Journal Issue

Toward a new framework for international commodity policy: An analysis of the problems associated with this issue

International Monetary Fund. External Relations Dept.
Published Date:
June 1976
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Isaiah Frank

Inspired by the dazzling success of the Organization of Petroleum Exporting Countries (OPEC) in redistributing world income and wealth, the less developed countries have called for a new international economic order to be achieved through comprehensive negotiations on a wide variety of matters affecting their growth prospects. As expressed in many resolutions and declarations in the past couple of years, the developing countries want to bargain collectively with the rich countries for new rules and arrangements in trade, development assistance, the monetary system, the operations of transnational enterprises, and the conditions for the international transfer of technology.

Spokesmen for the Third World concede that over the long term successful development depends ultimately on domestic policies, including the capacity of countries to mobilize their own resources. Nonetheless, the prime focus of attention in international bodies has been not on the internal prerequisites for development but on the external environment. The tendency to look outward has been strengthened in the recent past by seriously adverse trends in the world economy. The developing countries have been assaulted simultaneously by rising prices for their imports, not only of fuel but also of manufactured products, by world markets that have sharply contracted in volume as the industrial countries go through the longest and deepest depression of the postwar period, and, more recently, by falling prices for their exports of raw materials. The combined balance of payments deficit on goods and services of the non-oil developing countries in 1975 has been estimated at the unprecedented sum of $35 billion.

Of all the elements included in the new international economic order, the commodity problem has attracted the greatest attention and been the subject of the most comprehensive and detailed preparatory work in international bodies. The United Nations Conference on Trade and Development (UNCTAD), in particular, has prepared an elaborate “integrated” program for commodity agreements including buffer stocks and a common fund for financing them.

The problems

The dependence of developing countries on exports of primary products, while diminishing, is still large. Excluding the major oil exporters, the export of primary products still accounts for about 50 per cent of their total export earnings. But the proportion of exports of primary products is falling rapidly for developing countries with per capita incomes over $200, reflecting the rapid growth of their exports of manufactured products.

From the perspective of the developing countries, the commodity problem (excluding petroleum) has traditionally been viewed as consisting of two aspects: the short-term instability of markets for primary products as reflected in wide year-to-year fluctuations in prices and export earnings; and the adverse longer-term trends in commodity markets as reflected in deteriorating terms of trade and sluggish growth in export earnings.

More recently, however, a new set of interrelated issues has emerged. In the aftermath of the commodity shortages associated with the boom of 1972–73 and the oil embargo combined with the quadrupling of oil prices in 1973–74, importing countries have become increasingly concerned with the long-run adequacy of supplies of primary materials and with the uncertainties of their access to such supplies. At the same time, some developing countries saw the possibility of capitalizing on this concern through the establishment of producer associations designed not only to raise the prices of individual commodities but also to exert collective bargaining power vis-à-vis the industrial countries for broader objectives in the world economic arena. With the collapse of the commodity boom and more sober projections of the medium-term outlook for commodity markets, the practicability of the latter objective has become questionable.

With respect to the more traditional issues of short-term instability and adverse long-term trends, a good deal of confusion results from a failure to differentiate between the two. In part, the confusion arises from a causal link between the two problems and in part from the identity of the prescriptive measures for dealing with them. Long-term demand for a primary product may be adversely affected by short-term price instability when purchasers have the option of switching to a more stable synthetic substitute. Long-run supply may also be adversely affected by instability to the extent that, for example, it discourages farmers from moving from subsistence cultivation to cash crops. On the prescriptive side, international commodity agreements have often been proposed to deal with both the short-term and long-term problems—as a means of stabilizing prices and improving the long-term trend. Despite these links, it is necessary to separate the two problems in terms of both analysis and policy.

Long-term trends

Of the two problems, the adverse long-term trends in commodity markets is the more fundamental. In a major study of this subject in 1970–71, the World Bank found a strong correlation between rates of growth in GNP in developing countries and the growth of their export earnings, but only a weak relationship between GNP growth and export stability. Put another way, instability of export receipts can be a critical problem when superimposed on an unfavorable trend in export earnings, but it is a much less serious disability where the overall export trend is sharply upward.

Sluggish long-term growth in primary commodity exports is often accompanied by a decline in the price of such exports relative to the price of other commodities. It is the alleged general tendency toward such adverse movement in the terms of trade of primary commodities that underlies much of the drive in the Third World for a new international economic order that would correct the “inequities” of the present system.

The classical view of the terms of trade is rather different. This view, which was shared by Keynes, held that relative price trends would move in favor of raw materials and against manufacturing, on the grounds that the former were characterized by diminishing returns and the latter by increasing returns to scale. Underlying this prognosis was the belief that manufacturing technology would eventually be diffused rather evenly throughout the world, whereas the geographical distribution of natural resources is inherently unbalanced. Thus, continuing economic development would tend to turn the terms of trade in favor of the owners of scarce gifts of nature. A new lease on life was given to this classical view with the release by the Club of Rome of its first report in 1972 which called attention to the imminent danger of resource shortages as constraints on growth.

Nevertheless, it is the doctrine of declining terms of trade for the producers of primary materials that holds sway in most of the developing world. The existence of such an inexorable tendency was popularized in the 1950s and 1960s by Raul Prebisch against a background of a decade of sliding raw material prices following the Korean War boom. In summary, Pre-bisch’s reasons were as follows: the elasticity of demand for most primary materials, with respect to both income and price, is low; most raw materials are produced in worldwide competitive markets (tending to drive prices down as output increases) whereas the manufactured products imported by developing countries are produced in oligopolistic markets (where output is controlled and prices maintained); because workers in the advanced countries are organized, productivity gains in manufacturing take the form of higher incomes rather than lower prices, whereas the gains from technical progress in primary material production are passed on by the developing countries to the rich countries in the form of lower prices.

According to this view, the rich countries have it both ways: they are the principal beneficiaries of economic progress abroad through lower import prices, and at home through higher incomes. At the same time the inequitable system trapped the developing countries in their poverty. Hence the case is overwhelming for some sort of offsetting arrangement, whether through producer cartels or through broader international “indexing” arrangements, for raising the prices of primary products over the long run.

Price raising

However appealing, this line of argument fails to take account of the wide divergencies in market structures and earning trends for individual commodities. All primary commodities do not show sluggish trends in export earnings. In the period 1960–62 to 1970–72 commodity export earnings from developing countries increased at an annual rate of only 4.3 per cent. But exports of six commodities—copper, sugar, iron ore, timber, beef, and bananas—accounting for almost 40 per cent of their total export earnings, grew at a rate of 7.8 per cent. Similarly, the prices of primary commodities show highly divergent trends over the same period. Because of the pressure of substitutes, agricultural raw material prices declined substantially in terms of the prices of exports of manufactures from developed countries. But in those terms the prices of food (other than beverages) and metals more than held their own.

The commodity problem is widely presented as a confrontation between rich and poor countries. Yet the source of most exports of raw materials (other than oil) is not the developing countries but rather the resource-rich developed countries including the United States, Canada, Australia, South Africa, and increasingly the Soviet Union. In 1970–72 the developing countries accounted for only 47 per cent of world exports of primary products other than oil. Whatever validity there is, therefore, to the doctrine of declining relative prices for primary products, it cannot be regarded as automatically descriptive of the terms of trade between rich and poor countries.

To the extent that individual commodities principally exported by developing countries show unfavorable long-term price and earnings trends, should not an international effort be made to alter the trend by setting their prices at higher levels than would otherwise prevail? Theoretically, this might be done through producer cartels (such as OPEC), or through commodity agreements in which producers and consumers participate. In the latter case, consuming countries would presumably cooperate as a means of trans-fering resources to the developing countries through trade as a supplement to the traditional government-to-government aid-giving process.

Both the possibility and desirability of such arrangements are open to serious question. Although importing countries have shown an increasing willingness to cooperate in commodity arrangements designed to stabilize prices, there is no evidence of any comparable willingness to join in schemes to raise prices above the long-term market trend. While the possibility of joint action by producers alone to raise prices by controlling the volume of exports cannot be ruled out, the scope for such action appears to be quite limited despite the dramatic success of OPEC. For most other commodities the possibility of joint control over the volume of exports is much less, and the availability of substitutes over the short and long term much greater. The prospects of concerted action also depends on such other factors as the relative income needs of the producers and the extent to which they share common economic and political goals. Most past attempts at producer cartels have either failed or been extremely short-lived.

As to the desirability of transfers of resources to developing countries through price-setting schemes, some lessons can be gleaned from the OPEC experience. True, no other commodity is a close analogue of oil either in the size of potential price increases or the impact on importing countries. But the OPEC experience does point up how blunt a resource-transfer instrument such schemes can be. The distribution of benefits is unlikely to conform to a rational system of aid allocation; and the distribution of costs is unlikely to correspond to a fair sharing of the burden. In the case of oil, some already very rich countries became richer while most of the very poor countries have suffered severely from higher oil import bills. Broad-scale attempts to raise primary commodity prices over the long run would likewise prove inequitable. For example, it is most unlikely that the South Asian subcontinent, comprising a population greater than that of Africa and Latin America combined, would derive any net benefit thereby.

One form in which price-raising proposals have been put forward is “indexation”—that is, tying the price of primary products to some measure of world prices of manufactured goods. Indexation cannot be brought about by decree, however. It could only be accomplished through the negotiation of concerted action by producers, either alone or in cooperation with consumers, to control the volume of exports of the commodities in question. It is therefore subject to the practical as well as the equity limitations of such schemes that have already been noted. In economic terms, moreover, indexation is highly objectionable as a long-run policy. The dynamics of growth require that relative prices change over time as demand shifts, as conditions of supply change, and as productivity increases at different rates in different sectors. By making price relationships rigid, indexation would lead to a misallocation of scarce resources including those of the developing countries themselves.


The more fundamental answer for those developing countries facing adverse long-run market prospects for their primary commodity exports (e.g., tea, bananas, jute, hard fibers) must lie in other directions. They require financial, technical, and other forms of assistance to diversify their economies into lines of production with more favorable market prospects, including manufacturing and service industries. In the last analysis, diversification is but another way of looking at development. It implies a process of restructuring output in order to increase a country’s returns on its land, labor, and capital. As with development generally, the constraints are numerous, and it is the task of external finance to help developing countries overcome them.

Among the diversification options that should be considered is the domestic processing of their own raw materials, where such activity can be economically carried out. A larger part of the final price would then accrue to the producing country. Increased processing and fabricating at home would also contribute to higher employment and export earnings.

But the scope for successful diversification along these lines depends very heavily on changes in the trade policy of the industrial countries. At present, primary materials are generally imported by them free of restriction whereas successive stages of processed products tend to be subject to increasing levies. The result of this tariff escalation is that the effective protection of processing activity in the industrial countries is a good deal higher than indicated by the nominal duties. The liberalization of developing countries’ access to the markets for processed products in the developed countries should be a high priority of the present multilateral trade negotiations.

In order to increase their earnings from exports of primary products, developing countries need assistance not only to diversify out of commodities in long-term surplus but also to increase the production of those with more favorable long-run prospects. Despite the depressed state of the world mineral market today, rising future demand combined with the depletion of existing mines means that major new mining projects need to be undertaken.

Where the new supplies will be produced in years to come will be determined by investment decisions made today. But the massive capital requirements for the production of minerals in the developing countries are unlikely to be met from the customary sources of funds. Host governments are less ready today to enter into concession agreements on traditional terms, and most foreign investors are less ready to risk their capital under conditions of great uncertainty regarding host government policies. During the period 1970–73 about 75 per cent of the world’s mineral exploration expenditures (outside the centrally planned economies) appear to have been made in the United States, Canada, Australia, and South Africa despite attractive geological possibilities in the developing world. If the low-income countries are to take full advantage of opportunities in expanding markets for minerals, new sources of finance and new types of co-financing arrangements will have to be developed in which the international financial institutions play a much larger role than in the past.


Unlike commodity arrangements designed to transfer resources to exporting countries by altering their long-run terms of trade, arrangements to moderate the short-run fluctuations in commodity export earnings command a wide degree of international support. The main reason is that stabilization is perceived by both exporters and importers as being in their mutual interest, whereas changing the terms of trade is viewed as benefiting the one at the expense of the other.

Fluctuations in export prices and earnings adversely affect the ability of developing countries to plan and carry out rational investment programs through their impact on domestic incomes, savings, tax revenues, and, above all, their capacity to import. At the same time serious problems are created for the industrial countries in the form of shortages of basic materials and inflationary pressures. Sharply fluctuating food and raw materials prices have a ratchet effect on their wage rates and manufactured product prices which respond to an upward movement in basic commodity prices without a corresponding correction when the boom collapses. These inflationary consequences reverberate onto the developing countries through the higher prices they must pay for imports of manufactured goods.

Instability in commodity prices and earnings is due mainly to variations in weather and business cycles which have a sharp impact on price-inelastic markets. Agricultural commodities are most vulnerable to changes in supply due to natural causes such as weather and pests, while minerals are more vulnerable to changes in demand due to business fluctuations in the industrial countries. Where changes in supply predominate, the prices and volume of exports tend to move in opposite directions, thereby moderating the fluctuations in earnings; where changes in demand predominate, prices and volume tend to move in the same direction, intensifying the swings in earnings.

Two basic approaches have been followed in dealing with the instability of primary commodity markets—price stabilization agreements and compensatory financing arrangements. These two types of arrangements are the international counterparts of the more familiar domestic agricultural stabilization programs through the devices of price supports, on the one hand, and deficiency payments, on the other.

International commodity agreements have sought to stabilize prices within a prescribed range through export quotas (for example on coffee) or through a combination of export quotas and buffer stocks (such as tin). In the past, three main problems have inhibited the successful negotiation of commodity agreements: the difficulties of reaching agreement between exporters and importers on an appropriate price range; differences among exporters as to the proper basis for sharing export quotas; and the provision of the necessary finance for stock acquisition.

The UNCTAD program

A highly imaginative and carefully prepared “integrated program” for commodity stabilization has recently been put forward by the Secretariat of UNCTAD. Its central feature is the establishment of a system of international buffer stocks for the main export commodities of developing countries and a common fund for financing the stocks. The “core” commodities that would be included are coffee, cocoa, tea, sugar, cotton, rubber, jute, hard fibers, copper, and tin.

Although UNCTAD recognizes that separate agreements would have to be negotiated for each commodity, it sees two advantages to financing stock acquisitions through a common fund. First, the size of the common fund would be smaller than the sum of separate funds for each commodity because of the different pattern and timing of fluctuations in the various commodity markets. And second, as risks would be pooled, the safety of lenders would be greater and borrowing costs correspondingly smaller. The UNCTAD Secretariat has estimated the total size of the required fund at about $6 billion, half of it to be made available currently in the form of capital and loans and the other half to be on call when needed. Contributions to the fund would come in varying proportions from exporting countries, importing and OPEC countries, multilateral financing agencies, and borrowing in the private capital markets.

The UNCTAD program recognizes that commodity arrangements based on buffer stocks as the primary stabilizing mechanism must make provision for frequent re-examination of price ranges in the light of the level of purchases and of sales by the stock. Moreover, if prices remain depressed and large stocks are accumulated, export quotas may be necessary. It should be recognized, however, that whereas the combination of stocking and quotas can in principle effectively defend an agreed floor price, the situation is asymmetrical with respect to the ceiling. Once quotas have been lifted and stocks have been exhausted, there is no way of defending the ceiling. The difficulty of reaching agreement on price changes and quota shares has proved historically to be the Achilles’ heel of commodity agreements. It is to be hoped, therefore, that some objective standards or automatic formulas can be agreed to which would minimize the need for extended negotiations on these matters.

Although the UNCTAD program has been criticized as overambitious, it lays out a set of constructive ideas and a pattern of arrangements that can be initially pursued on a more limited basis. The major obstacle in practice is likely to be not the problem of financing the buffer stock fund, on which so much attention has been devoted by UNCTAD, but rather the ambiguity of the pricing principles for commodity agreements that the program sets forth. While reduction in fluctuations is given as the primary goal, the difficult-to-define and correspondingly controversial objective of “equitable” and “remunerative” prices over the long run is also included. Any effort to achieve both of these goals through a single instrument is bound to complicate the negotiations enormously.

Regardless of the degree of success achieved in negotiating individual commodity price stabilization agreements, a need will exist for more general arrangements to stabilize export earnings. For some commodities (such as bananas) buffer stocks are simply not practical. More stable prices, moreover, will not always mean more stable earnings as, for example, when a drought has reduced the supply of an export crop. Nor is it likely that a comprehensive series of price stabilization agreements can be quickly concluded or that all commodities of export interest to developing countries will be covered.

On the other hand, it would be a mistake to view even the recently liberalized IMF compensatory financing arrangement as a full substitute for price stabilization agreements. The distinctive contribution of the latter is their moderation of the distortions in resource allocation that result from uneconomic price signals during boom-and-bust commodity cycles. Nor is compensatory financing directly responsive to the importing countries’ interest in avoiding the inflationary shock to their economies of shortages and soaring prices for primary products. Earnings stabilization, therefore, should be regarded as a valuable complement rather than as an alternative to individual commodity price stabilization agreements.

One final point bears emphasis. The export markets for the primary products of the developing world are overwhelmingly in the developed countries. As the experience of the last several years dramatically demonstrates, sharp cyclical fluctuations in the industrial countries have even more profoundly destabilizing effects on the exports of primary producers. The business cycle may never be completely conquered by the industrial countries, but more effective measures to tame it would make a major contribution to stability in the Third World.

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