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Distinctive features of the natural resource sector give rise to
non-standard arguments for trade policy and for international rules.
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.
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