Managing Commodity Lifecycles, Mining

4. The role of the state in managing mineral commodity price cycles

Countries also struggle to manage the effects of mineral price cycles. Extreme swings in prices can result in similarly difficult swings in a country’s GDP and make long-term planning challenging. Prolonged periods of weak commodity prices can result in low tax revenues from the sector, corporate disinvestment and unemployment.

Rising commodity prices bring a different range of challenges. Although they generally have the positive effect of boosting tax revenues they can also result in hard-to-manage inflows of capital which distort local markets and drive up the value of the local currency. The principal impacts of commodity price volatility are felt in the following areas:

  • Government revenues

  • Exchange rates

  • Structure of the economy

  • Employment

The remainder of this topic overview discusses these challenges, as well as strategies to address them.

Revenue effects

Governments obtain revenues from mining both through taxation (which includes direct taxes such as income tax as well as indirect taxes such as payroll taxes) and from royalties. Since corporate income taxes are effectively a tax on profits, they shrink markedly when commodity prices fall, reducing the flow of government revenues.

A table that can be found here shows revenue contributions from mining can be significant in some countries.

Government revenues also originate from royalties, which are effectively a tax on production, are less sensitive to commodity price movements. For this reason, there is often a strong temptation for governments to boost royalties to maintain their income through a cyclical trough.

However, royalties are a direct cost to business and, as such, royalty increases make producers uncompetitive with those elsewhere and carry the risk that a producer will curtail operations or be put out of business.

“Market instability makes it difficult for developing countries to count on revenues from the production and export of primary products. This can hamper the effective planning needed for economic development.  It also means that government revenues and foreign exchange earnings are curtailed just when expansionary monetary and fiscal policies are needed to help the economy survive a downturn in a vital economic sector.”

JE Tilton and JI Guzmán, Mineral Economics and Policy (RFF Press, 2016)