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Tuesday, 4 March 2008

Free riders....

Interesting comments from Enoch Kavindele last week vis-a-vis the weak incentives for mining companies to support development of North West Rail Line:

.....As it stands, the [road] repair and rehabilitation costs are borne entirely by the government and cease to be their problem. In the next three years, both Kitwe to Chingola road and the Kitwe to Lumwana road will be completely damage.....All this heavy traffic combined with all other road users will place an extraordinary strain on all services, utilities and infrastructure....the combined Democratic Republic of Congo (DRC) and Zambian mines related freight volumes in 2010 would be 2,400 000 tonnes of copper ore per annum..... In Chingola, this will translate to having a truck on the roads every three minutes to and from. Roads in the town will become completely congested with the route between Chingola and Kitwe becoming almost impassable not to mention the hazardous conditions that will be faced by normal motorists and pedestrians,”
Two observations spring from this.

First, the people of Zambia should stop irrational expectations that mining companies would behave in the nation's interests when it comes to the delivery of new infrastructure. There's no such as thing as "social responsibility" because mining companies are motivated purely by profit and will always act in the interest of their shareholders. If using an existing road is cheaper than building a new one, then they use the existing one. The same goes for local schools and hospitals. When they occasionally provide a new school or fund the local football team, they "appear" to be socially responsible. Their true motivations is always those of the company. It follows that we should not expect these companies to invest in local infrastructure unless it was legally mandated.

Secondly, Government's failure to put in place a coherent framework that leverages private sector investment into delivering local infrastructure has created perverse incentives in other areas. There's no doubt that many mining companies are free riding local infrastructure and therefore have no incentive for investing in inter-urban infrastructure such as rail or motorways.

Zambia is projected to receive over $3bn in foreign direct investment this year. Very little of that amount will be spent on transport infrastructure beyond the immediate requirements of a particular mining venture. Most of this investment will rely on existing inter-urban infrastructure to make their business work. Now is the right time for new legislation that basically makes it a condition that any new investment, in any local area, should provide some minimum level of investment in schools, transport and other things, if the local authority deems it necessary. Failure to take this approach will result in road and rail network that mirrors our crippling electrical situation. As the IMF noted, Zambia's infrastructure is lagging behind the rate of investment.

There's another reason for tackling the free riding of transport infrastructure. If new investors are mandated to contribute to transport provision (where they are proven to contribute significantly to transport demand), it would strengthen the bond with the people. At the very least, local people would appreciate that the firms are contributing in a direct way and are not simply exploiting the existing system. Public acceptability of foreign investment is critical in signalling Zambia as an attractive and secure place to investment.

11 comments:

  1. First, the people of Zambia should stop irrational expectations that mining companies would behave in the nation's interests when it comes to the delivery of new infrastructure.

    That would be the goverment first. They were the ones who didn't collect taxes which would do just that.

    And I didn't know that 2.4 million tonnes would be transported across Zambia's roads. Obviously, in a country where 70% of the population earn less than a dollar per day and presumably don't own a car, the mining companies would be the ones putting the most stress on the country's roads.

    There's no such as thing as "social responsibility" because mining companies are motivated purely by profit and will always act in the interest of their shareholders.

    Right, if it is not in the contract, and there is no legislation or regulation on the statutes, there is no obligation to do anything.

    So the best thing the government can do is collect all the taxes from the mining companies that it can.

    If using an existing road is cheaper than building a new one, then they use the existing one. The same goes for local schools and hospitals. When they occasionally provide a new school or fund the local football team, they "appear" to be socially responsible. Their true motivations is always those of the company. It follows that we should not expect these companies to invest in local infrastructure unless it was legally mandated.

    It seems to me that UNIP was there decades ago. If only they'd had the economic and financial policies to make their vision successful and permanent.

    There's another reason for tackling the free riding of transport infrastructure. If new investors are mandated to contribute to transport provision (where they are proven to contribute significantly to transport demand), it would strengthen the bond with the people. At the very least, local people would appreciate that the firms are contributing in a direct way and are not simply exploiting the existing system. Public acceptability of foreign investment is critical in signalling Zambia as an attractive and secure place to investment.

    But why would foreign investors build infrastructure in Zambia?

    Isn't it about time that Zambia did it itself? From taxes?

    It isn't that difficult to supervise the execution of projects and weed out bad contractors.

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  2. Just in case no one has read it yet, but check out anti-neoliberal economics book of Cambridge economics professor Ha-Joon Chang:

    Bad Samaritans: The Myth of Free Trade and the Secret History of Capitalism (Hardcover)
    by Ha-Joon Chang (Author)

    Available at Amazon.com.

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  3. MrK,

    "But why would foreign investors build infrastructure in Zambia?

    Isn't it about time that Zambia did it itself? From taxes?"


    My view is that we should be striving to ensure that government funds only those things that it has to. The private sector should not look to government to build roads and rails for them when they derive the most benefit from it. This is the principle of "beneficiary pays". Those that benefit most from the infrastructure should fund it.

    Until Zambia adopts that approach government will keep taxing only to spend the money on repairing the roads and rails for the mining companies.

    I am not against government funding infrastructure. I am simply against government using tax funds to do a job that the private sector should be doing. At the moment these companies are free riding in two areas. They pay low taxes and don't provide any infrastructure. Why can't we get them to pay the right taxes AND ensure they don't free ride on infrastructure????

    This is logical. There's no country in the developed world that builds infrastructure for investors. Even Cecil Rhodes funded his own infrastructure. The British Colonial Office had the sense not to spend a penny!

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  4. My view is that we should be striving to ensure that government funds only those things that it has to. The private sector should not look to government to build roads and rails for them when they derive the most benefit from it.

    As long as the business sector pay for every cent through taxes, I would very much favour the government building infrastructure.

    This is logical. There's no country in the developed world that builds infrastructure for investors. Even Cecil Rhodes funded his own infrastructure. The British Colonial Office had the sense not to spend a penny!

    They were always failing to figure out to make the colonies pay for themselves - as a result, they were cheapskates. :)

    Well of course I agree. However, I think we're confusing three things:

    - how infrastructure is paid for (taxes or directly by business)
    - who is paying for it (government or business)
    - who does the actual construction job (government and/or private contractors)

    I am for high taxes on corporate profits, from which the government can then finance infrastructure projects. Or for a road tax, so government can fund infrastructure from the people who use it - which seems fair.

    However, as long as the money comes to the government from business, the government can then hire private contractors, or even permanently employ a government agency to construct some or all jobs.

    What I would object to is that some infrastructure development can be stipulated in the Developoment Agreements, but can then be ignored by the companies in question - for whatever reason.

    So the way the government has the most control, is when it simply receives lots of taxes, and then build infrastructure itself, or supervises private contractors.

    However, what is your view on the massive works projects that the US introduced after the Great Depression - FDR, Hoover?

    I think they would have a huge potential for upgrading infrastructure and reducing unemployment while stimulating the economy through wages, all at the same time.

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  5. Why can't we get them to pay the right taxes AND ensure they don't free ride on infrastructure????

    Then why are they paying taxes ?

    That's the thing with the Cecil Rhodes analogy. I doubt he paid much taxes. On the other hand, in Belgian Congo, the colonial administration taxed the colonial companies a bit more and paid for the infrastructure.

    What I really fail to get is why those companies would want to pay for roads that everybody *could* use. Isn't there a prisoner dillema involving companies currently involved financing infrastructure that late-comers would "free-ride" ? Financing infrastructure though taxes and privatization of infrastructure seem to me the only solutions with sufficient clarity and fairness.

    (my mother worked in the timber industry for a while for a company involved in northern Congo. and i spent my teenage years hearing about the various issues caused by "privately financed public infrastructure.)

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  6. Random,

    The problem of prisoners dilemma only arise if you don't set the incentives correctly.

    The aim is to devise a system based on funding for infrastructure proportion to the damage they impose or the benefits they'll get.

    Government contributions would come in where the infrastructure delivered by the mines is beyond their economic obligations i.e. beyond the fulfillment of "polluter pay" requirements. Most likely this will come if the solutions proposed are indivisible and may create "free riding" problems.

    Let me illustrate how it would work in practice.

    Mining Company X would step forward with a proposal to develop the mine. That mine would require widening of an existing road or may be road maintaince.

    The local authority / road development agency would decide what the transport problem is. Let us just say they decide the road needs to widened from existing parameters and then maintained.

    The next question is who should pay for that?

    The way it would work is that if the road was widened and maintained just to make sure that the mine traffic went through, without any additional benefits general users, economic theory suggests that they mine should pay all the costs.

    If the road was widened beyond the need to handle mining traffic, may be because infrastructure may be indivisible or lumpy..so they over provide...this may results in benefits to general users e.g. quicker travel times etc.

    What would happen is that to stop general users free riding, government would also contribute relative to their benefits.

    So what you have is basically a framework that ensures that no free riding takes place.

    I have been developing this framework for the last two years and I am convinced it can work for Zambia. There might be certain practical problems in terms of modelling demand or ascertaining detriment, but in general i think the economic incentives would be accurately realigned.

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  7. Mrk,

    I think the reason we need a combination of taxes and infrastructure contributions is that taxation is a blanket approach, infrastructure contributions are more tailored.

    In principle we can tax everyone highly, and then use the money to fund infrastructure. But that is not very fair...because some use the infrastructure more than others.

    My proposal is to use both taxes and develop contributions to strike the right balance between government and private sector delivery.

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  8. But that is not very fair...because some use the infrastructure more than others.

    Why not privatize then ? Or at least, make the users pay (proportionally to the use and the load) ?

    Let me give an example of the kind of prisoner dillema I had in mind.

    The timber company my mother was working for had plans to improve the road (widen and resurface) connecting their concession to the small port on the Congo river. The problem was that there were other concessions that had yet to be granted to anyone along the road. So the company got into endless negotiations with the government about those concessions. They didn't want to pay for infrastructure that someone else will benefit for. And of course, the potential buyer of the new concessions decided to wait AFTER the road was improved to make the deal since the goal was to avoid paying.The company my mother was working for attempted to get those new concessions at a lower price in exchange for the infrastructure investment they needed anyway. Of course, that wasn't a good option for the government as it was aiming for a win-win situation.

    As a result ? The road didn't get the improvements for 2 years, output slowed down until the company decided to invest in another road which linked them to the CAR border. There was loss of tax revene but also loss of port activity.

    My thing is your framework makes sense but it is incredibly complicated. Especially since future use is hard to properly evaluate. Activity follows infrastructure even when it's built for one company.

    What's wrong with tolls again ?

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  9. Random,

    "Why not privatize then ? Or at least, make the users pay (proportionally to the use and the load) ?"

    I agree that "user pay" or private toll roads are first best solutions.

    But for a country like Zambia we have to accept that the poor would not afford to use the roads, and it them that we need to lift out of poverty in the general scheme of things. With that in mind, Government assumes the role of the custodian for "general demand" for transport. The issue is therefore reduced to the straight question of how much should government contribute to infrastructure, and how much should be borne by significant entities that can afford to pay (e.g. the mining companies)?

    "My thing is your framework makes sense but it is incredibly complicated."

    The example you have given is very interesting!
    The problem there is one of "second round beneficiaries" as I call them. Those are also considered in my framework.

    The first step in my framework would have been for government to assess present and future demand for the road WITHOUT the timber company. We would call that the "base case scenario". Now in this scenario there's a lot of uncertainty because no one wants to reveal themselves that they plan to use the road. So projections of traffic would be made based on usual drivers such local GDP, trade activity, demand constraints etc. A simple transport model could be built to simulate these effects.

    Once that is done, we can then ask the question, what would happen if the timber company put its additional demand on top? That would also be simulated. May be what we would find is that additional demand from timber companies would increase congestion, reduce travel times and so forth. The question then is to ask, how much does the road need to be improved to cater for the timber company? The road would then be improved accordingly.

    If someone else decides to come forward and set up a different company, the process would resume again, and ask them for improvements. Note that in the model simulation, our mother's timber company is now in the "base case scenario".

    The key to making the process work is two fold:

    1. To stop every small company to be subjected to the process, you need to set thresholds for when traffic improvements are necessary and contributions are needed from the company e.g. may be we should only require the process if the timber company (or another company that follows) generates traffic more than 10% of existing and future "base case" demand.

    2. Government needs to make it clear how the framework operates to give certainty to developers. We basically need a planning system that is transparent.

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  10. But for a country like Zambia we have to accept that the poor would not afford to use the roads, and it them that we need to lift out of poverty in the general scheme of things.

    Really ? They could and can use railways or cellphones that make you pay for use, right ?

    The first step in my framework would have been for government to assess present and future demand for the road WITHOUT the timber company.

    In that case it would be "none". I mean, that was northern Congo. The timber company by building the road to start with created a small town around its camp and trade up and down the road followed. Even government services followed..

    I'm still unconvinced though. For instance, the "10% threesold" is for individual companies. What if you have a thousand different traders each increasing traffic by 5% while the single mining company increases it by 11 % ? Or what if the second-round users don't increase significantly increase congestion after the improvement but moved in because of the improvement ? And.. Does that mean roads will be slowly improved to increase capacity by 10 or 20% EACH TIME a company moves in instead of say doubling capacity every 10 years ? Is that cost-efficient ?

    I still believe it's unnecessary complicated. And a transparent but complicated planning system will give potential investors the certainity of complication.

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  11. Random,

    "Really ? They could and can use railways or cellphones that make you pay for use, right ?"

    I would not rule out government subsidies on cell phone provision to farmers or nurses for example. That these services are currently provided through the market and that no government subsidy is employed is purely a policy issue. On economic grounds you can justify such subsidies.

    My general point though is that even if the poor can afford to pay for the road, government intervention would allow them to use that money elsewhere in the economic system. In general, I don't think that general toll roads would necessarily be commercial viable nor politically attractive in Zambia. The framework I have suggested has some political mileage.

    "In that case it would be "none". I mean, that was northern Congo. The timber company by building the road to start with created a small town around its camp and trade up and down the road followed. Even government services followed.."

    Your example is similar to Lumwana, which has basically built a town from the scratch.

    This is not a problem. The timber company must in the first instance pay all the costs. Then we can charge whoever (including government) follows along the lines I have explained.

    "What if you have a thousand different traders each increasing traffic by 5% while the single mining company increases it by 11 % ?"

    In general under the proposed framework, the small traders would "free ride", because their individual demand is insignificant to trigger the "developer contribution" process.
    BUT,with your "special example" of building a town from the scratch, government would bear the cost of incremental demand from small traders, as the custodian of "general demand". It can then pro-rata the cost among them, if deems it necessary.

    Or what if the second-round users don't increase significantly increase congestion after the improvement but moved in because of the improvement?

    The model is traffic led, rather than a "contigent benefit" type of assessmen e.g due to agglomeration economies. In theory of course you can estimate those benefits and include them as part of the formula for government, as custodian of general demand, to use in its pro-rata exercise beyond general consideration of traffic impacts. My framework aims to be much simpler than that!

    ".. Does that mean roads will be slowly improved to increase capacity by 10 or 20% EACH TIME a company moves in instead of say doubling capacity every 10 years ? Is that cost-efficient ?"

    A very interesting question.
    I don't think so. Infrastructure is generally indivisible, so in theory the 1st round beneficiary will always over provide capacity. It is that over provision beyond the narrow requirements of "polluter pays" that necessitates government intervention.

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