Looging concessions

how to stop losing money

A.J. Leslie

A.J. LESLIE is the Director of the Forestry Industries Division of the FAO Forestry Department.

In the bargaining for timber concessions between government of developing countries and big companies' the companies usually come out ahead. Governments often cheat themselves through unpreparedness and the lack of basic technical skills. This can be corrected through training and practice.

The tropical hardwood forests of Southeast Asia are today one of the main resources of the region rising, over the past 25 years, from a minor item in the commodities trade to a major component of the regional flow: as log exports from Indonesia, the Philippines and Malaysia; as processed timber from Peninsular Malaysia, the Philippines and, more recently, Indonesia; and as log imports into Japan, Singapore and the Republic of Korea. Had it not been for the wars affecting other Southeast Asian countries, these, too, would almost certainly have had their share in that exploitation boom.

The development of the tropical timber trade in the region over the last two decades can be seen in the table. It gives some idea of the rate at which exploitation has expanded. It also pinpoints other characteristics of that trade which we shall discuss further on.

All of this exploitation involves a large number of sequential transactions, transferring rights or commodities along the chain from forest owners to the final consumer. The sequence starts with the sale of standing timber. The most common technique for the legal recognition of the right to exploit areas of forests is to allocate tracts of government or public or community owned forests to private or quasi-private companies (the concessionaire or the concession holders) under licences which specify the conditions of the contracts (the concession agreement). In Southeast Asia many of the concession holders are locally owned companies, but transnational corporations are often the more important.

The conditions under which the rights to exploit an area of public forests are transferred from the owner or the owner's agent to the concessionaire are, therefore, crucial in determining how the forest should be treated. The ability of the forest owner to hold the concessionaire to the agreement is however, critical in determining how the forest is actually treated. Many features of the tropical timber trade and its effects may thus be associated with the nature of the concession agreement.

One of the most obvious aspects about the tropical forest is that there is a lot of it and that some of the species are quite valuable. The forest, therefore, should be able to make a very substantial cash contribution to national welfare and development, and it does. In 1978, tropical timber exports from Southeast Asia and the Pacific were worth more than US$2.5 thousand million. Even in a very depressed year such as 1975, the trade still earned around $1.5 thousand million in foreign exchange. On that performance, a hectare of Dipterocarp forest is a very valuable piece of property for somebody.

"... licencees are unlikely to proceed expeditiously with the utilization plan and prefer to export logs for as long as (the government) will permit the terms of the agreement to be flouted."

The total is certainly high enough to have some impact on development, but the effect is probably not discernible in per caput terms. However, other effects of this large-scale exploitation are clearly visible. Exploitation, for once, is the right word to use. Not even the most generous assessment could describe what is happening to the major part of the Southeast Asian tropical forests in any other terms.

Forests, on the whole, are simply being mined, taking out the easiest to get - and the most highly priced trees-without any real concern for what happens afterwards. And what happens afterwards is very commonly a sequence of:

· Forest destruction by agricultural settlement following the logging operation.
· Land degradation through post-logging shifting cultivation on too short a fallow cycle.
· An almost complete absence of reforestation.
· Continuity of large-scale rural poverty.

MAHOGANY LOGS IN PERU IN 1957, collectors' items then, not to be found today

Thus, for the forests and the people who are dependent on them, the only obvious lasting effect is retrogression.

The outcome is naturally the cause of some dissatisfaction since utilization of a forest resource through forest industries should dead to economic development. It is hard to see, however, that the utilization of forests in Southeast Asia has, for the most part, led to the long-term positive benefits that can accrue to the countries in which the forests occur. The failure is largely the result of the utilization, leaving out the industries phase. From the table, it can be seen that log exports still dominate the trade, as they have for the past 15 years at least. The logs are exported to developed or more advanced developing countries and with the logs goes most of the development potential. The fact that the fog-importing countries have made much greater progress in economic development than the log-exporting countries may not prove that the theory is right, but it certainly points in that direction. So, the basic dissatisfaction is rooted in the failure of log export-oriented exploitation to benefit in actual fact the log-exporting countries.

Exporting countries are convinced that they could be getting a lot more of the benefit from the exploitation of their tropical forests than they are getting now. It may therefore be worth while to examine the circumstances, especially those relating to concession agreements, which could have contributed to such an unsatisfactory outcome.

Criticisms of the way in which concession agreements have operated come from both sides, and say the same thing: that the other party failed to live up to its obligations. On the government side, with which we are at the moment concerned, the main allegations against the concessionaires are that they:

· Have not converted to processed products once the log exports have provided the cash flow that the companies claim is necessary to finance further investment.

· Have not paid enough for the timber or their rights to exploit it.

· Have not made any contribution to reforestation.

· Have not trained local people to any higher level than plant operators.

· Keep the real management power firmly in expatriate hands.

· Have repatriated exorbitant profits instead of ploughing them into local investment.

· Operate grossly unfair transfer pricing systems to the benefit of the parent company at the expense of the host country.

· Have creamed the forests in a way they would never do in their own forests or be allowed to do in the forests of a developed country.

· Treat the concession areas as their own property and government officers as trespassers.

· Falsify the figures in any returns or information they provide.

In 1978, tropical timber exports from Southeast Asia and the Pacific were worth more than $2.5 thousand million. Even in a very depressed year such as 1975 the trade still earned about $1.5 thousand million On that kind of performance a hectare of Dipterocarp forest is a very valuable piece of property for somebody.

This does not mean that all of those criticisms necessarily apply to all transnationals in all countries at all times. Indeed, there is not much solid evidence that all of the allegations are justified, although admittedly supporting evidence for some of the allegations would not be hard to find. What is important, however, is that the exporting countries in general believe that this is how the transnationals operate. Quotations from the Indonesian Observer of 22 January 1980 illustrate the points.

"The concessions given to Indonesian firms were transferred to foreign companies under the pretext of joint venture which were, in effect, fully dominated by the foreign partners."

"These foreign companies have been cutting huge trees in Borneo, Celebes and Sumatra wildly, without -plans for replanting or reinvestment."

"They have ignored the government's ruling that only processed logs (sic) must be exported."

These views may, of course, be dismissed as mistaken and prejudiced, but that could not be said about everything. As the table shows, log exports are just as dominant now as they have been for the past 20 years. This may not be conclusive evidence that promises on processing have not been kept, but it is certainly not evidence of great enthusiasm on the part of the concessionaires to make the switch to processed products. The reason-the high profitability of log exports - is well attested. For instance:

"The overall conclusion that logging in East Kalimantan throughout the early 1970's was a highly profitable business seems inescapable." (1)

"The export of logs from the state is highly profitable. The return on the capital invested (in the forest products industries) is much lower that the return on capital obtainable from log exports." (2)

The high absolute, as well as relative, profitability of log exporting is not, in itself, supporting evidence for the other criticisms of financial behaviour but it does give some plausibility to the beliefs. Clearly it is in the interest, short-term at least, of any company, transnational or otherwise, to act in this way, especially if it has no stake in the future of the country where it is operating. Equally clearly it is in its interest to continue to do so for as long as the practice pays and for as long as the company can get away with it. As one report puts it ". . . licencees are unlikely to proceed expeditiously with the utilisation plan and prefer to export logs for as long as (the government) will permit the terms of the agreement to be flouted." (2) It might be worth considering therefore the extent to which weaknesses in the concession agreements, or in the process of negotiating a concession agreement, permit such practices to occur.

Production and exports of tropical hardwood logs and processed wood by developing countries in the Asia-Pacific region, 1961-78

	1961	1966	1972	1978
	Volumes in million m³
Log production
Southeast Asia	18.9	28.8	52.6	68.0
western Asia	6.7	7.7	8.9	10.0
Pacific	0.1	0.5	1.3	1.6
Total	25.7	37.0	62.8	79.6
Log exports
Southeast Asia	7.4	15.3	31.7	37.5
western Asia	0.2	0.3	0.3	0 3
Pacific	-	0.1	0.7	0.6
Total	7.6	15.7	32.7	38.4
Processed wood production
Southeast Asia	5.6	6.7	10.0	13.4
Western Asia	2.5	3.4	3.7	4.2
Pacific	0.1	0.1	0.2	0.2
Total	8.2	10.2	13.9	17.8
Processed wood exports
Southeast Asia	1.0	1.2	3.1	5.0
Western Asia	0.1	0.1	0.1	0.1
Pacific	-	-	-	0.1
Total	1.1	1.3	3.2	5.2
Percentage of log production exported
In processed form ¹	10.7	8.9	12.8	15.7
As logs	29.6	42.4	52.5	47.8
Total	40.3	51.3	65.3	63.5

¹Converted to roundwood equivalent at 0.4 m³ processed wood per m³ of log imported.

Weaknesses in concession agreements can originate at any of three stages:

· Those in the negotiating process which result in a weak (from the government's point of view) agreement.

· Those in the documenting phase in which the terms of the agreement are transformed into a legal instrument.

· Those in the administering phase which lead to weak (from the government's point of view) control.

The three phases go together. For instance, no matter how favourable (from the government's point of view) an agreement is negotiated, and no matter how precisely it is recorded, without the ability to enforce compliance it is virtually useless. The interdependence between the three should always be kept well in mind.

The negotiation of a concession agreement is, in principle, a form of the bargaining process. In any bargaining situation, the participants are likely to differ in:

· The strength of their bargaining position.
· Their bargaining skill.

The differences between the parties in these two attributes determine the outcome. In practice, the two are very closely linked. A skilful negotiator may be able to force through a very favourable agreement despite a weak initial position as long as it is kept concealed. Similarly, an inept or careless negotiator can throw away the advantages of a very strong initial position.

Although the strength of a bargaining position is extremely difficult to evaluate, some of its components can be readily identified. Thus, the relative bargaining power of the parties in a negotiation might be gauged by comparing:

· Their knowledge relating to the technical and economic factors involved.
· The pressure exerted on them to reach an agreement.
· The costs to them of not making a deal.
· The alternative available if a deal is not made.
· Trade-offs available between the negotiable items and their relative values.

Actually, the last three are parts of the second component but, for analytical purposes, it is useful to give: them a separate identity.

Of these, lack of knowledge is perhaps most commonly cited as a basic weakness. It is an obvious target since lack of knowledge is, almost by definition, a characteristic of under development. However, it is hard to see why it should be a source of serious weakness as far as forests and forest :industries are concerned. The knowledge required, while extensive, is not all that esoteric. It can be acquired by learning, by research or even by purchase. Nevertheless, if the differences between the two parties in their knowledge of the matters :involved are great enough, they could determine the outcome: the party with the greater, the better or the more up-to-date knowledge inevitably gets the better deal.

In looking at this possibility, it is important to distinguish between the two classes of knowledge involved. One concerns knowledge relating to the concession area, the other to knowledge of the industry and business. These two sets of information are the inputs for evaluating a concession area-they are the first step in negotiating a concession agreement. The basic question on the government side is: what are the minimum teens on which we should let this concession go? And the corresponding question on the transnational side is: what is the maximum we are prepared to offer or accept for this concession? Both involve a valuation of the concession by each party. Rarely and only by accident will these two valuations coincide. Only between these bounds - the seller's minimum and the buyer's maximum - will an agreement be reached, if both parties act rationally. But where, within this range, it will be achieved will depend on their relative bargaining strengths and skills.

But the matter is more complicated in practice because the value of a concession is not solely reflected in the valuation of the timber at $x per cubic metre -- an explicit stumpage, in effect. The net benefit that each party expects to get from a concession agreement is, in reality, a set of interdependent values. A number of considerations other than stumpage can be a trade-off against stumpage or against one another to make up a satisfactory package deal. A higher stumpage could be worth while to the concessionaire in exchange for a longer-term concession or for some taxation privileges. A lower stumpage could be worth while to the government in exchange for the early establishment of a processing industry or a wider range of processes. For the government it is even more complicated since there are many more ways of generating revenue out of a timber concession than through stumpage. Nevertheless, the principle still holds that the better a participant is able to establish its limits and the tradeoff ratios between the various factors of interest to it, the stronger will its bargaining position.

The first step in negotiating a concession agreement is, therefore, for each party to establish its own limits and the relevant trade-off ratios. If it can also estimate with some confidence the other party's limits and trade-off values, then its bargaining position is even more enhanced.

A transnational company is often in a better position than a government in both respects. The knowledge it needs of the concession area consists essentially of the quantity of wood in each of the relevant value groups that the concession carries, and the likely costs of extracting it. Such inventory information is notoriously scarce in developing countries. In fact, quite often, only the concession holders have any real idea about it. With its greater flexibility and readier access to the cost advanced, and remote sensing and data processing technology, a transnational company card often obtain a more accurate anal up-to-date assessment of the resource on a new concession area, and can do it more quickly, than a government: department. With its practical experience in logging under a wide variety of conditions, it is then easy to convert the inventory and topographical information into a reliable estimate of what the logging will cost in any new area.

However, the reasons that prevent a government from being in an equally strong position on either of these aspects are only institutional. As far as knowledge of the resource is concerned, the government, with its greater access to local knowledge, should be more than able to match any transnational. Logging cost studies are fairly easy for experienced loggers to conduct, interpret and extrapolate. In fact, that is exactly how any company makes its estimates. The only thing that prevents a government from having the same capacity is the lack of experienced loggers on its staff. And disadvantage in these fields of knowledge, therefore, arises purely from institutional weaknesses. There may be good reasons for allowing them to continue, but the blame for the government's relative lack of knowledge can in no way be attributed to the transnationals.

In the remaining elements of a concession valuation-the costs of processing and marketing, and market parameters-the advantage obviously lies with the transnational. No government department or official can know as much about the affairs and operations of a successful, overseas based company as the company itself. Yet again, it is only institutional reasons that prevent governments from having an adequately authoritative knowledge of forest industry processes, industrial structures, market structures and business methods. Most of that knowledge is public property. All that is needed is a small group of staff specialists with appropriate industrial know-how and experience, efficiently organized so that up-to-date authoritative knowledge is available when needed.

The knowledge acquired in this way would, of course, be general in nature and not specific to any particular company. Despite that, it would be enough to strengthen greatly the bargaining position of governments. Nothing weakens one's position in negotiation more than to display such ignorance of industrial matters that even dubious claims or calculations relating to the economics of the industry can be successfully put forward without challenge, query or refutation. For a government to be in such a position is as unnecessary as it is damaging.

On the other hand, it can be somewhat easier for a transnational to acquire-if it wants to-a working knowledge of a specific government's situation. Again the reasons are mainly institutional -governmental systems tend to be much more open. Careful and critical analysis of departmental reports, in conjunction with ministerial and other political statements, can often reveal more operational detail than the public reports of private business. Leaks of information are also more difficult to prevent in governmental organizations, and when they do occur they are often more revealing. Inter-departmental jealousies and conflicts increase the leakiness of the system, leading, as well, to contradictory policies, actions, statements and counter-statements, and off-the-record confidences which can be exploited by outsiders to advance their own interests. Furthermore, professional scientists in governments provide, and, in fact, are expected to provide, technical information to a much more complete degree than their counterparts in business. With such a variety of sources to draw on, skilful company analysts can piece together a much more accurate and dynamic picture of the government's situation than any government could extract from a transnational company.

Government systems are open, but not fully. The opportunity that this imperfect openness offers for behind-the-scenes manipulation can, in fact, undermine a government's bargaining position much more than the outflow of information. In negotiations, the side under greater internal pressure to reach an agreement is, ipso facto, in the weaker position. Anything that can be done by one party to add to the internal pressure on the other is likely to be tried. Governments are far more vulnerable in this respect than the transnationals. The reasons for this lie in the complexity of government systems combined with their imperfect openness. Many more people in governments than in a transnational company have a say, as well as an interest, in the outcome of negotiations; their actions and objectives are much less consistent and controllable so that the criteria by which alternatives are judged are much wider and often unquantifiable. This situation makes a government rather vulnerable to external pressures for reaching agreement, but even without that, there are enough internal pressures on government negotiations associated with governmental policies. For instance, the need to provide employment in a certain locality, or to maintain the level of government revenue, or to earn foreign exchange, or to provide land for settlement can exert strong enough pressures for finalizing an agreement, unfavourable though it may be in other respects.

Exploitation, for once, is the right word to use... Forests, on the whole, are simply being mined, taking out the easiest to get-and the most highly priced trees - without any real concern for what happens afterwards.

Transnationals may be less prone to pressures of the sort that affect governments, and they may have alternatives open to them which are not available to governments. That does not mean that they do not have their own sorts of pressures to worry about. Particularly important, in this respect, is the pressure on companies with heavy investment in the forest industries to safeguard their future raw material supplies. As time goes by, this pressure could move the balance in favour of governments. There is only a finite area of forest resource, and hence a finite number of possible concession areas. Each concession agreement that is concluded thus reduces the number of concessions still available. The increasing scarcity value of concession areas could enable governments to exert considerable countervailing pressure on the transnationals. If, in addition, the forest-owning governments cartellized their timber sales, and sought bids from more than one transnational, they might in fact hold the stronger bargaining position.

On balance, therefore, the relative weakness of governments in their bargaining power is largely self-inflicted. Some weaknesses, commonly regarded as among the more serious, can in fact be quite simply overcome; others, inherent in the structure of governmental systems, are probably insuperable. Nevertheless, this source of weakness could be counterbalanced by exploiting the scarcity value of the diminishing resource that they control. Hence, as far as tropical timber is concerned, there is no need for the relative weakness of a government with respect to bargaining power to be a crippling one. The more fundamental causes of unsatisfactory concession agreements actually stem from weaknesses in bargaining skills. Some of these weaknesses even can be corrected by training and practice.

References

1. RUZIKA, I. 1972. Rent appropriation in Indonesian logging: East Kalimantan 197273 - 1976-77. Bulletin of Indonesian Economic Studies, Vol. 1 5(2).

2. FAO. 1980. Forestry development in Sarawak. Working Document of For. Dept, Project Mal/76/008/ Rome.