Commodity Agreements

Aims: By the end of this chapter, you will be able to
(i) define a commodity agreement, and
(ii) evaluate the role of commodity agreements in economic growth and development.

  1. Introduction
    Box 1. Introduction
    "Out of 141 developing countries, 95 depend for more than half of their export earnings on commodities [62 countries if oil is not included]. For 70 of them, these revenues were generated by only three commodities. This makes these countries very vulnerable to price declines and volatility.

    And indeed commodity prices have declined over the long-term, especially after 1980. Between 1980 and 2002, agricultural prices relative to manufacturing prices have declined by 47 per cent and the prices of metals and minerals by 35 per cent, again relative to manufacturing prices. For some individual commodities, the price declines are even larger. For instance, coffee producers now receive roughly a third of the price that prevailed in the mid-1990s. "

    Source: "Developing country dependence on commodities must be addressed for any chance at meeting anti-poverty goals, says deputy secretary-general." 4 Nov. 2003, published by United Nations Information Service at http://www.unis.unvienna.org/unis/pressrels/2003/dsgsm210.html.

  2. Commodities are primary goods used as inputs in manufacturing processes and traded in world markets. Commodities can be agricultural produce like coffee, cotton, jute and olive. This is also called soft comoddities. Commodities can also be minerals like tin, zinc, copper and oil that are extracted from the land. This latter category is also known as hard commodities.
  3. As seen in Box 1 above, many developing countries depend heavily on commodities for export earnings. Thus, it is not a surprise that they prefer to have high and stable prices for their commodities. The United Nations Conference on Trade and Development (UNCTAD) was created in 1964 by 77 developing countries to promote development through trade and international commodity agreements is part of this strategy.
  4. An International Commodity Agreement (ICA) is an agreement among producer countries to coordinate commodity exports in order to (i) stabilize price (i.e. to reduce price fluctuation) and (ii) raise the long run price level (i.e. to achieve an improvement in terms of trade in the long run).
    These objectives are achieved either by (a) agreeing to a production or export quota system in which each member will limit their export to the given quota or (b) to by creating a buffer stock to stabilize the world supply. The International Coffee Agreement uses the quota system which is in effect a "cartel" similar to OPEC and the now defunct International Natural Rubber Organization (1999) operated a buffer stock.
  5. Most ICAs are negotiated under the auspices of UNCTAD. There are ICAs on cocoa, cotton, grains, sugar, tropical timber, olive oil and table olive.
  6. Member countries will gain economic growth if the ICA is able to provide a stable price level for the commodity and in the long run improves the term of trade. If the increase in export earning is invested in infrastructure, education and healthcare then ICA also contributes to development.
  7. Unfortunately, ICA with the exception of OPEC is not sustainable in the long run because
    (i) the financial costs associated with the management of buffer stock (see Buffer Stock in Supply and Demand Analysis) which includes the cost of storage,
    (ii) difficulty in maintaining the price band when the ICA contains both producers and consumers as in the now defunct International Natural Rubber Organization (1999)- in this case, producers will have the incentives to push the price as high as possible and consumers will like to have the lower price,
    (iii) when there are many small producers outside the ICA which reduce the ability of the ICA to control world supply,
    (iv) if the ICA is operated using the quota system then member countries tend to have incentives to cheat by exporting beyond their quotas which again reduce the ability of the ICA to control world supply, and
    (v) when the commodity is fast being replaced by synthetic substitutes as with natural rubber and jute- in this case, ICA will not be effective as declining global demand will lead to a falling price in the long run.
  8. Evaluation
    (i) Even if the ICA can guarantee a stable and high price this does not necessary translate into higher export earning because the yield can vary from year to year depending on weather conditions, quality of inputs and political stability.
    (ii) It is probably not a good development strategy to depend heavily on the export of a narrow range of primary goods and ICAs for export earnings. As seen in Box 1, such a dependency exposes the country to price fluctuation or/and the problems associated with ICAs. A developing country will probably be wiser to invest in infrastructure and institutional reforms, diversify its economy, and add values to commodities by processing and manufacturing.
    (iii) Having said that, ICAs can be used to reduce price fluctuation and ensure a reasonable export earning that can be invested in infrastructure and institutional reforms, to help diversify the economy and to promote the manufacturing sector. Malaysia for instance was the world largest natural rubber producer for many years and was active in the now defunct International Natural Rubber Organization but when its economy was sufficiently diversify and it has become the world largest maker of surgical gloves, Malaysia pulled out of the International Natural Rubber Organization (The Economist, 16 December 1999). Malaysia exited from International Natural Rubber Organization because the artificial high price for natural rubber was distorting the allocation of resources in the country, and as a large consumer of rubber, Malaysia was interested in a lower global price for natural rubber.

Questions

  1. Define Commodity.
  2. Define International Commodity Agreement.
  3. Explain how an international commodity agreement is expected to work.
  4. Evaluate the role of international commodity agreement in development.
  5. Project. Visit http://www.bized.co.uk/virtual/dc/works/cprice.htm and download the worksheet on commodity prices. Go on a suggested virtual "field trip" in Bized and complete the worksheet.