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sharing in governance of extractive industries

New Paper: The Extractives Dependence Index (EDI)

Here is the final version of the paper: The Extractives Dependence Index (EDI)

The Extractives Dependence Index (EDI) 

By 

Degol Hailu and Chinpihoi Kipgen

March 2015 

A common measurement of a country’s dependence on the oil, gas and mineral industry is based on the share of earnings from these commodities in total export earnings. Another measurement is tax revenue generated from these same commodities. These indicators, however, do not entirely capture the degree of reliance on the extractive industry, mainly because they are isolated measures and do not give a full picture.

In this paper, we propose a composite index. The three indicators that make up the index are: a) the share of export earnings from extractives in total export earnings; b) the share of revenue from extractives in total fiscal revenue; and c) extractives industry value added in total value added.

Our approach, however, goes beyond a simple creation of an index from the above three indicators. We weigh each of the indicators to capture the productive environment under which the extractive sector exists. First, we adjust export earnings from oil, gas and minerals by the share of high-skill and technology intensive manufactures in total exports. This is because, even if two countries have equal shares of export earnings from extractives, the country with a higher degree of skill and technology intensity is likely to have higher productive capabilities and greater probability of spillover of skills to other industries that are export oriented.

Second, the revenue generated by the extractive sector is adjusted to take account of tax revenue collected from other sources. Countries that generate a significant percentage of their fiscal revenue from oil, gas and minerals are vulnerable to commodity price volatilities. Such vulnerability is best tackled if countries generate revenue from other sources including, for instance, personal income tax, corporate income tax and capital gains tax.

Third, the capacity to domestically process oil, gas and minerals into intermediate and final goods is an important indicator of the difference among countries in terms of their dependence on the extractive sector. In a country where domestic value addition is higher, there are also technological and skill transfers to other sectors. In other words, a higher capacity in value addition is likely to be associated with a higher level of diversification within GDP.

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Comment by Degol Hailu on July 20, 2015 at 11:31

Comment by Antipas Massawe on June 8, 2015 at 20:46

I thought the different ways countries spend the non-renewable oil, gas and mineral industry revenues would also give them different degrees of effectiveness in their reliance on extractive industries. Countries which invest most of these revenues as seed capital in the most important in Global Economy multinational companies would also enjoy most effective reliance on their extractive industries  as the non renewable revenues they generate earn them  fiscal spending  sustainably in the form of indirect profits  rather than the direct nonrenewable and therefore unsustainable fiscal spending which is counterproductive as it switches the living activities of society on to chronic dependence on the nonrenewable mineral revenues. The composite EDI would therefore delivered useful applications if it was a measure of the effectiveness of countries reliance on their extractive industries depending on the three indicators considered plus the share of sustainable profits invested non-renewable oil, gas and mineral industry revenues would earn them indirectly.

Comment by Bryan Christopher Land on June 1, 2015 at 18:31

The development of an index to measure and presumably rank country dependence on extractives is a great innovation. Moreover, going beyond the simple combination of the three levels of measurement usually employed (as in IMF resource rich listings) is important to be able address the implications of dependency.  However, I am still left wondering how the results will be interpreted once the index is generated.

 

The underlying question is whether (rising or falling) dependency is good or bad. Take Zambia's level of dependence on mining sector revenue. The structure of the mining fiscal regime in Zambia has, even after several reforms, resulted in tax receipts contributing a relatively low share of GDP and of domestic tax receipts compared to peers (although this has been rising of late). This has been viewed, for the most part, as bad - a reflection of Zambia being cheated of a fair share and ill-prepared to close tax loopholes. If this was remedied, by adjusting the fiscal regime and strengthening tax collection, mining sector revenues as a share of GDP and of total tax receipts could rise. This would be good .. or would it? Over dependence on mining sector revenues would expose the country to higher risk of volatility and might reduce tax effort overall, if taxing other sectors is i) hard and ii) a burden on non-mining sector growth. That would be bad, wouldn't it? Well, this is indeed a concern but maybe, through wise use of mining revenues, the overall performance of the economy could be enhanced, by addressing infrastructure gaps and improving basic service provision ... in this case higher dependence could be good.

 

The value addition measure is an interesting one, as well.  While it may be broadly correct to associate value addition with sophistication and diversity of an economy, I think one could think of some circumstances in which greater value addition of extractives resources is not associated with greater economic diversification. A focus on beneficiation of a mineral, for example, especially if it were to require significant inputs such as energy, could result in diverting capital away from alternative uses, locking in subsidies in input supply and reinforcing exposure to commodity price volatility (if the benefiating to intermediate product level only). Chile, which exports most of its copper in concentrate form, would probably score low on the dependency index of value added but may, nevertheless, have developed a highly diversified economic base. Good or bad?

 

So overall, while the index is a very welcome development, careful judgement will still need to be exercised in using it as an indicator of appropriate public policy. Countries may find themselves wondering whether they want to move up or down in the rankings and what policies to use to assure that one or another happens. 

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