By Paul Columbus Collins
One of the much heralded acts of justice injected into the renegotiated concession agreements of Mittal Steel Liberia and Firestone Liberia was the replacement of discretionary pricing by the concessionaires with “prevailing global/international market prices” for our natural resources. This provision is supposed to correct the ills of transfer pricing and give Liberia a fair price for the natural resources being exported from Liberia. Following that revision, all other concessions negotiated stipulate “prevailing global/international market prices” for our resources. This is considered best practice, and deemed fair for both the concessionaires and the host country. In fact, Global Witness praised the Mittal revision and urged Firestone to follow suit. Immediately after assuming office in 2006, former President Ellen Johnson Sirleaf had requested assistance from Ivy League lawyers from the USA to review the concession agreements so that Liberia could derive greater economic returns from its natural resources.
In a recent dissertation submitted as final requirement for a Master of Law (LLM) degree in International Commercial Law, I reviewed the standard terms or provisions of concession agreements in Liberia, and identified a number of “bad” clauses or terms that I argued are responsible for a significant proportion of the annual illicit financial flows adversely affecting Liberia (and a number of poor countries in the world). One of such terms is the requirement for “prevailing global market prices” to be used for our natural resources. Global Financial Integrity (GFI) estimates that Liberia is losing around US$900 million a year through illicit financial flows. GFI doesn’t identify prevailing market prices as a culprit, but my Economic, Accounting, Tax and Auditing background enables me to see a little more than the ordinary law student, giving me a broader perspective that most people with narrow specializations are likely to miss.
So here’s my case. Transfer pricing is criticized because it is that price that related companies use when they transact among themselves. A company is related when it is associated with another either through common control or ownership. The idea is that related companies are not likely to set objective market competitive prices when they transact with each other or among themselves. To correct mispricing however and ensure arm’s length transactions, prevailing market prices are used to ensure fairness and transparency in transfer pricing. This is the norm. This is the standard. And this is what we now have in our concession agreements. And yet, our concessions are not meeting our socio-political and economic objectives.
The thrust of my argument however, is in “prevailing market prices”. (1) How are prevailing market prices determined? (2) Who determines prevailing market prices? (3) Are prevailing market prices susceptible to manipulation by our concessionaires?
- My background in Economics teaches me that market prices are determined by the forces of supply and demand. The supply and demand curves are a function of quantity and price. The higher the quantity, the lower the price; the lower the quantity, the higher the price. Equilibrium price (and equilibrium quantity), which becomes the market price, is that price at which the supply curve intersects with the demand curve. This is the minimum price that suppliers will accept for a certain quantity of their goods; and the maximum price that buyers will pay for that same quantity of goods. In Liberia, however, the only constraint on supply is productive capacity. Concessionaires aim to increase export at all times, whether prices are low or not.
- It is the sellers (they supply) and the buyers (they demand) who determine market prices. If the sellers don’t supply the goods because they do not like the prices being offered for their goods, there will be scarcity. When goods are scarce, and buyers must have them, then buyers offer more money for the scarce goods, which can lead to increases in supply at the attractive prices being offered. In other words, the more buyers are willing to pay, the more sellers are willing to supply. Who sell our natural resources? The concessionaires. Who buy our resources? The same concessionaires.
- Our concessionaires are all increasing production and exportation of our natural resources when prevailing market prices are falling. All the Central Bank/MFDP reports and the IMF/World Bank economic outlook reports blame lower GDP growth on falling market prices for our exports, which are predominantly our natural resources. Budget shortfalls are reportedly a direct consequence of these falling market prices. Why are concessionaires “happy” with falling market prices and therefore exporting or supplying more of our natural resources in the face of lower prices? The answer is simple and obvious: the concessionaires play the dual role of sellers and buyers, the one and same entity, which therefore cares less about what the prevailing market prices are for raw materials. Had it been finished products whose prices were falling, then they would care, because their finished products are sold to the world, not to themselves. Firestone would care if the price of tires fell, because tires are not sold to Firestone, but to the world. ArcelorMittal would care if the price of steel fell. , etc. Nobody wants to do business to make losses, so they would scale back production during periods of falling prices to reduce their losses.
ArcelorMittal Liberia sells to ArcelorMittal India. China Union Liberia sells to China Union China. Sime Darby Liberia sells to Sime Darby Malaysia. Firestone Liberia sells to Firestone USA. Etc., etc., etc. There is therefore no real buying and selling, but a simple extraction of natural resources in Liberia for shipping to their operations abroad. Why then would they want to set market prices high? Prices of natural resources are controlled and determined by the concessionaires. Prevailing market prices are therefore the prices that these concessionaires communicate to the world.
Liberia gains nothing by continuing to allow its natural resources, most of which are depletable, to be exported almost free of charge. The agreements should therefore stipulate that prices of our natural resources would be a factor of the prices of the finished products that our concessionaires sell to the world. There should be some kind of direct relationship between prices of our natural resources and prices of the finished products. As long as prices for steel are going up, prices of iron ore should also be going up. If tire prices are going up, our natural rubber price should also be going up. Extraction and exportation of our natural resources should be scaled back when prices are falling and unfavorable.
This is one of my arguments in my dissertation, which focuses on the revenue side of the equilibrium- transfer pricing and prevailing global market price. My next article will look at another argument proffered, that looks at cost — transfer cost and trade misinvoicing.
The author is a Liberian and the CEO/Senior Partner of Gedei & Associates. He holds an MSc and a PhD in Economics, is a Liberian CPA and a Fellow of the ACCA-UK, a Certified Internal Auditor, and now a candidate for the LLM in International Commercial Law. He can be contacted at [email protected] and Cell (+231) 776641184 / 886641187.