Local Content Requirements in the Oil and Gas Industry in Developing Countries: The Return of ISI?

Abstract

In the recent years, a growing number of developing countries are adopting local content (LC) requirements as condition for exploring and developing oil and gas resources in their home countries, with Brazil being a leading example and Mexico as the latest follower. Similar to the Import-Substitution Industrialization (ISI) model, LC creates incentives to the development of indigenous industries by protecting domestic markets against free imports of goods, like drilling rigs, oil platforms and subsea equipment. Given this similarity, it is worth questioning: Is LC a contemporary reenactment of the ISI development model? ISI has been extensively criticized in the literature and most developing countries – including Latin America nations – had abandoned it in the 1990s after market-driven reforms. This paper will highlight the similarities and differences between LC in the resource sector and the historical experience of ISI. Using a principal-agent framework and Hirschman’s concepts from Exit, Voice, and Loyalty, this paper remarks the monitoring and voice capabilities of oil operators in pressuring suppliers over the quality and time to market of the goods used by the oil industry and limit rent-seeking. Drawing evidence from a recent Petrobras corruption scandal, we show how bribe rates differ from LC contracts in comparison to other Petrobras’ projects, using data from 88 projects signed between 2003-2010, worth over $ 30 billion. This paper advances our theoretical understanding of local content as part of the political effects of resource abundance, how it differs from previous industrial policy efforts, and provides corroborating evidence from a rich dataset of corrupt practices.