Monday, May 19, 2008

Diamonds Are Forever, Wars Are Not: Is Conflict Bad for Private Firms?

Every once in a while The American Economic Review publishes something interesting. A recent article gave pretty solid evidence that the Civil War promoted by Jonas Savimbi raised profits for the diamond industry.

A long-standing theory in economics is that peaceful development is in the interests of business. 18th century theorists use to write about "sweet commerce." But Savimbi offered business the opportunity for an alternative government to bid against the Angolan government, thereby converting government rents into profits.

Once peace broke out, the levels profits subsided.




Here are my notes from the article:

Guidolin, Massimo and Eliana La Ferrara. 2007. "Diamonds Are Forever, Wars Are Not: Is Conflict Bad for Private Firms?" American Economic Review, 97:5 (December): pp. 1978-1993.

1978: "... the Angolan civil war suddenly ended with the death of the rebels' leader, Jonas Savimbi, on February 22, 2002. This allows us to conduct an event study to assess investors' reactions to an exogenous conflict-related event, and one in which one party gained an unambiguous victory over the other. Restricting our analysis to the diamond mining sector is useful because, unlike oil production sites, which are located offshore and were removed from the fighting in the mainland, the activities of diamond extracting firms were located in areas very much at the heart of the conflict. A priori, one would therefore expect the (negative) impact of the war to be maximal for these firms."

1978-9: "Our main finding is that the cumulative abnormal returns of "Angolan" stocks experienced a significant drop in correspondence to the end of the conflict, while those of a control portfolio made of otherwise similar diamond mining companies not holding concessions in Angola did not. In other words, international stock markets perceived Savimbi's death (and later the ceasefire) as "bad news" for the companies operating in Angola, but not for others. On the event date, the abnormal returns of the "Angolan" portfolio declined by 4 percentage points, and the difference between "Angolan" and control abnormal returns was 27 percentage points. This suggests that, no matter how high the costs to be borne by diamond mining firms in Angola during the conflict, the war appears to have generated some counterbalancing "benefits" that in the eye of investors more than outweighed these costs. Although our result is based on a small sample of seven firms that were operating in Angola and were also listed on major international stock exchanges, this is a (sad and) striking result which suggests that much of the wisdom on the incentives of the private sector to end conflict may need closer scrutiny. We offer a number of interpretations for our finding, including the fact that during the conflict: (a) entry barriers for new diamond producers were higher; (b) the bargaining power of Angolan authorities was lower, hence licensing (and rent-seeking) costs for incumbent firms were lower; and (c) the lower transparency standards permitted by the ongoing war allowed for relatively profitable unofficial dealings."

1979: "The second branch of literature concerns the role of natural resources in civil wars. This literature, started by the work of Paul Collier and Anke Hoeffler [Collier, Paul, and Anke Hoeffler. 1998. "On Economic Causes of Civil War." Oxford Economic Papers, 50(4): 563-73.], investigates whether natural resource abundance increases the likelihood of conflict onset, as well as conflict duration."

see also Ross, Michael L. 2004. "What Do We Know about Natural Resources and Civil War?" Journal of Peace Research, 41(3): 337-56; and Miguel, Edward, Shanker Satyanath, and Ernest Sergenti. 2004. "Economic Shocks and Civil Conflict: An Instrumental Variables Approach." Journal of Political Economy, 112(4), 725-53.

1979-80: "Following its independence from Portugal in 1974, Angola was plagued by a long and cruel civil war between the Movimento Popular de Liberta‡ao de Angola (MPLA) and the Uniao Nacional para a Independencia Total de Angola (UNITA). In September 1992, national elections were held and Jos‚ Eduardo dos Santos, leader of the MPLA, won by a slight margin. This victory was never recognized by UNITA's leader, Jonas Savimbi, who initiated a civil war that was perceived by many as driven by his own desire of political power as much as by ideology. Throughout the war, UNITA's military strategy was aimed at occupying the areas of highest concentration of diamond mines and at using diamond sales to finance weapons purchases. The MPLA relied mostly on oil for financing its military operations through the Fuerzas Armadas de Angola (FAA), while also earning money from official diamond concessions. As part of the Lusaka Peace Protocol, in 1994, UNITA was given legal rights to mine and to form partnerships with foreign companies. The peace process collapsed in the summer of 1998, however, when the rebels returned to massive attacks against the military and civilians. The years between 1998 and February 2002 marked the last phase of the Angolan conflict and constitute the sample period on which our empirical analysis focuses. During these years, many commentators talked about a "military stalemate" between government and rebel forces. On February 22, however, Jonas Savimbi died in an ambush 100 kilometers from the Zambian border. Six weeks later, on April 4, the cease-fire was signed."

1980: "Since the beginning of the war, there was a close link between conflict and the diamond industry in Angola. Angolan diamonds have traditionally been mined in alluvial deposits, where capital investments take the form of light machinery and river diversions, and production was relatively easy to control by rebel forces. The key role of diamond sales in financing UNITA's operations has brought the problem of "conflict diamonds" to the attention of the public. To give an idea of the importance of the sector, Angola is the fourth largest diamond producer by value in the world, largely because most of its production is of gem quality. Angolan diamond sales in 2000 reached $1.1 billion, i.e., 15 percent of the world production of rough diamonds. This amount was almost equally split between official industrial production, official artisanal production, and illegal production. It is estimated that between 1992 and 1997, when UNITA controlled most deposits in the Cuango valley, the rebel movement supplied between 8 and 10 percent by value of the rough diamonds on the world market (Tony Hodges 2004, 174-77).

1980: "Diamond production and marketing in Angola have traditionally been controlled by the stateowned company Endiama through joint ventures. The diamond law passed in 1994 established that in order to obtain mining rights, foreign companies had to form a partnership with Endiama and with at least one other Angolan company, and get approval of the Ministry of Geology and Mines. This led to the proliferation of local mining companies owned by well-connected Angolans, who obtained concession rights for nominal fees and then sought lucrative partnerships with foreign companies. Many army generals also benefited from the situation by establishing private security firms that were contracted by the mining company being awarded the concession, sometimes as an implicit part of the deal. These high hidden costs restricted participation in diamond mining in Angola to a relatively small number of industrial companies and a large number of artisanal miners (garimpeiros)."
1980: "Between December 1999 and February 2000, the Angolan diamond industry underwent further restructuring. First, the government created a marketing monopoly in which all Angolan diamond production would be bought and resold by the Angola Selling Corporation (Ascorp). This was a joint venture between the state-owned Sodiam (51 percent) and two foreign companies with strong political connections, Welox and Tais. The creation of Ascorp was perceived as a serious blow to major international companies operating in Angola, primarily to De Beers. Another reform in early 2000 suspended all contracts that had been signed between Endiama and other mining companies and expropriated prospecting concessions exceeding 3,000 square kilometers. Needless to say, these reforms were not welcomed by existing companies, which saw their contracts unilaterally renegotiated. Since the end of the war, the situation has not changed significantly. Partnerships with local companies remain a cornerstone of the Angolan diamond industry, and the government has established a security body that has been seen by many as an attempt to centralize control of diamond production under domestic intelligence services."

1986: ""Mining companies are condemned to operating wherever they find minerals. They can consequently find themselves in the middle of conflicts that have erupted around them. In some instances they also deliberately enter conflict zones as part of a high risk-high profit strategy to exploit areas lacking competitors, or to gain a toehold before competitors arrive." (Oxford Analytica, Congo-Kinshasa: Resource sector brings political risks, 20 July 2005)."

1986: "A concise quote from a local source is possibly more explicit: "The end of the war in Angola means that right now the main institution in the country is corruption." Quote by Rafael Marques, a dissident journalist from Luanda. Reported by Tim Butcher in "As guerrilla war ends, corruption now bleeds Angola to death." www.telegraph.co.uk, 30 July 2002.

1986: The civil war created "a price war between the government and UNITA over the concession of mining rights. The length of the conflict, and the withdrawal of the external funding that had helped both sides during the Cold War, put increasing pressure on the two parties to obtain immediate revenue. This is likely to have shifted bargaining power in favor of firms and allowed them to strike better deals. This was particularly true in the case of UNITA after the imposition of UN sanctions that rendered dealing with rebel forces illegal and forced them to do business on terms very favorable to the buyers. Indeed, industry sources suggest that working under UNITA protection was a particularly cheap way to extract diamonds: "According to one former garimpeiro who worked in the twilight zone between UNITA and government control, foreign dealers paid $250 to UNITA for prospecting rights" (Justin Pearce 2004, 4). The end of the war would dramatically decrease the demand for weapons (and for immediate revenue) by the two parties and thus increase firms' licensing costs. Through this channel, company profits would have decreased after Savimbi's death even if the extent of regulation and rent extraction by the government had not changed."


1 comment:

Myrtle Blackwood said...

"this is a (sad and) striking result which suggests that much of the wisdom on the incentives of the private sector to end conflict may need closer scrutiny. We offer a number of interpretations for our finding, including the fact that during the conflict: (a) entry barriers for new diamond producers were higher; (b) the bargaining power of Angolan authorities was lower, hence licensing (and rent-seeking) costs for incumbent firms were lower; and (c) the lower transparency standards permitted by the ongoing war allowed for relatively profitable unofficial dealings."

An economic system that is based on: (i) the accumulation of monetary profits; (ii) artificial pricing that does not account for costs to people and the environment; (iii) the unequal terms of exchange.

How wonderful war is for capitalism.