How to dig yourself out of a hole: realising the benefits of extractive industries

By on 07/12/2017
Botswana has realised the benefits of its natural resources; too many other countries have not (Image courtesy: Debswana).

The ‘resource curse’ too often converts countries’ mineral wealth into human poverty. But some developing world nations have worked out how to harness their natural resources for public good. Gavin O’Toole reports

“It all comes down to governance – that’s where countries fall short,” says Dr Nana Boateng, as she explains the challenges facing economies dependent for their development on natural resources. “It’s also poor planning, not doing enough realistic forecasting to anticipate price changes, and a lack of fiscal discipline.”

Boateng is programme manager for fiscal and budget policy at the Collaborative Africa Budget Reform Initiative (CABRI), which has been helping government public finance managers to share good practice in managing resource revenues.

Her work is much needed – for across much of the developing world, rich natural resources have as often proved a curse as a boon. In countries such as the Democratic Republic of the Congo, Angola and Nigeria, huge reserves of fossil fuels, precious metals, minerals and rare earth elements have fostered corruption, inequality, pollution, instability and conflict. The result is a ‘resource curse’: under the ‘paradox of plenty’, nations with abundant natural resources often have weaker economic growth, less democracy and worse development outcomes than other comparable countries.

The African experience

This paradox is by no means confined to Africa, but it’s a particular problem in a continent where minerals alone account for 28% of overall GDP. The African Natural Resources Centre (ANRC), a department of the African Development Bank (AfDB), estimates that the continent supplies 30% of all global mineral reserves and has 8% of the world’s oil reserves and 7% of its natural gas.

Turning this natural wealth into developmental gains is a major challenge. The ANRC says that while foreign direct investment in Africa’s extractive sector increased between 2000–12 from US$10 billion (€8.4bn, £7.4bn) to $50bn, it’s clear that the continent has not reaped the full benefits – with much of the revenue going to overseas companies and tiny local elites.

Yet some countries with mineral reserves, such as Côte d’Ivoire and Botswana (see case study, below), have used them to support wider economic development, fund public services and raise living standards. Not every developing nation is cursed by its resources.

Management challenges

The task facing resource-rich developing world nations is not an easy one. Governments face significant technical challenges when appraising extractive projects and negotiating contracts with large corporations, and often lack the capacity to design fiscal and regulatory mechanisms to maximise the value for their citizens.

These challenges begin as soon as a resource has been discovered and a country enters negotiations with a mining corporation. “Often, there is huge asymmetry in information – as you have investors who know far more about what lies underground than the countries themselves,” explains Boateng.

Developing countries need to build skills fast so they can assemble teams able to negotiate a fair deal. As most do not have the capacity to operate mines themselves, says Boeteng, their approach must be to forge long-term partnerships with private companies – and the agreements they sign should be crystal clear agreements in order to avoid future disputes.

“The onus falls on governments to get a better handle on selecting the right company – making sure they know who those companies are, who their parent companies are, and getting the best deal possible in financial modelling terms,” she adds.

The policy framework

There is help available: the ANRC and African Legal Support Facility (ALSF), also hosted by the AfDB, provide states with advocacy and technical assistance. But in order to reach a good deal, officials must first have a clear vision of the kind of development they want.

“Extractive sectors are often thought of in a silo, but need to be considered in the broader context of the economy and aligned with long-term goals for the next 20–50 years,” says Boeteng. “The extractive sector is just an engine to help you reach your long-term development goals.”

Those long-term goals, and the strategies developed to deliver them, can vary widely between countries. But successful delivery will normally require new policy, legislative and regulatory frameworks, as well as fiscal rules to manage resource revenues. Good policymaking also demands strong analytics based on financial modelling and forecasting. And it’s essential to have clear policies to cope with market fluctuations and avoid poor spending decisions: tools to manage commodity price volatility include hedging against price swings, borrowing arrangements linked to prices, and fiscal rules to limit spending.

Dr Nana Boateng (Image courtesy: CABRI).

What to save, what to spend

One critical issue when managing resources is finding the right balance between saving and spending.

It is considered good practice to save some of the bonanza generated by extractives, both for stabilisation – to tide countries over periods of low commodity prices – and to generate revenues for current and future generations. At least 14 African countries have created sovereign wealth funds; together, they estimated to hold assets of more than $159bn, or about 6.4% of Africa’s GDP.

These funds remain far less significant than their equivalents in the developed world. This is partly because many developing nations, saddled with long-standing debts, are better off paying off expensive loans than making new investments. And Boeteng points to compelling arguments for spending mineral revenues on supporting public services, infrastructure projects and economic diversification: “If you have a lot of development challenges, it makes sense to try to use those resources to tackle this problem now, with the expectation that you set your country’s economy on a different path for future generations.”

Making and breaking the rules

Clear fiscal rules can be useful in protecting mineral revenues – helping to counter politicians’ temptation to tap resources for discretionary spending. Chile’s rules governing the use of revenues from copper mining, for example, are often regarded as a benchmark that has enabled it to avoid the ‘resource curse’.

But Boateng says a rule is only as effective as the extent to which it is enforced: “Sometimes policies may look good on paper, but the devil is always in the detail and how well they respect their own rules.” Some resource-dependent countries, such as Ghana, have broken their own rules by spending recklessly during boom years. The Natural Resource Governance Institute says Ghanaian rules designed to ensure prudent management of oil revenues failed to protect Budgets’ sustainability, resulting in a damaging borrowing spree after 2010.

“When you don’t have the necessary policy environment, leadership, skills and discipline to ensure that every drop of oil, every ounce of gold, is going towards development spending, the spending can go into a higher wage bill, spending on elections and so on, which doesn’t reduce poverty or transform the economy in a meaningful way,” she comments.

Public education

When prices are high, ministers often come under pressure to allocate more to social programmes – so politicians should work at managing public expectations, says Boateng. “Governments need to do a really good job at sensitising people to risks, saying: ‘Yes, we do have these resources, but, just like in your households, there may be a drought or something and we need to put something aside for the future.” Those countries which put aside a nest egg during the recent period of very high commodity prices are now better placed to continue developing even as revenues decline.

In the end, says Boeteng, the solution to good management of natural resources lies not in proclaiming the right policies or rules, but in adopting the right attitude. In Botswana, she concludes, “they have a mindset that resources belong to the people, and the government is just a custodian. That mindset is really powerful and inspiring – and is something that other countries can learn from.”

Jwaneng Diamond Mine (Image courtesy: Debswana).

CASE STUDY: Botswana – a success story

For Jacob Thamage, chief mining officer at the African Natural Resources Centre (ANRC), it is clear why Botswana has gained a global reputation for the way it has managed its extractive resources over the last 30 years.

“Good governance and leadership explain why Botswana has been a success story,” he says. The country is recognised internationally for avoiding the pitfalls encountered by other extractive economies and investing its mineral revenues in education and healthcare.

The mining sector – in particular diamonds – continues to be the backbone of its economy, and is the largest contributor to GDP. From 2005-14, mineral earnings accounted for 40% of government revenues and 72% of export revenues.

Be realistic, be informed, be fair

Thamage says Botswana’s leadership has built this success on a candid recognition that in the extractive economy the country is dependent on a strong partnership with the private sector.

“Good leadership has created an enabling environment based on a realisation that the private sector has to be the driver in extractives in terms of investment,” he says. “Building a partnership with the private sector to aim for a win-win arrangement has been the main principle.”

Policy choices have enabled Botswana to make the right long-term fiscal decisions based on the recognition that extractive resources will eventually deplete, says Thamage.

Funding diversification

According to the ANRC, revenues from minerals in Botswana may have peaked, and in 2014 mining fell to second place as a share of GDP/value added.

“From day one, they have always tried to plan around extractives clearly having a declining role in the economy eventually,” says Thamage – so the government worked to “use these resources as a platform to ensure that the economy does diversify.”

Policy in Botswana has, therefore, aimed at using revenues derived from minerals to finance investment in other areas, creating a basis for generating income that can replace eventually replace mineral wealth.

Total mineral revenues during the 1983-84 to 2014-15 period, at 2012 prices, were BWP406bn (US$39bn, €33bn, £29bn) and these were almost entirely invested in physical and human capital in areas such as education and healthcare. As at March 2015, only BWP44bn – just over 10% – had been saved by the government.

In Botswana, minerals revenues have played a crucial role in developing public services (Image courtesy: Debswana).

When to bend the rules

Botswana does have rules around the use of its mineral revenues. But its approach is characterised by the flexible use of these rules, allowing the country to adapt its use of revenues as circumstances change. The only constant has been a commitment to responsible public financial management.

So there are no restrictions on withdrawals from the country’s savings to fund budget deficits, providing public finance managers with a valuable fiscal tool. During the global financial crisis of 2008-09, for example, the government funded large spending deficits by drawing on its foreign currency reserves.

Nor is there is a strict legal requirement for savings to be preserved for future generations. But Botswana does have a well-regarded sovereign wealth fund: the Pula Fund.

Established in 1994 to save diamond revenues for future generations, the fund accrues foreign exchange reserves above those required for medium-term public spending. And rather than simply building an asset base for the use of future generations, it acts as a reserve of cash that can be spent during hard times.

This approach has earned Botswana’s central bank a high profile in global discussions about the prudent management of sovereign wealth funds, confirming for Thamage the country’s status as a regional leader.

“Leadership is not necessarily about having experience; it’s about having a vision,” he says. “Botswana’s leaders wanted certain things to happen: they wanted the country to develop.”

About Gavin O’Toole

Gavin O’Toole is a freelance writer and editor in London. He has written for leading newspapers, magazines, wire services and business schools about financial markets, business and regulation around the world. He has a particular interest in international relations, and a specialism in Latin American affairs. He has conducted research on this region’s political economy and has also published a number of books about its politics and natural environment. His latest title, Environmental Security in Latin America, will be published by Routledge in September 2017.

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