Between Rocks and a Hard Place, Foreign Policy

Posted January 27, 2016

Categories: Articles, Featured, Highlighted

A large billboard on the side of the road urges residents of this dusty capital city to restrict their showers to under three minutes. Even now, during the rainy season, Gaborone is experiencing a severe water shortage. At the luxury casino resort hotel where I stayed on a recent trip, water flowed from the taps only a few hours each day.

The current water shortage offers a stark reminder that Botswana — an arid, land-locked country just north of South Africa — has always been at the mercy of the elements. For its entire post-independence history, the most important element for Botswana has been carbon — the fanciest grade. The discovery of diamonds in the late 1960s propelled the country from a GDP per capita of $70 to its current upper-middle-income status of roughly $16,000, close to the highest in Africa.

Botswana is one of a very few countries in the world to have largely avoided the so-called “resource curse,” a term economists use to describe the often debilitating economic and governance outcomes associated with large natural-resource endowments. Throughout Africa, in places like Sierra Leone and Equatorial Guinea, underground riches have fueled civil conflict and corruption. Botswana’s cut of diamond sales, by contrast, has translated over the years into modern infrastructure, high rates of literacy, and a stable democracy.

But the country remains dangerously dependent on its mining sector. And the diamond market, like the weather in Botswana, is unpredictable. In 2015, consumer demand for the expensive gems slackened, and suppliers cut prices for rough and polished diamonds by 15 percent and 8 percent, respectively, in an effort to boost demand. Meanwhile, tighter banking regulations worldwide, aimed at reducing risk and preventing money laundering, have reduced the amount of credit flowing into the diamond sector. Even the slowdown of the Chinese economy and policy changes there have depressed the market: A recent push by the Chinese Communist Party to eliminate the appearance of corruption has cut into global diamond sales.

“The giving of nice gifts has been cut back in China because of the perception of corruption,” said John Vardis, owner of the Diamond Analyst, a firm that advises on diamond acquisition and investment.

The increased volatility of the diamond market comes at a particularly sensitive moment for Botswana. The country is still in the early stages of a partnership with De Beers, the world’s largest diamond corporation and by far the largest producer in Botswana, to keep more of the value from each diamond inside the country. The mining industry calls this process “beneficiation.” It’s an effort to build an additional market around the mining sector so that countries like Botswana can make money, not just from the sale of rough diamonds, but also from their cutting and polishing. It’s not a new idea — South Africa has implemented beneficiation in the diamond sector for years — but Botswana is making an unprecedented investment in it, gambling that the process can help kick its economy to a whole new level.

It has several reasons to be optimistic.

Among all the players in the global diamond market, Botswana is the grandmaster. The government nets nearly 80 percent of the profits that De Beers makes on the sale of the country’s rough diamonds (by comparison, Namibia only gets 50 percent of De Beers’s profits). To get such a generous slice of the take, Botswana has taken advantage of its market position — it’s the second-largest diamond producer in the world after Russia — as well as its canny bargaining tactics. Over the years, for instance, the government has acquired a 15 percent share in De Beers itself and retains the right to name two members to the company’s board, giving it a say in decision-making.

But in the mid-2000s, when a 25-year lease came due on the country’s most profitable mine, the government made its biggest demand yet: a beneficiation plan to extend the life of the country’s diamond industry and help diversify the economy. The plan turned the global diamond industry upside down. In the past, buyers traveled to London to view the rough gems that De Beers had mined from operations in 28 countries. But for the past two years, as a part of the beneficiation process, these buyers have gone to the other side of the globe, visiting the capital of Botswana to buy an annual $6 billion worth of diamonds.

These so-called “sightholder visits,” 20 of which have taken place since the beneficiation process was launched in 2013, have turned Gaborone into a diamond destination, and locals have been scrambling to take advantage of the influx of wealthy merchants. New hotels and restaurants have opened in the capital, and De Beers has even created an enterprise development program to mentor local entrepreneurs in support services like IT and catering.

But it’s not just that Gaborone has become a diamond-trading Mecca overnight; it has also started to build up its diamond-processing sector to ready the rough gemstones for sale. Whereas in the past nearly all of the diamonds were cut and polished abroad, now roughly 15 percent are handled by the 20 or so cutting and polishing operations that have sprouted up in the capital in recent years. These outfits are mostly run by expats, many from India, but they are training local workers to turn rough diamonds into the finished gemstones sold directly to Tiffany & Co. and other upmarket retailers, as well as to a handful of local jewelry manufacturers. In 2013, sales of cut and polished diamonds in Botswana reached nearly half a billion dollars.

Given its sizable investment in the project, De Beers is anxious to present its experiment with beneficiation in Botswana as a success. The company recently partnered with Chatham House, a London-based think tank, to hold a conference in Gaborone on the so-called “Botswana model” and invited a group of visiting journalists, including me, to view their operations in the capital. Attendees toured De Beers’s highly secure Diamond Trading Company (DTC) complex, connected to the airport by a dedicated road, and watched as local employees sorted rough gems from around the world so they could be sold to 200 or so visiting sightholders.

“The transition has been seamless,” said De Beers Executive Vice President Paul Rowley, adding that most customers are happy with the recent changes and not put off by the periodic water and electricity shortages in Gaborone.

But beneficiation has not been an entirely smooth process — not in Botswana and not anywhere else it has been tried. Several of Botswana’s cutting and polishing operations have gone belly-up during the ongoing downturn in the global diamond market, and others have shed employees. An estimated 1,000 jobs have been lost in the sector in the last year, more than a third of the country’s total.

Competing against lower-wage labor in India, which currently finishes about 80 percent of the world’s rough diamonds, has not been easy — especially since the buyers who come to Gaborone in search of rough gems are not obligated under the beneficiation agreement to cut and polish even a small percentage of their purchase in Botswana. “It’s as if people are expecting the DTC to take off without the direct involvement of government,” said Tshireletso Motlogelwa, publisher of Botswana’s Business Weekly and Review. “You need a more direct role so that you keep it going until it’s established. A lot of people say that’s the meddling of government in business. But the business is so strategic that the government might as well get involved.”

These challenges should not have come as a surprise. Nearby South Africa, which has a longer experience with De Beers and beneficiation, has weathered an even greater upheaval, with employment in the cutting and polishing sector dropping from 4,500 jobs in the 1990s to fewer than 600today. Critics there point to a failure by the government to invest in the technology and training necessary to compete against not only India and China but also neighboring Botswana.

So far, beneficiation in Botswana has added several thousand well-paying jobs to the economy. But it has done little to spread around the tremendous wealth generated by the diamond industry. The fifth-richest country in Africa by per capita income is still one of the continent’s most unequal, ranking near the top of global indices of economic inequality. The youth unemployment rate still hovers around 35 percent while 62 percent of households in poorer areas of the capital are “severely food insecure,” according to a 2014 article published in the journal Urban Forum. Several decades of economic growth based on diamond mining have improved roads, health care, schools, and governance, but it hasn’t put much money in the pockets of ordinary people or created a significant middle class.

To achieve the elusive goal of equitable growth, beneficiation must do two seemingly contrary things: It must allow Botswana to pry more money from each diamond while also diversifying the economy so other industries are capable of growing the middle class and the diamond sector no longer commands a 70 percent share of exports. “If there was a growing economy like Kenya, where there’s a growing middle class and more people buying engagement rings, more money from diamonds would be left in the country,” said Vardis.

In the past, the country has ventured into game-park tourism and beef exports to the European Union, and the country’s service sector is still growing, but a more ambitious development strategy is needed that goes beyond diamonds and beneficiation. According to Keith Jefferis, the former deputy governor of the Bank of Botswana, the country can thank “well-managed good luck” for its modest success to date. To make the next leap, he says, the country will need to invest in alternative sectors like “high-value, low-bulk manufacturing” that can compete with South African exports.

But even good management can no longer be taken for granted. The country’s performance on the Worldwide Governance Indicators has slipped in the last 10 years. And Botswana has fallen over 30 places in the World Bank’s Doing Business index, from 40th in 2006 to 72nd in the 2016 report. Several mysterious deaths, including that of an opposition politician just before the 2014 elections, have also reduced public confidence in the government. On top of that, economic growth is currently anemic in Botswana; the country faces its first budget deficit in four years; and the government is thinking of dipping into its sovereign wealth fund to prime the pump.

Diamonds, as De Beers likes to say, are forever. But diamond wealth is fleeting. At the mercy of the elements and the diamond market, Botswana needs more than the current beneficiation plan to achieve equitable, broad-based growth.

Foreign Policy, January 11, 2016


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