Boom or Bust
A study, funded by the government of Norway, of the
tools countries and producers can use to generate
more predictable revenues from commodity exports.
Five tools:
• Supply management
• National revenue management
• Market-based price risk management
• Compensatory finance
• Alternative trade initiatives
Seven case studies:
• India, Ghana, Uganda, Southeast Asia, Chile, Malawi,
Côte d’Ivoire
Website: www.iisd.org/markets/policy/price.asp
The commodity gamble
95 of 141 developing countries derive at least 50%
of their export earnings from commodity exports
2 billion people are employed in commodity
production, half of them in agriculture
Dependence can be advantageous when prices
are high - but is a highly risky strategy
The commodity price problem
1. Historically declining prices
Primary commodity prices are declining over the long term
•
1862-1999 historical decline of c. 1% per year in real prices
•
Drivers: increased productivity, structural oversupply, subsidies, substitutes
The commodity price problem
2. Volatile prices
•
Drivers: business cycles, slow response to changes in demand, weather,
conflict, exchange rate fluctuations, price speculation, export dumping
= low returns + high risk
The problem has not gone away
Since 2001 prices have been rising steadily:
• Prices of copper, zinc, wheat, soybeans, oil, rubber, gold, lead, cattle
and cocoa all at or near record levels.
Partially hiding the problem – raises 2 questions:
1. Does this constitute a commodity price bubble?
“In the midst of a slightly sub-par upturn in global growth, a low-inflation world
is experiencing the sharpest run-up in commodity prices in modern history…
If that’s not a bubble, I don’t know what is”
Stephen Roach,
Chief Economist, Morgan Stanley, May 2006
2. Has the world’s economic well-being ‘decoupled’ from
America’s economic health?
The next 6-12 months may answer both questions.
World rubber prices, 1990-2006
Active commodity markets
In theory…
• very good at setting prices
• improve efficiency
• create incentives for increased market access
But in practice…
• imperfect nature of commodity markets
• producer responses are rarely smooth
• developing country producers don’t have the same
safety nets
• most of the benefits of volatile markets accrue to
players in the developed world
• the ‘invisible hand’ of the market treats some very
roughly
The problems of unpredictability
1. The planning problem
2. The dependency problem
3. The environmental problem
“There is a clear link between dependence on exports
of primary commodities and the incidence of extreme
poverty… The commitment to reducing extreme
poverty by half by the year 2015 necessarily implies
attention to the primary commodity problem”
UNCTAD, 2002
More predictable incomes (not fixed
prices) should be the goal
• Price volatility is not a new problem
• Tackling the price problem has fallen out of political
favour
• Diversification is best protection – but can be tricky
• This is not a problem without solutions
• Basic economic tools to help producers and countries
get more predictable incomes are better-understood
than ever before
Supply management
• SM attempts to reduce income risk by directly influencing world
prices for a particular commodity
• SM mechanisms have had a mixed record – but have not always
been unmitigated failures
• SM can dilute corporate control in buyer-driven commodity chains
• Technological advances are creating new ways to enforce production
agreements
• But deals primarily with price management and not the other social
and environmental risks faced by producers
• Problem of free riders
• Low international support for conventional SM
National revenue management
• NRM is a general term for fiscal management laws and institutions
set up to smooth national spending and to insulate a nation’s economy
from the negative effects of volatile revenues – most commonly
associated with oil-exporting countries
• Does not affect world prices – instead can isolate revenues from
short-term domestic interests, increase transparency, protect against
real exchange rate appreciation, save surplus revenues, etc.
• If properly designed and executed NRM can create a situation of
‘well-managed’ commodity dependence
• But can’t create fiscal discipline from scratch in countries that do not
otherwise practice prudent fiscal policies
Market-based price risk management
• Refers to any strategy that uses financial products to help producers
transfer commodity price risk to outside investors (through forward,
futures and options contracts)
• Doesn’t affect prices but can make incomes more predictable over
the short-run
• Can take many forms – allowing producers to choose the package
that best fits their individual needs and degree of risk aversion
• But it represents an additional cost and is rarely accessible to small
producers
Compensatory finance
• Compensatory finance mechanisms attempt to support income
stability with reactive loans that help countries ride out periods of low
commodity prices
• In theory compensatory finance mechanisms based on loans can be
self-financing after the initial set-up and can reduce the likelihood of
aid dependence among recipient countries
• But if not well designed, compensatory finance mechanisms create
market distortions, perverse incentives and aid dependency
Alternative trade initiatives
• Allow producers who meet certain requirements to differentiate their
products through a certification mechanism (fair trade, organic labels)
• Almost all have a stabilizing effect on prices. i.e. fair trade sets a
minimum price for buyers or a social premium if the market price
exceeds the minimum
• Can address a whole range of livelihood, price and environmental
risks
• But constitute a tiny fraction of total commodity sales – inherently a
niche market
• Complex and expensive certification requirements and the
proliferation of competing initiatives can be difficult for developing
country producers to navigate
The benefit of experience
• We have options that work—under the right
circumstances
• Access to knowledge infrastructure and skills are
enduring obstacles
• Stabilization interventions can create their own
moral hazards & market distortions
Towards re-engagement
1. Look for complementary policies
2. Engage stakeholders at all levels
3. Do not underestimate the importance of the
private sector
4. Keep it as simple as possible
5. Address moral hazard by integrating income
stabilization into a wider rural development or
diversification program
6. Build flexibility into programs
7. Ensure that the reach of the implementing agent
matches the scope of a policy’s goals
For more information on this project, please visit:
www.iisd.org/markets/policy/price.asp
or contact:
Oli Brown
IISD Geneva
+41.(0).22.917.8630
obrown@iisd.org