Endowments have fixed locations
For many goods, the possibility of causing (or preventing) the relocation of
production is a primary motive for trade policy. Deposits of non-renewable
natural resources are immobile, so these motives do not apply. Countries
without a resource endowment have no local firms or workers in the sector to
protect, and cannot use tariffs to attract production. For these countries
user taxes are equivalent to import tariffs. Similarly, for resource
producers a resource export tax is equivalent to a subsidy on domestic
consumption. While immobility of production reduces the scope for tariff
induced production losses, use of domestic taxes (e.g. in fuel importing
countries) and user subsidies or export taxes (in fuel exporting countries)
support substantial fuel price wedges in different national markets. These
create massive efficiency losses from low-value marginal consumption in
producing countries and forgone high-value marginal consumption in importing
countries. An international policy deal which did not affect the
distribution of rents but which eliminated the efficiency losses would be
mutually beneficial. Reaching such a deal, in which world prices were
gradually harmonized, would be analogous to the mutual de-escalation of
tariff wars - a core function of the WTO.
Resources generate rents
Rents belong to the country in which the resource endowment is located.
However, investing firms and consumer countries employ a variety of policies
to increase their share of these rents. The policy game is primarily about
getting rents rather than about relocating production. Manipulation of
supply or demand can change the price of the resource, and this is one of
the motives for countries to use resource taxes.
Resources are finite and depleting
However, the net effects of supply and demand changes are intertemporal
because natural resource extraction depletes a finite resource. Changes in
supply in one period have equal and opposite effects in later periods. A
limited total supply of a resource sets the long-run average price, so
attempts to manipulate the price can only have a small impact on long run
average prices. The long-run payoff to cartel power is low or negative,
although short-run use of market power can bring temporary efficiency
losses.
Extraction is dependent on discovery
Natural resources must be discovered before they can be sold, the incentive
for discovery being a share in the rights of extraction. Hence, trade policy
is not just about the market for the resource, but also the market for
licenses. These arrangements determine the distribution of rent and shape
the incentives for depletion and exploration. Most inefficiencies arise in
this area, rather than in the market for the resource itself. Projects are
long term with high initial sunk costs. As a result incentives to prospect
and to develop new sources of supply can be undermined by the process of
allocating and enforcing contracts. Contracts leave parties open to an acute
‘hold-up’ problem; government is unable to commit not to renegotiate and
investors are deterred by the consequent risk. In some regions there is
systematic bias towards under-exploration and over-rapid depletion. Were
known reserves increased in these territories to the OECD average, world
reserves would increase by around one quarter, allaying fears such as ‘peak
oil’. As a near-global organization the WTO has the authorizing space in
which to codify rules and standards that might mitigate these political
impediments to investment. This would require that renegotiation of
contracts be limited through agreed codes of practise or by binding dispute
resolution
Each project is unique
Projects are unique and subject to asymmetric information, with the investor
better informed about geology and technology than is government. Extraction
rights are commonly sold through secret bilateral negotiations giving rise
to social inefficiency due both to the agency problem and to asymmetric
information. In conjunction they enable the private capture of rents that
should accrue socially, and award contracts to companies on criteria other
than efficiency. Because there is no market, secret and bilateral deals do
not constitute a breach of the letter of the Most Favoured Nation Clause,
even though they breach its spirit. Processes for selling extraction rights
are potentially appropriate for regulation by the WTO. The analogue of the
MFN clause would be a rule requiring or encouraging open bidding as provided
in auctions. Auctions provide equity among bidders, and also overcome the
asymmetric information and agency problems noted above. In bypassing
international markets, bilateral deals also risk a vicious circle in which,
as an increasing proportion of world supply is pre-empted, the residual
international market becomes more volatile and so less reliable, inducing
further bypass.
Resource extraction is often the dominant activity
Resource projects dominate many economies and so are central to the nation’s
development strategy. Since actions in this sector have non-marginal effects
on virtually all aspects of the economy, they are quite properly in the
realm of public policy. Government will therefore seek to retain control of
the rate of extraction and seek to take some part of the rent in terms of
local participation, labour training, domestic content requirements and
development of local supply. While governments might be well advised to use
commercial criteria in their decision taking, simple ‘leave it to the
market’ arguments are not valid once the dominant role of the sector is
recognised.
Unassigned ownership
Natural assets have no natural owners though by near-universal consensus,
ownership is vested in the national governments of the territories in which
they are found. Currently no international agency has a clear mandate to
negotiate the assignment of rights to resources in international territory.
However, this is essential for future exploitation, given the likely
development of deep sea and polar resources.
No: ERSD-2010-06
Authors:
Paul Collier — Professor of Economics at the University of Oxford,
Director of the Centre for the Study of African Economies and Professorial
Fellow of St Antony's College
Webpage (opens in a new window)
Tony Venables — Professor of Economics at the University of Oxford and
Director of the Centre for the Analysis of Resource Rich Economies.
Webpage (opens in a new window)
Manuscript date:
December 2009
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official position of any staff members. Any errors are the fault of the
author. Copies of working papers can be requested from the divisional
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