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Revisit local content requirements as a policy option

Introduction

Today’s column goes back to my original opinion on local content requirements. Five years ago, I opined that three major political priorities were apparently driving the government’s preparations for impending oil and gas extraction. These priorities were: 1) establish a sovereign wealth fund (SWF) and accordingly design a fiscal regime for the sector; 2) provide a best practice governance framework, alongside an autonomous regulatory commission for the extractive sector; and seek membership in the Extractive Industries Transparency Initiative (EITI); and, 3) the creation of a local content requirements (LCR) regime, the latter being today’s topic.

What is “local content?”

Readers may recall my earlier observation that the notion of “local content” has evolved rapidly since the 2000s. At first it simply meant “that a producer ensures that a certain percentage of the inputs of production process comes from local sources”. (S. Lester, International Economic Law and Policy Blog, 2013) Nowadays, the notion embodies the emphasis on the location of production, growth and development potential. This result has sparked heated debates on whether “state policies favoring localization create barriers to trade”? And, if so, do they legally comply with the free trade provisions of the World Trade Organization (WTO)?

Thus, Silva (2013) stated bluntly: “The purpose of LCRs is to create rent-based incentives for investment and import substitution”. It elaborates and asserts that the LCRs guide foreign investors/companies to ensure that a minimum threshold of goods and services are procured locally. This directive is, in fact, the creation of import quotas by government decree! Such a development is simply a shift in policy from protected export platforms in developing countries (which flourished in the 1960s and 1970s) to welcoming foreign direct investment (FDI) and then taxing of CRL. Such a change in policy reduces the risk of investing in poor countries.

Origins of CRL

The rationale for the development of LCRs in Guyana is rooted in the country’s historical reliance on the fortunes and woes of extractive industries sales in global markets. While the goals/objectives of the LCRs are many, I have focused them on seven: 1) to ensure growth and development offsets when oil and gas revenues peak because depletion rates have also peaked; 2) leverage oil and gas revenues for value-added downstream products; 3) consistent with 2, promote economic diversification through the growth of non-extractive sectors; 4) strengthen inter-industry links (upstream and downstream); 5) placing R&D and innovation at the center of Guyana’s productivity, growth and development; 6) fight against environmental challenges (degradation, destruction, pollution) of our biodiversity, and 7) promote economic, political and social stability.

Forms of links

Researchers who have studied these phenomena have identified four broad forms of linkage, based on global practices aimed at decomposing enclave characteristics across LRCs. These are: first, the use of fiscal transfers. This involves mobilizing revenue through tax and non-tax sources (sale of assets – land) from the oil and gas value chain. It also includes state capital expenditures for beneficial activities, for which the oil and gas sector is eligible (a good example being infrastructure expenditures).

Second, there are spatial links. In Guyana, this includes government spending on things like infrastructure, transport, communications and ports. These reinforce the geographical (spatial) integration of Guyana’s off-shore, coastal, intermediate and interior geographies and their economic cohesion.

Third, there are links through knowledge development; for example, training in STEM (science, technology, engineering and mathematics) and public expenditure dedicated to Research & Development, as well as Innovation (RDI).

Finally, intersectoral and interindustrial links are also advanced. There are both forward linkages (downstream value-added activities, such as processing, services) and forward linkages (input supplies to the sector, such as consumables, services (accommodation, business related) , as well as other goods and services.

If this happens, the landlocked sector could be integrated, through these channels, with the non-landlocked sectors, rather than crowding them out.

LCR and protectionism

As a result of the above, as expected, the concept of LCR has evolved from the idea that it simply referred to the percentage share of local inputs that must be incorporated into the production of a domestic producer to now where it is meant to encompass the concepts of location and control/ownership, has sparked debates on whether RCs are inconsistent with WTO principles. However, I have also noted that, empirically, most countries, large and small, rich and poor, industrialized and non-industrialized and located in all continents and regions of the globe have implemented and continue to implement LCRs . This contrast between WTO trade principles and global practices creates hidden pitfalls, of which local authorities and the general public should be aware.

I had suggested then that the best defense of the view, which most Guyanese intuitively hold – that the LCRs for Guyana are fair and equitable – is indeed rooted in economic theory. I have therefore tried to indicate in these columns “the rationale for the development of LCR in Guyana is rooted in the country’s historical experiences of extensive and intensive dependence on the vicissitudes of extractive industries operating in global markets and the particular characteristics of the petroleum sector “.

Indeed, I developed this with specific discussions on: 1) the landlocked economy; 2) the concept of infant industry; 3) economic linkages and benefits; and, 4) Caricom as a production platform for Guyana. I have been careful to emphasize that the reputed case of the LCR as a form of “backdoor protectionism” should not be dismissed lightly. If the authorities do so, they risk great legal peril.

Conclusion

Next week, I will conclude the discussion on this topic.