Economic Incentives for Investments Downstream

At a Glance
  • Economic incentives designed to enhance investment in downstream activities include: export taxes on unprocessed products, favorable tax treatment and direct investment incentives, and the provision of cheap inputs via subsidies. 
  • Taxing the export of unprocessed raw materials is the most commonly employed incentive, but because these taxes tend to reduce exports, governments should be aware that tax revenues may decline correspondingly.
  • Profit taxes and royalties are other normal methods of taxation on extractive industry production, but require more sophisticated government competencies and institutions.
  • Government provision of investment incentives for downstream production can include tax holidays, reimbursing some of the initial costs of investment, and accelerated depreciation.
  • A major problem for government is calculating whether support for downstream production is necessary, and if so, how much.
  • The two most significant inputs that attract government support are transport and power.

Many governments provide economic incentives that are designed to enhance investments in downstream activities. The most commonly employed incentive is the levying of taxes on the export of unprocessed raw materials. This section will cover three types of incentives:

  • Export taxes on unprocessed products
  • Favorable tax treatment and investment incentives for downstream processing
  • Provision of cheap inputs to downstream production via subsidies

Export taxes on unprocessed products

At least 18 African countries levy export taxes on mineral exports or exports of scrap metals. However, in many cases, the export taxes are limited and are actually designed to collect revenue rather than promote downstream production. In many developing countries, a significant share of government revenue is derived from export taxes.[1]

Export taxes tend to reduce exports. Governments should be aware that, as a result, tax revenues may be less than expected. Profit taxes or royalties are other normal methods of taxation on extractive industry production but require more sophisticated government competencies and institutions.[2]  

China imposes export duties on a wide range of mineral products – bauxite, coke, fluorspar, magnesium, manganese, silicon metal, yellow phosphorus, and zinc. In addition, India imposes export taxes on iron ore. In the case of both China and India, the aim of export taxes is to enhance local processing and downstream activity.

Policymakers contemplating export taxes and/or other restrictions on exports of raw materials in order to encourage downstream production will need to take account WTO regulations. While export taxes per se are not forbidden by WTO rules, other restrictions, including conditions surrounding the taxes, may be prohibited. In most cases, particularly in relation to smaller countries, export taxes and other export restrictions do not exert appreciable damage on other countries and so generally remain unchallenged.

However, in respect of large countries where export taxes and restrictions are designed to encourage local processing on a large scale, damage may be significant and may result in countries taking action at the WTO. China’s position as a leading global producer of a number of raw materials means its export restraint measures give it the ability to affect global supply and pricing. Restrictive measures accordingly can provide important advantages to Chinese firms that use the raw materials, to the detriment of other countries. These measures also can create substantial pressure on foreign producers to move their operations, jobs, and technologies to China.

The raw materials in question are key inputs into a wide range of high-value products in vital industrial sectors, including steel, automotive, aerospace, construction, and electronics.

China’s policies were challenged at the WTO and ultimately, this challenge was successful:

WTO Dispute concerning Chinese export taxes on minerals: In June 2009, the EU and the United States both filed requests for consultations with China. In August, they were joined by Mexico (DS394, 395, and 398). According to the requests, China imposed quantitative restrictions on the export of bauxite, coke,      fluorspar, silicon carbide, and zinc, and it also imposed export duties on bauxite, coke, fluorspar, magnesium, manganese, silicon metal, yellow phosphorus, and zinc. These measures were considered to be in contradiction to Articles VIII:1(a), X:1, X:3(a), and XI:1 of the GATT 1994. On 5 July 2011, a dispute panel found in the complainants’ favour. Both sides appealed, and the Appellate Body upheld most of the dispute panel’s findings. In particular, China had argued in its defence that some of its export duties and quotas were justified because they related to the conservation of exhaustible natural resources for some of the raw materials. But China was not able to demonstrate that it imposed these restrictions in conjunction with restrictions on domestic production or consumption of the raw materials so as to conserve the raw materials. On 28 January 2013 China notified that it had implemented the dispute panel’s           recommendations. A similar case brought by the United States, the EU, and Japan in 2012 concerning restrictions on Chinese exports of rare earths, tungsten, and molybdenum also resulted in victory for the complainants in 2015.[3][4]

In contemplating the introduction of an export tax to encourage downstream production, governments should determine whether such an incentive is indeed required. In some instances, governments have instituted an export tax in order to encourage further processing where no incentives are necessary. As an example, Zambia levies an export tax on copper concentrate of 10% of the sales value. The tax is intended to promote the smelting and refining of copper concentrate from mines in the country. The cost of transporting copper in its raw state, concentrate, is almost three times the cost of transporting refined copper. As a consequence of the far higher cost of transportation of concentrate, a mining company is better off refining its copper even in the absence of the export tax. In brief, the export tax is redundant as a means of encouraging refining.[5]

Export taxes can also be detrimental to the actual production of the raw extractive industry resources in some cases. Where a mine is too small to produce the volumes required for a smelter and where smelting capacity is not available nearby or where there are impurities that are not easily managed within existing smelters, an export tax may render such mining projects unprofitable and thus have the effect of curtailing mining output and investment.[6]

Export taxes have a negative impact on the profitability of the producers of the raw materials. Governments seeking to promote downstream production will accordingly need to balance the interests of downstream producers with the interests of the producers of the raw materials. This is a complex task, particularly where the profits of the producers of raw materials are very low and their capacity, therefore, to absorb the tax is very limited. As an example, India has favored steel production through a number of measures. Export taxes were imposed first on iron fines and later, on iron lumps. In March 2011, both fines and lumps attracted a 15% tax which was raised to 20% later that year. The impact on the iron ore industry was detrimental. Iron ore exports which had been significant declined to effectively zero. From being the world’s third-largest iron ore exporter, India has, just two years after the imposition of the export taxes become a net importer of iron ore.[7]

When a processing facility is not itself profitable but is dependent on taxes levied on the export of the raw material, the processing facility is vulnerable when either the prices for the refined product that it produces falls, or if the price of the raw material exported falls. There are many examples of marginal or unprofitable processing facilities reliant on export taxes to survive, ceasing operations when the prices decline. For example, small copper smelters set up in Katanga in the Democratic Republic of the Congo (DRC), which could exist only because of the DRC export tax on copper concentrates and the high transport cost. Most of these smelters closed rapidly when copper prices fell in late 2008.

Favorable tax treatment and investment incentives for downstream processing

Positive incentives, for instance in the form of tax credits for downstream processing, have been discussed but no current examples are known. However, downstream processing can be favored by provisions in tax codes that do not obviously aim at providing incentives for downstream processing. For example, Kazakhstan imposes an excess profit tax (EPT) on mining profits. Investments in respect of downstream processing are deductible costs, so reducing the EPT to be paid by mining companies that invest downstream.[8]

Government provision of investment incentives for downstream production are more widespread. Investment incentives can take a variety of forms including tax holidays, reimbursing some of the costs of the investment and accelerated depreciation.

Downstream investments tend to be very capital intensive. Subsidizing such investments through government bearing some share of the costs tends, to also be very expensive. In many instances, the potential recipients of these incentives are foreign companies. Government will need to carefully evaluate whether expenditure of its scarce resources in supporting downstream investments is the best use of its limited resources.

A major problem for government is calculating whether support is necessary and if so, how much support is required to secure downstream processing. Providing support where none or less is necessary is clearly wasteful of government resources. It is very difficult for government to ascertain the precise level of support required to attract the desired downstream investment.

As an illustrative example, the Mozal smelting facility in Mozambique has been the recipient of extensive investment incentives, as well as several other support measures. In addition to exemptions from the value added tax, excise duties, customs duties, stamp tax, property tax and municipal tax on rental income, Mozal is also exempt from corporate income tax payments and instead pays a 1% turnover tax. In 2006 these investments, which have been granted for 50 years, resulted in foregone public revenues equivalent to 11.9% of total government revenues. Moreover, there is a strong case that the internal rate of return on the investment in Mozal would have been adequate to secure this investment in the absence of such costly and long duration incentives.[9]

Provision of cheap inputs to downstream production via subsidies

Governments frequently subsidize input costs to downstream producers. The two most significant inputs that attract government support are transport and power. Particularly widespread are governments provision of subsidized electrical power to aluminum smelters. These contracts are generally long term. Since electricity generally constitutes the single largest input cost item and investment in aluminum smelters is very capital intensive and long term, this provides a significant and long-term incentive to investors.

In addition to being the recipient of significant investment incentives and tax concessions (see above), Mozal in Mozambique has benefitted from a long-term low-cost electricity agreement. Mozambique’s demand for electricity in 2007 was less than half of Mozal’s peak demand. Other consumers, residential and industrial are prepared to pay a far higher price for electricity, but government must first satisfy Mozal. This illustrates the opportunity cost that this electricity agreement may entail for Mozambique, especially as Mozambique develops and residential and industrial demand for electricity increases.[10]

View footnotes

[1] Isabelle Ramdoo and San Bilal, Extractive Resources for Development: Trade, fiscal and industrial considerations, Discussion Paper No. 156, (Maastricht: ECDPM, 2014), 55-61

[2] K. Fung and J. Korinek, “Economics of Export Restrictions as Applied to Industrial Raw Materials”, OECD Trade Policy Papers, No. 155, (Paris: OECD Publishing, 2013)

[3] Olle Ostenson and Anton Loft, Downstream Activities. The Possibilities and the Realities. WIDER Working Paper 2017/113, (Helsinki: UNU-WIDER, 2017), 16: Box 1

[4] Jane Korinek and Jeonghoi Kim, “Export Restrictions on Strategic Raw Materials and Their Impact on Trade”, OECD Trade Policy Working Papers, No. 95, (OECD Publishing, 2010)

[5] Ostenson and Loft, Downstream Activities, 20-22

[6] Ostenson and Loft, Downstream Activities, 20-22

[7] Ostenson and Loft, Downstream Activities, 18-20

[8] Ostenson and Loft, Downstream Activities, 16-17

[9] Columbia Center for Sustainable Investment (CCSI), Linkages to the Resource Sector. The Role of Companies, Governments and International Development Cooperation. (Bonn: Deutsche Gesellschaft fur Internationale Zussamenarbeit, 2016), 39-41

[10] Columbia Center for Sustainable Investment (CCSI), Linkages to the Resource Sector, 39-41

Key Resources