This is a Boom of Mineral, Not Agricultural Prices

The recent surge in food prices has generated significant concern all over the world. It has had a significant effect on poverty in developing countries. In the case of Latin America, the United Nations Economic Commission for Latin America and the Caribbean (UN-ECLAC) estimated that extreme poverty would increase by 10 million people in 2008, despite rapid economic growth. In poorer parts the world, the situation is, of course, significantly worse. Measures to counter the effects of rising food prices on extreme poverty are thus an essential response at the current conjuncture, and must include both domestic policies in developing countries as well as active international cooperation in bringing adequate amounts of food aid to poor countries.

The boom has also given rise to the hypothesis that we have entered a new phase in the history of commodity markets, similar to the one experienced in the nineteenth century, where there were ample growth opportunities for commodity-dependent economies. In the present story, China would play the role that Britain and other countries in Western Europe played in the nineteenth century as a source of demand for commodities that led to dynamic growth in the newly settled areas of America and Oceania, as well as in some developing countries, many of them Latin American.

However, the story is a bit more complicated. Many analysts do not take clearly into account the collapse of commodity prices that took place in the 1980s or, for that matter, long-term trends in commodity prices. There is, of course, copious literature on the subject, including the now classic paper by World Bank economists Grilli and Yang (1988), which showed that the Prebisch-Singer hypothesis on long-term deterioration of the commodity terms of trade (relative to manufactures) was empirically correct in the twentieth century. The literature that followed indicated, however, that such dynamics were dominated by a few major shocks. In a paper published a few years ago (Ocampo and Parra, 2003), we showed, with an updated version of the Grilli-Yang index, that the long-term fall in real non-oil commodity prices throughout the twentieth century could be explained by two major downward shocks: the first took place during the post-World War I crisis (1920-1921), the second during the 1980s. We also concluded that tropical agriculture faired the worst in terms of adverse long-term price trends.

We updated the index for recent years and for March 2008 and came to the very interesting conclusions that are evident in the enclosed graph. Comparisons are made with the average of 1945-1980 (to which we will refer below as “the post-war average”). This is a good base period, as our 2003 paper indicated that commodity prices had actually been trend-less during the three and a half decades following the Second World War (the period, of course, in which the Prebisch-Singer hypothesis was formulated and, according to critics, proved wrong). We could have used the 1970s as an alternative –which, as shown in the graph, is in fact not very different from the post-war average. As is usual in these exercises, the Manufacturing Unit Value of the United Nations/World Bank is used as a deflator. (This deflator gives in fact a better impression of the evolution of real commodity prices than the alternatives, such as the US CPI).

The results are quite interesting. Metal prices are very high. They are double the post-war average in 2007 and more than double that average in March 2008. There are only a few years in our whole series where real metal prices were as high – indeed only one, 1916, in the midst of the First World War. If we were to add oil to the graph, it would show with an index of over 500 in 2007 and 700 in March 2008. So, we are really in the midst of a boom in mineral prices.

On the contrary, agricultural prices have just recovered from the very depressed levels reached after the collapse of the 1980s and the smaller additional reduction that took place during the Asian crisis. The major reason for the collapse of the 1980s was the “fallacy of composition” effect in the attempt by many developing countries to increase commodity exports to manage their debt crises. The most surprising result is that in March 2008 (which, according to some analysts, such as Otaviano Canuto, may have marked the end of the recent boom—see his piece in this Monitor on April 21, 2008), real agricultural prices just went back to levels similar to the post-war average and the 1970s. Indeed, tropical commodity prices were still somewhat below those averages. As supplies increase and demand weakens during the ongoing world slowdown, they are likely to fall again in the immediate future.

There are many factors that influence recent prices, including the demand for biofuels, subsidies and protection measures, droughts (particularly in Australia) and a few export restrictions (particularly in rice) or taxes (such as in Argentina). Some of these effects are quite high. In particular, US corn ethanol has introduced significant distortions and is, according to most analyses, both economically and environmentally inefficient: as its production is too energy intensive, it would not survive in free markets and it generates net environmental costs. There has been no better time since the 1980s to correct the massive distortions in world agricultural markets generated by the subsidies and protectionism in the industrial world.

So, this is more a boom of mineral than agricultural prices, which have just recovered from very depressed levels. This conclusion is also borne out by an analysis of terms of trade improvements experienced by Latin American countries in recent years. Using the most recent report of UN-ECLAC (the December 2007 Preliminary Overview of the Economies of Latin America and the Caribbean), the 2007 terms of trade stood 90 to 100% above 2003 levels for Chile and Venezuela, 40 to 60% for Bolivia and Peru, and over 25% for Colombia and Ecuador (contrary to common views, Colombia is today mainly a mineral exporter, as these goods make up more than two-fifths of its export basket).

In contrast, main agricultural exporters, such as Argentina and Brazil, saw terms of trade improvements of 10% or less; oil importers (such as Uruguay) have actually had terms of trade deterioration. Interestingly, all the winners are actual or former members of the Andean Group/Community.

Finally, it is important to note that there have been very large changes in relative prices over time. So, the enclosed table classifies a subset of individual commodities into three categories: booming, under average, and still depressed. The only food staple in the first group is wheat; corn and rice come in the second. Tropical beverages, as well as cotton and sugar are still depressed. Major sources of bio-fuels come in the three groups. If corrected by productivity trends, the story would be equally heterogeneous.

We may thus have entered an era of significant opportunities for mineral exporters. The data do not show a similarly bright future for agricultural exporters – despite the spillover from high energy prices generated through bio-fuels.