Commodity Markets and the Developing Countries: A World Bank Business Quarterly

November 1997

Annotated Table of Contents
Summary
Special Feature: Global Economic Prospects and
                                        the Developing Countries

• Developing country growth in 1996 was the highest so far this decade. The external environment for developing countries is expected to remain broadly favorable over the coming decade. The challenge for policymakers in developing countries is to establish the conditions that attract more global production and realize more of its benefits.

Energy

• Coal
  Weak demand and rising supplies lead to lower prices this year. Prices are expected to decline in 1998 with increasing production, greater competition, and growing reliance on spot markets by purchasers.
• Natural gas
  US prices surge on strong demand for storage and flat production. Prices are expected to decline in 1998 on higher production from the Gulf of Mexico and rising imports from Canada later in the year. In Europe prices remain indexed to oil, but the introduction of UK spot gas into the continent in late 1998 and ongoing liberalization of the gas sector will lead to lower real prices.
• Petroleum
  The market balance is much improved from a year ago because of higher inventories, rising production, and renewed exports from Iraq. Higher production from OPEC and non-OPEC sources is expected to lower prices next year.

Beverages

• Cocoa
  The impact of El Niño is intensifying the recent structural deficits in the cocoa market. Production is stagnant, and consumption is growing. Prices are up accordingly.
• Coffee
  Arabica prices fall sharply on expectations of a large crop in Brazil next year and the departure of speculative money from coffee markets. El Niño affects supplies of Indonesian and Colombian coffee, keeping prices from falling very far.
• Tea
  London prices are 31% higher than in the third quarter last year in real terms. Tight world stocks, uncertain global weather conditions, and seasonal effects are likely to keep world prices high.

Food

Fats and Oils

• Fats and Oils
  Although the regional effects of El Niño may be large, world supply of fats and oils is not expected to be severely affected. Declines in the Southern hemisphere should be offset by increases in North America. EU reforms under Agenda 2000, if implemented, could further depress EU oilseed production.
• Coconut oil
  Production is expected to increase slightly in 1997/98. The 1998/99 outlook is not as promising because of severe El Niño-related drought in the Philippines.
• Palm oil
  El Niño-related droughts are expected to affect yields from 1998 on. Reduced yields and increased consumption in Indonesia and Malaysia will push up prices.
• Soybean oil
  Prices remain unchanged while production is expected to rise. Stocks are declining sharply. While El Niño is expected to affect both Argentina and Brazil, favorable weather in North America should offset any decline in production.

Grains

• Grains
  Large supplies and currency devaluations in Asia cause grain prices to weaken during the quarter. World grain production is estimated to be slightly above last year's level and 8.5% above levels in 1995/96. Stocks are expected to build, but still remain low by historical standards at 15.4% of total use.
• Maize
  Prices strengthen from their mid-summer lows. Production is expected to shrink 2.4%, and stocks are expected to drop 14%, keeping the market tight and prices firm.
• Rice
  Devaluation of the baht reduces the US dollar price of Thailand's rice exports by 15%. World production and stocks are projected to rise slightly from last year's levels. The three largest exporters are expecting good harvests and large supplies for export, which should keep prices from rising.
• Wheat
  Prices fall to $146.2/ton for the third quarter, from a high of $262/ton in May 1996. World production for 1997/98 is expected to reach a record 603 million tons, up 3.4% from the previous year, putting year-ending stocks up 18%. Prices should remain near current levels until the spring of 1998, when new crop prospects begin to emerge.

Other Food

• Bananas
  Prices fall, and El Niño threatens production. The WTO rejects the EU's appeal of its banana export regime.
• Shrimp
  Prices continue to rise, bringing the year's increase to 15%. Reasons include smaller harvests in Thailand and increasing demand in major importing countries.
• Sugar
  Prices remain firm, with world supplies expected to decline. The US and Mexico continue to quarrel over high-fructose corn syrup.

Agricultural Raw Materials

• Cotton
  Production and consumption remain in balance. Declining Chinese imports may offset any increase in prices stemming from El Niño effects. State-owned textile industries in China and India are undergoing reform.
• Rubber
  International prices slide, but producer prices improve following devaluations in Asia. El Niño's arrival ushers in drought and threatens supplies.
• Timber
  Sluggish demand in Europe and Japan contributes to price declines for tropical timber. Reduced housing starts, a stronger dollar, and the substitution of softwood logs for tropical logs are also depressing demand.

Fertilizers

• Fertilizers
  Most prices remain strong, with the exception of urea. However, weak world grain prices may drive fertilizer prices down.
• Potassium chloride
  Prices remain firm as supplies from Canada have been limited. An increase in second-half contract prices of $5/ton was sought and attained by some exporters. However, most prices remained at $116.5/ton.
• TSP
  Producers are operating at near capacity, and production is up 4% for the first half of 1997. With such rapid production growth, demand is not likely to be strong enough to support prices at current levels.
• Urea
  Prices continue to fall, with the average down 11.1% from the second quarter. Further declines will probably be limited in the near term as demand begins to increase for the spring plantings. However, supply remains well ahead of demand, and more firms are cutting production in response to building inventories.

Metals and Minerals

• Aluminum
  Consumption growth in Europe and the US and investment fund buying spur prices. Consumption weakens in Asia, mainly as a result of the recent currency crisis.
• Copper
  Increased demand in Western Europe and North America is not enough to offset lower demand from Asia and worldwide growth in copper supplies. Prices continue to fall to their lowest levels of the year.
• Gold
  Prices continue to fall on central bank selling and a loss of speculative interest. Prices average $323.6/toz for the quarter. At current prices, mine closures are expected.
• Iron ore and steel
  Despite high levels of production, the global iron ore market remains tight. Performance in steel markets is more varied. Demand is up in Europe but way down in Southeast Asia because of the recent currency crisis.

Commodity Prices

Summary

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The World Bank's index of energy prices rose 1% in the third quarter on strong demand and lower than expected supplies. Nonenergy prices fell nearly 8%, however, with declines in all the main groups (table 1). Beverage prices were down 12%, pulled down by an 18% drop in arabica coffee prices as Brazil's frost season ended. Tea and cocoa prices recorded moderate increases. Food prices fell 7.8%, with a 9.3% decrease in grains and moderate declines in most other foods. Metals and minerals prices fell only 2% for the group, but there were larger drops in several individual products. Timber prices fell 11.5% on sluggish demand, while rubber prices plunged nearly 20%, in part a consequence of currency devaluations, which stimulated production among South east Asian producers. Cotton and sugar prices remained firm.

Petroleum prices rose during the quarter, a response to the temporary halt in Iraqi supplies from May to August, continued shortfalls in non-OPEC supplies, and strong demand, particularly for transport fuels in the US. However, prices were 20% below January levels, reflecting the improved market balance. Stocks have risen, particularly in North America and Europe. Non-OPEC supplies were 1.0 mb/d higher than a year earlier, but 0.8 mb/d below IEA projections at the beginning of the year. OPEC production continued to edge up, bringing output to 2.3 mb/d above quota. There are indications that OPEC may raise quotas at its November meeting, which would lead to higher output from the Gulf countries. Although a rollover of Iraq's oil-for-food deal in December may be in doubt due to heightened tensions over weapons inspections, continued Iraqi exports plus higher output from the rest of OPEC would likely tip the balance into surplus. Non-OPEC supplies are projected to increase significantly in 1998. Thus oil prices are projected to decline next year.

Coffee prices fell sharply as the risk of cold weather in Brazil subsided and prospects for next year's crop brightened. Nevertheless, prices for arabica were more than 50% higher than a year ago because of lower supplies. Estimates for the 1997/98 crop have been lowered more than 10% in both Brazil and Colombia. Robusta prices, which had previously risen less than arabica prices, fell 12%, reflecting good supply availability. There is some nervousness in the market about possible El Niño effects, but thus far the only large effect has been in Indonesia, where drought significantly reduced production. Many Central and South American countries worry that recent dry weather will lower the quality of this year's crops and cause production declines next year.

Grains prices led the decline in food prices, with wheat off 13.8%, maize down 6.8%, and rice down 3.9%.

Metals and minerals prices posted the smallest decline among the main commodity groups, mostly because of a large increase in zinc prices and a moderate rise in aluminum prices due to strong demand in the US and Europe. Copper prices fell 9.4% on rising stocks and weak demand. Price declines were also recorded for nickel (down 8.1%), silver (4.7%), and gold (5.7%). Iron ore markets remain tight, despite high production, because of strong demand. Steel demand remains strong in the US construction sector but is weakening in Asia following the recent currency crises.

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Developing country growth in 1996 was the highest so far this decade, an estimated 5.6% (excluding transition economies), and the most rapid rate in 20 years. The integration of developing countries in the world economy also gained ground: foreign direct investment in developing countries topped $100 billion for the first time, approaching 2% of their GDP. Their international trade volumes expanded at a robust 7%, despite a downturn in overall world trade growth.

The external environment for developing countries is expected to remain broadly favorable over the coming decade. World output growth in 1997-2006 is expected to average 3.4% a year, more than half a percentage point higher than during the past decade, with modest inflation of about 2.5% in the Group of 7 (G-7) countries and real short-term interest rates of slightly more than 3%. In this setting developing country growth is expected to average nearly 5.5%, double its pace in the preceding decade, accompanied by mounting capital inflows and solid increases in trade of 7%-8% a year.

Economic growth is expected to increase in every region except East Asia, where it should still remain high (table 2). Sub-Saharan Africa and the Middle East and North Africa, two regions where incomes fell in the past 10 years, are expected to achieve positive per capita income growth (though the projected pace of about 1 percent would remain below that in high-income countries).

In some of these countries basic political and macroeconomic conditions for investor confidence are still lacking, and many enterprises remain largely cut off from foreign markets and competition because of policy weaknesses, institutional impediments, and inadequacies in transport and communication services. The same is true of some economies in Europe and Central Asia, although most of the countries in the region are expected to recover much of the ground lost during the difficult transition from a planned to a market economy.

Developing countries in South Asia will continue to show faster growth in output and investment and will further increase their share of world trade. Though there is still some way to go before firms in India are fully exposed to international markets, recent reforms there have proved resilient, and growth in the South Asia region is expected to improve on historical trends. Countries in Latin America, which have become considerably more integrated into the world economy over the past decade, should also experience accelerated growth in the next decade, though in some large countries the risk of macroeconomic instability persists.

The Big 5

Increased integration and faster growth in China, India, Indonesia, Brazil, and Russia--five countries that today account for half the world's labor force but only 8-9% of its GDP or international trade--will likely redraw the economic map of the world over the next quarter century, although these countries' share of world trade is barely one-quarter that of the European Union's today, it could, under reasonably conservative assumptions, be 50 percent larger by 2020. The share in world output of both the Big 5 and developing countries in general will nearly double, with developing countries absorbing half the growth in industrial country exports over the next quarter century.

Model simulations for the world economy in 2020 suggest that the emergence of the Big 5 will generate significant welfare gains for both the industrial countries and most other developing countries, resulting from broader opportunities for specialization along lines of comparative advantage and from improved terms of trade. The emergence of the Big 5 is expected to have a beneficial effect on real wages for both skilled and unskilled workers in most countries and regions.

Among developing regions the Middle East and North Africa, Sub-Saharan Africa, and Latin America and the Caribbean derive the largest welfare gains from the emergence of the Big 5. Trade liberalization and increased participation by countries with abundant unskilled labor, such as China and India, are expected to lower relative prices for some labor-intensive products, generating some pressure on unskilled wages in a few countries with closely similar endowment structures.

These countries will, however, have the incentive and the ability to offset such pressures by accelerating their own trade liberalization (a policy tending to benefit their most abundant factor of production, unskilled labor) and by undertaking other reforms to improve the efficiency of resource allocation and use. The analysis also suggests that fears that fast growth in the Big 5 will generate significant increases in world food and energy prices do not appear to be well founded.

Openness and Growth

Several trends in the world today are contributing to the expansion of cross-border production by multinational enterprises and their networks of closely associated firms. These include the liberalization of economic policies in most countries, continuing reductions in the costs of transport and communications, and the growing importance of knowledge and other intangible assets in modern production and distribution. These forces are heightening the competitive pressures on firms in both industrial and developing countries, while also facilitating their efforts to improve efficiency and gain access to new markets by reorganizing production processes on a global basis.

The challenge for policymakers in developing countries is to establish the conditions that help attract more global production and realize more of its benefits. These include political and macroeconomic stability, open trade and investment regimes, better transport and communication infrastructure, adequate protection for property rights, and a predictable institutional environment without excessive red tape. Ensuring that foreign and domestic firms face a high degree of competition in host country markets is likely to be important in maximizing the spillover benefits of global production.

There is growing evidence that increased openness and faster economic growth go together, suggesting that the longer-term effects of trade liberalization on employment, wages, and income are likely to be strongly positive. To be effective, however, trade liberalization requires resources to be redeployed between sectors. In the process, workers in import-competing industries may become unemployed for a time. The output losses suffered by the economy as a result--the social costs of adjustment--are expected to be temporary, and empirical estimates suggest that they tend to be small, especially relative to benefits.

The size of adjustment costs will nevertheless be affected by the policy environment, and there is indeed much that governments can do to minimize them. Adjustment costs will be lower if macroeconomic stability and other complementary policies strengthen the credibility of reforms and support a quick and substantial increase in new private investment. Adjustment will be delayed and its costs will be higher if labor and other factor markets are distorted and inflexible.

Trade reforms are undertaken because they yield large net social gains. By contributing to improved growth in the longer term, liberalization is likely to make a substantial contribution to the reduction of poverty. And where unskilled labor is the relatively abundant factor of production, it is likely to raise returns to this factor.

Nevertheless, the private costs of trade liberalization for specific groups, such as capitalists and workers in the previously protected sectors of the economy, can sometimes be large. Given that these losses are usually more concentrated among a few groups than are the larger but more widely diffused gains from trade, the opposition to liberalization will often be more focused and better organized politically than is support for it.

Poverty and the Environment

Prospects for the global economy are among the most promising for growth and poverty reduction in developing countries in many decades. However, such encouraging projections must be qualified by significant areas of risk for individual countries, including macroeconomic imbalances or financial sector weaknesses that increase exposure and vulnerability to external shocks. Strengthening the framework of institutions and improving access to information to allow markets to work more effectively will be an important consideration for development strategy in many countries.¹ Growing competitive pressures and rapid transformation of the world economy along many dimensions will give unprecedented weight to the ability to handle change. Careful management of the transitional strains associated with global integration will be an important task for all countries in the coming decades.

As to the risks to the natural environment from faster growth, in the long run greater reliance on market forces is likely to be reflected in many countries in more efficient use of natural resources such as energy. Demand for a cleaner environment rises with income, and so growth in developing countries will also be associated with greater incentives for policymakers to implement strong environmental policies over time. Nevertheless, given the complexity and scope of this issue, it is clear that analysis of the environmental implications of global integration is an important task for further research.

  This feature is drawn from World Bank, "Global Economic Prospects and the Developing Countries 1997", Washington D.C., 1997. To purchase a copy, contact World Bank Publications at 703-661-1580 or visit the World Bank's publication catalog at www.worldbank.org.

1.   Joseph E. Stiglitz, "Agenda for Development in the Twenty-First Century," in Boris Pleskovic and Joseph E. Stiglitz, eds., Annual World Bank Conference on Development Economics 1997, Washington D.C.: World Bank, forthcoming.

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