Export instability, investment risks and mineral taxation in Papua New Guinea

Abstract

The instability of export earnings is usually defined In terms of short-run fluctuations in export proceeds around a trend. Fluctuations in export earnings of primary commodities have long been a major cause of concern for many developing countries. Studies of export instability and its effects on growth and development vary in their findings; while some suggest that export instability is detrimental to growth and development, others draw the opposite conclusion. In Papua ~ew Guinea, there has been considerable concern with t,he fluctuations of export earnings originating in both the agricultural and mineral sectors. Since the mineral sector has become the single most important government and export revenue-earner, there has been a particular concern with fluctuations in international mineral prices. Economic growth in Papua ~ew Guinea since t,he early 1970s has been described as 'low'. Our empirical results suggest that in general export fluctuations have a negative effect on growth. In particular, the analysis shows that export earning instability has a negative effect, on the growth of private expenditure, fixed capital formation (fixed investment), imports and total employment. These results confirm that fluctuating export earnings are an important factor in the relatively 'low' economic growth of Papua New Guinea. When export earning instability is regressed against the growth of government expenditure, exports, savings and capital inflows, we find no negative effect. This suggests that some stabilisation mechanisms are at work. Given t hat government expenditure is subsidised by Australian aid, this result is not surprising. The heavy flows of investment to he mining sector especially during the period of analysis may also have offset, the otherwise adverse effects of export fluctuations on savings and capital investment. Th concern of the governments of Papua New Guinea with t,he stability of public expenditures has led to the introduction of mineral resource taxation and to the establishment of the Mineral Resources Stabilisation Fund to absorb fluctuations in revenue from mining. Mineral resource taxation became an important source of revenue for the Papua New Guinea economy when the Bougainville mine came into production in 1972. It was the renegotiated Bougainville Copper Agreement (1974) that saw the emergence 01 a form of resource rent tax. Income from mining was especially set aside in the Fund to provide a -teady now into he year ly budget. This was necessarv gIven the nuctuating nature of mineral prices. The empirical analysis focu ses on government revenue sources and the way these are affected by export earnings instability. To the extent that revenue sources are affected by fluctuating ex port earnings, they are channels of transmission of export instability. In terms of tax revenues, the analysis shows that mineral revenues, via the Mineral Resources Stabilisation Fund flows. are an important channel of the transmission of export instability. Papua New Guinea is likely to become even more highly dependent on mineral revenues in the future when new mines come into production. This points to the need for a better fiscal regime that will capture the rents in 'boom' periods to be used in 'bust' periods. Fluctuation in mineral revenues require a two-tier tax system to capture the benefits of mining to the host government without discouraging investment in the sector. The company tax, royalty and additional profits tax as presently in use in the mining sector in Papua New Guinea captures the benefits of mineral exploitation for the government , at the same time maintaining 'efficiency' and 'neutrality' conditions. It does. however , increase the amplitude of income swings to the government. The Mineral Resources Stabilisation Fund should therefore be used for stabilisation purposes. Show more