Capital, capital everywhere – How to invest it wisely?

August 30, 2000
By

With oil revenues soaring, the time has come for Norway to consider how best to apply them to strengthen its economic infrastructure and policy framework to promote the nation’s longer-term development. As matters now stand, the oil wealth is causing problems by making the krone a petrocurrency pricing Norwegian labor and industry out of world markets. Rather than lowering production costs by using the oil revenue to cut taxes, financial policy makers have let themselves be frightened by an unwarranted fear that tax cutting and infrastructure investment are inflationary. Indeed, by unduly burdening industry they are aggravating rather than alleviating inflationary pressure.

If there is any economy today that need not tax its manufacturing, shipping and other industries out of business, it is Norway. Yet the nation is subjecting itself to austerity more befitting an indebted third world country. The failure to make best use of its oil wealth threatens to cause inflation by driving yet more labor out of the private sector into the public sector.

Fortunately, there is a better alternative . . .

Discovery of North Sea oil in the early 1960s has provided Norway with enough money to cover its basic needs and much more. The problem is now the pleasant one of deciding what to do with this revenue, and with the gift of nature remaining in the ground. Thanks to it, a set of new, previously unimaginable opportunities now present themselves for evaluation and implementation.

This report sketches a framework of analysis to evaluate Norway’s options with respect to developing its non-oil sectors. In principle, three options offer themselves for how Norway may use its oil revenue: (1) to spend it on consumer goods and luxuries, (2) to leave the money and its rapidly mounting revenues unspent “in the bank,” buying stocks and bonds at home or in other countries to fund foreign industries and governments, and (3) to invest the revenue in the creation of domestic infrastructure, capital projects and other tangible capital formation.

The first option – using North Sea oil revenue to finance an increase in current consumption – would seem to represent an appropriate use of some part of this windfall. Certainly the coming on-stream of North Sea oil production has made obsolete the premises of Norway’s pre-oil taxation of personal income, corporate profits and consumption.

However, the magnitude of oil wealth is so large as to exceed the ability of most families to consume. For centuries Norwegians have responded to their challenging natural environment by developing habits of thrift. There is room for increased consumption, but there is no way that most families could spend more than a small portion of the oil windfall without going mad. Estimates are that if this oil wealth were distributed evenly to Norway’s population, each family would receive either a lump sum of approximately $25 million or an annual oil dividend of $1.25 million.

The only way for increased personal consumption to avoid creating a destructive inflation and loss of international competitiveness under these conditions would be to spend the money abroad. Already, Norwegians spend a historically high proportion of their revenue on imports. Much of the oil revenue has been devoted to funding a real estate boom. Construction is rising sharply, but the banking system is channeling a substantial portion of Norway’s increased savings into mortgage loans that are used to bid up the price of land rather than to finance new building.

The second option – to invest the oil money in financial assets abroad and at home – must remain an important means of allocating Norway’s oil revenue in the foreseeable future, given the limits to its use in financing current consumption and prudential constraints on investment in domestic infrastructure and capital projects. But it should be borne in mind that such financial investment simply has the effect of deferring decisions as to what to do more concretely with these revenues. Every million dollars invested abroad is money that Norway refrains from using to increase its productive powers. In this sense the growth in its oil fund represents a measure of how imaginative (or unimaginative) the nation’s policy makers are.

Of course, one problem with investing the oil fund in foreign stocks and bonds is the risk of a downturn from today’s peaks following the incredible stock and bond market boom of the 1990s. In late August the petroleum fund announced that losses in stock-market investments (heavily weighted in technology stocks) fully offset interest receipts from bond investments.

The third option is to invest the oil revenue in domestic infrastructure and capital projects. So large a windfall would be beyond the ability of almost any economy in the world to invest without sharply changing its shape. Yet over time this is the option that holds the greatest promise for using North Sea wealth to sustain Norway’s population in the centuries to come. For this reason it must be the focus of discussion in official and private forums.

The magnitude of this oil wealth is so large that whatever Norway chooses will involve a quantum leap. One way or another, traditional political values and policies will be transformed.

When a cultural characteristic becomes an economic problem

If any nation typifies the parsimonious Protestant Ethic of saving one’s income to tide one safely over the hard times, it is Norway. But North Sea oil has provided the nation with a sudden embarrassment of riches. For most countries a sudden gift of nature of this unprecedented magnitude would seem to be a fortunate problem to have. But it is not the kind of problem with which Norwegian character has been accustomed to deal. For centuries the nation’s austere living conditions have imposed an economic ethic that has emphasized reliance on mutual aid and communal welfare spending to tide its population through difficult times. Simultaneously, a rugged individualism has been developed to cope with these conditions.

The discovery of North Sea oil has been much like winning a lottery – the lottery of natural endowments. Such windfalls almost always create problems for their recipients. Winners of financial lotteries typically suffer the well-known problem of finding themselves out of their depth as they find themselves in possession of a capital sum far in excess of their ability to cope along traditional lines.

For individuals, one response to such conditions is to be happy-go-lucky and spend the money on a bigger home, the most expensive automobile one can find, jewelry and fur coats, trips for one’s family and friends, and other luxuries that are here today and gone tomorrow. For governments, the military often is a beneficiary, followed by the construction of vast infrastructure projects.

A saner response – and that of most Norwegians – is simply to put the money in the bank, stashing it away as if it were only a modest stroke of good luck, to be balanced out against the inevitable times of bad fortune. But in many ways this is a non-response, for any economy should use its endowments for the maximum advantage of its population and productive powers. It would be an exercise in self-denial for Norway to act as if its oil windfall had not become a new fact of national life. The oil revenue exists; it belongs to Norway, and should be used for the benefit of the Norwegian people.

The impact of North Sea oil for Norway is more than just a bit of good luck. Its order of magnitude as a pool of liquid capital available for spending or investment is larger than all the savings that Norwegian industry and agriculture, labor and capital could have created in an entire generation. As energy prices have risen since 1999, the Oil Fund has outstripped even the most optimistic forecasts. It is up to Norway to turn this from a problem to a national benefit.

How should this money be invested? Part of the answer involves reviewing how the nation’s tax system might be changed so as to make economic life less burdensome and imbue it with a higher quality.

Norway’s ultimate problem is not economic as such, but is social and ideological

The economic ideology that Norway’s population has created to keep its consumption and investment in proportion to its demographic and capital potential has been based largely on self-denial.

Matters are aggravated by the fact that the department of government charged with steering Norway through its new expansion phase is the Finance Department, along with Norges Bank. In every country, finance departments and central banks have adopted a common body of economic theory developed as a by-product of political lobbying by the financial, insurance and real estate (FIRE) sectors. The business in which these three sectors are engaged involves extracting interest and rent from the economy, not investing capital directly in profit-making activities.

Financial institutions, along with the government departments in which their ideas are represented, have a different worldview from that of industry. Taking production capabilities and employment patterns for granted, this worldview seeks to maximize returns from them at any given point in time. Bank credit is extended on the basis of collateral already in place in the form of land and buildings, or goods that have been produced and for which orders have been placed. Or, a banker may lend after assuring himself that the borrower’s income is sufficient to cover basic break-even expenses and still leave enough margin to defray the interest charges.

Few bankers will lend for income or assets not yet created and hence, not “a sure thing.” Bankers rarely are risk-takers. Hence, interest charges are not really a payment for risk. Bankers simply confront borrowers with the fact that they have the legal authority to create credit, and will do so only on condition that the borrower pay the interest out of what they already are earning or assets that can be sold off.

By contrast, the industrial worldview emphasizes economic potential and how a nation’s savings may be invested so as best to finance a higher economic horizon. This view is best exemplified by 19th-century German, French, Japanese, Scottish and Russian industrial banking as it evolved along different lines from Anglo-Dutch mercantile banking. The upshot has been to create two different financial philosophies, reflecting the difference between business economics and national economics. (This was the primary criticism of Friedrich List and subsequent American protectionists against Adam Smith.)

Whereas the purpose of national economics is to deal with the repercussions of economic activities on the overall economy, the scope of business economics deals only with economic returns on the individual company level. What economists call “external” economies – effects that do not appear on the business balance sheet – often outweigh the direct economies of the business enterprise. When a nation’s savings are entrusted to private firms, for instance, money managers do not take externalities into account when they review potential investments, nor are labor’s pension funds invested with a view to maximizing employment and living standards. From the national vantage point this results in a sub-optimal pattern of investment, unless creditors are regulated so as to behave with national responsibilities. But precisely because major effects of investing these savings are indirect (external), such regulation risks the solvency (or at least the competitive position) of banks and other financial institutions. This fact obliges governments either to “level the playing field” or to establish separate institutions with broad social responsibilities, to be subsidized or funded from the government budget. (Tax credits and differential reserve requirements also may play a role.)

Two negative examples may suffice. Norway’s agricultural bank has been used not only for agricultural purposes, but also for regional purposes. The merged public Norwegian Industrial and Regional Development Fund had its budget cut in half during the late 1990s in order to ease inflation threatening economic pressure. The primary instrument for long-term growth thus was used as an instrument to regulate short-term fluctuations.

The classical way to raise economic potential is to provide returns to entrepreneurs for investing savings in building new factories, hiring more labor and undertaking more research and development. Under full employment conditions this often has caused inflation by bidding up the price of labor, making workers the beneficiaries as well as (or even more than) borrowers, while eating away at the fixed income that accrues to bondholders and other creditors. Over time, the financial sector has developed a rentier mentality of finding the major “economic problem” to be that of limiting inflation rather than raising productive capacity and living standards.

This financial worldview happens to coincide with Norway’s traditional ethic of self-denial. It has not well prepared the nation for approaching the problem of how to deal with its oil wealth.

Reshaping Norway’s economic profile

Norway successfully fought off proposals by the international oil cartel to gain control of its North Sea oil in the 1960s. Instead of leasing the fields to foreign companies, Norway retained public ownership of this natural asset.

Meanwhile, the nation used strong protective measures to turn its crisis-ridden shipyard industry into a successful, high-tech oil service industry and provider of international shipping services. Western i dependence on Arab and Russian energy supplies provided a helpful international legal and diplomatic context for these developments.

Now that the money from North Sea oil is mounting up, Norway finds itself confronted by a second challenge: to prevent global financial investors from appropriating the fruits of this gift of nature. International banking functions as a cartel dominated by a few major commercial banks, investment bankers and money managers, although the rivalry among them is intense. They are a cartel in the sense that they have a culture and mode of operations that is uniform and imitative in seeking to make money by loading assets down with debts that turn profits and other cash-flow into interest. On the national economic scale, many of the services performed by these institutions are not ultimately productive.

Today’s test of Norwegian economic self-determination is thus more challenging than the issue a generation ago over who should exploit Norway’s oil. It was relatively easy in the 1960s and ‘70s to insist on maintaining control. That was the most risk-free strategy, as Norway was able to acquire the technical expertise to develop and market its oil. Today’s challenge is to formulate a world-view on the national level able to withstand peer pressure from global financial interests and the government’s own finance department and central bank.

Never before has Norway had so much free capital as to create the need to develop its own capital market or a strategy to allocate wealth of this magnitude. What is called for today is a quantum leap, not a merely marginal modification Norwegian modes of allocating national income and wealth. In this respect Norway is about to undergo nothing less than a change in its social and economic character. In the life of nations, as for human beings, this is always a traumatic experience.

The appropriate level of any nation’s capital formation is what it can invest over and above its consumption needs, duly adjusted for the standard of living that its people can afford. But Norway has not yet drawn up a menu of national infrastructure projects or tax cuts to use this oil revenue. Although there are a number of projects on the waiting list, their funding has been denied as a result of the financial ideology of austerity stemming from an unwarranted fear of inflation. It almost seems that the nation – or at least the Finance Department and central bank – are living in a state of denial with regard to Norway’s vastly enhanced economic circumstances.

Such an attitude plays into the hands of global investors. Privatizing public assets has paid investment bankers a hundred or even a thousand times the salary for most other professions over the past two decades as the rates charged for underwriting have run as high as 5 percent in developing countries, and 3 percent in Britain. These levels are far in excess of the rates that the scale and risk of large public enterprises should entail, giving investment bankers a “free ride” at the expense of the governments selling off public enterprises and other national patrimony.

In this endeavor financial institutions have found their strongest allies to be the heads of the public enterprises being privatized. The reason is not hard to find, for upon privatization these administrators have multiplied their salaries as much as tenfold and give themselves stock options that increase their remuneration a hundred-fold without obliging them to do more work than they did before.

Financial engineers have replaced industrial engineers in creating “shareholder value” to reward stockholders and staff with stock options. Using cash flow to buy a company’s own stock to drive up the stock price is euphemized as “wealth creation,” but it is paper wealth rather than tangible wealth.

Popular resentment against privatization has grown as the rewards to investment bankers and chief executives are coming to be viewed as exploitative. But the most serious problem concerns the loss of autonomy for the governments whose enterprises are being privatized. Once this revenue passes out of the public domain, it is removed from the national budget and earmarked for the payment of dividends, interest and salaries. Matters are aggravated as multinational firms acquired privatized enterprises and use transfer pricing and related accounting practices to take their profits in tax havens, depriving governments of the anticipated tax revenue from privatized companies.

Decisions as to how to invest the revenue generated by Norway’s natural endowments and public enterprises should not be made only by the Finance Ministry and Norges Bank. An industrial agency needs to be created to draw up a menu of prospective infrastructure improvements, tax changes and related uses of this money. Neither advocates of privatization, nor financial ministries have acknowledged the conflict of interest that tends to exist between their desires to gain fees from underwriting privatizations and earmarking the flow of interest and dividends to investors, and the national interest in modernizing and upgrading the economy.

Using natural wealth as a public dividend to reduce Norway’s fiscal overhead

Societies across the world over the past 2500 years have debated whether governments should use the proceeds of natural resources to reduce taxes or to invest directly. A famous early example is Athens in the 5th century BC. The city-state leased out its silver mines at Laurion, and put matters to a public vote as to whether to distribute the proceeds to the citizenry on a per capita basis or to spend the money to build up the navy. As the Persian military threat mounted, the citizens voted to use the money to build a fleet of warships – the fleet that defeated the Persian navy in the battles of Salamis and Plateia in 480 and 479 and saved Athenian (indeed, Aegean) independence.

In today’s world, a government dividend payout leaves the choice of productive v. unproductive consumption to the population at large. For open economies such as Norway a public payout is likely to be spent on consumption, and indeed on imports. To the degree that such spending remains in the economy it may create an inflationary pressure that impairs international competitive power. But to the extent that credit or tax cuts are invested productively in new means of production, it is anti-inflationary.

The state of Alaska has paid a dividend of several thousand dollars to every resident from its oil revenue. This disbursement has not transformed Alaskans from hard workers to passive rentiers, but has enabled them to enjoy a somewhat higher standard of living, to take more vacations, modernize their homes and obtain more “creature comforts” and a modicum of luxuries appropriate to the state’s great natural wealth. (There was no significant degree creating inflation, as the disbursement occurred within the U.S. economy as a whole, in which Alaska has only a minor impact.)

Some modest portion of Norway’s oil wealth could well be used to provide its citizens with greater abundance, while making its enterprises more competitive. But as matters stand, Norway seems to be getting the worst of both worlds. The government has rejected the option of distributing its oil revenue for consumption on the ground that this might have an inflationary effect. What has not been discussed is the use of this revenue for direct investment (in contrast to financial investment in the securities of enterprises already in place).

If Norway does not choose to benefit in these ways, the fruits of its oil wealth are in danger of being taken by the international financial firms that purchase the right to privatize and dispose of the nation’s oil wealth, along with the bureaucrats who gain personal control of the newly privatized wealth, and the real estate speculators who end up riding the wave of petro-affluence. Norway’s choice therefore boils down to whether its own citizens or foreign investors will end up the ultimate beneficiaries of North Sea oil. The question is whether the Norwegian people or the financial and real estate interests will end up with the lion’s share of the gains.

Some dangers to avoid

Just as it is desirable to draw up a menu of prospective infrastructure and industrial investments to upgrade the nation’s labor productivity, its transport and educational systems, communications and related technologies, Norway also needs to be aware of the dangers posed by letting its oil wealth be channeled in unproductive ways.

The most common danger for nouveaux riches economies is to let their affluence be dissipated in bidding up the price of real estate or creating a general inflation and loss of industrial competitiveness. It is a common experience for “new economy” computer and financial centers to see the major fruits of new technology reaped not by the innovators but by the real estate speculators. The increased value of real estate in America’s major “ new economy” centers, for instance – Silicon Valley in northern California, Los Angeles, Boston, New York, Chicago and Austin – have far outstripped the value of tangible capital formation in new technologies.

This need not occur, of course. Norway could tax “unearned income,” that is, wealth not created by personal enterprise – the rental revenue produced by nature from the land, fuels and minerals, along with the electromagnetic (TV and radio) spectrum and natural monopolies. This policy is classical and age-old. Just as the land and its subsoil endowments produced most income from antiquity through medieval times (and for local municipalities in the modern epoch) so Norway today could base its tax system on this free rental revenue rather than taxing the income earned by labor (wages) and tangible capital investment (profit).

Such a policy may be especially justified inasmuch as Norway’s agriculture and industry have been rendered high-cost by the fact that the krone has become a petrocurrency.

The greatest challenge confronting Norway during the remaining years of the present decade will be to manage its oil wealth so that it serves as a benefit rather than a burden to Norwegian labor and industry.

Coping with economic myths inherited from Norway’s past

One of the most dangerous myths is that investment is inflationary. To the extent that investment increases output, it is counter-inflationary. Indeed, infrastructure investment and tax relief has become is a precondition for keeping down Norwegian inflation. This can be done ultimately by private investment. Under today’s circumstances, such investment is not being encouraged. Unduly high interest rates also are to blame – high interest rates that are not needed in view of the krone’s international strength as a petro-currency.

As less than 5 percent of the population is employed in agriculture, the two major sources of labor for private sector industry must come from downsizing the government sector’s employment rolls, and from the immigration of skilled professional labor from abroad. Domestically, the problem is what industries to shift these workers into. This is best resolved by the market, except to the extent that foreign teachers and researchers are hired by Norwegian universities or other not-for-profit sectors.

Another myth is that the government budget (and economic balance generally) can be stabilized by a policy of high interest rates. Norway’s government is almost unique in being a heavy creditor to the private sector. Under these conditions, raising interest rates has become a favored means of balancing the budget, in the name of keeping inflation down.

But interest rates are an element of cost – so large an element that higher rates deter new investment just as severely as do taxes. The effect of higher interest rates is thus to slow investment and private-sector employment, spurring the transfer of labor into the public sector. This aggravates rather than alleviates the budget deficit over time, adding to inflationary pressures rather than lessening them. At issue is once again the financial mindset in contrast to the industrial point of view.

A related focus should be on government spending as it relates to non-inflationary investment in productive infrastructure, defined widely. The aim of this line of study would be to establish a systematic method to evaluate public procurement procedures, so as to establish new standards that promote innovation and discourage bureaucratic deadweight.

This policy focus would address the fact that Norway is awash with capital while simultaneously ranking at the bottom of OECD countries in R&D spending. An attitude seems to be developing within Norway that its oil wealth is so abundant as to not require the nation to use industrial engineering and economic planning to modernize its economy in keeping with its neighbors.

This attitude has contributed to punitive tax policies toward shipping and other major industries. It also has left Norway with a relatively backward transportation system (rail, road and urban transit), as well as with libraries, schools and an educational system that is suffering from needless financial strangulation. Despite its natural wealth and affluence, Norway is letting less richly endowed neighboring countries attract the best international researchers, professors and other skilled professional expertise from around the world. If this trend should continue, Norway would be in danger of replacing its human resources with natural resources. Over time, this would aggravate the squeezing out of private sector employment and investment, and leave Norway dependent on a public sector financed by oil rents rather than maximizing the productive powers and economic opportunities for its population.

This problem may be traced to the growing bureaucratization of Norway’s administrative system. By not actually producing more, it contributes to inflationary pressures and a related loss of international industrial competitiveness.

Another, related focus of study therefore should design proposals for how the social security system (defined widely, including pension funding in general) could be reorganized and simplified with a view to enhancing national productivity (and decreasing inflation in the FIRE sector) without endangering social security. Ultimately at issue is the contrast between the “Fabian” redistributive and the “Bismarckian” productive points of view.

Taken together, these studies reflect a common denominator in proposing to increase the productivity of labor employed in Norway’s private sector, and hence in the nation’s overall economic performance. The basic thrust of such studies differs from that promoted by most financial approaches. It emphasizes the need for low-priced credit rather than high interest rates. And it prepares the ground for supplying low-interests credit in a non-inflationary way, by distinguishing between productive credit (that which finds its counterpart in higher output) and unproductive credit (a real estate and stock market bubble or related speculative activities).

To make these points in a way that is clear and understandable to politicians and their public, it is necessary to rearrange Norway’s national income accounts and balance sheet of assets and liabilities so as to distinguish between productive and unproductive forms of lending and investment. This task is best achieved by creating a data-bank and publishing an annual chart-book describing Norway’s economy in functional terms. Probably a staff of four or five people will need to be engaged in this program.

‘How to proceed with creating a think tank

First, we need a name. The Norway Institute? A major waterway or boundary? A Norwegian economist such as Thorstein Veblen? A mythical hero?

A brochure and statement of purpose need to be drawn up. Once this is done, a group of initial participant-subscribers can be canvassed. I suggest from four to eight members, drawn from the private sector (individual companies and industry-wide associations), labor unions, and government agencies paying $50,000 annually as support. Further operating revenue may come from members commissioning separate statistical reports and policy studies.

In consultation with our initial subscribers and funders, we will name a board of directors and officers and decide on the staff and its remuneration. We may want to have two groups of board members, foreign and domestic. Alternatively, there may be a division between public (including academic) and private members.

The next step is to decide on the topics for our initial studies and publications, and the scope of the statistical data bank that needs to be created.

Perhaps we could enhance the role of the proposed Institute by compiling a data bank and survey reports for Norway’s major trading partners as well, especially for the United States, Britain and Japan. The analytic and statistical format would be much the same, and therefore would tend to give more weight to the particular perspective and sense of proportion that we are trying to popularize for Norway itself.

Some studies to consider conducting

The impact of North Sea oil – and its prospective privatization – on Norway’s balance of payments, and hence on the krone’s exchange rate.

The economics of the global shipping industry as they affect Norway. What kinds of tax breaks and (concealed) protectionism have the United States, Britain and other major nations provided for their shipping. What is the role of flags of convenience? What is shipping’s role in the balance of trade and payments?

The economics of Norwegian industry, its possible national advantages and existing cost structure vis-à-vis that of other countries. Special emphasis would be placed on financial charges (the “costing” of capital), energy prices, real estate and site location charges, government tax policies and the exchange rate. Also, how important the supply and price of labor is for determining Norway’s competitive international cost structure.

Norway’s tax structures, and possible ways of using it to enhance Norwegian productivity and revenue.

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