The PNG economy is projected to grow 7.5 per cent this year, supported by high government spending, high commodity prices, and a US$16 billion liquefied natural gas (LNG) project, which is now entering its peak construction phase. Business is also booming. A recent survey of PNG’s top 100 Chief Operating Officers (COOs) found that 90per cent expect company profits to be higher in 2012 than in 2011, with none expecting a decline. Two thirds said their 2011 profits had exceeded expectations. With over US$27 billion (equivalent to 190 per cent of 2011 GDP) expected to be invested in the mining, oil and gas sectors before the end of the decade, PNG’s medium-term growth outlook is strong.

But PNG’s macroeconomic success masks growing unease about the distribution of the benefits of growth, including the government’s ability to translate wealth and macroeconomic stability into better public services. Progress has been made in some areas: the proportion of the road network in ‘good’ condition has risen from 10 per cent in 2003 to 33 per cent in 2011, and under-5 mortality rates have fallen in many provinces. Yet many other core public services have deteriorated over the last decade, particularly in rural and remote areas. PNG is one of a handful of countries that is not on track to meet any of the Millennium Development Goals.

Rising inequality is partly a result of constraints on non-mining investment. While the stock of private sector employment has doubled over the last decade, ADB estimates show that less than 5 per cent of the population, (or roughly 10 per cent of the working age population) are currently able to earn a wage in the formal economy. PNG’s COO survey highlights that a shortage of skilled labour, poor law and order, lack of technical expertise, unreliable utilities from state owned enterprises (SOEs), and the poor state of transport infrastructure impose major barriers on investment in the non-mineral economy, where poorer people are more likely to be employed. The Asian Development Bank estimates that less than 10 per cent of the working age population are currently able to earn a wage in the formal economy, These constraints combined with rising firm profitability have led to a dramatic outflow of investment funds from PNG over the last decade. For example, PNG’s investment in Australia reached $US1.2 billion (equal to 12.8 per cent of GDP) in 2010—350 per cent higher than the amount of money invested by Australian companies in PNG.

High inflation also undermines equality: roughly 85 per cent of the population relies on cash crops for semi-subsistence livelihoods, so their purchasing power has deteriorated rapidly in recent years. The combination of structural constraints in land and housing markets and rising property demand has contributed to a sharp increase in rental prices. As a result, a growing proportion of urban residents are being forced to live in informal settlements with poor access to power and sanitation facilities, and significant security risks.

PNG’s booming mining sector is also creating inequality at the village level. In the next 12 months, the government must manage 8,000 local workers who will be retrenched from the LNG project. Landowner groups are warning of social unrest if alternative work arrangements for these workers cannot be found.

Managing these problems will be difficult for the new government, which faces a period of much slower growth in government revenue. Later this year the Government will finalize its third Medium Term Fiscal Strategy (MTFS 2013-2017) which will play an important role in establishing the fiscal rules required to balance PNG’s large social and physical infrastructure investment needs with maintaining the macroeconomic stability that has underpinned the last decade of economic growth. Maturing mining and oil operations, for instance, will contribute to a 5–10 per cent decline in real government revenue by 2014. LNG revenues starting in 2015 will help, but given the generous tax concessions, current expectations are that there will be zero net savings within the newly created sovereign wealth fund in the next five years.

The budget is a big challenge because, at US$650 per capita, PNG’s revenue is among the lowest in the South Pacific.

Three main factors contribute to PNG’s low revenue base. Firstly, only 5 per cent of the population is engaged in formal private sector employment, which gives the government a small income tax base. Secondly, as a result of tax concessions and the end of additional mining profits tax in 2003, the average effective tax on PNG’s mining, oil and gas companies is low compared with other fiscal regimes. The recently opened Ramu Nickel and Cobalt mine has a ten year tax holiday before it will contribute to national revenue. Many other similarly beneficial concessions have been made to firms across the sector. Thirdly, PNG suffers from poor tax compliance and enforcement because the national tax office lacks the staff and resources to investigate evaders.

PNG’s low revenue means the incoming government will have to turn to some sort of fiscal austerity. Expenditure should focus on rehabilitating existing infrastructure rather than creating new assets, because the government will struggle to maintain new projects. Strengthening the tax office and taxing the mining sector more heavily would help alleviate fiscal pressures over the medium term.

The government’s biggest challenge for the next decade is improving the inclusiveness of economic growth. And this will require a re-invigoration of the microeconomic reform agenda: the government needs to strengthen competition, lower barriers to new business and stimulate growth in the non-mineral economy. Service delivery by SOEs must also improve. The new administration should make SOEs more accountable and performance-oriented, improve management structures, and encourage greater private sector participation.

The 2012 budget unveiled plans to restructure SOE governance and accountability frameworks. If these initiatives can be implemented, they will create the conditions for much faster growth in the non-mineral economy. This reform is a crucial step to avoid overreliance on commodity exports, thus improving the range and quality of employment opportunities for the people of PNG.

Aaron Batten is Country Economist at the Port Moresby Resident Mission, Asian Development Bank. A version of this article was first published here in the Development Policy Blog.