International Commodity Market Policies

Presented by
Jim Greenfield
Former Director
Commodities and Trade Division
Food and Agriculture Organization of the United Nations

Introduction

For most agricultural commodities, we have witnessed several years of relatively low world prices and, whenever this occurs, we are prompted to ask whether this is the downside phase of a recurrent price cycle or the latest step down on the long-run declining trend of prices due to a change in market fundamentals. This is the same question that has been asked for the past 30 years at least. For instance, in the late sixties prices were depressed. Then came the first petroleum shock and the world food crisis with rocketing prices during 1972-74. A few years of retrenchment were followed by the second petroleum price spike and large but short-lived increases in food prices. The eighties were characterized by rampant protectionism in the industrialized countries, trade wars and, after the costs became apparent to all, the beginning of the reform process that led to the Uruguay Round agreements in 1994. The last price surge took place in 1995/96. A look at agricultural prices over the past 30 years, therefore, suggests the picture of a seismograph with one large shock in 1972-74 followed by a series of smaller shocks interspersed with periods of relatively flat market prices.

Policy history has reflected these developments in markets and prices. Before the 1972-74 crisis the policy focus was on developing disciplines on surplus disposal, and on diversification out of traditional products, but the crisis generated new concerns - those of resource exhaustion (the Club of Rome), famines and of newly found producer power. Governments responded by increasing the resources going into agriculture, often in the industrialized countries through increased protection thereby locking in the domestic producer price rises for another decade. This had a particularly strong effect on the temperate zone commodities although these often influenced developing countries via increased competition for such products as rice, sugar and oilseed products as well as through their effects on food imports of developing countries. The policy change also manifested itself through the negotiation of several international commodity agreements, for both temperate zone and tropical products in an attempt to moderate the perceived power of the producing countries. The disarray in commodity markets following on the policy induced output and stock increase together with the anti-inflationary macro-economic policies of the early eighties had two effects. First the market weakness undermined many of the ICAs and secondly it focused attention on what to do about agricultural protectionism. Today the problems facing us are still those of depressed agricultural markets interspersed with bouts of price fever, which, therefore, makes an analysis of past policy lessons of topical interest.^[4]

International commodity agreements^[5]

Turning to the first of the two main issues to be discussed, it is pertinent to recall just how much things have changed for the ICAs in the past two decades. At the end of the seventies negotiations were underway on a large number of ICAs with "economic clauses" and the Integrated Programme for Commodities, which led to the Common Fund for Commodities, was being hammered out. Today there are no ICAs with functioning economic clauses left and the prevailing view is very negative about their utility. Instead ICAs today concentrate on the provision of market information, policy discussions and commodity development. ICAs have always had both "economic" and "non-economic" objectives using "economic" to mean market intervention with price objectives. Other objectives such as the promotion of consumption are not in this context considered to be under the rubric of "economic clauses". The latter basically cover the levels and the variability of prices. For obvious reasons ICAs with importer participation (the ones that would normally qualify for treatment as exceptions to the GATT/WTO disciplines- see below) cannot usually be expected to foster the raising of the average level of prices under the ICA. Most ICAs with economic clauses have, therefore, price stability as their main objective.

What then is the record? The verdict on this score is "not proven". The INRA kept natural rubber prices within the agreed range for most of its period of operation and the coffee agreement did much the same during the early eighties. Others did not come into operation for a variety of contingent or technical reasons so that their ability to keep prices within target ranges was not tested. To review the history of the functioning of ICAs with price stabilization objectives three separate steps are covered a) the nature of difficulties faced; b) the criteria for judging their success; and c) the value or otherwise of price stabilization. The details are given in the Appendix, but briefly the main difficulties experienced, which affected both buffer stock ICAs as well as export quota schemes, were (i) the uncertainty of future price trends (ii) the need for considerable start-up capital and for the existence of "normal" market conditions at the outset, (iii) Built-in flexibility to deal with changes in market requirements, (iv) the chances of being outwitted by the market if the target prices are not credible, (v) difficulties over the choice of currencies to denominate the target prices and (vi) the need to "police" the agreement.

For an agreement to keep prices within a target range has a lot to do with how ambitious the agreement is. If the price range is set very wide it is obviously easier to keep prices within the range. There are two criteria suggested to evaluate an agreement whatever the range set: whether prices vary less after the coming into operation of the ICA and whether the ICA intervened successfully or not.^[6] It is important to keep in mind the possibility of a stock build-up during the period of the ICA, there being a tricky evaluation issue for terminal stocks. Finally it is suggested that a proper evaluation of an ICA requires a cost/benefit analysis to be done. In undertaking such analyses it is necessary to bear in mind the costs associated with the crowding out of private stocks both in the case of a buffer stock as well as an export quota scheme.

To conclude on this point, therefore, ICAs with price stabilization aims seem to be difficult to judge because of the extensive cost/benefit analysis required even if it is technically possible to design such schemes and verify ex post whether they worked or not.

Producer-only agreements

As was mentioned above, part of the spate of interest in ICAs in the seventies was the perceived need to offset the threat of the use of the newly acquired producer power as revealed in the petroleum and food price peaks reached in 1972-74. Producer cartels were considered a real risk by the importing countries. More recently in two books by Maizels and Bacon, Maizels and Mavrotas the case is advanced that the real problem of most basic commodities has been the long-run fall in international prices rather than the variability of prices. They then analyse the possibilities of a producer-only agreement to raise (or stop the fall of) primary commodity prices.

The basic conditions listed by these authors are: a high percentage of production in the hands of the group of exporters seeking to curb exports; price inelastic demand; modest price objectives and a high degree of commitment to a simple instrument. The conditions are not prohibitive and the share of trade that a group needs to command (which depends on elasticities of import demand and export supply in non-members^[7]) need not be impossibly high to achieve gains in export earnings by withholding some supplies from the market especially in the relatively short-run. In the longer-run the elasticities rise and with them the critical share required for the successful operation of a producer only agreement, but this should not rule out modestly aimed agreements for a limited number of years. It is not a requirement for an international agreement that it should be designed to last for ever; periodic re-assessments of the membership and tactics make good sense.

But what in the new trading order are the constraints for members of the WTO to form producer only agreements? Article XX(h) of the GATT allows for certain measures to be taken that are " undertaken in pursuance of obligations under any inter-governmental commodity agreement" acceptable to members and that should not be "...arbitrary or unjustifiable discrimination between countries or .... A disguised restriction on international trade". Specifically these agreements must meet certain conditions set out in the Havana Charter.^[8] For in the WTO international commodity agreements should either meet the Havana Charter conditions or not otherwise infringe WTO rules. To get Article XX(h) protection the agreements must however meet a number of conditions particularly those concerning provision for adequate participation of importing countries. (Article 60d of the Havana Charter) and tight safeguards for importers on prices and decision-taking powers if the agreement is one with "economic clauses". This means that unless importers are very concerned over future supplies or unless they would support an agreement favouring exporters for some other political reason or as a trade- off for some concessions made by exporters there can be no agreement with "economic clauses" benefiting from Article XX(h) protection.

The alternative for a producer-only agreement is, therefore an agreement that is compatible with GATT/WTO principles. Thus a producer only agreement that used generic consumption promotion, stocks that are counted against AMS and a use of export taxes not quotas and did not discriminate among WTO members would presumably stand a good chance of being compatible with WTO rules, although even this simple sounding proposition would need to be carefully examined by GATT law specialists if countries wished to pursue such approaches.

Trade liberalisation

As was said at the beginning there have been two main approaches to tackling the problems of weak and variable international commodity prices, international agreements and trade liberalization. It is perhaps necessary to set out briefly why trade liberalisation was seen in this light. The reason goes back to the reaction of governments to the fear that food and raw materials would be scarce. This fear was present in the post war world and again after the Korean War and this shaped the policies in most importing countries in the post war period. The fear was rekindled by the commodity crisis in 1972-74 and reinforced by the mini-crisis around 1980. In response the richer countries increased support to agriculture to extraordinary heights and erstwhile importers like the EEC became net exporters of a range of agricultural products. The consequent disarray that hit international commodity markets as several major industrialized countries turned to export subsidies to dispose of uneconomic surpluses lasted throughout the eighties. The surplus production hit prices while high non-tariff barriers and unbound tariffs constrained market growth. Reducing the levels of protection and disciplining policies were necessary to take the pressure off prices and restore some degree of confidence in the market.

While, however, few doubted that reduced protection and binding of tariffs would work to halt the slide in prices, there was less than unanimity on the effects of trade liberalisation on the variability of prices.^[9] The issue turned on two points. First most of the analyses ignored the stabilizing role of government stocks, which had risen to extraordinary heights by the mid-eighties. Secondly the analyses tended assume that the disturbances to equilibrium prices were random in their incidence. If instead good crops (e.g. due to favourable weather tended to occur in most countries at the same time (and bad ones too) then trade liberalization would tend to be de-stabilizing as all the surpluses (deficits) would hit the market at the same time. If on the other hand there were no correlation or a negative correlation between the incidence of good and bad crops, trade liberalization would tend to stabilize markets. Most of the rather limited evidence points to the latter being true but the issue was not examined in any great depth. Disturbances need not only be generated by the weather but were also generated by policies. A policy of increasing trade subsidies when world prices were low destabilized markets whereas a policy of increasing subsidies to stocks when world price were weak would tend to be stabilizing. Again though the bias of policy was probably destabilizing this was not explored in depth for more than a few cases.

The results of the Uruguay Round for the level and variability of prices were probably not great. As has been repeatedly noted the Round did more for the rules of agricultural policy than for the extent of liberalization. Domestic subsidies were capped and re-engineered, tariffs were bound and reduced somewhat and export subsidies reduced but protectionism remains very high in the industrialized countries and agricultural trade did not grow significantly. There is no evidence that prices are more stable and the best that can now be said is that their level is probably higher than it would have been had there been no agreement and that the relatively flat trend of prices in the past decade owes something to policy reform. What is worrying, however, from a development point of view is that there has been more growth in the agricultural imports of the developing countries than in their exports of agricultural products.

To conclude the analysis of the past, it appears that the attempts to halt the slide in agricultural prices and reduce their variability have been rather questionable. Where they have not been terminated, ICAs are now working without market intervention activities and trade liberalisation, though successful in developing many new rules and in capping support in the industrialized countries has yet to have evident price effects. Where then do we go from here? As always there are two basic approaches; to fight the problem by making efforts at the multilateral level to boost and stabilize world prices or live with the global problem but seek national or regional initiatives that enable the country to cope as well as possible with the problem of depressed and variable prices.

Possible approaches in the future

Fighting to boost the level of agricultural prices and reduce their price variability must surely focus on reducing protection in the industrialized countries and in expanding markets in the developing countries.

Probably first in importance should be the reduction of export subsidies. It is widely recognized that export subsidies cause difficulties for producers in non-subsidizing and importing countries. Where there are gains to consumers and where the reduction in export subsidies could cause distress to poor consumers this factor should be taken into account in assessing the gains/benefits from trade liberalization. If it is found that there are quantifiable losses to the low-income countries (which is quite likely judged by earlier FAO estimates), special concessions really need to be made in other areas; such losses should not hold up reform of export subsidies.

Secondly^[10], there is a need to cut deeply the more punitive tariff rates, which are often combined with some still remaining barriers to trade that look suspiciously like non-tariff barriers, which were theoretically banned in the Uruguay Round Although reduced during the Uruguay Round tariff escalation remains a problem for agricultural exports. This is particularly felt by the developing countries trying to diversify in perhaps the best way open to them, which is via the expansion of processing in agricultural products in which they are already efficient. A more widespread tariff cutting by the developing countries will possibly be tied to the development of appropriate safeguards.

Thirdly, reductions in AMS should in general be pursued although cutting the AMS for some products would be of concern to many developing countries whose interests need to be safeguarded. In particular the concerns of the preference receiving developing countries should be acknowledged. Often industries like sugar and bananas have been developed over long periods of time and skills have been built up, which could be lost if there were too rapid a liberalization. Cuts in AMS in food commodities of interest to developing importing countries are of the same type as mentioned above in connexion with export subsidies. A tightening up of the other boxes is also needed.

One of the more attractive ways open to expand markets is to boost demand for the product although whether this can rival the effects of market opening is to be doubted in most cases. Moreover, the costs of demand enhancement can be significant when a publicly funded programme comes into conflict with private sector advertising clout. Better probably is the development of new technologies that transform the traditional product in a way attractive to consumers e.g. the development of cassava as a feed ingredient in the 60s or the work being done on environmentally friendly fibres.

The possible role of producer-only agreements in boosting prices may not be that great but history shows that whenever fears about the sustainability of future supplies take hold, the interest of countries in various types of commodity agreements is revived. As said above the conditions for a successful agreement are not too restrictive.

While efforts should surely continue to be made to boost and stabilize world prices through a reduction in protectionism and more direct commodity action, countries will continue to be reluctant to get too involved in the world market where prices are depressed and variable unless there are policies that they can pursue to allay some of these fears. At the same time a rational pursuit of national interest can if undertaken by all countries be counterproductive. There is the danger in other words of the "fallacy of composition". Some policy choices are worse in this respect than others. To live with variable and often weak prices seems currently to focus on four main approaches.

First, for there is the use of various market based risk instruments to cut the risk associated with fluctuating prices even though it does nothing to stabilize the prices themselves. This is not the place to discuss such instruments but short of a subsidy it amounts to getting traders to pay a premium for increased certainty over prices in the future. Countries have to be sure of the costs of price variability and the alternative approaches before entering such contracts

The second approach is diversification, which should reduce the fluctuations in export earnings but this suffers from the relatively high correlations among agricultural prices. Moreover as has been shown for Africa there are costs in developing viable diversification projects in countries with underdeveloped credit systems. Finally countries have to be careful not to forsake hard-won experience and accumulated skills in producing their traditional product in the quest for diversification.

The third approach is that of seeking compensatory payments for export shortfalls/import surges. This has a long history with some considerable success in some schemes but others like the cereals facility at the IMF suffered from too great a conditionality to be of much use. Recently a lot of interest has been generated by the proposal for a Revolving Fund to assist net food importing developing and least developed countries with food import surges, whether triggered by world price rises or steep increases in the volume of imports. This would be in fulfilment of one of the promises made at the time of the Uruguay Round reflected in the Decision on the concerns of these countries.

The fourth approach is to provide importers with the chance to use safeguards against sharp decreases in world prices. If countries open their markets all round then this should help stimulate trade and prices but leaves these countries vulnerable when world prices slump. Developing countries cannot afford income safety nets and classical WTO safeguards are usually too slow or costly to use. What, therefore, is needed as part of a market opening deal at Geneva is lower tariffs plus some simple to use, partial in effect, limited coverage and temporary safeguard duties. The danger of clogging up trade with untransparent and arbitrary safeguards must of course be avoided but some simple, robust scheme would go a long way to reducing the negative effects of variable world prices.

For the developing countries there are some particular aspects of the above policy options that need emphasizing. First, in the trade liberalization process developing countries will be accorded Special and Differential Treatment in the next round. This will not only apply to export subsidies, AMS and tariff reductions, where traditional STD measures will continue to apply but it should also apply to the creation of special measures like the Revolving Fund and special safeguards against import surges discussed above. The second area where developing countries have particular interests is technical assistance. The need to boost competitiveness in both their export goods and among import substituting goods is clear; these countries have lost market shares in the tropical competing crops and, overall, they have moved from being net exporters of agricultural commodities 30 years ago to being in balance or even net importers today. These countries also need assistance to make risk market instruments user-friendlier. Thirdly there is scope for an extension of free trade areas among developing countries. Although many are sceptical of their value it should be recalled that as we move to a largely tariff dominated trade system there is more scope than hitherto for tariff cutting among members to generate increased trade. It should also be borne in mind that much of the growth in world demand for agricultural commodities is expected to come from these countries in the future and that it is important that they capture a reasonable share of this market not leaving it all to the developed country exporters.

Finally in attempting to pull some of these policy ideas together, it may be helpful to look at two types of commodity situation. For the classical tropical commodity facing weak markets and variable prices, the approach of the 1970s type of ICA with buffer stocks and /or export quotas and with the full participation of importers is not on the cards at the moment even though technically feasible. There could be space for producer-only agreements even though they do not seem to have much staying power. This may, however, be more to do with the choice of instruments rather than the idea itself. Nor in their case does trade liberalization necessarily offer much except an elimination of tariff escalation. There is a good case for a greater examination of the costs/ benefits of risk management instruments as well as measures to boost demand. Diversification is always worth examining but there is no easy path to be followed, the existing productive structure needs to be exploited for possibilities of linked products and assistance needs to be given at all stages of the process not just the generation of ideas. Finally export earning compensation schemes continue to be of great value if the conditionalities aren't too tight. For the typical temperate zone commodity the trade liberalization approach has much more to offer by way of boosting the demand for non-protected producers even though SDT must be effectively implemented. Because these commodities include the main food products, the issue of food security (in a wide sense) is vital so that import safeguards, and special provisions to cope with price spikes are required. Naturally much the same is true for these products as for tropical products with regard to the future activities of ICAs, which will continue to focus on product development, the forum function and perhaps greater involvement with risk management instruments.

APPENDIX

TECHNICAL ASSESSMENT OF WORKINGS OF ICAS

Difficulties experienced with price stabilizing schemes

The two most commonly used types of stabilization schemes are stock operations and export quotas. There are several differences between them but also some common difficulties. As to their differences, export quotas tend to be slower moving and get tied up committees arguing over whether to increase/decrease quotas, by how much and according to what shares. This is not a day-to-day operation more likely quarterly. Buffer stocks, on the other hand, can be in continuous operation via paper transactions for physical delivery after a lag of weeks or more. Operations can be in futures markets where physical delivery is not usually taken. But despite the differences there are some similarities.

The first difficulty refers to the uncertainty over future price trends. Stabilization involves action with respect to a normal or target range of prices. If this range is falling or rising, the ICA needs to recognize this by adjusting the target range of prices accordingly. Any alternative would be unsustainable. But identifying when a trend is changing is difficult, very difficult. On this perceptions have changed. It is safe to say that we were more optimistic on this score when econometric techniques were in their early stages. At that time medium term forecasting seemed to be more feasible.

The second difficulty that was faced with particular force by the cocoa agreement was the absence of appropriate market conditions when the agreement was supposed to begin operation. Thus when the initial market is tight the ICA cannot intervene to buy stocks and can only get underway if, fortuitously, it inherits significant stocks. Per contra if the market is depressed and there are private (even non-ICA government stocks), the ICA would have to have very large funds to effect a transfer of stocks into ICA ownership with no guarantee that intervention sales would be needed in the next year or two (because of the difficulties of price forecasting). To be realistic an ICA needs a lot of start-up capital and needs to begin operations in normal market conditions.

The third difficulty is the need to build in enough flexibility to deal with changes in market requirements. A shift in tastes towards a particular type or variety - as happened in the case of coffee and rubber in the eighties - needs to get reflected in the stock or export quota composition of the ICA, which can otherwise finish up trying to support a type or variety that is going out of fashion while being unable to meet the rising demand (and hence rising prices) of the other types more in fashion.

A fourth difficulty, which mainly affects the buffer stock ICAs, concerns the transparency of the operational rules. Private traders do not publish offers to buy unlimited quantities at fixed prices well into the future. The doing so by a public stock operator is designed to offer the private trader and farmer a more certain trading environment but to this the public stockist must be credible. If the private sector suspects that the public stockist will run out of money or stock, this can set up a strong speculative movement in the market. This was very clearly seen in the foreign exchange market when governments tried to defend a particular, publicly announced target rate of exchange. In these cases the amounts that went long against the governments targets were innumerable billions of dollars, sums that would completely swamp any likely buffer stock's funds. However it should be noted that public stabilization has been successful in some cases (e.g. the US CCC stocks and the EU intervention stocks) although the sums involved were huge, the objective was basically to defend only a floor price and the stock policy was supported by a strong import policy that essentially ruled out arbitrage imports from third countries that could have otherwise swamped the intervention agencies.

The fifth difficulty, which affects both types of agreement, is the question of the currency(ies) in which the target price(s) is fixed. This was a particularly tricky matter for the last rubber agreement, when by fixing the intervention prices in currencies that were subsequently devalued sharply, world market prices expressed in dollars were falling (justifying intervention on realistic grounds) while prices in Malaysian and Singaporean currencies were rising (thereby not justifying purchases under the agreement). This particular problem was fixed by setting prices in a basket of currencies.

The last difficulty, which affects more export quota agreements, is that of " policing" the agreement, of ensuring that sales outside quota are either eliminated or kept within bounds. The ICA also needs to regulate quota sales regarding timing, quantities and discounts. Control over quotas is much easier if the ICA has full participation of importers. Their attitude is shaped by questions of prices, quality/variety and whether there are non-quota sales or not (as was the case in the earlier coffee agreements).

The criteria of success of ICAs^[11]

Despite these difficulties some agreements have been made to work and in the case on INRO I for a considerable period of time. In this agreement prices were nearly always within the agreed range, which was altered to meet changes in market conditions and only broke down when there was an unpredictable boom in demand associated with the AIDS epidemic. In general terms the agreement can be said to have been a success but what criteria can be invoked to support this claim? The most obvious criterion is whether prices were within the agreed range or not although this is not a good criterion if the range is very wide. But what is wide? Wouldn't an ICA that kept prices most of the time within a narrow range be a better one than another that kept them all the time within a wider range? The answers are to be found in comparing the statistical variance of prices before and during the ICA. As the typical target price range can be expressed as an indicator price plus or minus some percentage this can be re-expressed as an indicator price plus/minus a certain multiple of the historic standard deviation (the statistical measure of the variation in prices). If the multiple is say 2 then the ICA is setting a range that historically was wide enough to have been adhered to 19 years out of 20; a bigger multiple would indicate that in the past the price was nearly always within the target range. In other words the ambitiousness of a scheme can be measured statistically and the variability during an ICA can be compared with the situation before the agreement in purely statistical terms. In this way the reduction in variance covers both the case of a narrow range with a degree of failure and a less ambitious scheme with a wider target range and higher success rate.

The second criterion is whether or not the ICA intervenes in the market. While it could occur that an ICA is successful without actual intervention just by being ready to intervene, it is surely strong evidence for an ICA's efficiency if it both intervenes and reduces price variance. At the same time an absence of intervention together with a reduced variance would not count as evidence against the efficacy of the ICA. Indeed it could simply mean that the objectives were easy to achieve. What do we mean by intervention? The most obvious senses would be increases in export quotas at the ceiling price or reductions at the floor price or stock operations that are profitable. In evaluating the profitability of intervention, however, it is important to include the value of any initial or terminal stock. If for instance an ICA has maintained its profitability by not selling all its stock during its period of operation the terminal stock needs to be evaluated either at historical or at re-sale values. This is a difficult point to resolve but it would not detract from the success of an ICA in meeting its targets but it would put into question at what cost the success was achieved. While the second criterion is more qualitative than the first both criteria could (and perhaps should) be put into one overall cost/benefit analysis where the value of the lower price variability to consumers and producers and the lower amounts of private storage are compared with the net costs of the ICA's stock holding and/or the administrative costs of the export quota scheme.

Benefits and costs of price stability

This leads to the final issue as to whether there is any value to public attempts to stabilize world prices even supposing that the difficulties are overcome and the two criteria met. It is widely recognized that reducing large price variability confers benefits on producers and consumers. Weighing against these gains are the net costs of the intervention, which are often larger than first meets the eye when the role of private stocks is considered. In the absence of private stocks, the ICA buffer stock manager would buy near the agreed floor and sell near the agreed ceiling making a positive return to be set against the costs of stock holding. The presence of private stocks complicates the situation. The private stockist acts to profit from price variability and an ICA that seeks to reduce price variability, if credible, will eliminate some private stock holding. The absence of these private stockists from the market would increase the amount that the buffer stock manager had to buy. The narrower the price range that the ICA wishes to enforce, the greater the crowding out of private stocks and the greater the costs of the buffer stock manager. It is therefore clear that the ICA would have to adopt a price range that crowds out some private storage if it is to reduce price variability significantly. But crowding out private storage means increasing the public sector's costs of stabilization and thereby affecting the overall cost/benefit calculus. Similar considerations apply to export quota schemes. Even if such schemes work without ICA stockholding, they still have an effect on private storage. If the target price range is narrow and credible, the ICA will crowd out private stocks and cuts in export quotas would have to be bigger than otherwise. The similarity is extended if the export quota changes are managed not through domestic production changes but rather through domestic (public) stock changes. In this case the observation above on evaluating the full costs/ benefits of an ICA should be extended to cover national public stocks.