Part II: The Full Economic Costs And Benefits Of Transparency In Extractive Industries

February 17th, 2012

This post is the second part of a two-post series. The first post, on the economic costs of Section 1504, is available here.

Embedded into the Dodd-Frank Wall Street Reform and Consumer Protection Act–also known as the “financial overhaul bill”—was Section 1504, which will require companies listed on the U.S. stock exchange to disclose payments to governments for oil, gas, and mining. The American Petroleum Industry (API), a U.S. trade association for the oil and gas industry, is pushing back against this provision. In a letter to the SEC, API claims Section 1504 defies Executive Order 13563, which Obama signed in 2011, to require federal agencies to “engage in a cost-benefit analysis…of proposed and existing regulations.” API argues the SEC has failed to conduct that compulsory cost-benefit analysis. They’re even threatening to sue.

This post establishes a theoretical framework for that cost-benefit analysis. In my first post, I addressed the costs of Section 1504. Below are the benefits.

Benefits of Section 1504

Economic and political benefit to impoverished residents of foreign countries.[1] At its core, the intent of Section 1504 of the Dodd-Frank Act is to reverse the “resource curse” in developing countries. The resource curse is the tragic phenomenon that countries well-endowed with natural resources tend to have slower economic growth than their counterparts without. This theory has been demonstrated in strong quantitative terms. According to an analysis of developing countries by Jeffrey Sachs and Andrew Warner, the more an economy relies on mineral wealth, the lower its growth rate. Countries with significant natural resource endowments also tend to have an increased likelihood of experiencing war and violence and a decreased likelihood of having a democratic system of governance.[2]

How do we appropriately value the benefit to residents of mineral-rich developing countries whose economic and political opportunities are lost to corruption? Secondly, how would we value the potential economic and political impact of the Act on those residents? These questions are nearly unanswerable in quantitative terms. But in the answer lies the heart of this discussion.

At this point, anecdotes are the most useful. The World Resource Institute (WRI) examined the potential effect of Section 1504 on Uganda, which in 2006 discovered a potentially large quantity of commercially-viable oil. WRI found it would represent “important step” in ensuring “sound revenue management in Uganda, promoting effective reinvestments and fighting the corruption that contributes to the disjuncture between resource wealth and poverty reduction.” Of course, Section 1504 is not a silver bullet. On its own, it will not eradicate corruption from resource-rich countries and eliminate the resource curse. But as Firger (2012) notes, transparency in extraction industries, alongside financial and political support “can do some good in countering corruption and, ultimately lifting the resource cures once and for all.”

Benefit of positive influence on other nations’ laws and regulations concerning transparency. Researchers at Colombia Law School have pointed to the law’s potentially positive impact on the national regulations of other countries. For example, after theUnited States’ passed the “conflict minerals” bill (also part of Dodd-Frank Act) the government of Rwanda released a plan to cooperate with the ITRI Tin Supply Chain Initiative (iTSCi), a global tin authority, to ensure its tin is not from conflict zones. Likewise, Publish What You Pay (PWYP) is now heavily engaged with the UK and the EU to pass similar laws, under the argument that the European governments don’t want to “fall behind” in their best practice measures. These policies could create a virtuous cycle which would further contribute to the first benefit, on poverty reduction.

Benefit to Americans who care about poverty alleviation. Should the Act deliver benefits to those in the developing world through increased transparency, as described above, benefits would also accrue to Americans and other foreign nationals who value a reductions in poverty and corruption. A useful concept for thinking about this benefit is “existence value,” which occurs when people value the knowledge something is in better condition, though they do not directly benefit from it.  For example, a resident of Canada might value preservation of Brazilian rain forests, even though the Canadian has no intention of ever visiting the rainforest and does not believe the forests directly enrich his life.  We can also apply this concept to development economics.  For example, a resident of Germany might value a reduction of malaria amongst children inMali, though the German never plans to visit Mali and no one he knows will benefit from the immunizations.

It is difficult to measure non-use values, but from anecdotal evidence, we see American consumers show a significant propensity to pay additional premiums for reduced poverty in developing countries. Many Americans are consistently willing to pay more for products whose proceeds benefit development; think, for example, of Product(RED) or Ethos water.[3]  One recent study showed the average consumer is willing to pay 11% more for fair-trade label coffee. And the American government’s expenditures of billions of dollars on development aid indicate a high of willingness-to-pay for economic development worldwide.

Distributional Effects

Distributional effects lie outside the simple computation between costs and benefits. They are dependent on our values. In Executive Order 13563, President Obama has declared that cost-benefit analyses should consider “equity, human dignity, fairness, and distributive impacts.” The Executive Order itself recognizes that these values are often “difficult or impossible to quantify.” From an economics’ perspective there are no accepted principles for determining when one distribution of net benefits is more equitable than another.[4] According to the official guidelines of the Office of Management and Budget, when conducting cost-benefit analysis, researchers should “describe distributional effects without judging their fairness.”

So here’s my description. The distributional effects of Section 1504 would be significant. The costs of the Act lie disproportionately on the shoulders of oil and gas companies and corrupt government officials. The benefits, on the other hand, would accrue to the poverty-stricken citizens of corrupt and resource-rich developing countries, through economic and political gains. They would lessen corruption, improve rule of law, and reduce poverty, for some of the world’s poorest people, who had the bad luck of being born in a country with oil or diamonds underground. At the end of the day, that is the choice we are making. Only our values, not economics, can tell us which path to choose.

[1] When conducting benefit-cost analysis, the analyst must define the relevant beneficiaries. My conclusions rest on the assumption that foreign nationals are relevant beneficiaries toU.S. legislation and that we should consider the well-being of those residents of developing countries when considering the full range of costs and benefits of this Act.

I rest this assumption on several facts. First, most federal guidelines, including Circular A-94, the Office of Management and Budget, and the EPA guidelines on cost-benefit analysis, do not specifically exclude foreign nationals from the scope of relevant beneficiaries, but rather require analysts to consistently define the relevant beneficiaries. Second, other federal agencies explicitly include foreign nationals as potential beneficiaries. For example, the U.S. Army Corps of Engineers defines general public as “anyone, bothU.S.and foreign, who might realize a financial benefit from the project.”

[2] Transparency has emerged as the leading tactic among development-advocates to deal with resource-rich nations. As Firger (2010) notes this solution has emerged as “institutional failures and governance challenges confronting such states have proven resistant to traditional development strategies.”

[3] To date, sales from (RED) products have generated $166 million for the Global Fund and Ethos Water has raised over $6 million to support water programs in water-stressed countries.

[4] See, for example, Office of Management and Budget’s Guidelines to Standardize Measures of Costs and Benefits and the Format of Accounting Statements.

Written by Ann Hollingshead

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