Writing for our year-in-review series last year, former PNG Prime Minister Sir Mekere Morauta, one of Papua New Guinea’s truly great public servants and statesmen, observed that the Somare government had been fortunate to have ridden PNG’s biggest resource boom ever. But while the economy and government revenues had grown strongly, and there was some progress in economic reform under the Morauta government, the boom has impacted little on basic services and the living standards of Papua New Guinean people. ‘There have been follies’, Morauta wrote, ‘and sometimes outright theft: the mortgaging of PNG’s shares in Oil Search to borrow A$1.68 billion from Abu Dhabi; the disappearance of Kina 5 billion from government trust accounts; and the mismanagement of the development budget. With the Somare government stymying debate and refusing to be held to account, it was hard. It was the most frustrating period of my career’.

After a long stand-off, Peter O’Neill, PNG’s new prime minister, ousted the Somare government last year, committing to fight corruption and deliver development.

In this week’s lead essay, Stephen Howes asks how can Papua New Guinea do a better job of converting growth into development?

Howes reckons that five issues will make the difference. At their core is the issue of how to capture revenue from the resource boom and transform it into effective development spending. As Australians know, it’s an issue that is certainly not unique but there are some aspects particular to Papua New Guinea. What’s not unique is the challenge of putting in place a taxation regime that captures resource rents and smooths expenditure growth without distorting investment incentives. What’s a special challenge in the PNG setting is directing the revenue take to economic and social development purposes rather than wasting it as ‘grease’ money. In a small resource-dependent developing country the case in principle for using a sovereign wealth fund (SWF) instrument for smoothing expenditure patterns is strong. The government has moved to establish an SWF to manage the flows of dividends and tax revenue that will come on stream in 2015 from the massive LNG project currently under development.

PNG has been at the forefront of policy-institutional innovation aimed at managing the problems of resource-based development. It was among the first developing countries to put in place a resource-rent taxation regime. Its experience with the PNG Sustainable Development Program (PNGSDP) has also been very positive. That was set up in 2002 to manage revenues from the Ok Tedi mine for investment in economic and social development and is now chaired by Morauta after the retirement of Ross Garnaut and before the controversial ban put on his travel to PNG by the O’Neill government. The PNGSDP was set up under a legally binding agreement between BHP Billiton and the PNG government, when it ceded the mine to a charitable trust for Papua New Guinea development and paved the way for an environmental remediation program. Garnaut also chaired Ok Tedi until he retired after the travel ban.

The aim of a sovereign wealth fund is to stabilise potentially volatile revenue flows from the mining and petroleum sectors. Instead of flowing directly to government, mining and petroleum revenues are put into a separate fund, managed independently by experts and invested prudently on the state’s behalf. Current spending is thus in principle delinked from the revenue stream under rules that, properly designed, specify that annual budgetary withdrawals from the fund should not, for example, exceed long-term mining and petroleum revenues. The rules need to be conservatively designed to allow the sovereign wealth fund to grow, while at the same time providing a smooth and predictable flow of funding into the national budget. Predictable funding is important to planning development expenditure because many programs, such as free basic education or transport infrastructure, have large ongoing expenses and, if unwisely managed, national budgets will fail to allocate sufficient funding to meet these costs that are the foundation for development.

But, as Howes points out, the mechanisms for delivering on these objectives in Papua New Guinea are still problematic. This year, he says, will be an important year for PNG’s new sovereign wealth fund: ‘Too often, the SWF is seen as the key for PNG to avoid the resource curse. In fact, it’s only one piece of the puzzle, and it remains to be seen whether the SWF will make a positive difference. With the decline in commodity prices [under way], it now seems unlikely that any funds will flow from government tax revenue into the SWF in the foreseeable future. But dividends from the country’s mega LNG Project also go to the SWF. Whereas tax revenues were to be saved (in the Stabilisation Fund), the dividends are to be spent (through the Development Fund)’. Crucially, the legislation to determine spending rules for the Development Fund in Papua New Guinea is yet to be seen. This is a real hole in PNG’s fiscal governance arrangements.

Sorting out exactly how these arrangements are going to work, including what fiduciary restraints are put in place on their management, will make the critical difference between whether the objectives that are supposed to be served by the SWF are served or whether the outcomes are a mess.

It is on getting the rules in place for managing the revenue stream from PNG’s Asia-driven resources boom and on following through on his anti-corruption rhetoric that the promise of the O’Neill government will later be judged. An earnest of intent on whether the public good comes to triumph over the politics of the personal in PNG will be seen in how the O’Neill government extricates itself from the fracas over banning Garnaut’s travel to Papua New Guinea following a comment by Garnaut on the political economy of economic governance in the country, a comment that appears to have been taken totally out of context. The Australian foreign minister, Bob Carr, has implausibly suggested that this is a personal consular matter, presumably because he currently but wrongly judges that there are bigger fish to fry in the relationship with Papua New Guinea. It most clearly is not: it goes to the heart of the freedoms and protections of highly reputable Australian and other foreign nationals in doing business in Papua New Guinea. And, uncorrected, it will be damaging to PNG’s economic interests (of which the representations by BHP Billiton on the matter, including its binding agreements with Papua New Guinea, are a harbinger) and to Australia’s interests in the integrity and credibility of its dealings with one of its most important neighbours.

Peter Drysdale is Editor of the East Asia Forum. He was an advisor to the Government of Papua New Guinea in the early years of PNG’s independence and Professor of Economics seconded to the University of Papua New Guinea by the Australian Vice-Chancellors’ Committee in 1976. He has been a long and close associate of Professor Ross Garnaut.