A tale of two countries: Brazil must decide if it would like to be Norway or the Netherlands -- or Venezuela

Brazil recently unveiled plans for its government to scoop up a large share of future oil profits from undersea drilling off its coast, where there are alleged to be up to 50 billion barrels of oil (The Economist). Is this good news or bad news for Brazil?

Oil and other valuable and tradeable natural resources have always been a mixed blessing. In well-governed countries that manage the resources properly and invest the resulting profits wisely, they can lead the country to greater prosperity. In poorly run countries or in countries where the resources and their profits, for whatever reason, are invested poorly, they can lead to political corruption and economic ruin.

An example with less of the former and more of the latter is the Netherlands. The discovery of oil proved not to be much of a blessing for the Netherlands. The sudden increase in export values caused a current account surplus, which in turn caused the Dutch currency to revalue to the point where other exporters in the Netherlands had difficulty competing in foreign markets and domestic producers had difficulty competing at home against cheaper, foreign rivals. The result was dubbed the "Dutch disease." This is one possibility for Brazil, but given Brazil's size, this is probably unlikely.

A further possibility is that things will work out in a way similar to Norway. There, the currency was not permitted to rise too far. Instead, money was siphoned off the top and exported, balancing the current account surplus with a capital account deficit. This has allowed Norway's exporters to continue to export (although they must be competitive, as Norway's currency is still quite expensive), and Norway's domestic producers to continue to be able to compete against outsiders. The cost: high taxes and a large sovereign wealth fund. The money in the fund will then later be used to fund Norway's transition from an oil-based economy to something else, and to slow the slide of the currency once the oil dries up. All in all a well-managed, prudent system.

These two cases show the impact oil can have on even wealthy countries with good governance. Either they take action to prevent the Dutch disease, or they succumb to it. But Brazil is vastly larger than either Norway or the Netherlands. Although it is better managed, it may be closer to compare Brazil with Mexico or Venezuela. These are two countries whose governments are heavily involved in the day-to-day procedures of oil drilling. Both governments also rely heavily on the oil for revenues. And in both countries, revenues are dwindling as oil fields dry up due to a lack of investment in, and technology for, new ones. Much of this is the result of taking too much of the profits and failing to reinvest them in discovering or accessing new fields. Another significant factor is a lack of private investment due to heavy restrictions placed on foreign firms, firms that have the necessary capital, expertise, and technology to get the stuff out of the ground in fields that are almost invariably getting more difficult to utilize (requiring a greater investment in capital and technology, as well as higher risk).

What should Brazil do? Taxation is the simplest method. Doesn't it make more sense for private companies to do the work finding and drilling fields? Isn't it better for private money to be invested to get the oil? And wouldn't everyone be more comfortable if private firms' money were being risked on fields that might not be viable, rather than public funds from citizens' taxes? Having the government run these operations, even if only partly, doesn't make a whole lot of sense. Furthermore, beyond economics, having a government-run organization is an invitation to cronyism and corruption, and may become a political liability. The argument that a government organization would be required to ensure equity and provide for social programs doesn't make any sense at all, either. Those aims can be achieved most easily and efficiently with sensible legislation, regulation, and taxes. No matter how you look at it, Brazil is probably going down the wrong track with its plans for big government in big oil. Let's hope they take a closer look at some other oil producers (Russia has similar problems to Mexico and Venezuela) before making their choice.


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