International borrowing for resource extraction

Abstract

This is a theoretical study of some basic aspects of foreign investment (and foreign borrowing) and natural resource exploitation. Our emphasis is on optimal planning and regulation but the consequences of the lack of social interventions are also pointed out. Whether a community should plan for more or less consumption for future generations depends not only on its rate of time preference but also the cost of foreign borrowing. It also is warned that even for a small country, the Fisher Separation Theorem - separating production decisions from financing decisions - may not apply when natural resources have aesthetic values not reflected in market prices. The problems of efficient allocation of resources over time and distribution of gains between the home country and foreign investors received particular attention. Optimal fiscal mixes (in particular, tax on foreign capital and royalty) are derived under various assumptions about the behaviour of firms. Conditions under which the usual static optimal tax on foreign capital must be modified are identified. It is shown that foreign investors may react adversely to the risk of nationalization and that resources may be exhausted too quickly as a consequence. There is also another argument for more conservation : the country may obtain better information as events are observed, causing a revision of expectations. The irreversibility of resource depletion calls for more caution in this case. The optimal behaviour of a risk neutral community exhibits properties akin to risk aversion under these circumstances.

Under uncertainty, the optimal allocation of natural resources between the domestic and the foreign sectors depends on the community's attitudes to risk. Not only primary characteristics of the community's utility function - such as risk aversion or risk preference - but also secondary properties such as the measures of relative and absolute risk aversion play important roles in the determination of the optimal amount of foreign investment in natural resources. Show more