Europe's Petrostates Fall Into the Oil Trap
Countries with vast natural resource income have a choice: Spend the money or save it for later. As the Netherlands and Norway are discovering, both have their disadvantages.
The Dutch Court of Audit has just released a damning report on the government's management of income from the Netherlands' natural gas fields over the past half century. It calculates that if the government had accumulated the revenues in a special fund, the roughly 265 billion in gas proceeds would have swelled to 350 billion euros ($442 billion at the current exchange rate) by January 2014. Instead, the money largely disappeared into the Dutch treasury. The only traceable "gas money" was 26 billion euros used to finance some transport and environmental projects, including a railroad connecting Holland to the European high-speed network. If Holland had created a fund, the investment income alone would have been enough to cover half the cost of the projects, the audit court calculated.
Now, it's probably too late for Holland to change course. With gas extraction shrinking and an aging population demanding more and more government expenditure, the budget needs whatever gas income it can get. The Netherlands, in other words, has a case of hydrocarbon dependence, even though it's not as bad as those afflicting Russia or the Arab oil-producing nations.
Norway has taken a completely different approach. Its 1990 decision to separate hydrocarbon revenues from what it calls the "mainland economy" was as courageous as a refusal to take any habit-inducing substances. The resulting Government Pension Fund now contains nearly $900 billion -- more than enough to cover the budget shortfalls that the government expects to appear in the 2030s as the share of retirees in the country's population increases. You can watch the fund grow in real time here. Even a static picture looks impressive (the numbers are in billions of Norwegian kroner):
Problem is, there can be such a thing as too much money. In their search for places to invest, the Norwegian authorities have had to expand the fund's mandate from just government bonds to equities in 1997, to emerging markets assets in 2000, then to corporate bonds in 2002 and finally to real estate in 2010. There are barely enough quality assets for the fund to keep up its successful money management record (it made 15 percent last year and almost 5 percent in the first six months of 2014). Now, the government is suggesting the fund venture into private equity and infrastructural investments. Norges Bank Investment Management, the company that handles the money, has an insatiable hunger for more managers.
Spending the money is difficult, too. The coalition government's proposal to spend a record $25 billion, or about 3 percent of the fund, in 2015 has raised concerns about overheating the economy, in which the government already accounts for about half of gross domestic product -- more than any other European country. Some of the coalition's member parties are suggesting a downward revision of the country's fiscal rule, which allows the spending of up to 4 percent of the fund's value per year. According to the Norwegian finance ministry, that amount of new spending "would entail a large and unwarranted fiscal expansion."
Norwegians have so far resisted the temptation to cut taxes and use the oil money to make up the difference. They are well aware of research showing that resource-rich nations have to keep taxes high to avoid government corruption and maintain accountability to citizens. As a result, the fund is likely to keep growing faster than the investment income can be spent. It is already double Norway's annual economic output, and technically makes all Norwegians millionaires -- a distinction that has little effect on their daily lives.
It's probably better to have Norway's problem than the Netherlands'. Still, one wonders if it wouldn't be preferable to have some kind of global mechanism for evening out resource inequalities. As Norway's example shows, markets might not be well equipped to handle the capital flows.
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