Governing the 'resource curse': Advancing transparency

EDITOR’S NOTE: International transparency efforts on the extractives sector are shifting from governments to companies. In a guest post for the Council on Foreign Relations, Alexandra Kerr, program coordinator in the International Institutions and Global Governance program, discusses how recent legislative moves based on this new paradigm can help end the “resource curse” for developing countries.

Ahead of the G-8 summit this June, economist Paul Collier remarked that “instead of preaching to poor countries or promising to double aid, which we never did anyway, the idea now is … to put [our] own house in order, in ways that are good for us and also good for Africa.” Prefacing the summit’s strong focus on transparency, Collier’s statement touches on a recent series of international actions that shift the approach to solving the problem of corruption in the extractives industry. Where countries with natural resource abundance have often been scrutinized for failure to turn their endowments into sustained wealth for their populations, the onus is now on the companies that partner with these states to extract natural resources, to instigate change. Consequently, a new paradigm is emerging wherein the extractives industry is increasingly accountable for its financial transactions — which, in remaining largely ungoverned, have contributed significantly to the “resource curse.” At the heart of this shift, transparency is taking center stage.

The lack of governance at both ends of the supply chain — from the mines on the ground to the financial accounting in the offices of multinational extractives companies — allows for unsound industry practices to feed off of and sustain corruption. And this corruption contributes directly to the “resource curse” — the idea that (contrary to a logical connection between the discovery of natural resources and higher GDP per capita) there is instead a nexus between oil, mineral, and gas resources in a poor country, and conflict, poverty, and social and environmental degradation. While the direct correlation between resource wealth and the exacerbation of poverty is spurious at best, there is no doubt that the extraction of oil in Venezuela, Nigeria, and Ecuador, of diamonds in Sierra Leone and Angola, or of coltan in the Democratic Republic of Congo has not translated into social and economic prosperity for their populations.

International efforts to remedy the problem have largely focused on the resource abundant countries and specifically their lack of institutional capacity, incidents of widespread government corruption, and the on-site problems faced by the local communities. However, taking Robert Klitgard’s equation for extractives corruption in reverse (corruption = monopoly + discretion — accountability), the recent concentration on transparency seeks to shift the onus from the states in which resource extraction takes place to the companies that bring the resources to market. In a system entrenched in a cycle of corruption, the goal is to ensure transparency from companies that have both the means and institutional capacity to implement accountability regulations effectively. It is one step in solving a complex problem, but it is an important one.

Currently, transparency is an issue at every juncture of an extraction project lifecycle. In the initial stages, for instance, companies undertake extensive exploration followed by concession assignments, negotiations, and contract preparations. Under the veil of opaque and unmonitored deals, companies take advantage of their financial upper hand over weak governments, creating unbalanced contracts that often exempt the foreign company from local taxes and rarely, if ever, make provisions for how and where the revenues will be distributed by the government agencies involved in a sale. While ignoring the local governments’ ability or willingness to plan ahead for the social, environmental, political, and economic impacts of a project, multinational companies have long been able to avoid blame from transparency watchdogs, like Publish What You Pay, due to weak reporting standards. Furthermore, without transparency to enforce accountability, funds have been moved to tax havens or revenues misreported to avoid tax in the foreign company’s own country.

The lack of transparency demonstrated in the acquisition phase, can be found in each subsequent phase of an extractive operation — from the implementation of operations to the establishment of management, and even mine closure and post-closure. The implementation of governance mechanisms that expose the financial records of companies operating in and benefitting from resource rich developing states, to the scrutiny of their home governments, third party regulators, and the public, is being recognized as a key step to transforming the industry.

Consequently, transparency initiatives have taken hold at the multilateral, regional, and unilateral levels. The strongest and most recent initiatives include the following:

• Multilateral: The Extractives Industry Transparency Initiative has been leading the way in financial transparency in the extractives industry since 2002. It is a voluntary initiative and, while it requires members to report revenues, it has weak punitive mechanisms to enforce standards, besides suspending membership. While the Initiative has become an important catalyst for international cooperation on the issue of extractive industries and has the potential for arresting corruption in weak states, its shortfalls must be made up by national legal regulation.

• Unilateral: In July 2010, the Dodd-Frank Wall Street Reform Act was passed in the United States. Sec. 1504 of this act requires all oil, gas and mining companies to disclose taxes and other payments to the U.S. Securities and Exchange Commission on a country-by-country and project-by-project basis. Given the United States’ position in the market, Section 1504 applies to 90 percent of the world’s largest internationally operating oil and gas companies, as well as eight of the world’s ten largest mining companies. Similarly in June 2013, the Canadian government announced that Canada would establish mandatory reporting standards for all extractives companies operating in or registered in Canada — standards that would apply to over 1,700 mining companies.

• Regional: In June, the European Union passed legislation that will force EU-listed and non-listed extractives industry (oil, gas, mining, and logging) companies to declare payments they make in resource-abundant countries, showing how much tax they pay, to whom the payments are made, and where the payments go.

These regulations are hard won victories, considering that most extractives industry companies have strong reservations against transparency measures; while these regulations enforce transparency across the majority of the extractives industry market, the requisite reporting standards could put those companies not covered (such as those registered in solely China, Russia, or India) at a competitive advantage by increasing the transaction costs for companies following the new regulations. To solve this problem, a recent working paper by the Center for Global Development suggests that the EITI ought to revise its reporting regulations. Currently companies can choose to disclose the payments that they make through either disaggregated (company-by-company) or aggregated (total for all companies combined) reporting, allowing some countries to send aggregate reports that do not reveal the companies or countries that have failed to make the correct payments. If this regulation were amended to stipulate disaggregated reporting only, a significant degree of corruption would be exposed.

The new legislative moves towards transparency may yield the beginning of a new era in which companies benefitting from natural resources are governed in such a way that endemic resource wealth becomes the blessing to the countries that need it most, rather than a curse. With two-thirds of the world’s poorest people living in resource-rich countries and recent discoveries of oil, gas, and minerals in countries like Ghana, Kenya, Mozambique, Tanzania, and Uganda, cementing financial transparency is a fundamental progression to ensure the appropriate development not only of the resources, but of the political economy of those states.

Edited for style and republished with permission from the Council on Foreign Relations. Read the original article.