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sharing in governance of extractive industries

Yay! IPSASB is starting on a natural resources IPSAS

At the end of February, an important but little noticed step to mitigating the resource curse and climate chaos was taken. When governments sell mineral wealth, they treat royalties and other proceeds as income rather than the sale of inherited mineral wealth. Politicians find extraction irresistible — it generates income without the matching pain of imposing taxes — easy money for patronage or clientelism. In reality, there are significant hidden losses as well. The Work Plan 2019–2023 of the International Public Sector Accounting Standards Board (IPSASB) has as its top priority a new International Public Sector Accounting Standard (IPSAS) for Natural Resources. The new standard would enable politicians and citizens to get an accurate picture of the impacts of extraction on national wealth.

Background

In most sovereign nations, sub-soil minerals are owned by the state as a trustee on behalf of the people. The minerals are a shared inheritance — trust assets for the benefit of the people alive as well as future generations. Mining ends with selling the minerals, converting mineral wealth into financial wealth. Intergenerational equity arguably requires that future generations inherit either the minerals or their full value.

Framing mining as the sale of mineral wealth

Under the current international standards for government accounting, statistics and disclosure — IPSASs & IMF’s Government Finance Statistics Manual (GFSM) 2014 — the proceeds from selling minerals is treated as “revenue”, identical to rent received on property leases. At the same time, since most governments do not prepare balance sheets, the depletion of the mineral asset goes unrecognized.

Minerals are often sold for much less than their true value. As IPSASB notes, “Governments often have little idea of the monetary value of natural resources until after they are extracted. However, the rights to extract such resources are often granted beforehand to third parties who then profit from their extraction.” For instance, it is estimated that Australia received only 18% of the economic rent of the minerals extracted over the decade 2000–2010 — a loss of 82%, US$ 159 billion or US$ 7,000 per person. These losses are simply not recognized in the present accounting.

The present accounting incentivizes a number of perverse behaviors. Politicians love extraction, easy “revenue” for patronage, clientelism, arms and corruption. Voters support lower taxes. Imagine a country that has just started extracting. The government budget gets a boost to “revenue”. Then commodity prices go up. Extraction increases. The budget swells & the currency appreciates. All sorts of claimants appear — job seekers, the military to keep the claimants in check, the elite, etc. Then the boom ends. “Revenues” crash but expenditure is sticky. The choices are to cut revenue, impose new taxes, run large deficits, or run down assets.

Very often, even though commodity prices are low, extraction expands further on worsening terms as it is politically the least painful. Of course, if all countries increase extraction, commodity prices will drop even further. In the end, part of the mineral inheritance is captured by cronies, and the proceeds are largely spent. The present & future generations have been cheated. With these incentives, it is difficult to stop extracting fossil fuels, endangering civilization.

In practice

Norway started extracting North Sea oil in the 1970s. By the late 1980s, it became clear that the budget volatility and currency appreciation caused by oil exports was difficult to manage. Consequently, Norway set up its oil fund in 1990, with the explicit fiscal rule that the entire proceeds from oil be saved in the fund. Mineral wealth is converted into financial wealth, also a part of the public trust. However, Norway continues to treat the proceeds from mining as “revenue”. It is yet to estimate whether it is selling its oil for the full value or making a loss in the process like Australia.

In 1970, Alaska received $900 million as a lump sum from the Prudhoe Bay oil & gas lease sale. This was a few years worth of “revenue” for the state. Alaska went on a spending spree. By 1975, it was clear that much of the “windfall” was wasted. In response, Alaska set up its Permanent Fund, in essence to convert mineral wealth held in trust into financial assets held in trust. As a corollary (& unlike Norway), Alaska has been paying out an annual dividend from the income of the fund to the living beneficiaries — the people of Alaska.

Proper accounting for minerals as a shared inheritance would require the recording of extraction as the exchange of assets, mineral wealth extracted in exchange for the proceeds of mining. The proceeds of mining would no longer add to the “revenue” of the government. On the other hand, the losses would have to be recognized and disclosed as an expense. Would voters look as favorably on proposals to sell their own family silver for peanuts?

Mitigating the resource curse

Framing minerals as a shared inheritance and mining as their sale suggests a three step passive benchmark: (a) sell the minerals for Zero Loss; (b) like Norway, save the proceeds in a Future Generations Fund invested overseas; and © like Alaska, distribute the real income only as a citizen’s dividend. If the passive benchmark were implemented and the fund were invested overseas, it would considerably reduce incentives for mindless extraction, mitigating dutch disease, the resource curse as well as impacting the supply side of climate chaos.

Goa Foundation has been advocating this change in accounting for minerals since 2016. (Full disclosure: the author is Research Director, Goa Foundation.) In the public consultation on the IPSASB Work Plan, Goa Foundation was supported by David Leiser (President, IAAP — Economic Psychology Division), Bob Traa (retired from the IMF), Publish What You Pay — UK, Samata India, the Peaceful Society, the Natural Resource Governance Institute, Open Oil, and The Future We Need.

The new standard found broad support from the accounting community as well. As the IPSASB points out, “From a public interest perspective, this is an important issue, particularly in jurisdictions with resource-based and resource rich economies because the recognition and measurement of these assets impact their management and the benefits derived by citizens from their extraction.

Mitigating Climate chaos

There is a more direct connection to climate chaos as well. The environmental movement has long argued that by ignoring the value of natural resources depleted, the national income is overstated. This is the origin of the System of Environmental-Economic Accounts (SEEA). As this accounting treatment originates from the System of National Accounts (SNA), it has been carried forward into the IMF’s Government Finance Statistics Manual 2014 (GFSM)as well as the SEEA. It is essential that all these standards also correct this error.

For the natural resources IPSAS, the IPSASB notes that “the scoping phase of this project will not only have regard to extractive resources, but will also consider the potential for inclusion of broader natural resources, such as water, natural phenomena and living species.” Proper accounting for natural resource depletion would have a significant impact on the management of natural resources by politicians and governments.

Conclusion

In conclusion, the present accounting for natural resources incentivizes politicians and voters to collaborate in a fire sale, cheating future generations of their inheritance, creating fertile conditions for dutch disease and the resource curse, and eventually endangering civilization itself. A new accounting standard on natural resources is essential for the existence of the future. Indeed, it is a simple accounting change that could save countless lives, perhaps even civilization. Will the IMF & UN follow IPSASB’s lead?

Rahul Basu is the Research Director of Goa Foundation, an environmental NGO in India. The Future We Need is a global movement asking for natural resources to be viewed as a shared inheritance we hold as custodians for future generations. This work is based on the practical work of the Goa Foundation.

Whose Mine Is It Anyway is a campaign to make government finances and national income statistics treat mining as the sale of minerals. Read Mitigating the Resource Curse by improving Government Accounting and Government Accounting and the Resource Curse — Response to FAQs.

The Goenchi Mati Movement is advocating these principles for all mining in Goa, India. A joint campaign is asking for these principles to be part of India’s National Mineral Policy.

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