Economic crisis and commodity downswings: Can local content policies provide a transformative solution for Africa?

The current commodity slowdown has once again laid to bare the structural weaknesses of a number of African resource-rich economies. But can this misfortune be turned around, and this time permanently if countries adapt their strategy by leveraging their resources to create more economic linkages? This article suggests that local content can be an efficient policy tool to make the difference. By Isabelle Ramdoo

Since the turn of the century, as a result of the accelerated growth paths in a number of large developing economies such as China and Brazil, notably through massive infrastructure and construction, the demand – and price – for raw materials and energy have soared spectacularly. Most resource-rich African economies were seen as net beneficiaries of this boom, witnessing unprecedented growth rates, even during crunch times of the financial crisis. This brought about a whole narrative about Africa Rising.

However, recent years have proved that nothing grows forever, and emerging economies, with a lot to catch up, were no exception. Some commodity-exporters, like Brazil or Russia, landed abruptly as prices deflated; others have taken a more cautious path, by seemingly re-calibrating their economic structures from an investment-driven growth towards domestic consumption to ensure sustainability, mainly to reduce over-dependence on the global market. This is the case of China these days, although some argue that China’s economic structure is yet to change. Whatever the reason, what is clear is that China has been driving global growth and any major policies in China are likely to have deep knock-on effects on almost every other commodity-producing country.

As emerging economies wobbled, commodity prices were the first to be hard hit. The price of metals has taken a deep dive, once again exposing the vulnerable fiscal situations of a number of African economies, making it difficult to pursue any meaningful reforms aimed at maximising revenue from resource rents and taxes.

The commodity boom however did not translate into industrial gains in Africa. On the contrary, as highlighted by the United Nations Economic Commission for Africa’s Economic Report on Africa in 2013, the continent witnessed a reversal of industrialization. The share of manufacturing in aggregate output contracted from 12 to 11 percent in the last two decades, underscoring the case for structural transformation and the failure of current revenue-first model that was used by most countries.

While the revenue from resources has declined sharply, the pressure from the population to derive more benefits from resource endowments, both on countries and on companies, has not weakened. On the contrary, more than ever, governments are compelled to find sustainable solutions to ‘disenclave’ their resource sectors and to reduce, once for all, the over-reliance on mineral resources. It has become clear that, while getting a fair fiscal share from resource rents is important, fostering broader economic diversification is even more important, as it creates jobs and economic spillovers, well beyond the mining sector.

As such, many governments have scaled up reforms to develop and deepen economic linkages between the extractives sector and the rest of the economy. To attain this objective, most governments are focusing significant effort on strengthening ‘local content’ requirements, i.e., the use of domestic factors of production, such as labour, capital, supplies of goods and services, in order to create value in the domestic economy.

Local content policies (LCPs) are quite controversial in conventional economic circles. Some view it as disguised protectionist policies, similar to import substitution policies which were implemented in the 1960s in Latin America, but which did not leave a very positive track record in a number of countries. But, research has shown that it is crucial to go beyond the ‘extractivist’ approach to the mining sector, and instead leverage mineral resources to boost industrialisation, notably through the development of upstream, downstream and sidestream linkages.

Implemented in a smart way and in partnership with mining companies, LCPs are thus a powerful tool to stimulate the creation of upstream linkages by capitalising on companies’ own procurement needs as well as labour requirements. Similarly, using LCPs to foster downstream linkages are critical to develop industrial activities: the case of cement in Nigeria is a case in point.

It is estimated that 90 percent of resource-rich countries apply one form of local content policy or another and that 40 and 80 percent of the revenue created in extractive sector (oil, gas, mining) is spent on the procurement of goods and services. In Ghana for instance, it is reported that 80 percent of procurement expenditure stays in the country. Although the definition of ‘local’ and ‘content’ is not universally agreed, the scope of procuring domestically nonetheless represents a unique opportunity to supply the extractive sector.

Moreover, in times of crises, companies are under pressure from their shareholders to cut costs. Industry has so far viewed LCPs as a compliance issue. As a consequence, only a few companies have integrated local content requirements into their core strategic business operations. A different approach to LCPs, notably by supporting local businesses that have the capacity to deliver can become a game-changer to extract business opportunities of mutual benefit.

Of course for all this to work, conditions are necessary and governments need to guarantee them. First, some pre-requisites must be in place to enable the private sector to thrive: these include a conducive business climate; availability of skills and talents; and cost-effective infrastructure and logistics, amongst others. Second, it is important to understand the potential risks and opportunities associated with LCPs in order to mitigate or minimise potential costs. Policy-makers must ensure they do not breed inefficiencies in the supply chain and that the country has sufficient capacity at home to be able to deliver on quality, without inflating costs. On the other hand, they must have an in-depth and detailed knowledge of the resources supply chain in order to evaluate the opportunities for businesses and the potential for employment creation.

The overall economic and political costs of having ‘no policies’ should be carefully weighed against the costs of having such measures in place, for both firms and consumers. Third, stakeholders should have a profound understanding of the political economy of the habitat of their extractives sector. Fourth, a certain level of institutional readiness in resource-rich countries is necessary and countries’ capacities to deliver on LCP promises are critical to prevent unrealistic or ill-targeted LCPs, which may be cost-inflationary and hence compromise the viability of the extractive sector. Finally, LCPs need to be targeted and specific enough to be successful and they must be flexible enough to be able to adjust to domestic supply to avoid harming industries’ competitiveness.

Beyond local initiatives, at the continental level, the African Union has given a political impetus for a better governance and economic utilisation of mineral endowments. The Africa Mining Vision, endorsed by African Heads of State in 2009, “is a pathway that puts the continent’s long term and broad development objectives at the heart of all policy making concerned with mineral extraction”. To implement the Vision, the African Minerals Development Centre was set up in 2011 to support and provide implementation compasses to countries and regions, notably with the domestication of the AMV at countries level. On the linkages front, the Country Mining Vision is expected to complement national efforts to stimulate linkages and economic diversification, including through an interactive and iterative engagement process within, and across countries on the continent.

Success stories in countries like Chile, Brazil, Malaysia or Canada show that LCPs work in practice. Often times, the key to transformation lies in the consistency in which countries implement, monitor and constantly evaluate their policy tools. Trusted partnerships with companies (mining and procurement alike) are likely to lead to LCPs that are realistic, workable and efficient.