Primary Commodities and Economic Development: New Challenges and Policy Option in the 21st Century

1
Primary Commodities and Economic Development New
Challenges and Policy Option in the 21st Century

• Machiko Nissanke
• Department of Economics
• School of Oriental and African Studies
• University of London
• 16 September 2008

2
Introduction -Backgrounds

• The high prices and volatility across primary
  commodities hit the global community at the time
  of turmoil of financial markets Placed commodity
  issues back at the international policy agenda
• In contrast, the persistent reluctance to
  acknowledge commodity-related developmental
  issues and the resultant failure to deal with
  them effectively in a timely fashion in the 1980s
  and 1990s entailed a heavy cost to economic
  development of commodity-dependent low-income
  DCs
• Maizels (1987, 1992 and 1994) convincingly
  revealed how the beginning of the debt crisis of
  poor countries in the late 1970s coincided with
  that of the conveniently forgotten commodity
  crisis (the depth of which was worse than the
  Great Depression in the 1930s)
• His in-depth and comprehensive analysis of
  commodity issues and his urge to formulate
  correct international policy responses to the
  debt crisis could have led to an early resolution
  of the protracted debt overhang condition in
  low-income countries
• Many HIPC and LDCs, mostly in SSA- very high
  commodity-dependence
• All debt relief efforts, including HIPC
  initiatives, failed to pay sufficient attention
  to the plight of commodity-dependent economies-
  an international poverty trap through a
  commodity-dependent integration into the global
  economy in the 1980s and 1990s

3
Introduction Backgrounds (Contd)

• The contrast between commodity-dependent
  economies and newly industrialising economies
  through climbing technology and skill-ladders
  largely accounts for their divergent growth and
  development experiences.
• Globalisation has not left commodity-dependent
  countries untouched
• Changing landscape governing world commodity
  markets and production both at the Global and
  National Levels
• At the global level
• High price volatility a rapid expansion of
  derivatives markets attracting portfolio
  investors not engaging in physical commodity
  trading, leading to a loosening of the
  demand-supply relationships
• Fundamental demand-supply relationships shifting,
  originating from fast growing economies
  (e.g.China and India) for raw materials and
  agricultural goods
• The impact of climate changes shifting the
  relative composition between food crops,
  bio-fuels, cash crops effects on food prices
  food security
• The changing relative positions between TNCs and
  producers in GVCs

4
Background (Continued) and Objectives

• At the national level
• Institutional changes affecting agricultural
  producers in input provisions, access to new
  technology, extension services and output
  marketing arrangements
• Producers exposed to high price volatility-
  costly and imperfect hedging instruments- uneven
  access
• Institutional changes affecting mineral-based
  economies privatisation negotiated between TNCs
  and governments, based on the asymmetric power
  relationships mineral rents not accruing much
  to producing countries
• Objectives of the paper
• Examine the emerging landscape affecting
  commodity markets and production
• Discuss new challenges, opportunities and
  development issues in the light of these changes

5
Commodity Prices and Economic Development in a
Historical Context

• Two key issues in the North-South divides i)
  the declining TOT (Prebish-Singer Hypothesis)
  ii) High price volatility and instability
• Explained in terms of fundamental differences on
  supply and demand sides affecting price
  formations between primary commodities and
  manufactured goods (e.g. low income elasticities
  on the demand side and technology advancement etc
  for the declining TOT as well as low short-run
  price elasticities on both demand and supply side
  for high price volatilities of tree crops and
  minerals)
• Increasing high price volatility due to the
  closer two-way links between financial and
  commodity markets (Maizels 1994)
• Numerous empirical studies i) Large price
  volatility dominating secular decline in real
  commodity prices ii) the real commodity price
  index fell by four-fifths between 1900-1999 (the
  link between the commodity crisis and debt crisis
  in the 1980s and 1990s.
• large commodity price cycles have become more
  frequent with shortened duration and increased
  amplitude over the recent decades.

6
Commodity Prices Trends and Volatility(1862-1997)
7
International Commodity Agreements (ICAs)

• The focus of attention of the commodity problem
  mainly on short-term price instability and its
  effects on export earnings and income of
  commodity-dependent DCs (Maizels, 1992-1994).
• Keynes (1938 1942)- the importance of
  establishing buffer stocks for the main
  commodities (reflecting his deep understanding of
  the effects of commodity price dynamics on
  financial macro performance)
• Integrated Programme for Commodities of UNCTAD in
  1976 ICAs (Cocoa, Coffee, Rubber, Suger and
  Tin)- price stabilisation within a band through
  financing buffer stocks or export quota
• The collapse of ICAs by the end of 1980s
  (finally the abandonment of INRA in 1999)
• Technical problems with implementation of ICAs
  and the lack of political and financial support
  from consuming countries (disagreements over
  stabilisation bands at the time of sharply
  declining prices collective action problems and
  disincentives, free-rider problems)
• CCFF (high conditionality) STABEX, FLEX-
  pro-cyclical disbursement etc
• With the collapse of the ICAs, a shift to the use
  of risk hedging instruments.

8
Selected Commodity Prices (1957-2005)
9
Nominal commodity Price indices (1957-2008)
10
Monthly Commodity Pice index by commodity groups
(1995-2008)
11
Recent Trends General Observations

• The general commodity price index in US dollars
  from 100 in 2000 to 300 in the mid-2008, but not
  uniform across commodities
• The sharp rise in the last two years (2006-8) of
  basic and political sensitive goods, pushing fuel
  and food cost, affecting adversely the poor most
• The price of tropical beverages and agricultural
  materials increased less, but, the prices of
  vegetable oilseeds and oils (bio-fuel crops)
  increased sharper than general food crops
• The sharpest increase of all is for mineral
  commodities (copper, zinc, nickel, iron,
  aluminium etc.)
• The shifts in fundamental demand-supply
  relationships -a key factor for price movements
  for commodities over medium term (China and India
  factors on the demand side, and supply
  constraints due to subdued investment in the low
  price periods of the 1980s and 1990s)
• Inventories was low at the time of price surge
  for minerals asymmetry in inventory and price
  movements
• The high correlation between minerals, and
  agricultural vs energy prices

12
Inventories and Stock-Price Relationships for
minerals
13
World Cereal Consumption, Production, Stocks and
Prices
14
Recent Trends General Observations (contd)

• Close interlinks between oil and agricultural
  commodity prices through higher transport costs
  and other input cost
• Higher food prices from the abrupt shift in
  arable land use from food crops towards bio-fuel
  crops (the Climate-change effect)
• Increases in demand for agricultural products
  from EM economies
• Neglected agricultural sectors, resulting in low
  investment in agricultural technology and
  supporting infrastructures
• Over medium term an entering into a super price
  cycle?
• Real prices of non-fuel commodities still follow
  a downward trend from a longer historical
  perspective for 1960-2007
• continuing high price volatility the rapid
  growth of commodity derivatives markets since the
  early 2000 associated with dot-com babble-burst
  and the recent upheaval in financial markets
  the flight from equities/bonds to commodities as
  well as inflation hedging
• New actors in commodity markets ( investment
  funds, pension and hedge funds and sovereign
  wealth funds)
• High correlation across commodities as a result
  of commodity index trading- noise trading and
  less reflective of the fundamentals.

15
Primary Commodity Prices Real and Nominal
Real Price
Real Price Tend
Nominal Price
16
Price Volatilities of Non-Fuel Commodities vs
Fuel and Manufacturred goods
17
Changes in World Market Structures

• The need to understand structural changes and
  institutional arrangements (Maizels
  1984)Commodity markets not text book perfect
  competitive markets
• oligopsonistic and oligopolistic market
  structures - the relative bargaining power of
  actors shifting in favour of TNCs (Maizels 1984)
• The effects of derivatives markets on commodity
  price dynamics
• Q whether futures markets operate as an
  efficient mechanism for price information and
  discovery in the presence of powerful trading
  conglomerate TNCs and portfolio investors with
  little interests in physical commodities
• Q Whether price volatility is exacerbated by the
  entry and presence of speculative noise trading
  or the prevalence herd behaviour (Pindyke (2004)
  

18
A Case study of NYBOT Coffee Markets
- A test of the ratio of non-commercial open
interest to total open interest
-test of structural breaks in this ratio in the
relationships between prices and world demand and
supply
- test of the monthly volatility index of future
prices and future trading activities reflecting
new kind players since 2000
19
Evolving Global Commodity Chains (GVCs) and the
Price Transmission Process

• Actors in commodity producing countries have
  become marginalized and isolated with withdrawal
  of institutional support and the subsequent loss
  of their bargaining power, as vertically
  integrated TNCs had consolidated their positions
  over GVCs (production, processing and marketing)
  
• The parallel process of fragmentation and
  integration has often resulted in a hugely skewed
  distribution of gains from commodity trade.
• The governance structures of GVCs have become
  buyer-driven with a shift in the distribution of
  value skewed in favour of consuming countries
• The widening gap between producer and retail
  prices for a composite bundle of commodities-
  showing how much rents can be created and how
  skewed rents distribution is in commodity chains.
• Hedging instruments do not provide a perfect risk
  management tool -the greater divergence between
  spot prices and future prices
• Hedging instruments require high liquid resources

20
Evolving Global Commodity Chains (GVCs) and the
Price Transmission Process (Contd)

• An examination of the price transmission
  mechanisms along coffee supply chains and how
  different actors are engaged in price risk
  management
• A market consolidation by very large
  multinational commodity trading conglomerates in
  green coffee and processing
• Conglomerates with own in-house brokerages in
  futures and options and research departments-
  engaging in hedging as well as speculations with
  knowledge of both physical and derivatives
  markets ( the use of a price-to be fixed
  contract, linking to prices on future markets at
  delivery date through hedging)
• Smaller single-commodity trading firms have
  entered into niche markets, trading in specialty
  coffees

21
Impacts of Changing Market Structures on
Producers

• Changes in Institutional environments at the
  National Level
• State-run marketing boards were dismantled or
  downsized and price stabilisation funds or
  mechanisms ceased to exist
• Domestic commodity traders and producers are
  exposed to greater price risks as volatile prices
  are transmitted from the downstream to the
  upstream
• International Task Force on Commodity Risk
  Management (ITFCRM) to promote a application of
  risk hedging management by actors in upstream
• Issues- the prohibitive financial cost and skewed
  access to information and high technical barriers
  for small actors as well as creating an adequate
  regulatory oversight agency
• Resulted in geographical fragmentation of
  marketing activities, and placed small-holders in
  a weaker position viz private traders in both
  inputs provisions and marketing of their produce.

22
Price Risk Management in Upstream Coffee Chain in
Uganda and Tanzania

• In the pre-liberalisation period
• in Uganda -a dual marketing system with both
  private and cooperative channels but controlled
  all exports under the Coffee Marketing Board.
  Price risks were borne by the marketing boards
• In Tanzania- marketing was conducted through the
  cooperative marketing system and all exports went
  through the coffee auction. Price risk was borne
  by cooperatives but shared out amongst members
  through the payment system to smooth out farmers
  income.
• In the post-liberalisation period
• In Uganda- most liberalised system. The marketing
  is dominated by the top 5 companies (all
  subsidiaries of large MNCs) taking over 70 of
  market share
• In Tanzania- the auction system retained and
  cooperatives remain strong in N. regions law to
  eliminate captive coffee prohibiting local
  traders from profiting at the auction, but again
  the top 5 MNC subsidiaries market share of 68 .
  

23
Price Risk Management in Upstream Coffee Chain in
Uganda and Tanzania

• In Uganda, local traders shielded from intra-day
  price fluctuations, through MNCs hedging, but are
  exposed to inter-day or weekly swings. To protect
  their interests, they purchase coffee at stable,
  but low prices. Producers are offered low
  farm-gate prices coffee production has been
  declining despite increasing world prices.
• In Tanzania, where cooperatives remain strong,
  farmers are protected through the payment system,
  allowing farmers to smooth income within season
  to some extent. Auctions take place weekly, so
  weekly price fluctuations are shared among
  members. In other areas, gfarmers organise some
  POs. A tendency to get into niche markets with
  premium prices (fair-trade marketing etc with the
  use of forward contracts-Kili-cafe).
• -Still coffee production falling in Tanzania
  too.

24
Changing institutional environments for coffee
and cotton farmers and their consequences in
Tanzania

• After liberalisation, both sectors suffered from
  institutional vacuum In the cotton sector
  cooperative unions collapsed, while in the coffee
  sector, cooperative unions and POs survived in N.
  regions, but facing resource constraints
• In purchasing and processing
• In cotton no thriving markets with competing
  traders and ginners. Producers are spatially
  fragmented and isolated both between and within
  villages. The poorest hardest hit.
• In coffee Choices between selling traders or
  coops. More differentiation taken place, smaller
  holders hit hard.
• In input provisions In both sectors, no
  reliable supplies- most devastating. Neither the
  passbook system of CDF for cotton, the voucher
  system for coffee not working for the poor,
  exploited by ginners and traders.
• In extension services, access to new technology
  information Ukiriguru for cotton and TACRI for
  coffee under-funded, and no systematic
  provisions
• Implications for farm-gate prices for cotton and
  coffee Farmers are fragmented between and
  within villages- no competitive integrated market.

25
Cotton Prices (World, export and producer Prices)
26
Coffee Prices (World, export and producer Prices)
27
Managing Resource-Based Economies over Commodity
Price Cycles

• The economic cycles of commodity dependent DCs
  are dominated by commodity price movements
• The hypersensitivity to externally originated
  instability is one of the critical weaknesses of
  natural resource-rich economies
• An eventual transformation into diversified
  economic structures is the real solution to the
  problems
• The commodity trap can be overcome only through
  an effective use of natural resource rents in the
  transition period
• Successful economic management over the commodity
  price cycles, are indispensable for the critical
  intervening period
• Yet, so far, demand management has been
  pro-cyclical to the direction of both internal
  and external market forces rather than
  counter-cyclical
• Dutch-Disease is by no means inevitable, and its
  symptoms are observed because economies tend to
  run into short-term absorptive capacity and
  supply bottlenecks
• The policy of time-phasing is one key - a policy
  of de-synchronization of the path of absorption
  from that of income.

28
Macroeconomic Management over Commodity Price
Cycles

• Intertemporal optimal allocation of resources is
  an issue of intelligent portfolio management of a
  whole range of domestic and foreign assets and
  liablities in the light of the current and the
  expected return-risk structure over the commodity
  price cycle
• A call for a strategic approach to fiscal and
  financial management of mineral rents over a
  medium term price cycle of commodities
• Decisions over the inter-temporal portfolio
  allocation of rents for smoothing an absorption
  path as well as over the spending and expenditure
  patterns i.e. the sectoral allocation between
  tradables vs non-tradables or domestically
  produced goods vs imported goods, in view of
  avoiding to aggravate various critical supply
  bottlenecks.
• Allowing a time to build supply capacity to move
  PPF outwards.
• The role of exchange rate policy combines with an
  appropriate monetary framework with a view of
  intra-cycle movement of the real exchange rate.
• Taking into account the tendency of Dutch Disease
  Syndrome induced by market forces

29
Exchange Rate Management

• The centrality of a coordinated policy framework
  to work out appropriate exchange rate management
  and monetary policy regimes not only for a
  short-run stabilisation purpose, but also for
  avoiding the detrimental long-term effects of a
  commodity boom
• Allowing a flexibility but managing with a view
  of controlling and reducing volatility in a
  countercyclical manner
• Evaluation- the proposals for the Inflation
  Target framework for monetary policy under a
  floating regime and the commodity currency (Peg
  the Export Price, PEP) regimes for exchange rate
  management the inflation
• IT regime with a pure floating a nominal anchor
  to be provided by a credible institutional
  commitment to the IT regime( with intermediate
  regimes vanishing under the impossible trinity)
  transparency and accountability
• Fear of floating prevails in EMs, so operating
  with an escape close for CA management
• In LDC, fear of floating coming not from a high
  pass-through rate or liability dollarisation but
  from fear of macro instability from CA
  development

30
Exchange Rate Management (contd)

• Exchange Rate Protectionism actively using
  exchange rate as a development policy tool
  (Korea, Chile and Botswana) for attaining a
  desirable CA position on a sustainable basis by
  keeping exchange rate at competitive levels to
  pursue export-led growth
• The IT regime may subject economies to large
  swings and shifts in the real exchange rate.
• The PEP (Commodity Currency) Proposal by J.
  Frankel- peg to peg to the real price of main
  export commodity (or commodity index- PEPI)-,i.e.
  to stabilise the price of local currency in
  terms of commodity
• PEP delivers simultaneously a nominal anchor as
  promised under a fixed exchange rate regime and
  automatic adjustment in the face of commodity
  price fluctuations on world markets as promised
  under a floating regime.
• PEP- the export price targeting instead the
  Inflation Targeting based on CPI , to take into
  account TOT shocks
• Operationalising PEPs it can be set with in a
  band on a monthly basis, rather than daily
  operations
• Many questions to be answered about suitability
  as a counter-cyclical instrument on a basis of
  simulation analyses.

31
Changing Landscape Governing the Mining Sector
and Macroeconomic Environments Zambia vs Chile

• Privatisation of mining industry in Zambia and
  Chile
• In Zambia, ZCCM privatised with a small share
  allocated to the government TNCs benefiting from
  very low royalties and low taxes on profits
  contribution of mining rents to the fiscal
  budget- marginal.
• In Chile, CODELCO privatised, but negotiated to
  retain governments share of 40 and fair tax
  rates constantly renegotiated Fiscal surplus is
  saved in a sovereign fund offshore, according to
  the structural budget rule set with a view of
  medium term copper price forecasts to relieve
  short-run absorptive capacity constraints
• Monetary and exchange rate regimes
• In Zambia aggregate monetary target with a
  floating regime only to smooth out extreme
  short-run volatility now a move to the IT
  regime is under consideration Exchange rate is
  not deployed as a development tool ( See Bovas
  econometric study of the inflation-appreciation
  trade-off revisited).
• In Chile active management of exchange rates
  with in a band till 1999, and a shift to the IT
  regime with a escape clause to keep CA in
  balance.

32
Comparative Analysis of Real Exchange Rate
Movements (Chile and Zambia)
33
Concluding Remarks

• The hypersensitivity to externally originated
  instability is one of the critical weaknesses of
  commodity-dependent low income countries
• The real answer to the commodity Trap
  transformation into diversified economic
  structures, which require rigorous investments in
  production capacity and physical and social
  infrastructures.
• Call for a strong commodity sector, where the
  process of active learning-by-doing experiences
  and accumulation can take place
• The new landscape emerging under globalisation
  tend to discourage this process of learning and
  accumulation
• The institutional environments facing commodity
  producers both at the global and domestic levels
  in SSA have weakened the capacity and resiliency
  of small holders and mining industries
• The need for strengthening international and
  domestic institutions governing commodity trade
  and production throughout commodity chains
• more active forms of cooperation and joint
  action with TNCs to accelerate the learning
  process
• The renegotiation of distribution of mineral
  rents and more regulations over transactions on
  derivatives markets.
• Calls for a more innovative compensating
  financing facilities as ex-ante debt relief
  mechanism.