Rising China and Africa's development: oil
Rising China and Africa's development: oil

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Rising China and Africa's development: oil

2.2 Types of linkages

In the aftermath of the Second World War, building on the work of the Staple theorists, Hirschman (1981) and other scholars proposed an analytical tool for applying the Staples theory as a development model. From Hirschman’s work, we can identify three main types of linkages associated with resource extraction: fiscal linkages; consumption linkages; and production linkages. Richmond Atta-Ankomah explains in the following video.

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MAN
When we talk about the oil sector and linkages, broadly we could speak about three main types of linkages. The first is what we call fiscal linkages, the second is what we call consumption linkages, and then the third- which is quite significant, if you ask me, in my own opinion- is worldwide production linkages. We talk of fiscal linkages in terms of the fact that the resource extraction could generate some windfall in terms of revenue for government. And the government could use that revenue to invest in other productive areas. And it's part of the productive- it could be the agriculture sector, it could be the infrastructure sector, it could be other social- even social services. And that says you see a linkage between resource instruction and those other sectors. When we talk about consumption linkages, what we're saying is that the resource instruction itself could lead to an increase in income or generate income for those who directly participate in the instructive activities- and even the linked activities. And that income could generate consumption for products that are also produced within the economy and then expand activities for those sectors producing those products. And so, that is what we mean about consumption linking. Production linkage, we have what we call the forward production linkages and then the backward production linkages. Earlier on I spoke about the forward and backward a bit. So when you have resource input into the instructive activities, then you have the resource instruction being linked to various activities that are provided by that input. And so, that is where we call the backward linkages. And then, the other way around is when the output of the resource instruction has ended up in the activities of other sectors as inputs. Factors of factor linkage development- we could really speak of a lot of factors. The first that I would speak about, largely, is about the location and geology of the resource instruction. So the location and geology, it determines the kind of capital involvement and technology involvement. And so if you're speaking about a local economy, if the local economy doesn't have the capacity- technical capacity, and they live in the capital for such investment, then linkages that will be built within the local economy will be limited. So you will have high participation from, maybe, transnational corporations, who then come and then generates all the resource rent around it. And then, even repatriate some of the profits- the profits and everything. So, the linkages would then be a bit limited, in that sense. And then the other factor that we need to consider is what we call ownership. Ownership of the lead operator, in this sense. There's this idea that if the lead operator is owned locally, this local entity would have some affinity within the local economy, and has the interest of promoting, implementing [INAUDIBLE] and other things within the local economy. And so, would like to do the instruction or do activities subcontracted in such a way that it would affect the various sectors within the economy. So there is also an idea about China, as a lead operator in the resource instruction in Africa and how that is affected. Because the whole idea is that China- the Chinese entities, if you think of the oil, the Chinese national oil companies- they tend to have some sort of integrated approach to instruction. So they come with their label, they come with their own capital input. And that can lead to limited linkages being developed within the economy. Whereas, if you've got a lead operator from, let's say, a Western company, where you've got [INAUDIBLE] site organisation, you're putting pressure on them to ensure that linkages, builds, and [INAUDIBLE] activities are well entrenched in the activities, then the story or the results, the outcome, could be different in terms of linkage development. The other important factor to consider is infrastructure- the level of infrastructure development. Infrastructure development is very important when it comes to linkage development. Because we've got different sectors feeding into the activities of the oil sector, infrastructure, if it's well-built- for example, roads and railway network- it can reduce the logistical costs of supplying the lead frame in all of your structures. So infrastructure is very key when it comes to linkage development- the state of the infrastructure development. If the infrastructure development is a bit limited, you wouldn't expect much linkages to happen, especially within the local economy. The other point is policy- what kind of policy in place. So there's a lot of talk about, what we call, local content policy and how to ensure that localization happens, or linkage are developed extensively within the local economy. So if the policies, the targets, are not well thought through and if the targets or the policies are run achieving those targets are not well thought through and not well implemented, then you wouldn't expect much linkages to happen. Here, policy coherence is very key because there are so many- if you think about linkages in the economy in a sense of a system, then everything that happens- policies, even the financial sector- is key to building linkages with the oil sector. Policies in infrastructure sector is key to building linkages. So here, policy coherence- and that simply means this is very critical to ensure that linkages are developed properly. The other thing that we need to also mention is the time. Linkages take time to happen. You can't just start oil instruction today and expect linkages to happen within a short period of time. So, observations that we've seen from various places, where oil construction has taken place, is that where the instruction has been there for a lot longer, that you see more linkages happening compared to areas where they've just begun the instruction activities. Yeah, so, essentially, these are some of the key factors that can affect linkage development from the resource sector, especially if you're talking about oil.
End transcript: Video 1 Understanding different types of linkages
Video 1 Understanding different types of linkages
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Now focus on linkages from investment in resource extraction, particularly oil resources.

Fiscal linkages

Fiscal linkages relate to the economic rents that accrue to governments from the resource sector. The rents are in the form of royalties and corporate taxes, as well as personal income taxes. Another source of rent could be dividends arising from the governments’ equity participation in the resource extraction, which is quite common with oil extraction. Many governments in the developing world have tried to exert a bit more control over oil exploration and production and to appropriate more rent by establishing national oil companies which represent the governments’ interest in petroleum agreements with foreign companies that lead the extraction business. In Ghana, for example, the Ghana National Petroleum Corporation (GNPC) is a 100 per cent state-owned company, which by law must have at least 15 per cent equity holdings in all exploration and production agreements in Ghana’s oil sector.

Fiscal linkages actually arise when the rents accruing to government from the resource extraction are used for investment in other sectors of the economy such as agriculture, manufacturing, infrastructure and the provision of social services. Whether effective fiscal linkages will be derived from resource extraction depends on two critical factors. The first has to do with the capacity of public institutions to design, negotiate and implement rent appropriation mechanisms, which are usually built into petroleum agreements between the government and the foreign companies undertaking the extraction, and usually backed by explicit Exploration and Production laws, as in the case of Ghana. The second factor relates to how the derived rents are put to use. The rents can be invested productively, when the investments are in sectors that generate high returns, but they could go into unproductive investments, especially in systems where corruption is high and/or into financing the short-term electoral objectives of politicians. A major approach to addressing this problem has been the use of legislation to minimise the discretion exercised by politicians and state technocrats in spending oil revenues, a typical example being Ghana’s Petroleum Revenue Management Act which came into force in 2011, a year after oil production began in Ghana.

Consumption linkages

Consumption linkages arise when personal incomes derived from resource extraction lead to an increase in demand for products from other sectors in the local economy. However, consumption linkages can bear a negative impact if the earned income is spent on imported products or shifts demand away from domestic products to foreign substitutes, in which case, the domestic industries will suffer.

Production linkages

Production linkages involve two sub-categories, namely, forward linkages and backward linkages. Forward linkages occur when the output from resource extraction feeds into the production activities of other sectors as inputs. For example, in oil extraction, the crude oil extracted from the oil fields ends up in refineries for the production of refined petroleum products such as gasoline and diesel, with several by-products that also serve as inputs for the production of petrochemical products. It has been argued that a key reason why such forward linkages may not develop in the local economy is that the processing industries usually tend to be ‘residentiary’, i.e. they are usually located near the final consumption market. So, when local demand for the processed products is low or non-existent, the secondary value-added activities are likely to be located outside the local economy.

Backward linkages relate to the supply of inputs to the resource extraction. Hirschman (1981) and other scholars such as Watkins (1963) argued that when compared to forward linkages, backward linkages are more likely to develop in the domestic economy, particularly where the resource is located. A major reason for this is that a proximate supplier offers the opportunity for the contracting firms to cut down logistical inefficiencies in their supply chain. Moreover, the need to minimise production cost while adhering to high product quality and delivery standards in recent times has resulted in the adoption of production techniques that require firms to outsource activities outside their core competences to the lowest cost and closest suppliers.

In the next section, you’ll look into some of the key factors that determines the extent to which linkages, in particular production linkages, can be developed locally from the resource extraction.

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