Global lessons on local content requirements for Guyana’s coming oil and gas extraction industry

Introduction

Last week’s column had indicated that, starting today, I would seek to draw lessons arising from global experiences with national local content requirement (LCR) regimes, which are aimed at maximizing economic benefits derived from the creation of export-oriented oil and gas extraction industries, based on significant domestic resource finds. I shall further indicate these experiences are very varied and derived from a wide range of both developed and developing economies. Of significance also, these experiences have been growing at a significant rate since the early 2000s.

The Organization for Economic Cooperation and Development (OECD) in a recent Trade Policy Note has revealed that, commencing with the financial crisis of 2008 and up to February last year (2016), as many as 140 LCRs regimes have been put in place worldwide. This observation was made as an expression of deep concern.

And, the reason for concern is that orthodox economic theorizing (and established inter-governmental bodies like the OECD) hold the strong view available empirical economic evidence establishes clearly that, “long-standing and predominantly negative evidence of the detrimental effects LCRs have had on those countries that have put these regimes in place”.

Readers of this column should not be surprised at this concern regarding the negative role LCRs are supposedly playing, in trade policy.

The claim is that governments of all stripes erroneously view LCRs as efforts to improve domestic employment and industrial performance while empirical economic studies reveal consistently that, over the long-run, LCRs 1) promote inefficient resource allocation; 2) generate increased costs both for the sectors benefiting from LCRs as well as other economic sectors; 3) result in trade reduction/diversion (both exports and imports); 4) inhibit growth; and 5) stifle productivity, technology and innovation.

I point this out at some length here, just to alert readers to the fact that, despite the strong intuitive appeal of local content policy, and the slogan “producing in Guyana all that Guyana can produce”, the case for LCRs still has to be reasoned. It cannot be assumed and taken for granted. My discussion on this is intended to provide the reasoned case for LCRs in Guyana. I should advise, however, that the previous discussions on the notions of the enclave economy and infant industries do form an essential part of the economic rationale.

Lessons

Going directly to the heart of the matter, the first lesson I would draw for readers’ benefit in framing Guyana’s LCRs regime, is the need for a clear and precise conceptual definition of the LCRs that are intended to be implemented. Here I believe the best operational economic definition available is the one offered by Sacha Silva in a 2013 Consultant Report to the United Nations Conference on Trade and Development (UNCTAD). There it aptly states: “the aim of LCRs is to create rent-based investment and import-substituting incentives”.

This definition captures the overtones of Hossein Mahdavy’s notion of the “rentier economy”, which was introduced back in 1970.

This concept refers to circumstances typical of Guyana-type economies, where after the establishment of oil and gas extraction industries, they became substantially reliant on external rents received for the use of its oil and gas resources, rather than on a strong domestic productive structure.

The chief advantage of this definition is that it establishes the need for a framework that requires specific laws and regulations, which unambiguously commit foreign capital (investors and companies) to minimum thresholds of goods and services that must be purchased or procured locally.

As we shall note, going forward, experience also indicates that such thresholds should be expressed quantitatively (for example, through precisely stated percentages/ratios) and not qualitatively (for example, using imprecise terms like ‘substantially’ or ‘as far as feasible’).

From the perspective of international trade this approach reveals the requirements for import quotas on specific goods and services.

And, the reason for this is, market demand is created by legislative and administrative action, allowing for domestic value added substitution of imported inputs.

Readers should note as well that, as an economic strategy, this approach stands in contrast to earlier traditional efforts to industrialize poor countries. Those had sought to develop protected industrialized export platforms in poor open countries, with all the risks attached to such an approach. Instead, the approach suggested by the definition above seeks to attract direct investment at reduced risk through the provision of domestic market protection.

A second lesson is that the approach identified here suggests is that effective LCR regimes should combine both stick and carrot approaches.

The stick-approach generally refers to items that fall under the rubric of performance requirements. These include technology transfer requirements, employment targets, domestic input stipulations, training requirements, Research Development and Information (RDI) stipulations, domestic equity/ownership requirements, and much more.

These are imposed on investors/companies with respect to their operations in the country.

As we shall note later some of these measures are not permitted at various intergovernmental forums; and, specifically, the Trade Related Investment Measures (TRIMS), under the World Trade Organization (WTO) Agreement.

The carrot approach refers to items that fall under the rubric of investment incentives.

These are generally designed to offset costs of doing business for those that choose to operate under a LCRs regime. These incentives cover a wide range of items, including direct transfers such as grants for RDI and pioneer status for new investment to indirect transfers such as low cost (cheap) provision of government services.

There are few available economic estimates of the size of these subsidies. However, the UNCTAD study cited above has estimated this at being valued for about US$300 billion globally, in the early 2000s.

Conclusion

Next week I shall continue with the identification of useful lessons Guyana can learn from worldwide experiences with LCRs in general and in the oil and gas sector, specifically.