jubilee 90% proven to give
components
Cumulative oil revenue when oil price=$75/barrel, $ m (2010)
Name Size

Royalty 5% gross

GNPC 13.75%
commercial net profit
profits

Additional Oil 10-25% if
Entitlement rate of
return
18-33%

Income Tax 35% net
profit


The level of revenue depends closely on the oil price, and may amount
to a potentially significant share of GDP and govt income per year
Ghanaian government oil revenue from Jubilee field, % 2010 GDP and % 2010 Govt Revenue
8% The “Additional Oil $/barrel:
Entitlement” increases 100
6% with the oil price
Oil revenue 75
from Jubilee 4% 50
field as a share 30
of 2010 GDP 2%

0%
2011 2013 2015 2017 2019 2021 2023 2025 2027 2029

50% 100
Oil revenue 40% 75
from Jubilee 30% 50
field as a share 30
of 2010 20%
Government 10%
Income
0%
2011 2013 2015 2017 2019 2021 2023 2025 2027 2029
Source: World Bank 2009, Team Analysis Harnessing Ghana’s Oil Windfall 8

Ghana will thus have a small and temporary windfall which has
particular challenges compared to other resource rich countries
Taxonomy of different types of resource rich countries

Windfall size Windfall duration Challenges Example

Small Temporary • Speed up economic Ghana
development
• Provide for future generations

Large Temporary • Speed up economic Nigeria
development
• Provide for future generations
• Manage absorption constraints
• Prevent underutilisation of capital
•Prevent inequality and corruption

Large Long-lasting • Manage oil price volatility to Iraq
(Large economy) safeguard recurrent spending
(mostly government jobs)
• Less focus on future generations

Large Long-lasting • Avoid becoming a rentier state Kuwait
(Small Economy) • No absorption constraints due to
imports of skilled/unskilled labour
and capital

Ghana also has its own specific challenges such as low GDP, low
capital, unproductive agriculture and high inflation
Ghana vs the largest 48 oil producers, percentiles p10 p50 p90 p100

GDP/Capita Ghana: 1,192
Low GDP/capita 2005 USD
2,001 9,006 43,560

Ghana: 0.01
Capital/capita
Low physical capital
Proportion of US
0.02 0.19 0.92

Ghana: 0.63
Human Cap/capita
Low human capital Proportion of US
0.54 0.67 0.86

Ghana: 998
Large and unproductive Labor prod. Agr.
agricultural sector 2005 USD
514 3,594 50,874

Inflation rate 9.20%
High inflation % pa, Mar 2011

Source: World Development Indicatiors, 2011 Harnessing Ghana’s Oil Windfall 10

To address these challenges Ghana must consider all aspects of oil
production, though this work focuses on spending
The twelve precepts of the Natural Resource Charter
Stage Precepts
Overarching
Issues 1. Maximising benefits to citizens

Decision to 2. Ensuring openness and accountability
Extract
3. Realising full benefit subject to attracting investment, with stable and robust
Fiscal Regime policies

Contracts & 4. Using competition to award contracts and development rights
Operations 5. Protecting or compensating the environment and local society

6. Operating nationally owned resource companies transparently and
Tax & Royalty
competitively
Collection
7. Promoting growth through high levels of investment Focus
Revenue 8. Smoothing spending through stabilization funds or limited foreign borrowing of this
Management 9. Effectively spending to increase efficiency and equity work
Sustainable 10. Building private investment to stimulate and diversify growth
Development

International 11. Requiring and enforcing best practice amongst the international community
Actors 12. Following best practice amongst resource companies
Source: http://www.naturalresourcecharter.org Harnessing Ghana’s Oil Windfall 11

The spending decision can be divided into two questions: whether to
consume or invest the windfall, and what to consume or invest in

A Consume or invest the windfall?

B What to consume or invest in?


A The Ghana Petroleum Revenue Management Act (PRMA) has
recently been passed, outlining the planned spending/savings mix
Spending
•Unless otherwise directed by the national development
min 70% Long-term plan, allocated to 11 priorities:
investment •human resources •agriculture •welfare
•education /health •transport
•water/sanitation •rural
Annual Budget
•institutions/governance •security
70%* •alternative energy •environment
30% •Unallocated
Consumption
Petroleum Account
(BoG) Saving
• Built up quickly to capped level, which is reviewed
30% 70% Stabilisation regularly
Fund • Used to cushion the impact of adverse
price/production changes
•After production ends, combined with Heritage fund for
Petroleum Funds
permanent income
• Built up slowly initially, then receives all contributions
min30% Heritage Fund once stabilization fund established
• Used to support welfare of future generations once
resources exhausted
*: Mix based on “Benchmark Revenue”, moving avg of past and predicted oil prices and output. Can vary from 50-70%
Source: Petroleum Revenue Management Act 2011

A To assess various spending rules we construct a simple model of an
intertemporally optimizing agent who can either consume or save abroad

As a benchmark we take the permanent income, spend- The permanent income rule is then adjusted for a range
all and bird-in-hand rules of assumptions
Substitutability and impatience
Household chooses consumption and foreign assets to
maximise intertemporal utility
Finite lives (Blanchard Yaari constant hazard rate)

Consumption is perfectly smoothed, and the permanent
income from the windfall is consumed, when r=ρ Productivity growth

Population growth
The spend-all rule dictates that all oil income is
consumed as it is received

Precautionary savings
The bird-in-hand rule consumes a fixed proportion of
foreign assets: 4% in the case of Norway Dynamic programming following Skinner (1998), see
Backup


A On the spectrum of spend/save options, The PRMA is closer to the
spend-all than the permanent-income or bird-in-hand rules
PRMA Spend All
Elaborated in next slides
Bird in Hand (4%) Permanent Income
Spending options Benefits Spending and Asset Profile
Consumption*, % 2010 GDP
Spend all
5%
• Better returns earned through
domestic investment than foreign 4%
Sovereign Wealth Fund
3%
• Discounting future generations
2% PRMA
welfare (impatience); e.g., finite lives
1%
•Substitutability of generations
welfare 0%
2011 2013 2015 2017 2019 2021 2023 2025 2027 2029 2031 2033
• Spending stability
Assets*, % 2010 GDP
• Less inflation and currency 50%
appreciation
40%
• Less Dutch disease 30%
• Precautionary savings 20%
10% PRMA
• Population growth
0%
Permanent • Absorption constraints
Income -10%
201120132015201720192021202320252027202920312033
*: Assumes oil price is constant at $75/barrel. r=2.5%. Ignores current debt position
Source: Team analysis Harnessing Ghana’s Oil Windfall 16

A Spending the windfall upfront can make sense if policymakers
have a short decision horizon or are very utilitarian
Comparison of spending rules to permanent income baseline Substitutability Finite Lives Spend All
Impatience Permanent Income
Adjustment Description Spending and Asset Profile
Consumption*, % 2010 GDP
• Utilitarian (perfect substitutability between 5%
utility of different generations, EIS = ∞) versus
Rawlsian (no substitutability, EIS = 0). 4%
Substitutability • More substitutability brings consumption
forward, so that it is not affected by discounting 3%
•This analysis assumes r=2.5%, ρ=20% and
2%
EIS=1 (spending peaks at 7.5% of GDP)
1%
• Impatience describes the rate at which future
periods are discounted 0%
• This analysis assumes the real rate of interest 2011 2013 2015 2017 2019 2021 2023 2025 2027 2029 2031 2033
Impatience r=2.5%, ρ=20% and EIS=0.5
• It could be thought of as a 17.5% chance of Assets*, % 2010 GDP
the government being removed from office 40%
each year
30%
20%
•Finite lives may be another reason why 10%
policymakers are impatient 0%
Finite Lives • We use a stylised adjustment setting the
average lifetime to 61 years (Blanchard constant -10%
death rate=1.64%) -20%
-30%
201120132015201720192021202320252027202920312033
*: Assumes oil price is constant at $75/barrel. Ignores current debt position

A Alternatively, saving beyond the PI rule may make sense if there is
population growth, though precautionary savings is only a minor concern
Comparison of spending rules to permanent income baseline Prec Saving CRP=3 Pop’n Growth Spend All
Prec Saving CRP=11 Permanent Income
Adjustment Description Spending and Asset Profile
Consumption, % 2010 GDP
2%
• Precautionary savings is when people Zoomed In
save more when income is volatile as a
buffer against future income shocks.
Precautionary This delays consumption
1%
Savings • This assumes oil is the only source of
income
• CRP=3 and CRP=11 (very conservative)
• P_O=$75, StdDev_O=24*
0%
2011 2013 2015 2017 2019 2021 2023 2025 2027 2029 2031 2033
Assets, % 2010 GDP
• Population growth delays
consumption to allow more when 70%
there are more people in the future 60%
•This analysis assumes population 50%
Population growth at 1.85% (Ghana 2011 rate)
Growth 40%
30%
20%
10%
0%
-10%
201120132015201720192021202320252027202920312033
*: fit to annual Brent Crude data, 1970-2010

A On balance, Ghana’s windfall spending can be brought forward relative to
the PI rule. What it should be spent on is discussed in the next section
Spending rule Importance Comment

Spend now High •If properly considered then should borrow heavily to smooth consumption
GDP growth PI
across generations

Spend All High • Too aggressive due to inflation and absorption constraints

PRMA N/A •Less spending than spend-all and is just as volatile which is not so good.
However, does accumulate some assets for future
•A more utilitarian social welfare function leads to much more
Substitutability High consumption by present generations at expense of future generations
made possible by large-scale borrowing.

Medium •Consumption is much more upfront if politicians are myopic due to the
Impatience fear of being removed from office.

•Allowing for finite lives (no bequest motive) implies more consumption
Finite Lives Low upfront and less in future, so initially borrowing and less asset
accumulation in the long run than the PIH.

Permanent High •Good benchmark for developed countries, but development needs mean
Income more should be spent upfront in countries like Ghana

Precautionary Medium •Prudence leads to less consumption upfront and more precautionary
Savings buffers

Population Medium •Realistic population growth also leads to less consumption upfront and to
Save now Growth a gently rising stock of assets.


B Once the decision of whether to consume or invest the windfall is
made, Ghana must decide what to consume or invest in

i Repay foreign borrowing
We focus on
Investment ii Accumulate foreign capital (SWF) investment
iii Accumulate domestic capital

iv Citizen dividends

Consumption v Lower taxes or higher public consumption

vi Subsidies to specific industries or consumers


B i) Repaying foreign borrowing may reduce spreads and the risk of
lower creditworthiness due to resource-driven conflict

Lower foreign borrowing will reduce interest rate spreads, Lower foreign borrowing will also reduce the risk of
boosting capital accumulation and development reduced creditworthiness due to resource-driven conflict

Ln bond spread residual vs debt/GNI residual, Ln bond spreads vs resource exports/GDP

Slope = 1.89

•Expect oil wealth to improve credit worthiness and
lower spreads
•But, in more fractionalized, corrupt societies oil wealth
may cause conflict and civil war (Collier, Hoeffler)
•Creditworthiness falls and bond spreads rise
Source: van der Ploeg and Venables (2011) Harnessing Ghana’s Oil Windfall 22

B i) If Ghana faces an increased cost of borrowing due to foreign debt, it is
optimal to postpone windfall consumption and quickly repay borrowings

Ghana may be facing high interest spreads due to its The interest rate premium makes it optimal to postpone
stock of foreign debt consumption in the short term to repay debt

•External stock of public debt is ~37% of GNI (2009) •Solving a standard CRRA maximisation, with a risk
• S&P rates 2007 10yr $750m Eurobond as “B”, 3 steps premium on debt:
below Egypt’s “BB”. Yield range from 6.7-7.1% past 6 mth

If Ghana’s debt is increasing the cost of borrowing it can
be represented by a kink in the interest rate
•The inclusion of the debt premium alters the Euler
equation, depending on the level of debt

•Both converge to the steady state

= r * for F ≤ F and = r * +Π ( F ) > r * for F > F
r r
•Kink allows interest premium and endogenous choice
of F in steady state

Source: van der Ploeg and Venables (2011), World Bank Datacentre, Bloomberg (2011)

B i) Following a windfall, consumption should rise slightly and debt
should be repaid quickly. A SWF is only suitable if the windfall is large

The dynamics from a small and large windfall can be It shows that a SWF is only suitable if the windfall is
expressed in a phase diagram sufficient to completely reduce the interest premium

Time Consumption, C Debt, F
After Consumption Borrowing,
announcement path jumps up increasing level
of debt
During Steep increase Rapid pay down
extraction in consumption debt
Small windfall case:
Large windfall
After depletion Resume growth path but ‘further
along’ the development path
Small windfall Large windfall case:
During Run debt down to F during
Initial jump in total consumption: extraction extraction.
Start building SWF
After depletion Support permanent increase in
λu is eigenvalue with positive real part > r*, so consumption from interest on SWF
smaller in a smaller capital-scarce economy as
Π′ pushes up λu.

B i) Now, if there is endogenous capital formation, then the windfall
should be spread between debt repayment and public infrastructure

We assume the government can choose public capital, When transfers are available, taxes are set to zero, and
transfers and taxes to maximise welfare the windfall is spent on public capital and repaying debt

•Government chooses time paths for lump sum transfers •Optimal income tax rate is zero
T, distortionary taxes τ, and public capital stock S, and
hence paths of K, Y, W, D, C, to maximise •Intratemporal smoothing: G =ψ σC
∞  C1−1/σ +ψ G1−1/σ 
∫   exp(− ρ t )dt •Optimal infrastructure: WS ( S ,0) r * +Π ( D) + DΠ '( D) + δ S
=
0
 1 − 1/ σ 
• •
= [r * +Π ( D)]D + G + T + S + δ S − N − τ Y
D •Optimal time profile of private consumption:

•Production with private & public capital: Y = K α L1−α S γ C σ C [ Π ( D) + DΠ '( D)] for D > D, else C 0
= =

•Foreign capital supply: (1 − τ )αK α −1L1−α S γ = r* => K = K ( S ,τ ) When transfers aren’t available, consumption must rise
(Marginal product of capital = world interest rate) through lower taxes and higher public infrastructure
•Private consumption is now C = W(S,τ)
•Consumption: C =W + T •Marginal Cost of Public Funds increases with tax
rate: = φ
1
>1
•α=0.4, γ=0.25, ρ=r*=0.05, σ=0.75, ψ=0, δK=δS=0.05 - Depresses demand for  α  τ 
1−   
public vs private C  1− α   1−τ 
σ
This lets us find the optimal mix of policy - resources relax this ψ 
G =   W( S ,τ )
after a resource windfall φ 
•Public infrastructure:


B i) If lump sum transfers are possible, income taxes are stopped,
debt is repaid and public capital is accumulated
Response of economy to anticipated temporary windfall

When a windfall is
announced (division of
1st yr resource
revenues):
-Transfers rise (68%)
- Debt is quickly repaid
(11%)
- Public capital is
accumulated (21%)

This results in:
- lower r
- more private K
-higher output
- higher wage
- high consumption
No windfall brought forward
Anticipated windfall

B i) If lump sum transfers are not possible, income tax is reduced,
debt is repaid and public capital is accumulated
Response of economy to anticipated temporary windfall

When a windfall is
announced:
-Tax falls
- Debt is quickly repaid
- Public capital is
accumulated

This results in:
- lower r
- more private K
- higher output
- higher wage
- high consumption
brought forward

No windfall
Anticipated windfall

B ii) If the windfall is large enough, accumulating foreign capital in a
Sovereign Wealth Fund may help with volatility and absorption

Arguments for and against setting up a Sovereign Wealth Fund
Argument Discussion

1. Providing for future generations Part A

2. Smoothing against oil price volatility Next slide >>
For
3. Holding funds temporarily until Part B iii)
absorption constraints are alleviated

1. Greater marginal benefit from Part B iii)
current consumption or investment
in domestic capital
Against


B ii) Oil volatility is a major part of the resource curse and should be
managed by hedging, stabilisation funds and a flexible economy

Mexico oil export price, $ barrel
• Use derivatives to hedge against
adverse price movements

• Used by Mexico (spent $1.5bn on
option, earned $8bn), Ecuador,
Colombia, Algeria, Texas, Louisiana
Hedging
• Unlikely to become widespread:
• Political risks when lose
• Market impact of hedging
(information and market power)


B ii) Oil volatility is a major part of the resource curse and should be
managed by hedging, stabilisation funds and a flexible economy
Stabilisation funds should be considered The size of a stabilisation fund should be
separately to “future generations” funds: determined according to four criteria:
SWF of 31 oil producers, 2005
• Cost of volatility to the domestic economy?
Stabilisation Stabilisation
Fund • Opportunities for borrowing in downturn?
Stab/Savings
Savings • Stochastic process governing resource?
None
• Political risk – fund is lootable?

It is impossible to fully insulate an economy from oil price volatility
•2008-early 2009, MENAP FOREX reserves fell $40 bn and non-oil growth fell 5% points.
•There were transmission channels other than revenue:
- Resource sector investment - Capital mobility – Zambia
Flexible - Other private sector responses
Economy
Therefore, the domestic economy should be designed to handle residual volatility
• Encourage flexible labour and capital markets
• Avoid hard to reverse commitments
• Diversify…..
Source: IMF Harnessing Ghana’s Oil Windfall 30

B ii) A sovereign wealth fund can be used to smooth “Dutch disease”: a
contraction of the traded sector and a real appreciation during an oil boom

Dutch disease overview Dutch disease simulations

•Oil output increases

•Spending rises on traded (T)
and non-traded (NT) goods

•T goods can be imported, but
NT goods must be produced
domestically

• Labour (and capital) switch
from T to NT

• The relative price of NT also
rises – a real appreciation

These effects will be • If total labour (L) fixed, workers will move from T to NT
Substitution effect
mitigated if capital as NT goods can’t be imported
and labour are
imported Wealth effect • If total labour (L) flexible, workers still leave T as these
goods are imported, but they choose to retire instead
Managing Resource Revenue in LIC's 31

B ii) Sovereign wealth funds can also be used to park funds
temporarily abroad to avoid absorption constraints binding

• If there are absorption constraints, i.e., it takes nurses to train nurses, it takes roads
to build new roads, etc., there may be real absorption constraints so that windfall
can in the short run not be properly spent.
• In that case, the real exchange rate will appreciate and reverse back as absorption
constraints are relaxed.
• This happens via gradually running down capital in the traded sector via wear and
tear if traded sector is capital intensive or via gradual build up of home-grown
capital if non-traded sector is capital intensive.
• Message is that there may a justification to temporarily park revenue from windfall
abroad until domestic capacity is big enough.
• Must avoid investing in white elephants.
• See van der Ploeg and Venables (2010)

Managing Resource Revenue in LIC's 32

B iii) To complement debt reduction, accumulating domestic capital
will boost GDP and begin structural transformation

• Ghana has both low GDP and low GDP growth
Low GDP
•This can be attributed to all sectors

•To boost GDP growth Ghana must invest in domestic capital
•Traded capital can be imported
Capital
•Non-traded capital must be “home-grown”: teachers
Investment
teaching teachers
•Investment should be in:
•physical capital (infrastructure )
•human capital (education and health)
Elaborated in
•stimulating risk taking, entrepreneurship and R&D (via
following slides
generic tax subsidies).
•Domestic investment will begin the structural transformation
Structural away from agriculture, which should be promoted
Transformation •Now that the PRMA is passed this is the major question
facing Ghana

Smooth •Although there will be pressure to support agriculture, this
Transition should be done only to smooth the transition to more
productive industries


B iii) Ghana’s GDP per worker is low and growing slowly, driven
largely by small and slow growing capital stock
Ghana has low GDP per capita and low GDP per This is driven in large part by a small and slow-
capita growth growing capital stock
Contribution to GDP growth, 1993-2007

Growth accounting following Caselli (2005):

Data flaws mean employment in manufacturing is
overpredicted in Nigeria

Source: Penn World Table, UN, IFPRI, Own Calculations

B iii) This suggests Ghana is far from its steady state. To analyse the
effect of the oil windfall we therefore must capture its transition path

We use a simple three sector model to generate structural This is driven by exogenous growth rates and different
transformation and capture Ghana’s transition path factor intensities in each sector that drive overall growth
Parameterisation of simplified Acemoglu and Guerrieri (2006) model

•Non-homothetic preferences for agriculture
• Exogenous growth. Highest in Manufacturing, Services
then Agriculture
• Services are L intensive, manufacturing is K intensive
• As capital accumulates, draws labour into M, then S (eg
Rybczynski effect for 1 country over time)

Source: Acemoglu and Guerrieri (2006); Gollin et al (2002)

B iii) By including growth we find that the importance of oil declines with
time. The level of Dutch disease depends on the stage of development

As the economy grows the relative size of the oil shock The shock causes a small reallocation of factors from T to
declines NT, the extent will depend on the stage of transformation.

“Dutch disease”

•The model is fitted to data from 1993-2007. It also
assumes constant growth rates, based on these years.
This explains why there isn’t a large hump in
manufacturing factor shares.

Source: van der Ploeg, Stefanski and Wills (2011)

B iii) As well as sector effects, the optimal response of total capital is to fall
before the shock, and accumulate during it, to smooth consumption
Optimal response of total capital to oil shock, expressed as ratio of K in oil vs non-oil economy

• Without capital markets
(relative to a world with no oil)
capital stock should be driven
down in anticipation of the
shock
•Once shock hits, capital
should be accumulated
•With international bond
markets, the effect is weakened
but still dominant

Source: van der Ploeg, Stefanski and Wills (2011)

B iii) The fluctuations in K cause a small real depreciation then
appreciation, as capital becomes relatively scarce then abundant
Optimal response of P_S/P_M, expressed as ratio of oil vs non-oil economy

•Relative prices follow similar path to
capital – first depreciation of RER (as
capital is driven down) then
appreciation as boom hits
•This reflects the anticipation effect
and the higher labor intensity of the
non-traded sector :
• Since capital declines initially,
labor more abundant relative
to capital
•Price of sector that uses labor
more intensively (NT) goes
down
•As capital increases relative to
labor, opposite effect
•Notice the relatively small
magnitudes! Reflects small oil find
and (assumed) flexibility of labor and
capital.

B iii) To boost growth Ghana should invest in domestic capital,
especially as the largest sector (agriculture) is the least productive
Sectoral employment estimates, labour productivity and TFP
Employment Labour
Share Productivity TFP
Sector % 2005 USD Levels
•Large size and
Agriculture 55% 849 2 low productivity
are linked
(Lagakos and
Waugh).
Services 31% 7462 180
•Cocoa has been
crucial for
combating
Manufacturing 12% 1011 35 poverty.

Construction 1% 18280 341

Mining and utilities 1% 21354 14

Source: Kuralbayeva and Stefanski (2011) Harnessing Ghana’s Oil Windfall 39

B iii) By investing in domestic capital Ghana will raise its genuine
savings rates
Adjusted net savings (Genuine savings)* 2008 excluding pollution damage, % Gross National Income
Ghana Malaysia Venezuela Kuwait
30
20
Ghana’s genuine
savings rate is 10
currently
negative 0
-10
1970 1975 1980 1985 1990 1995 2000 2005

East Asia & Pacific Sub-Saharan Africa Latin America & Caribbean
30
20
As is Sub-
Saharan Africa’s 10
as a whole 0
-10
1970 1975 1980 1985 1990 1995 2000 2005

*: Gross savings – depreciation of fixed capital + education expenditure – depletion of natural resources
Source: World Bank Harnessing Ghana’s Oil Windfall 40

B iii) This will involve investing in education to boost intangible
capital, which is the main creator of wealth
Composition of wealth, $ per capita and % share, 2000

Total Wealth 7,532 27,616 439,063 95,860
$ per capita Expanded next
100% slide
90%
80%
70%
Type of capital
60%
Natural
50%
Produced
40%
Intangible
30%
20%
10%
0%
Low Middle High (OECD) World
Country income group

Note: All dollars at nominal exchange rates. Oil states excluded. National wealth is PV sustainable
consumption 2000-25 using discount rate of 4%. Produced capital from PIM.
Source: World Bank (2006, Table 2.1). Harnessing Ghana’s Oil Windfall 41

B iii) And moving away from the reliance on natural capital which
characterises low income countries
Composition of land resources, percent of total wealth, 2000
Total land
1,925 3,496 9,531 4,011
resources
$ per capita
30%
Type of land
25% resource
Pastureland
20%
Cropland
15%
Protected
10% NTFR*

5% Timber

0% Subsoil
Low Middle High (OECD) World
Country income group
*: NTFR = Non-Timber Forest Resources
Source: World Bank (2006, Table 1.2).

Summary

Ghana has • Ghana has discovered oil with estimated reserves of
discovered oil
between 780 and 4000 million barrels, but this is being
revised upwards frequently
• This is relatively modest on a global scale, though it will
still comprise a significant component of Ghana’s GDP
It is a small, • The oil windfall will also be temporary, so the issue is how
to spread the new found wealth between present and
temporary and future generations.
volatile windfall • Ghana will also have to cope with the notorious volatility
of oil prices and the effects this will have on its budget and
economy.
• To make the most of this windfall Ghana must consider all
aspects of oil production, though our focus is on spending.
To harness the
windfall they • Ghana should spend some of the income upfront to
stimulate GDP growth, whilst considering inflation,
should repay debt absorption and Dutch disease. This differs from typical
and invest in recommendation of establishing a Sovereign Wealth Fund
capital, rather than • Ghana should focus this spending on reducing foreign
a SWF debt and investing in domestic capital to promote
structural transformation of the economy


Background material

44

It is also likely to affect the exchange rate as it will amount to a large
component of exports per year
2008 Ghanaian merchandise exports by sector, $ million

4,000
3,500
3,000
2,500
2,000
1,500
1,000
500
-
Food Manuf Agriculture Ores and Fuel Oil at peak
Minerals production*

*: Based on 120,000 bopd at USD 75/barrel
Source: World Bank WDI, 2011 Harnessing Ghana’s Oil Windfall 45

A Wealthy future generations are often used to justify upfront
spending, though if taken seriously spending should rise even further
PI rules for government spending under different growth and oil assumptions, $ m (2010)

12,000
If the wealth of future generations is properly considered, then government
should borrow heavily now to smooth consumption across generations
10,000

8,000

6,000

4,000 No oil, no growth
Oil, no growth
2,000 Oil and growth (0.5% pa)

-
2011 2013 2015 2017 2019 2021 2023 2025 2027 2029 2031 2033

*: Based on 20% of GDP accounted for by government expenses
Source: World Bank data, team analysis

The effects of precautionary savings were solved using dynamic
programming
Dynamic programming methodology, following Skinner (1998)
The stochastic Euler equation is given by:
This gives the full system of
equations:
The second order Taylor expansion is:

Simlifying and solving recursively gives:


A Ultimately Ghana should focus on spending upfront to stimulate GDP
growth, whilst considering inflation, absorption and Dutch disease
Aim Policy Pitfalls
•Protect wealth • Invest windfall abroad in SWF • Fund governance
for future - Diversify amongst bonds, - Ensuring it is preserved for future generations
Mature generations equity and real estate,
economy ensuring it is orthogonal to the
stochastic path of the oil price

•Develop wealth • Invest windfall domestically: •Political bias
for future - Focus on generic ways of - investing in illiquid, partisan projects to avoid
generations promoting entrepreneurial political rivals raiding liquid, non-partisan funds
spirit and research & •“White elephants”
development, eg. education, - high visibility, low use investments
Developing health, infrastructure •Absorption constraints
economy - Some capital must be “home-grown”: eg. existing
teachers must train new teachers
- This may justify temporarily investing abroad.
•Inflationary pressures
•Dutch disease
•For explanation see backup

With these aims in mind, Ghana’s Petroleum Revenue Management Act looks to be
appropriate. The challenge now is to avoid the pitfalls


B iii) Ghana’s low TFP growth can be attributed to all sectors, and is
lagging behind other oil exporters like Nigeria and Malaysia
TFP decomposition by sector: Total to Agriculture, Industry , Services; 1970=1

All sectors have low TFP growth in Ghana.

But, lowest growth has been in industry
and agriculture.

Nigeria and Malaysia have had more TFP
growth in agriculture and services.

Source: UN, IFPRI, Own Calculations Harnessing Ghana’s Oil Windfall 49

B iii) Genuine savings rates are a particular risk for Ghana as a
resource rich country, many of which have negative intangible capital
Intangible capital, $ per capita and percentage share of total wealth

Intangible capital 6,029 2,176 1,173 4,360 -3,215 -1,598 -3,418 -1,959 -12,158
$ per capita

300

200

100
Intangible 0
capital
% total -100
wealth
-200

-300

-400
Type of capital
Natural Produced Intangible

Source: World Bank (2006, pg 29).

B iii) As Ghana develops, labour will shift out of agriculture as part of
the structural transformation process, which is happening in Malaysia
Sectoral employment share, %

In contrast to Ghana and Nigeria,
Malaysia has been making a steady
transformation of moving people out
of agriculture into industry and
services.

Source: UN, IFPRI, Own Calculations Harnessing Ghana’s Oil Windfall 51

B iii) Cocoa is a large part of the unproductive ag. sector and may be
hurt by the transformation, though supporting it sustains low growth
Share of sectoral value added, % 2005

•A large part of the
Share of sector: unproductive agricultural
•Cocoa: 16% sector is cocoa.
•Yams: 12%
33% •Dutch disease effects
39% (appreciation of the currency)
may especially hurt the export
of cocoa and thus the
livelihood of many Ghanaians.

•One should be cautious of
supporting this sector which
11% could exacerbate low
8% aggregate TFP growth.
9%
Agr. Mining Mfg. •There may be more efficient
Cstrn. Serv. ways to alleviate poverty.

Source: IFPRI Harnessing Ghana’s Oil Windfall 52

B Finally, consuming the windfall has been done in a number of ways
with varying levels of success

• (i) Citizen dividends: Alaska hands out the windfall to its citizens. The idea
being is that the natural resources belong to them and that they know
best what to do with it.

• (ii) Lower taxes or higher public consumption: Another way is to let the
oil revenue flow into a fund and withdraw say 4% from it each year for the
general budget as Norway does. This can then be used for cutting taxes
(higher private consumption) or raising public consumption.

• (iii) Subsidies: The Netherlands has used its gas windfall to raise welfare
benefits in the 1970s and 1980s (but later used it for a fund for investing in
the domestic infrastructure). Iran, Kazakhstan, Netherlands and many
other countries use the windfalls for fuel subsidies to consumers or ‘pet’
industries, but that is very inefficient indeed. Better is to use the windfall
in that case for conditional transfers (e.g., to stimulate education or risk
taking).

Ghana was previously a net-importer of oil, but net exports are soon
to comprise more than half of production
Ghana oil production and consumption, ‘000 bbl/day 2009 vs 2012

2009 Production 2012 Production
140 140

120 120

100 100

80 80

60 60

40 40

20 20

0 0
Production Net Import Consumption Production Net Export Consumption*

*: Assuming constant oil consumption for comparison
Source: CIA World Factbook, Tullow Oil 54

Ghana experienced a period of hyperinflation during the 1970s-80s,
which has since come under control but remains high

CPI Inflation, % pa

Military Coups 1966-81

Source: World Bank Datafinder 55

Ghana’s economy is largely focused around agriculture and non-traded
services
Value added and employment share of total, % 2007

40% Value Added
35% Employment

30%

25%

20%

15%

10%

5%

0%
Agriculture Services Mining and Construction Manufacturing
Utilities

Source: UN, IFPRI, Own Calculations 56

Ghana’s agricultural sector is dominated by cocoa, and this accounts
for 1/5 of global production

Ghana accounts for approximately one fifth of world
Cocoa is the largest part of Ghana’s agricultural sector
production
Share of GDP Share of Agr Cocoa production
Product % of GDP % of Agr Country % world, 2005
Cocoa beans 6% 13% Ivory Coast 38
Forestry 5% 2%
Ghana 21
Yams 5% 2%
Vegetables (domestic) 4% 2% Indonesia 13
Cassava 4% 4%
Other 10
Fishing 2% 4%
Maize 2% 5% Nigeria 5
Plantains 1% 6%
Cameroon 5
Sorghum and millet 1% 9%
Other meats 1% 11% Brazil 4
Cocoyams 1% 12%
Ecuador 3
Rice 1% 14%
Other 5% 16% Malaysia 1

Total Agriculture 39% 100% Total World 100%
Source: GSS, IFPRI, Own Calculations, UNCTAD 57

Gujarat Pollution Control Board :
Improving Industrial Pollution Control

Hardik Shah
Member Secretary
Gujarat Pollution Control Board
Gujarat, INDIA

IGC
21 September 2011 1

Gujarat
Area 196,024 sq.km. (5.96 % of India)

Capital Gandhinagar

Climate Tropical

Population 50.60 million as per 2001 census (4.93% of India)

Urbanization 38 % (Compared to the national average of 28%)

258 persons per sq.km. vis-à-vis 324 of national
Population Density
average
Official Language Gujarati
Rs 1,050,230 million (=US$ 22,036 million) in
Net State Domestic Product
2001-02
Share of secondary sector in SDP 38.5% in 2001-02 at current prices

Per capita income (in 2009-2010) Rs 21,276 (=US$ 446)
2

GUJARAT
LAND OF MAHATAMA GANDHI

The Mother Earth Provides
for Needs of Everyone
But
Not for the Greed
of Everyone

Economic Snapshot

5

Gujarat- Strong Industrial Base

6

Challenges to Regulating Industrial Pollution
GPCB’s monitoring of industrial emissions includes three strategies:
• Regulatory inspections of industrial plants
• However, in the face of high industrial growth, staff time constraints limited GPCB’s
in-house capacity to expand inspection operations

• Court-mandated third-party environmental audit programme
• However, concerns about auditor objectivity exist, since industry selects and pays
auditors

• Third-party environmental monitoring involving Technical Institutes
• However, it can only be complimentary and not substitutive to GPCB’s monitoring

• GPCB tested two innovative solutions to these challenges.
• GPCB partnered with external evaluators to measure the impact of
changing these two programmes.

The Innovations
Making environmental audits
independent
• Auditors paid from central pool, and
not by individual firms
• Auditors randomly assigned to firms,
not chosen by them
• Audits back-checked by independent
team from a local technical university;
auditors’ payments based on their
accuracy
Question: Would changing auditors’
incentives make reporting more accurate?
Do reliable audits induce plant compliance?

Evidence from the Evaluation
• Under the status quo (control group), auditors often
reported readings just below the norms. Their reports
were much lower than the readings from random back-
checks conducted by the evaluators.

• Under the modified programme (treatment group),
auditors reported significantly higher pollution readings
consistently.
• Auditors who used to report readings just below PCB
norms now reported higher readings that matched back-
checks

9

Using evidence for policy change
• The preliminary results from
this evaluation were shared
with GPCB officials and third-
party auditors

• Auditors suggested that
adopting parts of the modified
audit programme permanently
would improve the quality of
work they are able to provide

10

Using evidence for policy change
GPCB may consider changes to the audit
policy in response to this evidence and
feedback from the auditor conference.

• GPCB centrally administers a random
assignment of auditors to firms,
instead of allowing firms to select an
auditor.
• GPCB sets a fee structure for audits
and verifies that auditors are paid
accordingly, instead of allowing firms
and auditors to negotiate a price.

11

A Continuing Collaboration
• GPCB is partnering with researchers to test
another pilot programme for air pollution
regulation with two components:
• Continuous emissions monitoring (CEMs)
• Gives GPCB more detailed information on the total
load of particulates emitted by industry
• Emissions trading system
• Tests the use of market-based regulatory
instruments to reduce airborne particulate matter

12

India-Environment Protection-Religion

• ALL IN THIS MANIFESTED WORLD, CONSISTING OF MOVING AND

NON-MOVING ARE COVERED BY THE GOD. USE ITS RESOURCES

WITH UTMOST RESTRAINT. DO NOT COVET THE WEALTH OF

OTHERS.

– UPANISHAD (RELIGIOUS GRANTHA WRITTEN CENTURIES AGO)

Marketing Improved Cook-Stoves

Mushfiq Mobarak
Yale School of Management

[Primary Collaborator: Grant Miller (Stanford Medical School)]

Drawing on collaborative projects with BRAC (Bangladesh), Rob Bailis
and P. Dwivedi (Yale FES), Sandro Gomez (Yale Mech. Engr.), S.
Barnhardt (IFMR, India), Biolite Stove (USA)]

Understanding the Low Demand

• Inexpensive welfare-improving technologies are often
not adopted by poor households
– Insecticide treated bed-nets, new varieties of seeds
and fertilizer, improved cook-stoves, migration

• Puzzle: Why do so many rural households refuse to
adopt stoves even when the benefits are not external?

– ARI: leading killer of children under 5 worldwide. Accounts
for 22% of all non-communicable child deaths (WHO 2005)
– Biomass combustion is the leading environmental “risk
factor” for female mortality worldwide

Southern Bangladesh, Weds 8/9

7000
10-sec averages
avg over entire cooking period
avg over 30 mins
6000

5000

4000 U.S. 24-hr PM2.5
Standard = 65 ug/m3

3000
Cook
not in
2000 kitchen

1300 ug/m3 ~70ug/m3
1000
640 ug/m3
0
11:00 11:15 11:30 11:45 12:00 12:15 12:30 12:45 13:00
Time (local Bangladesh)

Why Don’t People Adopt?
• Some hypotheses:
– Lack of liquidity, Information failure or learning
externalities (inefficiently low experimentation), Intra-
household externality, “Taste” and tradition

• Disentangling different reasons for adoption has
important policy implications – do we need to
address costs, risk aversion, a stove attribute (food
taste), or an information failure?

• De we push existing technologies or do we need to
develop new ones that people like better?

Traditional
stove

Improved stove
1: Portable
Improved stove 2:
Chimney

Experiments
2900 Households in 58 Villages, 2 Districts

2100 Households in 42 Villages 800 Households in 16 Villages

Stove at Stove at Husband Wife
Full Price Half Makes Makes
Price Choice Choice
No Opinion- Choice of Free
Leader A B Chimney or E F
Information Free Portable
Stove
Publicizing
Choice of Tk.
Opinion-Leaders’ C D
250 Chimney or G H
Adoption
Tk. 50 Portable
Decisions
Stove

Pricing Results
• Highly price-elastic and non-linear demand.
• Very low adoption at education plus “financially-
sustainable” pricing
• Inelastic chimney demand implies households less
elastic with respect to health costs than time costs
• The “refusal rate” (drop from stove orders to stove
purchase) highly positively correlated with price
– Suggests that liquidity / savings constraints are key
• Adoption far from universal even when free
– Non-price factor (e.g. stove characteristics) matter

Opinion Leaders
• Asymmetric Effects – unanimous ‘no’s generally
have a stronger effect on behavior
– If the leader adopts, it’s not necessarily right for me,
but if he doesn’t, then it cannot possibly be right for
me.
• OL influence larger for portable stove than the
chimney stove
• After households gain more experience with
stoves, the OL influence smaller, and the
difference between chimney and portable stoves
almost disappears

Stated Adoption
If Yes, Type Chosen
Total No Stove Yes Stove Portable Chimney
E - Men Choice, Free 197 12 185 94% 36 149 81%
+5%
F - Women Choice Free 202 0 202 100% 26 173 86%
G - Men Choice Subsidy 197 55 142 72% 27 115 81%
-2%
H - Women / Subsidy 203 63 140 69% 29 111 79%
Overall 799 130 669 118 548

• In the free treatment, women prefer stoves, and they
prefer the healthier chimney stoves
– Women have larger valuation for own and child health
• Once we start charging for stoves (and relative price of
chimney stove is increased), women less likely to
purchase altogether, and shift towards the cheaper
stove (relative to men)
– Women more liquidity constrained, and cannot act on their
preferences

Stove Orders
Ordered a
Ordered a chimney chimney stove out
Any Stove stove out of those of those offered a
Order who ordered a stove stove

Free Stove Condition -0.0597*** -0.0724* -0.121***
(standard error) (0.0175) (0.0375) (0.0391)
sample size 397 382 394

Subsidized Stove Condition 0.0259 0.0140 0.0502
(standard error) (0.0457) (0.0450) (0.0482)
sample size 398 282 398

p-value for equality of
coefficients on 'male' between 0.0400** 0.0764* 0.00384***
free and subsidized cases

Stove Purchase
Purchased a
chimney stove Purchased a Refused to
Any out of those chimney stove Purchase of
Stove initially accepting out of those those who
Purchase a stove offered a stove Ordered one

Free Stove Condition -0.0101 -0.108** -0.0803 -0.0496
(standard error) (0.0477) (0.0492) (0.0516) (0.0462)
sample size 397 275 394 397

Subsidized Stove -0.0276 -0.00802 -0.00350 0.0535
(standard error) (0.0455) (0.0746) (0.0399) (0.0505)
sample size 398 111 398 398

p-value for equality of
coefficients on 'male' 0.652 0.231 0.0809* 0.0041***
between free and subsidy

Policy Implications
• Can’t really market to either men or
women.
• Solution: bundle an attribute that men
want with the stove.
• Need financing solutions for a liquidity
or credit constraint, or risk aversion
about a new/unknown product
• Clever marketing and persuasion
techniques have limited effects when
households can evaluate the technology
for themselves

Growth Week 2011: Ideas for Growth Session 9 - Climate Change, Environment, Natural Resources

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