Economic Linkages in the Extractives Sector

2. Types of linkages

Fiscal linkages

Fiscal linkages occur when revenues generated by extractives sector activity in the form of corporate or income taxes and royalties are used in other non-commodity sectors. In most jurisdictions the State is the recipient of such revenues and revenues are often used for meeting budgetary needs, however they can also be used to promote diversification of the economy.

Fiscal linkages alone are not usually considered sufficient to avoid the enclave nature of the extractive industries, for a number of reasons:

  1. The profits of extractives sector companies (which impact on fiscal revenue) are beyond the control of host states;
  2. The ability to tax the sector depends on the ability of host governments to negotiate with extractives companies and effectively and efficiently calculate and collect agreed fiscal revenue (see also the related negotiations topic);
  3. Commodity prices fluctuate significantly;  
  4. There needs to be transparency in the management of revenues to ensure that they are being spent on transformative reforms such as public assets (i.e. transport and power) and industrialisation; and
  5. In less developed countries, there may be high levels of public debt which can absorb much of the fiscal revenue from the extractives sector.

For these reasons, fiscal linkages should ideally be backed by production linkages.

Production linkages

Backward (or upstream) linkages

Backward linkages refer to inputs to the oil, gas and mining projects from the national economy, which can include local community-focussed procurement, such as security, clothing and food supplies and high value-added items, such as capital machinery and equipment. Backward linkages encompass subcontracting, supplier contracts, input service collaborations and hence can create employment and offer potential for enhancing domestic manufacturing capacity.

Backward linkages may be established between the extractives sector and other sectors. For instance, if the required standards could be met by farmers, they could secure contracts to supply food and catering services to the extractives sector employers. The manufacturing sector could provide the extractives company with protective clothing and safety equipment (often more specialised equipment used in the extraction and production activities is outsourced from international companies). The services sector also offers a variety of opportunities such as geological mapping, site management, financial services, human resources management, security services and even engineering services. Some types of construction and labour-intensive employment may also be locally sourced. In principle, backward linkages offer location-specific advantages to local suppliers.

Upstream linkages are closely related to local content policies (see more detail below), which are one means of creating upstream linkages. However, local companies may not always have the capacity to provide the equipment that the extractives companies need.

Local Content Policies

Local content has gained increased importance in the last decade as a means of developing domestic supply chains for the extractives industries. The challenge is to identify which industrial and service sectors provide greater opportunities for development and create initiatives that build local capacity. Mining, oil and gas companies are under pressure to enhance local content in their procurement to demonstrate “good corporate citizenship” and to ensure a social licence to operate. Read more in the local content topic overview

South Africa provides a significant example of successful formation of backward linkages. Particularly in the mining sector, many small and medium size companies operating in the region are involved in metal products, machinery and equipment and construction activities. However, the situation in South Africa is quite different to the situation in Southern Africa more generally. A study by BGR concluded that mining investments in Southern Africa region have not resulted in the significant increase in local purchasing or sales linkages as the majority of local companies lack the financial stamina, an ability to digest large contracts, reputation and sheer size. The study however does not deny the potential of added value on the local economy and employment by the mining industry.

Forward (or downstream) linkages

Forward linkages are created by adding value to the commodities extracted by the industry by processing and refining in order to locally to produce finished goods instead of exporting them in their raw state. The economic viability of forward linkages varies from commodity to commodity. For instance, in general in gold processing to semi-pure dore bars is feasible near the mining facilities, whereas these are then sold and transported for further refining. Gold is high value, low volume and traded on a terminal market. Therefore, the actual refining of gold may be more economical away from the mine. There are very few integrated mine/refineries. In China for instance, many large-scale gold mining companies also own an integrated large scale refining company. In South Africa, Rand Refinery is located within the mining district in Johannesburg. Rand Refinery is one of world’s largest gold refinery plants and receives gold for value addition from all parts of Africa.

Similarly, the processing activity for coal and iron is not economically viable near the extraction place. The share of countries manufacturing or processing diamonds is also largely unrelated to share of countries producing diamonds. This is because diamonds are largely not processed where they are sourced. However, there are successful examples of   formation of forward linkages. For instance in Botswana, following the discovery of diamonds by at Orapa in 1967, the Botswana Government and De Beers established De Beers Botswana Mining Company, which later became Debswana. wherein 2011,the Government and De Beers signed a 10-year agreement that required De Beers’ sales and sorting operations to move to Botswana from London. The deal also enables the government to market a portion of Debswana’s production independently. The transfer of activities from London has been completed in 2013 and Debswana has already started its operation in Gaborone (see more at related beneficiation topic overview).

Traditionally in the oil sector, downstream linkages have not been able to develop due to oligopolistic control of technology by multinational oil corporations, controlling international oil production and refining technologies. International development policies have overturned this trend from 20th century. Today, technological progress makes it possible to construct oil refineries in low-income producer companies. For instance, refineries built by the Chinese National Petroleum Corporation in Chad proved economically viable and competitive. Domestic refining capacity secures local supplies and creates more jobs and helps with balancing the national budget as opposed to importing crude oil that would otherwise be purchased at a volatile exchange rate. Other than refineries, forward linkages in the oil sector also include use of refined products in petrochemicals industry, gas use in electricity generation and in energy intensive industries. Increased refining capacities may help with diversifying the economy and enhance consumption linkages.

Side-Stream Linkages

Side-stream linkages involve economic links created to support infrastructure (power, logistics, communications, and water), agriculture and skills & technology development, covered in more details below.

Infrastructure (or spatial) Linkages

Infrastructure linkages refers to the development of roads, railways, water, ports, communication and power grids as a result of the extractives sector activity. Infrastructure linkages can help create a local industry because they promote the shared use of infrastructure for development. Infrastructure development can create multiplier effects and open up opportunities in other sectors, for example agriculture and tourism. Many host governments struggling with sourcing finance for the development of infrastructure projects could see benefit in making the grant of natural resource exploitation rights or contracts conditional upon investment in infrastructure. These initiatives may also be instigated to improve diplomatic ties. One example is China Export-Import Bank’s transactions in DRC, where the country’s resources act as a collateral to realise transport projects. Increasingly, many investors voluntarily invest in infrastructure development projects in local communities to earn a “social license to operate”. Successful implementation of resource for infrastructure projects requires synergies between public and private investments to ensure shared use of the infrastructure.

Linkages to agriculture

Infrastructure linkages can open up opportunities in the agriculture sector. Traditionally, the extractives sector, especially mining, is seen to have a predominantly adverse impact on land, water, people’s livelihood and agriculture. However, the trend today is to acknowledge that mining and agriculture can work together. Mining companies are increasingly focused on the need to secure and maintain their social licence to operate. The concern over linkages to agriculture is less visible in the petroleum sector as often oil and gas extraction activities take place offshore, hence agriculture activities are often not adversely impacted by exploration and extraction operations

Mining companies can contribute to economic development by providing services and creating production linkages (see below), for instance by creating a downstream sector capable of transforming materials to higher value-added products Mining companies can also take an active role by encouraging local farmers to increase the efficiency of their production facilities. For instance, in Ghana, Newmont Ghana Gold established a successful community-based agricultural development project, Ahafo Agribusiness Growth Initiative (AAGI) to strengthen agricultural production, improve farmers’ management skills and build the capacity of farmers while increasing market linkages and supply chain interventions.. Since Newmont started its operations in Ahafo, it has invested more than 10 million dollars under its Agricultural Improvement and Land Access Programme and other Livelihood Re-establishment programmes such as Skills Development for Income Improvement Programme and Vulnerable Peoples' Programme. Further, the Newmont Ahafo Development Foundation (NADeF), a sustainable development community foundation. Established in 2008 on agreement between Newmont Ghana Gold Limited (NGGL), a gold mining company, and the Ahafo Social Responsibility Forum, has overseen electrification and water supply programmes, microcredit schemes and apprenticeships to enhance employment access among others initiatives. It is upheld as a model of inclusive, responsive, and sustainable community development. Mining companies can also support agricultural activities by providing shared access to storage facilities, warehousing and processing facilities.

Technology and knowledge linkages

This refers to technology and knowledge transfer from the extractives value chain. Technology linkages may include the transfer of non-sector specific information technology, finance, civil engineering skills or sector specific skills such as petroleum engineering. Horizontal linkages (see below) enable the adaptability of skills gained in the extractives sector to other sectors such as construction and agriculture; however, it is the technology and knowledge linkages that develop capabilities to do so.

In the petroleum sector, for example, National Oil Companies typically are set up to absorb technology and know-how from foreign investors to the public sector, which can then be turned into productive human and capital assets over time. The oil industry itself has an impact on the use of information and communication technologies (ICTs) in the global economy. Nigeria has built up its ICT sector to source these services locally. Assessments of the nature of the transfer and acquisition of oil technology in the Nigerian oil industry shows that learning of technology was initiated and achieved through the Petroleum Technology Development Fund (PTDF). The fund provided scholarships for Nigerians to study engineering and technology courses within the country and abroad. The oil companies also supported the development of engineering-based programmes in the Nigerian universities as a result of the Petroleum Decree of 1969. The establishment of the Petroleum Training Institute (PTI) was a major step towards the development of technological capabilities in the oil industry. . It is difficult to measure the spill-over effects of knowledge and technology transfers, but the benefits tend to be higher where the information gap is not too large. In many Sub-Saharan African countries the lack of basic (technical) skills leaves less room for knowledge and technology spill overs. The cost of transmitting and absorbing all of the relevant unembodied knowledge is too high –where the knowledge gap is large. There needs to be technical training facilities locally.

Horizontal (or lateral) linkages

Horizontal linkages refer to skills developed in the extractives sector being transferred to other sectors. This includes cooperation between different companies in the same industry based on licencing, technology, joint buying and venture agreements. Examples include knowledge in process control, construction equipment and material handling. Bulky commodities and Liquefied Natural Gas (LNG) for instance can generate civil engineering skills which may be transferred to other sectors. These usually emerge in the advanced stages of industrial development. The ability to adapt capabilities is also very important for horizontal linkages to be realised. Horizontal linkages often occur from the upstream sector, so are more likely to happen in countries where backward linkages are already developed. The challenge with horizontal linkages is the first mover advantage (also known as technology leadership). Many governments may wish to avoid offering incentives to technologically advanced companies to branch out of mining and instead offer these incentives on a competitive and non-discriminatory basis.

Consumption linkages

Consumption linkages refer to increased spending because of the rise in wages (labour income) and profits from the commodities sector (capital income). These spending effects can fuel structural change at the local level as income is reinvested in the domestic economy. The effect of consumption linkages is reduced where earnings are lower (for example unskilled or skilled labour), where earnings are spent outside the region, or where multinational profits are expatriated to home jurisdictions for shareholder payments. The sectors that tend to benefit most from consumption linkages are hospitality, local transport, construction sector materials, perishable agriculture products and local services. Consumption linkages may be more evident during the construction phase of projects, where larger numbers of people tend to be employed.

In countries where production, side-stream and horizontal linkages are strong, consumption linkages resulting from an increase in capital income are also stronger. However, consumption linkages may not create sustainable development outcomes, as extractives revenues and incomes are inherently cyclical and volatile and revenues may be prone to illicit practices such as corruption, tax avoidance and erosion.