Is Julius Malema right? The increasing role of government ownership in Botswana's Mining Sector?

Botswana’s Increasing State Ownership in the Mining Sector

I woke up sweating at what the Europeans know as the ‘devil’s hour’- 3AM. The previous evening I had just finished reading a taxation report. The report was important and as I calmed myself I thought …how pathetic, only an economist can wake up sweating at 3 am over the results of a mining taxation report. But the report has enormous implications for Botswana and all of Africa. It was completed by the reputable  International Centre for Taxation and Development (ICTD) in 2013 came to really significant conclusions. Basically it said that only in Botswana in Africa and Chile in South America, which both have significant government ownership of mining  companies (Debsawana in Botswana and Codelco in copper rich Chile),  have  governments  ever earned  a significant proportion of the revenues from mining. In those jurisdiction where governments rely solely on taxation systems to extract returns from mineral assets, they have gained precious little.

Mining, when it works, is a high rent (profit) business e.g. Debswana. But unless you are on the inside your will never know whether what you are being told by the mining company is exported is in fact accurate. Most countries in Africa, which have limited technical capacity to check, simply take the mining company’s export figures, valuations  and profits for granted.

This is not just a theoretical question for tax economists as it has been the very basis of Julius Malema’s argument for the nationalization of the South African mines when he was still leader of the ANC Youth League. It is a position that Malema continues to support in the South African parliament today as leader of the Economic Freedom Fighters The debate Malema unleashed four years ago terrified South African mining investors but while the debate over how countries benefit from their mineral assets changes its form, it will simply not go away easily anywhere in Africa or for that matter in any resource rich country in the world whether it is Indonesia or Kazakhstan or Venezuela.

The unavoidable fact is that most resource rich countries that followed the dominant advice given to them by the World Bank since the 1980’s that governments should not own mines and should only tax them have proven not to be bid winners. Equally, those that take no risk have not proven to be big losers. The report by the ICTD authored by Olav Lundstøl, makes it very clear that state ownership only really works to bring  economic benefits to a society when  the mines are ‘managed in a strictly commercial manner’.  This is no small caveat because as we know governments are very reluctant to just leave business alone to get on with the business of making a profit.

…. Yes, but what about Zambia?

If state ownership can do such wonders for resource rich countries then why was the Zambian nationalization of its copper mines by President Kenneth Kaunda at independence such a commercial disaster? By the end of the period of nationalization in 1998 the Zambian state mining company  Zambian Consolidated Copper Mines  (ZCCM)  was losing about US$1 million per day. The reason is that copper prices which peaked in the early 1970’s fell dramatically over the next 20 years but just as importantly Lundstol’s caveat was not applied. The mines were not run in a commercial manner. The government mismanaged the commercial side of the business and so it proved to be a monstrous failure that brought Zambian government to the point of bankruptcy in the 1990’s. Zambia was  eventually forced by the World Bank and the IMF to privatize its copper mines as a condition for a financial bailout.

This fire sale of Zambian assets occurred just before the current commodity ‘super-cycle’ which began in 2004 and saw copper and other metal prices sky-rocket under demand pressure from China and developing Asia. In retrospect it could not have a been a worse time to sell. The Zambian government was forced to give ‘away the crown jewels for almost nothing’ and then agree to a taxation regime on the newly privatized companies that meant that government earned very little taxes. This was all done with the technical help of the World Bank and the Commonwealth Secretariat and it was definitely not seen as one of the high points of their policy assistance to developing countries.  

 State ownership of mining and resource companies has gained a new lease of life over the last decade, especially in the BRIC countries where it was the largely state owned enterprises have lead the growth and development of the mineral sector. Vale, the giant Brazilian miner is owned by largely the government of Brazil but has been allowed to operate in a largely commercial manner.  These BRIC largely state owned or controlled companies, from Gasprom in Russian to Vale in Brazil to Sinopec in China have been the driving force behind minerals policies in these countries.

Vale or BMC?

Over the last while the government of Botswana has moved quietly to increase government ownership in the mining sector. Unlike some other policies that are written up in policy statements but are never implemented, this increasing state ownership was not written in a policy document but appears to be happening nonetheless. There has been a  take-over of the last remaining private shares in BCL owned by Norilsk after Anglo American and AMEX sold out. Normally well informed sources in the mining industry suggest that the government, perhaps through BCL, will very soon announce the takeover of the remaining interests in the Tati Nickel mine that is currently owned by the Russian nickel company Norilsk. The government has  established a fully government owned diamond trading company Okavango Diamonds, has established the Botswana Oil Company and is going to establish a  state owned mining company which is likely to be what BCL will eventually become.  

Those who care for Botswana should view these developments in the mining sector as both a real opportunity for the economic future of the country as well as a possible threat. It is an opportunity because for once the role of mining may go beyond just digging holes in the ground and extracting maximum short term profit.  But it will be only a threat to the future of Botswana if we do not apply Lundstøl’s caveat as we did with Debswana. It is possible for government to own a very large share of a mining asset and greatly profit from it but only so long as we allow business to get on with the business of making profits. That often involves truly ugly decisions that no politician likes- dismissing redundant workers and squeezing costs where necessary.

We have sufficient examples in Botswana. In the case of the Botswana Meat Commission (BMC), for example, following  Lundstøl’s  caveat  means shutting abattoirs that don’t make profits such as Francistown, laying off hundreds of workers who are redundant rather than keeping them for years. In the case of BCL, it means shutting mine shafts that are sub-economic or in the case of Tati closing mining operations where there are no more profits because ore grades are too low. It also means not even beginning iron ore operations when world prices hit rock bottom. All this means politically unpalatable job losses.

Is Malema Right…..No, but Seretse Khama  probably was?

Sir Seretse Khama came across an excellent formula for Debswana which is now the envy of all resource rich African countries. The government gets 50% of the profits but Sir Seretse Khama was wise enough to leave De Beers with the business of running the mine and running the diamond cartel and making money. If BCL or Okavango or the Botswana Oil Company turn out to be managed like BMC has been over the years then this will threaten the economic stability of the nation. There are two or three pretty basic ways to avoid this threat. First, is to put any management out to tender on a commercial basis and second is to sell a chunk of the shares to   Botswana citizens and float them on the Botswana stock exchange as quickly as possible. Because the stock market will tell the government and the public right away if the company is being mismanaged. But there is no substitute to government which understands that its strengths do no lie in managing businesses.  

Malema’s road of mine nationalization will lead South Africa and any African country that follows to where Zambia was in 1998. This is because the amount of economic power that governments  possess with ownership of mines make its exercise irresistible of political power ‘in the public interest’ and that is exactly where much of the troubles begins. Seretse Khama’s model of a 50/50 joint venture with Debswana where government does not manage business is one of the main reasons the nation is as relatively prosperous as it is today. The formula precluded unilateral action without De Beers agreement. It is a first class model that Botswana should not forget as we  go ahead with the policy of increased state ownership in the mining sector. The way Botswana proceeds will determine whether we develop strong and healthy state owned companies like the Brazilian miner Vale, or we just produce more loss making BMCs.

These are the views of the author and not necessarily those of any institution with which he may be affiliated.

What will Happen to Botswana as the Diamonds Run Out?

What will Happen to Botswana as the Diamonds Run Out?

On 25^th September BOCCIM (Chamber of Commerce)  and BIDPA (Botswana Institute for Development Policy Analysis)  under the auspices of the Ministry of Finance and Development Planning will hold a one day meeting to present the results of three studies undertaken over two years of work on what will happen to Botswana once the diamonds run out. The studies also look at what needs to be done in the coming years. Some of the predictions regarding the decline in mining revenues and resultant decline in living standards need to be confronted for the nation to advance.

There is increasing concern about what will become of Botswana as the diamonds are depleted. Unfortunately there has been much hype about the fact that diamond mining  is almost certainly likely to continue in the country until 2050. Botswana has been blessed by the discovery of diamonds slightly after independence. At first the Orapa mine was discovered and developed after 1966 which produced extremely large volumes of diamonds that has not been seen since the main discoveries in Russia and even as far back as the discoveries in the Kimberly a century before. Orapa remains prolific as it is a very low cost mine. The only problem was that the mine produced a very high concentration of industrial diamonds which are relatively low value. Approximately half of Orapa’s output was industrial diamonds.  

The discovery of Jwaneng and its development by 1982 produced the richest mine on earth. The Kimberlite produced not only very high volumes of diamonds confirming Botswana as the world’s most important diamond producer, but high quality diamonds with the vast majority being gem quality rather than industrial diamonds. We have now been mining diamonds for over 40 years and will, even based on the current deposits continue to mine substantial quantities for the next 35 years. It is said that at Jwaneng it takes 10 thebe of operating cost to produce one pula of diamonds. There is no such mine on earth-it is rightly called the richest piece of real estate on earth! 

The second blessing that has come with diamonds is that those who managed this massive wealth in the past did not plunder it. One need only look at the record of some, but by no means all of our neighbours and one sees a political elite that has enriched itself massively through corruption and malfeasance. In Botswana the mineral resources have been used to fund education and health programs and huge improvements in the nation’s infrastructure. The results are plain to see- a country that has moved from one of the world’s poorest at independence to a middle income country now. 

While there has been prudent macroeconomic management in the past, some of the wealth has been accumulated in the nation’s so-called sovereign wealth fund the Pula Fund. But as the diamonds become depleted we shall probably conclude that we did not save enough for a rainy day… and the rain will certainly come.

What will happen over the next fifteen years

 The great wisdom of those who ruled in the past was they did not listen to the prevailing advice that was offered to them by international institutions. Throughout the 1980’s and 1990’s the World Bank was consistently advising countries that they should not own shares in their mines and  helped many like Zambia to privatize their mines, often on terms that were not to the country’s advantage.

In Botswana a different path was taken. Debswana, unlike the copper mining interests in Zambia was never fully nationalized. The agreement was that the company would be owned 50%/50% by De Beers and the government. This would mean that decisions had to be made by consensus. But more importantly the private sector was left to run the business as a business, there was no attempt to politicize business decisions as was the case with other enterprises such as BMC or in the mining sector in Zambia in the early 1990’s. It is this that has been the great secret of Botswana – joint profits but business was allowed to get on with the business of business i.e. making a profit. Not only did Botswana own 50% of Debswana it became a significant partner in De Beers itself holding currently 15% of the value. The vast bulk  of the revenue that the government receives from mining is not from taxation but from dividends and royalties which in 2013 made up P9 billion while taxes from minerals were P4.2 billion.

The fact that such a large proportion of the revenues from mining come from dividends and royalties should give some indication of what will happen as we have to dig further and deeper to extract diamonds. Profits which have been extraordinarily high at the nation’s mines will start to fall as the cost of extraction rises. This is a typical end of mine life scenario and should not be surprising to anyone in the industry. There will be no immediate ‘cliff’  but revenues from diamonds will probably start to fall off slightly  from the end of the current decade and then sharply as diamonds production is expected to fall in the period post 2026/27. At that time, if not well in advance, severe economies will have to be made and considerable  economic pain will be felt. 

What the numbers say….

Dr Fichani and Mr Freeman, two eminent mining specialists were hired by BIDPA to help develop models of what would happen to the mining sector over the next fifteen years. In their most likely or ‘base case’ none of the propitious mines in coal, copper uranium, coal bed methane would be developed in time to arrest the decline in diamond revenue. But most startling is that even in the best case, even if all the propitious deposits were developed by 2026/27 this would not generate enough revenue to compensate for the fall off of government revenue from diamonds when the decline in output really begins. In other words the main conclusion of the report is that even if everything went really well with new mining project we are still likely to face a major fiscal crisis post- 2026/27 and we need to prepare ourselves.

The next article will look at the implications of the fall off of government revenues on living standards in Botswana.  These are the views of the author and not necessarily those of any institution with which he may be affiliated.

 

 

 

The International Diamond Trade - A very rough business

The International Diamond Trade - A very rough business

It is said in the diamond business that each rough diamond crosses at least three borders before anyone even tries to cut and polish it. In 2012 total world diamond production of mined diamonds stood at some 128 million carats of diamonds at a value  US14.5 billion. But the total imports of diamonds as recorded by all countries in the Kimberly process which exists to regulate ‘conflict diamonds’ was three times this figure at 393 million carats valued at some $50 billion. So without cutting a diamond their value had risen from $98 to about $125/carat.

The first time a rough diamond crosses a border it is from the country of production in Africa, Canada or Russia to where it is aggregated which was until very recently in London at De Beers office at Charterhouse. Under the 2011 marketing agreement between Botswana and  De Beers aggregation of diamonds  is now returning to its geological home in Africa ie Botswana so diamonds produced by De Beers in Canada, Namibia and South Africa will go to Botswana rather than to Charterhouse in London, the former capital of diamond aggregation.

The second time a rough diamond  crosses a border it is often traded for ‘cleaning purposes’ i.e. either to clear it of any possibility that the owner will ever pay  a penny in income  taxes in another jurisdiction, to gain other commercial benefits  or just simply to launder money from other businesses  and increasingly to fund criminal activities. The beauty of diamonds lies not just in their appearance but their high value to weight. This has always made them easy to smuggle and because of their natural scarcity as well as the De Beers cartel they were, in the 20^th century, a good hedge against inflation  and economic and political crises. But increasingly organizations like the OECD are taking a keen interest in diamonds and their  use for money laundering and funding of terrorism. A major publication by the OECD on diamonds and money laundering is expected in the coming months.

The third time a rough diamond crosses a border it is to be cut and that normally is in India which despite the pretensions of the Southern African countries like Botswana, South Africa and Namibia  is basically where 80-90% of the world’s diamonds were cut in 2012. India regularly boasts that 14 out of every 15 diamonds set as jewellery in the world were  processed in India. For India diamonds are amongst its biggest export sectors responsible for exports US$ 43 billion (14% of total exports) in the financial year 2011-12. Diamond production is one of the leading growth sectors of India’s economy with an estimated 1 million jobs.

Dubai  and Switzerland – laundries of choice?

The equivalent of about half of the world’s production of rough diamonds passed through the Dubai Diamond Exchange in 2012. In the 21^st century it is rapidly replacing Antwerp and Tel Aviv as the trading centre of choice. In 2012 Dubai imported some 60 million carats of rough and exported virtually the same volume. So what were the diamonds doing in Dubai? -  The short answer is they were increasing in value. The average price of the 60 million carats of rough entering Dubai in 2012 was $78/ carat and when the same volume of rough left it was worth $112, an increase of almost 45% which is what you would expect from trade with a country that offers businesses a 50 year tax holiday.  Make your profits in the tax haven and there are no issues with those very few countries that are still taxing ‘diamantaire’ on what they say their income and profits are. Because diamond traders are notoriously  economical with the truth when it comes to the real price of diamonds most diamond jurisdictions like Belgium and Israel  have long ago dispensed with  the nicety of even asking ‘diamantaire’ what their incomes are and have moved to presumptive taxes based largely on turnover.

But evading income tax in the diamond industry where there are potentially thousands of different grades of diamond which can make the appearance of low or zero profits almost pro forma certainly predates the ease and simplicity of evasion that tax havens like Dubai and Switzerland created.  One the most important commercial benefits of these havens lies in the secrecy they permit when it comes to the corrupt trade in diamonds. Let us say you are a corrupt official of a diamond exporting country. Assume that you have a shipment of USD 100 million of diamonds that you value it at $50 million. This allows the trader to avoid the payment of export taxes or royalties and to split the benefits with the corrupt official. This is amongst the more profitable of rough diamond transactions but you need a place where secrecy is respected and where you can realize the full $100 million value of the transaction by trading with a related company.

Dubai’s imports of rough in 2012 came from several very conflict prone producing countries in Africa including Congo (DRC), Zimbabwe and Angola. Not one of these countries has had a happy history with diamonds and Zimbabwe and Congo have had their share of problems with the Kimberly process itself. If the Kimberly statistics are to be believed then three quarters of Zimbabwe’s 12 million carats of diamond exports in 2012 went straight to Dubai. The importance of Zimbabwe to Dubai is such that permanent secretary of Mines and Mineral Development in Zimbabwe is, as a regular matter appointed to the board of the Dubai Diamond exchange. Almost one half of Angola’s production and one queater of DRC’s production was exported to Dubai and one quarter of DRC total production of 21 million carats went there as well. But this is by no means where the bulk of Dubai’s trade is coming from. Of course it would be easy to blame the three weakest African  producers but the real magnitude of the Dubai’s trade with Africa is small stuff when compared to the two biggest users of tax free trading environment. – the EU and India. India imported roughly a quarter of its rough diamonds through Dubai and the rest from Europe. For Dubai exports to India in 2012 were approximately half of its total exports of rough. Thus it remains an entrepot for African rough going into India for processing.  The other main trading partner with Dubai was the EU which has been one of the main destinations for exports. It is by no means simply Africans and Indians using Dubai as a laundry service of choice.

Round tripping –scamming the Indian export incentives 

Dubai also has a thriving polished diamond market where its tax free environment has lead to massive growth and the country becoming one of the truly great diamond centres of the world. But there is another reason for this burgeoning trade in rough and polished diamonds. Until early this year India allowed the import of polished diamonds duty free while simultaneously providing financing subsidies to stimulate the exports of  the country’s largest export. The ever industrious Indian diamantaire, developed a new technique of ripping off their national diamond trading system called ‘round tripping’. The Indian government has long provided subsidized export credits at subsidized rates for the diamond sector and these subsidies were very lucrative but dependent on the export of cut diamonds. So some of the Indian traders would ship the same consignment of cut and polished diamonds five or six times across the Indian ocean to Dubai claiming export credits each time. But this illicit trade went full circle because the Indian authorities also required the Indian cutters to show that they had processed the rough and so they would have to ‘round trip’ rough diamonds as well as cut and polished and so volumes in this very rough trade also increased massively until the Indian government finally imposed a 2% import duty earlier this year on imported cut diamonds. With gold prices tumbling, import duties on gold in India rising the Indian government is set to increase the import duty on cut diamonds yet again to 5% in the coming weeks. As there remain several commercial reasons for round tripping, not just skimming for export credits, this may decrease the trade significantly across the Indian Ocean.   

Dubai is by no means the only country that plays the role of entreport for the free wheeling trade in rough diamonds but it is now by far the biggest. Its importance is a reflection of the shift in international trade patterns that  increasingly excludes Europe and  brings Africa and Asia closer together. For many years Switzerland has performed a similar function. Now Dubai as well as several provinces in China are starting to swamp the traditional tax havens and are gaining an important place in the global diamond market. And in the meantime the world’s diamantaire will continue to claim that they make no profits from diamonds in the middle of the pipeline and schools and hospitals will not be built in Africa and India.

These are the views of Professor Roman Grynberg and not necessarily  of any institution with which he may be affiliated.

Synthetic Diamonds and the Reform of the Kimberly Process

Synthetic Diamonds and the  Reform of the Kimberly Process

‘The moment the average divorcee finally becomes aware that diamonds are no longer rare, and can be made, as Karl Marx once famously said ,  ‘as cheap as bricks’, then the diamond ring she has in the jewellery box from her last failed marriage, which she believes is appreciating in value every year will suddenly hit the market and then we will all discover that diamonds are not forever.’   

For a decade now the world has been engaged in what has been seen as a battle against blood diamonds i.e. diamonds that have been used to fund wars in countries like Sierra Leone, DRC and Angola. The Kimberly process, has been a unique but flawed example of an attempt at global co-operation by producers and consumers to stamp out blood diamonds. That the Kimberly process even succeeded in being established is because it was in just about everyone’s interest for it to do so. No-one in the diamond business needed these stones which are sold as symbols of love being associated with war and bloodshed. Moreover, the blessing of the World Trade Organization and the UN to restrict the trade of blood diamond did much to help do what the De Beers cartel could no longer do in the 1990’s. Unfortunately not all went to plan as the Kimberly process did not come with a system of traceability.

The Kimberly Makeover

The Kimberly process is named after the town in South Africa where in the 1860’s Cecil Rhodes, who owned De Beers and was the first of the great African war lords, made his millions in diamonds and went on to use those funds for the pillage of Zimbabwe. Kimberly,  a name that should go down in infamy as the first source of blood diamonds in Africa,  has with a rare marketing brilliance, rebranded itself and has become synonymous with the good governance in the diamond industry. Given its history it is a truly spectacular marketing makeover, almost as big a marketing coup by De Beers  when in 1948 it introduced the marketing slogan that ‘diamonds are forever’ which convinced every poor consumer in the western world that if he wanted to really demonstrate love for his fiancée he would need to part company with at least two months salary to buy his beloved a diamond engagement ring. Diamonds, like his love and despite the high divorce statistics,  were supposed to be forever and if the love was not going to last forever then the diamonds were supposed to stay forever off the market. As long as the diamond rings stayed off the market supply could readily be controlled which it was at least up to the end of great De Beers cartel, the Central Selling Organization (CSO) in 2000.  As long as De Beers could assure buyers that in the longer term that their diamond rings would be a real store of value rising by at least the rate of interest after taking into account inflation then diamonds were indeed forever.

But now it is Zimbabwe and the De Beers success in the marketing of diamonds that is requiring a fundamental change in the decade old global consensus around the Kimberly process. For NGOs like Global Witness, which were amongst the original drivers of the war on blood diamonds,  the multiple sins of the diamond industry went well beyond the funding of Africa’s wars.  The abuses of human rights at the alluvial Marange diamond fields as well as the use of child labour in cutting in India were all human rights issues that needed to be addressed. But many of the participants in the Kimberly process want no part of an expansion of its mandate beyond the narrow confines of what are conflict diamonds. Like all international organizations the Kimberly Process is made up of 54 countries and works on consensus and many of the participants who profit from a system without real traceability want no part of the extension of its mandate to human rights or to polished diamonds.

But some participants in the Kimberly process like the US as well as NGOs like Global Witness which withdrew from the Kimberly process in 2011 want to see fundamental reform. The Kimberly certificates, which allow trade in parcels of rough diamonds  are issued by governments and are in some, but not all cases are simply not credible. Because there is no system of traceability of  rough and polished diamonds some certificates cannot be trusted. Conversations between diamond traders will inevitably turn to the cost of the bribe one has to pay to launder one’s diamonds in one or other jurisdiction. It was also in the interests of the major diamond mining companies to control the value chain for diamonds and to get the international community to do voluntarily what De Beers had so effectively done as a cartel for 80 years. But without traceability it was simply not far enough.  

Synthetics – real diamonds but not real value

The De Beers marketing campaign has not yet run out of steam and as more and more people enter the urban upper middle classes in China and India, the more diamonds are becoming part of Asian engagement ceremonies. As a result, diamond demand  is rising in Asia but diamonds, at least in nature, remain rare and supply is not keeping pace with the success of diamonds. Enter synthetics!

In the  early 1950’s synthetic, as opposed to imitation diamonds, were first developed. At first the synthetics were only used for the production of industrial diamonds. Up until the late 1990’s the technology to create these synthetics was dominated by three companies, De Beers in Europe (Element 6), General Electric in the US and then Sumitomo in Japan. The three flooded the industrial diamond market with millions of carats and the price in the US and EU collapsed over a period of three decades. But suddenly now the technology for making these near perfect copies of mined diamonds, which are virtually undetectable to the naked eye, is no longer dominated by the traditional producers. The big boy on the diamond block is no longer Botswana or Russia and certainly not South Africa but China, which with no diamond mines to speak of, has entered the market and is now the world’s biggest producer of diamonds selling what the US Geological Survey estimates to be between 6-10 billion carats of diamonds for largely but not exclusively for industrial uses. Total world production of mined diamonds in 2012 was only about 128 million carats.

In most countries gem diamond traders and retailers are supposed to inform buyers whether the goods they are buying are mined or synthetic. However, despite the best efforts of De Beers to brand some of its own diamonds, develop machines that can, at a price, detect synthetics and work with agencies such as the Gemmological Institute of America to issue certificates to differentiate mined from synthetic diamonds more and more of these synthetics are entering the gem market without being detected. But with the smallest of diamonds below 0.2 carats called melees the cost of detection of an individual synthetic diamond is so high relative to their price that significant penetration of synthetics into the mined diamond value chain has already occurred. Unless the whole diamond value chain can be controlled from ‘mine to mistress’, and this can only be done with a system of traceability, then diamonds almost certainly have no future as a store of value. The moment the average divorcee finally becomes aware that diamonds are no longer rare, and can be made, as Karl Marx once famously said ,  ‘as cheap as bricks’, then the diamond ring she has in the jewellery box from her last failed marriage, which she believes is appreciating in value every year will suddenly hit the market and then we will all discover that diamonds are not forever. 

The biggest threat to diamonds is no longer blood diamonds or the effect of Marange or child labour exploitation in Surat but synthetics.  One large diamond trader in South Africa said to me that he knew that the synthetics that he sells in increasing volumes would kick the bottom out of the lower end of the mined diamond market. But he assured me this was only the bottom end. Unfortunately most mined diamonds are very small – about 80-90% of stones are under half a carat. If this market collapses the profits from the entire mined diamond sector will collapse with it as well as the stock market funds for further diamond exploration.

There is at least a partial confluence of interests once again. It is in virtually everyone’s interest in the diamond industry, even the synthetic producers, not to allow the value of gem quality diamonds to follow the experience of industrial diamonds. But markets are markets and they are driven by human greed and what is true of China as a whole is certainly not true of each individual synthetic producer in China. To control the supply of diamonds, both rough and polished can,  be done by extending  the mandate of the Kimberly Process beyond its current mandate of rough diamonds. This was recommended in a draft report late last year on the Kimberly process by Harvard University and the so-called Multi-Stakeholder initiative integrity. Extending the Kimberly process to polished diamonds will require a system of traceability which those in the low profit middle of the diamond value chain will find difficult to afford. Moreover, those who profit from issuing of Kimberly certificates for laundered diamonds would also lose and would certainly oppose such an extension.

Consensus will not be possible

Much to the chagrin of the South African government the Americans are using the developed world’s proxy of choice, the Organization for Economic Co-operation and Development, as they did in the past over tax havens a decade ago, to impose a new trading regime on the developing countries without any real consultation. It is a fundamentally undemocratic process and yet it is in the interests of virtually all participants that the Kimberly process be extended from rough to polished diamonds. It will then make the Kimberly a truly global standards body. But the South Africans are mistakenly leading the charge because they believe that all countries need to be consulted. While it is also in Zimbabwe’s and DRC’s interests that the value of diamonds not collapse, they will not voluntarily agree to a global trade regime which imposes higher human rights standards on them.

The mined diamond industry is living on borrowed time and unless it is able to show developed country consumers that the products they are buying are both ethical and mined and hence rare, then the industry’s demise seems only a matter of time, just as happened with industrial diamonds two decades ago. Only a truly global process that offers traceability of rough and polished diamonds ‘from mine to mistress’ will give the NGO’s and the US the instrument of control of human rights in mining that they seek. By extension this same system, will also give the industry the instrument it needs for diamond to survive as a store of value. Seeking global consensus from individuals that profit from illegal trade and laundering and with countries that will not agree to heightened standards will only delay the process of establishing a global diamond standards body and time is not on the industry’s side.

These are the views of Professor Roman Grynberg and not necessarily those of any institution with which he may be affiliated.

Germany Exports More Coffee than All of Africa!

Why African coffee isn’t worth a bean!

Perhaps the one thing that stands out the most in the international coffee trade is not its obvious injustices of African , Asian and Latin American coffee growers which get  some 7% of the value of roasted coffee sold in super-markets. The Fairtrade people have complained  for years and have made some impact when it comes to farmers returns for their coffee. An even more glaring issue is the coffee trade  of countries like Germany which  has grown so rapidly over the last decade  that it now exports more coffee than all of Africa  put together. According to the International Coffee Organization, in 2011 African countries exported some 10 million bags (60kg each) or about 9% of total world production. Germany, without actually growing  one bean, exported or more correctly re-exported, 11.9 million bags of coffee in the same year. The value of those German coffee re-exports was approximately USD3.6 billion in 2011. In 2010, the last year for which coffee value figures were available Africa’s total coffee exports of around USD 2 billion, not worth a bean when compared to the German coffee exporters.

In coffee- Germany rules OK!

The irony of all this is that European firms often don’t even  add a great deal of value to the coffee- they often  merely re-exported unprocessed green bean, which was half of Germany’s total coffee exports in 2011.  Germany has done for coffee what De Beers has done for a century for diamonds, they aggregated without adding any value. The remainder of German coffee re-exports was sold as roasted  (about 3 million bags) and a further 3 million is made into soluble coffee ie Nescafe which Latin American coffee aficionados rudely call ‘Non es cafe’, or translated to mean ‘it is not coffee’.

Why Germany has become a linchpin in the international trade in coffee is fascinating to those who think that what it is doing is precisely the sort of activity that developing African countries ought to be doing. The problem is that roast coffee looses freshness quickly and hence while you do not have to roast the coffee in the place it is consumed, proximity along ‘the value chain’ is considered important in explaining the strategic positioning that Germany has  achieved. This is one of the reasons so commonly cited for why African coffee exporting countries have been confined to the export of unprocessed beans to places like Germany. Germany exports the vast bulk of its coffee to neighbouring countries in the European Union and some to the USA. Unlike Africa, its first class logistical connections are both quick and efficient and it can get the product on the supermarket shelf in Poland or Austria and maximize shelf life.

Concentrated Value Chains

          But the trade in coffee gets more complex when you look at the structure of the companies one trades with. Most of the industry has  traditionally been  dominated by four large coffee traders ECOM, Neuman, Luis Dreyfus and Volcafe which together control 40% approximately of the world coffee trade.  Tchibo which advertises itself as only using pure Arabica and not lower priced, low quality robusta coffee.  Half the global market for roasted and processed coffee is controlled by five companies Kraft, Sarah Lee, Nestle, Proctor and Gamble and Tchibo. Nestlé’s Nescafe is said to control about 50% of the world market for instant coffee. While the coffee market is relatively highly concentrated and this helps explain why countries in the developing world which have tried to beneficiate their coffee have generally failed to do so it is simply not enough because unlike high tech export sectors, roasting coffee while requiring skill is not rocket science. The barriers to Africa getting its beans roasted and sold are both logistics and marketing.

Roasting coffee- not rocket science!

Most rich countries do not maintain high tariffs for roasted coffee and in most cases it is duty free from all sources, though not in Europe. Unlike complex food products or other beverages the sanitary constraints on coffee are fairly limited even in a sophisticated market like Europe. Roasting coffee requires no enormous skill or technology so what stops African countries from beneficiating their green coffee beans? The problem is that with almost every product that one considers there is a market constraint that is often binding that limits African producers moving down the value chain to getting more value added. There is certainly sufficient incentive as the price of good quality green beans is USD 3.30/kg in April 2013 while roasted coffee in the supermarket in southern Africa retails at prices at USD18-25/kg. So why no value added in Africa?

Papua New Guinea, like so many African  countries,  spent an entire decade from the mid-1990’s onwards trying to export its high quality low caffeine, organic Arabica coffee into the world speciality market. Despite its duty free access to Europe and Australia there were scores of constraints to even moderately well resourced companies with considerable government financial assistance from penetrating developed country markets. Most had to do with getting the product onto the market. Roasted coffee had to be marketed in such a way that attracted customers. Therefore large amounts of advertising were necessary in each market.  Exporters had to get special packaging material which allowed a vacuum pack to preserve  the limited shelf life but simultaneously allowed the coffee aroma to penetrate the packet in the super market. The biggest constraint was getting the product on to the supermarket shelf. New coffee exporting companies have to pay for getting shelf access in many supermarkets and the product would be pulled from the super market if it failed to deliver the desired level of sales.  Despite millions of dollars in subsidies spent in attempting to develop the roasted coffee market  in both Europe and Australia today more than 99% of total PNG exports of coffee remain green beans. This experience has been replicated all over Africa.  

This ‘German coffee paradox’ is very much a direct result of the first class logistics that allows the export of freshly roasted coffees something that is difficult to achieve in more challenging environments like Africa where delays in delivery are common and can result in greatly diminished shelf life for a roasted coffee product. It is also the product of consumers who want particular European brands and has meant that African countries have never been able to  export.  

Brazil’s ‘Non-es-cafe’ wins

           By contrast countries like Brazil, Columbia and Ecuador have succeeded in coffee beneficiation where Africa has not. They have both played it smart and not played by the rules of free trade given to them by the USA and Europe. These countries succeeded because they  moved to the soluble or ‘Non Es Cafe’ end of the coffee market. Brazil is now not only the world’s largest exporter of green bean, s it is also the world’s largest exporter of soluble coffee. This it achieved through a series of policy measures in the 1960’s and 1970’s which imposed high export taxes on unprocessed coffee and allowed domestic producers of instant  coffee to avoid these taxes. This gave a very substantial local Brazilian firms that started producing.  The North American and European producers of ‘non-es-cafe’ simply could not compete and many moved to Brazil to take advantage of the export tax regime. Being the world’s largest producers as well as the second largest consumer of coffee meant that these companies stayed and increasingly used it as a natural platform for their exports.
          Size really matters

If Africa wants to beneficiate the lessons of Brazil and the other Latin Americans are clear- this will only be done where there are local champions and commercial advantages created by governments along with policy makers who understand markets and value chains. But in coffee, as so many other endeavours size really matters, and no-one is bigger than Brazil. African countries simply do not have the same export volumes to follow exactly what Brazil did in the 1970’s but the ingredients for success are the same.

   These are the views of Professor Roman Grynberg and not necessarily those of the Botswana Institute for Development Policy Analysis where he is employed.

The SADC Economic Partnership Agreement with Europe- Hold your nose and ratify!

The Economic Partnership Agreement with Europe- Hold your nose and Ratify!

Before they went away on the one truly ‘religious’ festival in the EU calendar- the month long summer vacation each August, EU trade negotiators hurriedly initialled the Economic Partnership Agreement, a free trade agreement  between several SADC countries and the European Union. With this agreement which has been 12 years in the making, the  most important thing to celebrate  is that it is finally over, and there will be no more tedious lectures from EU officials and diplomats about how generous the EU is to Africa in providing trade agreements that are so concerned with development. I had the distinction of being in the room when then EU Trade Commissioner Pascal Lamy announced that the EU would negotiate an agreement with  all the African Caribbean and Pacific(ACP) states that was truly based on development. No-one could have imagined a dozen years later the agreement would ultimately be so concerned with the EU’s development rather than that of Africa.

What is so noxious?

The EPA  will give Botswana  quota free and duty free market access to the EU market for beef along with virtually all other products. How could anyone think this is a bad outcome? Under the old Lome´ Convention and subsequent Cotonou Agreement Botswana had fixed quotas established by the EU on the amount of beef we could export. This was set at  around 19,000 tonnes. Of course we never achieved this volume of exports, not even close, so eliminating the quota is of no commercial significance because it never effectively held back our beef exporters. We also used to export almost all our rough diamonds to the EU and some copper/nickel matte but these are duty free no matter what the source so the  EPA is commercially  meaningless there. In the past we used to export large amounts of garments to the EU. In 2007 exports of garments to the EU reached a whopping P1.1 billion before disappearing to virtually nothing within five years. This was a result of the full effects of garment sector liberalization at the WTO which were only felt throughout Africa and the world after 2005.

Of Sugar and Hangovers from Cheap Wine Negotiations

But the real big winner of the EPA has not been Botswana or Namibia but South Africa. When South Africa was finally liberated from the grip of apartheid the EU, in a rare and uncharacteristic moment of generosity got teary eyed and offered South Africa  an extraordinarily generous trade agreement. At the time trade negotiators called it ‘the Mandela effect’. The EU  gave South Africa first class access for agricultural products as well as South African plonk which has always been one of the most important issues for SA negotiators. While EU Trade Commissioners and their officials could get sentimental about Mr Mandela the  Portuguese, Spanish and Italian wine makers were having none of it, and  they forced the commission to effectively renege on the access that they had negotiated for SA wine producers. The SA trade negotiators, ever practical, reluctantly agreed knowing well they would get a second bite at the grape, so to speak,  when it come to the negotiations of the EPA. The EU knew this as well- the EPA might in theory be about all the small African states like Botswana and Namibia but unless they could buy off the South Africans there would be no deal because the South Africans could use their power in SACU to stop smaller states from signing. And so the really big winners from the EPA were the South Africans who got a significant increase in their market access for wine ( from 47 million to 110 million litres),  sugar producers who got a duty free quota of  150,000 tonnes as well as 80,000 tonnes of ethanol. So if the EPA was supposed to be about the small countries in SADC like Botswana (beef) and Namibian (grapes and  fish) and Swaziland (sugar) then how is it that  SA ended up the big winner? Simple… the more things change, the more they stay the same!

The four headed BRIC Hydra

Sometime around 2004/5  I noticed a quantum change in EU officials and it was most evident in their attitude to the BRIC countries. Up until that time the Europeans were at forefront of the ‘rah-rah brigade’ of globalization. ‘ Look how globalization is lifting up these developing countries’ they would tell the ACP countries … ‘you Africans, Caribbeans and Pacific islanders  should follow them’. Then suddenly the attitude changed when it became all too obvious   that the high Russian export taxes on gas and petroleum were giving Russian energy intensive firms a massive advantage over the EU and that India was likely to dismantle the EU service sector with their competitive service export firms. Inefficient and subsidized agriculture in Europe was going to be destroyed by hyper-competitive Brazilian farmers and finally the Chinese would ultimately eliminate what little was left of European manufacturing. Suddenly from the vantage point of Brussels and London globalization was now seen as a threat to Europe and much less as a commercial opportunity.

At that time in the EPA negotiations the EU attitude also changed to reflect its much darkened protectionist mood. It was personalized in the form of the move of Pascal Lamy as trade Commissioner, to the WTO and his replacement by Lord Peter Mendelssohn, aka ‘ The Prince of Darkness’ as he is not so affectionately known in the British press. The EPA negotiation started to become not about what was even in theory good for the ACP countries but what the EU needed in order to sign. Legally, the EPA was supposed to be completed in 2007 but has dragged on for another seven more years because it was the EU that would not sign any agreement that permitted ACP countries the unrestricted use of export taxes even though they are perfectly legal under WTO law. The EU also insisted that in future anything the ACP countries gave the BRICs would have to automatically be given to the EU etc etc.

Learn to say ‘Ni hao Zhongguo’ ( hello China) !

Botswana will get almost nothing of commercial value from the EPA, despite all the hype that will follow. We will maintain our preferential access for beef and the BMC will continue to eat up those benefits with its production inefficiencies. The few economic benefits that Botswana as a country does get will help cover the massive and increasing cost the taxpayer has to pay for the cost of the Department of Veterinary Services to assure that   our framers can comply with ever rising EU heath and food safety standards.  Soon we will need to look for new beef markets as already high food and health standards in Europe will continue to rise but unfortunately the very high EU prices for beef that we are have been getting of late are likely to lull those responsible to sleep.

Nevertheless, we must sign and ratify this agreement with the EU, not for the subsidy it provides to BMC or for the farmers but because our relationship with Europe is at the very core of the nation’s geo-political DNA. Botswana is a small country in a not so good neighbourhood with some really bad and aggressive neighbours around us. Batswana have known this fact since the three dikgosi went to London to seek the protection of Queen Victoria from the Boer Republics and Rhodes in the Cape Colony. For the moment we still need Europe and even though the EPA is clearly meant to limit our ability to conduct trade policy in future, and will help South Africa far more than anyone else, the nation needs to hold its collective nose and ratify this odious agreement. But it is the geo-political rather than commercial needs that are the only really good reason to ratify. After all in 30-40 years time, when our children have all learned to speak Mandarin fluently and Europe is as relevant to Africa as the Carthaginian Empire, we can still tear up the EPA because China, unlike Europe, is a rising power will not have to ask such things in order to protect its commercial interests in Africa. It will have other tools!

These are the views of the author and not necessarily any institution with which he may be affiliated. The author was, much to his subsequent regret, responsible for the EPA negotiations for the Pacific Islands until 2006.