The decision chain of natural resource management

The natural resources are the biggest opportunity for rapid development that many poor countries have. And the supercycle of the last ten years has been the biggest opportunity that they've had in history. And for most of them, it's been a missed opportunity. And so it's really important, society by society, to discover what went wrong and what is needed to be understood in order for next time to go better. And there will be a next time. So, I'm giving two lectures. One will look at the challenge of discovering natural resources, getting them out of the ground, and getting them into revenue. The next lecture will look at what you do when you've got revenues, turning them into something that is sustainable. Because the revenues themselves are only temporary. If we look at what went wrong during the supercycle, most of the problems occur in that second half. It's using revenues for sustained development. And so, of the two lectures I'm giving, the more important one is the second one. But as a matter of logic, we are going to start with that process of discovering natural resources, getting them out of the ground, and turning them into revenue And that's what we'll deal with in the rest of this lecture. So the first step in that is discovering your natural resources. And in most poor countries, this has gone badly wrong. The key evidence for that is that, as of a few years ago, the typical poor country, if we look at how many resources it had discovered per square kilometer and compare that with how many resources the typical rich country had discovered per square kilometer, the poor countries had only discovered about one-fifth as much. That's not because there's less down there under the ground. These are random geological processes of millions of years ago. They'll be the same. It's because the discovery process, which depended upon investment and prospecting in discovery, has gone wrong in poor countries.There are various reasons why it has gone wrong. We just haven't got time to go into them. But I'll take one key solution to the problem, which is that we need public geological information. There's a strong case for international public money, aid money, to be used to prospect the geology of poor countries so that poor countries know what they've got. And the World Bank now has launched a one billion dollar campaign to try and raise money for a comprehensive geological prospecting of Africa. And I think that's the right way to go. So that's the first step of discover what resources you've got. Then we come to the next link in the chain, which is taxation. The key feature of natural resources, gas, oil, gold, whatever, the key feature is not the resource itself, it's the money it generates. So it's easy to get fixated about some particular natural resource, what should we do with iron ore or something? But really what's coming out of the ground predominantly is money. But the money in the first instance accrues to the companies that are managing the process of resource extraction. Usually you need international companies because they have the skills, the core competence, the finance, in order to manage the extraction efficiently. But then there has to be a taxation process, which takes the, what economists call the rents, which is the difference between costs, including reasonable return on capital, and the total revenues that are generated from natural resources. Those rents have to be transferred to the government. To give you an example, the typical barrel of oil at the moment sells on the world market for about $60. It might cost about $30 to get it out of the ground, to discover it, to pay the labor costs, the capital costs, the return on risk that company has taken. And the difference between the $30 of cost and the $60 of the barrel, that's the rents. And those rents need to be taxed and transferred to the government. If we look at other commercial activities like manufacturing, or services, for the most part those activities don't generate big economic rents. And the distinctive feature of natural resources from a point of view of taxation is that there are these big rents, which have to be taxed. And so the design of a tax system has to be specific to natural resources. You need a different tax system for natural resources than you do from the rest of the private sector. It also has to be geologically specific because the rents on oil are vastly higher than the rents on say, coal. And so you need a lot of information about costs. Now that takes us to one of the big problems in designing a good tax system, which is asymmetric information. The companies have much better knowledge than the government. And so the government has to devise a system which gets around that asymmetry of knowledge. Partly that's a matter of the government hiring-in expertise. You don't need expertise all the time, but you certainly need expertise at the stage of negotiation and design of a tax system. So you can do part of the solution by just buying in expertise that works for you, but you can also design a system which reduces the problem of asymmetric information. And that system is structured competition. I'm a very strong believer in auctions, in selling the rights to resource extraction through a transparent process of an auction.  Companies tend not to like auctions precisely because they force them to compete with other companies that have just as much information. And so a government which knows nothing can still benefit a lot as long as knowledgeable companies are competing against each other in a structured way. And so an auction flushes out, it reveals, the true value of the resource as a result of this competition between informed companies. A lot of governments sell resource rights sequentially by the first company to get off the plane and get to the president and negotiate. And that's precisely the wrong way to do it. Gather the field of three or four respectable companies, and then run an auction. Let's turn from taxation to the other upstream issue which is how to deal with the local environment, the local situation. The resources are discovered somewhere, not everywhere. And that locality has some rights, but not absolute rights. The resources are under the ground. The local community that lives on top of the ground didn't put the resources there. And so it's not really right to think of the local community as owning the resources. They didn't create them. Nobody created those natural resources. And so who should own them? In most contexts it's sensible to think of the largest group possible as owning them, which is all citizens of the country, both present and future. And so the rights of the local have to be balanced against the rights of the national. That suggests to me that the locals shouldn't have a right of veto, saying 'unless you do things the way we like it, we won't let you extract', but they do have rights to extract in such a way that protects the environment and gives them proper compensation for any environmental damage. And the local population has to be confident both that it's participating in the benefits in a fair way, the national benefits, and that any of the environmental damage that it suffers, it's getting rapid and fair compensation for that damage. Resource extraction in a locality is also an opportunity for benefits in the locality. Probably the biggest single benefit is economic spillovers from the resource extraction. Old-style corporate social responsibility tended to be the resource extraction company would build a couple of schools, build a clinic. That sort of thing. I think that resource extraction companies shouldn't be in that sort of business. Providing schools and clinics is the responsibility of the local government, not of the company. And the company shouldn't try and do things that are the responsibility of local government. It might be sensible for the company to work with local government to build the capacity of local government to deliver those services, but it's basically a government job. What the company can do is share its infrastructure. If you're running a mine, you'll need a railway, you will need electricity. And at very little extra cost, that railway and that electricity generation can be designed not just to benefit the mine, but to benefit all the people living along the line of rail and all the people in the vicinity of the electricity generator. So the company could do a local electricity grid and sell it, electricity at cost which will be very much cheaper to small businesses in the locality. In the places I work in, electricity is terribly scarce and terribly expensive. It's individual diesel generators. And so if you have reliable, cheap electricity in a locality, that's a huge benefit to local companies. So that's the first part of the decision chain. Discover resources, tax them, and deal properly with the locality where the resources are coming out. What we're now going to turn to is the more important second half, which is how to convert those revenues into something that's sustainable.