Dutch disease may impair growth prospects

THE area most open to criticism in the 2010 Budget has been the systemic risks posed by inflation, which has been forecast to rise by an average of 9.5% next year.
High inflation acts as a deterrent to investment and economic growth.
This is a reflection of rising costs that put imported goods out of the reach of many people at a time when many people will see their fortunes improve through strong job creation and rising wages.
The immediate question is why the National Government has chosen to maintain high levels of public sector expenditure when the PNG LNG project, led by ExxonMobil, will be initiating unprecedented levels of construction activity.

Windfall expenditures
Would it have been better to have gone for a surplus budget or a less potentially inflationary path?
The latter would have been possible if the K502 million in windfall revenues from resources – export prices are high enough to suggest the good days will be back again next year – were treated in the manner recommended by the Medium Term Fiscal Strategy.
This would have seen 30% of “additional mineral revenues” used to repay Government debt.
Instead these funds have been directed to the Development Budget, which are up by 22% to a record K3.39 billion.
This is a head versus heart issue for me.
My head tells me yes the safer path would point to lower Government spending and/or a paydown of public debt.
But the idea of being more proactive and taking on some level of risk also does have an appeal.
If this was Australia or some other western country, the former would certainly be the way to go, but for PNG and many developing countries, the notion of “nothing venture, nothing gain” does apply.
Developing countries have to weigh the odds and sometimes challenge conventional wisdom to try and secure progress in difficult times.
We have heard repeatedly in the media and elsewhere how roads, hospitals, schools, public housing, police infrastructure and other facilities have been totally rundown after two or more decades of neglect.
Getting these fixed to proper standards will take a decade or more – on the assumption that things go well in future and adequate funds are allocated and used for these purposes.
The sums needed in every area of public sector activity amounts to billions of kina.
Even if that kind of money was available, which it is not, there is also no capacity to immediately tackle the vast amount of work that is necessary.
These are areas that, at least in theory, have received Government funding via supplementary budgets that commenced in 2005 but Treasury candidly admits they have yet to be reflected in any improvements in the nation’s social indicators.
If such spending is properly planned and implemented – and there are wide scale concerns on the level of effective implementation – this should provide a sound basis for longer-term growth.

Inflation and the ‘Dutch disease’
Higher spending does not necessarily translate into higher inflation.
If expenditures by the PNG LNG project – or Government spending – contributes to creation of an equivalent value of goods and services during the construction phase, this spending need not be inflationary.
However, with such a big surge in expenditure some inflationary impacts are inevitable.
Particularly in the face of capacity constraints, there will be strong upward pressure on wages and other costs, such as property values and rentals.
The Government decision involves some risk, somewhat like the risk in allowing a significant budget deficit last year.
If inflation can be kept at bay, it will be a win-win situation; the consequences will not be easy to tackle.
While the effects of high inflation can be insidious, the problems that come with the “Dutch disease” are also highly problematic.
They generally revolve around complex reactions to a huge inflow of funds from major resource projects that will tend to strengthen the value of the kina and cause some key sectors of the economy, particularly agriculture, to become uncompetitive.
Contrary to what some commentators appear to think, aspects of the “Dutch disease” will be with us from commencement of the LNG project.
Broadly, this will see more than K10 billion spent annually on construction activity from 2010-13, a sum that is significantly larger than the Government’s annual budget.
Treasury forecasts in the 2010 budget provide some indication of the perverse impacts of the “Dutch disease”.
From 2011, most sectors of the economy, with the unusual and rare exception of agriculture, are forecast to become relatively smaller contributors to economic growth.
Leaving aside one off impacts on mining and the downward trend in oil production, there are four sectors in 2011 forecast to provide a 0.4% addition to total GDP growth of 6.2% in that year – manufacturing; transport and communication; finance and business services, and community, social and personal services.
Their contributions are forecast to weaker further in subsequent years.
By 2014, when LNG exports are surging, these sectors are expected to become negative contributors to GDP growth.
Among them are mining (-2.5%), wholesale and retail trade (-0.6%), and finance and business services (-0.2%).
Electricity, gas and water; transport and communication; and community, social and personal services are forecast to be neutral, making zero contribution to anticipated GDP growth in that year of 8.4%.
Looked at in another way, total non-mining GDP is forecast to slow from a high of 8.1% in 2010 to a low of 1.6% in 2014 following a steady decline in the intervening years.
In constant kina terms, the value of most sectors will continue to grow but each will be overshadowed by the forecast 900% growth anticipated for the oil and gas sector in 2014 caused by the surge in LNG export earnings.
The bottom line for all this is that Treasury is anticipating that the PNG economy will grow by 30% in real terms, or about 50% in nominal terms, between 2010 and 2014.
This is in sharp contrast to the projections by the Australian consultancy, ACIL Tasman, which predicted the LNG project would cause the economy to grow by 100% or to double in size in that time frame.

Tomorrow: Dynamism of PNG economy is severely under-rated

* Brian Gomez, a former journalist with The National, is presently corporate and public affairs manager for the Independent Public Business Corporation. Comments in this article represent his personal views.