Volatile Commodity Prices Detrimental to Developing Economies

01/11/2011
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Commodity price volatility has detrimental effect on the public finances of developing countries, according to research conducted by two lecturers at the University of Auvergne in France.

In a paper presented at the sixth African Economic Summit in Addis Ababa, Ethiopia, Hélène Ehrhart and Samuel Guérineau said developing economies must devise ways of reducing commodities price volatility, and their detrimental impact on sustainable growth.

The paper, “The Impact of high and volatile commodity prices on public finance in developing countries”, presented existing data, which indicated that there have been commodity price booms and busts since 2004, with oil reaching US$120 and the FAO Food Prices Index reaching 200.

The study said that commodity price instability was particularly affecting developing countries, whose export earnings mostly came from commodities and whose imports bills are dominated by food products. The authors say they found robust evidence that tax revenues in developing countries increase with the rise of commodity prices but that they are hurt by the volatility of these prices.

“Increased prices on imported commodities lead to increased trade taxes and (to a smaller extent) consumption taxes being collected,” the authors said, adding that a large share of public revenue came from external trade (tariffs & VAT) thereby creating public revenue dependency.

The research highlighted “the importance of finding ways to limit price volatility and to implement policy measures to mitigate its adverse effects.”

The authors recommended fiscal policy measures such as reducing the dependency of public revenues on trade taxes, reducing the fiscal impact of food and energy price peaks, and complementing regional markets, which could be sources of short- and medium-term treasury bonds, by international cooperation.

Finding ways to limit price volatility and implementing policy measures to mitigate its adverse effects are important, according to the authors.

Another study, “The Impact of Trade Facilitation Mechanisms on Export Competitiveness” by Malcolm D. Spence and Stephen N. Karingi, compared the export productivity of developing and developed countries by comparing Ethiopia’s major exports, coffee; and Ireland’s, complex chemicals. The report found that coffee accounted for 35% of Ethiopia’s exports, while its productivity was limited to US$1,303. In the case of Ireland, the chemicals accounted for only 19% of the total export and their productivity was US$39,813.

These studies affirmed the weak trade among African countries. The authors said that trade facilitation by various means including the development of infrastructure, had been shown to increase both the import and export of a country and the world as a whole.

A third study, “The Implications of Hecksher Ohlin (HO) and the increasing return to scale (IRS) theories for Bilateral Trade Flows within Sub-Saharan Africa” by Julie Lohi, West Virginia University, argued that bilateral trade flows were low within SSA as compared to other regions due to lack of comparative advantage, similar endowments in factors of production, and homogeneity of traded goods.

It recommended that Sub-Saharan African countries gain the “know-how” from interacting with mature markets, benefit from their comparative advantage over industrialized countries, and use new technologies for industrialization and differentiate their products in many varieties.