Kenya’s resource challenge


This month, the leaders of East African Community member countries are set to endorse amove to establish a monetary union, which they have been pursuing since 2000. But the recent discovery of massive natural-resource deposits in Kenya and elsewhere should prompt them to rethink this goal.

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Kenya has been exporting energy for years – in the form of some of the world’s fastest long-distance runners. But Kenya will soon be exporting another, far more profitable kind of energy, as it taps into a string of recently discovered oil fields in its 450-mile-long section of the Great Rift Valley, a fissure in the earth’s crust that runs from Lebanon to Mozambique.

African countries have plenty of experience with the downsides of major resource endowments. Kenya must learn from these cases, in order to prevent its new oil riches from tripping up East Africa in its headlong dash toward monetary union.

The riches are indeed vast. In the last two years, more than 1.7 billion barrels of oil have been discovered in the Lokichar basin. Estimates vary widely, but there could be up to 20 billion barrels – a volume that would make Kenya one of Africa’s most resource-rich countries, second only to Nigeria, which has 37 billion barrels of proven reserves. Nearby, Uganda has discovered 3.5 billion barrels, and Tanzania has found vast reserves of natural gas.

These countries now must determine how to avoid the “resource curse” – an all-too-common affliction whereby rising resource revenues lead to volatility, rent seeking, and corruption, while spurring real exchange-rate appreciation and wage increases, thereby undermining other economic sectors’ competitiveness. The key will be to capture the oil revenues and invest them wisely, thereby converting below-ground assets into above-ground assets that yield an adequate rate of return and stimulate economic development.

In Africa, oil is usually extracted by foreign companies, so well designed taxes are needed to ensure that countries retain a fair share of the profits. While taxing profits looks good on paper, it encourages oil producers simply to shift their profits to a tax haven. Royalties, which tax each barrel as it is produced, are a more effective approach. Oil prices are also notoriously volatile, so the tax scheme must ensure that the government and the oil companies share the costs and benefits of price fluctuations.

Kenya’s next challenge will be to invest the taxes in much-needed infrastructure projects, including roads, sanitation, hospitals, and schools. High-income countries like Norway can borrow to finance such projects, allowing them to save their oil wealth in a sovereign fund. For Kenya, by contrast, borrowing is expensive. Oil therefore provides an important opportunity to lay the groundwork for long-term economic growth and development.

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Article prepared by Klaus Cooper

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