Will Government Allow the Diamond Cutting Industry to Perish?

Will Government Allow the Diamond Cutting Industry to Perish?  

 ‘Diarough which owns Teemane in Serowe, will continue to operate its Bhopal factory in India as well as its factory in Thailand and neither they nor De Beers  will suffer the consequences of the job losses in Botswana.’

For the diamond cutting industry the news last week could hardly have been much worse. In January the press reported that MotiGanz and Leo Schachter had laid off 150 workers. Then last week a bombshell was dropped at Teemane Manufacturing Company  owned by Diarough would close with the loss of some 320 jobs in Serowe. This is the bigesst employer in the village of Serowe and the consequences  will be felt for years to come and for what are probably around 2,000 people who are dependents of those employed in the industry. With a total reported employment in the diamond cutting and polishing industry of 3,750 in 2014 this was a massive retrenchment and will cause real pain to many thousands of low income Batswana. This is a time of great sorrow and pain in many households in Botswana. 

Low Productivity and High Costs

In 2013 Botswana is reported to have exported P6.6 billion of polished diamonds making  it by far the biggest manufacturing exporter in the country. Two reasons are commonly given for the sudden rash of closures in Botswana’s diamond sector. The  first is quite correctly a structural one- Botswana, like Namibia and South Africa, is simply not competitive in comparison to low cost and high productivity locations like Surat and Mumbai where most of the world’s diamonds are cut. The second is the squeezed margins. Wages in Botswana are about the same as they are in India but the differences are in the  productivity. Indian cutters will produce 2-3 times as much as those in Botswana.  This is correct but not new and it has been well known since before the establishment of the industry in the 1990’s. The table below presents the costs cutting and polishing a rough diamond in various locations.  Botswana has become more competitive over time but it just cannot compete with India yet but it is a more competitive location than either South Africa or Namibia.

Cost of Processing in Botswana Compared to Other Diamond Cutting Centres

	Approximate Cutting and Polishing Costs (USD/crt)		Approximate Total Cutting and Polishing Jobs		Comment
	2008	2013	2008	2013
Canada	125	140(NWT)	300	50-80
		180(Ontario)
Botswana	45-125	60-120	2200	3750	Diamond producing countries gaining market on the back of
Namibia	45-125	60-140	1500	970	government policy, despite higher costs than traditional manufacturing locations
Belgium	120	150+	1000	150-200	Old cutting locations have lost share of manufacturing following
US	110	300	100	80-100	migration first low cost locations
South Africa	60-100	130-150	1800	1000	and subsequently to producer
Israel	47->55	140-->300	2000	400	countries
Far East	15-35	20-50	29,000	10,000	The trend of growth in low-cost
India	6-50	10-50	850,000	800,000	locations has recently started to reverse

Source: De Beers   2014 ‘Diamond Insight Report’ page 40    

 

Decreasing Rough-Polished margins

This structural lack of competitiveness of Botswana and the rest of southern Africa has meant that, despite growth in employment in Botswana over  the last few years,  they are now all ‘going  south’ in terms of employment in the industry. But what has changed to make it necessary to close so many factories and to lay off thousands of workers across the continent? As can be seen from the chart below since about July 2012 the margins between the price of rough diamonds and 0.5 carat polished diamonds have been narrowing. Even in good times it is said that Botswana’s diamond manufacturers are not  able to make a profit on diamonds that are much smaller than half a  carat polished. 

This narrowing of margins has given rise to some increasingly bad tempered exchanges between Mr Philippe Mellier, the CEO of the De Beers Group and the head of the International Diamond Manufacturers’ Association, Maxim Shkadov, who in January this year claimed that the margins of his members are close to zero. The diamond cutting industry has also fallen victim world wide to a limiting of bank credit to the industry which has made it even more difficult to operate.

…and a bad deal for Botswana and southern Africa

So gross margins are falling in the cutting industry and diamond manufacturers are closing their highest cost operations in Southern Africa. No surprises in any of this except for the fact that the deal that the Government of Botswana made with De Beers in 2004 and revised in 2011 specifically required diamantaire who were DTC (Botswana) sightholders to cut and polish in Botswana. Under this deal these sightholders would eventually get $800 million worth of rough to process here in Botswana. But these sightholders are not fools, they knew at the time that Botswana is a high cost  location, so why did they set up here ? Industry sources have claimed that in the past the DTCB sightholders would get thrown a ‘special stone’ by De Beers occasionally to compensate them for locating in Botswana.  These stones are multi-million dollar diamonds and the profits from one is often enough to compensate producers for low productivity in Botswana. De Beers strongly denied this at the time but now this practice has certainly come to an end. In 2012, the last year before diamond exports figures became confused with re-exports associated with aggregation, Botswana exported some $4 billion of diamonds.

If $800 million or so goes to DTCB sightholders what happens to the other $3 billion that Botswana produces? Well De Beers has many sightholders, 84 according to its web site of which some 21are in manufacturing in Botswana. The rest take their diamonds in what is one of the other four boxes i.e. Namibia, South Africa and Canada where some of these De Beers sightholders have beneficiation obligations. But a large chunk of all the diamonds produced in southern Africa go into what used to be called the  ‘London box’ which,  since the move to Gaborone is called,  an ‘international sight’. Therefore sightholders may get up to 5 boxes of diamonds  at the  Gaborone sights every 10 weeks. But the  so-called London or international  box can be sent anywhere for processing and so in a bear market for polished diamonds, such as is presently the case, the local manufacturers, many of whom have access to a London box, can simply close their factories in Botswana, lose access to their Botswana box but still continue production in India or China.

As Chaim Even Zohar, the guru of the diamond industry, pointed out in a recent statement on the 2004 agreement ‘There were penalties to be paid if the targets (of beneficiation) were not reached. In the current (2011) contract, I understand, the US$ value of local rough sales are still contractually agreed, but there is no agreed minimum employment level’. This was done to allow the companies to use highly automated machinery but will have effect of allowing these sightholders and De Beers to get off without the sorts of  fines in the earlier agreement.

Time to renegotiate the 2004 and  2011 agreement with De Beers?

What has happened to the diamond cutting industry is what economists call ‘regulatory failure’. The closure of the factories in Botswana would probably never have occurred if our agreement with De Beers had said that firms that do not beneficiate a portion of their sites in Southern Africa cannot have access to southern African diamonds … full stop. But instead we have created a complex marketing formula which made the cost of exiting Botswana in the current bear market very low indeed. The firms that closed their doors will continue to have access to Botswana’s diamonds. Thus in a sense the situation where De Beers was claimed to have ‘subsidized rough with rough’ has now been reversed … Botswana provides rough for Indian industry at the cost of our evaporating polished diamond industry. If we had an arrangements which said that only those firms operating plants in Botswana, Namibia and South Africa can have access to De Beers African diamonds the plant in Serowe would probably be open today.

Diarough which owns Teemane Manufacturing Company in Serowe, will continue to operate its Bhopal factory in India as well as its factory in Thailand and they nor De Beers will suffer the consequences of the job losses. Was this foreseen at the time the agreement with De Beers was signed in 2011? Almost certainly not – it was what economists call an ‘unintended consequence’ of the negotiated marketing system.  

Similarly Botswana has imposed beneficiation obligations on De Beers but at the same time we are exempting state owned companies like Okavanago or private ones like Lucara and Gem Diamonds from the same obligations. The buyers from these companies can take their stones and cut in India and so it is becoming easier and easier to get Botswana diamonds without any beneficiation. In this way government policy encourages diamond  trading but undermines our beneficiation efforts.

Policy Failure- Infant industries and Delinquent parents

Most of humanity enjoys making babies… or at least trying. The unfortunate consequence of success is some 20 years of nurturing an infant until it has reached a level of maturity and effectiveness in the world where it can stand on its own feet. That is the minimal definition of a good and fit parent. A delinquent parent abandons the infant at birth without paying the bills, taking the responsibility for proper nurture and assuring proper discipline and gets on with making even more infants. This is an unfortunate but nonetheless good metaphor for the history of industrial policy in Botswana and much of the region. Over 35 years Botswana has created many ‘infant industries’ as they are known in economics and they have almost all been abandoned at birth without the requisite hard work and money to make them work. What we know from the Asian experience of industrialization is that setting up the ‘infant industry’ is the sexy part of policy- but the expensive, boring and very unsexy part is spending the huge amount of money, effort and time and imposing the discipline to make your infant an effective and competitive adult. Most countries fail and that is why they do not develop.

I was reminded by a colleague that some eighteen months ago we attended a meeting between government, the diamond manufacturers association and the other stakeholders who met to form a diamond industry ‘cluster’. We talked about the need to improve productivity but  to the best of our knowledge, nothing ever happened. If Botswana continues to conduct industrial policy towards the diamond cutting and polishing industry in this manner then it will go the same way as the clothing industry and the automobile industry. We need to work with the private sector, the unions and spend what it takes to assure that our workers are effective and competitive. Industrial policy, like raising children, is not a free lunch. In the end diamond cutting must occur here in Botswana because it is a great place to do business but that is not today but may be the product of 20 years of hard work to create a developed competitive and vibrant industry.

In the meantime it is certainly time for Botswana, Namibia and South Africa to reconsider their agreements with De Beers and see  what can be done to assure that diamond beneficiation in Southern Africa occurs in the way it was intended. 

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