What prospects, instruments and challenges for African economies?

Isabelle RamdooDeputy Head of Programme, Economic Transformation and Trade

ECDPM

21 – 22 April 2015Nairobi, Kenya

Extractives, local Content Policies and Industrial Development

Conference on Local Content Policy in the Extractive Sector in Africa

Introduction

Part I: A reality check on local content and industrialization in Africa

Part II: What prospects for local firms? • Where do potential exist?• What policies?• What initiatives in Africa and elsewhere have worked and why?• What instruments?

Part III: Challenges facing local firms• Domestic and global challenges• Legal challenges

Conclusions

Structure of presentation

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Part I

A reality check on local content in Africa

Some facts and figures

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• Increasing recognition that extractive resources (ER) have not been sufficiently translated into benefits overall and have not created opportunities for local businesses;

• Debate even more important as governments are put under mounting pressures to ensure more benefits from the ES notably through more and better jobs and more value creation locally

• In this context, series of policy measures and reforms undertaken to capture more gains from ER: LCPs seen as one way is to stimulate the domestic use of factors of production

(i) The debate: why local content matters?

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• No universal definition of what “local” is or what “content” means. A multidimensional issue.

Key features• Spatial dimension : is ‘local’ related only to the geographic

proximity of the mine or does it have a national dimension? Experience vary (Ghana, Nigeria, Mozambique have some requirements for local-local sourcing or employment)

• Local employment at different stages of the VC and different competencies

• Max. local procurement and preferences• Share of value addition and optimizing linkages (forward,

backward and lateral)• Ownership and participation of local stakeholders (beyond the

scope of the presentation)• Multi-purpose infrastructure use (corridors) (beyond the scope of

this presentation)

(ii). What is local content?

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(iii) Contribution of the extractive sector (mining)

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Contribution of the mining sector should not be underestimated.

Generally more significant in terms of FDI inflows, export and fiscal revenues

But much less impressive in terms of local value added, business spillovers and employment creation

(a) Employment: Actual job creation and potential

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Case of Zambia

In Zambia, although the no. of direct jobs increased, total number of indirect/ induced jobs largely outweighed directed job creation (capital intensive industry).

LC a stimulus to combine use of locally extracted raw materials with domestically available factors of production (labour, locally produced goods and services) to create more value in the economy;

Must be built upon existing capabilities within the manufacturing, fabrication and services sector (at least in ST);

Where these capabilities do not exist, they need to be developed, supported & strengthened; Necessary conditions must be created for companies to be able to operate;

So far, in many African economies, these conditions may be insufficient or weak. LC definition is also not very clear

(b) Local sourcing of goods and services

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Case of Zambia

Source: ICMM 2014

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1. Sources of growth varies: More than just natural resources;

2. But insufficient economic transformation: share of manufacturing declined over time

3. Natural resources refer essentially to raw materials production with little value addition.

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(c) Structural transformation

Source: Ernst and Young (2013): Africa Attractiveness Survey 2013

Potential is significant if policies are sustained in a systematic way overtime; adaptive and flexible and if SS-side constraints are addressed

But significant prospects along the value chain

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Smile Curve

Notably in upstream and downstream linkages

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Source: Adapted from Stan Shih Smile Curve concept

Mining cluster Manufacturing cluster

High labour, capital

intensity

Low labour, high capital intensity

Med to high labour and capital intensity

< jobs but > qualified

< jobs but > qualified

> Jobs but < qualified

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Some e.g. of countries that have performed well along the resources value chain

Part II

What prospects, policies and instruments for local firms?

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LC opportunities depend on the stage at which the industry is in the mining cycle

Site construction phase is more labour intensive, but short-lived and temporary;

Operation phase more capital intensive but with greater and more sustainable potential for the supply of goods and services

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Source: ICMM

1. In which sectors do potential exist?

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Substantial (potential) contributions thro’ employment, skills dev’t & supply chains. Companies spend between 40 - 80% of revenue on procurement of goods & services (in some cases that exceeds tax & royalty payments).

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Mining and hydrocarbons offer different potentials

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Clear distinction has to be made among various types of policy objectives:

1. Policies aimed at increasing the economic contribution of the mine (e.g through local sourcing, employment etc). Require different and more targeted sets of policy instruments;

2. Development of spillovers through broader resource-based industrialization policy objectives (upstream and downstream linkages), which may not necessarily be feasible for the mine but possible for the country. Require other sets of policy instruments (industrial policy, support policies to attract investment from other firms etc).

3. Horizontal policies such as sound macroeconomic policies, equitable fiscal policies, trade & investment policies, infrastructure, skills development policies, R&D, financial policies for SMEs etc.

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2. What policies?

In recent years, numerous countries have undertaken profound economic reforms including on local content policies. Mix of hard and soft policies:

In the oil and gas sector, examples include Nigeria (LC Act require specific % of local procurement and employment requirements), Angola (specific quota for local work force), Mozambique (non-specific requirement for local preferences), Uganda, Ghana (preference for locals in bidding rounds), Tanzania.

In the mining sector, e.g. include Ghana, South Africa (BEEE and beneficiation strategy), Guinea, Mozambique (preference for local suppliers enacted), Zambia (Mineral resource development policy requiring preferences for local G&S although “local” is not defined).

3. What initiatives?

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Where have LCRs worked?

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LCRs have been more effective when:

1. There was the capacity to deliver and industries are competitive (Norway in its early days for eg.)

2. They were temporary and performance-based (Norway)3. They were flexible and adaptive (Norway, Chile, Mozambique)4. There was a balance between regulatory measures and ensuring

the competiveness of companies5. Initiatives are collaborative i.e where industry and government

defined together how to realistically implement objectives of local content (Chile, Norway, Brazil, Malaysia)

Risks of LCRs being a barrier to business when:1. Targets were too prescriptive and no or weak domestic capacity (Indonesia, Nigeria)2. Penalties that can cause license withdrawal (S. Africa, Nigeria)

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a. Hard instruments: • Legally binding targets companies need to achieve in terms of

employment or procurement sourced locally. • Where found? in laws, regulations, contracts, tendering

procedures etc. If not applied, may lead to fines or even cancellation of contracts or licenses (e.g SA, Nigeria)

Soft instruments:• Non-binding instruments seeking to attain same objective as

above.• Where found? Policy documents and guidelines, tendering

procedures (qualified on basis of competitiveness)

Horizontal incentives:• Instead of putting a requirement on companies, Govt sometimes

gives incentives to (domestic) companies to attain the same goal. E.g fiscal support, financial support to develop local industries (subsidies) or other ‘soft’ industrial policies.

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4. What instruments? hard v/s soft

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Part III

What challenges for local firms?

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Potentially: Many African economies have 2 key advantages: labour cost advantage (although labour competitiveness may be a challenge) and abundance of NR.

YET…. Many economies are plagued by:• Under-industrialization; undiversified economic bases; significant

productivity gaps; skills mismatch and shortages; financial constraints.

• Local private sector, if not informal, is weak, small and not

embedded in national, regional and global supply chains; Facing demand-side constraints (as a result of the low purchasing power and levels of income); Supply-side constraints due to weak productivity which affect capacity to upgrade and expand production

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i. Domestic and international conditions matter:

Conditions in which business operate in many countries are fraught: (i) the business climate is stiff; (ii) costs of transportation are high, in particular across borders; (iii) infrastructure and other utilities are insufficient and unreliable; (iv) technology and skills are not adequate; (iv) access to finance is limited, in particular for MSMEs; (v) Insufficient skills, know-how and expertise to deliver on time, quality and competitive price;(vi) Insufficient support and accompanying measures for MSMEs; and(vii) Governance challenges (corruption, mismanagement of fiscal revenues);

Industrial policies have often been influenced by external actors, either because countries have been advised by international institutions (e.g. during structural adjustment programmes) or because their policies were donor-funded, in which case the poor alignment of strategies between donors and governments has lead to policy fragmentation rather than coordination.

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Changing these conditions is essential and require:

a) Setting up efficient institutional frameworks;b) Role of the state to support policies on a systematic basis;c) Addressing governance issues;d) Providing a conducive business environment to reduce costs of

doing business;e) Providing efficient public goods – infrastructure, energy,

technology;f) Addressing crippling effects of skills, technology, research and

innovation shortages and mismatches;g) Managing expectations;h) Ensure fair share of revenues, “follow the money” and manage

revenues and expenditures; i) Striking the balance between investment and fiscal

frameworks.

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1. Most LCRs would be inconsistent with WTO disciplines, unless implemented through government procurement. Key WTO provisions relevant to LCRs are:

1. GATT III.4: Prohibits discriminatory treatment bet. domestic & foreign firms for like products.

2. GATT III.5. Specifically focused on LC, prohibits quantitative regulations for use of products in specific amounts.

3. TRIMS (do not apply to services): prohibits performance requirements;

4. ASCM: Prohibits (i) export subsidies that favour specific industries (LDCs and developing countries with GNP/capita < $1000 exempted) (ii) subsidies linked to LC (Art 3.1b). If subsidies are combined with local content implemented through govt procurement, they will fall under Art 3.1b)

5. GATS Art XVI: Depends in what countries have committed in their schedules

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ii. Legal constraints

2. If countries have signed BITs: contain provisions that prohibit, condition or discourage the use of LCPs, such as:

Establishment of joint ventures with domestic participation; Min. level of domestic equity participation; Location of HQs in a specific region; Employment conditions; Export conditions; Restrictions on sales of goods or services in the territory where they

are produced or provided; Supply of goods produced or services provided to a specific region; Transfer of technology, production processes or other proprietary

knowledge and R&D requirements. Contain ISDS provisions

3. FTAs: new generation of agreements may have even more restrictions on use of LCPs

So far, no case brought in at the DSB at WTO on LC on extractives. But 25% of cases under BITs are extractives related. Why? Compensation mechanisms more favourable under BITs than in WTO.

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1. No sustainable development path without industries. LCPs are key to stimulate entrepreneurship and development of PS.

2. But not an end in themselves. Must be viewed as part of broader industrial strategy. Importance of innovation, R&D, upskilling, capabilities and technological transfer not to be underestimated.

3. Clear definition and objectives of LCPs is fundamental & should be very clear: otherwise difficult to monitor results;

4. Effective LCPs require holistic approach: should be well targeted, flexible and adaptive and need to assume politically difficult trade-offs.

5. Successful policies pointed to the importance of a balance between regulatory measures and the need to safeguard the competitiveness of the industry.

6. Finally collaborative partnerships is paramount: Government is a strong actor, but in the end, the business is conducted by the PS and without their buy-in and support, difficult to have sustainable results.

Conclusions

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Thank youwww.ecdpm.org

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