Local Content – a missed multi-billion dollar opportunity

Guest post by Martin Summers

Local Content policies already drive billions of dollars of spending on local suppliers and enterprise development initiatives by foreign investors in the extractives sector.

But the latest industry guidance from IPIECA misses the opportunity to set out a clear and positive agenda for reform.

Reforming Local Content is crucial at a time when nearly $400bn of oil and gas projects – and many in mining, too – have been shelved and many existing ones are marginal, particularly in countries where costs are high – some imposed by Local Content requirements to use local suppliers that are more expensive and often less capable than established foreign suppliers, but with the promise of sustainable local economic development.

This trade off and the high costs were bearable when oil and gas prices were high and the policies were created, but that era has ended. So what should change? Four changes are needed to move the debate on.

  1. An open debate

The first change should be the beginning of an open debate questioning whether some Local Content regimes are still fit for purpose. Although Local Content in some countries has been hugely beneficial, cheerleading for Local Content per se should stop, as it has inhibited debate about the need for fundamental reform in many cases.

Companies are understandably reluctant to drive these debates because they are wary of publicly criticising governments who control their license to operate. Local Content consultancies are similarly compromised, as many work for governments too.

The initiative may therefore need to come from business forums, think tanks, multilateral institutions and experts that are willing to set out a clear reform agenda and principles of best practice in policy

Companies should however be more open and public about their concerns about Local Content, rather than just publicly communicate good news about how they have boosted local economies. Governments are unlikely to take an open, evidence and principles-based approach to policy reform if companies don’t take that approach themselves in their advocacy.

  1. Benchmarking

The second change needs to be a shift from qualitative assessments to quantitative assessments and benchmarking. As the World Bank concluded in a major 2013 report: “existing research is mainly qualitative, with few attempts to measure the economic impact of LCPs [Local Content Policies] and their sustainability over time. This may be due to the paucity of publicly available information on LCPs.”

This change is crucial because governments rarely change policy because of company complaints (about costs, delays and unrealistic targets, etc.) but will if convinced by evidence that other countries have achieved similar goals more effectively and efficiently.

Ideally, Local Content would have the equivalent of the annual competitiveness and regulatory indices produced by the World Bank, the World Economic Forum and Verisk Maplecroft. But such an undertaking could be preceded by small comparative surveys of countries with similar objectives but different approaches, to establish a robust methodology, to provide comparative assessments of the costs and benefits of different regimes and the many different policy tools.

  1. Local Content policy is not the only relevant policy

Too much debate focuses on Local Content policies and not on other policies and wider factors that contribute to the social and economic development that Local Content aims to foster.

IPIECA’s new guidance rightly cites the WBCSD’s list of factors that contribute to the competitiveness of the local workforce and suppliers, such as the broader regulatory environment, capital markets and infrastructure. But discussions of the potential of Local Content policies – to develop a more vibrant SME or technology sectors, etc – rarely take account of these factors.

Indeed, many governments that champion highly ambitious Local Content programmes have not really improved these factors, despite plenty of evidence that they need fixing. For example, Angola, Brazil, Ghana and Nigeria all score outside the top 100 in the World Bank’s annual Doing Business index, which measures the ease of doing business in countries against well-established metrics.

A local company may benefit from Local Content targets but will still struggle to grow in the face of extensive bureaucracy, poor infrastructure and high regulatory costs. I have set out elsewhere how companies can map, mitigate and advocate the necessary reforms to improve these conditions.

  1. An agenda for reform

The new industry guidance has articulated the issues around Local Content well, as have the World Bank, McKinsey, OECD and PWC, but no clear reform agenda has emerged. Its absence, combined with the paucity of benchmarking and regulatory review, means that there is no clear consensus on the right direction for Local Content. Poor policies will continue to spread in this vacuum.

Mexico’s recent decisions suggest a shift away from the sort of very ambitious targets set out by Brazil, but there are many other aspects of Local Content policy crying out for the promotion of best practice.

At the very least, clear principles for reform based on more general regulatory best practice (e.g. OECD’s Guiding Principles for Regulatory Quality and Performance) should be articulated, such as impact assessments, transparency and simplicity – many of which are absent from many Local Content regimes. A recent Innovation Forum conference on sustainability in the extractives sector indicated an appetite for a clear set of policy principles.

These principles would ideally be articulated by a multilateral institution but it would also make sense for an industry body to articulate such principles based on a review of best practice and company experiences. The ICMM’s Principles for Climate Change Policy Design is a good model: it explains why each of the seven principles is needed and what implementation would mean.

Any principles document could usefully build on the five fundamental principles for effective Local Content Policy set out by McKinsey in its 2013 report, namely: 1) Know where the value is and where the jobs are; 2) Understand the competitive edge; 3) Carefully assess the opportunity cost of regulatory intervention; 4) Don’t just regulate—enable; 5) Carefully track and enforce progress.

Local Content done well can bring sustainable and substantial benefits and competitive advantage to foreign investors and the countries and communities they invest in. It’s time to openly debate and reform policies and programmes that fall short of best practice and are no longer sustainable in today’s environment.

Martin Summers is director of Maginot Consulting. martin.summers@ymail.com

More from Martin on this blog:

Sustainable supply chains: Time to treat smallholders as businesses

Why business needs to embrace institutional reform at long last

Also likely of interest: Podcast: Third party risk in the extractives sector with Thomson Reuters

Ian Welsh is joined by James Swenson and Michael Harris of Thomson Reuters. The three discuss unique extractives sector risk, fluctuating prices and changing risk, and bribery and corruption.