This paper addresses the efficient management of natural resource revenues in capital-scarce developing economies. It departs from usual prescriptions based on the permanent income hypothesis and argues that capital-scarce countries should prioritize domestic investment. Because revenue streams are highly volatile, governments should protect consumption from shocks by increasing it only cautiously. Volatility in domestic investment can be moderated by a buffer of international liquidity, but it is also important to structure investment processes to be able to cope efficiently with substantial fluctuations. To date, most of the resource-rich countries of Africa have not had investment rates commensurate with their rate of resource extraction.

The Green Paradox states that, in the absence of an appropriate tax on CO2 emissions, subsidizing a renewable backstop such as solar or wind energy brings forward the date at which fossil fuels become exhausted and consequently global warming is aggravated. We shed light on this issue by solving a model of depletion of non-renewable fossil fuels followed by a switch to a clean renewable backstop, paying attention to timing of the switch and the amount of fossil fuels remaining unexploited. We show that the Green Paradox occurs if the backstop is relatively expensive and full exhaustion of fossil fuels is optimal, but does not occur if the backstop is sufficiently cheap relative to the cost of extracting the last drop of fossil fuels plus marginal global warming damages as then it is attractive to leave fossil fuels unexploited and thus limit CO2 emissions. We show that, without a carbon tax, subsidizing (taxing) the backstop might enhance social welfare if fossil fuel reserves are not fully (fully) exhausted. We also discuss the potential for limit pricing when the non-renewable resource is owned by a monopolist. Finally, we show that if backstop are already used and there is a new sequence of backstops becoming economically viable as the price of fossil fuels rises, a lower cost of the backstop will either postpone fossil fuel exhaustion or leave more fossil fuel in situ, thus boosting green welfare. However, if a market economy does not internalize global warming externalities and renewables have not kicked in yet, full exhaustion of fossil fuels will occur in finite time and a backstop subsidy always curbs green welfare.

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