Optimal fiscal management in an economy with resource revenue‐financed government‐linked companies

King Yoong Lim,Shuonan Zhang

doi:10.1002/ijfe.2533

Abstract

AbstractWe present a dynamic stochastic general equilibrium (DSGE) model in which a resource‐rich government allocates its excess resource rents between a resource stabilization fund and the facilitation of costly domestic fund‐raising activities of sovereign wealth funds (SWF), which holds a portfolio of government‐linked companies (GLCs). Despite being less productive efficient, GLCs' operation benefits from scale economies tied to the resource sector: its profitability is procyclical to commodity shocks. The model is estimated to Malaysia using the Bayesian approach, with the results suggesting a business cycle heavily influenced by resource shocks. Based on this, we solve numerically for a socially optimal combination of excess resource savings allocation. We find the present allocation to be sub‐optimal, regardless of the structural shocks. This suggests that the Malaysian economy might have hit its absorptive capacity constraint (i.e., a domestic economy saturated by GLCs).

Highlights

Over three decades of theoretical contributions have advised on the fiscal management strategies of resource rents, notably in resource-rich developing economies, ever since the ‘Dutch disease’ phenomenon was formally modelled by Corden and Neary (1982)
If one preferred to think that the economy is more affected by domestic preference shocks, the optimal foreign-domestic allocation is approximately (0.38,0.62). This socially optimal combination appears to be lower than the benchmark case, suggesting that the Malaysian economy might have hit its absorptive capacity constraint
In the specific context of Malaysia, it appears that the present allocation is sub-optimal, regardless of the structural shocks considered. This suggests that the Malaysian economy might have hit its absorptive capacity constraint, requiring greater allocation of savings from resource revenue to foreign assets investment abroad to be socially optimal

Summary

| INTRODUCTION

Over three decades of theoretical contributions have advised on the fiscal management strategies of resource rents, notably in resource-rich developing economies, ever since the ‘Dutch disease’ phenomenon was formally modelled by Corden and Neary (1982). We calibrate the model to the Southeast Asian economy of Malaysia, using seven quarterly detrended time series for the period 1991Q1-2016Q4 (year 2016 is the latest year for which actual, and not projected, official population data is available): real per capita GDP, real per capita consumption, real per capita private investment, employment, real oil price, Malaysia's and United States' 10-year government bond rate.. We calibrate the model to the Southeast Asian economy of Malaysia, using seven quarterly detrended time series for the period 1991Q1-2016Q4 (year 2016 is the latest year for which actual, and not projected, official population data is available): real per capita GDP, real per capita consumption, real per capita private investment, employment, real oil price, Malaysia's and United States' 10-year government bond rate.8 These series are obtained from Department of Statistics (DOS), Bank Negara Malaysia (BNM), and Federal Reserve Bank of St Louis Economic Data (for the non-Malaysia data series). The spread parameter for foreign bond returns, θF0 , is set at a very low value of 0.01, so that the rate of return on TABLE 1 Benchmark calibrated parameter values

Preference parameter for leisure θF0

Findings

| CONCLUDING REMARKS