Why was war good for Angola's diamond miners?

The search for better economic policy.
Aug. 17 2007 11:43 AM

Diamonds Are a Guerrilla's Best Friend

Why was war good for Angola's big miners?

A diamond. Click image to expand.
An African diamond

Five years ago, most citizens of Angola were getting by on less than a dollar a day despite their country's rich deposits of diamonds and oil. After decades of civil war, they were poorer than they had been 30 years earlier upon independence. Then Jonas Savimbi, commander of the UNITA rebel group, was killed in combat with government forces, leaving UNITA in disarray. As the citizens of Angola poured into the streets of their capital, Luanda, to celebrate, the rebels' fall augured newfound prosperity as well as peace.

Not so, however, for the businessmen who had extracted Angola's diamonds amid the chaos of war. When news hit of Savimbi's death, investors dumped their shares in mining companies with Angolan operations. In a paper forthcoming in the American Economic Review, economists Massimo Guidolin and Eliana La Ferrara show that these companies' stock prices fell by an average of 12 percent within a matter of days. Why was peace bad for the diamond business?

Guidolin and La Ferrara argue that the mining companies took a beating from investors because the fortunes they'd made from Angola's diamond mines relied on the treacherous conditions created by civil war. The authors showed that after Savimbi's death, mining companies with Angolan investments saw their stock prices plunge, while those without Angolan exposure appreciated in value. In other words, an end to conflict hurt the dominant diamond companies by knocking down barriers to entry. Most people, including nearly all of my first-year MBA students, think that the key to business success is cheaply and efficiently producing something people want to buy. If this were the case, then war's end should have made Angolan miners and their shareholders richer as production costs plummeted. But the effect of peace on diamond mining in Angola shows that more important than producing something well is doing it better than the competition—and the potential competition.

Wartime Angola was a very expensive place for diamond miners to operate because of the bombed-out roads, kidnappings, and other hazards of operating in a conflict zone. Running a mine often meant getting your hands dirty. Companies reportedly employed guns-for-hire like Executive Outcomes, a private army recruited from South Africa's disbanded apartheid-era special forces units, to keep their operations safe from rebel attacks. The cost of protecting a mine alone could run as high as $500,000 a month, as the Angola Peace Monitor reported in 2001. And to keep mines safe from government meddling, paying bribes was reportedly the norm.

Not every CEO or shareholder is willing to set up a private army, or partner with a real-life Danny Archer, the mercenary and smuggler played by Leonardo DiCaprio in the film Blood Diamond, about Sierra Leone. But some know how to turn wartime adversity to their advantage. Firms like Mano River Resources, DiamondWorks, and Rex Diamond have operated mines in multiple African war zones over the years despite the costs and hurdles that drive out everyone else. In 2002 Angola, peace looked like an opportunity for many new companies to bid for mining licenses.

Guidolin and La Ferrara found that, in fact, most of the wartime-dominant companies kept their mining concessions, and some even expanded their Angolan operations at war's end. But the mere presence of potential competitors helped the government to renegotiate its contracts from a position of strength. Previously, Israeli diamantaire Lev Leviev had a monopoly on the marketing of Angolan diamonds. With peace at hand, as many as six other companies reportedly also vied for his contract. Among them was global mega-merchant DeBeers, which had pulled out of Angola some years earlier during the war. Leviev remains the largest player in the Angolan diamond market to this day, but he continues to fend off potential rivals.

Guidolin and La Ferrara also point out that a peacetime Angolan government could afford newfound patience in its negotiations. Before, the government had faced a constant budget crunch, and in its desperation to obtain hard currency to purchase arms, was forced to accept unfavorable terms. Peace meant that businesses no longer got the same sweetheart deals. Royalty payments to the government for mining concessions jumped from $37.5 million in 2002 to nearly $110 million one year later, despite only a modest increase in the value of the diamonds extracted. Overall, the Angolan economy has taken off since the war's end, with income per capita rising by more than 20 percent between 2003 and 2005. If the old diamond companies are suffering, the industry's expansion has helped the rest of the country.

In the oil rush that has seized much of the African continent in recent years, we may be witnessing another instance of disconnect between economic prosperity and certain business profits. Western oil companies, whether inhibited by ethics or constrained by law, have shied away from working with unsavory and corrupt African dictators. But such qualms haven't stopped the China National Petroleum Company from drilling in countries like Chad, as the New York Times reported earlier this week. As long as Chad's government remains a global pariah, the Chinese will face little competition.

The situation means that CNPC, like Angola's wartime diamond miners, has no incentive to work for peace. Quite the opposite. There is a tragic mismatch between the social imperative to end war and the business imperatives of incumbent firms to maintain their entry barriers. La Ferrara and Guidolin don't have data about whether Angolan miners helped to prolong the conflict. But it appears it would have been in their shareholders' interests to do so. The fear is that companies with a taste for operating in war zones, or collaborating with corrupt governments, may be willing to do what it takes to keep things as they are. Because that's what's good for profits.

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