Year

2011

Degree Name

Doctor of Philosophy

Department

School of Economics

Abstract

This study aims to investigate different aspects of the relationship between oil revenues and economic development for the Libyan economy. To do so this thesis revises the historically fundamental role of oil revenues in the economic development of the Libyan economy, and the potential adverse consequences of the oil boom sector upon the non-oil sector. It then develops a long run dynamic macroeconomic model for the Libyan economy that is capable of analysing the impact of oil related shocks on its macroeconomic adjustment and development. The model explicitly incorporates the fundamental features of the Libyan economy, and it is capable of incorporating alternative government policy responses toward the allocation of oil production for either domestic usage or export, the spending of the oil revenue either upon consumption or investment, and budget financing. The spending of oil revenue, in particular development expenditure in the form of government investment spending upon infrastructure, human capital formation and technology acquisition, is a key policy issue which has important implications for the development of the Libyan economy. The model is also capable of incorporating different degrees of international capital mobility, along with the adoption of either a fixed or flexible exchange rate regime.

A numerical simulation procedure is adopted to analyse the positive and negative macroeconomic effects on the Libyan economy arising from exogenous shocks from increased oil production and oil prices, and how such positive and negative effects can be maximised and minimised, respectively, through conducting a number of alternative government policies.

It is obvious from the simulation analysis of the base model that either a positive oil production shock or oil price shock exert a significant influence upon the domestic economy throughout the adjustment process to long run steady state. The positive oil related shocks will potentially result in an increase in private capital stock, private sector wealth, real income, domestic physical capital stock, human capital stock, imported capital stock and non-oil supply (demand). However, the oil sector boom also has the potential to deteriorate the non-oil trade balance through a combination of increasing non-oil imports and declining non-oil exports. Increasing non-oil imports is stimulated by an appreciation of the real exchange, an increase in real domestic income and government spending on capital imports. The adjustment of non-oil exports is strongly influenced by the appreciation of the real exchange rate.

Regarding the appropriate alternative government policies, aiming to enhance the benefits and/or minimise the adverse impact arising from oil related shocks, the major outcomes of this study suggest that a development oriented policy in the form of increased government investment on public physical capital, human capital formation, and technological acquisition results in an improvement of economic growth and development. However, it leads to Dutch Disease consequences, as indicated by developments in the non-oil trade balance, in the early stage of the adjustment process.

On the contrary, motivating government consumption spending at the expense of government investment (development) spending upon physical capital, human capital formation or imported capital produces less favourable results during the early periods of the adjustment process for key macroeconomic variables and throughout the remainder of the adjustment process to long run steady state equilibrium.

A more oil export oriented policy can result in advantageous developments throughout the adjustment process to long run steady state for some key macroeconomic variables, particularly that of foreign asset stock. However, it deteriorates the non-oil trade balance during the early stage of adjustment, exacerbating the Dutch Disease effect.

It is also found that a flexible nominal exchange rate policy combined with perfect capital mobility not only contributes to improved outcomes for key macroeconomic variables such as that of non-oil output supply, but also minimises the Dutch Disease consequence upon the non-oil trade balance and, therefore, leads to better macroeconomic performance.

Hence, it is apparent that the short and long-run feasible strategy of sustainable development for Libya is to utilise the oil revenue not only to develop its infrastructure, but also to accumulate foreign technology acquisition and to achieve a highly skilled and well-educated labour force. This strategy, in conjunction with an alternative nominal exchange rate policy, will offer Libya the capacity to use and absorb the foreign capital and ultimately develop its own economy. An accumulation of physical, human and foreign capital stock, along with adoption of a more flexible nominal exchange rate, would transfer the economy into a well-equipped one able to diversify and build a viable non-oil economy, and, therefore, to maintain and improve its competitive advantages. That is, it will enhance the ability of the Libyan economy to withstand shocks in the future by promoting diversification of the economy towards other tradable and more labour-intensive sectors such as that of agriculture and manufacturing.

The study concludes that such policies require well-established government institutions and well-skilled and informed policy-makers to implement these strategies expeditiously and efficiently. Well-established institutions will enable the well-skilled policy-makers to carry out sound policies in response to positive oil related shocks, and hence stimulate economic development and avoid adverse effects such as that of the Dutch Disease. On the other hand, the lack of such institutions would lead to poor policy choices, and hence a deepening and extension of the negative effects of the external shock.

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