Sustainable development in mineral exporting economies

Sustainable development in mineral exporting economies

R. Auty and A. Warhurst

Sustainable development requires that consumption by present generations should not be at the expense of future generations. For mineral economies this means substituting an alternative income source for the depleting mineral asset and curbing environmental degradation. But Dutch disease (the negative symbiosis between the mining and other tradable sectors which mutes both the rate and efficiency of economic growth) can subvert both sustainability goals. First, Dutch disease weakens the non-mining tradables sector so that it cannot propel the economy should mining be marginalized. Second, Dutch disease retards economic growth so that investment in environmental management and clean technology is slow and environmental damage is the greater. Sustainable development must therefore overcome Dutch disease and this requires a pragmatic orthodox macroeconomic policy. The latter mutes the damaging impact of fluctuating ore revenues and spurs competitive diversification and economic growth so that new investment and the rapid adoption of environmentally sensitive technology is facilitated. Richard Autv is with the Department of Geography, University of Lancaster, Lancaster LA1 4YB. UK: Alvson Warhurst is with the Science P&icy Research Unit, University of Sussex, Brighton BNl 9RF, UK. Alyson Warhurst gratefully acknowledges the financial support of the John D. and Catherine T. MacArthur Foundation. Richard Auty thanks RTZ for funding data collection.

14

Mineral economies are defined as economies which generate at least 10% of their GDP from mining and at least 40% of their foreign exchange earnings from mineral exports. Such countries comprise about one-quarter of all the developing countries (DCs). They include two important subgroups: oil exporters and ore exporters (ie the producers of copper, bauxite and tin). This paper argues with reference to the ore exporters that, despite the harsh lessons of the 1970s and 198Os, few governments of mineral economies have learned that the control of Dutch disease (the negative symbiosis between the mining and other tradable sectors which mutes both the rate and efficiency of economic growth) is a prerequisite for sustainable development. Sustainable development requires that consumption by present generations should not be at the expense of future generations. For mineral economies this imposes two conditions. First, that investments must be made in alternative wealth generating assets in order to substitute for the depleting mineral asset. Second, that the environmental damage caused by mining and smelting should be minimized. Yet these two sustainability goals can be blocked by Dutch disease which saps the competitiveness of the non-mining tradables sectors (principally agriculture and manufacturing) and retards both economic growth and investment. Dutch disease can be especially severe in mineral economies because the occurrence of high rents (ie returns in excess of those required to earn a normal profit) on the mineral can cause the sustained appreciation (strengthening) of the exchange rate. This reduces the competitiveness of the non-mining tradables and typically results in the premature shrinkage of the agricultural sector (to a share of GDP half to one-third that of a non-mining economy of similar size and level of development) and excessive protection for the inefficient manufacturing sector (with levels of effective protection in excess of 100%). Sectors damaged by Dutch disease are ill equipped to generate revenues and foreign exchange as a substitute should those from mining abruptly diminish. Yet such abrupt declines are characteristic of mining, whose lumpy capital-intensive investment makes the smooth adjustment of supply to demand especially difficult to achieve. Furthermore, an economy damaged by Dutch disease elicits low levels of investment which retard the switch to environmentally sensitive technologies.

0301-4207/93/010014-16

@ 1993 Butterworth-Heinemann

Ltd

Sustainable development in mineral exporting economies

The analysis of sustainable development in mineral economies has mistakenly focused on compensating for the depleting ore reserves. This has fostered complacency about the risk arising from high levels of mineral dependence because exhaustion of the mineral reserves of most ore exporters (and also of oil exporters whose reserves are large in relation to their population) is far into the future; so far, in fact, that depletion theory indicates that countries need set aside only a modest fraction of net mining income to substitute for the wealth producing mineral asset.’ Among the leading ore exporting economies only Zambia and possibly Bolivia (where only a small portion of the mineral rich zone has been explored) may have less than two decades of reserves left. Most ore exporting economies, however, have many decades of reserves left so that asset depletion is not a pressing problem. But the abrupt marginalization of the mining sector is a very immediate and serious threat, given the volatility of mineral prices and unsound macroeconomic management. It is especially serious for mineral economies weakened by Dutch disease. Consequently, this paper focuses on the neglected components of sustainable development, namely Dutch disease effects and their implications for environmental management. As such, it offers a partial analysis of sustainable development. It shows that resolution of the Dutch disease problem is a prerequisite both for assuring the replacement of the depleting asset and for improving environmental management. That is, the elimination of Dutch disease is a prerequisite for sustainable development. The first part of the paper examines the impact of Dutch disease on sectoral diversification and identifies policies which mute its harmful effects. The second part of the paper draws on a recent study by Warhurst to identify both the cause of growing environmental degradation from mining in DCs and the potential remedies.

Mineral exporters’ economies underperform

‘S. el Serafy and E. Lutz, ‘Environmental and natural- resource accounting’, in G. Schramm and J.J. Warford. eds. Environmental Management and ‘Economic Development, Johns Hopkins University Press, Baltimore, MD, 1989, pp 23-38. *A. Warhurst, Environmental Degradation From Mining and Mineral Processing in Developing Countries: Corporate Responses and National Policies, OECD Development Centre, Paris, 1993. ‘G. Nankani, The Mineral Economies, World Bank Staff Working Paper No 354, World Bank, Washington, DC, 1979. %.R. Lewis, Development Problems of the Mineral-rich Countries, Williams College Centre for Development Economics, Research Memo 74, Williamstown, MA, 1982.

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Mineral exporters have three advantages over other DCs.” Their mineral sectors provide an additional source of foreign exchange, additional government revenues and also an additional route to industrialization. That extra route is through resource based industrialization (RBI), the further processing of the mineral resource into metal and fabricated products (as well as the production of inputs for the mining sector). RBI is only justified, however, if the natural resource yields sufficient comparative advantage in downstream processing to compensate for deficiencies in other inputs such as capital and technology. If the comparative advantage is there, then import substitution (which has been very badly executed in most DCs) and competitive export manufacturing (in which only a few countries, most Asian, have been successful) are not the sole options for industrial diversification in mineral economies. Yet compared with other DCs, Nankani found that, far from achieving a superior economic performance, the mineral economies have been less successful. The mineral economies have slower rates of economic growth, lower levels of social welfare and more highly skewed income distributions than the non-mineral DCs. In fact, the superior resource base of the mineral economies has been more of a curse than a blessing, a finding confirmed in a study of oil exporting countries by Gelb.4

Sustainable development in mineral exporting economies Table 1. Investment and growth rates by developing

Hard mineral exporters 1971-83 1960-71

Measure Investment/GDP: Gross IOCR” Growth of GDP per capita (%) Number of countries

country groups (%).

Mean 0 Mean

Zfean 0

0.21 0.06 0.28 0.05 2.5 1.1 10

0.23 0.05 0.07 0.02 -1.0 1.2 IO

Oil exporters 1960-71

1971-83

Other middle income countries 1960-71 1971-83

Other low income countries 1960-71 1971-83

0.21 0.10 0.34 0.06 2.9 1.7 10

0.28 0.10 0.12 0.05 1.9 3.7 10

0.20 0.05 0.32 0.02 3.7 1.8 29

14.3 4.1 0.26 0.03 1.3 1.4 20

Terms of trade indices (relative to unit value of manufactures Metals and hard minerals 1960-62 1970-72 1980-82

100 104 78

0.24 0.05 0.17 0.01 2.0 2.3 29

17.2 6.1 0.17 0.04 0.7 2.2 20

imported by developing countries) Petroleum

Agriculture

100 92 636

100 91 84

a Incremental output/capital ratio. Sources: World Bank, World Tables database. Commodity Price Forecasts; A.H. Gelb, Oil Windfalls: Blessing or Curse?, Oxford University Press, New York, 1988, p 34

5A.H. Gelb, Oil Windfalls: Blessing or Curse?, World Bank Oxford University Press, New York, 1988. %M. Auty, Resource-Based Industrialization: Sowing the Oil in Eight Developing Countries, Clarendon Press, Oxford, 1990.

16

Gelb examined the response of six such countries to the oil shocks of 1973-74 and 1979 and found that political pressure for rapid domestic windfall use was the reason why, in most cases, the potentially favourable resource endowment impaired the economic performance of the oil exporting countries. Table 1 is taken from Gelb and shows that the economic growth rate of both basic types of mineral economy (the oil exporters and the ore exporters) was disappointing and actually declined through the oil booms. It also shows that the mineral economies tended to have higher rates of investment than other DCs, so it was the efficiency of that investment which was disappointing, especially through the post-1960s period of heightened global economic uncertainty. Lewis’ argues that the predominant linkage from minerals is taxation (unlike the linkage from many soft commodities), which requires skilled government management if the revenues are to be deployed constructively. Gelb found that prudent use of the boom windfalls was the exception rather than the rule. Even the strongest governments, like that of Indonesia, found political pressures for overrapid domestic windfall absorption difficult to resist. In addition, governments have rarely been able to prevent mine workers from capturing a fraction of the rents in terms of high wages whose demonstration effect has then pushed up wages in the non-mining sectors, eroding their competitiveness. The overrapid absorption of the oil windfalls led to inefficient investments and unsustainable patterns of consumption. These proved damaging when oil prices fell because the non-mining tradables sectors could not replace the lost resources at anything like the scale and speed required. Rather, when oil revenues declined, both cuts in real incomes and prompt corrections of the real exchange rate were resisted, thereby intensifying the subsequent adjustment required.h The supply-side rigidity during mineral downswings partly reflected the disappointing diversification away from the depleting oil resource into RBI which rarely generated sufficient revenues to service RBI debt, let alone to make a positive contribution to exports and government revenues. But a more damaging factor was the inadequate sterilization (ie overrapid domestic absorption) of the windfall during

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Sustainable development in mineral exporting economies Table 2. Trends in key economic

Sources: World Bank, World Tables 7988, World Bank, Washington DC, 1988, except for exchange rates: A. Wood, Global Trends in Real Effective Exchange Rates 1960 to 1984. World Bank Discussion Paper 35, World Bank, Washington DC: fiscal gap, Interamerican Development Bank, Social and Economic Progress in Latin America, IADB, New York, 1988.

a 1983-87;

b 198>84;

parameters

GDP growth (%) Bolivia Chile Jamaica Peru Terms of trade (1980= 100) Bol~a Chile Jamaica Peru Real effective exchange rate (1965= 100) Bolivia Chile Jamaica Peru Balance of payments (% GDP) Bollvia Chile Jamaica Peru Fiscal gap (% GDP) Bolivia Chile Jamaica Peru Debt/GDP (%) Bolivia Chile Jamaica Per11

197048:

Bolivia, Chile, Jamaica and Peru.

1970-73

1974-78

1979-82

4.2 1.7 4.6 5.0

4.4 1.9 (3.2) 3.2

(1.2) 1.9 (1.4) 3.8

56 202 116 137

81 113 119 113

96 93 100 93

76a 81b 99 77a

86.6 88.2 87.2 87.0

101.3 64.6 96.5 73.6

128.1 83.1 72.8 76.8

212.3 65.0b 77.9c 70.2

1983-88 ug) 0.9 0.5

(0.3) (2.5) (11.6) (0.6)

(4.8) (3.9) (6.0) (6.4)

(10.4) (9.4) (9.9) (2.9)

(11 .O) (7.4)a (11.3) (2.9)a

(3.1) (10.2) (3.6) (2.1)

(2 8) (1 .O) (11.4) (7.3)

(6.2) 3.0 (13.9) (4.8)

(10.5)

0.50 0.29 0.66 0.35

0.59 0.43 0.53 0.40

0.87 0.46 0.61 0.39

I:::;” b (5.9) 1.29b 0.94a 1 .26b 0.52a

’ 1983-86.

the boom which caused an appreciation of the real exchange rate and triggered Dutch disease effects. This sapped the competitiveness of the non-mining tradables, resulting in either a fall in output (typical of agriculture and tourism) or an intensification of excessively high levels of protection (typical of manufacturing). Adjustment to the oil price downswing was therefore painful and its costs more than offset the gains made during the booms. In some cases per capita incomes fell below pre-boom levels. The response of the ore exporters to the mineral price swings 1972-90 reported here confirms Gelb’s conclusion about the resource being a curse.

Diverging economic performances

1970-90

The governments of the ore exporting countries, like those of the oil exporting countries, were overly optimistic about future mineral revenue streams. When ore prices fell after the first oil shock, most of them borrowed from abroad in order to adjust to the revenue loss rather than shifting resources into non-mining exports (manufacturing and agriculture) which would have entailed slowing their economic growth. They also misadjusted to the second oil shock because they assumed that it would be associated with a strong boom in metals. When that boom failed to materialize, most mineral economies found it difficult to service their accumulated foreign debt, which typically more than doubled from the early 1970s to early 1980s to match or even exceed their total GDP (Table 2). In many cases, the cumulative disadjustment not only weakened the non-mining tradables sectors (reversing any progress in substituting for the depleting asset), it also starved the mining sector of resources. This meant that investment in mining was insufficient to maintain output, let alone to incorporate new techniques in order to curb environmental

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Sustainable development in mineral exporting economies Table 3. Trends in mineral dependence

a 1986-87

only for Peru and Jamaica.

Sources: Banco Central de Bolivia, Memoria 1988, Banco Central, La Paz; Comision Chilena del Cobre, Estadisticas de/ Cobre, Comision Chilena del Cobre, Santiago, 1989; Jamaica Bauxite Institute, Jamaican Bauxite andAlumina, JBI, Kingston, 1991; Banco Central de Reserva del Peru, Peru; Compendia Esfadistico de/ Sector Public0 de/ Peru, Departamento de Analisis del Sector Publico, Lima, 1989.

Bolivia Share of GDP: Exports Revenue Mineral dependence Chile Share of GDP: Exports Revenue Mineral dependence Jamaica Share of GDP: Exports Revenue Mineral dependence Peru Share of GDP: Exports Revenue Mineral dependence

1970-88

(%).

1970-72

1979-81

1986-88”

index

20.1 77.0 44.0 47.0

15.8 87.6 23.7 42.2

13 2 82.2 47.7 47.7

index

7.4 85.7 6.7 33.3

8.6 56.2 12.5 25.8

9.1 51.4 7.6 22.7

index

10.8 63.5 10.0 28.1

14.2 75.1 20.1 36.5

8.8 49.2 22.2 26.7

index

10.1 47.6 6.7 21.5

15.2 62.6 13.5 30.4

10.6 52.3 3.5 22.1

degradation. This model of accelerating economic deterioration was especially marked in Zambia, Zaire, Bolivia and Peru. Yet within the some mineral economies (notably Botdisappointing global picture, swana and Chile) performed rather better. An analysis of six ore exporting economies 1970-90 includes three that experienced an accelerating weakening (Peru, Bolivia and Zambia), two which underwent a slow strengthening (Chile and Jamaica) and one which remained stable (PNG). The three more successful countries adhered to an orthodox macroeconomic policy which, with its twin commitment to fiscal prudence and a competitive exchange rate, reduced the risk of cumulative economic deterioration. A comparison of Peru and Chile shows why this was so. But it also reveals an important qualification of the orthodox prescription, namely that the doctrinaire pursuit of orthodoxy can delay recovery. Table 2 shows that the long-term economic performance of Chile from the early 1970s was one of an abrupt contraction (during the Allende populist boom) followed by a sustained strengthening, despite the disadjustment in 1979-82. In contrast, the Peruvian economy underwent an accelerating weakening with disastrous consequences in the late 1980s (Table 2). Yet the preconditions to the price swings of the 1970s and 1980s appeared to favour Peru over Chile. This is because, first, Peruvian dependence on the mineral sector was initially less than that of Chile, Jamaica or Bolivia (Table 3). Second, whereas Chile experienced political weakness in the early 197Os, Peru had a strong military government which was committed to reforms that addressed Peru’s excessively unbalanced income distribution. Finally, overall Peru experienced milder negative external shocks through the 1970s than those of Chile (Table 4). Yet Chilean economic growth was 1.9% pa 1974-82 contraction) and 4.3% in (which includes the d eep 1982 economic Table 4. External shocks 1974-78

Source: World Bank, World Tables, Washington, DC, 1989.

18

Bolivia Chile Jamaica Peru

and 1979-83

(% GDP).

Trade shock 1974-78

Trade and interest shock 1979-83 Trade Interest

12.1 -10.6 2.4 -4.3

4.5 -1.9 -10.2 -3.2

RESOURCES

-1.5 -4.2 -3.7 -2.7

Total 3.0 -6.1 -13.9 -5.9

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Sustainable

development

in mineral

exporting

economies

1983-88 (on a rising trend). In contrast, the growth rate for Peru slowed from 3.5% in 1974-82 to 0.9% in 1983-88 on a decelerating trend (Table 2). Macroeconomic policy accounts for Chile’s superior economic performance. Chile pursued orthodox policies after 1973, albeit with important shifts in emphasis, whereas Peru swung from structuralist to strong orthodoxy and back to a structuralist stance in the decade 1975-85. The case for macroeconomic orthodoxy rests on a number of well established points. First, the policies of post-war DC governments became excessively interventionist and increasingly counterproductive. La17 has argued that it makes no sense to expect that DC governments (which he compares to 18th century European governments) can play a greater economic role than the more modest one pursued by modern European governments (and with limited success at that). Others (for example, Hughes)’ have made the argument less polemically. The DCs’ interventionist policies captured rents (returns in excess of those needed to keep competitive producers in operation) from the multinational corporations (MNCs). Unfortunately those rents encouraged domestic industrialists to expend more effort in lobbying for state favours than on evaluating efficient investment options. Such rents benefited a minority of businessmen and workers at the expense of the consumer who paid for the privileges of the rent seekers through high prices for poorer quality goods. Over the long term such structuralist intervention drove a negative feedback loop which transferred resources from efficient sectors (mining and export agriculture) to subsidize internationally uncompetitive firms in the protected sectors (notably in import substitution industry whose inefficient implementation was a key policy error of Africa and Latin America from 1950 to 1980). By contrast, Asian economies like Taiwan and Korea, with much smaller resource-based sectors to exploit, abandoned such policies sooner and encouraged from an earlier date the efficient use of investment and labour in competitive export-oriented manufacturing. Convergence

7D. Lal, The Poverty of Development EcoHobart Paperback 16, IEA, London, 1983. ‘H. Hughes, Achieving industrialization in East Asia, Cambridge University Press, Cambridge, 1988. nomics,

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on doctrinaire macro orthodoxy

In the aftermath of the Allende populist boom and as copper prices weakened, Chile in 1974-75 moved quickly to adopt orthodox policies (including an outward oriented trade policy). The government cut public sector expenditure from 45% of GDP to 24% 1974-78 and the fiscal deficit shrank from 25% to 0.8% of GDP. The real exchange rate was devalued to a competitive level and maintained in the face of inflation by a crawling peg adjustment. Economic liberalization began with the easing of price controls during 1973 to 1975, the freeing of interest rates and the lowering of quotas and import tariffs. Consistent with the resource curse thesis, the more generously endowed country, Peru, reacted more slowly to the post-1973 economic difficulties than Chile. Peru was under less pressure to stabilize promptly because it expected a rapid expansion of its oil production and it attracted a sharp inflow of foreign capital. In addition, its economy was stronger than Chile’s and the negative impact of the first oil shock was smaller. When its policy proved inadequate, however, Peru resorted to doctrinaire orthodoxy 1978-80. It was partly for this reason that, like Chile and many other mineral economies, Peru disadjusted to the 1979-81 mineral boomlet.

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Sustainable development in mineral exporting economies

By the late 197Os, both Chile and Peru were pursuing doctrinaire orthodox macro policies which responded to the anticipated inflationary effects of the mineral boom by strenthening the real exchange rate rather than by sterilizing capital inflows through the accumulation of overseas assets. Their simultaneous pursuit of trade liberalization (also adopted in part to dampen inflation) exposed domestic manufacturing and agriculture to foreign competition under decreasingly favourable circumstances. The resulting intensification of the Dutch disease effects weakened the ability of the non-mining tradables sectors to offset the mineral sector’s decline when the mineral boom evaporated as world economic growth slowed in 1981-82. Both Chile and Peru sought IMF assistance in the early 1980s under difficult circumstances and experienced sharp recessions involving GDP contractions in excess of 10% (in 1982 for Chile and 1983 for Peru). Chile’s reversion to pragmatic orthodoxy It became clear that doctrinaire orthodoxy had been a mistake, but the two countries reacted differently to this lesson. Chile responded decisively and tempered its doctrinaire orthodox policy stance with more pragmatic measures. Peru departed much more from orthodoxy, however, and eventually reverted to dogmatically structuralist policies, with disastrous consequences. The Chilean government intervened in the banking system to avert its collapse (largely due to high foreign lending to a severely weakened manufacturing sector). The exchange rate was devalued and import tariffs were raised to 40%, but as a temporary measure to give a protective breathing space to the manufacturing sector - and to raise extra public finance. In addition, and in order to offset falling average copper prices with higher production, the policy of encouraging MNC copper expansion was dropped and a strong expansion of the state owned firm (SOE) Codelco was sanctioned. Meanwhile, in pursuit of fiscal balance, the government cut public spending and stepped up efforts to monitor the efficiency of domestic investment, both public and private. A further important intervention was the establishment of a mineral stabilization fund (MSF) in 1985; this was activated when copper prices began to rise in 1987. Basically, the MSF reduced the Chilean Treasury’s access to the higher tax revenues from the booming copper sector in proportion to the degree to which realized copper prices exceeded the target price used in macro policy formulation. The MSF therefore limited the extent to which politicians could spend a windfall for short-term advantage and thereby damage the economy by amplifying the Dutch disease effects. A further step in this direction was the granting of greater autonomy to the central bank in 1989. By 1985, some three years after the economic nadir associated with doctrinaire orthodoxy, the Chilean economy was recovering rapidly. The growth of non-mining exports - such as fruit - triggered in the mid-1970s continued apace and helped reduced mineral dependence substantially (Table 3). By 1989 the Chilean economy was widely regarded as Latin American ‘best practice’. It had a sustained high rate of economic growth, falling debt and high levels of economy diversifying investment. The mineral sector had become only one of several internationally competitive subsectors within the Chilean economy and it was attracting large inflows of investment which, by virtue of

20

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Suslainable development in mineral exporting economies

incorporating tally sensitive Peru’s

‘G. Sachs, Social Conflict and Populist Policies in Latin America, NBER Paper 2897, National Bureau of Economic Research, Cambridge, MA, 1989. “Ft. Fiani and J. de Melo, Adjustment, Investment and the Real Exchange Rate in Developing Countries, PRE Working Paper 473, World Bank, Washington, DC, 1990. “P. Wheeler, ‘Sources of stagnation in sub-Saharan Africa’, World Development, Vol 12, 1984, pp l-23. “P. Krugman, ‘The narrow moving band, the Dutch disease, and the economic consequences of Mrs Thatcher’, Journal of Development Economics, Vol 37, 1987, pp 41-55.

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lapse

state of the art technology, technology. into

structuralist

embodied

more environmen-

policies

Peru’s economy diverged from that of Chile after the 1978-82 disadjustment. Peru’s shift from orthodox policies began earlier than that of Chile and went much further by adopting a strongly structural& stance in the late 1980s. After the 1980 election, the government launched a large public investment programme to consolidate its political position. Fiscal balance then proved difficult to achieve (Table 2) - even under pressure from the IMF. The trade liberalization drive was reversed - but not temporarily, as in Chile, and regression to a highly distorting quota system of protection occurred in 1984. Inflation remained very high and domestic patience with (half-hearted) orthodox measures snapped, ushering in the Garcia government. Under a strong structuralist influence, Garcia launched a populist boom in 1985 which resembled that of Chile (1971 to 1973) and Jamaica (1973 to 1976). The sequence began with a sharp rise in real wages but degenerated into an inflationary spiral with exchange rate appreciation, growing (and counterproductive) state intervention and alarming deterioration in the fiscal and current account deficits.” Such policies alienated external lenders and thereby limited recourse to foreign finance when they failed. Peru’s failure shows that structuralist remedies are unsound, but Chilean experience (1979982) indicates the damage which doctrinaire orthodox policies can inflict. That damage comes from adherence to the principle of sectoral neutrality, which rests on the false assumption that economic sectors can adjust smoothly to external shocks. That assumption is expecially inapplicable to the mineral economies because, in addition to the existence of overprotected and inefficient manufacturing sectors, their agricultural sectors are invariably smaller than the norms for non-mineral economies of a similar size and level of development (typically by one-half to two-thirds). This makes for an especially rigid response to mineral driven shifts in the real exchange rate, contrary to the assumptions of doctrinaire orthodoxy. Several recent studies confirm that rapid shifts in the exchange rate do not bring smooth adjustments in the production of tradables within economies at pre-NIC levels of development.‘O Wheeler analyses the greater adjustment difficulties which mineral economies have with reference to sub-Saharan Africa.” There is clear evidence that an exchange rate appreciation can permanently destroy productive capacity leaving the economy in a very weak position to respond to a fall in mineral prices.” A mineral economy therefore requires some dilution of the doctrinaire macroeconomic orthodoxy which was increasingly adopted by Chile 1975-82. Orthodox policy, applied to mineral economies, should eschew sectoral neutrality. The mineral sector should be viewed as an economic bonus that assists competitive diversification: it should not be used to justify relaxation of such efforts by becoming the backbone of the economy, as doctrinaire orthodoxy allows. The theoretically grounded doctrinaire orthodoxy ignores the abrupt real world shifts in mineral revenues and the overly rigid response of the nonmining tradables. Prudent macro management calls for some limitation on mineral driven exchange rate shifts to safeguard the competitive diversification

21

Sustainable development in mineral exporting

economies of the non-mining tradables sector. It requires pragmatic interventions such as the creation of an MSF to expedite such a policy. Countries like Jamaica with chronically immature manufacturing sectors also need a competitive industrial policy to prevent the extinction of such sectors. l3 It is ironic that when Jamaica’s Michael Manley returned to office in the late 1980s he overreacted to the damage inflicted by his populist boom 1973-76 and adopted an orthodox stance which was too doctrinaire. The remedy for Dutch disease, therefore, also advances the sustainability goal of establishing substitutes for the depleting mineral asset. It does so by promoting competitive activity outside the mineral sector irrespective of the stage that mineral depletion has reached. This also means that unexpected shocks arising from changes in the competitiveness of mining can more easily be absorbed and rapid long-term growth more easily sustained. As the next section shows, the resulting improved economic performance also leads to improved environmental performance. Pressure for environmentally sound mineral production may, in turn, enhance the economic efficiency of mining and mineral processing.

Environmental

degradation

The problem

‘%. Frischtak, Competition Policies for /ndusfria/izino Countries. lndustrv and Energy Department, Policy and &search Series, World Bank, Washington DC, 1989; R. Wade, Governing the Market, Princeton University Press, Princeton, NJ, 1990.

22

Mining related activities affect the three environmental media of land, water and air. Exploration, mine development and the dumping of barren overburden or waste can degrade the habitats of local flora and fauna and prohibit alternative land uses - forestry, agriculture or leisure. Water quality may be affected by naturally occurring acid mine drainage from mines and waste piles or leaks and spillages from tailing dams or reagent ponds. Smelter emissions (and to a lesser extent those from refineries) of carbon, sulphur and nitrogen compounds and toxic metal particulates may affect air quality. Indirect emissions occur with fossil fuel burning, and the releasing of potentially hazardous dusts and gases related to the workplace. Such problems are likely to worsen in a cash starved mining sector where insufficient investment has caused technology to stagnate or even regress. In the DC context it can be argued that the mining industry was traditionally structured to externalize environmental costs so that profit maximization was achieved not so much through efficiency and innovation, as through the appropriation of undervalued resources and the shifting on to others of the environmental costs of doing so. For example, Bolivian peasants whose farmland was ruined through pollution from a tin valorization plant received small compensation payments which covered only the loss of that particular year’s crop rather than the potential loss of their livelihoods. The plant in this example was state owned and there is evidence that the severity of the pollution problem is linked to ownership patterns. In particular, the smaller private mines and large SOEs have proved less responsive to the need to improve environmental management than the more dynamic MNCs. This divergence in performance-has widened as domestic economic conditions have deteriorated in the DCs, although there are significant exceptions to this rule. Mine ownership Small-

and environmental

and medium-scale

mines

response account

for at least one-quarter

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of DC

1993

Sustainable

“‘CEMYD, Environmental Degradation from Mining and Mineral Processing (Bolivia), Mimeo, CEMYD, La Paz, 1991; A. Nunez, Heterogeneity of Production and Domestic Technological Capabilities in Mining and Mining-related Productive and Service Activities in Peru: Their Relevance for an Environmental Strategy, Mimeo, Peru, 1991. ‘%.M. Auty, ‘Determinants of state mining enterprise resilience in Latin America’, Natural Resources Forum, Vol 16, forthcoming.

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development

in mineral exporting economies

mining output. The growing number of small-scale enterprises, cooperatives and family groups of miners increasingly create serious problems by exploiting gold, copper or tin in alluvial deposits, rivers or the effluent from large-scale mines and processing plants. These miners are generally poorly educated with no forma1 technical training. Such miners may move from plot to plot in nomadic fashion without a long-term perspective on the negative environmental effects of their behaviour. An example is provided by the excessive use of mercury as a reagent in gold mining in the false belief that the more mercury used the greater the rate of gold recovery. Such releases of excess mercury into both streams and the atmosphere account for the fast developing and widespread instances of mercury poisoning which are being reported in Bolivia and Peru.14 Small-scale mining frequently occurs in symbiosis with inefficient large-scale mines, often state owned, whose low levels of recovery yield metal bearing effluent. For example, when Bolivia’s Comibol collapsed in the mid-1980s, it fired all but 7000 of its 27 000 miners and triggered a surge in activity within the small mining sector, as redundant miners set up mining cooperatives. The state-owned enterprise buys back the product from the small miners and so benefits from the miners’ work without having to pay a ‘social wage’. This situation is common in Bolivia and Brazil where SOEs employ obsolete technology in poorly managed mines. The technology often dates from the 1950s and 1960s and has not been modernized since nationalization. Nationalization of mines peaked in the late 1960s and early 197Os, reflecting efforts to prevent perceived unfair exploitation by MNCs. The state-owned mining firms often performed poorly, however, because political interference reduced their commercial autonomy and sapped their ability to cope with deteriorating macroeconomic conditions.15 They have usually been given multiple objectives which blur an evaluation of their performance and undermine profitability. Output is maximized to increase government revenue leading to high grading the inefficient exploitation of richer reserves, reinforced by the lack of careful mine planning and a failure to reinvest profits in exploration to extend reserves. Ministries intervene in pursuit of political objectives, whether overtly for macroeconomic reasons through price controls and tax imposts which can decapitalize SOEs, or less openly for political patronage through personnel changes. Meanwhile, the perceived absence of the risk of bankruptcy blunts the competitive spur to both economic and resource use efficiency and corrodes worker discipline and managerial initiative. Large mining SOEs such as Comibol in Bolivia, Centromin in Peru and ZCCM in Zambia have been decapitalized as a result of onerous levels of taxation (reflecting macroeconomic policy errors), the use of their operations for political patronage, and a related lack of investment in technological and managerial change. The resulting inadequate cash flow, overmanning and poor maintenance has increasingly starved such SOEs of the resources to buy spare parts to sustain production, let alone to update equipment and limit environmental damage. Management also deteriorated, so that even where foreign aid provided new technology it risked being inappropriate. It could even prove counterproductive to the environment, particularly if it was operated with excess capacity or incorrect ore feed - as the example of the Russian-supplied Bolivian tin smelter cited earlier shows.

Suslainable development in mineral exporting economies

Even where the mining SOE is relatively well managed, as in the case of Chile’s Codelco, the adoption of environmental measures may lag behind that of MNCs. Chile’s environmental standards were based on North American practice: they proved unenforceable by the relatively untrained and insufficiently numerous administrators and were selectively employed. The country’s only privately owned smelter, operated by a subsidiary of Exxon, was forced to meet emission standards more stringent than current US practice, while in the same valley an SOE smelter and refinery continued operating with neither sulphur dioxide nor arsenic removal facilities. Moreover, as Chile’s state-owned mines expanded vigorously through the 1980s in an attempt to offset falling copper prices with higher volumes, the government stopped reporting sulphur dioxide levels in the air.‘” Clearly, increased environmental damage may be one unforeseen consequence of the wave of mining nationalizations in the decade prior to the first oil shock. For in addition to promoting SOEs whose declining operational efficiency mirrored and amplified the macroeconomic deterioration, nationalization also deterred MNC investment, which appears to be becoming more responsive to environmental needs. Contrary to earlier fears, MNCs have not looked to the DCs as pollution havens but instead have attempted to commercialize their new technology which is generally more environmentally sensitive. Explanatory factors for this trend include access to technology which combines economic and environmental efficiencies developed under industrial fears of expropriation or retroactive country regulatory constraints; environmental penalties for ‘poor’ environmental behaviour; the conditions of loan finance for new mining projects which require sound environmental practice; stricter regulatory requirements and greater public concern at home; and the views of the MNCs’ more environmentally conscious shareholders. In addition, recent changes in the environmental behaviour of mining MNCs may have been as much responses to long-building economic (cost minimizing) pressure for materials and energy conservation as to these positive factors the environmental challenges alone. *’ However, are emerging influences and by no means apply to all MNC operations in the DCs. For example, even a relatively well managed mineral economy like PNG, which eschewed nationalization and bargained hard with the MNCs, failed to pursue adequate safeguards for mineral effluent disposal.” Or again, the Southern Peru Copper Corporation (a subsidiary of ASARCO) still prefers to pay a relatively small annual fee into the ‘black hole’ of the Peruvian treasury rather than invest a greater amount in water treatment and clean up. ‘% D Crozier, ‘Chile’s legacy - pollution’, Min& Journal, 24 August 1990. ‘%.M. Auty, ‘Materials intensity of GDP’, Resources Policy, Vol 11, 1985, pp 275283; M.S. Bernstam, The Wealth of Nations and the Environment, IEA Occasional Paper, No 85, IEA, London, 1990. “W. Pintz, ‘Environmental negotiations in the OK Tedi mine in PNG’, in C.S. Pearson, ed, Multinational Corporations, Environment and the Third World, Duke University Press, Durham, NC, 1987. 19P. Daniel and W.R. Brown, Environmental Issues in Mining and Petroleum Contracts, Mimeo, IDS, Sussex.

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Environmental

management prospects

Environmental regulations designed specifically for mining and mineral processing have until recently been uncommon in DCs, although most do have in place a basic standard for water quality and, less commonly, air quality. Progress may yet be delayed by a recent emphasis on the liberalization of the investment climate in order to attract foreign investment, particularly in Latin America, Ghana and South-east Asia.‘” Offsetting this, however, is the increasing environmental conditionality of private, bilateral and multinational credit in new mineral projects, which demands environmental impact assessments and best practice technology. At the other extreme, a few DCs have adopted

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“01)

cit. Ref 14.

Paredes and J.D. Sachs, eds, Peru’s Path to Recovery, Brookings Institution, Washington DC, 1991. “‘C:E.

“A.V.

Kneese,

Economics

and the En-

vironment, Penguin, London, 1977.

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extensive regulatory frameworks, sometimes based on US models which are too stringent to be enforceable (as in Chile). In Brazil, equipment should be operated according to the environmental norms in the country of technology origin. Most opposition to mining regulation comes from established firms faced with the costs of paying for past environmental damage. Some firms react defensively and seek to reach agreements with governments to postpone compliance. Others, however, have adopted innovative solutions under pressure, as in the case of Alcan’s Jamaican alumina refineries which developed a new technique for dry-stacking the red mud effluent. Yet a third reaction has come from firms which display considerable dynamism in coping with pollution restrictions. Exxon’s Los Bronces mine in Chile is one example: it developed a bacterial leaching technique in order to circumvent government fears concerning acid mine water pollution of rivers providing drinking water to Santiago. The method adopted for Los Bronces had the double advantage of extracting extra copper and avoiding government charges for water treatment. It underlines the superiority of gains from new projects over those from retrofitting, which often involves a higher investment with a poorer return. Overall, dynamic mining companies are not closing, reinvesting elsewhere or exporting pollution to DCs; rather they are adapting to environmental pressures by innovating or by improving their environmental practices abroad. Lobbying by mining firms in the industrialized countries for international standards is an important mechanism both for the transmission of improved practice worldwide and for the commercialization of their new technologies. This is an important reason why a high level of mining investment, which a soundly managed economy can attract, is the key to environmental improvement. Opinion is shifting away from ‘command and control’ regulation as a solution for environmental problems, in part towards market-driven solutions. In Peru, where a long tradition of environmental lobbying has established a complex web of environmental regulation, most cases of environmental pollution continue unresolved.*” This is likely to persist until improved economic management rectifies Dutch disease damage arising from both the 1985-89 Garcia populist boom and the high exchange rate policy of the next (Fujimori) government.*’ One regulatory problem in the DCs is the remoteness of many mining enterprises, especially the smaller ones in the high Andes and remote Amazonian rainforests. Regulation in DCs is of the command and control type and usually deals with the symptoms of pollution, once reported, and not the causes of environmental mismanagement from the outset. It rarely imposes fines commensurate with the costs of abatement or remedial treatment. Moreover, it also carries hidden costs by creating opportunities for corruption and rent seeking. Meanwhile, in the industrialized countries emphasis has moved away from a ‘pollutee suffers’ principle to one in which the ‘polluter pays’, whereby the polluter is charged for destructive use equal to the damage caused. This was the approach recently recommended at the Earth Summit in Rio (1992). Such market incentives allow greater scope for companies to choose how best to attain a given environmental standard. Intervention to correct market failure rather than to substitute government regulation for such failure may yield significantly more efficient solutions to environmental problems. ‘* Command and control regula-

25

Sustainable development in mineral exporting economies Technological

frontier

x

X X

X

x

x

Developing country technology-behind the frontier, with high environmental and low or high economic costs X

C’

Existing

technologies

X

on the

frontier

Some firms make incremental changes which lower environmental cost at the expense of production costs, moving down the curve

Figure 1. Environmental

and econo-

mic trade offs. Source: A. Warhurst, ‘Environmental management in mining and mineral processing in developing countries’, Natural Resources Forum, Vol 16, 1992, pp 39-48.

The dynamic are innovating pushing the technological frontier to new economic and environmental efficiencies

B3

jj\_ Production

costs

per

unit

of output

tion tends to foster costly retrofitted solutions to existing technology rather than the adoption of new technologies. The most common market-driven measures include pollution taxes, emission charges and deposit funded systems such as the posting of bonds up front for the rehabilitation of mines after closure, which is now standard practice in Canada and Malaysia. But the utility of such measures is still conditional on effective price signals in a well managed economy. The environmental

23A. Warhurst, ‘Environmental management in mining and mineral processing in developing countries’, Natural Resources Forum, Vol 16, 1992, pp 39-48.

26

trade off

Environmental regulation is most probably here to stay and bound to become widely adopted, more stringent and better enforced. Therefore, the winner in the division of shares in the metals market will not necessarily be whichever company avoids environmental control for a short-term cost advantage. The evaders of environmental management are likely to be forced to internalize the high cost of having done so at a later date. Instead, the gainers are more likely to be those companies that were ahead of the game, those that played a role in changing the industry’s production parameters, and those that used their innovative capabilities to their competitive advantage. Figure 1, drawn from Warhurst ,23 shows that for dynamic companies the traditional trade off between production costs per unit of output and environmental costs is disappearing - contrary to the widespread belief that such a trade off exists (which presupposes a static technology).

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Indeed, new technology is being developed which lowers both environmental and economic costs and pushes forward the frontier of leading technology. Figure 1 summarizes different patterns of firm behaviour towards the internalization of the mining sector’s environmental costs (traditionally imposed on the pollutee or absorbed by the state). DC firms appear in a generalized group behind the technological frontier (there are obviously exceptions to this general pattern), and their behaviour is associated with high environmental costs but wide ranging, generally lower, production costs (linked to their ore grade and the efficiency of their operations). The technological frontier in Figure 1 is a generalized band within which most mining companies operate, to a greater or lesser extent absorbing the environmental costs resulting from their activity. Those less dynamic firms with high sunk costs in existing facilities tend to experience environmental regulatory pressures as a cost burden. This pushes them down the curve (B’-B2-B3) as they respond incrementally to successive regulation with generally expensive add on controls (emission gas scrubbers, water treatment plants, dust precipitators and acid neutralizing plants). The more dynamic firms innovate by building into the new generation of technology lower costs of both production and pollution control. In the process they avoid having to undertake costly add on incremental technological change and clean up at later stages in their operation. Thus, they push forward the technological frontier (A’-A2). There are also cases where well planned incremental innovations reduce environmental costs at no extra cost to production (Cl-C’) or overall efficiency. But imposing too strict a regime too fast may lead a plant with high sunken costs in equipment to close down, in some situations without a legal need to accept liability for subsequent clean up and waste management programmes. Growing evidence suggests, however, that improving a mine’s environmental management may not be detrimental to economic performance, and in some cases may provide considerable economic benefit.24 New and flexible scale, low cost and less hazardous hydrometallurgical (leaching) alternatives to conventional smelting may be of added advantage to the DCs, improving the competitiveness of their mineral production. For example, processing right up to the final saleable metal product can be undertaken at the mine site - whereas in conventional process routes a smelter requires feed from at least 10 large mines and ore may have previously been exported to overseas smelters. But investment in such improvements is unlikely to occur unless macroeconomic management improves. Firms must be able to respond to effective market signals without fear that their viability will be eliminated by arbitrary taxation levels which bear no relation to profitability, or by massive shifts in the exchange rate. A key environmental challenge is therefore how to keep the industry sufficiently dynamic for it to be able to afford to invest in environmental management.

Conclusions Planned mines (and some planned expansions) in DCs will increasingly be implemented by the more dynamic MNCs, often in partnership with rejuvenated SOEs, rather than by inefficient SOEs. In many instances

240p tit, Ref 2.

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Sustainable development in mineral exporting economies

‘% F Mikesell, ‘Project evaluation and sustainable development’, paper presented to the Western Economic Association international meeting in Seattle, June 1991; FL Repetto, ‘Natural resource accounting for countries with natural resource-based economies’, Mimeo, UNDPAVorld Bank Workshor, on Environmental Accounting, World Bank, Washington DC, 1986.

these investments will be partly financed by credit which will be conditional on demonstrable good environmental practice, including environmental impact analysis. The new technology should benefit the DCs by allowing them to reduce the trade off between higher environmental costs and lower production costs. Improving on past performance can be facilitated through the design of country specific regulatory frameworks which deal with the potential causes of environmental mismanagement and not just with the symptoms (ie pollution). It would also help to include the social costs of mining in future project evaluation, 25 because this would raise the price of the mineral and slow extraction. To the extent that the levels of exports would be lowered, it would also reduce the Dutch disease risk. But an important prerequisite for achieving environmental efficiency is improved productive efficiency and that requires sound macroeconomic management. An economy experiencing rapid growth and sectoral diversification can expect to absorb environmentally sensitive technology faster. But rapid growth has proved difficult for mineral economies to sustain. The mineral sector differs from most other economic sectors. The existence of sizable mineral rents means that it is frequently the repository of a strong comparative advantage that generates large foreign exchange and tax revenues which dominate the entire economy. Such a resource is a double-edged weapon because its main economic contribution (taxes and foreign exchange) is volatile. DC policies have all too often exacerbated such volatility, intensifying the Dutch disease effects so that economic growth has been slow and mineral dependence has become excessive. The non-mining tradable sectors (agriculture and manufacturing) become uncompetitive as a result of Dutch disease. They require subsidies from the mining sector and respond inflexibly to exchange rate shifts, contrary to the assumptions of doctrinaire orthodoxy. In extremis, the transfer of resources from mining to the feeble non-mining tradables may persist during a mineral downswing. This decapitalizes the mining sector where low autonomy SOEs are dominant, as in Zambia, Bolivia and (to a lesser degree) Peru. All tradable sectors therefore become weak. Dutch disease slows economic growth, retards competitive diversification and perpetuates a risky dependence on mining. The resulting weak economic performance threatens economic, welfare and environmental goals alike. The sustainable development of a mineral economy therefore requires that the mineral sector should be seen not as the backbone of the economy but as a bonus with which to accelerate competitive diversification. In this way the emergence of competitive non-mining sectors, especially manufacturing, will be encouraged long before the theory of resource depletion dictates it. This reduces the risk of economic deterioration arising from abrupt revenue losses which many ore exporters experienced in the 1970s and 198Os, for example. Such abrupt losses might arise from excess global mining capacity or materials substitution. Not only is the damage from such events reduced by competitive diversification but, consistent with sustainability criteria, asset substitution is facilitated as the resource finally nears exhaustion. The macroeconomic policy needed to mute the potentially harmful effects of the mineral sector and thereby successfully harness it for sustainable development is one of pragmatic orthodoxy. Such a policy stresses adherence to fiscal prudence and current account equilibrium

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‘%.M. Auty, ‘Mismanaged mineral dependence: Zambia 1970-90’, Resources Policy, Vol 17, 1991, pp 17&183.

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but, unlike doctrinaire orthodoxy, sanctions state intervention to mute the damage done by mineral booms and downswings. It smooths sectoral adjustment to shifts in foreign exchange earnings and taxation through a mineral stabilization fund. Other interventions may also be justified to stimulate technological innovation, improve environmental management, train engineers and managers and implement a competitiveness enhancing industrial policy (where past errors have spawned an immature manufacturing sector). Technology transfer clauses and training schemes within the newly emerging joint ventures governing the terms of the current new round of mineral investment projects may be one vehicle for achieving such aims. Yet among the ore exporters, Bolivia and Jamaica shun such an industrial policy, Peru and PNG still tolerate exchange rate overvaluation, while Zambia remains torn between too little and too much orthodoxy.26 Many governments in mineral economies have still to fully digest and apply the harsh lessons of the 1970s and 1980s. The rise of the environmental imperative may force them to confront such potential problems earlier rather than later.

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