Encouraging downstream processing: industrial policy or resource nationalism?

Why is it crucial to consider downstream processing at this time?

There has long been a discussion in economic policy circles about downstream processing, most notably in the context of central planning or mercantilism, as evidenced by the former Soviet Union. With the fall of the Soviet Union, the demise of central planning, and the dismal outcomes of industrial policy as it was implemented in both developed and developing nations during the 1970s and 1980s, it would have been simple to assume that this conversation had come to an end. It seemed reasonable to assume that recent history would have provided enough empirical proof to reassure even the most doubtful. Over the last three decades, global trade has expanded at an unprecedented rate, leading to a significant decline in poverty. This can be attributed, at least in part, to specialization and the dispersion of supply chains. Notably, global trade has outpaced global GDP growth, refuting the claims made by proponents of policies that encourage vertical integration within a nation.

One could argue that government initiatives to lower transaction costs might enhance the environment for processing downstream. These initiatives may be considered components of industrial policy, which has many different flavors (see Smart 2017).

The interest in downstream processing is confirmed by policies in an increasing number of nations. Positive fiscal incentives have been implemented by certain nations. For example, tax holidays, lower corporate income taxes, and duty-free imports are used by Indonesia to encourage primary resource companies to invest in processing facilities (Bellefleur 2014). For projects exporting processed minerals, Rwanda levies a 15% preferential corporate income tax, up to 50% of the turnover of minerals produced in Rwanda (Rwanda Development Board, n.d.). In Rwanda, companies typically pay 30% in taxes. Zambia (copper) and India (iron ore) are two other nations that have imposed export levies on raw materials. Lastly, some nations have gone so far as to completely forbid the export of raw materials. These include Tanzania since March 2017 for copper and gold, and Indonesia from 2014 to the end of 2016 for bauxite, copper, nickel, and tin (Östensson and Löf 2017).

All of these trends call for a closer examination of the policies intended to encourage or assist the downstream processing of minerals, especially through export limitations, as well as an attempt to determine the likelihood of these policies' success. These options may vary depending in part on how well the policies fit into a larger framework of industrial policy or whether they are attempts by populist politicians to reward certain constituencies or rally the people under the guise of "resource nationalism."

There is no consensus definition for the term "resource nationalism." The definition of resource-rich countries' people's desire to derive more economic benefit from their natural resources and their governments' resolution to exercise greater control over the country's natural resource sectors can be broadly and uncontroversially described as follows (Southern African Institute of Mining and Metallurgy 2012), or it can be more specifically defined as “anti-competitive behavior designed to restrict the international supply of a natural resource” (HM Government Horizon Scanning Programme 2014).

It is important to keep in mind at this stage that export limitations intended to encourage downstream processing may conflict with national obligations made under WTO regulations.Note 1 Since no nation other than the one enforcing the rules suffers any appreciable harm, the majority of export levies and bans are not contested at the WTO. However, under many bilateral trade agreements or investment treaties, such as the EU Economic Partnership Agreements, tariffs can also be contested. Therefore, "Except as otherwise provided in Annex III and for the duration of this Agreement, the Parties shall not institute any new duties or taxes on or in connection with the exportation of goods to the other Party in excess of those imposed on like products destined for internal sale," states Article 15 of the Interim Agreement establishing a framework for an Economic Partnership Agreement between the Eastern and Southern African States and the European Community and its Member States (European Union 2012).

The underlying analysis and goals are not always obvious, and the accompanying language occasionally seems like resource nationalism directed at home audiences. Nonetheless, there are a number of commonplace justifications for making additional processing a goal of industrial policy:

Products with higher levels of processing may have more consistent prices, so additional processing would offer some protection against fluctuations in revenue;

Processing raw materials can enhance abilities and have significant learning consequences;

The processed goods might be useful or, at the very least, less costly inputs for regional building, manufacturing, or agricultural projects.

The goal of this article is to critically survey the arguments put up in the discussion of laws that encourage the downstream processing of minerals, especially those that impose export restrictions or taxes. In the section that follows, "Market failure, policy failure or comparative advantage?", some of the reasons why mineral downstream processing does not necessarily occur in the nation where the minerals are mined are reviewed. The costs and advantages of coercive regulations are covered in the section "Costs and benefits of downstream processing policies," which partially uses Indonesia's export ban on unprocessed minerals as an example from 2014 to 2016. Finally, an attempt is made to make some very general generalizations in the "Conclusions" section.

Is it comparative advantage, policy failure, or market failure?

Much of the discourse around the downstream processing dispute is predicated on the notion that downstream processing ought to occur naturally and that its lack indicates one or more shortcomings in the market or in policy. Lower freight costs should, in theory, be a strong inducement for additional processing because, in the case of minerals, downstream processing from the ore or concentrate stage usually involves weight reduction—by two-thirds for copper and by three-quarters for bauxite/aluminum, less for the majority of other minerals. Some people perceive the fact that it still doesn't happen frequently as evidence that the playing field isn't level. It's crucial to remember that, in contrast to the case for manufactured goods, branding, market segmentation, connections to services, and disparities in quality are all relatively insignificant in the markets for minerals and metals. As a result, the characteristics that typically underlie market failures are missing. It is usually never a question of mining countries' processed goods not being competitive on the global market, but rather of how to make the downstream stages profitable enough.

Thus, comparative advantage may be the primary factor behind why downstream integration is not a practical or advantageous strategy for many businesses. The distinction is significant because, in theory, market failures may be fixed, but addressing comparative advantage is more challenging and requires more time.

The idea that there is an asymmetry of market power, allowing later stages of the supply chain to impose pricing and other restrictions on early levels, is the foundation of the market failure argument for the lack of downstream integration.In actuality, though, processing margins are frequently narrow and very changeable, which suggests that processors in these situations are more like price takers than monopsonists.