1. adverse effect caused by mineral resource curse. The

1.           INTRODUCTION

1.1       Background

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Mineral resources have been the source of wealth but it can also be the source of misery if not treated properly. The volatility of mineral price can be one of the reason to put it as a source of wealth or misery. Some countries earned fortunes by the rise of mineral prices, some others crawled themselves to hell as price fall. There is a theory of inverse correlation between mineral dependency and economic growth, where the economic growth tends to be slower as the increasing share of metal and ore export, called a resource curse. The resource curse thesis was arisen in the 1980s where countries which are well-endowed with natural resources did not seem to develop properly. The abundance of mineral resource is slowing the economic growth1. The wealth produced by mining activity is expected to support the economic growth but some mineral-rich countries fail to develop, due to poor policy or regulation.

Figure 1 Indonesia GINI Ratio
Source: Indonesian Central Statistics Bureau (online, accessed in 19 December 2017)

Many argue that high dependency on mineral wealth lead to income inequality. Indonesia is one of the country that is blessed with mineral resources and also known as a raw material exporter country, including coal and minerals. The mineral prices boom around 2008-2009 affected mining sector contribution to the national income but this also leads to the rise at GINI ratio after the boom of mineral prices as it seen in Figure 1.

This paper examines the existence of mineral resource curse in Indonesia based on the economic dimension, including economic growth, national income, human development index, and also income/revenue distribution from mining. This research will conduct an empirical and non-empirical analysis and propose a recommendation of possible mitigating policy to prevent the adverse effect caused by mineral resource curse. The paper also analyses related literature with resource curse.

 

1.2       Research Paper Overview

The second chapter will discuss about Indonesian economic condition before and after the mineral boom period while mineral resource curse indicators are reviewed in the next chapter. The conclusion and recommendation for the mitigating policy will be explained in chapter 5.

 

2.           SUMMARY OF INDONESIA’S CONDITION

2.1       Geography

Indonesia is passed by the circum-Pacific belt, also known as The Ring of Fire. This belt stretches from the Andes, Central America and Russia to Indonesia, New Zealand and Antarctica. In a geological phrase, the ring of fire is indicated by two essential evidence of tectonic activity: deep linear trenches and chains of active volcanoes2. The existence of volcanoes is the source for mineral formation. Igneous rock formed by magma crystallisation from the volcanoes, this magma may contain crystals of high-temperature minerals. This is why areas which are located in the ring of fire usually categorised as mineral-rich countries.

Figure 2 Ring of Fire belt

Source: Wikipedia (online, accessed on 18 December 2017)

 

 

2.2       Economy

Indonesia has experienced ups and downs in the GDP growth as it can be seen in Figure 3. In 1998, Indonesia experienced the fall of GDP growth due to the Asian financial crisis in 1997 followed by unstable political condition during the end of Suharto’s regime. Indonesia financial condition’s bounce back might not as high as the other regions, but it was more stable for the next decade compared to Malaysia, Singapore and Thailand that had experienced another fall in 2001. Even in the global financial crisis in 2008, Indonesia was proven to be more stable financially than those regions.

Figure 3 GDP Growth – Southeast Asian Region (%)

Source: World Development Indicators (Online, accessed on 20 December 2017)

 

Indonesian economic condition is dominated by the processing industry. Its contribution to Indonesian GDP is about 24-25% for the last 10 years followed by agriculture sector as the second most contributed sector to GDP. On the other hand the mining sector; including mineral, coal, oil, and gas; is in the third position by average 11%.

Figure 4 Sector Contribution to Indonesian GDP

Source: Indonesian Central Statistics Bureau (online, accessed on 19 December 2017)

 

   The definition of mining sector varies depend on its purposes. Mining has no clear-cut boundary. Some people say that mining activity is simply extracting the ore reserve to the ground, some say that it also involves the procession after the extraction stage until it becomes a middle or final product. In Indonesia, in terms of contribution to GDP, metal processing is categorised in the processing industry, not in the mining industry. The permit for mineral or metal processing plant is also issued by two different ministries: Ministry of Energy and Mineral Resources and Ministry of Industry3. The overlapping regulation is one of the problem causing the mining downstream industry is not well-developed.

 

3.           RESOURCE CURSE

Resource wealth is different compared to other wealth. There are two things that become the key difference4. The first is that natural resources do not need to be produced, they simply need to be extracted. The term “simply” in extracting mineral is not that simple after all, it involves high technology and skilled labour in order to get the optimum potential of mineral resources. The second is natural resources are valuable finite material. Some argue that it is a waste to invest in something that will be depleted, but without the investment on mining sector, it is impossible for the current generation to be able to receive the benefit from mining wealth. Therefore, for an economic dimension, they are not a source for income but more like an asset.

The resource curse thesis was first conceptualised by Richard Auty in 1993 where he found that resource-rich country has a poor management system to manage their resource wealth in a way that promoted their economies and also, those resource-blessed-countries were having a slow economic growth5. This is similar with the inverse correlation theory that is mentioned in the Introduction chapter, where countries with a high share in natural resource exports will have a slower economic growth than those who is more dependence in manufacture sector.

Brazil

Brazil

Chile

Peru

Peru

Indonesia

Figure 5 GDP growth to ore and metal exports dependency

Source: World Bank (online, accessed on 19 December 2017)

Figure 6 indicates that the inverse correlation theory does not happen in all period and in all country because even though many argue that the inverse correlation concept matched for every mineral but it does not necessarily happen for all countries and all time. For example, according to Figure 6 Chile has a bigger rate of GDP growth compared to Brazil in the 1980s-1990s period and the same time Chile has more share in ore and metal exports than Brazil. Therefore, in this period the inverse correlation theory is not suitable. In Indonesia, there is a slight tendency that the higher share of mineral rents in GDP slower the GDP growth as it can be seen in Figure 7.

Figure 6 GDP Growth and Mineral Rents in Indonesia (1970-2015)

Source: World Bank (online, accessed on 24 December 2017)

 

3.1       Income Inequality

One indicator that defines the success in mineral resource management is income equality. Income can be described as profit when the market price of mineral exceeds the total of extraction cost. The other term for this is economic rents6. These rents are the tool that the government used to be taxed away and is used to contribute to the national development. Mineral deposits have no value when they are still on the ground. Therefore, it is the mining activity’s role to transform the mineral wealth into capital to develop a country.

There are two types of income distribution: vertical and horizontal. Vertical distribution is the distribution between the rich and the poor. Horizontal distribution is between areas in one country7. One of the measurements of vertical income equality from mineral rent can be described in Figure 7, that there is a strong negative relationship between income inequality and mineral rent in Indonesia. But when talking about Gini ratio, there are some dimensions that are not captured, for example the income inequality between rural and urban worker or between men and women. Therefore, further research needs to be done to stimulate this relationship8.

Figure 7 Mineral Rent vs Gini Ratio in Indonesia

Source: Indonesian Central Statistics Bureau, World Bank (online, accessed on 22 December 2017)

 

The unique characteristic about mining is site-specific9. It means that the existence of mineral deposit really depends on the geological condition in that area. When a mineral wealth is concentrated in one region, it will affect the income in that area as well. Horizontal inequality happens when a government fails to use the full benefit of mining sector which causes the disparity of income in each region in the country. Sometimes, this failure leads to social tension or even civil war. the birth of Organisasi Papua Merdeka (OPM) – Free Papua Movement in 1965 is one example of social tension happened in Indonesia. OPM is an independence movement as a result of unsatisfactory of the current governmental regime. One of the cause was a high disparity of income between Papua, which is a mineral-rich region, and other regions in Indonesia especially West Java where the capital city is located.

The government of Indonesia then try to decentralise the government affair using a new principle called regional autonomy. decentralisation is a system where the central government transfer the government affairs to the local government. The regional autonomy is, as described in Law of Republic of Indonesia Number 23 of 2014 Article 1 Paragraph 6:

“It is the right, authority, and duties of the autonomous regions to set up and manage their own affairs and interests of local communities in the system of the Republic of Indonesia”.

This law, as the date of the stipulation, gives the local government an authority to use the rents mainly for the local region with the specific provision about sharing system between local and central government that is also regulated in the same law. This is the government’s effort to make sure that natural resource rich-regions get the most benefit from their natural resource wealth.

In theory, decentralisation system helps the local government to be able managing their wealth independently but in practice, there are several drawbacks10:

·       The capacity of local government to absorb the full potential of mineral wealth is less than the central government’s capacity.

·       The central government is able to manage the mineral wealth from the bigger picture, for the national level importance, instead of local importance.

·       When local governments create their own taxes or royalties, it may cause an overlapping with the central government’s taxation regime.

In short, the decentralisation system might reduce the government’s effectiveness if not govern properly as can be seen in Figure 8. According to the graphic on Figure 8, Indonesian government effectiveness ranking fell significantly in 2015 as the government issued the Law of Republic of Indonesia Number 23 of 2014.

Figure 8 Government Effectiveness Ranking

Source: World Government Indicators (online, accessed on 22 December 2017)

The output from mining sector can be used either for consumption or investment depends on the government regimes of host countries. The consumption of mineral benefit tends to increase the welfare. On the other side, using the benefit from mineral resources as investments will lead to economic growth and a rise in future welfare. This ideal condition can only happen if the government can manage the income equality not just between the poor and the rich but also between each region in the country11.

Figure 9 Inequality in Indonesia

Source: Indonesian Central Statistics Bureau (online, accessed on 20 December 2017)

 

3.2       Rent-seeking and Corruption Behaviour

Mineral rent is a value added when the price of mineral products exceeds the overall production cost. The economic rent for mineral will occur as long as the mineral deposit still generate wealth12. Each mine is unique. Therefore, the value of mineral rent cannot be generalised. Some mines may not produce mineral rent as their production cost is too high.

Mineral deposits will only be valuable until it is extracted. Mining sector needs high technology and skilled labour as mentioned before, so mismanagement in extracting process will dissipate the rent. Mineral rent can be used as a source for supporting national development if treated well. The surpluses or mineral rent should be distributed fairly for the company, government, and local communities13. The rent-seeking behaviour usually occurs when the stakeholders are not satisfied with the distribution of the rents. For instance is when a company use its capital to support one politician in order to influence the law or regulation in one country. This behaviour tends to lead to corruption.

Figure 10 Mineral Rents vs Corruption Rank in Indonesia (2007-2015)

Source: World Development Indicators (online, accessed on 19 December 2017)

Notes: the higher corruption rank, the better.

According to Figure 9, there is a negative relationship between mineral rent and corruption rank. The figure shows that the higher share of mineral rents to GDP, the higher corruption behaviour in Indonesia.

3.3       Income Volatility

Mineral prices are very volatile. Price of minerals is dictated by the supply and demand of mineral products itself. Moreover, supply is dictated mostly by production cost. There are so many factors that determine production cost, for examples political instability, economic condition, introducing new technology and world’s preference14. Mining activity is a high-risk project, the risks are determined by the world’s condition generally, and host country’s condition specifically. This is why many argue that revenue from mining is very volatile. Thus, the development of mining sector will lead to a curse.

Figure 11 Real Sector GDP Growth of Indonesia

Source: Indonesian Central Statistics Bureau (online, accessed on 19 December 2017)

 

According to the graphic in Figure 4, the GDP growth of mining sector is unstable throughout the period compared to the other sectors. It can be seen that mining sector growth rose significantly in 2009 during the mineral boom and fall quite dramatically in 2011 and continue to fall until 2014. It can be assumed, from the graphic above, the revenue that comes from mining sector is also volatile because, with unstable growth, the government will also receive inconsistent income.

 

4.               GOOD GOVERNANCE

The abundance of natural resource wealth is always within a nation. Even though the benefits of natural resources are not only specifically for the nation where the resources exist because raw materials are needed by every nation in the world, but the rights of managing the wealth belong to the host countries. Natural resource wealth tends to bring negative political regimes15. It is still debatable for the positive correlation between resource-rich and poor political condition because it does not happen in all resource-rich countries and not in all period. The key to avoid the resource curse is to manage the wealth comes from natural resource and focus to develop general social welfare by having a good governance system that honour the transparency. In order to have well-management in the abundance of mineral resource, it needs the coordination from each governmental institution because the host countries cannot only improve one institution to achieve the ideal condition. The agenda of transparency and accountability from the governmental institutions needs to be supervised by the local community because they are more important to question the institutional status quo than using the external agents to supervise it16.

Mining activity is an economic activity, which like other economic activity, it is governed by regulation and influenced by the behaviour of many stakeholders. Uncertain legal process and property rights, unpredictable permit contract agreement, ineffective tax and fiscal regimes and high rate of corruption are several factors that will bring negative atmosphere to the economic activity17. The present of government is important because of its ability to create a just system in terms of supporting economic development. A proper regulation and an effective government system will help all economic sectors, including mining, to develop sustainably.

 

5.               CONCLUSION AND RECOMMENDATION

This paper shows that there are several mineral resource curse characteristics noticed in Indonesia. In general, there is no correlation between high shares of mineral rents in GDP and vertical income inequality but if the point of view shifted to the national level, it can be seen that horizontal income inequality in Indonesia is immensely reflected by its poverty rate in each region. There is also a tendency where a higher share of mineral rents in national income leads to corruption behaviour. Mineral prices are very unstable and this causes a volatile growth of mineral sector GDP in Indonesia.

Indonesia which is located in the circum-Pacific ring has big potential in mineral resources. Based on the data presented in this paper, a likelihood that Indonesia is facing mineral resource curse quite high. Therefore, the recommendation of possible mitigating policy is to draft mining policy that is proper and be able to strengthen the management and institution system also creating a strong and effective government that is transparent and accountable and also using the domestic agents to supervise the government. Involving local communities as an agent to supervise the transparency and accountability of the government can be the device to make the society more cohesion. The more cohesive the society, the stronger it is to ensure that the government does its jobs and responsibility to use the mineral wealth to develop the nation and with a good governance system, equitable growth can be promoted for all.

1 PCF (Phillip CF. Crowson, Mining Unearthed (London?: Aspermont UK 2008).

2 Macartan Humphreys, Jeffrey Sachs and Joseph E Stiglitz, Escaping the Resource Curse (New York?; Chichester?: Columbia University Press 2007).

3 Downstream industry permit from Ministry of Energy and Mineral Resources is issued based on Government Reulation of Republic of Indonesia Number 01 – 2017, the name of the permit is Mining Licence for Smelting and Refinery (Izin Usaha Pertambangan Khusus Untuk Pengolahan dan Pemurnian). While permit from Ministry of Industry is issued based on Government Regulation of Republic of Indonesia Number 107 – 2015 and under the name of Industrial Business License (Izin Usaha Industri – IUI)

4 PJ Fox, ‘The Ring of Fire: Backarc Basins.’ (1996) 272 Science.

5 ibid.

6 Humphreys, Sachs and Stiglitz 4.

7 Graham A Davis and John Tilton, ‘Should Developing Countries Renounce Mining? A Perspective on the Debate’ (2017) 12 Version Dec.

8 Humphreys, Sachs and Stiglitz 237.

9 ibid 238.

10 Crowson, Mining Unearthed 8.

11 Humphreys, Sachs and Stiglitz 248.

12 William Easterly, ‘Inequality Does Cause Underdevelopment: Insights from a New Instrument’ 1997 How Latin America Fell Behind Journal; A Davis and Tilton.

13 Phillip Crowson, ‘Economic Rent and the Mining Industry’ (1998) 13 Minerals & Energy – Raw Materials Report 22.

14 Crowson, Mining Unearthed.

15 Paul Stevens and Evelyn Dietsche, ‘Resource Curse: An Analysis of Causes, Experiences and Possible Ways Forward’ (2008) 36 Energy Policy 56.

16 ibid.

17 Brian van Arkadie, ‘Good Governance and Donors’ in Jomo Kwame Sundaram and Anis Chowdhury (eds), Is Good Governance Good for Development? (1st edn, Bloomsbury Academic 2012) 55; Gjalt de Graaf and Hester Paanakker, ‘Good Governance: Performance Values and Procedural Values in Conflict’ (2015) 45 American Review of Public Administration 635.