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Should Developing Countries Constrain Resource-Income Spending? A Quantitative Analysis of Oil Income in Uganda

Abstract:
A large increase in government spending following resource discoveries often entails political risks, inefficient investments and increased volatility. Setting up a sovereign wealth fund with a clear spending constraint may decrease these risks. On the other hand, in a capital scarce developing economy with limited access to international borrowing, such a spending constraint may lower welfare by reducing domestic capital accumulation and hindering consumption increases for the currently poor. These two contradicting considerations pose a dilemma for policy makers in deciding whether to set up a sovereign wealth fund with a spending constraint. Using Uganda's recent oil discovery as a case study, this paper presents a quantitative macroeconomic analysis and examines the potential loss of constraining spending through a sovereign wealth fund with a simple spending rule. We find that the loss is relatively low and unlikely to dominate the political risks associated with increased oil spending. Thus, such a spending constraint appears well warranted.

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Energy Specializations: Energy Investment and Finance – Public and Private Risks, Risk Management; Energy and the Economy – Resource Endowments and Economic Performance; Natural Gas – Policy and Regulation; Petroleum – Policy and Regulation; Petroleum – Pipelines; Petroleum – Exploration and Production

JEL Codes:
D81 - Criteria for Decision-Making under Risk and Uncertainty
Q34 - Natural Resources and Domestic and International Conflicts
E60 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook: General
N5 -
D24 - Production; Cost; Capital; Capital, Total Factor, and Multifactor Productivity; Capacity

Keywords: Economic Development, Macroeconomic Dynamics, Oil, Resource Curse, Sovereign Wealth Fund, Uganda

DOI: 10.5547/01956574.38.1.jhas

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Published in Volume 38, Number 1 of The Quarterly Journal of the IAEE's Energy Economics Education Foundation.