Key Word: Mining, Fiscal Policy, Commodity Boom
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Working Paper No 2009/13
APRIL 2009
The implications of mine ownership for the management of
the boom: a comparative analysis of Zambia and Chile
Elva Bova*
ABSTRACT This paper assesses the relevance of mine ownership for the management of the resource curse. It first indicates how macroeconomic management is paramount to cope with the shocks and the instability induced by commodity prices’ behaviour. Then it underlines that under private ownership the space for fiscal and monetary policy results to be substantially reduced. The paper also analyses and compares the experiences of Zambia and Chile in the management of the current copper boom and maintains that the existence of a state-owned enterprise for copper has greatly contributed to the positive economic performance in Chile.
Yet, the study concludes that ownership is a necessary condition but not sufficient condition to escape the resource curse.
Key word: mining, fiscal policy, commodity boom
* Elva Bova is a Doctoral student of the NCCR individual project on “Primary Commodities” and a PhD candidate in the Economics Department of the School of Oriental and African Studies, University of London.
NCCR TRADE WORKING PAPERS are preliminary documents posted on the NCCR Trade Regulation website (
A framework for the analysis of commodity booms in an era of highly liberalised economies should take into consideration the kind of ownership and management of the commodity industry. In this respect ownership, perceived as the degree of privatisation of the industry, should also encompass the taxation system, for the latter provides a measure of the sector’s integration in the rest of the economy. The distinction between kinds of ownership and taxation regimes bears its relevance in the way a boom impacts on the economy since spending and saving responses may differ accordingly to whom precisely gets the inflow, and this is especially the case when the foreign private sector is considered. Furthermore, this study maintains that the presence of largely privatised commodity industries does not only matter for the effects originated by spending and saving behaviour, but also for the scope of macroeconomic management.
For a better understanding of the implications different kinds of ownership have during a commodity boom, this study compares the experiences of Chile and Zambia. In the two countries mines ownership differs greatly, with a large public sector in Chile and an almost completely privatised copper industry in Zambia. Although additional differences between the countries ought to be considered, there are valid grounds to believe that the kind of ownership has played a role in the different ways the copper boom has impacted on the economy. As we shall see, the argument appears also to be supported by the fact that the exchange rate regime is approximately the same in both economies, with very little intervention in the Chilean foreign exchange market.
This paper also offers more insights on the way the boom has been managed through fiscal policy, although not much can be say regarding Zambia, since very little amount of foreign exchange accrues to the government. To a certain extent, however, one can assess whether fiscal policy has been pro-cyclical, meaning that the government has increased spending and this has exacerbated the impact on the currency, or whether it has not accommodated the shock.
The paper is structured as follows. Section 6.2 provides the analytical framework of the paper and reviews issues surrounding privatisation of state-owned enterprises (SEOs) in developing countries.
More particularly, we examine how the literature has treated the effects of the reform on fiscal policy while very little has been written on the way the reform impacts on foreign exchange management, and consequently on the currency. Section 6.3 provides the contextual framework for the paper and illustrates the privatisation reforms and taxation regimes in the two countries. In section 6.4 we compare the fiscal responses to the boom, while in section 6.5 the monetary ones. Section 6.6 concludes.
2 Privatisation reforms and macroeconomic policy
In its broaden conception privatisation identifies a process by which the state’s role within the economy is reduced while at the same time the scope for the participation of the private capital is extended (Young 1991). The process entails the transfer “from the public to the private sector of the ownership and/or control of productive assets, their allocation and pricing and the entitlement to the residual profit flows generated by them” (Adam et al. 1992: 6).
In line with the neoliberal revival of the 1980s, privatisation started as an initiative propounded and embraced by industrialised countries, mainly the UK and the US, and was subsequently taken on by developing countries. As expressed in Bennel (1997), within the World Bank and IMF structural adjustment program, privatisation became “the super ordinate medium long term objective” everywhere in Africa (1997:1785).
There are usually two main motivations advocated for privatisation of state-owned enterprises
(SEOs) (Adam et al. 1982, Pinheiro and ….). On the one hand is the need to enhance efficiency in obsolete public companies while promoting the crowding in of the private sector; and, on the other hand is the rationalization of public finance, usually in terms of increasing revenues to alleviate the fiscal deficit, which will result from the inflow of privatisation receipts, from corporate taxes and royalties but also from the elimination of state subsidies (Pinheiro..Buchs Kayizzi-Mugerwa and
Adam et al. 1992).1 Empirically, the success of privatisation both in terms of efficiency and revenues is not clear (Bhoubakhri 2002, Buchs 2003) probably because privatisation has been embraced within a set of other economic reforms and also because more than the reform as such one should gauge the procedures adopted, the initial conditions and competition discipline (Fine 2007).
Along with a privatisation reform a government should decide on the taxation regime to impose on the private companies, which to a certain extent regulates the new relationship between the private and the public sector. In the specific case of a foreign private sector, the taxation system becomes also an indication of the degree of integration of that sector into the country’s economy.
As mentioned, one of the main assumptions of this study is that the combination of a loose taxation regime and highly privatised commodity industry may limit the scope of macroeconomic management during a commodity boom and this occurs mainly in two manners.
1 Besides these general theoretical issues, literature on privatisation has been also sensitive to the effects on the development of the capital market (Bhoubakhri 2002) or to the implication for the labour market, which usually constitutes the main deterrent to the policy. Firstly, the privatisation regime is relevant for the fiscal budget. As mentioned, the fiscal impact of privatisation identifies changes in government revenues resulting from the one-off increase in the privatisation proceeds, from the elimination of possible subsidies to public owned enterprises and from changes in the mining tax regime (Davis, Ossowski et al. 2000, Barnett 2000, Mansoor 1987).
Whether a larger private ownership determines an increase in the fiscal revenues or not depends on the entity of all these changes.
When the economy is struck by a commodity boom, the presence of a large privatised industry may have additional implications on fiscal policy. This is because it limits the amount of export receipts accruing to the government and with this its possibility to save the inflow and use it to allocate resources to key sectors of the economy. As mentioned in the analysis of the literature on commodity booms, the best response to a shock is to stretch investments until the boom is over, through saving in foreign assets, which also mitigates the impact on the currency. Yet, when the private sector is local its possibility to save in foreign assets may be leveraged due to its low credit rating. Furthermore, when the private sector is foreign, it may opt to repatriate profits and little would accrue to the economy as a whole. Our implicit conclusion out of this is that between a private and public response, as long as saving is the most appropriate measure, then a largely privatised regime would limit this option.
While the issue on the effectiveness of fiscal policy has been widely looked at, the implications of a largely private mining industry for monetary and exchange rate management have not been similarly examined. The issue is neither considered in the literature on trade shocks nor in the literature on absorption and spending of aid inflows. In principle, whenever the role of fiscal policy during a boom is limited, then the government could rely on monetary and exchange rate policies to offset the adverse consequences of the shock.
The second implication of a largely privatised commodity sector refers thus to the constraints it poses to monetary and exchange rate policy. While when the inflow of foreign exchange accrues directly to the government it can be saved and not spent so as to avoid exchange rate appreciation and possible Dutch disease effects, when the inflow accrues to the private sector in order to curb the appreciation, the central bank needs to conduct foreign exchange interventions, and this has a cost.
When purchases of foreign exchange cannot be easily sterilised then they will result in an increase in the money supply, which under conditions of full employment may increase inflation.
Thus, a large private ownership may be of hindrance to monetary and especially exchange rate management since it exposes the central bank to a trade-off between nominal appreciation and inflation. 3 Ownership and taxation regime in Zambia and Chile
The economic and political history of Chile and Zambia has been long dominated by their production and export of copper. Still at present, both economies are heavily dependent on copper, which constitutes 40% of total exports in Chile and more than 70% of total exports in Zambia. As a capital-intensive sector, the mining industry employs only 1% of total employment in Chile and around 10% of the Zambian workforce.
Figure 1a Figure 1b
Zambia: GDP, exports and copper price (1970-2006) Chile: GDP, exports & copper price (1970-2005)
4500 250 4000 100000 250 90000 3500 200 80000 200 3000 150 70000
s 2500 60000 150 n o s i l l n i 2000 50000 o M 100 i l l 1500 i 40000 100 M 30000 1000 50 20000 50 500 10000 0 0 0 0
Exports (constant 2000 US$) GDP (constant 2000 US$) Exports (constant 2000 US$) GDP (constant 2000 US$) Copper price (right scale) Copper price (right scale)
Source: IMF-IFS, WB- WDI
While in the early 1970s both countries nationalised the copper sector, their experiences in terms of management and ownership of the mines have diverged since the late 1970s and, at present, the ownership structure in the two countries differs widely, with an almost completely privatised industry in Zambia, and a largely publicly-owned one in Chile.
The nationalisation reforms
The nationalisation reform in Zambia was implemented in 1969 as part of the general strategy of import substitution, for which the mining sector was considered to be the stepping stone (Andersson et al. 2000). In 1982, the government created the Zambian Consolidated Copper Mines (ZCCM), out of the merger of two state mining companies, in an attempt to rescue the mining sector from the prolonged depression in the international price of copper which stemmed from the end of the 1970s. ZCCM had, as main shareholders, the Zambian government (60,3%) and Anglo American
Corporation which controlled 27,3% of the interests. As stated by law, Anglo American had pre- emptive rights to purchase any shares sold by the government and it had an effective right of veto over the sales of any major assets (Craig 2001). Besides mining exploration and exploitation, ZCCM was deeply interlinked with the rest of the economy, through backward linkages with suppliers and forward linkages with traders and manufacturers (Fraser and Lungu 2007). As expressed in Craig
(2001:x) “the strategic and symbolic significance of ZCCM was frequently expressed in terms such as ZCCM is
Zambia, Zambia is ZCCM”.
In Chile, the nationalisation experience was enacted in 1971, soon after the election of President
Allende, with the approval of law 17540 which stated that “...the foreign companies forming the great mining are nationalized and incorporated to the full and exclusive dominion of the Nation….2” The new regime decreed that the goods and facilities of the companies, at that time the US companies
Anaconda and Kennecott3, would become property of the State of Chile, and the operations would be managed by collective societies coordinated by the State Copper Corporation (Cochilco 2007). The government could dispose of the organization, exploitation and administration of the nationalized companies (Ministero de Mineria 2007) and in April 1976 the government created a state-owned mining company, Codelco (the Corporación Nacional del Cobre de Chile) in charge of administrating the nationalized copper mines, also defined as Gran Mineria (Chuquicamata, El Salvador, Andina and
El Tenente).
The privatisation reforms In the two countries the privatisation reforms occurred in very different periods of time. In Zambia, the reform was introduced in the mid 1990s, as in many other
African countries where privatisation was considered to be the centre piece of the structural adjustment programs (Appiah-Kubi 2001, Bennel 1997). In Chile the reform was adopted in 1974 with the neoliberal reforms realised by the Pinochet regime.
Zambia embraced privatisation of many state owned enterprises in an attempt to rescue itself from a prolonged economic slowdown which had degenerated into a fiscal crisis. The reform was backed by the Movement for Multiparty Democracy whose perception of the role of the public sector was expressed in the following terms: “the government
2 From transitory disposition of the Article 10 of the Chilean Constitution. 3 For a full description of the copper industry in Chile in the 20th century until the 1970s see Gedick 1973. restricts itself to rehabilitate and build economic infrastructure with a small public sector
in the midst of a basically private enterprise economy” (Andersson et al. 2000, 6).
Table 1
Copper mining companies in Zambia Turnover[1] Mines Owner 2000 Owner 2006 in 2005 Vedanta Resources, Konkola Anglo American Corporation (US) India (51%), Zambia Copper Mines 65%, IFC (7.5%), CDC (7.5%), ZCCM Copper Investment 200,00 t/ per (KCM) 20% (28,4%), ZCCM (20,6%) year First Quantum 145,000 Kansashi Minerals Ltd, Canada t/per year China Non-Ferrous Chambishi Metals Corp (85%), 140,000 Metals Plc Anglo-Vaal (South Africa) ZCCM (15%) t/per year Chambishi Mines Plc. Co.-Africa (China) Co.-Africa (China) Glencore International AG, Glencore International AG, Switzerland (73,1%), First Mopani Switzerland (73,1%), First Quantum Quantum Minerals, Ltd, Copper Mines, Minerals, Ltd, Canada (16,9%), ZCCM Canada (16,9%), ZCCM 135,000 Plc (10%) (10%) t/per year J & W Holding AG, RAMCOZ Binani, India (85%), Switzerland (85%), 50,000 t/per Luanshya ZCCM (15%) ZCCM (15%) year Equinox Resources, Australia (51%), Phelps 25,000 t/per Lumwara Dodge Corp US (49%) year Chibuluma Metorex Ltd, South 15,00 t/per Mines Africa year Source: AnMbendi 2006, Fraser and Lungu 2007
While the privatisation of major sectors of the economy was introduced in 1992, it was only in
1996 that the government implemented the reform for the copper industry, which is indicative of the
importance bestowed to the sector. The reform was deemed necessary to rescue the company from a
dramatic crisis which saw a loss equal to 1 million $ per day in 1998 (Andersson et al. 2000,
www.bbc.radio4). Between 1997 and 2000, ZCCM was split into seven different units and sold off.
The units were initially bought up by seven multinational mining companies, including Anglo-
American (AAC) which chose to exercise its per-emptive rights and took on 65% of Konkola Copper
Mines (KCM), the largest operating mine at that time. Yet, in 2002 AAC pulled out from Zambia
handing the mine back to the state, and in 2004 the mine was sold to Vedanta at a knockdown price.
The seven multinational companies in 2000 were Anglo-Vaal from South Africa, Binani from India, Metorex South Africa, Glencore and First Quantum from Canada, International Financing
Corporation, Commonwealth Development Corporation.
As illustrated in the chart, at present the largest share in the Zambian copper industry is owned by First Quantum, with other large corporations owning more than 15%, like Co-Africa from China,
Vedanta from India, which took over Anglo American in 2004, and Glencore.
Figure 2: ownership structure in Zambia 2006
E q u i n o x Z C C M - I H
J & W H o l d i n g
V e d a n ta
G l e n c o r e
F i r s t Q u a n tu m
C o - A f r i c a
Source: AnMbendi 2006, Fraser and Lungu 2007
As stated in the Mine and Mineral Act adopted in 1995 the new companies would be registered in
Zambia and would be subject to the monitoring of an inter-ministerial group. The Government would retain a share in each mine through direct ownership of ZCCM-International Holdings. However, so far the Government of Zambia has not received any dividend from the company, despite the boom, due to the accumulation of liabilities (Ministry of Finance).4
The Mine and Mineral Act adopted in 1995 greatly simplified the licensing procedures, placing minimum constraints on exploration and exploitation activities. It established a royalty calculated as
2% of the market value of minerals f.o.b., less the cost of smelting, refining and insurance, handling and transport from the mining area (www.zambiamining.co.zm). According to the Act copper exporters were levied 35% of taxable income whereas other mineral and non-traditional commodities attract a levy of 15%. Despite what established in the Act, the rate negotiated by most mining companies was 0.6% of the gross revenue, as stated in the development agreements which were secretly signed between the companies and the Government (Fraser Longu 2007). Also the export tax was set at 25% instead of 35% and carrying forward losses was allowed for periods of between 15 and
4 ZCCM-IH is a state-owned company; a joint venture 87% owned by the government and 13% in the hands of private shareholders. It is listed in the LUSE and has a separate legal entity from the Government. Actually the Government owes money to ZCCM. 20 years.5 The companies were also granted deductions of 100% of capital expenditure in the year in which this incurred and were exempted from paying customs, excise duties or import tax levied on machinery and equipment. The mining sector was authorised to claim back from the Zambian
Government all of the VAT paid on goods that it buys locally. The government undertook not to amend any of these tax regimes after the agreement was s for as much as 20 years. It has been estimated that in 2007 the Government would have received at least 50 millions US$ if the mines had paid a 3% of Royalty.6 (from BBC) In Chile, the privatisation reform was embraced in the 1970s after a long period of debate and discussion which is indicative of the concerns regarding privatisation of the mines. Differently from Zambia, the reform did not determine a large shift in ownership to the private sector; on the contrary, a large share of copper production was indeed retained by the government through Codelco. However, the new mining code enacted in 1974 reset constitutional protection for the right of private ownership of mines in terms of full exploration and exploitation, and granted equal treatment of domestic and foreign companies, setting no limits on profits and capital repatriation (Spilimbergo 1998, Ruiz-Dana 2007, Pawlett 1999). Despite these concessions to the mining companies, very little foreign capital flew into the industry during the 1980s, probably because of the risk associated with the military regime and only with the return to democracy in the 1990s the share of foreign companies in copper production (the so-called Mediana Mineria) increased substantially, with an increase from 6% to 54% between 1980 and 1996 for the large private mines (mediana mineria), whereas CODELCO shrank from 84% to 39%.
Figure 3
5 This indicates that losses made in year 1 of operations could be subtracted in subsequent years from taxable profits. 6 The development agreements also dispose that if the global copper price increases significantly and exceeds (US$2700 per tonne) then the Government can actually claim back a percentage of each sale made. However the impact of price participation clauses is minimal because the payment to the government is again deductible by the companies for income tax purposes (Fraser and Lungu 2007). Public and private sector ownership s
n 6000 o T 5000 c i r t
e 4000 M
f
o 3000
s
d 2000 n a s
u 1000 o h
T 0
Codelco + Enami Private Companies
Source: Cochilco 2007
As illustrated in the chart below, the structure of ownership in Chile is characterised by a large
state ownership through Codelco which owns almost 40% of the mining production, while the rest is
owned by trans-national corporations.
Figure 4: ownership structure in Chile (2006)
others
PhelpsSource: Dodge AnMbendi 2006, Cochilco Codelco2007
Rio Tinto
BHP
Source: AnMbendi 2006, Cochilco 2007 Falconbridge Anglo American
Source: Cochilco 2007 Table 2 Copper mining companies in Chile Turnover Turnover Turnover Mines Owner 2006 1987 1996 2006 Chuquicamata Codelco 502,9 632,3 634 Radomiro Tomic Codelco - - 306 Division Salvador Codelco 97,1 89,9 80 Division El Tenente Codelco 369 344,7 418 Division Andina Codelco 121,6 154,4 236 Anglo American (US) 44%, Falconbridge 44%, Japanese Collahuasi Consortium 12% - - 440 Anglo American (US) Mantos Blancos 100% 85,7 122,4 149,7 BHP Billiton Limited (Australia) 57.7%, Rio Tinto Escondida (UK) 30% - 841,4 1255 Phelps Dodge La Candalaria (US) 80% - 136,8 169,6 Phelps Dodge El Abra (US) 51% 218,6 Pequena Mineria7 Enami 114,1 128,3 107,3 Source: AnMbendi 2006, Cochilco 2007
Until 2006, the taxation system for the mining companies was regulated by the Decree Law 600 enacted in 1974, which establishes the foreign investment statute. The act grants all investors access to the foreign exchange market, the right to return capital without taxation, a tax invariability for 10 years, in some cases extended to 20 if the capital is greater than 50 million US$.
As far as the taxes are concerned, in Chile profits earned from business are subject to the First
Category tax and to the Global Complementary tax (for local investors) or the Additional tax (for foreign investors). The First Category tax has a 17% rate which is levied on profit received or accrued by the mining enterprise, while the Global Complementary and the Additional one, with rates from 0
7 The mining code of 1974 also contemplated the existence of small private owned mines (Pequena Mineria), which produce 10% of the total copper and sell their output to the public enterprise ENAMI (Spilimbergo 1998). to 40% and from 1.75% to 35%, respectively, are levied on the remittances of dividends and other profits received by the shareholders or partners. When the base for the Global or Additional tax is calculated the First Category tax is deducted. Companies benefit from deductions to apply when calculating the First Category tax, related to organization and start up expenses, interest expenses, technical assistance, tax losses and asset depreciation.8
Since January 2006 the taxation system is regulated by the law 20.026 article 64bis which establishes a specific tax on mining activities. The tax will be levied on the taxable operational income of the mine operator in accordance with the following schedule:
Table 3
SALES (in MT) TAX RATE <12,000 no tax 12,000-15,000 0.5% 15,000-20,000 1.0% 20,000-25,000 1.5% 25,000-30,000 2.0% 30,000-35,000 2.5% 35,000-40,000 3.0% 40,000-50,000 4.5% >50,000 5.0% Source: www.cinver.cl/ (2007)
The reform also imposes a royalty equal to 2%. It appears that prior to the reform the actual mining taxes paid by Codelco represent 28.7% of the final price while taxes paid by private mining amounted to only 5.3%. This meant that while Codelco paid 10,659 millions US$ in the years 1990-
2001, the private companies paid only 1,638 million US$ in spite of their product being 25% greater. It is therefore estimated that the total of lost tax revenue during that period amounts t more than 10,000 million US$ (www.cinver.cl).
Table 4
8 Tax losses if net operation losses exceed the tax payer’s undistributed or accumulated after tax retained earnings, the excess can be used to offset the tax payer’s profits of the subsequent tax year. Asset depreciation: a tax deduction is allowed for fixed asset depreciation, corresponding to the annual installment of depreciation of movable and immovable property tax payers may opt for an accelerated method of depreciation with respect to new fixed tangible assets when acquired locally or new or used fixed tangible assets when imported. Mining taxation in Zambia and Chile Zambia: the Mine and Mineral Act (1995) Chile: the Mining Code 1974
2%; specific mining tax since Royalty 2.5%, but effective 0.6% 2006*
Tax on profits 17% Tax Tax on exports 35% Tax on dividends 35%, less 15% of tax on profits From tax on profits: organization and start up Deductions 100% of capital expenditure expenses, interest expenses, technical assistance Losses made in year 1 can be Tax losses subtracted in subsequent years for 20 It applies indefinitely Carry-forward years
customs or excise duties, import Exemptions tax on machinery and equipment
other Asset depreciation mechanisms Source: Fraser and Lungu 2007, anMbendi 2006, Cochilco 2007
Given this combination of ownership and taxation our main question is on whether this has had different implications on the way the boom has been managed as well as on its effects.
4 Fiscal responses to the copper boom
As far as fiscal policy is concerned, a largely privatised regime determines a reduction in export receipts accruing to the public and, in turn, a low appropriation of commodity revenues may then limit the scope for policy intervention during a boom, which we see identified as the possibility to save the inflow in foreign assets and then spend it progressively according to the country’s developmental needs and absorptive capacity.
In the case of Zambia and Chile, evidence illustrates how the amount of export receipts accruing to the fiscal budget differs, as expected given the differences in the privatisation regime. During the years of the boom the two economies experienced indeed an increase in fiscal revenues, in absolute terms, excluded rents. Yet, while in Chile the timing of the increase coincides with the one of the boom which indicates that export receipts may have positively contributed to the budget, in Zambia the increase in government revenues seems to date from before the boom.
Looking at the origin of revenues in both countries the bulk of government revenues comes from taxes. However, while in Chile the contribution from the copper sector has reached almost 30% of taxes and 20% of total revenues in 2006, in Zambia the contribution of the mining sector to the total revenues has been roughly of 10% in 2006, and almost non existent in the previous years. Thus, the increase in government revenues in Zambia should be rather attributed to a general increase in taxes, mainly VAT and income tax associated probably with the GDP growth experienced in those years.9
(figure x).
Figure 5.a Figure 5.b
Revenues in Zambia (in ZMK) Revenues in Chile (pesos)
8000 25000 7000 20000 6000 s
n 5000 o
i 15000 s l l i n B o
4000 i l l i 3000 B 10000 2000 5000 1000 0 0 2001 2002 2003 2004 2005 2006 2000 2001 2002 2003 2004 2005 2006
Mines taxes Revenues Taxes Codelco's contribution Revenues Taxes
*mining taxes in Zambia do not include PAYE for workers
Source: WB-WDI, Zambian Revenue Authority
Figure 6
Tax payed by mining companies (Kwacha)
s 1,000 n o i l l
i 800 B 600
a 400 h c a
w 200 K 0 2001 2002 2003 2004 2005 2006 2007
Compay Tax Withholding Tax PAYE Mineral Royalty
Source: Zambian Revenue Authority
9 The hypothesis is also advanced by Cali and Te Welde (2007) who indicate how the increase in government revenues in Zambia has to be traced in the improvement in the tax collection procedure Another interesting information which is consistent with the taxation system in Zambia, is that the most relevant contribution to the Zambian budget coming from the mining companies is in the form of taxes paid for the workers (PAYE), and not from royalties or any other form of tax; while the rate of company tax has been increasing in the years of the boom10.
An additional element to be considered is that, although revenues have increased in both economies, in Zambia revenues as a percentage of GDP have not increased. As illustrated in the graph below revenues as a share of GDP in the country have sharply declined since 2001 and fluctuated without any rising trend in the years of the boom. This is quite indicative of the fact that
GDP growth in Zambia, mainly driven by the copper boom, has contributed to an expansion of government revenues. On the contrary, in Chile revenues as a share of GDP have increased, indicating that the budget has been benefiting from the country’s economic growth more than proportionately.
Figure 7.a Revenues in Chile Figure 7.b: Revenues in Zambia
Revenues as % GDP in Chile Revenues as % of GDP in Zambia
25000 30 20 8000 20 7000 25 20000 19 6000 a
20 h
19 5000 c a s 15000 o w s K e 18 4000
15 f p
o f
o s
10000
18 3000 n s o
n 10 i l o l i i l
l 17 2000 i 5000 B B 5 17 1000 0 0 16 0 2000 2001 2002 2003 2004 2005 2006 2001 2002 2003 2004 2005 2006
Revenues Revenues (%GDP) Revenues as % of GDP Revenues
Source: World Bank- World Development Indicators
In considering the fiscal response to a commodity boom, one should look first at the amount of export receipts appropriated by the government and then examine how these receipts have been used. Probably, the most relevant information is on whether revenues have been saved or spent soon afterwards, since 2 this has implications on the way the boom can be stretched in the future without incurring into Dutch disease kind of effects.
10 This datum is confirmed also by Fraser and Longu (2007). When very little accrues to the government, then fiscal policy will be conducted according to the ordinary budget management. However, given that in Zambia revenues have increased in absolute terms, though not because of the boom, it may be interesting to understand how the government has responded to this increase. This is because an increase or reduction in government spending during a commodity boom can still amplify or mitigate the effects on aggregate demand and domestic currency. As illustrated from the graph below the spending response in Zambia has been clearly of increasing expenditure and registering budget deficits for al the years of the boom. On the contrary
Chilean fiscal policy has been rather cautious and the economy has been registering consistent fiscal surpluses since 2003.
Figure 8.a Figure 8.b
Zambian budget Chilean budget 25 30 25 20 20 15 15 10 10
5 5 0 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2000 2001 2002 2003 2004 2005 2006
Expenditures (% of GDP) Revenues excl. grants (% of GDP) Expenditures (% of GDP) Revenues excl. grants (% of GDP)
Note: due to data availability the two graphs have different starting dates
Source: WB-WDI
As illustrate in the following graph, patterns of government spending in Chile have been rather constant throughout the years, whereas the increase in spending in Zambia is also associated with a change in the composition of government expenditure with an increase in spending in goods and services and a reduction in employee compensation.11 The shift towards spending in goods and services may partly explain the increase in infrastructure and construction experienced by the economy.
Figure 9.a Zambia expenditure Figure 9.b Chile expenditure
11 The datum on grants refers to the grants conceded through the budget support which accrue directly to the budget and then through this are transferred to the different ministries and sectors of the economy. Expenditure composition Government Expenditure Composition 100% 100% 80% 80% 60% 60% 40% 40%
20% 20% 0% 0% Interest Subsidies 2000 2001 2002 2003 2004 2005 2006 2001 2002 2003 2004 2005 2006 2007 Grants Social benefits Interests Subsidises Grants Social benefits Other Goods and Services Other Use of goods and services compensation of employees Compensation of employees
Source: WB-WDI
The prudent fiscal policy in Chile is regulated by the structural budget rule enacted in 2000.
According to this rule, every year a structural government income is calculated on the basis of the medium term price of copper and the economy’s output gap. Fiscal expenditure is then set in a way that structural revenue minus fiscal expenditure is equal to 1% of GDP (since 2007 this has been lowered to 0.5%), so as to maintain a surplus12. Since 2006 part of this surplus, a maximum of 0.5% of
GDP, is channelled to the Pension Reserve Fund and the remaining part net of capital contributions to the central bank is channelled to the Economic and Social Stabilisation Fund. The two funds are sovereign wealth fund, with assets wholly invested abroad. The funds are managed by the central which can then recapitalise the assets every five years (Ministry of Finance 2007, Pedersen 2008). The rule has valid countercyclical properties since it allows for higher conventional surpluses during expansions and it registers lower surpluses or moderate deficits during recessions. Also it provides a sort of fiscal anchor for economic agents. As expressed in Marcel et al. (2001:3) “…considering the indicator’s public nature and wide broadcast, this rule provides an anchor of credibility on fiscal policy which means that the economic agents will know how fiscal policy will react when changes in the macroeconomic environment occur.
As indicated, while the boom has probably positively contributed to both countries’ GDP, only in
Chile this has lead to a substantial increase in government revenues, since Zambia revenues in relative terms have not increased. Revenues in Zambia do increase in absolute terms, but there is not enough evidence that this increase is originated from the copper boom. As far as expenditure is concerned, the fiscal choice has been to save and accumulate surplus in Chile, as regulated by the
12 Marcel et al. (2001) and Pedersen (2008) illustrate the rule as follows. E Bst = Bt – Tt + [Tt (Yt*/Yt) ] – Ct + Cst; where Bst is the structural balance, Bt is the actual balance, Tt are the net tax revenues, Tt E (Yt*/Yt) is the actual tax revenue with Yt* as the potential output and E the output elasticity of tax revenues, Ct are the taxes
from Codelco at time t, and Cst are the taxes from Codelco under a medium term level of the copper price. structural budget rule; whereas, in Zambia the government has spent the additional revenues, mainly into the provision of goods and services.
5 Monetary responses to the copper boom
A specific kind of privatisation regime may influence the impact a commodity boom has on the currency and relative prices not only through fiscal responses, namely through the option to spend the inflow as opposed to save, but also through a complication of foreign exchange management. In this last case the problem is identified by the fact that foreign exchange accrues directly to the market and any accumulation of reserves by the central bank can be done only through foreign exchange interventions which need to be sterilised.
To understand how and to what extent the privatisation regime may indirectly impact on monetary policy responses we shall look here at the effect of the boom on the domestic currency, since prices of tradable and non tradable goods and services are not similarly available. For this analysis one should bear in mind that clearly monetary and exchange rate responses do depend on the kind of exchange rate regime. Notwithstanding the differences in the commodity industry and in the fiscal responses, the monetary frameworks adopted in the two countries are relatively similar.
Both the fully fledged inflation targeting in Chile and the monetary targeting in Zambia maintain price stability as the primary objective for monetary policy. De iure the two countries have adopted floating exchange rate regimes, which postulate no foreign exchange intervention to determine the trend of the exchange rate, no “leaning against the wind”. Accordingly, in Chile very little intervention is usually conducted by the central bank (see De Gregorio and Tokman 2004). In Zambia as seen before the foreign exchange interventions conducted during the boom where not so substantial to offset the appreciating trend of the currency. All in all, then we consider that the two countries conducted no relevant interventions in the foreign exchange market in the years of the boom, implying the currency has been mainly market determined.
Despite these similarities, the impact of the boom on the domestic currency has been rather different, indicating that the combination of inflation stabilising policies with different degrees of private ownership may engender opposite effects.
Figure 10.a Figure 10.b Nominal exchange rate for Zambia Nominal exchange for Chile 8000 1200 6000 1000 800 w 4000 K Z P
L 600 C 2000 400 0 200 0 1 7 1 7 1 7 1 7 1 7 1 7 1 7 1 7 1 7 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1 7 1 7 1 7 1 7 1 7 1 7 1 7 1 7 1 7 m m m m m m m m m m m m m m m m m m 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1 1 6 6 7 7 8 8 2 2 3 3 4 4 5 5 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 m m m m m m m m m m m m m m m m m m 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1 1 2 2 3 3 4 4 5 5 6 6 7 7 8 8 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2
ZKw to SDR ZKw to US$ CLP to SDR CLP to US$
At a first glance, the extent and duration of the exchange rate appreciation in the two economies are very different. The graphs in figure x illustrate how the Zambian Kwacha sharply appreciated at the end of 2005 and after a depreciation it appreciated again from the end 2006 to beginning 2008. The magnitude of the appreciation appears to be more intense if we account for the value of the currency with respect to the Special drawing Rights, as opposed to the US$. On the contrary, the Chilean peso has indeed steadily appreciated since 2003, but while the appreciation has continued up to 2008 if we consider pesos to US$, the currency with respect to the Special Drawing Rights has remained relatively stable, at least since 2005. Thus, it seems that the US$ depreciation may somehow account for the peso appreciation starting from 2005.
Also, when considering the effective exchange rate, thus taking into account the trading partners, the distinction in the two currencies’ behaviour is even more striking. As illustrated in the graph below, while the Zambian nominal effective rate has appreciated sharply mainly in two different occasions, at the end of 2005 and end of 2007, in Chile the currency has been rather stable with respect to the other trading partners in nominal terms.13
Figure 11.a Figure 11.b
13 Chilean trading partners are US, Japan, China, South Korea and the UK. In Zambia these are Switzerland, the EU, the UK, China and the US. Bilateral exchange rates (2000-2007) Nominal effective exchange rate 6000 800 160 5000 700 140 600 120 4000 500 100 $ $ S S
U 80 U
3000 400
o o t t
60 a 300 s h 2000 o c s 40 a 200 e w P
K 1000 20 100 0 0 0
NER Zambia left-scale NER Chile right-scale Chile Zambia
Source: IMF-IFS
The behaviour of the effective exchange rate provides a measure of one country’s competitiveness with respect to the trading partners, which clearly appears to have deteriorated in the case of Zambia.
The limited appreciation of the Chilean peso indicates how the economy has managed to shield from the shock, and has been able to mitigate the pressure on domestic prices and on the currency.
According to Corbo and De Gregorio (2007), the reasons for such behaviour in the exchange rate can be explained by the low pass-through of the exchange rate to domestic prices and the existence of the sovereign wealth funds. The authors illustrate how the low pass-through from exchange rate to prices is mainly a result of the fact that locally produced goods are invoiced in local currency and not in foreign currency which buffers these productions from the currency risk. Then, clearly the possibility to save the inflow into funds abroad has mitigated the pressure on the currency since the foreign exchange is largely kept abroad.
On the contrary in Zambia, the performance of the Zambian Kwacha indicates how the absence of a stabilisation fund together with a higher degree of pass-through has contributed to a currency appreciation. In Zambia, as we shall see, the pass-through is believed to be relatively high and some local productions even if they are directed for the local market are priced in dollars. Had foreign exchange flown into a separate fund the pressure on the exchange rate would have been much less, and the Bank could have directly accumulated reserves without the need to issue money base as the counterpart.
6 Conclusion This paper intends to develop an aspect of the analytical framework for commodity booms. In line with the literature of commodity booms the paper examines to what extent private ownership of mines may matter for the effects a commodity shock has on the economy. Yet, this analysis goes beyond the framework provided by the literature since it also considers the implications for fiscal and monetary policy.
In support of the hypothesis that a large private ownership of the mining sector with a little degree of taxation may complicate the management of a boom and exacerbate its effects, we compare fiscal and monetary responses in Chile and Zambia. Yet, we assume that these fiscal and monetary responses are largely defined by the ownership structure of the copper mines, which in the two countries is substantially different.
The comparison first illustrates how the combination of large trans-national corporations in the
Zambian copper sector and the loose taxation conceded to them has limited the amount of resources that accrued to the government from the boom. On the contrary the share of revenues from mines in
Chile has been much larger and it appears to have contributed substantially to an increase in government revenues both in absolute terms and as a share of GDP.
Secondly, the fiscal response to the boom in Chile has been cautiously regulated by the structural budget rule according to which the bulk of the inflow has been saved in sovereign wealth funds. In
Zambia fiscal policy has indeed been pro-cyclical, as long as revenues net of grants are considered, and spending has been channelled to goods and services which may have further exacerbated the appreciation of the currency.
Thirdly, as far as the monetary response is concerned, little needs to be say with respect to Chile.
This is because due to the cautions saving behaviour the impact on the currency has been limited, thus it has posed no challenges to the inflation targeting regime and consistently with the framework no foreign exchange intervention has been conducted. As for Zambia the situation is very different, since the currency has appreciated due to the spending of the inflow, and this has posed the central bank to a difficult situation since to avoid the appreciation it should have breached the monetary framework.
All in all, the impact on the currency seems to suggest that given the same exchange rate arrangement, economic outcomes on the currency may substantially differ according to the kind of privatisation regime. However, with this argument we are far from concluding that public management is superior to private management as such, since we believe that in the choice between private and public management one should take into considerations additional issues, like efficiency and the history of ZCCM in the 1980s provides a valid example for this. On the contrary, we intend to emphasise the importance of saving of the export receipts, which is really what made the difference between the Chilean and the Zambian boom. Although the issue is in line with the policy recommendation proposed by the commodity boom literature, it is at odds with what maintained by the absorption-spending literature and also by the more recent studies on commodity booms (Collier and Venables 2008).
To this end, we question whether the private sector, especially trans-national corporations, would be as prone to save as the public sector, and we doubt whether their savings instead of being repatriated could be as easily used in funds for the future development of the economy. Thus, what we question is more the possibility and willingness to save of the private sector, and also if they save.
Thus, we maintain that inasmuch saving is the appropriate response to a commodity boom then the possibility and willingness to save tend to be higher in the public sector, rather than in the private one, especially if foreign owned.
Finally, the paper highlights a theoretical point in addition to the one on the relevance of the kind of ownership for the analysis of a commodity boom. This refers to the interconnection between fiscal and monetary response, since different fiscal settings may have different impacts on the economy and may require two distinct managements of the exchange rate. Therefore, we believe that in a commodity dependence-context the choice of an exchange rate regime has to be done in accordance with the kind of fiscal settings and regulation with an eye on the commodity sector ownership.
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