The Columns

In Depth: Professor Martin Davies Assistant Professor of Economics

— by on September 5th, 2016

Professor Martin Davies

Economics professor Martin Davies grew up in Papua New Guinea, a developing country that is currently ranked #157 on the World Bank’s Human Development Index. Davies’ father is Australian and his mother American, and as a young child, he lived with his family in some of Papua New Guinea’s most remote regions. It was easy for him to see that the country faced challenges far different than those of Australia and the United States.

Davies studied economics first at Australian National University, where he earned his bachelor’s degree, and then at Oxford University where he earned his doctorate. To him, it made a certain amount of sense to devote his research career to the study of international trade and development. Today, he studies the macroeconomics of developing countries.

“There are a group of about 30 resource-rich developing countries (RRDCs), and Papua New Guinea is one of them,” said Davies. RRDCs are classified as low- or middle-income countries in which at least 20 percent of exports are natural resources. “Over the last 50 years, Papua New Guinea has had a sequence of large natural resource projects that have both benefitted and hurt the development process. One of the questions I’m interested in at the moment is how governments in developing countries spend the wealth that these projects generate.”

Papua New Guinea is unique in that it is a small country that is rich in both mineral resources, such as gold and copper, and petroleum resources, such as oil and gas. The 2008 decision to exploit the country’s gas reserves led to a construction boom; there were plenty of jobs to be had as PNG built new processing facilities and improved its distribution channels.

The ripple effect of the construction boom on Papua New Guinea’s economy was nice, but it was nothing compared to the inflow of foreign exchange the country began to enjoy once the government started selling liquid natural gas (LNG) to other countries in mid-2014. A new revenue stream — particularly one of this magnitude — could pay for roads and schools and hospitals. The question for Papua New Guinea and other resource-rich developing countries is this: should they spend their new-found wealth up front or exercise restraint and spend at a slower rate over a longer period of time?

To answer this question, Davies traveled to Papua New Guinea this summer at the invitation of the Institute of National Affairs, a private think tank based in Port Moresby. He conducted a macroeconomic analysis of the country’s economy, and made a series of policy recommendations based on that data.

“It’s a challenge in resource-rich developing countries. The impulse is to spend upfront because there is a lack of infrastructure. The desire is to build roads, schools and hospitals but there is a shortage of skilled labor for construction, as well as a shortage of teachers to put in schools and doctors to put in hospitals. Constraints on administrative capacity mean that disbursement of revenues for projects can also be a challenge.”

Papua New Guinea’s natural gas project is forecast to have a lifetime of 30 years. At the time it launched, no one foresaw oil prices falling by 50 percent. Since LNG prices are determined by oil prices, the government has had to curb the country’s revenue projections and take a hard look at its current spending.

Davies recommends Papua New Guinea and other resource-rich developing countries in their predicament do two things. First, they must slow government spending relative to revenue. Then they must devalue the exchange rate — something Papua New Guinea is doing, but not quickly enough, in Davies’ opinion. Slowing government spending causes the economy to contract but devaluation will offset this effect.

The PNG government is making adjustments to its spending path, but Davies and other economists argue that the exchange rate adjustment is an important part of the policy mix. The government also needs to be cautious to cut its spending slowly, even if it requires borrowing to smooth the slow down. Cuts to education and healthcare can be particularly painful for citizens.

Davies’ research will go into a working paper published by the Institute of National Affairs and will also be presented to government officials in Papua New Guinea. Before Davies left PNG, he gave a public lecture in which he outlined his recommendations.

“There’s a compulsion to exploit natural resources,” said Davies. “The big challenge is timing the spending of the resource windfall. Ideally, you want to save some wealth for future generations.”

Photo: Martin Davies, photographed as a child at home in Papua New Guinea

– by Rachel Beanland