GOVERNANCE IN THE EXTRACTIVE INDUSTRIES: SOME NEW DIRECTIONS

• Jurisdiction: Derecho Internacional

Mining and Oil and Gas Law, Development, and Investment - Book 1
(Apr 2007)
CHAPTER 3B
GOVERNANCE IN THE EXTRACTIVE INDUSTRIES: SOME NEW DIRECTIONS
Craig Andrews
Principal Mining Specialist, World Bank
Washington, D.C., USA

Abstract

Good governance has been identified as an essential pre-requisite for countries to derive maximum economic development benefits from the extractive industries. This is especially important for international development institutions such as the World Bank, which is committed to helping developing countries improve economic performance and to reduce poverty. This paper describes recent work at the Bank in terms of measuring over-all governance indicators for a country and describes how these may be applied to the specific case of the extractive industries. The paper discusses macro and sector level criteria for assessing the quality of governance in a country. It discusses critical governance issues related to allocation and administration of mineral rights and mining development agreements. It discusses key aspects of management of revenues streams as well as current trends and principles of disclosure and transparency of revenues by the extractive industries. Finally, it discusses the issues related disclosure by individual firms or on a sector-wide basis.

The author wishes to express his appreciation for the published work of Daniel Kaufman, Aart Kraay, and Massimo Mastruzzi of the World Bank on overall governance indicators, the unpublished work of Gary McMahon and John Strongman of the World Bank on mining sector governance indicators, and for the published work James Otto, Craig Andrews, et. al. on Mining Royalties.

Background

The perception of some observers of the extractive industries have is that instead of contributing to a country's economic development the extractive industries do exactly the opposite. That is, countries with the high dependence on oil, gas and minerals tended to do less well in terms of economic performance than countries which are not so heavily dependent on the extractive industries. This phenomenon, known generally as the "resource curse" or the "paradox of plenty", seems to apply to both countries dependent on oil and gas as well as hard rock minerals. The World Bank Group is committed to helping countries develop economically and to alleviate poverty. Over the years the Bank has been supportive of the extractive industries, as for instance programs of the International Development Association in developing countries to improve the enabling environment for new investment or the participation by the International Finance Corporation or the Multi-Lateral Insurance Guarantee Agency in private sector investments. But if, as the "resource curse" theory would have us believe, the extractive industries do not contribute to economic development then why would the World Bank be supportive of these industries? In 2004 the World Bank Group commissioned an independent review (Extractive Industries Review - EIR) of its

[Page 3B-2]

funding of extractive industry projects in developing countries in an attempt to answer this question. After a thorough analysis including extensive interviews and meetings with various interested parties around the world, the EIR panel determined that "...the World Bank Group did have a role in the extractive industries but only if its interventions allow the extractive industries to contribute to poverty alleviation. And this can only happen if the right conditions are in place ...."

By right conditions the EIR commission targeted the issue of good governance and transparency in the countries where the Bank is currently (or may potentially become) involved in the extractive industries. Some of the resource rich countries where the Bank is, or may become involved, have poor or questionable governance records.

Some countries, such as Myanmar, are viewed as so corrupt as to preclude Bank involvement altogether. Other countries, such as Saudi Arabia, Kazakhstan or Angola are rich enough not to need the involvement of the Bank. Some new-comers to the extractive industries, such as Cambodia, Timor Leste or Equatorial Guinea are highly susceptible to corrupting influences. Finally, there are an increasing number of countries with extremely weak government structures or those which have been destroyed by years of civil war or political turmoil. The so-called "post conflict" or "weak governance" countries include, for example, Liberia, Afghanistan, Sierra Leone, and Democratic Republic of Congo. The question for the Bank is whether there is some minimum level of good governance in a country where the Bank's involvement in an extractive industry project could result in a positive outcome. And, if so, what criteria could be used to measure the governance threshold.

A Governance Methodology

A methodology¹ to measure governance has been developed by senior researchers at the World Bank, Messrs. Daniel Kaufmann, Aart Kraay, Massimo Mastruzzi and others. Their research has defined and developed broad governance categories: "voice and accountability", "political stability", "government effectiveness", "regulatory quality", "rule of law", and "control of corruption". Within each of these categories a numerical score for a particular country may be derived from the work of independent research organizations or rating agencies such as the Economist Intelligence Unit, Freedom House and the Heritage Foundation, among others. The "scores" of countries are not the focus of this paper (if interested, the reader can access the full report "Governance Matters" on the website: www.worldbank.org). Rather, the categories and their definitions can be a useful starting point to focus on particular governance and transparency aspects relevant to the extractive industries at both the macro and micro levels.

Macro Level Governance and Sustaining Reforms

A significant development in developing countries in recent years has been the withdrawal of the state from direct public investment in the extractive industries in favor of a more welcoming attitude in respect of private (foreign) sector investment. This shift from public sector to private sector investment has been accompanied by changes to the enabling environment

[Page 3B-3]

, specifically the mining and natural resources laws, regulations, and taxation. As well, government supervisory institutions have been re-organized and/or reformed to be more responsive to the needs of the private sector investment community. The sustainability of these reforms is of particular relevance to the extractive industries due to the long term nature of the investments. This sustainability of the reform is dependent in large measure on the overall political stability of the country and of the public support for the reforms. Two criteria may be used to measure these dimensions at the macro level.

• Voice and Accountability - includes the process by which those in authority are selected and replaced and various aspects of the political process, civil liberties and political rights. Specific indicators include the extent to which citizens of a country are able to participate in the selection of the government and the independence of the media, which serves an important role in holding monitoring those in authority and holding them accountable for their actions.

• Political Stability² and Absence of Violence - means the likelihood that the government in power will be destabilized or overthrown by possibly unconstitutional and/or violent means, including domestic violence and terrorism. Fundamentally, such instability undermines the ability of all citizens to peacefully select and replace those in power. Also important is the fact that the quality of governance in a country is compromised by the likelihood of wrenching changes in government which has a direct effect on the continuity of policies.

Specific questions³ may be useful to refine our understanding of these criteria as they apply to the extractive industries. For instance:

• Is the government widely perceived as legitimate? If it is not, this means that reforms undertaken during its tenure may not be respected or sustainable once it leaves.

• How are decisions on what and how to reform undertaken? If they are done secretly by a small group of insiders, this will not only affect their legitimacy but may mean that opposition will surface while the reforms are being implemented, weakening or undermining their sustainability.

[Page 3B-4]

• When the government changes, what happens to bureaucrats? Changes in bureaucracy may make it difficult to complete sector reforms, but may not be as serious if only the very top level jobs are political. More importantly, if bureaucratic change goes beyond the top managerial levels then, in addition to the problem of generalized incompetence, there will be very little `learning' in the system, leading to a loss of institutional memory and a tendency to make the same mistakes over and over. In addition, corruption is likely to be much more rampant if positions are filled by `rent-seekers' rather than people with professional competence.

• What is the diversity of fiscal revenues and what happens to extractive industry revenues during boom/bust periods? If diversity of tax revenues is low -- that is, most revenues come from a small number of taxes and, especially, from the extractive industry sector -- there is a significant risk that the sector revenues will be asked to play a corrective role disproportionately greater than its size in the economy. If increased expenditures during good times lead to medium- and long-term increases in recurrent expenditures, this will usually signify future fiscal problems.

If the answers to these questions are heavily tilted towards the negative side, this is a good indication that straightforward attempts to improve governance--for example, stronger penalties, more...