Investing for a Dynamic & Inclusive Timor-Leste

Timor-Leste Village Children Attend School. UN Photo/Martine Perret.

Harnessing Natural Resource Wealth for
Inclusive Growth and Economic Development

Keynote Session of the Conference by the International Monetary Fund and
the Government of Timor-Leste in Collaboration with the Asian Development Bank, the World Bank and JICA
Dili, Timor-Leste, September 17-19, 2013

Dr. Noeleen Heyzer,
Under-Secretary-General of the United Nations,
Executive Secretary of the Economic and Social Commission
for Asia and the Pacific, and Special Adviser of the United Nations Secretary-General for Timor-Leste

Your Excellency, Mr. Kay Rala Xanana Gusmão,
Prime Minster of the Democratic Republic of Timor-Leste

Excellencies,
Distinguished Guests,
Development Colleagues,
Ladies and Gentlemen,

Introduction

Many thanks for inviting me to this very important deliberation. It is my great honour, privilege, and pleasure to address you in my new role as Special Adviser of the United Nations Secretary-General for Timor-Leste.

You have asked me to speak on governance issues, especially in relation to the Petroleum Fund. Governance issues are particularly important for countries rich in natural resources because their greatest challenge is how to invest in sustainable growth strategies, providing economic opportunities for their people, and building inclusive, peaceful, and dynamic societies, without exhausting their natural wealth for the next generation.

A large body of literature exists which explores the phenomenon of the “resource curse” – and groups such as the Extractive Industries Transparency Initiative have been established to counter it. As Nobel Laureate Joseph Stiglitz has said, “Resources should be a blessing, not a curse. They can be, but it will not happen on its own. And it will not happen easily.”

Three common elements of “the curse” are well-known: (1) Because resource extraction often entails little job creation, unemployment rises together with inequality as the newly exploited natural riches may easily benefit a few. (2) Volatile resource prices cause growth to be unstable especially now, when volatility and uncertainty has become the “new normal”. (3) Resource rich countries tend not to have other exports, as their economies are not yet diversified.

But this so-called resource curse can be turned into a resource blessing, when resources underground and under the sea are invested above ground into productive investments and the building of peaceful, inclusive societies where all citizens are assured the full benefits and value of these resources, not just elites and those who live in the capital. This is the scenario we all want. It can be, but it will not happen on its own, without political leadership, proper governance, and collective accountability.

Using this framework, let us reflect on Timor-Leste. Timor-Leste is a success story for our region and for the world. In only a decade, it has risen from the ashes of conflict and laid the basic foundations for peace and security, for trust and confidence-building, and for institutions supporting democratic governance.

It is a country of great courage, with a determined people who have sacrificed much to change and shape their own destiny – a people who deserve now to see the real dividends of peace, democracy and development in their own lives and those of their children.

Excellencies, Ladies and Gentlemen,

Petroleum Fund: Accomplishments, Challenges, and Questions

Timor-Leste has already done well, by following global best-practices in managing the revenues from its oil fields. Oil revenues are channeled solely through the Petroleum Fund, which now stands at over $13.6 billion, equivalent to more than three times Timor-Leste’s annual GDP.

The Petroleum Fund is also compliant with the Extractive Industries Transparency Initiative and the Santiago Principles, and is subject to parliamentary oversight especially regarding excessive withdrawals. The Fund’s investments are placed with major international fund managers, and withdrawals are governed by a rules-based approach designed to preserve the real value of oil wealth for future generations, with the estimated sustainable income (ESI) set at 3% of oil wealth.

All of this is good news. But allow me to raise some broader issues which relate to Timor-Leste’s major development challenges.

Despite rapid up-scaling of social spending and capital investment in infrastructure, including electrification and road upgrades with a view to developing the non-oil economy, creating jobs and reducing poverty, nearly half of the population still lives in poverty. Large disparities remain between rural and urban households, in terms of income, employment opportunities, education, and access to basic services. And Timor-Leste is unlikely to reach the Millennium Development Goals (MDGs) by the target date of 2015, especially as regards the Goals on poverty, underweight children, maternal mortality and sanitation.

The economy of Timor-Leste is still very reliant on the petroleum industry, with almost 80% of GDP originating from that sector. So far, contributions from agriculture and manufacturing have been modest, providing limited employment opportunities outside of the public sector and constraining widespread growth in living standards. Timor-Leste still lacks a functioning productive sector that can supply sufficient basic inputs, and it needs to diversify its economy.

In my first address in this new role, to the meeting of the Development Partners in June, I emphasized the need for sustainable use of resources and converting natural resources into development assets. I also emphasized the need for more inclusive economic growth and job generation, especially for the youth, considering the fact that 70% of Timor-Leste’s population is under the age of 30. This is vitally important for cementing social cohesion and creating hope for the future.

We have to ask, therefore, how best can the Petroleum Fund sustainably finance the development needs in education, health, food security, sanitation, housing, and infrastructure? What is the right balance between current expenditure and savings to allow the country to invest its resource and financial wealth to advance its development goals, and generate decent jobs? Is there too high an opportunity cost of investing largely in foreign assets? What is the best investment strategy for a stronger, dynamic, and inclusive Timor-Leste? These are key questions, especially when the real purchasing power of reserves may be declining with the volatility of the US dollar.

Excellencies, Ladies and Gentlemen,

Principles from Concrete Country Examples

We are fortunate to have a number of very relevant international and regional examples from other countries which have dealt with similar challenges.

Although the Republic of Korea (ROK), for instance, is not a resource rich country, and in fact was one of the poorest countries in the 1960s, it too had a fund – the war reparations fund from Japan. Forty years ago, the ROK had a comparative advantage in growing rice. Had it stuck to this strength alone, it might be the world’s most efficient grower of rice, but it would not be the industrial giant that it is today. Instead, the government invested in creating its future comparative advantages, by starting to build the Seoul-Busan expressway, one of the most important early ingredients of the country’s industrialization, against the advice of its development partners at that time. The expressway not only spurred economic activities along the corridor of two major population centers, its construction was a critical learning opportunity for the people of the Republic of Korea. Today, the Republic of Korea is regarded as a leader in infrastructure construction, and in 2012 overseas construction orders granted to companies in the Republic of Korea exceeded $500 billion. The country is also well-known for its successful Public-Private Partnerships, and IT innovations.

What is remarkable about the ROK is that during its early phase of rapid transformation, inequality did not worsen, and poverty declined rapidly with that growth, despite having inflation levels averaging 13 per cent for several years.

This experience shows that what matters is THE QUALITY OF INVESTMENT AND OF EXPENDITURE, not simply pre-fixed targets for expenditure, debt or inflation. Debt, deficits and inflation are important indicators but should not be the sole consideration in policy decisions for inclusive development or dynamic structural transformation.

Another useful country example, from further afield is that of Norway, which in 1969 discovered mineral reserves propelling it into the position of 2nd largest global exporter of natural gas and 7th largest exporter of oil. The design of the Norwegian petroleum fund set many of the benchmarks used today – not least because of its guiding principles to ensure fair distribution of benefits to all citizens and across generations. The Norwegian strategy of exposing their fund to moderate investment risk, and to ensuring ethical and environmentally sound investments, has reaped substantial dividends – as has their insistence on encouraging international companies to exploit the resource opportunities, but maintaining national control over these operations.

Overarching national control in important as, according to Professor Stiglitz, there is often an unavoidable conflict of interest between [usually foreign] natural resource companies and host countries: the former want to minimize what they pay, while the latter need to maximize it. Unfortunately many countries have already signed bad contracts that give a disproportionate share of the resources’ value to private foreign companies, but there is a simple way out – renegotiate in the interests of better long-term relationships; if impossible – impose a windfall tax which countries all over the world, including the USA, have done.

The experience of these successful examples suggests that the developmental State must play a critical role. Political leadership and public investment have to be the major instruments to promote development policy objectives — inclusive growth and diversification of the non-resource tradable sectors -- to increase the productive potential of the economy and private investment. Markets, including foreign investment, can deliver; but there need to be negotiations, and alignment with the development agenda of the country. We have witnessed what damage speculative markets can do to development by contributing to the 1997 Asian financial crisis, and recently to the Great Recession, not to mention the rise in inequality since the early 1980s.

Naturally the specific individual circumstances, resources, and priorities of every country differ widely, but the important common thread is how these successful countries managed to convert significant but ultimately limited resources into sustainable foundations for their future. They created the policy space necessary to ensure that they did not squander these resources – converting them into useful, longer-term productive economic assets, which in turn is the challenge for Timor-Leste as well.

Excellencies, Ladies and Gentlemen,

Good Governance Necessary But Not Sufficient

There are also many examples from less successful countries of populist policies and extravagant public expenditure causing balance of payments crises, hyperinflation, and debt crises. Public policies have to be formulated and managed wisely with parliaments and civil society for greater public legitimacy and accountability.

We need, therefore, to be mindful of government’s ability to spend in such a manner that benefits are shared equally among all citizens, and that nobody is left behind. As the Prime Minister has said in one of his speeches – it has to be development not just for the people but with the people.

The “good governance” agenda alone, including rule-based policies and institutions, are necessary but may not be sufficient for addressing critical development needs or building state capacity, including to deal with critical market failures.

It is often hoped that once an economy has stabilized and a government has become more restrained in terms of its budgetary expenditure, the private sector will step forward with the necessary investments for development. How realistic is this hope in Timor-Leste when the domestic economy is so small and the poverty rate is so high? Will foreign investment go beyond the resource sector? Will foreign investors transfer technology and management skills? Will Public-Private partnerships impose contingent liabilities on the government and be a burden on future budgets? Will Public-Private partnerships be inclusive and ensure access by the poor, especially those in remote areas? These are all important questions that we need to discuss.

As part of good governance, we need accountable and transparent political leadership which invests in a new and better social contract to build peace and security, and to promote citizens’ engagement, translating sustainable growth into productive employment for all. It has to adopt policies for the fairer redistribution of wealth, economic assets and opportunities – where there is better resource management and effective delivery of quality basic services to all. It also has to ensure better financial governance, addressing issues of money laundering and corruption, and encourage greater accountability of both the public and the private sectors, at the local, national, regional, and global levels.

Independent of how financial resources are generated, countries that have succeeded have invested in their people, in a social contract. Singapore, by way of example, has invested heavily in education – from higher education to vocational training, linked to job placements; in quality healthcare; and in affordable housing.

Rwanda, a county on the OECD list of fragile states, has risen from the hell of genocide to become a rising star of Africa. It has rebuilt its education and healthcare systems, and reduced poverty – including though targeted cash transfers, employment in public works, and the extension of micro-credit. As a consequence, overall poverty levels have decreased, and now extreme income poverty has fallen to 24 per cent from 41 per cent in 2000. Today, 60 per cent of the population lives within 5km of a healthcare centre, and life expectancy has doubled since the civil war. An effective partnership between donors and government, with a community health insurance scheme covering the whole population, has been instrumental in delivering this progress. Equally remarkable is the fact that Rwanda has the highest percentage of women in parliament in the world. I am pleased to note that, in the same vein, Timor-Leste has the highest percentage of women in parliament in Asia.

We are here today to discuss how Timor-Leste can further use its resource revenue judiciously for addressing its development deficits, to develop its human talents, to build quality social and economic infrastructure, such as roads and ports for better connectivity, good healthcare centers, and quality education, especially in rural areas. We are also here to discuss how it can build on both its current and future economic strengths, to diversify its economy – investing in sustainable tourism, agriculture, Special Economic Zones, and petroleum industries, in ways that create a peaceful, inclusive, and dynamic Timor-Leste and its neighborhood.

Excellencies, Ladies and Gentlemen,

The Role of Development Partners

What can development partners do to help Timor-Leste move in this direction? For one, we can be more concrete in proposing the types of economic and social investments the country can make to provide real dividends for future generations. Some examples could include better quality control for infrastructure projects, provisions in contracts concluded with foreign companies to train Timorese workers in new skills, and investing in more balanced social protection systems in the country.

The expertise of the IMF is crucial in helping Timor-Leste in setting up a stable domestic financial sector which is inclusive, serves the needs of SMEs, agriculture and remote areas.

Therefore, to my development colleagues here today, let me say that together with the United Nations, we can all invest in real development – improving people’s lives by closing development gaps and achieving the MDGs; exploring all possible economic and social linkages, by skilling-up the rapidly growing workforce, especially youth; developing viable local businesses, including women’s enterprises; encouraging domestic processing and value-addition; and integrating natural resource wealth into the country’s economic structure in sustainable ways.

Excellencies, Ladies and Gentlemen,

Conclusion

In conclusion, our shared responsibility is to ensure, that for Timor-Leste, the benefits of its natural resource wealth are directly harnessed to ensure dynamic and inclusive development. In this way, Timor-Leste will achieve its development aspirations, as outlined in its Strategic Development Plan (2011-2030).

Let us use this meeting to support Timor-Leste in becoming a dynamic economy and a more peaceful, inclusive, and sustainable society for its present and future generations, and for our region.

I thank you.