Resource trade: Policy and policy reform

Michele Ruta, Anthony Venables, 21 April 2012

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Resource trade is once again in the spotlight. Oil prices are up 14% since the beginning of the year, creating new concerns for the recovery of the global economy (Annunziata 2012). In March, the governments of Japan, the EU and the US filed a new dispute at the WTO with respect to China's restrictions on the exports of rare earths (WTO 2012). This week, tensions spurred over the decision of the Argentinian government to renationalize the oil company YPF, ousting the Spanish group Repsol (Financial Times 2012).

Controversies over natural resources have deep roots in international trade rules (Ruta and Venables 2012).

  • Policy is used to manipulate trade flows and the price of resources, yet this policy is largely outside the disciplines of the WTO.
  • The problem is exacerbated by market failure in long-run contracts for exploration and development of natural resources.

Policymakers could improve this situation; properly coordinated policy reforms offer an avenue to resource-exporting and -importing countries to overcome inefficiencies and obtain mutual gains.

Resources trade and trade rules

Around one fifth of global merchandise trade is in natural resources; fuels, of which two thirds of output is traded across international borders, are the largest element. Trade in natural resources has several features that make it distinctive and which bear on policy in the sector (Collier and Venables 2010, WTO 2010).

  • Uneven geographical distribution of resources means that some countries are dominated by resource production, while others have none. Twenty-one countries have more than 80% of their exports in natural resources, and for nine of these countries resource exports are more than 50% of GDP.
  • Many resource importers have no local supply, yet resources are an essential input to their economies.
  • Resource supplies are immobile, so incentives to use policy to relocate production are largely absent.
  • Exhaustible resources may carry large rents, and the division of these rents between producers and consumers is contentious.
  • Often projects are financed by foreign investors whose investments are sunk, and who enter complex contractual and fiscal agreements with host governments.

All these factors create incentives for trade policy, yet the most widely used policy instruments are outside the disciplines of the WTO. First, resource producers use export policy (taxes and quantitative restrictions) which are not subject to WTO rules. Thus, while import tariffs cannot be set at a rate higher than the ‘bound’ rate agreed in countries’ schedules of commitments, exports face no such binding, except for some new members that accepted them as part of their accession protocol (eg China). Second, the uneven geographical distribution of resource deposits means that many countries export a very high proportion of their output or, on the other side, import a very high proportion of their consumption. In this case domestic tax policy – for which WTO rules only require ‘non-discrimination’ – is equivalent to trade policy. Third, contractual and fiscal regimes under which long-run investment projects in resource sectors operate are generally embedded in bilateral arrangements that developed outside multilateral rules.

Policy inefficiencies

More than one third of notified export restrictions are in resource sectors, according to the WTO's Trade Policy Reviews. For instance, export taxes on natural resources appear twice as likely as export taxes in other sectors.

What motivates governments to use such policies?

  • First, exporting governments use trade taxes to manipulate domestic prices as a means to obtain government revenue, to transfer resources to households, or to subsidise the domestic processing industry.
  • Second, for a large-enough producer – or producer cartel – export taxes or equivalent quantity restrictions may increase the world price of the good and thereby redistribute rent towards the producer country.

On the import side, tariffs on natural resources are generally extremely low. In developed countries, tariffs range from 2.2% on fisheries to 0.5% on fuels. However, it does not follow from this that importers are policy inactive. Just as resource exporters may seek to attract downstream activities by using resource export taxes, so resource importers may attract these activities by offering higher protection for processed resources than for raw ones (tariff escalation). Moreover, for an importing country with no domestic production of a resource, an import tariff is identical to a domestic tax. This means that trade policy objectives can be met without recourse to import tariffs, and consequently without falling under WTO disciplines.

The use of these instruments results is an inefficient policy equilibrium. Trade measures (an export tax or tariff escalation) and domestic measures (a production quota in the exporting economy or consumption tax in the importing country) have a negative impact on the welfare of trading partners. This may trigger a response in kind and leads to an equilibrium where trade in both the resource and the processed good is inefficiently low (eg an export tax can be a countermeasure to an escalating tariff structure; higher domestic taxes can be a response to a production quota).

Evidence of this prisoners’ dilemma–like inefficiency is only indirect but suggestive. For instance, cross-country variation in consumers’ marginal valuations of gasoline vary from over $2 per litre in much of Europe, and $0.95 in the US, extending to even bigger differences once oil  producers are included. These international price variations dwarf those for other traded goods. Calculations suggest that the dispersion in fuel prices generates a deadweight loss which could amount to more than 20% of the value of consumption.

Beyond trade in the resource itself, there is a further international dimension. Extraction of natural resources takes place under long-term contracts between government and the private sector, often foreign firms. This is a form of FDI, although one involving a complex relationship between the investor and the state, and one which often leads to inefficient outcomes. One inefficiency surrounds the risk of hold-up (post-investment changes in fiscal terms) and consequent deterrent to undertake exploration and development. Another surrounds the allocation of licences to explore and to produce (discrimination and corruption).

Policy reform

Policies that aim at international rent-shifting or attracting downstream production have a beggar-thy-neighbour effect and induce reactions by trading partners (Latina et al 2011). The fundamental GATT/WTO principle of reciprocity that governs policy towards imports is largely absent for export policy and domestic measures, and suggests the need for reforms that bring salient aspects of these measures under WTO disciplines.

The hold-up problem is mitigated if countries have access to a commitment technology which would prevent post-investment contract changes. Internationalisation of contract enforcement is occurring through approaches including Bilateral Investment Treaties and the use of foreign courts and arbitration arrangements. While these arrangements have advantages (investors can obtain compensation for damages suffered) they face shortcomings, particularly as there can be large differences in bargaining power. These problems could be addressed by extending the role of the WTO in the enforcement of resource-extraction agreements, thereby giving governments a way of committing themselves to fiscal and contractual terms.

Efficient allocation of exploration and production rights requires a process analogous to the non-discrimination principle of the WTO. Because there is no market, secret and bilateral resource deals do not constitute a breach of the letter of non-discrimination, although they certainly breach its spirit; through such deals a government can offer privileged terms to a particular extraction company. The analogue of the non-discrimination principle would be a rule requiring an open process for allocating resource-extraction rights, such as provided in auctions. Essentially, this is not dissimilar from commitments made by a number of WTO members in the Agreement on Government Procurement.

Countering corruption in international contracts faces an acute weakest-link problem. As long as some companies are in jurisdictions where bribery is permitted these companies will tend to win the contracts. Knowing this, individual governments will be reluctant to act in isolation. This corruption problem is widely recognised and has been addressed by a variety of ad hoc international initiatives such as the Extractive Industries Transparency Initiative. These initiatives could be subsumed and made more effective by bringing corruption in resource-extraction contracts under the remit of the WTO.

Author's Note: The opinions expressed should be attributed to the authors only. They are not meant to represent the positions or opinions of the WTO and its Members and are without prejudice to Members' rights and obligations under the WTO.

References

Annunziata M (2012), “Shock 'n' oil”, VoxEU.org, 18 March.

Collier, P and AJ Venables (2010), “International rules for trade in natural resources”, Journal of Globalisation and Development vol 1, issue 1.

Financial Times (2012), “Argentina to renationalize oil group YPF”, 17 April.

Latina, J, R Piermartini, M Ruta (2011), “Natural resources and non-cooperative trade policy”, International Economic Policy 8:177–96.

Ruta, M and AJ Venables (2012), “International trade in natural resources: practice and policy”, CEPR Discussion Paper 8903; forthcoming in Annual Review of Resource Economics.

World Trade Organisation (2010), World Trade Report 2010: Trade in Natural Resources. Geneva: WTO.

World Trade Organization (2012), China — Measures Related to the Exportation of Rare Earths, Tungsten and Molybdenum. DS 431, 432, 433.

Topics: Energy, International trade
Tags: natural resources, oil, WTO

Senior Economist, Strategy and Policy Review Department, IMF

BP Professor of Economics, University of Oxford and CEPR Research Fellow

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