Why Are Extractive Industries Prone to Corruption? (Part III)

September 26th, 2013

This blog post is the third post in a series on the connection between extractive industries and corruption in developing countries. You can read part one here and part two here.

In a blog post two weeks ago, I discussed the relationship between extractive industries and corruption, noting that while they are related, the presence of extractive industries alone does not inherently lead to their political exploitation. Rather, it is the effect that these industries have on other economic and political conditions that can drive corruption. Last week, I introduced a few alternative hypotheses that explain the connection between extractive industries and corruption. I used a framework to explicitly point out the causal links between extractive industries and governance. This week, I’ll discuss some of the proposed solutions to the resource curse, again in the context of this model.

In each of these posts I’ve started with a framework adapted from a model presented by Tsegaye Lemma, a policy analyst with the United Nation Development Program’s Bureau for Development Policy. Lemma defines corruption as a function of monopoly, discretion, accountability, integrity, and transparency. Specifically:

Corruption = (Monopoly + Discretion) – (Accountability + Integrity + Transparency)

Last week I noted that extractive industries can increase the government’s discretion, create monopolies, reduce integrity and accountability. Missing from this discussion, however, was the issue of transparency. As it would turn out, many of the solutions to this problem lie in that variable.

As Lemma’s model implies, increasing transparency in governance and finance can reduce corruption. Yet I would also argue that the relationship doesn’t stop there. Transparency also affects accountability and integrity such that it reduces corruption both directly and indirectly.

To that end, here are three things developed and developing countries can do to increase transparency and reduce the risk of corruption from extractive industries.

Join the Extractive Industries Transparency Initiative. Extractive Industries Transparency Initiative (EITI) is a voluntary framework under which governments publicly disclose their revenues from oil, gas, and mining assets. Likewise companies make parallel disclosures regarding payments they are making to obtain access to these resources. This data provides an important point of comparison and fosters integrity and accountability.

Support a Global System of Country-by-Country Reporting. Beyond the EITI, multinationals in all industries should publicly report revenues, profits, losses, taxes paid, and number of employees in each country where they operate. Countries looking for more immediate and concrete progress should look to the Organization for Economic Cooperation and Development for a common template for country-by-country reporting to tax authorities.

Develop a Systematic Regulatory Framework that Fosters Transparency in Revenue and Contracts. Secret contracts between governments and private companies in extractive industries are prevalent, but damaging to the extent that the allow government officials to corrupt business deals. Contracts that are publicly available incentivize government officials to negotiate better deals that are free of corrupt influences. Countries with natural resource wealth can avoid these pitfalls by creating systematic frameworks that incorporate contract transparency into law and practice.

Here are two things developed and developing countries can do to increase government accountability and integrity and reduce the risk of corruption from extractive industries.

Create a mechanism for benefit-sharing between the national government and local governments. In some countries, extractive industries provide benefits to communities to the extent that the government uses their proceeds to improve infrastructure, employment, contracting opportunities, and economic development. For example, in Yemen, the oil and gas company Nexen worked in partnership with the Government of Yemen to increase the percentage of Yemenis in the company’s workforce with recruiting and training. To the extent that governments are able to develop benefit-sharing mechanisms that promote their communities’ interest, they may improve government integrity and reduce corruption.[1]

Enforce and encourage high standards of accountability and responsibility among corporate and investing entities. Some countries endowed with natural resources have had success with encouraging companies to make voluntary promises to participate in corporate social responsibility. When these promises are legally binding and contain explicit details and time frames, they may hold opportunities for local communities to participate in economic opportunity and provide mutual benefits. I would note, however, that this tact should be approached carefully. The line between expenditures designed to smooth social relations with local communities and outright bribery is blurred and thin.

Understandably, all of these solutions do suffer from some issues of causality in the model. For example, reducing government integrity may increase corruption, but corruption also reduces government integrity. To some extent, all of these suggestions put the cart before the horse. Nonetheless, I think this perspective offers some insights into the relationship between extractive industries, corruption, and some viable alternatives to what many consider to be inevitable.

[1] Of course, corruption also reduces government integrity, so this suggestion does put the cart before the horse.

Written by Ann Hollingshead

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