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Front Matter

Min Zhu
Min Zhu
Published Date:
September 2012
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Commodity Price Volatility and Inclusive Growth in Low-lncome Countries

I have been a guest scholar at the IMF for almost two years, and I have learned that there is an IMF approach to economics. A great many people have told me “I used to believe that in graduate school, but since I have been at the IMF I have learned that the world is different.” Commodity Price Volatility and Inclusive Growth in Low-Income Countries is deeply experience-based, reality-based. It reflects this practical, empirical approach that is the center of IMF thinking.

This book concerns a crucial, practical issue, always on, or near, center stage at the IMF: commodity prices and their variations. Most immediately, food price increases plunge a significant fraction of the world’s consumers into instant poverty; also, food price declines, which are the opposite sign of the volatility coin, plunge a significant fraction of the worlds food producers into instant poverty of a different kind. How to buffer this volatility, and how to respond to it when it does occur, are two of the core topics of Commodity Price Volatility and Inclusive Growth. But that is just the beginning. Of course it is not just food prices that are volatile; it is the prices of all commodities produced and consumed by poorer countries. Nor is it just a micro problem of how to deal with the poor people who are suddenly impoverished.

Commodity price volatility produces wild macroeconomic swings in both producer and consumer countries. And then, there is the question of longer-term growth. It is a commonplace that there is a trade-off between growth and better income distribution. But, as is a major theme of this book, the opposite is the case. The better the income distribution, the higher, not lower, is economic growth. The resource curse provides an assay. The same redistributive mechanisms that channel resource income to the elites are the same mechanisms that redistribute resource earnings away from growth-producing investments. This is just one more example of the highly practical nature of the contents of this fine book. Its analysis and prescriptions for how to deal with the resource curse could put a good share of the world on the path to sustained growth.

Commodity Price Volatility and Inclusive Growth in Low-Income Countries is thus a very important contribution. Its fine-grained treatment of practical, immediate problems casts it at the very heart of economic development.

George Akerlof

Nobel Laureate in Economics, 2001

IMF Guest Scholar

Commodity Price Volatility and Inclusive Growth in Low-lncome Countries


Rabah Arezki, Catherine Pattillo,

Marc Quintyn, and Min Zhu

Note to Readers

This is an excerpt from Commodity Price Volatility and Inclusive Growth in Low-lncome Countries. In the years following the global financial crisis, many low-income countries experienced rapid recovery and strong economic growth. However, many are now facing enormous difficulties because of rapidly rising food and fuel prices, with the threat of millions of people being pushed into poverty around the globe. The risk of continued food price volatility is a systemic challenge, and a failure in one country has been shown to have an impact on entire regions. The volume addresses the challenges of commodity price volatility for low-income countries and explores macroeconomic policy options for responding to commodity price shocks. It then looks at inclusive growth policies to address inequality in commodity-exporting countries. Perspectives from the Middle East and North Africa, sub-Saharan Africa, emerging Asia, and Mexico are presented and, finally, the role of the international donor community is examined.

The Table of Contents, Introductory Essays, and Chapter 1 are included in this excerpt. Please check quotations and attributions against the published volume.

Commodity Price Volatility and Inclusive Growth in Low-lncome Countries

Edited by Rabah Arezki, Catherine Pattillo, Marc Quintyn, and Min Zhu

ISBN: 978-1-61635-379-7

Pub. Date: October 2012

Format: Paperback, 6x9 in., approx. 390 pp.

Price: US$35.00

For additional information on this book, please contact: International Monetary Fund, IMF Publications P.O. Box 92780, Washington, DC 20090, U.S.A.

Tel: (202) 623-7430 ‘ Fax: (202) 623-7201


© 2012 International Monetary Fund


  • Foreword
  • Christine Lagarde
  • Acknowledgments
  • Essays on Commodity Price Volatility and Inclusive Growth
  • Josette Sheeran
  • Joseph E. Stiglitz
  • 1 Introduction
  • Rabah Arezki, Catherine Pattillo, Marc Quintyn, and Min Zhu
  • 2 The Natural Resource Curse: A Survey of Diagnoses and Some Prescriptions
  • Jeffrey A. Frankel
  • 3 The Political Economy of Petroleum Wealth in Low-lncome Countries: Some Policy Alternatives
  • Michael L. Ross
  • 4 Commodity Price Volatility: Impact and Policy Challenges for Low-lncome Countries
  • Hugh Bredenkamp and Julia Bersch
  • 5 How Should Emerging Market and Low-lncome Country Central Banks Respond to Commodity Price Shocks?
  • Rahul Anand and EswarS. Prasad
  • 6 ¡ Savings and Investment Decisions in Resource-Rich Low-lncome Countries
  • Paul Collier
  • 7 Fiscal Policy for Commodity-Exporting Countries: Chile's Experience
  • Klaus Schmidt-Hebbel
  • 8 What Is Inclusive Growth?
  • Elena lanchovichina and Susanna Lundstrom Gable
  • 9 Inclusive Growth in Natural Resource-Intensive Economies
  • Andrew M. Warner
  • 10 Inequality and Unsustainable Growth: Two Sides of the Same Coin?
  • Andrew G. Berg and Jonathan D. Ostry
  • 11 Commodity Price Volatility, Poverty, and Growth Inclusiveness in Sub-Saharan African Countries
  • François Bourguignon
  • 12 Natural Resources, Volatility, and Inclusive Growth: Perspectives from the Middle East and North Africa
  • Rabah Arezki and Mustapha K. Nabli
  • 13 Inclusive Growth in Sub-Saharan Africa: Evidence from Six Countries during the Recent High-Growth Period
  • Rodrigo Garcia-Verdu, Abebe Aemro Selassie, and Alun Thomas
  • 14 Distributional Consequences and Policy Responses to Food Price Inflation in Developing Asia
  • Shikha Jha and Changyong Rhee
  • 15 Mexico's Oil Price-Hedging Program
  • Javier Duclaud and Gerardo García
  • 16 Food Price Volatility: An International Policy Challenge? 315
  • Pierre Jacquet
  • 17 Trade Distortions and Food Price Surges
  • Will Martin and Kym Anderson
  • 18 The Role of Transparency and Civil Society in Managing Commodities for Inclusive Growth and Development
  • Antoine Heuty
  • Index


Over the past decade, low-income countries have witnessed a remarkable transformation. Strong economic growth has lifted millions of people out of abject poverty. The low-income countries also staged a rapid recovery from the global financial crisis. Last year, growth was expected to reach a strong 5 percent in the average low-income country.

This impressive performance is a testament to the hard work and dedication of policymakers across the developing world over the past decade. They reduced deficits and public debt. They brought down inflation and built up foreign exchange reserves. In short, they built up macroeconomic buffers and put their economies on a fundamentally stronger footing.

But the news has not all been good. Importantly, low-income countries still face enormous challenges in terms of pervasive inequalities and the lack of job opportunities, especially for the youth. Moreover, the food and fuel crisis of 2008, in conjunction with the global financial crisis that followed, has been devastating for the poor. And in 2011, we saw a renewed surge in commodity prices that could plunge an additional 44 million people into poverty, including in the Horn of Africa.

At the same time, downside risks to global growth have increased markedly—at a time when the capacity of many low-income countries to absorb further shocks has yet to be rebuilt from the two recent crises.

Once again, the low-income countries find themselves at a critical juncture. What policies are needed at this challenging time? And how best to rebuild resilience to future shocks? In the face of a more uncertain global environment, policymakers in low-income countries—as in many others—should be prepared to adapt policies as needed, according to country-specific circumstances. What policies are needed to unleash the growth potential of low-income countries over the medium term?

In the event of a sharp downturn, the key will be to protect vital spending, to mitigate the impact on growth, and to protect the most vulnerable. Because the scope for countercyclical fiscal policy has become more limited, monetary and exchange rate policy could be used more actively, provided that inflation is moderate.

For rebuilding resilience and promoting higher growth that is also inclusive of all the citizens, I see three priorities. The first priority is to build up “self-insurance” during the good times. When growth is strong and external conditions are favorable, it makes sense to rein in deficits and shore up reserves. This builds a cushion for the bad times—and especially for protecting the most vulnerable. Of course, self-insurance can only go so far. This is why low-income countries must be able to count on continued support from development partners when shocks hit.

The second priority is to strengthen social safety nets so that in times of crisis, support can reach the most vulnerable quickly and efficiently. This matters especially when food prices surge and when public support can mean the difference between life and death.

The third priority is structural change to boost longer-term resilience and achieve higher growth potential. Economies that are more diversified—and not overly dependent on a few products and trading partners—are better able to withstand shocks. Better domestic resource utilization (e.g., by deepening the financial sector and by broadening the tax base) also matters. More diversified economies are likely to deliver more inclusive growth; that is, growth that creates jobs for more people and shares the benefits more widely. We know from recent experience how much the social dimension matters for long-term stability.

Of course, countries that are commodity exporters have in recent years benefited from higher prices. For them, the challenge is to use the gains from higher prices wisely—to preserve macroeconomic stability, but also to share the natural resource wealth fairly across society and across generations.

The low-income countries have achieved remarkable gains during recent years, and they should be commended for that. But today, these gains are under threat. The international community—including the IMF—must be prepared to do even more to help the low-income countries help themselves. Aid commitments must be met. Trade channels must remain open. Private investment must be encouraged. All these would help low-income countries stay the course and address their important medium-term challenges ahead.

We must all do our part. If we do, I believe that the low-income countries will be able to withstand this new phase of the crisis, and we will be able to help bring lasting gains to the worlds poorest and most vulnerable people.

Christine Lagarde

Managing Director

International Monetary Fund


This volume is the culmination of the efforts of many policymakers, academics, and World Bank and IMF staff members. The majority of the chapters are based on presentations at a high-level seminar organized by the International Monetary Fund, “Commodity Price Volatility and Inclusive Growth in Low-Income Countries,” which took place in Washington, D.C., on September 21, 2011. Additional chapters on the seminar’s themes are also included.

The book is aimed at fostering our understanding of how to design policies that take into account redistributive objectives in the face of large swings in commodity prices in both commodity-exporting and-importing low-income coun-tries. It also explores ways in which policies can promote higher growth that is inclusive for all the citizens.

The leadership and vision of IMF Deputy Managing Director Min Zhu was instrumental in this book’s publication. As one of its editors, his strong commitment to the important issues discussed in the volume helped to ensure a high-quality result. The efforts of Tarhan Feyzioglu, Assistant to the Deputy Managing Director, were also invaluable in bringing the volume to fruition.

We are most grateful to Joanne Blake and Michael Harrup of the IMF’s External Relations Department for coordinating a very smooth editing and production process. Special thanks also go to Jeremy Mark, Anneta Orraca-Tetteh, Nathalie Kerby-Lachnani, Sandrine Albin-Weckert, Gloria Adidi, and Noor Abdul Rahman for their dedication throughout the process. Last, but not least, we would like to thank a large number of colleagues at the IMF for their intellectual support and suggestions both before and during the seminar and during the process of composing this volume.

Rabah Arezki, Catherine Pattillo, and Marc Quintyn

Essays on Commodity Price Volatility and Inclusive Growth


We all remember 2008, when global food and fuel prices went through the roof, when we saw food riots in 35 countries, and when more than 115 million were added to the ranks of the hungry. What we saw in 2008 was a new phenomenon: it was the first globalized humanitarian disaster, a silent tsunami that swelled the ranks of the hungry.

More than three years after the food and financial crises, food prices are again surging on global markets, and the result, according to the World Bank, could be millions more pushed into poverty. Even in spite of the troubled global economy, which has generally dampened demand, the World Bank’s food price index for 2011 remained above the level of 2010. Similarly, the Food and Agriculture Organization (FAO) price index showed prices at nearly twice the level reached before the 2007–08 price spike.

Food price volatility, as we are witnessing, is not confined to a few crises that, as devastating as they are, happen to dominate the headlines for a few months—it is a long-term challenge. The risk of continued high and volatile prices is a systemic and covariate challenge larger than any one country or group of countries can manage alone. And as we have seen, system failure in one country can quickly affect an entire region.

Many countries, especially developing and emerging economies, are struggling with the implications of high food prices, given their effects on poverty, inflation, and, for importing countries, the balance of payments.

In 2008, the International Monetary Fund estimated that food imports would cost 43 net food-importing low-income countries (LICs) as much as US$7.3 billion, or nearly 1 percent of GDP. In 2011, the FAO estimated that developing economy food import bills would rise sharply to US$460 billion, a 25 percent increase from 2010.

This “perfect storm” of vulnerability is hitting countries across the globe. From the Dominican Republic to the Kyrgyz Republic, staple prices have nearly doubled. In many other countries, such as those in the Horn of Africa, they have increased by one-half or more. Such food price volatility not only affects nations, but it also affects the worlds backup plan to support nations in times of crisis.

As the World Food Programme (WFP) procures most of its food in developing economies (over 80 percent) and much of that in local markets, we see first hand the impact of rising food prices. Such volatility impacts the WFP’s budget and the ability to provide food assistance to its targeted beneficiaries, such as the 109 million hungry people in 75 countries that it reached in 2010 with food and nutrition support. Every 10 percent increase in the price of the WFP’s food basket costs an additional US$220 million a year to buy the same required amount of food.

Rising food prices affect the WFP’s operations and, at the same time, the number of people needing food assistance also increases, compounding the challenge of ensuring access to nutritious food for the most vulnerable. Through the Vulnerability Analysis and Mapping unit, the WFP monitors staple food commodity prices in more than 60 countries. A network of 150 food security experts ensures that the WFP has the most up-to-date information on the cost of food to vulnerable households, allowing it to tailor its response in the most effective manner. Analysis has shown that the estimated 80 percent of the world population that lives without food safety nets bears the environmental, social, political, and economic risks of everyday life on their dinner plates.

Food price spikes increase malnutrition as the poor eat less and switch from more expensive, nutritious food to cheaper staples. These changes can permanently damage the most vulnerable, especially children under the age of two years, as well as pregnant and lactating mothers. For households living on less than US$2 a day, many of whom spend as much as 60 to 80 percent of their incomes on food, this volatility hurts. It is the extremely poor and vulnerable who suffer the most; for example, women and girls often have disproportionately less food during economic shocks: Families are forced to sacrifice tomorrow for today by eating income-producing livestock and putting schoolchildren to work.

History shows that without adequate access to food, nations fall, people migrate, and millions can die. Food security is nonnegotiable; if it is neglected, we face catastrophe. That is why we must not only provide nutritious food to those who are denied access to it, but also protect the most vulnerable and help them build resilience to food price shocks. This is humanity’s critical task.

Over the last four years, we at the WFP have worked to transform aid into assistance that connects people to markets and builds up resiliency programs that buffer the most vulnerable from shocks, including commodity price volatility.

The WFP is working with countries at the grassroots level to develop—and now scale up—innovative ideas and new tools that are transforming the fight against hunger. In Cameroon, for example, where about 2.8 million people are food insecure, every year can be a crisis for the most vulnerable, as the lean season in northern Cameroon lasts on average three to four months. To help break the boom-and-bust cycles of hunger, the WFP, working with the European Union, provides a one-time donation of 10 metric tons of cereal for each community granary and helps train farmers in food storage management and financial accounting. Community members can withdraw stocks from the granary during the lean season, and later replenish from their own crops during the harvest, with a little interest. The steering committee of each community granary uses the revenue collected from interest and sales of commodities to reconstitute stocks and ensure the local village access to affordable food year round.

Across the globe, the WFP is also supporting smallholder farmers, many of them women, in reducing their vulnerability and helping them become a bigger part of the supply solution to food security, including by leveraging local commodity purchases by the WFP. Women constitute, on average, 43 percent of the agricultural labor force in developing countries. According to the FAO’s 2010—11 State of Food and Agriculture, closing the gender gap in agriculture by giving women farmers more resources could bring the number of hungry people in the world down by an estimated 100 to 150 million people.

In theory, high food prices should be good news for smallholder women farmers. In practice, only a small minority of farmers in developing economies have enough land and capital to produce a significant surplus to sell to make the most of higher prices. Moreover, they do not always have access to markets. To increase production and take advantage of high food prices, farmers need to plant more acreage, raise more crops per year, or increase their crop yield. Small-scale farmers face many constraints that make it difficult for them to scale up quickly. These include small plots; high fertilizer prices; dependence on unpredictable rainfall; lack of ability to clean, package, and store produce; an inability to access loans; and long distance from markets. The WFP’s innovative Purchase for Progress program seeks to address many of these challenges by providing technical expertise, training, and credit, facilitating access to farming inputs, and promoting processing opportunities.

In 21 countries, Purchase for Progress is now empowering smallholder farmers, particularly women, by connecting them to the WFP’s supply chain and the broader marketplace and stimulating local economic growth. Over 100,000 famers (more than one-third of whom are women), warehouse operators, and traders have received training in improved production, postharvest handling, and other key agribusiness skills. Already more than US$68 million have been contracted through Purchase for Progress.

The WFP is also helping nations scale up social protection safety nets, such as mother and child nutrition, school meals, and job creation programs—both food and cash based depending on market conditions—to help the most vulnerable build resiliency to food price shocks. Such safety nets not only are important tools to protect the most vulnerable, but also generate long-lasting positive effects. School meals, for example, serve as vital safety nets for many countries and directly contribute to wider socioeconomic benefits. Studies by the American Economic Review, the World Bank, and others have found that in 32 African states absolute enrolment for girls increased by nearly 30 percent after the first year of school feeding, that one additional year of schooling for girls reduces the infant mortality rate by 5 to 10 percent, and that providing girls with an extra year of education increases their future wages by 10 to 20 percent. This is why the WFP works tirelessly to reach over 22 million children, half of whom are girls, with meals and take-home rations each year.

Examples such as these demonstrate that protecting the most vulnerable against hunger and malnutrition from shocks such as food price volatility is an issue not only for humanitarians, but more importantly, also for finance ministers and prime ministers.

Indeed, inclusive growth in LICs cannot be achieved without first addressing one of the most fundamental and basic human needs. As Alfred Marshall, one of the founding fathers of modern economics, noted, “The most valuable of all capital is that invested in human beings.”

Hunger and malnutrition are long-term economic issues that reduce the earning potential of individuals and human capital of nations. Studies, such as those by the Economic Commission for Latin America and the Caribbean and the WFP have found that malnutrition can cost countries an average of 6 percent of their GDP, and this amount can be as high as 11 percent. But a more stunning—and hopeful—statistic shows the tremendous payoff that comes from investing in nutrition. The World Bank estimates that US$10.3 billion a year in nutrition interventions in 36 countries with the highest burden of undernutrition would result in 30 million fewer children stunted, prevent more than 1.1 million child deaths, and cut in half the prevalence of severe acute malnutrition. Still other studies have found that children who receive adequate nutrition earn wages that are nearly 50 percent higher as adults. This is not simply a humanitarian argument; this is a return on investment.

While the previously cited examples demonstrate that the worlds most vulnerable people can be buffered against the shocks of high food prices, poverty, and instability while investing in the human capital of future generations, the challenge of addressing food security and helping the most vulnerable build resiliency begins with leadership. Hunger ends when leaders stand up and say, “Not on my watch.” That happened when Brazil’s President Lula put in place the Zero Hunger program, and it is happening in other countries where leaders are making this a priority.

But in a world in which a financial crisis in New York and London raises food prices in Dakar and Nairobi, we need global solutions. New challenges require new system-wide approaches. They require coordinated and complementary action at national, regional, and global levels, such as the leadership and action taken by the World Bank through the Global Food Crisis Response Program. As the world has learned, it is not enough, or cost effective, to simply react after a crisis, whether it is a food crisis or a financial crisis. Risk management, prevention, and building strong national and regional systems of resilience must be a focus.

At their meeting in Cannes in November 2011, Group of Twenty (G-20)1 leaders united to support humanitarian food supply systems and food security for the most vulnerable people; for example, they made the decision to remove food export restrictions and extraordinary taxes for food purchased for humanitarian purposes by the WFP, and made a commitment not to impose them in the future. The WFP moves the vast majority of multilateral food assistance, and now it will have unfettered access to food from G-20 nations that provide the biggest share of global food exports, enabling it to reach the needy rapidly and efficiently. During the 2008 food price crisis, export restrictions threatened the WFP’s ability to provide a lifeline to hundreds of thousands of people who were struggling to access the food they needed for their families. The G-20 nations’ agreement to exempt WFP food from export restrictions and extraordinary taxes is an important step to ensure that humanitarian food gets where it is needed the most.

The G-20 decisions form part of a package of food security actions, including backing for an Economic Community of West African States initiative on regional emergency food reserves in West Africa following the WFP’s feasibility study, and cost-benefit analysis and support for targeted nutrition safety nets, efficient and flexible food assistance (including forward purchasing), and efforts to improve the lot for smallholder farmers (which will reduce the effects and risks of price volatility on the most vulnerable).

The food crisis of 2007—08 took the world by surprise. Now we know, and the world must work together to mitigate the impact of food price volatility on the most vulnerable. The IMF, government ministries, think tanks, and institutions of higher education can play an important role in addressing the urgent food security needs of the most vulnerable at a time of growing risk and vulnerability. Today, the challenges facing us are more than a temporary emergency; they are a collective responsibility. The world has the knowledge and the tools. Now we must act.


In discussions of inclusive, sustainable development, we hear a lot about stability and growth. These are certainly important, but there is a third variable that is also crucial and which must be carefully considered in any strategy for inclusive growth—inequality.

Why should we be interested in the issue of inequality? First, we have to recognize that the objective of growth should not be an increase in gross domestic product (GDP), which I call “GDP fetishism.” We do not seek growth for its own sake. We need growth because it is often—but not always—an ingredient in improved well-being. But GDP is not, in itself, a good measure of well-being. Nevertheless, policymakers, journalists, and even economists use it as a proxy for well-being all the time.

We need to improve our methods for quantifying well-being; until we do so, it will be hard to design policies that promote it. At the behest of French President Nicolas Sarkozy, I chaired the International Commission on the Measurement of Economic Performance and Social Progress, which consisted of an outstanding group of researchers who had done important work on various aspects of the issue. The outcome was a report we completed in 2010, published as Mismeasuring Our Lives: Why GDP Doesn’t Add Up (Fitoussi, Sen, and Stiglitz, 2010). It explains why GDP does not reflect well-being and does not reflect sustainability—facts that the financial crisis of 2008 made so evident. Even in the absence of a crisis, though, GDP is inadequate because it does not describe what is happening to the lives of ordinary citizens. It does not measure security, and crucially, it does not measure inequality.

There was a time when it was easier to argue that a rising tide lifts all boats—in other words, when it seemed easier to argue for trickle-down economics. The idea was that if we increased GDP per capita, regardless of the distributions of the gains, then everybody would benefit, even if some benefited more than others. We now know that that is just not true. Of course, there was never theory or empirical evidence that supported that view, but the crisis and the Great Recession it spawned have driven home the fallacy. For instance, recent U.S. data show that while GDP per capita has been going up year after year for a long time (with the exception of 2009), this has not been true for most Americans—the median household income in the United States in 2010 was lower than it was in 1997. Even before the crisis, it had not recovered to its 2000 levels,2 and the current median income of a full-time male worker is lower than it was in 1968. So there has been stagnation for more than three decades for the average worker in the United States. What this makes clear is that GDP per capita can be going up but that the livelihoods of most citizens can still be going down. Any assessment of economic performance must focus on what is happening to the majority of citizens.

But there is another reason why we may be interested in inequality: Among its many deleterious effects is instability. This was one of the most important points raised at the IMF meetings in the spring of 2011, when the IMF announced a new official concern with inequality because of its recognized link with instability, the prevention of which is one of the principal mandates of the IMF. As then—Managing Director Dominique Strauss-Kahn put it, “Ultimately, employment and equity are building blocks of economic stability and prosperity, of political stability and peace. This goes to the heart of the IMF’s mandate. It must be placed at the heart of the policy agenda.”3

One of the reasons for this conclusion is found in another IMF study, which concluded: “We find that longer growth spells are robustly associated with more equality in the income distribution. . . . Over longer horizons, reduced inequality and sustained growth may thus be two sides of the same coin” (Berg and Ostry, 2011).4

This recognition by the IMF of the link between inequality and stability is consistent with a growing understanding in economics of the connections between the two. Part of the reasoning behind this had been put clearly in the report of a UN commission of experts (United Nations, 2010) charged with analyzing the causes of the Great Recession and the remedies. They pointed out that since higher-income individuals consume less than lower-income individuals (the savings rate at the top is 15 to 25 percent, and the savings rate at the bottom is normally close to zero5), moving money from the bottom to the top lowers consumption. That lowers total demand. The result is that unless something else happens, total demand in the economy will be less than what the economy is capable of supplying—and that means that there will be unemployment. The way that the United States sustained growth before the crisis was to create a housing bubble through a combination of lax regulation and loose monetary policy. It was inevitable that the bubble would eventually break, and it was inevitable that dire consequences would follow.6

Inequality can also have an effect on economic growth both directly and indirectly as a result of the instability that it helps foster, since instability for a variety of reasons can also affect economic growth. Space does not allow a discussion of all the channels through which inequality affects both instability and inequality—and there is considerable controversy about many of these channels. It is clear, though, that we need to understand the causes of the very large increases of inequality that have affected so many countries around the world, and we need to think about what we can do to reduce the sources of that inequality.

While markets are central to the determination of incomes and inequality, markets are shaped and affected by policies, including laws and regulations. Every aspect of policy has the potential for distributive consequences. Fiscal policy’s distributive consequences should be obvious: Cutbacks in spending hurt those at the bottom or in the middle the most. But trade policy can have strong distributive consequences, too, particularly in the context of globalization. Jobs can be destroyed faster than they are created, and the resulting unemployment has both a direct effect on inequality and an indirect effect as it exerts downward pressure on wages. When we design policies for growth, is it pro-poor growth? There are policies that foster anti-poor growth, and there are policies that are more or less inclusive.

Earlier I noted the link between inequality and growth. If we think that inequality affects stability and growth, then we want to make sure that we are sensitive to the impacts of policies on inequality. But the relationship is two-sided: Those at the bottom typically suffer the most in a crisis.

Commodity price volatility is also related to inequality. Take, for example, agricultural or food price volatility. Because the poor spend a larger fraction of their income on food, this kind of volatility affects the poor more than it does other people. The poor have less of a buffer and thus have the harshest experience with price volatility. They have less access to capital markets, less ability to borrow, and less savings. Average savings of those in the bottom half, even in a rich country like the United States, are close to zero, so volatility in their real incomes is felt immediately.

But there is also an indirect effect of this volatility. Commodity price volatility has macroeconomic effects on countries, and those macroeconomic effects lead governments to respond in ways that often exacerbate inequality. When prices go down, the government must often cut back on spending, and among the areas of spending that often get hit very badly is social spending. Also, many countries still have large fuel subsidies, and when fuel and energy prices go up, it eats into government budgets, leaving less for other aspects of growth and development expenditures. In short, anybody concerned about inequality should be worried about the high level of commodity volatility that we have seen in recent years.

Food and commodity price volatility is particularly important in sub-Saharan Africa for two reasons. For one, there are more countries in that region that are dependent on natural resources. They constitute a large fraction of exports and a large fraction of government revenues in those countries. Second, many of those countries have very low incomes, so food and oil are a large fraction of their con-sumption baskets.

Even within countries, the effect of price volatility is uneven, which can put additional burdens on the government. For instance, high food prices may benefit the agricultural workers in the country, but urban workers suffer a great deal. Those who benefit do not automatically compensate those who lose, and it is left to the government to try to deal with those who lose and to get revenues from somewhere else to make up for these increased expenditures. Commodity price volatility imposes real strains on government budgets.

The high volatility of commodity prices is one factor contributing to the natural resource curse, the fact that resource-rich, commodity-dependent countries have not grown as well as others. But another striking feature of the natural resource curse countries is they often have more inequality. This is a paradox because one would think that with all the revenue coming in from selling natural resources, which are inelastically supplied, it should be easier to engage in redistribution. If we tax rich individuals, they might decide to work less, and therefore, there is a limit on the taxes that we can impose on labor for redistribution. But if one taxes oil, oil will not decide to disappear. Oil is there. Natural resources are there. (Obviously you have to compensate people for extracting the resources, but the rents currently in the oil markets are enormous, as they are for a lot of the other natural resources, so one could increase the taxes on natural resource rents a great deal without adverse consequences; they are not going to disappear.) Given the magnitude of the rents that are available in these societies for redistribution, one would think that there would be more of it, more equality, and more spending on social areas; but in fact, these countries are characterized by more inequality.

Commodity price volatility does present a special set of problems for inclusive growth, and that is why it is important for us to discuss them. This is especially so because the problems of lack of growth, pervasive instability, and persistent inequality can be exacerbated by policy. It is important also to consider the origins of high commodity price volatility, although space does not allow us to do so in great detail here. But whatever the source of the volatility, policy can exacerbate the effects.

For instance, fiscal policies and monetary policies that are procyclical can exacerbate the macroeconomic fluctuations arising from highly volatile commodity prices. Inflation targeting, as it is normally formulated, is procyclical. It exacerbates these problems. In the aftermath of the 2008 crisis, many policymakers are discussing whether countries should continue with inflation targeting, which is a bit surprising. I would have thought that one of the big lessons of this crisis is that inflation targeting did not do what it was supposed to do. Many people thought that inflation targeting was necessary and almost sufficient for economic stability, but clearly even though monetary policy may have played a role in keeping inflation low and stable, low and stable inflation did not lead, as predicted, to high and stable growth; it did not protect Europe and the United States from the huge crash. In fact, the models that are used to argue for inflation targeting focused on effects that were really of second, third, nth order of importance. The models focused on the relative price distortions that arise in the presence of inflation; that is, that relative prices can get out of line, which distorts the economy.

But the fact is that the losses from the output gap that resulted from the financial collapse were a magnitude greater than these inflation-related dead-weight losses. The quantitative magnitude of the effects that are usually linked to inflation are really not very important. The losses from the gap between the economy’s potential and its actual output as a result of the crisis, on the other hand, are in the trillions of dollars. The focus on inflation targeting was misguided and a distraction from the really important issues. There was an interesting meeting at the IMF in the spring of 2011 that brought together many academic experts and policymakers.7 The meeting highlighted a broad consensus that we need to move beyond the preoccupation with inflation targeting. Not that one should forget about inflation—when it gets out of control one has to worry about it. But inflation must not be our only concern. Financial stability, even for central bankers, is something that is equally, or more, important. And in most countries today, inflation has been low to moderate and relatively stable.

Inflation targeting has another danger—it can contribute to inequality. Because inequality can contribute to instability, there is an indirect channel by which inflation targeting may contribute to the weaknesses in the economy. And the link is pretty clear. Think about a small African country where the source of inflation is imported food and oil. Raising interest rates is not going to have any consequences for global prices of food or global prices of oil, so raising interest rates is not going to change that. So how can one dampen inflation in these circumstances? The only way to do it is to cause massive unemployment among those workers within the country, adding insult to injury. Workers are already suffering from high food prices and from high energy prices. Now, they are going to suffer from high unemployment, too. Obviously, this should be politically unacceptable, but it also should be economically unacceptable. It increases inequality, real inequality, because it is the workers who will suffer the most.

Globalization and inequality are also strongly linked. Some of the most obvious connections are in trade policy, arising from unfair and poorly designed trade agreements that have allowed, for instance, the continuation of agricultural subsidies, such as for cotton. The United States subsidizes thousands of rich cotton farmers to the tune of billions of dollars a year, thereby depressing cotton prices. Without those subsidies, American farmers would not be exporting cotton, but because of them, the United States is one of the largest cotton exporters. The depressed global prices, in turn, depress incomes of cotton farmers in sub-Saharan Africa and increase poverty among the poorest people in Africa.

There are other examples. One way that globalization contributes to inequality arises from the fact that we have had asymmetric globalization (liberalization). We have liberalized capital markets but not labor markets, which means that capital can move all over the world much more freely than labor. This increases the bargaining power of capital relative to labor, which lowers wages relative to what they otherwise would be and increases inequality. It also puts pressure on countries to lower their taxes on capital, reducing the scope for redistributive taxation. Trade agreements and trade policy can be problematic in other ways. They often restrict the ability of countries to try to manage the risks that they face, including volatility in commodity prices. For instance, Colombia introduced a variable-rate tariff in recognition of the fact that international prices are very unstable. It wanted to stabilize incomes of those inside the country so that they would be insulated a little bit from the high volatility in international prices. But the United States put pressure on Colombia not to have these variable rate tariffs—it did not like the system.

Another example is that an important aspect of trade liberalization policy in recent years has been the elimination of quotas in a process that is called “tariffication.” But actually moving from quotas to tariffs can expose countries to more instability. Quotas are a way that a country can insulate itself to some extent from the volatility in international markets. If we had perfect risk markets, this would not make any difference. But we do not have good risk markets, especially in developing countries and especially in the least-developed countries. So this is another example in which international agreements focused on the wrong models. By relying on flawed assumptions, international agreements have thus contributed to increase the vulnerability of the poorest in the least-developed countries to the global volatility that has become so important.8

There are other aspects of globalization having to do with the globalization of international financial markets that have important consequences for stability and inequality. One is capital market liberalization. Should countries open themselves up to the destabilizing short-term flows of the capital market? This is in many ways very different from openness to foreign direct investment (FDI). China, for instance, has long been open to FDI and has been the largest recipient of FDI, with tens of billions of dollars coming into the country. For China, it has been an important way of getting access to international markets, access to technology, training, and so forth. But that is very different from the short-term capital flows that can come in and out of a country overnight. Those short-term capital flows were at the center of the East Asia crisis 13 years ago.

It should be clear too that these short-term flows, while they increase instability, do not in general lead to fast growth. One cannot build factories on money that can come in and out overnight. It does not lead to real development. Short-term speculative capital focuses on short-term opportunities, not the long-term growth that is at the center of development.

There is also a wide recognition that in general, more extensive capital market integration played an important role in the spread of the crisis in the United States to the rest of the world. This was a crisis that began in the United States and very quickly spread through several channels. One of the channels was this stronger capital and financial market integration. One of the broad lessons that emerged from the financial crisis was that we need to have well-regulated financial markets: A major source of the crisis was inadequate regulation. The core of the problem was that banks did not manage risk very well. They did not allocate capital very well. But this kind of problem has occurred over and over again in the history of capitalism. After the Great Depression, however, we put in regulations that worked. There was a long period of stability until about 1980, when we started removing those regulations. Then the banks went back to the way they behaved normally and we started getting more and more volatility and more frequent crises.

One aspect of regulation is regulation of cross-border capital flows. A lot of the instability facing developing countries comes from unstable cross-border capital flows. Countries need to protect themselves against these destabilizing short-term capital flows. Again, the people who tend to be hurt the most and have the least resilience to these downturns are the poorest. Capital market liberalization thus contributes to the creation of inequality through the crises that it brings about. This points to another failing of GDP—that it does not measure security. When I was at the World Bank, there was a study done called “The Voices of the Poor.” We interviewed 10,000 poor people, asking them what most contributed to the unpleasantness of poverty. One obvious answer was the lack of income, but there were two other important things as well. One of them was lack of security.

In most developing countries, there is no adequate insurance to mitigate the risks they confront. In fact, even in many developed countries, insurance markets are far from perfect, but in developing countries the lack of insurance is even worse and there are none of the buffers, none of the safety nets that people can fall back on either in the public sector, the private sector, or the nongovernmental sector. So that is why it is a special responsibility for developing countries to try to protect themselves against instability, and that is why policies like capital market liberalization need to be looked at very carefully—they can expose countries to greater instability.

Financial market liberalization is a final area in which globalization may be having an adverse effect on the poor and on inequality. Financial market liberalization entails opening countries up to international banks and other financial institutions. With financial market liberalization, in many countries, international banks have bought domestic banks and/or have come in on their own. Very often, they displace domestic banks. Depositors see the international banks as safer than domestic banks. It is not always clear why, and it is not necessarily because the banks know how to manage risk better—the crisis should have raised an important question: that is, whether, for instance, Citibank was safer than the local bank, as many people once assumed. Perhaps there was confidence that the U.S. government would bail out Citibank should it run into trouble—which, of course, was what happened. But for whatever the reason, the evidence is that many depositors feel that way.

How depositors allocate their funds is important because it affects access to credit. Banking is about lending, or should be about lending. It should not be about speculation, and it should not be about all the other activities that some of the banks have become involved in. The core function of banking is providing funds to firms to do investing, and this is especially true in developing countries. The funds provided by banks are particularly important for small-and medium-sized enterprises. The function of allocating capital to small and medium-sized enterprises (SMEs) is very information intensive. Domestic banks (and other financial institutions) tend to have an informational advantage over international banks. The latter often focus their lending activities to the government, multinational enterprises, and large domestic firms. The implication is that as depository funds shift out of domestic banks, the domestic banks have to get funding from other sources, which are typically less stable, and/or cut back in their lending. The result of all this is that there is less lending to SMEs and the lending that there is can be less stable. This is of particular concern because the SMEs in any country are the source of job creation. So financial market liberalization can weaken the labor market, with an adverse effect on workers and inequality. There can also be adverse macroeconomic effects on growth and stability.

There are a few concluding points. First, it is imperative that we focus more on the effects on inequality of policies both at the national level and the global level. The effect of policies on inequality is important in its own right, but it is also important because an increase in inequality can lead to social, political, and economic instability and indirectly lead to lower growth (appropriately measured). Second, volatility itself has a very high cost, so it is important to try to do what we can not only to reduce it, but also to manage that volatility, so that its economic and social consequences are mitigated and so that problems in one country (or one region in a country) do not spread to others. Third, there are some policies such as inflation targeting, financial market liberalization, and capital market liberalization that may actually increase economic instability and societal inequality and indirectly and directly lower economic growth. While there is not yet consensus on these issues among economists, the crisis of 2008 has at least undermined the opposing consensus that such policies facilitated growth and stability. Further research will be required to better elucidate the circumstances in which adverse effects are more likely to arise.

Finally, there is a range of policies that actually can encourage equality and reduce instability. Some of these have been curtailed by global agreements, and we have to make sure that those restrictions are removed from international agreements. There is thus a wide agenda ahead if we want to promote inclusive growth in the face of the high level of volatility in the price of commodities, which are so important to so many developing countries.

The final thought is the following: There has been insufficient attention to the distributive consequences of various policies, including those that I have discussed here, and the distributive consequences of volatility. These distributive consequences, while they may not show up in representative agent macroeconomic models (so they simply have nothing to say about inequality), are vitally important. They affect macroeconomic behavior. They affect how a policy affects most citizens of a country. They affect social and economic stability and sustainability. These distributive consequences should not be ignored in our analyses.

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