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18 January 2017

Who'd be a Resource Economy?



Who’d choose to be a resource economy? First off, it sounds really good. The geological formation of the earth has left you a store of wealth under the soil of your country, just right for exploitation and sales into the international market and a natural source of income for years to come. And undoubtedly that can be the way it works; look at Saudi Arabia and the Gulf, for example. But it’s not always that simple. The earth and the rock is valuable, but it has to be extracted from the unfortunately (usually) hard to reach location, moved to a port and then shipped across the sea to a different place where it is used. A lot of the time, the resources are concentrated in what we call developing countries which don’t necessarily have the infrastructure, skill or money to undertake the extraction themselves, so inevitably it falls to international mining companies to undertake the operations. They then tend to want to ship the most basic product out to supply the network of processing plants, very often in developed countries. 

Expropriation?

It all works fairly smoothly, on the whole; but it leaves the resource-rich but capital-poor developing countries watching value being added to their products far away, and particularly far away from their national treasuries. They can see the benefits of their geological good fortune being shared - in a way they generally would perceive as unbalanced - by large international companies whose shareholders are also mostly located in the developed world, rather than financing the development of their own fledgling economies. And so they want to get a bigger slice, quite understandably. The first step may well be nationalisation, or expropriation; that gives them control of the basic resource and perhaps leads to the development of a domestic industry that goes beyond mining and exporting. That would be the Chilean model of the 1970s, but is less popular now, probably because of a greater interconnectedness of global economies; nationalisation has more consequences, probably, than in a previous generation.

Indonesia

So we get to the Indonesian model (2014 version) - or at least, what we thought was the Indonesian model. That basically bans the export of untreated ore and requires miners to process it into a higher form of the metal domestically, before shipping it (which of course requires the construction of smelting and refining facilities). That makes sense in several ways. First, and this is the driving force, it enables the host country to capture more of the added value in the product domestically. That should, in an ideal world - in itself of course an open question - then be used to develop the local economy and improve living standards. For the world at large, the benefit is that instead of shipping large quantities of useless dirt (containing the ore) across oceans, the much more concentrated form of metal would be shipped, saving both cost and atmospheric pollution as the required ships would be smaller.

Sounds good? Well, in theory, it is. A logical development of the way resources are handled. But last week the Indonesian government announced that it was relaxing the ban on ore exports, allowing some to be made again, under certain circumstances - in other words, a reversal, at least partially, of the former policy. The first reaction has been to see those Chinese companies which had invested in smelting plant in Indonesia leaping for their lawyers, since they could - they believe - claim against the investment they had made in equipment under the old policy. We’ll see what happens there in the fullness of time. What the change does demonstrate, though, is the squeeze that such a policy change could put on an economy. Taxes on the mining industry, particularly on the export of ores, represent a substantial part of the Indonesian treasury’s income, and so the export ban caused a hole. Of course, in the fullness of time, that hole would be filled, and to overflowing, by the income stream not only from the ore  but also from the ancillary manufacturing activities. But not yet. Unfortunately, between desire and the fulfilment of it there is a great big chasm to overcome, with the sign “cashflow” next to it.  

Problems

The details of the changes are not entirely clear, and it seems that the right to export ore will be tied to the amount of ore processed in the country, so actually it’s possibly a kind of half way house, rather than a total reversal of the export ban. Whichever way, though, it’s an illustration of the problems faced by resource economies. Yes, they are geologically favoured, but it’s not all plain sailing. In this case, the Indonesian government would seem to have been trying to do the “right” thing, for its own people and for the industry more generally, since co-location of mining and smelting where possible surely makes sense in the twenty-first century. The old model (which was one of the foundation stones of the British Empire) of exploiting the developing nations for their raw materials and then taking as much of the added value back to the homeland is past its sell-by date. As ever, though, financing change and the cash flow that it requires is the tricky bit. It will be fascinating to see how this issue continues to develop. 

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