When a country goes from authoritarianism to democracy, one underappreciated and unfortunate aspect of the transition is an accompanying increase in corruption. The dismantled repressive apparatus of the previous regime gives way to an increase in political competition, greater demands for political funds, lawlessness, and politicians using the power of the state to extract campaign contributions from business. Something along these lines appears to be playing out in Indonesia, and the phenomenon is spilling into world metals markets.
Indonesia is an enormous archipelagic country of considerable ethnic diversity. When the Suharto regime collapsed in 1998, the country began a transition to democracy, understandably accompanied by demands for greater local autonomy. The central authority exercised by Suharto, his political machine, Golkar, and the military, was weakened. Fifteen years later, the country still faces governance issues.
Indonesia is blessed with abundant natural resources, including copper, nickel, bauxite, and other metals. In 2009 a mining law was adopted that included a 20 percent export tax and a ban on mineral ore exports starting in 2012. The tax went into effect, but the export ban was subsequently postponed until 2014. Earlier this year, the government issued regulations obligating miners to increase domestic value-added, or the contribution of local inputs to the value of the final product. As the target date approaches, few miners have invested in processing facilities, and the country faces a collapse in exports. This possibility has unsettled world metals markets. The government also faces a frenzied lobbying campaign to ditch the law. For fans of political economy, the maneuvering is fascinating. For the rest of us, it is a mess.
Two cleavages have opened up: one between the nickel and bauxite miners who export ore with low domestic value-added, and the copper producers whose exports embody a much higher degree of domestic processing. The other cleavage is between large multinationals and small local miners. The big transnationals differ from the small indigenous producers in that they may not be fans of the mining law, but they have the financial and technological resources to comply. Rusal and Norilsk Nickel, for example, have indicated that they would be willing to invest up to $4 billion in smelter facilities. On the other hand, the big multinationals have less of a stake in local politics than the small indigenous miners.
In recent years Indonesia has run a mining regime in which licenses were needed to export ores. (This requirement was suspended in August 2013 in response to the country’s widening current account deficit.) For nickel and bauxite, much of the recent increase in production has been driven by small local miners, producing for export to China. In the confusion over who ultimately regulates the industry, local officials have been issuing mining business licenses. Local politicians need to fund their campaigns, and the licenses are valuable to the recipient. Out of 175 countries surveyed, Indonesia ranked 114th (tied with Egypt) in the latest Transparency International corruption perception index. The result has been a proliferation of small producers, environmental damage, and smuggling.
In bauxite and nickel, China’s reported import figures exceed Indonesia’s recorded exports by a considerable margin. At an export tax rate of 20 percent, this implies significant revenue losses for the Ministry of Finance. Oxford Policy Management, a private consultancy, estimates the 2012 losses from tax evasion in the nickel and bauxite sectors alone at $527 million, or more than one third of the revenues raised by royalties and land rents. This is not small change.
Benefication, or the requirement that miners engage in downstream processing activities, may or may not make economic sense. The key issue is the relative efficiency of the new downstream processing activities. But rightly or not, the Indonesian government appears to be committed to the program. Unable to meet the benefication requirement, small local producers oppose the initiative and are demanding that the export ban be postponed or terminated. The copper firms have also opposed the law, but on different grounds: The new regulations conflict with their “Contract of Work” (CoW) terms. But the controversy has also created an opportunity to use international policy initiatives to anchor domestic reform.
Globally, the mining sector is being transformed by the Extractive Industries Transparency Initiative (EITI) and the stepped up enforcement of anti-corruption statutes, particularly in the United States and the European Union. Indonesia has begun the process of joining EITI but has not yet been certified by the EITI Board. Of the big multinationals, the copper producers Newmont and Freeport—which account for nearly all of Indonesia’s production—are EITI corporate stakeholders, as are Glencore and Vale. Chalco and Rusal in bauxite are not EITI stakeholders but come under Hong Kong disclosure rules because of their listings on the Hong Kong exchange. That leaves Norilsk Nickel alone outside of any serious regulatory scrutiny. (Its American Depositary Receipt [ADR] trades in New York, but those do not fall under the same Securities and Exchange Commission regulations that a regular listing would.)
The stock market listings are important because they also bring the firms under anticorruption statutes such as the Foreign Corrupt Practices Act (FCPA) in the United States and similar legislation elsewhere. For example, when a corruption case arose in Ghana in the oil sector involving a US-registered firm, the Ghanaian authorities were able to appeal to the US Department of Justice for help in the investigation. The department’s cooperation was facilitated by the FCPA.
These circumstances suggest the outlines of a policy. First, Indonesia should complete the process of joining EITI, as it appears on track to do. Second, it should enforce the export ban, unless the companies credibly commit to building the processing facilities and join EITI, preferably submitting to financial regulation in a market of an Organization for Economic Cooperation and Development (OECD) member country. Indonesia is trying to strengthen its governance, creating a specialized tax team for the mining sector within the Ministry of Finance. But while building indigenous capacity, it should piggyback on to anticorruption efforts in place, as Ghana did when it enlisted the help of the US Department of Justice. Third, Indonesia should grandfather or carve out copper, since they are already processing it domestically. This could be done by setting the threshold for benefication at a level consistent with the current degree of local processing. With the possibility of an export ban of copper removed, the government and the producers could negotiate acceptable taxation under their CoWs.
The net result would be to disadvantage the small indigenous producers and favor the large multinationals in bauxite and nickel, though if any local producers could meet the requirements this would be welcomed. The object is maintenance of best practices, not discrimination. Such a package could result in greater transparency and tax compliance, as well as better safety and environmental performance.
Normally, a policy of favoring big foreign firms over local upstarts would not be appealing to host governments. The reason to tilt in favor of the large transnationals is not that they are angels and the small indigenous producers are devils (though Freeport, a corporate supporter of the Peterson Institute for International Economics, must be saintly!), but simply that the big transnationals are under much greater effective scrutiny with respect to transparency and disclosure than their local competitors and have much more to lose legally and in reputation by getting involved in local politics. The Indonesian government can reinforce this by making the submission to regulatory oversight in an OECD market mandatory. Paradoxically, the large size of the multinationals may not only facilitate best practices with respect to environmental and safety concerns but make them the superior local corporate citizens as well.