A study, funded by the government of Norway, of the tools countries and producers can use to generate more predictable revenues from commodity exports.

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

Boom or Bust

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 gamble

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 commodity price problem

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.

The problem has not gone away

World rubber prices, 1990-2006

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

Active commodity markets

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

The problems of unpredictability

• 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

More predictable incomes (not fixed prices) should be the goal

• 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

Supply management

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

• 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

Alternative trade initiatives

• 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

The benefit of experience

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

Towards re-engagement

For more information on this project, please visit:www.iisd.org/markets/policy/price.asp

or contact:Oli BrownIISD Geneva+41.(0)[email protected]