What Changed in the World Bank's Adjusted Net Saving Measure?

In August, I showed that using the World Development Indicators' current Adjusted Net Saving (ANS) data there is no relationship between ANS and the share of mining rents in GDP. I now know the main reason why this relationship appeared to change but I don't know yet why the World Bank made the changes that they did. 

In 2006 and earlier, the World Bank measured mineral and energy depletion using mining rents – the difference between mining revenues and the cost of production not including a return to the resource stock. This is based on Hartwick's Rule – resource rents should all be invested in produced capital in order to achieve sustainability. 

In recent years, they have used a different method. First, they estimate the net present value of resource rents (assuming that they remain constant in the future) using a 4% discount rate. Then they divide that amount by the number of years, T, that they assume the resource would last. The ratio of the current rent to this quantity is given by:

So, for example, if the resource has an expected 30 year lifetime then resource depletion is about 58% of current rents. Energy depletion for Saudi Arabia is around 1/3 of reported rents. This would imply that the lifetime of the resource is around 70 years.* This could explain in general why adjusted net saving is now estimated to be much higher for resource rich countries than it used to be.**

What I don't know yet is why they made this change. I haven't been able to find a rationale in the relevant World Bank publications. It is similar to but different from the El-Serafy (1989) method of measuring depletion. According to El-Serafy, the ratio of depletion to rent should be (1/(1+r))^(T+1). For a 30-year life span and a 4% discount rate, this is equal to 30%.

* The notes downloaded with the WDI data say that the lifetime is capped at 25 years. But this isn't mentioned in the relevant reports and makes the gap between rents and depletion harder to explain.

** There are a lot of other issues with assuming that the lifetime of a resource equals the expected lifetime of reserves and that rents will not change over time. There are also apparent inconsistencies between the stated methods and the results...

Do Mining Economies Save Too Little?

I'm currently teaching Agricultural and Resource Economics for the first time. This week we started covering non-renewable resources focusing on minerals. One of the topics I covered is the resource curse. One of my sources is van der Ploeg's article "Natural Resources: Curse or Blessing?" published in the Journal of Economic Literature in 2011. In the paper, he reproduces this graph from a 2006 World Bank publication that apparently uses 2003 data from the World Development Indicators:

 

Genuine saving – now known as "adjusted net saving" – is equal to saving minus capital depreciation and various forms of resource depletion with expenditure on education added on. The idea is to measure the net change in all forms of "capital" in an economy. Mineral and energy rents are the pre-tax economic profits of mining. They are supposed to represent the return to the resource stock. The graph tells a clear story: Countries whose GDP depends heavily on mining tend to have negative genuine saving. So, they are not adequately replacing their non-renewable resources with other forms of capital. Van der Ploeg states that this is one of the characteristics of the resource curse.

Preparing for an upcoming tutorial on adjusted net saving and sustainability, I downloaded WDI data for recent years for some mining intensive countries, expecting to show the students how those countries still aren't saving enough. But this wasn't the case. Most of the mining economies had positive adjusted net saving. So, I wondered whether they had improved over time and downloaded the data for all available countries for 2003:

I've added a linear regression line.* There seems to be little relationship between these variables. The correlation coefficient is -0.017. Presumably, this is because of revisions to the data since 2006.

* I dropped countries with zero mining rents from the graph. The three countries at  top right with positive adjusted net saving are Saudi Arabia, Kuwait, and Libya. Oman and then does Democratic Republic of Congo have the next highest levels of mining rents and negative adjusted net savings.

Call for Papers: Special Issue of AJARE on Commodity Booms

Australian Journal of Agricultural and Resource Economics (AJARE)
Special issue on Resources and Energy Commodity Cycles: Maximising the Benefits of Resources and Energy Commodity Cycles

Focus
The Australian Journal of Agricultural and Resource Economics (AJARE) is publishing a special issue on managing mining and energy commodity cycles for publication in 2015. Submissions are welcomed.

The economic effects of commodity cycles in mining and energy sectors are a major policy topic in resource-rich countries. This Special Issue will follow a previous special issue on Mining and Resource Economics in the journal in 2012, which has been very highly cited.  Submissions to the Special Issue should be focused on identifying and analysing economic drivers and impacts, as well as evaluating different policy mechanisms available to manage and ameliorate boom and bust cycles.

It is planned that the Special Issue will be released in print form in April 2015. It is anticipated that an associated Symposium or workshop on the topic will be held in Australia in early 2015 to engage policy makers in the research findings.

Timeline
·         Issue Call – March 2014
·         Submissions due – 15th of September 2014
·         Manuscript selection – 30th of September 2014
·         1st round Reviews Due – 15th of November 2014
·         Review process completed – 31st of January 2015
·         Early bird publications – 28th of February 2015
·         Issued in print form – April 2015

Sample topic areas
·         Resource rents and taxation
·         Sovereign wealth funds
·         State roles to achieve benefit maximisation
·         Labour force transformations in the mining sector
·         Indigenous and remote area employment
·         Productivity growth over a commodity cycle
·         Positive and negative spillovers to other sectors / technology / workforce issues
·         Impacts of price and investment boom on exchange rates, interest rates and other sectors
·         Managing the transitioning from the peaks of resources and energy booms
·         Historical overviews of past commodity cycles
·         Managing conflicts over land use and environmental tradeoffs
·         Providing infrastructure, housing and services to resource regions
·         Economics of energy efficiency
·         Measuring and predicting price and investment cycles
·         Stranded capital and resource assets
·         Sustainable mining
·         Resource extraction and environmental tradeoffs
·         Coal and gas market analysis
·         Economics and regulation of unconventional gas
·         Energy demand and supply analyses

Editors  
The special issue will be coordinated by Professor John Rolfe (Central Queensland University) and Professor Quentin Grafton (Australian National University), with additional support from the AJARE Editorial team. Further information about the Special Issue can be sourced from Professor John Rolfe (Email: [email protected] / Phone: 61 (7) 4923 2132).

Early advice about intentions to submit would be welcomed. This can be done by emailing a prospective title and abstract to Professor John Rolfe ([email protected]).

Submission
Guidelines for authors and the process to submit an article to AJARE. 

Key Water Indicator Portal

The Key Water Indicator Portal has been released. This is one of the main outputs of the UN-Water Federated Water Monitoring System & Key Water Indicator Portal Project, developed by AQUASTAT of FAO, and coordinated by my former student Amit Kohli. This portal is intended to provide a simple way to view the latest data on UN-Water Indicators, which provide general water-related information on each country. Work on the portal has been ongoing for about a year, and its release was timed (Tuesday 20-March) for a few days before World Water Day.

Bob Gregory on the Mining Boom

Over the weekend I attended the 2011 PhD Conference in Economics and Business at the University of Queensland. This is an annual event held at ANU, UWA, and now UQ that has apparently been running for 24 years. Final year PhD students from across Australia present papers each of which has a faculty discussant. I was discussing Marjan Nazifi's paper on convergence (or lack of it) between EUA and CER permit prices on the European carbon exchange. My student Md Shahiduzzaman was also presenting a paper on interfuel substitution in Australia.

There was also a conference keynote given by Bob Gregory based on his paper with Peter Sheehan on the Australian mining boom. The key figure is this one:



which shows the gap that has opened up between Gross Domestic Income and Gross Domestic Product since 2003 due to the increase in the terms of trade. The increase in prices of minerals have boosted nominal mining income but this isn't reflected in the GDP numbers. I am still trying to get my head around the technicalities of this. It seems to be another case of where you need to be very careful about how national accounts are computed.

Sovereign Wealth Fund as a Solution to the Dutch Disease?

Yesterday, Max Corden gave a public lecture on the topic "The Dutch Disease in Australia: Policy Options for a Three-Speed Economy". A working paper is available here. Corden was a pioneer in the analysis of the Dutch Disease. This is where a booming mining sector leads to an appreciation of the exchange rate and a negative impact on other tradables sectors of the economy. "Dutch" refers to the natural gas boom in the Netherlands in the 1950s. Australia is currently suffering from this Dutch Disease.

He laid out three potential policies:

1. Do nothing
2. Protect the suffering industries
3. Sovereign wealth fund invested overseas

The idea of the SWF is that the outflow of capital will put negative pressure on the exchange rate. Of course, he didn't like policy #2. But in the end Corden was ambivalent between options #1 and #3. However, he recognizes that there is a push for option 2 and, therefore, promoting an SWF might help head-off that push.

Introducing BREE

In July 2010 ABARES was formed by the merger of ABARE (Australian Bureau of Agricultural and Resource Economics) and BRS (Bureau of Rural Sciences) two Australian government research agencies. Now ABARES will be effectively dismantled by transferring the resource and energy economics parts of ABARES into the Department of Resources, Energy, and Tourism to form the new Bureau of Energy and Resource Economics or BREE.

Leadership, Social Capital and Incentives Promote Successful Fisheries

A paper in Nature by Nicolas Gutierrez et al. carries out a meta-analysis of the literature on fisheries management. 130 fisheries are included. The aim was to test whether community co-management can promote sustainability as argued by Ostrom and others. They coded success of the fishery according to number of social, ecological and economic outcomes achieved and also counted the number of various "co-management" attributes associated with each fishery. The results look almost too good to be true:



Above a threshold level of co-management attributes there is a tight linear relationship between the number of success attributes and the number of co-management attributes. It looks almost too good to be true but would be a strong vindication for Ostrom.

Marginal Cost Curve for Crude Oil

Nice figure of the marginal cost curve for crude oil:



It's included in a post on the Oil Drum by David Murphy. Of course, reality is a bit more complicated than that and Murphy's article doesn't say that this is a marginal cost curve, but it does give a rough idea. Krugman is also on board for peak oil.

Call for Papers

The Journal of Industrial Ecology has a call for papers on the topic of "Greening Growing Giants". Quoting from the call:

"Questions relevant to this special issue include but are not limited to: What quantities of resources will be required globally in the near future, given the current dynamics of per capita resource use in developing countries? What role does the demand in industrial countries, and international trade, play in raising consumption levels in emerging economies? How much CO2 and/or pollutants will be produced through the resource use? What will be the technological potential for the reduction of resource demand and emissions? What are alternative development paths with low materials consumption and low emissions? What is the role of innovative practices at local level, especially in cities, in achieving alternative, more sustainable development pathways? What kind of policies, tools and practices are effective in achieving alternative development pathways?"

Deadline is 30 April 2011.

Is the Drought Over?

As you can see from the above graph, after a long period of standing at about 50% capacity, Canberra's dams are now at around 80% capacity. All the dams in the Western catchment in the Brindabella-Namadgi mountains are near capacity. Googong to the east which is half the total capacity is only at 60%. But that too is an improvement. As we flew into Canberra on Thursday we could see that the Eastern half of Lake George in now full of water. That's the most I've ever seen. I suppose that that is about a 1m depth. The historic shoreline is at 2m depth. The prehistoric shoreline, within the last 1000 years is at 17m! So far things seem to be following the prediction in one of my first blogposts.


Image of Lake George in August from Wikipedia

George Fane Seminar @ Arndt-Corden Division of Economics

I went to George Fane's seminar yesterday on "The Taxation of Rents from Mineral Resources". It was well-attended by both people from ANU and the public service. The seminar might have provided the answer to my confusion about why the Henry Review and most economists discussing it argue that royalties are inefficient, while my intuition tells me that they're not so bad.

One of the cases that Fane looks at is where mining companies engage in "work program bidding" with the government. Companies promise to carry out exploration and development of the mining lease they are allocated. The company that promises the most gets the lease. It seems that this is the way that mining leases are mostly allocated in Australia. Under this arrangement, assuming that all companies have the same cost structure, competition between companies would result in bids to spend so much on development so that the average cost of production (including a normal return on capital) is equal to the price of the mineral. If a company doesn't bid that much then another company has an incentive to bid more. As a result there are no "rents" from mining. This resource regime is similar to an open-access resource.

Introduction of a royalty will discourage this overbidding. In theory the royalty can be chosen so that the marginal cost of production is equal to the price of the mineral in the market. This level of production is the efficient level. The royalty collected by the government is then equal to the difference between the price of the mineral and the average cost of production. The government receives all the "rent" from production of the resource.

In this case, removal of royalties and introduction of a Brown tax results in over-exploitation of the resource and "dissipation of rents". Royalties are efficient and "rent taxes" are inefficient. (From here on, is my interpretation of what this means, not what George Fane said:) The model underlying the Henry Review analysis must be one where private landowners are developing the mineral resources on their own land. Obviously, they won't waste resources in doing so. Introduction of a royalty tax by the government is then distorting and inefficient. The Brown tax, where the government demands a share in the enterprise would be efficient assuming that the goverment really shares in all costs (including the CEO's time etc.) and there is no uncertainty.

(Back to what Fane said in the seminar:). Fane also discussed the case of auctioning mining leases. With no uncertainty a rent tax simply decreases the amount paid for mining leases by the amount of the rent tax. Introducing a rent tax results in the government taking on more risk. Rather than getting higher auction proceeds they take a bet on getting higher revenues from a rent tax but they also take on the risk that mineral prices are lower or the lease property is not as productive as expected and they have to pay out money to the mining company.

Global Map of Forest Canopy Height

NASA has produced a cool map of world forest heights. Woodlands and savannas are not included so the green areas are a very low end estimate of world forest cover.

Gittins Enters the Economics Consensus Debate

Ross Gittins agrees with Ken Henry that academic economists need to get behind "reforms". I don't understand this presumption that economists should all be in agreement about all policies that the government happens to come up with. I disagreed with the basic rationale for the RSPT as presented in the Henry Review. I see royalties as a charge by the resource owner not as a priori a "distorting tax". I don't, therefore, accept the basic argument that the Brown tax is neccessarily "more efficient" and I could certainly see the differences between that ideal Brown tax and the tax proposed by the government. Proponents of "rent taxes" apparently believe that inefficient mining companies should use Australia's resources for free just because they can't make a profit.

Now a profits based tax may in the long-run get the government more total returns on its minerals or maybe it will either encourage too much early exploitation of resources or discourage too much investment in the long-run. Or some combination of both. Additionally, my understanding is that the resources belong to the states and the Rudd government was obsessed with centralization - see the hospital/health policy. But lets see some more balanced debate around these issues rather than everyone rushing headlong after whatever the Treasury Department comes up with. Just because the economists there thought it was a good idea doesn't mean it is. Similarly, my ideas may not be good either, that's why we have peer review in academia.

The RSPT is Dead Long Live the MRRT!

The Commonwealth Government * is announcing changes to the RSPT. The interest rate is 7% above the government long-term bond rate, the rate of the tax is 30% no refunds of losses and it only applies to iron ore and coal. It is being rebadged the "Minerals Resource Rent Tax". The existing Petroleum Resource Rent Tax will be extended to onshore coal seam gas production.

These are changes which the industry argued for. It will be hard for them to argue against this tax. A rough guess is that it will collect no more than the existing state royalties at the moment. Corporation tax will be cut to 29% (from 30%) in 2013-14. And the government is still proposing to raise compulsory superannuation contributions to 12% from 9%, a policy that only seems to have the support of the superannuation management industry. I think these are sensible moves (though why shouldn't gold mining say pay the tax?) though as someone who thinks we either should have a federal form of government for real or just go ahead and abolish the states I still don't like the idea of the federal government taxing resources which according to the Constitution belong to the states. And I don't have a problem with the nature of state royalties in the first place.

These are of course still just proposals. This tax is going to have to survive the federal election, the Senate, and possible court action on the constitutional issue.

* I know they call themselves the Australian Government, which I see as a sign of Ruddist centralization.

Jerry Hausman on the RSPT

MIT economist Jerry Hausman has an article in The Australian today that includes a link to his full paper. As I suspected, real option analysis comes into play here.

TV Ad Campaigns

Though both the government and the union movement are running TV ads for the RSPT, I've only seen the mining industry's anti-RSPT TV ad so far:



Apparently, I'm not in the target demographic that either the government or the unions think they can influence. I'm amused how the guy says "if it goes ahead" and it sounds like he's talking about all that investment that's on hold rather than the RSPT.

Samantha Maiden has a post covering the ads from all three groups. I have to say the union one is best.

Ben Smith on the RSPT

Ben Smith, who did some research in the past on resource rent taxes, has an article in today's Australian on the RSPT. He favors the pure "Brown tax".

RSPT: Lack of Transparency is the Issue

From the point of view of the mining industry and their potential financial bankers in the banking industry there are two key issues:

1. How are existing projects where the government hasn't been accounting itself as a passive shareholder to date to be dealt with.

2. Whether the government is really going to refund losses in the event of a project failing. The miners and banks are saying they place no value on this guarantee and, therefore, no-one will lend to mining projects at the long-term government bond rate. Here, there are two sub-issues. One is that it seems highly likely that the government would do a backflip in the future and in the event of a recession that resulted in many mining projects going under, refuse to hand over billions in tax refunds to "rich foreign mining companies". Rudd's rhetoric on the RSPT suggests that this is a real risk. Second, there is a lack of clarity of how the refund interacts with bankruptcy law. Will shareholder and creditors really have access to the tax refund in the case of a bankruptcy? I don't understand the details of the latter but it seems to be a real concern.

The government could assuage these latter concerns by adopting the full pure "Brown tax" by immediately refunding 40% of all costs upfront on a quarterly basis. But they don't want to do this. Obviously, they must think they gain by pushing these costs into the future rather than by funding them themselves at the government bond rate. If the government won't fund them at 6%, why should the mining and banking industries?

From the taxpayers' perspective the downside of the RSPT over royalties is the increase in the risky of government revenue that results. The Brown tax makes that explicit. Again the government would seem to be concerned about making that obvious to the public.

More on the RSPT

I read a couple more papers on resource taxation and am not much clearer about things. Ben Smith wrote about the impossibility of a neutral resource rent tax and Diderik Lund wrote
a recent review.

It is pretty clear that a pure "Brown tax" where the mining company immediately gets refunded the tax rate (say 40%) multiplied by all losses minimizes the effect on investment decisions as long as the government is definitely going to keep on doing that. The government becomes an effective passive shareholder in 40% of each project. There is still a question of the government getting a free ride on the intangible capital/human resources of the mining company, which aren't usually expensed to individual projects. Under certainty, this would then be a neutral tax on investment.*

Further complications ensue when losses must be carried forward or some expenses are excluded. The RSPT carries forward losses at the long-term bond rate because the Henry review argues that as the government will eventually refund their share of any terminal loss the company is effectively lending money to the government. Whether this results in a tax that is still neutral in its investment effects is debatable, it appears to depend on modeling assumptions. Investors might not mind lending money to the government at the government bond rate but it is a different question to force them to do so when they have other investment opportunities. Emphasizing this point, the tax doesn't allow the deduction of interest expenses. The company's existing cost of capital is likely to be higher than the government bond rate. The Henry review lists a number of other expenses that cannot be deducted some of which seem reasonable and some not. All these variations on the pure Brown tax certainly reduce the neutrality of the tax.

I just read comments in the Australian from Ross Garnaut which further explain the reasoning behind the use of the government bond rate. If the government is promising to repay all losses then banks lending to the mining company should also be prepared to lend at the government bond rate. So, by this thinking there is no wedge between the returns on the RSPT capital account and the company's cost of capital. Garnaut is saying that this is a simplification which isn't likely to hold in reality. It certainly doesn't apply to existing projects - but accelerated depreciation is meant to deal with that issue. Shareholders will effectively put in 60% of the capital to projects and get the normal rate of return on that 60%.

I think I understand fully where the Treasury is coming from now.

* As Jerry Hausman argued after I wrote this blogpost originally things get more complicated even for this best case Brown tax when there is uncertainty.