An Analysis of the Government's Role in the Mining Industry in the Philippines

Steven B. Baria
Kim Edbonn C. Castillo
Maridy D. Nuyda

Economics 151
Prof. Teresa J Ho
March 13, 2013
The stance of the government in recapturing the essence of the mining industry in the country has been reiterated time and again. The industry has been tapped as one of the most viable provider of revenues and employment through local and foreign investments. Past administrations had stressed the importance of favorable investment conditions that is supposed to promote the economic growth and progress, particularly in the mining industry.
However, various issues has haunted the implementation of a holistic mining industry in the nation. This paper aims to provide a view of the efficiency and equity issues that plagues the whole of the mining sector and what the government can do in order to cater to these considerations. The Philippine case would be the vantage point of the study. The paper starts by defining some terms that is helpful in understanding the entire paper. A discussion of the externalities emanating from the mining industry and equity and efficiency arguments follows suit. Lastly an analysis of the government’s role in the Philippines and some recommendations are given.
Mining: Some Definitions
Mining is the useful extraction of minerals and other geological materials from the surface of the earth. This involves complicated and expensive processes and is accompanied by externalities that accrue to various stakeholders such as local residents and the environment. For a mining project to be pursued, the production of the desired mineral should be enough to compensate the total cost of extraction. Solutions to the mining implementation and the total quantity of minerals to be obtained are also focal considerations in this industry. The major kind of mining is surface extraction, which includes open-pit mining, strip mining and quarrying. Underground mining is also implemented for ore substances that lie significantly below the surface.
Mining is differentiated from other industries for its distinguishing characteristics. First, mining is a capital intensive industry, and a large part of the capital is considered 'sunk’, thus it is much harder to implement corrections under overcapacity and overinvestment compared to other industries. Second, a continual injection of capital is necessary even for maintaining production. There also occurs a large cost in obtaining information, because knowledge about mining prospects are often incomplete and imperfect. Moreover, the mining industry is very much sensitive to the cycle of economic booms and busts, which can be largely attributed to the nature of mineral deposits as intermediate goods (much are utilized at the start of the supply chain). However, even small scale mining projects can prosper in the international markets provided that the orebody is rich, an advantage which is not observed in other industries.
The mining industry is largely dependent on the current price of minerals in the market. Minerals are basically chemicals and compounds formed from geological processes in the immediate surface of the earth and underneath. Prices in a competitive market are determined by the demand and supply of the product. Demand for minerals such as copper, aluminum and coal is a derived demand; factors such as income, tastes and relative prices determine the demand for consumption goods utilizing these minerals for the production processes. Supply depends upon the cost of producing metal, and also on the price of the deposit. Minerals are usually intermediate goods, used for the production of final consumption products. Factors affecting the supply side include cost factors (scarcity, technology, and quality of deposits) and institutional factors (the occurrence of a cartel or monopoly, government interventions and environmental considerations).
Mineral reserves are basically common pool resources. Acquisition of minerals is rivalrous but also non-excludable because of the high costs of excluding others from its perceived benefits or costs, including externalities. Thus its composition as a public or private good is rather ambiguous, and ownership can be ideally held either by a public entity (the state), or a private one. Governments can also assign common property rights to communities where the mining sites are located. Most states take ownership of mineral reserves, including the Philippines as mandated by Republic Act No. 7942 (An Act Instituting a New System of Mineral Resources Exploration, Development, Utilization, and Conservation). By its very nature minerals are subject to depletion, wherein the rate of replenishment is so low that it does not offer a potential for augmenting the stock in any reasonable time frame. Consumption in the present also lessen the possibility of future consumption.
Mining Context in the Philippines
The Pacific Ring of Fire does not only tell what countries have many volcanoes; it is also a determinant of what places inside the ring are rich in mineral resources. The Philippines is one of the lucky countries enjoying these abundance of mineral reserves. The contribution of the mining industry to the Philippine economy has been only modest in the past years . According to the Mines and Geosciences Bureau, mining contribution to the Philippines’ Gross Domestic Product is just about 1% in 2011. Mining has also contributed about 252,000 jobs, 0.7% of total employment, in 2012 as stated by DOLE. The Philippines has already exported $2.84 million, 6% of total exports, worth of minerals in 2011. Total taxes, fees and royalties paid from mining were worth P22.08 million in 2011 (Mining industry statistics, 2012). The Philippines has numerous laws and policies related to and thus affecting mining in the country. There are actually three republic acts, 21 executive orders and a lot more policies set by the Department of Environment and Natural Resource and Mines and Geosciences Bureau. Some of these policies are created for the protection of the indigenous people living in the forested highlands in which minerals are found. Some policies such as the National Integrated Protected Areas Act or RA 7586 are mostly for the preservation of the natural biodiversity in certain places and for tourism. A clear evidence on how regulated the mining industry is in the Philippines is the numerous taxes a firm pay in its production. There are national taxes, corporate income tax, tax on stockholders’ dividends, excise tax, value added tax, and import tax for mining equipment and machineries (Oplas , 2013). The main policy governing mining industry in the Philippines is the Republic Act. No. 7942: An Act Instituting a New System of Mineral Resources Exploration, Development, Utilization, and Conservation signed by the former President Ramos. The law originally aims to liberalize the mining industry in the Philippines to attract more foreign investors. The call was for responsible mining by companies, the protection of the environment and a more sustainable use of resources. One of the objectives of the law is to rejuvenate the weakening mining industry by providing incentives and having a sustainable extraction of minerals. Some parts of the law says that foreign ownership can now be allowed however many had been alarmed by the provision when in fact a 60:40 ratio between local and foreign ownership of the firm was required by the constitution for an establishment of a business in the country. Last July 6 of 2012, President Benigno S. Aquino III signed the Executive Order No. 79 that suspended the government from signing new mining contracts up until a new revenue sharing scheme has taken effect. The EO 79 also said that small scale mining should only be done in the “minahang bayan” and the use of mercury will now be prohibited. Mining can never be done in a tourism destination, agricultural lands, and island ecosystems. Mining Industry Coordinating Council was created to create a complete implementing rules and regulations of the EO. Existing mining contracts approved before EO 79 are still legitimate and these existing contracts are subject to a review of the agreement. It also mentioned that it still allows having exploration and it can be used by the firm for its application for a mining permit in the future. The EO basically aims for solutions to the problems faced by the mining sector by having stricter enforcement of the environmental laws and rules done by both the national government and the local government units.
Externalities in Action Despite the millions of dollars it generates every year and the employment it creates, most of the costs of mining are impossible to be paid because of the very nature of them. Often times, the utilization of our natural resources leads to an inefficient use of the resources because some of the costs of mining are not accounted by the companies. It is where the market failure of externalities takes place . “We say that there is externality whenever an individual or firm undertakes an action that has an effect on another individual or firm, for which the latter does not pay or is not paid” (Stiglitz, 2000).
The private benefits of mining include the dollar it gains from the extraction and the creation of jobs. The private costs are the cost of land, labor, heavy machineries and equipment, taxes, and opportunity cost of mining. On the other hand, the social cost of mining is much broader because it also includes environmental costs such as pollutions, deforestation, biodiversity loss that leads to extinction, erosion, etc. In the aggregate, mining is an activity that privatizes benefits and socializes costs.
Carlos Primo David of UP NIGS cited that the Marcopper Mining Corporation in Marinduque Island was the source of major mine-tailing spills in the Mogpong River and in the Boac River in 1993 and 1996, respectively. It led to the deterioration of the water quality that resulted to loss in livelihood. The corporation was charged with P10.7 million as a fine but it was still insufficient for the recovery of the river. This is just one of many cases of not accounting the true cost of mining. There are also cases wherein the mining activity in a certain place resulted to the loss of habitat of a species that led to its extinction. Ideally, minerals should be priced at its total cost including those which are environmental, social and economic. However, it is very difficult to put value on these costs because we have imperfect information on the total effect of mining to society. Mining can also have an aspect of “tragedy of the commons” because the minerals are a common pool resource that can be utilized by anyone. Small scale mining is assumed to be labour intensive and it usually practiced by small firms, indigenous people, guerrilla, etc. Some of these people find mining as their primary way of generating income. The efficient level of extraction is located where the marginal benefit is equal to the marginal cost. Since they are small scale miners, the cost of mining for them are just the effort they exert in mining (close to zero) while their benefits are the income they get by selling the minerals they extracted. Following the logic, people will mine until the marginal benefits are zero, leaving the future generation with zero minerals to consume. Small scale mining is often times the main cause of negative externalities because most of them are inefficient in terms of extraction. An example of this problem was the case of the thousands of small scale miners who are digging on Mt. Diwata near the border of Surigao del Sur and Davao del Norte (Bagayaua-Mendoza, 2012). The minerals that the small scale miners are extracting in Mt. Diwata are nearly exhausted, leaving none for future generations.

The Efficiency Argument: Who gets the contract? According to EO 79, the mining rights and mining tenements over areas with known and verified mineral resources and reserves shall be given through a competitive public bidding. This may be not be fair because of the following reasons: barriers to entry, monopolistic tendencies and inefficient pricing. There may be barriers to entry due to the dominance of large companies in the auction. This can disincentivize some new firms to participate in the market. These obstacles will be beneficial especially to the firms who are already in the market. Due to the possibility of the dominance of large firms in the mining industry, they might have the tendency to exercise their monopoly power . There will be higher pricing of the minerals if the demand for them is high as well ( especially if they are rare). The graph below demonstrates how a large firm will regulate the pricing of the mineral goods. In a competitive market, firms will usually price the goods equal to their marginal cost. This would be different for a large firm exercising its monopoly power. They will price the minerals where the marginal cost of extracting and providing the goods is equal to the marginal revenue that they get from selling the minerals. When you draw a vertical line from the point where MC=MR up to the demand curve, you will realize that the price will be higher compared to the pricing of the competitive firm.
One problem that can be raised in the process of competitive public bidding is that the price that the firm will pay for gaining the mining right may not reflect the full cost of their extraction and activities. They may be paying for the marginal private cost of their extraction but not the marginal social cost. Externalities like pollution and spills are not yet accounted for. Thus, even if they auction the rights, the firms will not carry the full burden of the consequences of their activities . We can say that the system is inefficient in this perspective. The graph below demonstrates the problem.
The Equity Consideration: How about the Indigenous People?
Coase Theorem states that the parties may meet a mutually beneficial outcome as long as the property rights are clearly assigned and there are zero transaction costs (Stiglitz, 2000). How can the groups meet an efficient outcome if the property rights are not assigned properly? This can be seen in some indigenous people’s status. According to the data from the Mines and Geosciences Bureau of June 30, 2012, the government has already approved around 771 kinds of large – scale permits covering 1,009,161.21 hectares or almost 1/30 of the country’s total land area. Half of these cover the indigenous peoples’ ancestral territories (Salamat,2012). Clearly, the data shows that there is an underprovision of the government on recognizing the areas for mining and the areas where the IPs are living.
This conflict may result to another problem which is between the indigenous people living in their ancestral territories and the firms that were given legal mining rights to the same area . When it comes to conflicting laws, as in the case of the Mining Act and IPRA, decisions are often made in favour of business interests instead of the affected communities, which then resort to their own ways of resistance (Wetzlmaier,2012). One example was in Mindanao where the B’laan’s struggle for the defense of their rights lead to a violent outcome (Sarmiento, 2012; see also Peliño & Maderazo, 2012b). If these problems are not resolved , another situation may lead to the displacement of indigenous people in their own lands if the right of mining given to the firms is prioritized over rights of the indigenous people . It would be a great disadvantage for the Indigenous People if they are not informed and educated well of the transactions made and their rights on their own lands.
Let’s look at a possibility where the indigenous people would be okay if firms are to extract the minerals from their area due also to the IPs’ lack of capability and knowledge on utilizing these mineral resources. The firm on the other hand can compensate the damages and externalities that they may cause to the IPs on their activities. This is a good scenario if the marginal willingness to pay of the firm in utilizing the land for mining is equal to the marginal willingness of the community of indigenous people to accept the compensation given by the firm. But if both parties don’t arrive in that ideal point, a problem will arise and the effects stated a while ago can emerge as well ( violence and displacement of indigenous people from their ancestral lands).
What’s wrong with Minahang Bayan? According to EO 79, small scale miners will be allowed to mine only in the areas to be called as “Minahang Bayan”. The objective of this project is also to lessen the damages done by the small-scale miners to the environment and also contain in one place the wastes generated by the firms. But what could be an inefficiency with the said program? We will again face the problem of property rights assignment. There was a situation where the small - scale miners have already completed the requirements but did not pursue their applications because the areas where they plan to extract were also covered by Nadecor’s MPSA (Lacorte, 2012). If we analyze the problem using the Coarse Theorem, the parties will not lead to an efficient outcome due to the conflict regarding the assignment of property rights on the areas. The government should further take its role on checking further the lands so as not to have any unpleasant results.
Economic Rents and Government Taxation
Mining industries often generate economic rent, which is the difference between the amount paid for the inputs to a production process and the amount that would be paid for those inputs assuming a unitary (or greater) elasticity of supply. These economic rents are sourced from three forms. Scarcity rent is the price which can be imposed in the market due to the perceived eventual exhaustion of the deposits. Monopoly rent is due to the premium which monopolies can exact because of their monopoly power (witholding supplies to increase price). The Ricardian rent is the rent that can be exacted because of relatively low cost of production, compared to other suppliers.
Compared to the services and manufacturing sectors of the economy, which is dependent on the mobility of labor, capital and other production factors, the mining industry relies on natural resource inputs. The mining industry also has a low elasticity of supply, thus the slow expansion on the capacity of increasing production, compared to the constant returns to scale technology of most services and manufactured products resulting to perfectly elastic supply curves. Economic rents are usually associated with mines attributing lower costs, but not for higher costing wells. However, rents associated with monopoly market power and Ricardian rents are not ruled out by this situation.
There are two reasons that justify the taxation of these economic rents by the government. The first relies on the rationale that the state owns the subsurface minerals that are mined by these firms, so it is only just that the operating company pays for what it takes. The most plain way to administer this is the setting up of an auction for mineral permits. However, this process can lead to problems as discussed earlier. In addition, the few dominant players in the market may retort to a possible collusion that will cause the lowering of auction prices. Also, the assignment of permits will transfer all the possible risks to the firms, and it is generally viewed that the government is much better in handling risks than private entities. One way of efficiently spreading risks is by imposing a royalty system, which will be discussed later.
The second rationale for taxing economic rents is based on the feature of the rent itself. Reiterating its definition, it is a payment to a factor of production in excess of that required to keep the factor in its present use. Thus the taxation of economic rent does not affect resource allocation, which led to the belief that government should only adapt taxes levied on land, or natural resource, rent. Nonetheless, taxes such as this are oftentimes distortionary and affect the time-path extraction of a mineral source.
The Philippines depends largely on the implementation of numerous simple severance taxes such as income tax, excise tax and imposition of other fees, as promulgated in RA No. 7942. Payments for indigenous communities are also stated in the said law, but the exact amount or imposition of the payment is subject to compromise between the stakeholders. In Aquino's EO 79, government will assign property rights through a competitive public bidding (Sec. 6). The problems associated with these specifications on the tax system was already presented on the earlier paragraphs. Moreover, the main problem with the tax system in the country is that too much regulatory taxes are imposed to mining projects that only deter possible good investments in the mining sector.
One way for the government to maximize the gains from taxing mining ventures without creating too much distortions and at the same encouraging investors is to adapt a single yet sophisticated taxing scheme, such as a mineral royalty system. This scheme will claim a reasonable proportion of the value of the mineral for the resource owner (the local and indigenous communities, for example, or the national government for some cases). Royalties is preferably levied on pure profits, and not on an a specific or ad valorem basis, in order not to affect the extraction decision which in turn will render marginal resources uneconomic. This is also levied on a per project basis and is payable only until the investors are able to achieve their required rate of return.
One type of this royalty system is the resource rent tax (RRT) which specifies the investors' preferred rate of return that will cover their cost of capital. Any operating profits beyond the required return of the project comprise a rent, which will be taxed in turn for a preferably and reasonably high rate (in Australia, the tax rate is 40%).
Firms do not always record on a per project basis, so such system poses certain disadvantages. There is also the variability from taxing on a profit basis rather than on specific/ad valorem schemes.
Political Willingness of the Philippine Government
The Philippine government has been adamant recently on its stance about the state of mining in the country. This can be highlighted on EO 79, which aims to revitalize and change the country’s mining spectrum, which in the past is haunted by many inconsistencies and miscalculations from the government. The EO is far from perfect; the temporary holding off of new investments only benefit current investors and pose threats to future investments both abroad and domestic. Legal small scale mining is also put to a limbo because of the clause limiting these operations in favor of large scale mining. Such measure can create political instability coming from the indigenous people whose livelihood largely depend on it. The notion of a nationalistic stance on mining, an aim to promote local investments or a greater role of government in mining projects, has also been on rise in the past years. Moreover, protests against large foreign investments threatening indigenous culture and livelihoods has been observed. Red tape has been a perpetual problem and still a serious claim against investing inside the country. The government has much fixing to do regarding its somewhat insufficient actions towards these issues, although it is necessary to take a firm stand on the tradeoff between efficiency and equity considerations.
Synthesis
The mining industry is an unique case compared to the rest of the sectors present in the economy. Its vulnerability to risks and uncertainties are heightened by imperfect knowledge about the feasibility of a venture. Bad investments are unretractable and can incur significant costs to the investors. It is also one of the most unwanted industry because of the damage it can do to the environment and welfare of local communities. However, the resources extracted are largely needed for producing final products that are deemed necessities in modern life. It is no wonder why decision making in terms of investment is a great concern in the mining industry, for a venture can swindle in any direction and perceived benefits may not materialize at the end. The Philippines is teeming with mineral resources; intent in the exploitation of the mineral reserves is eminent in the number of pending mining projects that is being reviewed by DENR. In the premise that the government sees the mining industry as a potential harbinger of economic development, it would play a large role in ensuring that the perceived benefits of the state in venturing in this industry would accrue to the totality of the economy and to the people themselves. However, too much protectionism will result to a retraction of possible sustainable investments given that the mining industry is a fickle and risk-averse entity.
Considering the points rendered at the earlier parts of this paper, the government should properly intervene in the mining industry by imposing corrective measures for this market to efficiently work, at the same time taking into account equity stances. The first recommendation for the government’s role is a proper taxation that will not hinder the optimism of investments in the country. The current taxation system, wherein there are too many forms of taxes, is actually deterrent and creates a nauseated imposition to the investors. A single yet much sophisticated tax scheme such as the resource rent tax (RRT), levied on the net profits of the mining ventures, may work well in achieving greater inflow of investments at the same having a more efficient revenue aggregator. The scheme should also be able to minimize or even remove the monopoly power of these companies.
The second proposal is rooted to the fact that the mining industries produce externalities that affect various environmental systems. The government should ensure that the large scale industry has the “best methods and practices” that will minimize the damage it causes in the environment. Coercive penal costs should also be imposed to those violating environmental regulations. There should also be a separate implementing rules and regulations for small scale mining because they have a different set of effects in the environment compared to the large scale ones. Further intervention through imposition of environmental taxes may also be considered.
The last consideration that is deemed important in this discussion is the welfare of the local people living in these mining areas. They are major stakeholders because they are directly affected by the presence of such industries. The IPRA must be properly implemented and must also be involved in the decision making of the government when giving grants to mining firms. The government is also in the position to grant property rights to these IP’s, however such measure is still subject to discourse given that there is still a debate on who should really benefit in the mineral resources: it’s either the totality of the state or the local communities.
Conclusion
It is clear that the government should intervene in this kind of market because, for one, there is very serious negative externality that our country might endure in the form of irreversible destruction of the environment. Our country is not only the stakeholder in this issue but every human who cares for the environment. What the government needs to do is to strengthen the implementation of its laws and policies regarding mining. ie. the government should make a concrete list of what lands are open to mining and which one are not. The citizens together with the government, should have a clear value of the total cost of mining so that the tax system will also be clearer. Thus the investors will be enticed more to invest in our country. Lastly, a refusal to the presence of the mining industry in the country may tread problematic grounds for the reason that mining creates income and jobs and also promotes industrialization that is important for growth.

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