Introduction
Today’s column continues the effort to provide for readers’ guidance a response to the burning question: What are the lessons to be learned from oil and gas producing countries that have implemented policies/regimes for local content requirements (LCRs)? As previously indicated, such countries are many, and, unsurprisingly, their experiences are varied.
Beyond question, LCRs in the oil and gas sector have been used as a tool for promoting broad-based economic growth, economic diversification, employment creation, skills enhancement, and structural transformation for more than four decades now; following the spectacular North Sea oil discoveries in the early 1970s.
Those experiences (including Trinidad and Tobago’s) have undoubtedly revealed the aptness of the World Bank’s observation that: “Over time the aim of local content policies has evolved from creating backward links” (for example, supplying inputs from the local economy to the sector, localizing ownership and control of the sector) “to creating forward links” (for example, the establishment of refineries, petrochemical industries and the production of fertilizers). World Bank, 2013.
Readers should also note that the headline conclusion of the above cited 2013 World Bank study is: specialized inputs of the oil and gas sector as well as its technological complexity, have severely constrained the possibilities of local content policies in most countries. And, because of this it is therefore required that I note here that that seminal study (which is based on a wide cross section of case studies), has specifically elaborated this conclusion under the caption: “What this study does not do”. Further, in the first sentence following this caption, the World Bank declares: “This study does not advocate in favour or against the use of local content policies”.
The Lessons Continued
Following on from last week’s two lessons the Third lesson to be learned from global experiences is that, LCRs are routinely expressed both explicitly and implicitly. Explicit LCRs are usually framed as direct statements of performance requirements; and, invariably these are framed numerically or quantitatively in the governing legislation/regulation. Thus it may be stated as a fixed percentage of employees/staff of various categories who must be locally sourced; or, as a percentage share of locally produced goods and services that is attached to certain sector outputs. Implicit requirements are generally expressed as broad requirements for access to local support.
One can reasonably claim that, in in both instances, the aim of LCRs is to ensure they 1) raise the level of domestic industrial capacity 2) generate local jobs 3) encourage national entrepreneurs and thereby serve the growth of domestic businesses and, 4) at times, more ambitiously seek to “leap frog” barriers confronting local firms (technology access, skills, and credit risk).
Lesson 4 is of particular importance, since experiences indicate that it cannot be over-stated how the need to learn from policy failures as well as successes is great. Failures reveal that poorly designed LCRs pose almost unsurmountable problems for any economy. Thus one finds, poorly designed LCRs lead to several perverse results, including: 1) business failures 2) through these failures, broader shortages and delays in the supply of goods and services 3) high compliance costs for the state, as it tries to regulate the negative operational environment and 5) public dissatisfaction.
Above all, the lesson from failed regimes highlights an important truism, which is LCRs become unavoidable because of an economic pre-condition facing such economies. That pre-condition is the absence of market competitiveness and therefore resource optimization. Market failures and the breakdown of optimal efficiency/conditions generate the need for what economists’ term as “second best” policies to compensate for market defects. In truth though, all second best states run the risk of the following:
First, firm costs can rise as a result of inefficiency and through this increase business output prices also rise. Increases in business prices raise costs to producers further along the production chain, thereby, reducing the competitiveness of industries across the whole economy. When this lack of competitiveness spills over to the export sector, then international competitiveness is also compromised. Second, alongside higher costs/prices there is, unfailingly, negative effects on the quality of the goods and services affected. And, from these, other negative dynamic effects flow. Most likely these will be: 1) once LCR entitlements are given to firms, it is next to impossible for governments to claw them back, after finding out they are not working. Political and other interests cling to the “not-working” LCRs as entitlements and not performance conditional arrangements. This is the exact opposite of freeing entrepreneurial instincts in the country. Here, inefficiency and resource misallocation thrive.
Conclusion
Next week I shall provide yet further lessons. Before that however, I wish to acknowledge readers’ requests of me to provide comment on two specific issues (which I had intended to do anyhow). One issue I have already mentioned last week. That is, most Guyanese intuitively feel that a LCRs regime is right and just because of the developmental, employment, income, environmental and other challenges, the country faces as it approaches oil and gas production. However, they also need to appreciate the formidable task the Authorities face in leading a line of policy march that is not truly welcomed by key global economic institutions, including the World Trade Organization (WTO) and the World Bank. As I shall demonstrate the “official” view has been strongly advocating that, LCRs are a means of backdoor and backward protectionism. Given this, those who lead our case for LCRs must be well armed to contend with this; bearing in mind, as I have already indicated, LCRs are being practiced by nearly every country on earth!
The second topic readers have raised is the question of an “oil refinery” as an outcome for forward linkages. It is my intention to tackle both topics before concluding the discussion on LCRs.
In preparation for a wrap-up of the discussion on LCRs, I shall focus on presenting the main findings offered by the two key studies of UNCTAD and the World Bank, cited thus far.