International trade in commodities is characterized by excessive price fluctuations, declining export earnings for producer countries, vulnerability to fluctuations in export earnings, restrictions on access to markets, reductions in the variety of commodities produced, limitations on the degree of processing of commodities by the producers, declining competitiveness of natural products, inadequate market structures, marketing and distribution systems.
Instability of commodity prices, and associated fluctuations in earnings, pose a number of problems for developing countries. Price instability may make it difficult for producers to take rational investment decisions and may therefore lead to losses of real income through misallocation of productive resources. It may also weaken the competitive position of natural products against synthetic or other substitutes supplied at more stable prices. Fluctuations in producers' incomes and foreign exchange earnings may destabilize the economy through their influence on savings and consumer spending and through their disruptive effects on import budgets and development plans. The effects are usually self-cancelling except in the case of countries highly dependent on only one or two unstable commodities.
The greater concentration of developing countries production and exports in primary products makes their economy more vulnerable to external factors than that of industrialized countries. The world economic recession of 1980s has been transmitted from the developed countries to the developing countries to the large extent through commodity prices. Declining prices of commodities have increased the debt burden and impaired the ability to both maintain imports and service their debt.
Primary commodities account for most of the total exports of developing countries. Unlike world demand for processed foodstuffs and manufactured goods, demand for most primary commodities is relatively price-inelastic, with the consequence that prices of these commodities tend to be highly sensitive to changes in supply. The supply of primary commodities, moreover, is generally much less responsive than that of processed commodities to change in prices in the short run. For these reasons, and also because of the influence of random factors such as variations in harvests and strikes, prices of primary commodities often show considerable fluctuations both in the long and short-term. All these factors make the economies of developing countries extremely vulnerable to conditions outside their control. In addition, the primary commodities face a sluggish import demand in the countries that constitute their major markets, particularly where substitutions may be made, such as synthetics for natural commodities.
The International Monetary Fund provides compensatory financing to assist member countries encountering difficulties produced by temporary export shortfalls. Eligibility for such compensation is determined for the latest 12-month period preceding the request for which the Fund has sufficient statistical data. The shortfall is the amount by which the member's export earnings in the shortfall year are less than the geometric average of the member's export earnings for the five-year period centred on the shortfall year. A judgemental forecast is used for the period of the two post-shortfall years, provided that any amount by which the forecast for the two post-shortfall years would exceed the member's export earnings for the two pre-shortfall years by more than 20% is excluded from the estimate.
Trade in primary commodities has long been characterized by market instability. In post-war years, the value of trade in individual commodities has been subject to year-to-year fluctuations. Instability indices for price and export earnings of non-fuel primary commodities of developing countries are about 12 and 14% respectively for 1961–1980. Agricultural products experienced higher instability in both price and value. Since the early 1970s, instability has been intensified drastically. Gross shortfalls in export earnings for the basket of primary commodities exported from developing countries amounted to about $45 billion during 1973–1982. World Bank calculation in the mid-1980s showed that the price of all groups of commodities from foods to metals has been declining by about 1% a year in real terms over the last 35 years. Since the early 1980s, commodity prices have fallen to their lowest levels in 50 years with little hope of any improvement.
The instability of world markets for primary commodities is a general phenomenon; although there are significant differences in its incidence and magnitude, it is not confined to commodities of a particular nature nor to the trade of particular countries. Thus, among the commodities whose value on world markets has been least stable in recent years are many which only come to a relatively small extent from the developing countries: tallow, lard, wool, zinc, lead, soya beans. Nevertheless, many of the commodities of which the developing countries are the sole or chief suppliers (natural rubber, fibres, cocoa, coffee) have been among the least stable in terms of export value movements. The degree of instability is appreciably greater than is evident in markets for other products.
The instability in commodity export earnings is higher for individual countries and is caused mainly by volume instability. The instability may cause variations in incomes and, hence, in domestic expenditure on consumption or investment. It may also give rise to fluctuations in external purchasing power and, hence, in supplies of imports available for consumption or investment. These consequences pose numerous difficulties for national policy formulation extending beyond the immediate impact of the fluctuations in export proceeds upon public revenue. The fluctuations may result in immediate hardship to the small producers characteristic of many of these commodities, creating socially unacceptable inequities in distribution of income. Importation of supplies of capital equipment for integrated development programmes may be interrupted. The incentive to invest may be weakened or switched from long-term industrial ventures to short-term commercial investments. The credit-worthiness of the country, in the eyes of foreign governments and international banks, tends to be weakened as instability in the commodity market could lead to debt default and thus to destabilization of the world financial market.
Instability in developing country commodity export prices, volume and earnings has been in most cases greater in the 1970s than earlier. Out of 36 commodities examined in the 1971-80 period, 19 had an instability index of over 15% for export earnings, 20 for export unit values (prices) and 10 for export volumes. Recent rates of change from one year to the next include: over 20% changes in food and vegetable oils and oilseeds; over 10% changes in tropical beverages, agricultural raw materials, and minerals ores and metals. Taken together, these non-fuel primary commodities price levels declined 16% in both 1981 and 1982, with only partial recovery shown in 1983 and 1984.
In 1980 ten developing countries relied on only one primary commodity for 90% or more of the value of their exports; twelve for 80% or more; seven for 70% or more; ten for 60% or more and nineteen for 50% or more. In contrast, only one developed country depended on one commodity for 50% or more of its export earnings. Export earnings for developing countries, because of their greater dependence on primary products, are relatively more unstable than those of developed countries – whether because of wider fluctuations in export prices or in export volumes. Generally it has been presumed that the direct and indirect effects of this instability impose substantial losses in welfare and slow down the role of development. Schemes for trade restructuring import substitution, diversification, buffer stocks, compensation, and international commodity agreements have not been very successful. Instability has been important in the case of bananas, bauxite, cocoa, coffee, copper, cotton yarns, hard fibers, iron ore, jute and jute products, manganese, meat, phosphates, rubber, sugar, tea, tropical timber, tin and vegetable oils. Many of these commodity trades have recently seen a deterioration in trade terms, as well.
The incidence of shortfalls in non-fuel commodity export earnings of developing countries rose sharply during the 1980s, as a result of falling world prices for major commodities, as well as of supply fluctuations at the country level. It is estimated that such shortfalls for developing countries as a group averaged 4.5 billion SDRs a year between 1981 and 1990, with virtually all developing countries experiencing sustained shortfalls. Nearly 75% of the shortfalls occurred between 1986 and 1990, a period when prices were at their lowest levels for many commodities. The highly commodity-dependent developing countries, particularly the least developed countries of Africa and the Pacific island region, experienced the largest incidence of shortfalls relative to their export earnings. The LDCs accounted for 15% of total shortfalls, proportionally much greater than their 7% share of developing country non-fuel commodity exports.
African countries are estimated to have lost US$50 billion in net revenue in the five years up to 1991 because of the fall in world prices for their export commodities. This was accompanied by an equally damaging withdrawal of investment. Although Africa had received a net capital inflow of US$24 billion in 1986, after a special 5-year UN programme to boost foreign aid and export earnings, capital inflow had declined to US$23 billion in 1990.
Developing countries' long dependence in primary product exports and their lack of human and financial capital weakens their position vis-à-vis developed countries in processing domestically and externally locally-produced primary commodities. The development of commodity-related manufacturing and services sectors by developing countries is needed in view of the declining terms of trade of primary commodities vis-à-vis those of manufactured commodities, in view of the need to increase value added and in view of the state of the international trading and financial system characterized by protectionism and by obstacles to access foreign capital. This is particularly important for the cases of coffee, cocoa, tea, bananas, rubber, iron ore, bauxite, phosphates, sugar, manganese, hard fibres, hides and skins.