Showing posts with label Sovereign Wealth Fund. Show all posts
Showing posts with label Sovereign Wealth Fund. Show all posts

Friday, 17 January 2014

Was the UK government’s use of North Sea Oil a scandal?

Aditya Chakrabortty of the Guardian thinks so, as do many on the left. The evidence appears at first sight quite strong, if we compare the UK to Norway. The Norwegian government invested the proceeds from its share of North Sea oil in a sovereign wealth fund, and as a result each Norwegian citizen is currently about $150,000 richer. The fund holds on average 1% of the world's shares. In contrast, there is no equivalent UK sovereign wealth fund, but just a lot of UK government debt. QED?

Not so fast. The opposing argument can also be stated in an equally compelling way. Why should the government decide on what to do with the oil revenue? The democratic thing to do with the money is to give it to the people, and they can decide what to do with it. To the extent that they choose to invest it, so the argument goes, individuals are much better at making good investment decisions with their own money than the government is. Seen this way, the complaints from the left are just another example of the paternalistic belief that the state knows better what is good for people than people themselves. What Mrs Thatcher’s government did was allow individuals to create their own wealth from North Sea Oil revenues, if they so wished.

There are essentially two issues here: one involving distribution between generations, and the other distribution between individuals. Few would argue that the generation who paid taxes in the 1980s deserved exclusive rights to the benefits of North Sea Oil: most would agree that this resource should also benefit future UK generations. Now the current generation could look after future generations by investing rather than consuming a large part of the revenues. The standard macroeconomic model assumes this happens to some extent (agents care about their children etc), although in a way that heavily discounts the welfare of future generations. Did they do this?

It is difficult to know for sure, but when I looked at the evidence from current accounts and net national wealth here, it was hard to believe that most of the UK’s North Sea Oil money was invested. So on this occasion at least, the Norwegian government appears to have looked after the interests of future generations rather better than the average 1980s UK taxpayer did. Whether that is because these taxpayers were selfish or badly informed I have no idea. (For a fascinating account of how a sovereign wealth fund might be useful in a world with selfish agents and animal spirits, see these papers (pdf, pdf, pdf) by Roger Farmer.)

The other problem with the defence of the UK government’s approach is more straightforward. If North Sea Oil revenue was used to reduce taxes, this means that the revenue was distributed unequally rather than democratically. Those who didn’t pay any taxes at the time received nothing. Those that paid the most taxes, which of course means those with the highest incomes, received most. An alternative would have been to distribute equal oil ‘dividends’ to each citizen, for example as the US state of Alaska has done. (For more general discussion of how best to handle resource discoveries, see some of the papers produced by OxCarre.)

So was the UK government’s policy a scandal? One definition of scandal is “an action or event regarded as morally or legally wrong and causing general public outrage”. Well, general public outrage it did not cause: giving the majority of people at least some money rarely does, and that those who were better off got most was a feature of the decade. On the other hand the fact that so little of the wealth was left for future generations, in contrast to the ‘statist’ Norwegian alternative, does seem to pose serious problems for neoliberalism, as well as the core intertemporal macroeconomic model.

Friday, 1 February 2013

Safe Assets and Sovereign Wealth Funds: Norway, the UK and Oil

Miles Kimball was ahead of me in thinking about the safe asset problem. It was interesting that we seem to have reached similar conclusions thinking about very different things. He focused here on the immediate problem of what the Fed was buying as part of QE, whereas I was in a fictional (and perhaps utopian) world centuries ahead when the government owned net assets rather than net debt. A sovereign wealth fund can be helpful in both cases: the monetary authority can ask the fund to make the decisions about what assets to buy, and the fund can provide the assets to either match against government debt or help reduce the need to raise taxes to pay for government spending. A short list of his posts on this issue can be found here. They are especially relevant for the UK if you are worried that all the Bank has been doing with QE is buying Gilts.

The discovery of a finite natural resource is an ideal experiment in teaching macro. It uses the intertemporal consumption model to illustrate why current account deficits (pre-extraction phase) and surpluses (extraction phase) can be optimal things for economies to have. I’m afraid I use the discovery of North Sea oil as my example, and luckily there is still enough there that no student will ever say to me ‘so there was once oil under the North Sea?’ [1] But my excuse for showing my age is that it also allows a very nice contrast between what happened in Norway and what happened in the UK, and a nice way to throw Ricardian Equivalence into the teaching mix.

For anyone who does not know, Norway invested (and continues to invest) most of its tax receipts from North Sea Oil into a Sovereign Wealth Fund (which used to be called the Petroleum Fund, but is now rather misleadingly called the Government Pension Fund.) It was not a token exercise - its assets are around $654 billion, which is larger than Norway’s GDP. The UK, mostly under the Thatcher government, decided instead that it was better to give this money to the people, so it cut taxes using its receipts from North Sea Oil. Under Ricardian Equivalence, where agents who care about their children as themselves also internalise the government’s accounts (which include any oil fund), what the UK and Norway did will have identical effects.

They will have identical effects, because those receiving the tax cuts will invest much of the proceeds so that when the oil runs out, they (or their children) will be able to carry on as if nothing had happened because they can consume the returns from those assets instead of revenues from the oil. It is a classic example of consumption smoothing: saving or borrowing to smooth out the impact of variations in income. We know people do sometimes try and consumption smooth, because most save for their retirement. Yet did UK consumers save the proceeds from oil to create their own personal equivalents of Norway’s oil fund?

The data is not very promising. While the UK ran some current account surpluses in the early 1980s, there were also deficits, and by the late 1980s there were only (large) deficits. We almost got back to current account balance in the late 1990s, but have had large deficits ever since. No obvious sign of saving the revenues from oil there. Looking at our net foreign asset position is initially a little more hopeful, as it’s positive value increased in the first half of the 1980s, but that disappeared for good by 1990, and the UK is now a net debtor. Perhaps a more detailed study might come to different conclusions, but I do not know of any that does.

Nor did the government set a very good example. It should at least have been running down its net debt position while North Sea oil revenues were at their peak, so that it could reduce the need to raise distortionary taxes once the money ran out. Net government debt did fall in the second half of the 1980s, but it went straight back up again in the early 1990s, suggesting this was just a cyclical effect.

What has this got to do with safe assets? Only this. One of the arguments against establishing a Sovereign Wealth Fund is that, even if the fund is nominally independent, governments cannot be trusted not to interfere, and so it is better to give the money to the people. Miles Kimball discusses this ‘libertarian’ view here, and I alluded to the ‘communism by the back door’ idea at the end of my earlier post. That, presumably, was part of the justification for not establishing an oil fund in the UK in the 1980s. I suspect if you asked most people who were born in the UK in the decade after North Sea oil started flowing whether the UK or Norway made the better decision, they would say Norway. In Norway, I suspect they would say Norway too.[2] The evidence seems to suggest they would be right. So in this case at least, not setting up a Sovereign Wealth Fund for ideological reasons was a mistake.

[1] How to use resource revenue is a critical issue for many developing countries, and is discussed in many places by my colleagues at the end of my corridor, including here.

[2] Of course many would not have a view, but I cannot help feeling that strengthens the case for a Fund. Interestingly it seems
that it is the right in Norway that want to spend more of the Fund today, and the left that (financial crisis aside) want to stick to their 4% rule.