CREATING WEALTH THROUGH PROPERTY RIGHTS IN MINING
by José Piñera, former Mining Minister of Chile
[en Español] [in Russian]
In 1971, president Salvador Allende proposed a constitutional amendment to nationalize the four large American-owned copper mines. To avoid paying proper compensation, the amendment established that the State had "absolute, exclusive, inalienable and imprescriptible" ownership of minerals, thus changing overnight the centuries long legal tradition that miners could treat their mines ''as though they were their property". Regrettably, under heavy pressure from the government and the press, Congress approved this amendment unanimously. Consequently, private investment in mining came to a complete halt.
After the change of government in 1973, this problem remained unsolved pending the approval of a new Constitution that would pave the way to return to a democracy. Due to an unexpected disagreement within the government, the new Constitution approved by referendum in September 1980 failed to reestablish private mining rights. To resolve this crisis, the President appointed me Minister of Mining on December 29, 1980. Thus, after the approval on November 1980 of the Pension Reform Law which created the private pension system based on individual retirement accounts, I moved from being Minister of Labor to Minister of Mining.
The challenge was enormous: to draft a constitutional law to provide strong mining property rights, to secure legislative approval and to obtain the consent of the Constitutional Tribunal. It was also critical to convince local and international mining companies 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 amendments to the Constitution just approved in the September referendum, which had also set out the way and means to restore democracy.
After studying this problem in depth, I became convinced that what really mattered to investors in mining was how strong would be the concession rights and what would be the compensation criteria in the event of an expropriation.
In the meantime I declined to become involved in the highly politicized debate about the future ownership of Codelco, the huge state-owned company operating the nationalized mines and producing approximately 85% of Chile's copper output and a very high proportion of the country's exports. What Chile really needed was to solve the problem holding back the development of private mining, central to the Chilean economy. The solution was to establish mining rights on state property with strong private property rights and clear, market-based, rules for compensation payments in case of expropriation.
Therefore, my focus was to create the laws to encourage the discovery of new mines and the expansion of existing ones, thereby creating new wealth.
The Solution: "The full concession"
After extensive research and analysis of the content and evolution of mineral rights since ancient Rome, we decided to create a "full concession" that would provide property guarantees to investors while safeguarding the national interest. The key features of this concession are:
a) Protected as a property right. We subjected the “full concession” to the general rules governing private property rights. Thus, the owner of the concession can freely use, enjoy and disposed of it. He can sell or mortgage it, pledge as collateral or leave it in inheritance.
b) Allows rational operation of a mine. The concession is not subject to controls or obligations imposed by the government which may create tempting opportunities for corruption. Instead, the owner can freely manage the mine according to its own technologies, processes and production plans which evolve in response to market conditions.
c) Indefinite life of the concession. The life of the concession is indefinite and remains the property of the owner as long as he pays a mining claim annual fee. In this way we avoided political interference in the renewal process as well as irrational exploitation in the final years of the concession.
d) Not granted by politicians. Private investors apply for a mining concession to the local judge who checks formalities under the law and grants the concession which can be assigned for exploration or exploitation. The judge also oversees any future change on the concession as well as its termination if this were the case.
The remaining "knot" preventing the development of private mining was the issue of a fair compensation 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" companies, as they were called, had taken place.
This Gordian knot which was strangling mining in Chile could not be "untied". It had to be cut. The "sword" I found was embedded in a concept of economic science. It was the Present Value of the net cash flows, a figure which in a competitive and transparent market is equivalent to the economic value of a company. A key consideration was that this concept was entirely compatible with the overall philosophy of the Constitution.
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-story car park on the North Pole has almost no value, whatever it may had cost to build, whereas a shop on the best corner in downtown of a major city is worth far more than it cost to open. But these future profits cannot just be added up since they will arise at different points in time. They need to be taken to the present at the appropriate rate of discount.
To apply this formula to the mining concession, the full concession had to incorporate the right to exploit continuously the mine. 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 is the same as the Present Value of the net cash flows that would have been capable to generate in the future.
The Mining Law
The new Constitution had provided for a law with a constitutional rank (requires a supermajority vote of 4/7 of the sitting deputies and senators to amend it) to specify the rules that would govern mining rights. Therefore, on August 13, 1981, I submitted a draft of the Constitutional Mining Law to the President with a comprehensive explanatory report. This report was published later that year in my book "Principles of the Basic Constitutional Law on Mining Concessions", published by Editorial Juridica, 1981 (edited again in 2002 by Economía y Sociedad Ltda).
On December 1, 1981, the legislative body of the government ("Junta de Gobierno") approved the law. As required by the Constitution, the Constitutional Court subjected the law to a thorough constitutional review. On December 22, 1981, the Court unanimously approved the law. The unanimous approval was crucial to secure the future stability of the law. On January 21, 1982, formally became Law Nº 18.097 as published in the official legal journal ("Diario Oficial").
To this day, not a word of this Constitutional Mining Law has been changed.
Thus the 1970s decade of uncertainty over mining property rights in Chile ended and new options for investment, employment and development were opened in mining, a key sector of the Chilean economy.
The Law also showed other countries a way to make a nominal state ownership compatible with a robust property right through a "full concession". Thus, it opened up new avenues to create wealth for their citizens through the business and investment of private entrepreneurs.
The coherence of a government's economic and political vision is best judged by the answer 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 economic industry of the country, was the answer to that question and its approval sent a message to domestic and foreign investors that private property was fully guaranteed in Chile.
The process to liberalize the Chilean economy between 1973 and 1980 demonstrated the commitment of the country’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 industry and thereby create great wealth for the country.
The results speak for themselves. In the last 40 years, this Law has allowed a sixfold increase in Chile's copper output, and a twenty fold growth in private copper production. As a result, with its 5.5 million tons a year, Chile is the largest producer in the world, accounting for 30% of global output. In addition, Chile is the world's largest producer of natural nitrates, iodine and lithium, the second in molybdenum, the fifth in silver and the thirteenth in gold.
For the first time, Chilean companies have made major investments in mining, and the country has received a huge inflow of US$150,000 million in foreign direct investment in mining.
The Constitutional Mining Law reached its goal to allow the development of new riches, to create new and productive employment, to transfer valuable technology, and to generate substantial tax revenues that the government could invest in human capital (education and health). This Law also promoted significant investments in other areas of the production and service mining chain such as power, transportation, water, ports, highways, housing, machinery and a wide range of other supplies.
The idea that property is sacred in the Constitutional Mining Law, consolidated an intellectual framework supportive of the subsequent privatization 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 exclusively by the state.
The Constitutional Mining Law also 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 enabling the Chilean economy to grow at high rates of growth, by raising the living standard of the nation, by consolidating 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 realize its full potential.