Optimizing What?

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The previous post got a pretty good debate going about oil policy. One point, though, kept coming up in different ways from different commenters: seeing “optimizing the tax take” as the goal of the exercise is badly misguided. It’s the development outcomes associated with oil exploitation that we need to optimize, not the tax take.

Ni es lo mismo, ni es igual.

Update: One readers, though, thinks this is taking a step backward:

Development outcomes associated with oil exploitation? What does that even mean?

First of all, development outcomes are very broad and difficult to measure. Second, relevant development outcomes are not uniquely and directly related to oil exploitation. That is, those development outcomes depend on a broader set of policies, not only on oil policies. Ideally you’d like to design all government policies, not only oil policies, in order to optimize society’s welfare, which you could very well reduced to a battery of development indices. However, that might be a bit cumbersome.

One way to face that problem is to break it in a set of smaller problems. One of them would be to set an easy rule of thumb for your oil policy. One could argue that a good rule of thumb is to maximize the oil tax revenue over a reasonable period of time (i.e., the present value of tax revenues over 10 years). In this case, maximizing the tax take is only an intermediate goal towards optimizing whatever development outcomes you see fit. These goals are not at all contradicting. Quite the opposite, they are actually complementary.

In fact, one could prove that the optimal oil policy (having in mind the ultimate goal of people’s welfare) goes through maximizing oil tax revenues.

This goal has one advantage: it’s easy to measure. Also it relatively easy and straightforward to design your oil policy with that in mind.

Which sounds appealing, except maximizing the tax take suggests maximizing Dutch Disease as well. (La era del parásito feliz, is how Uslar Pietri used to call it…)

1 COMMENT

  1. “It’s the development outcomes associated with oil exploitation that we need to optimize, not the tax take.”

    True, regarding “not the tax take”, but the first part of that statement leaves out certain constraints, such as “without letting people continue to suffer critical poverty”, for example. The first part also uses a possibly royal “we” that is precisely at the crux of the petro-state model. In the royal “we” sense, no *we* do not need to do the optimizing, it’s the nation that needs for those development outcomes to be optimized.

    What are the chances that a government that is busy running an oil industry will have proper priorities in running the rest of the nation? What are the chances that the people in a nation are the most qualified to vote for the person best suited to run the oil industry, or the person who will select such a person? It’s crazy, crazy, crazy, just as crazy as la ley de precios…

    So instead of the royal “we”, simplify the governments role to simply selling to private extractors, then let “we” the Venezuelan citizens optimize the development outcomes via the market. Maximize decentralization to the personal level.

    • Extorres,

      How do you avoid what happened in Russia and Ukraine with the oil sector beginning in 2001? It was bad, really bad. Surely there is a way out, but how do you think we avoid selling out the nation in that way? (it’s not good with “Chávez is selling it out already”)

        • I’m not sure how you are imagining something similar to the Russia-Ukraine oil conflict happening in Venezuela, particularly in the context of having the government limit itself to pricing of crude and oversight of its extraction. It is my understanding that Russia was exporting oil and gas to and through Ukraine, and their issues were of non payment and illegal diverting of those resources.

          In Venezuela, we’re talking about letting private businesses extract the natural resources at a competitive price. Any issues that those businesses may have in getting the resources or their derivatives to their clients would be their problem. Some Venezuelans, naturally, would possibly be buyers of the crude, and would surely be buyers of the derivatives, espcially gasoline, but, again, that wouldn’t be the government’s problem, except to ensure that the market for those goods remains legal, including competitive. Gas stations would buy from the best/cheapest suppliers, and people would go to the pumps that offer the best/cheapest gasoline.

          I don’t understand how that could fall in the “selling out the nation” category, so perhaps I’m missing something. Could you please expand?

          • The fact I mentioned Ukrained led to this confusion. I am referring to what started to happen in early years of the change in both Russia and Ukraine, not in their relations between themselves:

            http://en.wikipedia.org/wiki/Economic_history_of_the_Russian_Federation#Privatization
            When Russia privatized all those companies, it basically sold off huge segments of the cake to insiders, the oligarcs of today.
            What private businesses are going to be chosen? Who is going to guarantee the best are chosen? Give me something better than “public tender”. The devil is in the details.
            How do we make the process as transparent as possible, how do we guarantee that no matter what prices are the nation gets enough money to invest in R&D for other things? Perhaps you are going to say on this last part what Loroferoz said: never mind, just give each individual their share and they somehow will know how to use it. It never worked (but that is another topic).

          • Thanks, now I see what you mean.

            It is my understanding that in Venezuela’s case, most of the oil industry is already owned by partnerships between Venezuela and various others. I would think that in most cases the privatization of the industry would start by selling Venezuela’s share to the partners of each business. You’re right that some sort of process would then have to be used for the cases in which the partners don’t buy out, or that Venezuela has no partner. My guess is that the process would be a type of open bidding, but the lack of details does not change the guiding principle that the government should not be owner of any of it.

            Clearly it is the government’s role to carry out the process. If you are willing to trust the government to run the business instead of it going to “wrong” people, then I’m sure you can find it in you to trust the government to carry out the process so that it doesn’t. Of course, this is Venezuela. We would need to oversee the process almost like overseeing the elections, and even then there will be accusations of fraud. But even if some of the businesses end up going to the wrong people, we’d be a step closer to tidying up the government so that those businesses make more money, get taxed properly, and any illegalities get caught and processed. The government would be less distracted running the businesses and more focused in doing what it’s supposed to be doing.

            ***

            But your last question perplexes me: how do we guarantee that no matter what prices are the nation gets enough money to invest in R&D for other things?

            I assume that you know I support Unconditional Cash Transfers, so clearly UCTs don’t answer your question. So I’ll answer without UCT in the answer. Imagine a country with no oil or other such Devil’s Curse. That nation would get its “money to invest in R&D for other things” from taxing its people and businesses. The more the government taxes, the more it becomes its own responsibility to prevent the nation from choking to a standstill. The less the government taxes the more the country’s future depends on its people and businesses to plow forward. So, there’s no exact answer to the amount of taxation, nor to how the taxation gets spent on R&D or whatever else. So there’s no guarantee, and that is an acceptable level of uncertainty for a typical nation. The government would have to find a happy range for its taxation and a varied spending that takes into account immediate, medium, and long-term needs, together with sound policies that let the market plow forward as much as possible, but reigned in enough to prevent social abuses.

            Now let’s imagine that oil is discovered in that nation. The government already had a stable taxation/spending process: when it’s people make more money, it gets more taxes and it spends it according to how much it has to spend and the things that need to get done. So what is the government to do with this new oil money? Should it

            A) plug the money into its pockets and use it as if it had increased taxes or as if the nation were producing many more taxable goods, or

            B) should it plug it into its businesses’s pockets, directing the development of the nation through market interventions, or

            C) should it plug it into its people’s pockets, thus changing its stable system as little as possible, and waiting for the money to come back anyway into its pockets by way of unchanged taxation?

            Unfortunately, Venezuela has cycled between A and B, the infamous petro-state model, where the amount of money leads to a kind of continuous lottery syndrome. I propose we try C, which has never been tried, but is based on two sound principles: the amount of money gets distributed amongst so many that it minimizes the potential for the lottery syndrome, and the government does not change its role of living off of taxation “to invest in R&D for other things”. Oh, and it eliminates poverty, to boot. That part would be guaranteed.

  2. “It’s the development outcomes associated with oil exploitation that we need to optimize, not the tax take.”

    We need sort of both… but the final question is really who is going to be in charge of the development the cacique or the indians?

    By the way talking about tax-take let me tell you a story. Back in 1978 as a manager of a leasing company I signed a leasing contract with one of the oil companies by which I was charging them 18 percent interest rate instead of the going 11 percent bank rate they could get. I had convinced them that because of the accelerated depreciation that meant they would effectively pay less. When I happy left the signing a thought came to my mind… those tax savings… are these not paid by the shareholder of the oil company?

  3. If I may preach to the choir on this one, turning oil into development is a lot harder than people think. I can’t think of a whole lot of places that have really done it. The ones that come to mind are 1) Norway/England (already democratic and developed when they discovered oil) 2) UAE (non-democracy that imports skilled labor from the developed world and unskilled labor from Somalia and Pakistan and gives them really dodgy access to citizen rights) 3) Maybe some in the middle like Malaysia that has a very respected state oil company. Or Brazil, where the state oil company’s job is to provide energy and not feed the country, and is spurring the local shipbuilding industry by building drilling rigs and platforms at home.

    I’m convinced nothing changes until people have more realistic expectations about what oil can really do for them. I remember a poll (from years ago I admit) showing that 15 percent of Venezuelans believe they shouldn’t have to work because of all the country’s oil money. This is not a country that’s going to make serious development progress from petroleum. I’m glad to see Caracas Chronicles trying to ask the right questions about these issues.

    • I asked a question in my blog in English for non-Venezuelans and the same question in the Spanish one for Venezuelans. Of course, I can’t be sure of the nationality of people who voted but I do think they very much followed the rules.
      Most foreigners consider Venezuela a poor country, most Venezuelans consider their country rich. Of course, wealth can be very relative, but in this foreigners are right and Venezuelans are not: Venezuela IS a poor country. No country, absolutely no country has become rich just because of oil or gold or stuff like that (see Congo); we need politicians who start to say just this very thing: only when Venezuela’s average citizen has the skills and productivity of a Canadian or a South Korean will we be able to say the country is rich. Only if the average citizen has a good real, do-things education – the heck with titles-, is his country a prosperous country.
      Who has the cojones to say that?

      • In the 1970’s, while speaking to other young guys where I grew up, some of us concluded that Venezuela had a great future because of oil. Something inside me said, that isn’t right. It took a few years but eventually I realized that oil doesn’t make a country rich; it makes a few people in the country rich.

        • I don’t know about this Steve.I lived in the US many years, and in Venezuela many more.It is amazing to see just how much easier it is to make money in Venezuela, with only a minimal effort.People survive on semi- permanent vacations, others live in families where only one person works and the rest hang out…..not sure Steve, but I think this might be a sign of ” oil rich”.

          Rich is one thing….well organized and productive are another.I like to keep the terms clear.

  4. I think domestic companies that produce products for domestic consumption are heroes. If they are making big profits, it’s not because consumers choose to pay high prices, it’s because they have NO choice. If the government policies create shortages, then domestic production is a solution, not a problem. If anything, government policies should support the companies, not make scapegoats of them. These companies provide jobs! It would be wonderful if the could modernize and grow. That would create even more jobs and increase the supply of consumer goods without tapping into the foreign reserve.
    Oil money is an addiction, I believe. But it makes no sense to me when the government needs to borrow money to keep oil production from decreasing. It seems that the government doesn’t mind paying interest to foreign lenders, but it doesn’t want domestic companies to make good profits. Forget the oil money! Just let entepreneurs do what they can do!

    However, entrepreneurs need a skilled work force. They don’t need brainwashed socialists!

  5. Development outcomes associated with oil exploitation? What does that even mean? First of all, development outcomes are very broad and difficult to measure. Second, relevant development outcomes are not uniquely and directly related to oil exploitation. That is, those development outcomes depend on a broader set of policies, not only on oil policies. Ideally you’d like to design all government policies, not only oil policies, in order to optimize society’s welfare, which you could very well reduced to a battery of development indices. However, that might be a bit cumbersome. One way to face that problem is to break it in a set of smaller problems. One of them would be to set an easy rule of thumb for your oil policy. One could argue that a good rule of thumb is to maximize the oil tax revenue over a reasonable period of time (i.e., the present value of tax revenues over 10 years). In this case, maximizing the tax take is only an intermediate goal towards optimizing whatever development outcomes you see fit. These goals are not at all contradicting. Quite the opposite, they are actually complementary. In fact, one could prove that the optimal oil policy (having in mind the ultimate goal of people’s welfare) goes through maximizing oil tax revenues. This goal has one advantage: it’s easy to measure. Also it relatively easy and straightforward to design your oil policy with that in mind.

    • “Ideally you’d like to design all government policies, not only oil policies, in order to optimize society’s welfare”

      In order to optimize society’s welfare you have to take into account mid and long term environment consequences. There is a very strong consensus in scientific community about human-induced climate change, good enough models about expected effects and people is now quantifying economical and social effects of this for the next 20-50 years.

      If we want optimize Venezuela´s welfare for the next generation, we have to put into the equation negative effects of climate change. Some could be calculate without big effort: infrastructure costs needed to prevent floods in coastal cities if sea level increases 0.5 or 1 meter in average, infrastructure needed to ensure regular water and electricity supply with bigger El niño-La niña oscillations, environmental “desplazados” and refugees, etc. Other factors are harder to evaluate: bio-diversity losses in Orinoco’s Delta, for instance. But the whole cost is high and will be worst if we continue doing business-as-usual.

      I guess that even today, for each barrel we sell to be burned, we actually receive less money than the damages it cause to us. This negative impact will probably be higher in the futur.

      A rationnal policy, in the long term, could be to reduce oil production. In an ideal world, this reduction could be decided by the international community, in parallel with a technological shift effort. But even for a single country as Venezuela it could be a good policy, if my supposition about actual cost of oil-barrel is confirmed by a carefully cost-benefit analysis.

      Reducing our oil production is probably politically unfeasable now, but maintain our production in the current levels is easy to do. Maximizing the tax take is a good way to reduce foreign investments, so to prevent production’s increase, but not the only way to do it.

  6. Quico, I would not worry too much about Dutch Disease. The negative effects of the real exchange rate appreciation could very well be more than offset by gains in productivity associated with government spending in infrastructure, education, health, etc. So, if the gov’t puts the oil revenues to good work, then the export sector and, more generally, the tradable sector could actually become more competitive, especially in the long run. I think that in the short run there is a lot of room for the gov’t to make the whole tradable sector more competitive almost instantaneously by cutting the red tape and getting rid of a bunch of insane gov’t regulations, not to mention by improving few basic and existing infrastructures such as ports, highways, etc.

    • It’s all a matter of trust in the competence of the people in charge, isn’t it?

      Because the real appreciation costs are real and immediate, whereas the productivity-through-improved-infrastructure gains are uncertain and off-in-the-future.

      Trust. It keeps circling back to trust.

      • Well…the implementation of any optimal policy ultimately depends on the competence of the people in charge. So, if we’re discussing how the optimal policy should look like, it is because we trust that whoever is in charge can actually implement it. Otherwise, the whole discussion is irrelevant.

        In any case, I believe that there could be immediate productivity gains by cutting red tape and improving existing infrastructure that offset the short-run negative effects of the real exchange rate appreciation. On top of that, in the short-run the Central Bank could intervene actively in the exchange rate market to prevent significant competitive losses.

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