A perspective on local content

Noise around local content

Guyanese have been clamouring for local content provisions in their relationship with ExxonMobil since it became obvious that oil production will be undertaken by the multinational oil giant.  The preparation for Exxon’s continued upstream operations has led the company to signal its intention to acquire certain skills, services and even goods to carry on its business.  While the noise around local participation in the oil industry brings Exxon into the picture, the issue really applies to all foreign investors who will need inputs into their production processes.  But what some writers have pointed out is that the demands for local content policy have been more pronounced in the oil industry than in other industries.  Countries like Brazil, Kazakhstan, Malaysia, Mexico, Nigeria and Uganda have been cited as examples of where there has been an insistence on the need for local content in the oil industry.  The issue of local content is not as straightforward as it seems on the face of it.  With the adoption of internationally-agreed trading rules in 1994, local content has become something of a pariah.  It is a policy concept that countries have been discouraged from using since restrictions on its use became an integral part of the trading rules that govern trade between countries.  In some of the local stories written about local content, it is often presented as if it is a right and one that cannot be challenged under the rules of the global trading system.  This article seeks to provide some perspectives on the matter of local content. 

 

Policy measure

In presenting views about local content, it is important to understand what the concept represents.  Local content refers to the purchase of certain goods from domestic sources by foreign investors as a condition for having the investment proposal approved.  Even if the investment proposal is approved, foreign imports could be made uncompetitive by paying higher duties that make them more expensive than locally-produced products.  Local content is not discussed in a vacuum.  It is discussed in the context of foreign investment and the protection such investment enjoys under international trading rules.

It is not a trivial matter either.  The provisions about local content fall under the rules pertaining to trade-related investment measures or TRIMS.  One important thing to note is that TRIMS is about foreign investment and how goods, not services, can be acquired for use in investment in a host country by the foreign investor.  Local content is therefore seen as a policy measure aimed at stimulating demand for products produced within a country by using the foreign investment as a guaranteed or captive market.  Therefore, local content serves as an economic tool to help boost investment by local producers and to help develop industries around locally available products.  Local content was designed also as a means of ensuring that foreign investment helped to build local capacity, including the creation of jobs.  While the sponsoring country sees domestic value and merit in the use of local content policy, those against whom it is directed do not.

Foreign investors have their own reasons for coming to a country and investing.  Where host countries have large internal markets, foreign investors may prefer to produce goods and services in those markets rather than export to them in order to avoid the tariffs.  Some may come because they want to be closer to the raw materials that give them greater competitive advantage over producers of similar products in their home markets.  Others might come because the technology that they control enables them to use inputs that could be sourced cheaper from the home country of the investor or places other than the host country.  Foreign investors argue that by being restricted to the domestic market alone to acquire inputs into their operation, they do not have choices and can be trapped in a monopoly situation.  The consequence of the monopoly situation is that trade is restricted and distorted.  When viewed from such a perspective, local content threatens to erode the competitive advantage that foreign investors believe that they could enjoy by reallocating resources from their home country for use in the host country.

 

Resemblance to import-substitution

The reference to local content reminds many people of the policy of import substitution for industrialization which dominated the development efforts of Latin American countries in the 1960s and which brought severe economic hardships on Guyana during the 1980s.  Policies of import substitution were designed to support local industries by limiting international competition.  Import substitution used policy tools like banning the importation of goods, restricting access to foreign currency for selected commodities and imposing high import duties on competitive or energy-inefficient products.  To the extent that local content restricts international trade and reduces the choices available to foreign producers, it resembles the policy of import substitution.  The local content policies of developing countries are targeted because more foreign investment flows from developed countries to developing countries than in the other direction.  Developed countries have greater negotiating clout and local content can become a contentious issue in international trade if it involves certain conditions or prohibitions that are not protected by the relief clauses of General Agreement on Tariffs and Trade (GATT).

Merits

Some observers point out that in today’s trading environment local content as a policy tool has merits since it is not entirely insulated from international competition.  When the GATT adopted TRIMS in 1994, it took control of local content away from governments and, in effect, transferred the decision about its use to the foreign investor.  An examination of the trading rules relating to local content would indicate that local content policy is regarded as a protectionist measure.  Its main point of emphasis is that products imported into a country by a foreign investor for use in its operations should be treated no differently from similar products that are produced by local companies in the host country.  This means that the laws, regulations and requirements affecting the sale, purchase, distribution and use of the product should be the same for goods of local or foreign origin.  The impact of the adoption of the trading rules was to free foreign investors from the control of host governments where the acquisition of goods for use in their foreign operations was concerned.

 

Discretion

Under the international trading rules, the foreign investor has the discretion of deciding if he or she wants to buy locally-produced goods.  The policy choice is not necessarily one that is controlled by the government, but could be tolerated since it involves more transparency and is less distortionary in its effects on international trade.  It should be obvious from the foregoing that Exxon does not have to comply with any local content laws that involve goods or products that it wants to acquire.  It is free to source the goods from any supplier, domestic or foreign.  The only way local content for goods becomes a benefit is if Guyanese manufacturers can produce the goods cheaper than they could be landed in the country.

The discussion of local content around the oil industry needs to keep two things in mind.  One is that foreign investors are more concerned about local content that is linked to the supply of goods that are directly related to the value-added operations of the oil industry.  In other words, these are capital goods like drilling rigs, oil platforms and subsea equipment that are critical to the competitive production of oil.  Guyana does not produce any of those items and is unlikely to start doing so soon.  Consequently, local content policies of Guyana could hardly have a direct bearing on the value-added or competitive position of any foreign investor in the oil industry.  There is less worry about sourcing such items from local suppliers like the purchase of food and other items that are important but not critical to the value-added operations of the company’s production.

 

Cry for local content

The cry for local content is a recognition that oil production will take place out of the view of most Guyanese and they will not benefit from an industry that pays well unless something was done to change that equation.  The pursuit of local content policies reflects the efforts being made by Guyanese to find a way to appear relevant to an industry of which many know very little.  This is not an unfair attitude since foreign investment must have some relevance to the economic and social development of the country and provide meaning to the people of the country.  At this stage, local content for Guyana is about providing services and goods that do not affect directly the operations of Exxon or any other oil exploration company.  Foreign oil companies can easily agree to do that.

Comments  

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