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.
"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.
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.
- 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.
- 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.
- 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.
- Most ICAs are negotiated under the auspices of UNCTAD. There are ICAs on
cocoa, cotton, grains, sugar, tropical timber, olive oil and table olive.
- 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.
- 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.
(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
(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.
- Define Commodity.
- Define International Commodity Agreement.
- Explain how an international commodity agreement is expected to work.
- Evaluate the role of international commodity agreement in development.
- 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.