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THE ECONOMIC COSTS OF THE KP ON GOVERNMENT AND INDUSTRY STAKEHOLDERS: AN OVERVIEW

It’s 2016. The Kimberley Process Certification Scheme (KPCS) has been operational for 13 years. The time has come to examine the costs that the KPCS imposes on the diamond pipeline.

 

Cost analysis only provides one side of the discussion. In this DIB, we present an extract of a 40-page study recently completed by Tacy Ltd. and Pharos Beam Consultants. The purpose is to encourage positive discussions about the costs and effectiveness of the system, with a view to ultimately be part of an overall discussion on the cost-benefit of the KPCS and ways to make the system more efficient.

 

There has always been a debate, especially of late, on whether the KPCS has been beneficial, or more precisely, to what extent did it contribute to achieving its purpose of ending conflicts in which diamonds are used by rebels. And if it was beneficial – is it still needed today, in light of myriad other compliance regimes in place.

 

We are not getting into that discussion here. We consider it axiomatic that KPCS has been successful. The world is (virtually) free of conflict diamonds – how much this is attributable to KPCS is hard to measure and, probably, an exercise in futility.

 

There are reasons to believe that the KPCS had a wider beneficial impact on the producer countries in which it operates.

 

The Mo Ibrahim Index

Ibrahim Index of Afriacn Governance
Credit: DIB

 

In this context, it is useful to examine the results of the Ibrahim Index of African Governance. This index, created by the Mo Ibrahim Foundation, an indigenous African NGO, is the most comprehensive collection of data on African Governance. It rates governments across 14 sub-categories and 93 factors, using 33 independent sources.

 

It is interesting to consider the outcome of this Index in the six diamond-producing African countries who were the most susceptible to conflicts, and who were the few of the intended KPCS beneficiaries.

 

The index for almost all these countries has risen, with the Central African Republic (CAR) being the exception. It is interesting to note that the KPCS has also been responsive to that situation, and the Administrative Decision in May 2013 on CAR was issued almost as soon as the conflict restarted in that country. In the Index, there is a sudden drop in the CAR value when the conflict began.

 

Also in the case of Zimbabwe, the index dropped when the diamonds shipments were stopped. It then showed an upward trajectory, which speeded up after the diamond exports from that country resumed.

 

All the KPCS participant nations need to be applauded for this demonstration of how industry self-governance can achieve tangible results and has a positive impact on good governance in their respective countries.

 

Rationale of this Study

 

Every diamond company has been affected by the KPCS, as its processes have added steps to companies’ daily mode of operations and, effectively, costs to the pipeline. Given that the KPCS processes are now generally well established routines, it might be a good time to review the additional costs that the system has introduced into the pipeline.

 

The costs of KPCS implementation were absorbed mainly by various governments of countries through which rough diamonds flow, as well as by governments of countries that host upstream and midstream levels of the diamond pipeline. The costs associated with the very establishment of the system varied according to country. Costs also depended on the complexity of governmental agencies involved and, of course, on the various ways devised to meet the minimum standards. There is no uniform template. Some “strong countries” have always come to the assistance of the “financially weaker” parties.

 

Types of Economic Costs

 

The first challenge is to determine the various kinds of costs which have arisen as a direct consequence of the implementation of the KPCS. While determining these costs, it should be kept in mind that diamond imports and exports, both rough and polished, had been going on before the KPCS system was conceived. Import and export transactions went through the normal channels; the customs formalities in the respective countries were carried out.

 

For the purposes of this analysis, the focus was on the incremental costs, namely the processes and steps which were added due to the implementation of the KPCS system and, hence, costs which are borne as a result. Costs of existing facilities, like customs and regular import-export processes, have not been considered, as these would not contribute additionally to the costs.

 

Classification of Economic Costs

 

Costs incurred in the implementation of the KPCS can be broadly classified along the lines of the following parameters:

 

Whether the costs are transaction costs or overhead/administration costs.

 

Transaction costs could be considered as costs that are directly incurred during the movement of the rough diamonds. These costs can essentially be estimated to be costs that are incurred per transaction and directly depend on the transaction being undertaken. If there is no transaction, these costs can essentially be saved.

 

Administration or overhead costs are those costs that are not incurred during the course of transactions. These costs are fixed in nature, at least in the short term. These costs are unavoidable and while they may vary in the longer term, these would be incurred to a major degree if the decision is taken to implement the KPCS. For example, countries deciding to be part of the KPCS will need to establish a KPCS authority, regardless of the number of transactions.

 

Whether the costs are borne by the government or the industry.

 

Industry costs refer to costs that the industry incurs as a direct consequence of following the KPCS system. These could be charges, or additional days added to the transaction, which incur interest costs.

 

Government costs refer to costs which are borne by different governments. These could be costs involved in actual issuing of the certificate, to tracking and reconciling statistics, to cost of attending KPCS meetings, etc. Based on the above 2 parameters, we get a 2×2 grid, or 4 types of costs which can be identified as the types of the costs which are a result of the KPCS.

 

Transaction Costs borne by the Industry
Transaction Costs borne by Governments
Overhead Costs borne by Industry
Overhead Costs borne by Governments

 

The cost heads can be summarized as below:

 

Apart from the four categories, there is an additional cost that is the cost of reputational risks, which are as a direct result of the KPCS. The KPCS is a unique system that has not been replicated anywhere else in the world. However, as a system, it also lends itself to being a target. It can be used by the critics of the system or other industries, like synthetics, to criticise the diamond industry. These costs are notional, but they could be called the “Reputational Cost” of the KPCS, as the KPCS and its processes are used to target the industry. [See Box on KP and Synthetics.]

 

Highlighting Some of Our Conclusions

 

Reputational Costs
Credit: DIB

 

This DIB is not the place to present the entire study, but rather to share some of the conclusions. The cost heads and the cost assumptions, which have been extensively discussed in the 40-page report, lead to the following highlights:

 

Pipeline Comparison

Economic Cost of KPCS
Credit: DIB

 

The costs need to be compared to the overall pipeline to get an idea of percentage of costs. The pipeline suggests the following for 2015:

 

Mine Sales to Industry – US$13.3 billion
Polished Sales – US$19.2 billion
Jewelry Sales – US$75.8 billion

 

The primary costs of the KPCS are borne by the upstream and the midstream levels of the pipeline. Therefore, the correct denominator will be the Polished Sales.

 

Hence, the KPCS costs account for over 1% of the total pipeline sales. This needs to be kept in mind while considering expanding the KPCS mandate.

 

Another important aspect is that the diamond pipeline has been steadily losing ground on its share of wallet. Looking at how the industry has grown compared to both World GDP as well as inflation, we see a fairly dismal picture.

 

It tells us that sales from the industry, namely jewelry sales, polished sales and rough sales, have all underperformed even global inflation, let alone GDP growth. Thus costs increase more than revenues.

 

The bottomline (below) clearly shows that it is the industry that carries the brunt of the KPCS burden
Credit: DIB

KPCS and pipeline costs become more relevant to governments and the industry when viewed in this context, because costs have a notorious way of only going up. Even if costs had kept pace with global inflation, it would mean that, for the industry, the incremental KP-associated costs have gone up from about 0.85% of pipeline polished to over 1%. For an industry that increasingly seems like a global non-profit organization, this is a heavy price to pay.

Growth of World GDP vs Industry Parameters
Credit: DIB

 

Virtually all international legal and ethical compliance mechanisms are in perpetual change. An arsenal of legal instruments and recommendations for fighting corruption, laundering, tax evasions, transfer pricing and bribery have emerged, many of which are now also covering all phases in our diamond value chain. In the banking industry, Basel III was introduced when in many countries Basel I and II had not yet been implemented. Changes occur ever more swiftly. Terms like FATF, BSA, OFAC, have become household terms, just like KPCS. There is only one difference – KPCS has become rather archaic, certainly in comparison to some other mineral origins disclosure regulations. If the KP cannot be reformed or “updated” to meet today’s challenges, some “rethinking needs to be done.” Whatever way the KPCS will, or will not, evolve – the burden placed on the midstream should become a factor to consider.

 

By: Chaim Even-Zohar

 

 

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