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.
Transcript: Video 1 Understanding different types of linkages
Now focus on linkages from investment in resource extraction, particularly oil resources.
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 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 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.