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Op-Ed: How mining supply chains can minimize political risk

The recent turmoil surrounding the Minera Panama copper mine in Panama exemplifies the intricate challenges facing international mining investments. The government of Panama initially offered First Quantum Minerals a generous package of tax exemptions and low royalties, but later revised its position when faced with popular protests for higher taxes and environmental concerns.

Constructing a new mining operation requires an extensive investment in physical capital which cannot be reallocated easily. The host government has an incentive to promise favorable tax agreements, royalties, and protection to attract that investment. Once the investor is stuck, the government can renege by raising taxes or applying onerous regulations. In extreme cases host states have declined to protect the asset from their own people or expropriated the asset themselves. Governments can easily underestimate the political costs of environmental damages, as seems to have occurred in Panama.

The mining investor is in a difficult position, asked to predict the policy choices of a foreign government sometimes decades in advance. The governments of the world are diverse; mining investors often come from low-corruption democracies in Canada, but develop mineral deposits in corrupt democracies, monarchies, military dictatorships, communist regimes, and even failed states like Afghanistan.

Decisions may be closely aligned with public sentiment, as in California’s referendum system or sequestered from the popular will in a communist party.

For a host-government leader breaching a contract has costs and benefits. Termination may appease environmental groups, look tough to xenophobic citizens, and give the leader a free hand to set policy. Leaders may also have unsavory motives, such allowing an SOE or a political ally to take over the mineral concession. But contract breach also brings costs from investor lawsuits, damaged reputations, and foregone revenue. When dealing with non-credible governments, a savvy investor should set up the project to maximize the costs of contract breach to future governments.

Domestic suppliers

One viable strategy is to use the project’s supply chain to build alliances with domestic actors in the host country. Domestic firms that provide goods or services to the operation will suffer a loss in demand if the operation ceases. Many of the riskiest states for mineral investment are small and have weak economies, such as Guinea Bissau, Turkmenistan, and Venezuela. In a small economy it will be difficult for your suppliers to find new customers, giving them a strong incentive to lobby on in foreign investors behalf. Similarly nationalization often results in underinvestment, which also hurts domestic suppliers.

Your domestic suppliers can provide protection in two primary ways. They can directly lobby the government directly. In a politically unstable country, you can expect the surviving businesses to have experience in the domestic political game. Secondly, their lost revenue would trigger layoffs in the domestic firms. Those layoffs would be directly attributable to the government action, potentially causing negative news coverage and domestic protests.

Political scientists Leslie Johns and Rachel Wellhausen have investigated this strategy in a 2016 paper. They conducted a survey of staff at US firms invested in Russia in 2016, asking about their concerns about contract breach or expropriation from the Russian government. As you would expect, the firms that relied more on domestic suppliers were less concerned about government action.

Any complex project will have a range of inputs that can be sourced domestically or abroad. Many of these will be no-brainers; Guinea Bissau will not compete with Taiwan on computer prices. But for those services that are competitive, it is worth considering domestic suppliers when they offer political benefits.

If the host government does consider contract breach, your suppliers will face what political scientists call a “collective action problem”. Supplier firms will be tempted to shirk on lobbying if they expect other suppliers to invest in lobbying. The tighter the networks among supplier firms are, the more likely a successful defense. This might look like a chamber of commerce in the US, a regional political movement, or a mafia-like organization. If domestic suppliers lack these networks, try to concentrate supply in a few large firms to ease coordination.

Similarly, individual workers who expect job losses will not protest on their own, because one person cannot move the government. Workers are most likely to protest on your behalf if they share a location, an ethnic/tribal identity, or are unionized. Accountants who commute by zoom from different cities are unlikely to move the needle, but a supplier who draws workers from a single region that shares an ethnic/tribal identity could.

People in advanced democracies tend to underestimate how sensitive developing country governments are to job losses and protests, particularly in highly corrupt or autocratic states. In fact, most modern autocracies are surprisingly sensitive to labor issues.

Minimizing public signs of social unrest is a key responsibility of regional governors even in the aloof and powerful Chinese Communist Party. Political scientists Sinisa Miric and Anna Pechenkina have shown that CCP regional officials are less likely to be promoted when labor protests occur during their tenure. This argument does not generalize to failed states like the Central African Republic and totalitarian North Korea, where states are insulated from citizens.

The complexities of international mining investments in diverse political landscapes necessitate a strategic approach to mitigate risks. By leveraging domestic suppliers not only for operational efficiency but also as political allies, investors can create a web of local economic dependence that acts as a shield against government unpredictability. This strategy, while effective in most scenarios, has its limitations in failed states where political instability and armed conflicts override economic considerations.

Therefore, mining executives must tailor their strategies to the specific political and social fabrics of their host countries, ensuring that their investments contribute positively to local economies while safeguarding their own interests. This dual focus on economic integration and political astuteness will be pivotal in navigating the ever-evolving challenges of international mining ventures.

(Timothy Liptrot is a political scientist and PhD candidate at Georgetown University, specializing in ways  governments set policy toward foreign investors, particularly in the extractive sector)

Source: MINING.COM – Read More