March 6, 2018
Norway is a largest Western European oil and gas producer, and this circumstance, alongside with the fabulous revenues, for the past 50 years since the discovery of oil field resources, has been a constant headache for Norwegian government. The reason to this is the so called Dutch disease. The government of the country did not notice the symptoms of the disease for decades, but now they have officially declared the recovery from it. Norway is regularly instanced to other countries: the state with a little over five million population achieved magnificent economic growth owing to oil export not only by efficient use of their natural resources, but also of moneys earned. The professionals in economy from Norway School of Business state that the country managed to avoid the “Dutch disease.” This term obtained its name after negative economic effect in the Netherlands, registered upon discovery in 1959 of a high grade gas field and explosive growth of mining sector. Commencement of mining the gas at the deposit was followed by rapid gas export growth, strengthening of national currency, which resulted in economic recession.
A disparity in favour of mining sector, which is under real boom, occurs when economy is in “Dutch disease.” Rapid export rise leads to strengthening of national currency. The mining industry attracts labour resources from the commodity-producing sector, which becomes non-competitive when the currency rates grow. Due to cheap import, it becomes non-profitable for this sector to produce their own goods and sell them in internal market to say nothing about exporting them abroad. In parallel, growth of population wellbeing provokes growth of demand to non-tradable commodities (for instance, real estate, land, or services, which are impossible to export). This “effect of expenses” also leads to loss of personnel from production, and now to the services sector.
In the short term, export of resources is efficient and allows receiving super profits, however, in long term, the resultant effect leads to degradation of production. The country finds itself in deindustrialisation situation, falls behind the rest of the world in industrial development, and becomes entirely dependent on the prices for the commodity to be exported. Venezuela is a current day example of the Dutch disease, where oil price drop provoked economic crisis. Dependence of a country on one type of export discourages the investors – the prices for the resource may drop or its resources may get exhausted. Such a state is left with a degraded and non-diversified economy and faces crisis. The USSR had this problem: when the mineable oil resources were nearing to exhaustion, the Soviet government had to deal with drop of state incomes, then inflation of national currency, and finally with real collapse of national economy.
The Dutch disease does not necessarily occur in resource-based economies – it may occur in any country, which has one product dominating in its export items. The Australian gold rush of 19th century and coffee export boom in Columbia in 1970’s can be shown as examples here. However, when the Dutch disease is spoken about, people often refer to economic boom due to oil and gas export.
There is no universal remedy for “the resource curse”, the main methods of avoiding occurrence of such situation is control of excessive currency exchange rate growth and increase of competitiveness of industrial sector that have suffered from the resource boom. To achieve this, the governments should not immediately “inject” the obtained super profits into their economies, but accumulate the profits in reserve funds and invest them. Such funds become government piggy boxes, where funds are kept for future generations, and which give confidence in the future.
Another method involves protective measures, which would stimulate the competitiveness of other sectors of economy, including using investments into education and infrastructure, but this may conceal the risk of leading own industry to a non-competitive level.
Using the Kingdom of Norway experience as an example, a group of researchers from the Norway School of Business showed that the resource dependence is not always a real curse and may become a positive case at smart internal economic policy. At the time of discovery of the oil resources in 1969, Norway did not have any technologies, knowledge, and professionals for independent development of the oil fields. Foreign players stepped into the resource market of the country, who undertook the key issues, which Norway did not have sufficient competence at that time. The state played the role of the beneficiary only by receiving profits from oil mining. However, smart policy of Norwegian government allowed integration and adaptation to oil mining of those citizens, who worked at other industries, establishment of support industries, and becoming an exporter of the technologies developed by the country.
The analysts instanced the Norwegians, who had worked as welders at shipbuilding yards before, but after discovery of oil resources and stagnation of the shipbuilding industry, they obtained experience in working in difficult and complex deep marine operations.
Moreover, starting from 1990’s, Norway managed to overrate neighbouring Sweden in manufacturing productivity. . According to the researchers from the Norway School of Business, this was possible only owing to development of the oil industry – Norway had had a long path from being another “fuel filling station” to turn into an exporter of technologies and professional knowledge in this field, while timely establishment of own reserve fund and smart financial management, which was intended for development of other sectors of national economy, helped the country avoid the Dutch disease symptoms.
Creation of the world largest national wellbeing fund – State Oil Fund, whose source comes from the super-profits from exports of the resource, allowed Norway avoiding the expenses effect. The head of the Norges Bank Investment Management Ingve Shlingstad said – “I don’t think that at the time of first injection of the oil profits into the fund in May 1996, nobody would have thought that the market cost rise of the fund would get this much overwhelming.”
The fund is practically inviolable- most of the funds, reporting to it, is invested into international assets, which turn the fund into a largest shareholder with shareholding in over twenty thousand companies all over the world. Only a small portion (about three per cent) of the funds is spent for state expenses – only the income from investments is allowed for spending. All the rest is planned for leaving for future generations – the name of the structure also states this fact (it was renamed in 2006) – State Pension Fund of Norway.
The Norwegian government are sufficiently successful in management of the fund assets. For instance, for 2017, the fund doubled its profit-earning rate from 6.9% in 2016 to 13.7 % in 2017 having earned over 130 billion US dollars. For comparison, management of funds of combined Reserve Fund and National Wellbeing Fund (NWF) of Russia suffered losses of minus 0.10% as per the 2017 year-end results from placing the funds in the accounts of the Bank of Russia.
According to the economists in Norway, one of the main reasons, why their country managed to avoid the Dutch disease, were timely measures from levelling of the expenses effect. Preventing the excessive overgrowth of services sector due to the oil boom, the state took the advantage of rise of labour productivity in resource mining. This lead to establishment of supporting industries (mineral exploration, transportation) and, generally, raised the labour productivity in all sectors of their economy, which allowed the country diversify their own economy, to become not an ordinary hydrocarbon supplier, but also an exporter of obtained knowledge and technologies.
In addition, for the avoidance of intoxication from successes and expenses effect, the Norwegian government keeps the oil industry in stiff frames – corporate tax is 23 per cent (20 per cent in Russia), moreover, the so called special tax is applied to oil miners at the rate of 55 per cent of income. Thus, maximum taxation rate in the oil sector may be as high as 78 per cent.
As a result, Norway has become a classical state of neo-socialism, which maximises human potential disclosure, for instance, expenses rate for health care in this country is one of the largest in the world – over six thousand US dollars per person per annum as opposed to 1.3 thousand USD dollars in Russia. The education system is in the same situation.
The Dutch disease symptoms of Russia are obvious, and the economic crisis (or long lasting recession) from 2013 continued currently is the proof of it. Russian government ought to take several positive examples from neighbouring Norway, for instance, the very taxation system. The Russian oil sector is taxed by two types of taxes – mineral mining tax (MMT) and oil export tax. The oil export tax is 120 US dollar per ton, however, if oil from oil fields with difficulties in recovery is exported, the owner is given wide privileges.
Russia’s MMT rates are loyal to oil miners. The tax rate for the industry is a serious mathematical formula, which includes a factor, which is determined by the current price per barrel of oil at world markets. In other words, the government preliminarily realises the oil miners difficulties by giving the privileges should the oil prices drop. In addition, the formulae also stipulates a factor that reduces the tax rate, if oil is mined at a field where oil extraction is difficult through reasoning by difficulties in development. As a result, it turns out that the oil miners are not interested in development of the industry for reducing their own expenses; they do not invest sufficient funds into development of technologies, which Norway had been doing.
Norway’s example is attractive for Russian authorities, which is supported by recent words by Anton Siluanov, Minister of Finance of RF, who called the experience of our northern neighbour “extremely attractive.” Serious changes are really expected in oil mining sector taxation system: from 2019 an added profit tax (APT) will be applied instead of MMT; this tax will be levied directly from oil sales incomes minus export fees. The tax rate will be 50%. It is planned to apply this tax at pilot projects.
While there is some progress in taxation system, we still have a grim state of affairs in management of oil profits – the case of losses in management of the Russian Reserve Funds while Norway could earn 13.7 per cent is evident without explanation. Moreover, the Russian reserve funds are often used for covering the shortages of the state budget, which finally has led to exhaustion, and later full liquidation of the Reserve Fund and merging it with the Fund of National Welfare, while Norway spends the profits for development of healthcare, education, high tech sector systems, which is generally called “social capital.” One ought to learn from Norway to make investments efficient.