CREATING GREAT WEALTH TO CHILE THROUGH PROPERTY RIGHTS IN MINING

José Piñera

[en Español] [in Russian]

In 1971, with the aim of nationalising four large copper deposits belonging to North American companies without paying proper compensation, Marxist President Salvador Allende got congressional approval for a Constitutional reform introducing the concept that the State had the "absolute, exclusive, inalienable and imprescriptible" ownership of all mines. In this way, a centuries long legislative tradition—stating that miners could treat their mines ''as though they were his own"---was changed overnight. Of course, all private mining investment was immediately paralized.

After the change of government in 1973, the situation remained unaltered pending a new Constitution which would establish the institutions for a return to a real democracy. It was expected that it would also restablish the traditional property rights in the mining sector. However, to the surprise of many, an unexpected disagreement within the revolutionary government led to the 1980 Constitution failing to establish clearly the nature of mining rights.

The day after the approval of the new Constitution, the mining sector began to urge a reform of the Constitution via what would have been an unusual "mining plebiscite", or via the mechanism of publishing a law interpreting the Constitution. Thus the country faced two important problems: the uncertainty concerning property rights in the mining sector, and a situation which could weaken the legitimacy of the new Constitution.

It was to resolve this crisis that I was appointed Minister of Mining on December 29, 1980, soon after the approval on November 4 of the Pension Reform which created the private pension system based on individual retirement accounts.

The challenge was to draft a constitutional law which would provide firm mining property rights, to secure presidential and legislative approval for it, to obtain the assent of the Constitutional Tribunal as it was required, and to convince local and international entrepreneurs of its rationality, as well as to persuade the public that the national interest had been safeguarded. All of this had to be achieved without either modifying or weakening the legitimacy of the Constitution which had just been approved in a national plebiscite, and which had set out the plans for the democracy to come as well as the timing and conditions for the election of Chile's political representatives.

The Gordian Knot

Very soon I became convinced that what was required to bring in private investment was considerably more practical and concrete than the doctrinal exchanges in which the various participants in the political and juridical discussion had become entangled. What really mattered to those who would take investment decisions in this sector was how strong the concession rights would be, and in particular, what would be the indemnity criteria in the event of an expropriation.

At the same time I declined to become involved in the emotive discussions about the ownership of Codelco, the huge state owned company operating the deposits then producing approximately 85% of Chile's copper output and a very high proportion of the country's export receipts. It would have been premature and impractical. I could never have been in favour of the creation of Codelco or of a similar state enterprise, but once it did exist - with a near-monopoly position in the mining and foreign exchange sector - and given both the exceptional circumstances under which the government had come to office and those of Codelco's formation, to have tried to privatise it would have set off a "holy war" which would have made it very difficult to make progress with the problem whose solution was the priority for Chile.

It was far more important to open the way for private production of copper (and other minerals) to grow to the point where it predominated, through a legislation which would encourage the discovery of new deposits and the expansion of existing ones, thereby creating new wealth.

I have always believed that the correct identification of a problem is the first decisive step towards solving it. The "knot" impeding the development of private mining was the question of a fair indemnity in the event of expropriation of the mining concession. For a private investor this was a vital consideration given the history of confiscations in natural resource rich countries, and especially in Chile, where in 1971 a confiscatory expropriation of the foreign-owned properties of "Big Copper" (as it was called) had taken place.

Soon I came to the conclusion that the Gordian knot which was strangling mining in Chile could not be "untied". It had to be cut. The "sword" I found embedded in a concept of economic science. It was the Present Value of the net cash flows of an asset or company, a figure which in a competitive and transparent market is equivalent to the market price of the asset or company. In my opinion it was entirely compatible with the overall philosophy of the Constitution, once the robust concession right it provided for had been defined.

The reasoning behind this criterion is simple. An asset - whether an industrial, farming or mining company - has value to the extent that it can generate future profits (assuming for simplicity that these are the only cash flows). Therefore a multi-storey car park on the South Pole has almost no value, whatever it may have cost to build, whereas a shop on the best corner in central Santiago is worth far more than it cost to open. But these future profits cannot just be added up and totalled since they will arise at different points in time; they need to be discounted to the present at the appropriate rate of interest and then added together.

In order to apply this formula in the case of the mining concession, the concession right had to incorporate the right to exploit and to continue to exploit the mine, and that is how we drew it up. As an expropriation deprives the owner of the concession of the possibility of future exploitation and of the ensuing cash flows, the loss occasioned to him by the expropriation of the concession is the same as the Present Value of the net cash flows which it is capable of generating.

To complete the definition of the ground rules for mining, to make this an entirely coherent solution to the fair indemnity problem, and to secure the assent of the Constitutional Tribunal to a concept never previously included in legislation of a constitutional order (in any country in the world I know of), it was necessary to define two points with great exactness: a) the nature of the concession right which would be established in the constitutional law, and b) the terms on which the concession-holder would hold the concession right.

The Constitutional Mining Law

In order to make this vision of mining property a reality, I called together several members of my previous team in the Ministry of Labour and Social Security, who had collaborated with me on the critical Trade Union Law and the important Pension Reform. After examining all the possible options and different scenarios, we decided that the most suitable legal instrument was the Basic Constitutional Law which the Constitution itself called for in order to complete the definition of mining rights.

The mining concession we designed in the Constitutional Mining Law has all the legal attributes required to provide guarantees to the private Investor as well as to safeguard the national interest. We named it the "full concession" providing the following:

a) protection as a property right. This meant that it was intimately joined to the rules governing private ownership. It follows firstly that the registered owner can freely exploit, enjoy, and dispose of the concession as he thinks fit: he can sell or mortgage it, pledge it as collateral, leave it to his heirs, etc., and secondly, that it cannot be taken from him except by means of an expropriation.

b) any act of expropriation has to be fairly indemnified. It flows from the ownership of the concession that indemnification in the event of an expropriation (paid in cash as another rule in the 1980 Constitution stipulates) must reflect the entire reduction in the owner's net worth, equivalent in the case of an exploitation concession to the Present Value of its future net cash flows.

c) permits the rational operation of a mine. The concession-holder is not subject to arbitrary "use it or lose it" clause, but may carry out the working of the mine in accordance with his own methods, processes, work tempo and production plans, which will evolve in response to the demands of a complex and ever-changing international market. The management of the mine will not be subjected to controls and obligations imposed by the government of the day, which in turn lend themselves to mistaken impositions or tempting opportunities for corruption.

d) a right with an indefinite life. There is no surrender date: retention of the concession is subject solely to the payment of an annual fee per hectare (“la patente minera”). The indefinite life was important in order to avoid the possible politicisation of the process of renewing the concession term for a deposit under operation, and in order to eliminate incentives to "perverse" exploitation of a deposit in the years leading up to expiry of the original concession term.

e) is not a political creation. Its creation, continued existence and termination are in the hands of the Judicial Branch, not the Legislative Branch or the Executive. The concession originates in a legal procedure whereby the judge recognises the existence of the right conferred by the act of discovery.

On August 13, 1981, I submitted the draft Constitutional Mining Law together with a comprehensive explanatory report to the President. The report was published in December that year in my book "Principles of the Basic Constitutional Law on Mining Concessions" (published by Editorial Juridica, 1981, and edited again in 2002 by Economía y Sociedad Ltda).

The Legislative power (the “Junta de Gobierno”) gave final approval to the Constitutional Mining Law on December 1, 1981. The following day, in my address at the opening of the El Indio mine high in the Andes at the head of the valley where our great poetess Gabriela Mistral was born, I publicly announced the passage of this key law.

After the Constitutional Tribunal had subjected the entire law to the process of "constitutional review", it was approved by all of its members on December 22; the unanimous approval being of crucial importance to the future permanence of the law. It was finally gazetted on January 21, 1982 in the “Diario Oficial” as Law No. 18.097.

Although the Constitutional Mining Law took effect when a further ordinary law was gazetted, governing a number of procedural issues (known as the Mining Code), its economic consequences were immediate. Since all the characteristics of a concession - its nature, the rights and obligations it conferred, its duration - were set out in the Constitutional Mining Law, from an economic and business perspective the positive effects of the law began to show themselves in the form of increased exploration and production activity from the moment its approval was announced.

It should be emphasised that any change to a basic constitutional law requires a quorum of four sevenths of the sitting deputies and senators (the quorum was formerly three fifths under the 1980 Constitution but was reduced in the 1989 Constitutional Reform). Not a word of the Constitutional Mining Law has been altered during the three administrations succeeding the one which originally approved it, despite an extremely unfair campaign against it led by certain Christian Democrat old-style politicians during the 1983 economic and social crisis.

Thus a decade—the 1970s-- of uncertainty over mining property rights in Chile was ended, and new horizons of investment, employment and development were opened in a key sector of the Chilean economy.

This Law also showed other countries that there is a way to make the nominal State ownership that is written into their Constitutions compatible with a robust property right over a "full concession", and thereby to open new fields for the creation of wealth through the activity of private entrepreneurs.

Good Policy, Good Politics

The coherence of a government's or a statesman's economic and political vision is revealed by the answer supplied to the fundamental question: "How is wealth created?" Or to ask it another way, "What is the key to riches?

The Constitutional Mining Law, by creating genuine property rights in the largest - and most politically sensitive - sector in the country, was the answer to that question and its approval sent a message to domestic and foreign investors from that moment that private property was fully guaranteed in Chile.

The process of opening and economic liberalisation taking place between 1973 and 1980 had demonstrated the commitment of Chile's new development strategy to realistic macroeconomic policies and to free market economic principles. Now we would see that full ownership of property was able to generate an unprecedented expansion in the mining sector and so to create great wealth.

The results speak for themselves. The key to wealth, in the case of the mining sector, was the Constitutional Mining Law, operating within a free market economic framework. In the last 20 years it has stimulated a near-fivefold increase in Chile's copper output, and a sixteen fold growth in private copper production. As a result, with its five million tons a year, Chile is now by some way the largest producer in the world, accounting for 35% of global output. In addition, Chile is the world's largest producer of natural nitrates, iodine and lithium, the second factor in molybdenum, the fifth in silver and the thirteenth in gold.

For the first time, Chilean entrepreneurs have made major investments in this sector, and the country has received the huge inflow of US$20,000 million in foreign direct investment in mining.

All these factors have combined to develop dormant riches, to create new and productive employment, to transfer valuable technology, to pay tax under a number of headings, and stimulated significant investment in other parts of the production and service chain such as power, transportation, water, ports, highways, housing, machinery and a wide range of other supplies.

The idea that property is sacred, so intensely reflected, despite the difficult starting point, in the Constitutional Mining Law, consolidated an intellectual framework supportive of the subsequent privatisation of large state-owned companies, notably in the telecommunications and power sectors. In the 1990s the concession system was extended into the infrastructure sector - highways, ports and airports - which had traditionally been part of the so-called "public works" carried out by the State.

The Constitutional Mining Law simultaneously made a decisive contribution to the consolidation of a prosperous nation, of a free society and of a democratic political system. It did this by helping enable the Chilean economy to grow at an average rate of 7% for 13 years, by helping to raise the living standard of the whole nation, by helping consolidate the right to property, and by rendering unnecessary either an immediate alteration or a questionable interpretation of the 1980 Constitution.

I hope that this endeavor has demonstrated that true politics does not consist, as many claim, in the art of “the possible", but rather in the art of “making possible what is necessary" for a nation to progress and to realise its potential.

 

 

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