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Commodity trading de-regulation: The real “curse” for resource rich countries?

The U.S. Federal Reserve recently announced it is reviewing its policy allowing financial firms to trade in physical commodities, which has been known to distort market prices of food, fuels, and metals. This reassessment comes almost a decade after the Fed ruled that Citigroup Inc. could continue trading in physical commodities after finding the practice within the bounds of the firm’s trading and investing in financial instruments.

U.S. reconsideration of physical commodity trading regulation is noteworthy as criticisms of the practice worldwide have been met with little change thus far. It must be mentioned though that the United States is only one of many commodity trading hubs. Hong Kong and Singapore, for example, have been on a rapid rise relying on their proximity to emerging Asian markets and an overall business-friendly environment. Switzerland is by far the largest due to the industry’s recent explosion this past decade. Within Switzerland, Geneva is the most prominent center, responsible for about 22% of global commodity trading. It is ironic that that the city is at the same time a famed center of development and human rights thinking and action given the loosely regulated commodity industry’s detrimental impact on development and human rights protection abroad.

Originating out of Middle Eastern studies, the resource curse theory emerged as an explanation as to why so many resource abundant states have generally been more unstable, undemocratic, and unable to develop. The curse has mostly been looked at with regard to how easy revenue leads individual states to fail with less attention being paid to the external role of commodity trading centers that enable human rights abuses, generally ineffective governance, and tax avoidance in resource-rich countries.

Indeed, the resource curse is seen as a frequent, but by no means inevitable outcome in a country with an abundance of natural resources. Norway, Chile, Botswana, Australia, Canada, and even the United States demonstrate that countries can develop through their natural resources. Indeed, Africa, the poster region when it comes to offering examples of resource curse issues, was the fastest growing region this past decade largely due to a massive commodity boom. Intra-state conflict dropped, education improved, and poverty has been reduced.

This is a welcome sign in a world where development has tended to be a path dependent process where growth/stability or stagnation/conflict reinforce themselves overtime often leading countries down two totally different paths. In this light, the impacts of the external forces that can potentially shift the fate of a country in one direction or another become all the more relevant. As put forth by the Swiss government in a background report on commodities, weak accountability and an overall lack of transparency in the industry must be reformed in order to actually help commodity-rich countries uphold basic human rights, prevent environmental degradation, limit corruption and rule of law erosion, and curb tax avoidance and illicit flows of money.

A major lack of transparency has allowed Swiss commodity traders to buy commodities from sources known to disregard human rights, finance conflicts, or unlawfully acquire their resources. Conflict often begins over control of valuable commodities while many armed groups come to rely on such resources to finance their operations. A number of reports draw attention to illicit gold extraction which is traded in Switzerland undermining efforts to end many existing conflicts. In the case of the Democratic Republic of the Congo, Swiss companies have been criticized for indirectly purchasing minerals from small-scale artisan mines which are often subject to serious human rights concerns including child labor, human trafficking, and environmental degradation. Additionally, mining licenses are frequently sold to businessmen closely linked to the government for a discount allowing corrupt officials to benefit from their trading with Swiss companies.

Tax avoidance has been another major concern. The same report by the Swiss government highlights the case of Zambia where Swiss-based companies have been accused of using “internal accounting practices to shift profits to countries with low tax rates and, simultaneously, to transfer costs to countries with high tax rates. This enables them to regularly post losses in spite of the relatively high copper price.” As put forth in a recent SOMO publication, states require financial and administrative resources drawn from taxes to develop and protect human rights. “Research shows that progressive tax systems contribute to good administration, democratic development and poverty reduction, whilst large-scale tax avoidance by MNCs undermines these goals.” Thus, allowing MNCs to avoid taxes undermines state capacity and its ability to uphold human rights.

While Switzerland has, as mentioned, the greatest share of commodities trading, the problems associated with lax control of commodity trading houses are not confined to Switzerland. Nor are they, for that matter, confined only to commodity trading houses, as shown by their inter-linkages with financial firms which the Fed’s review is evidence of.

Proper external regulation and control of commodity trading companies, including those owned by financial firms, can help make resources act as they should alleviating debt and reducing poverty. Such regulations should be tough on firms that facilitate corruption, human rights abuses, intra-state conflicts, and underdevelopment. Importantly, this is not something that the country where the resources are located can do on its own while it is quite feasible in the actual centers of commerce.

As previously mentioned, Africa was the fastest growing region this past decade largely due to a commodity boom. However, for improvements to be sustained, the external forces that help shape regional development and human rights protection need to be reoriented. A major problem facing underdeveloped regions has not been their increased connection to the outside world but rather how they are connected to it.

Traditionally, concepts of sovereignty guided state relations and international law. However, with the massive increase of global business operations in the last several decades, regulation has still only been relevant at the state level. The extraterritorial application of human rights has failed to catch-up to a different world. The best time to change this would have been years ago. The next best time is now.

Nathan Doctor is a program assistant at the Center of Concern.

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May 2017
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