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

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Primary Commodities and Economic Development: New Challenges and Policy Option in the 21st Century Machiko Nissanke Department of Economics – PowerPoint PPT presentation

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Title: 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.
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