Why the Repeal of the U.S. Publish-What-You-Pay Rule Is a Major Setback for Combating Corruption in the Extractive Sector

Bonnie J. Palifka, Assistant Professor of Economics at Mexico’s Tecnológico de Monterrey (ITESM) contributes today’s guest post:

Last Friday, following the U.S. House of Representatives, the Senate voted to repeal a Securities and Exchange Commission (SEC) regulation that required oil, gas, and minerals companies to make public (on interactive websites) their payments to foreign governments, including taxes, royalties, and “other” payments. The rule was mandated by Section 1504 of the 2010 Dodd-Frank Act, but had only been finalized last year. President Trump’s expected signature of the congressional resolution repealing the rule will represent a major blow to anticorruption efforts, and a demonstration of just how little corruption matters to his administration and to Congressional Republicans.

The extractive industry had lobbied against this rule, arguing that having to report such payments is costly to firms and puts them at an international disadvantage. Some commentators have supported their efforts, arguing, for example, that the Section 1504 rules are unnecessary because the Foreign Corrupt Practices Act (FCPA) already prohibits firms under SEC jurisdiction—including extractive industry firms—from paying bribes abroad. This argument misses the mark: The extractive sector poses especially acute and distinctive corruption risks, which the FCPA alone is unlikely to remedy if not accompanied by greater transparency. Continue reading

Community Development Agreements: A New Anticorruption Tool?

Projects in the extractive industries are often enormous, long-lasting, multi-billion dollar affairs. Given the disruption, potential for environmental disaster, and permanent changes in the state of the land, these projects tend to generate conflict and controversy, especially in low-income countries, where citizens may enjoy fewer legal protections. As a way to mitigate these risks, some nations require extractive firms to enter into “Community Development Agreements” (CDAs) with local communities. (CDAs—which are also sometimes known as Benefit Sharing Agreements, Impact Benefit Agreements, or Community Joint Ventures—are sometimes voluntary corporate social responsibility initiatives, but my focus here is on CDAs that are required by, and incorporated into, national regulatory frameworks.) At the most general level, CDAs are created through a process that engages local populations in important decision-making about the project and its profits. The process varies, but usually includes the following steps:

  • Identify the people who will be affected
  • Allow those identified to determine what the community could gain from the project (whether that be jobs, money, education, infrastructure, long-term benefits, etc.)
  • Write a CDA that encompasses the demands of the community and aligns with regulatory requirements
  • Provide monitoring tools to the affected population
  • Set up dispute resolution systems
  • Strategize for how to prepare the population for the end of the project’s lifespan.

This process takes time and can be expensive. But extractive projects typically last for decades, and so building a sustainable relationship with the local population is vital to the project’s success. After all, many corporations fund similar stakeholder engagement processes without being required by law to do so. That is because CDAs can be a good business decision: empowering the community allows the company to avoid violent conflict and signaling that the firm is a good corporate citizen.

For those countries that do require a CDA for extractive projects, the law also regulates the substantive terms, requiring CDA contracts to contain certain clauses–typically monitoring components, dispute resolution mechanisms, and local spending or employment quotas. However, one thing that is never included in a CDA is an anticorruption clause. The words “bribery” or “corruption” appear nowhere in the World Bank’s model CDA agreement, and the Columbia Center on Sustainable Investment (CCSI) is silent on the issue. Building on recent work by Abiola Makinwa and James Gathii, I posit that CDAs should include anticorruption clauses, to empower private citizens in fighting corruption in public contracts. The basic idea is to allow the recognized community members—those covered by the CDAs—as “third party beneficiaries” to the contract between the government and the extractive company. The community members would then be entitled to sue if there was corruption in the making or execution of the contract.
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Is the Resource Curse a Myth?

Perhaps one of the most surprising and influential findings in development economics research is the so-called “resource curse”: the idea that a large natural resource endowment (and, consequently, a significant role for natural resource exports in the national economy) actually leads to slower economic growth, and lower per capita incomes (at least in the long term). The resource thesis has the appealing feature that although it’s initially counter-intuitive (and so people like me can seem and feel clever when we point it out), one can immediately think of many salient examples that seem to corroborate the idea, and it’s fairly easy to construct plausible stories as to why it would be true. Although such stories originally focused on exchange rate appreciation (so-called “Dutch Disease”), contemporary research (see, e.g., here and here) tends to focus more on the impact of natural resource abundance on institutional quality, governance, and corruption. The hypothesized causal chain (at least one version) runs roughly as follows: Natural resource wealth creates opportunities for massive economic rents for those who control the government; the competition for these resources fosters corruption, and makes currying favor with the government more important than entrepreneurship or productive investment. Furthermore, and perhaps even more importantly, natural resource wealth enables corrupt or otherwise inefficient governments can use their control over resource rents to secure their power, alleviating pressure that these governments might otherwise feel to reform their institutions and govern more fairly and effectively. And indeed, many studies (see here and here) show a strong negative correlation between natural resource wealth (especially oil wealth) and various measures of institutional quality (including accountability, checks & balances, and control of corruption). The bad institutional environment that natural resource wealth fosters, the argument continues, has adverse effects on long-run economic performance that outweigh the boost to economic performance associated with natural resource wealth. This, the causal chain runs from resource wealth to bad institutions to poor(er) economic performance; absence of resource wealth tends to generate incentives for institutional improvements that ultimately lead to better performance.

The resource curse thesis grows mainly out of quantitative cross country research that finds a negative correlation between resource wealth and GDP growth (controlling for a range of factors). Some more recent research has refined or qualified the thesis in important ways. For example, (see here and here) suggests that the “curse” is only associated with particular sorts of resources, particularly “point source” resources (such as oil or certain minerals). Other research (see here and here) has suggested that countries that already have relatively good institutions prior to the discovery of resource wealth seem immune from the curse. Still, even with these qualifications, the core idea remains: If a relatively poor country, with less robust governance institutions, discovers oil, its economic prospects over the longer term are actually worse—largely because of the relationship between resource wealth and corruption.

But what if that’s all wrong? What if there is no “resource curse”? What if resource wealth—even from point source resources, even in countries with lower levels of transparency and accountability—is, on average, associated with higher rather than lower economic growth? And what if natural resource wealth actually has no consistent discernable impact on institutional quality? For many years I’d been entirely convinced of the resource curse thesis (at least in qualified form). But I recently read an excellent 2009 paper by the economists Michael Alexeev and Robert Conrad which has forced me to reconsider. I’m still not sure exactly what I think, and I hope to spend the next few months delving more into this research (so I may eventually do a follow-up post), but I thought it would be worth discussing the essence of Alexeev & Conrad’s critique and reassessment of the resource curse thesis. Continue reading

Update from Mexico: PEMEX Reform, Private Investment, and the Government’s Anti-Corruption Gamble

Two days before the Mexican government unveiled draft regulations for its ambitious opening of the state-run energy sector to private participation late last month, Oscar-winning director Alfonso Cuarón published a letter posing ten questions to Mexican President Enrique Peña Nieto.  “The reform will result in multimillion-dollar contracts” for private companies, wrote Cuarón. “In a country such as ours with a weak (and often nonexistent) rule of law, how can large-scale corruption be avoided?”  To the surprise of some, the President’s office issued a point-by-point response just a week later, naming a spectrum of anti-corruption measures adopted in the new regulations such as public bidding and agreements, disclosure of contractor expenses, a commissioner code of ethics, and institutional and procedural checks and balances unified under the oversight of the Secretary of Energy.  (Full text in Spanish here.)

The project to reform Mexico’s energy sector – particularly the state oil company PEMEX, which generates one-third of all government revenue and is bestowed of both a powerful workers union and tremendous symbolic importance in Mexican history – was always going to be controversial.  President Peña Nieto’s success in getting the law passed in December 2013 has been his signature achievement, lauded by the Washington Post as turning Mexico into “the Latin oil producer to watch — and a model of how democracy can serve a developing country.”

But both critics and many supporters of the reform recognize that corruption is an elephant in the room. Continue reading