12.1 Measurement of Commodity Dependence

The degree of national dependence on primary commodities can be measured in a variety of ways. One can alternatively try to establish the share of the commodity sector in GDP, or in investments, employment, government income, or exports. The nature of the production and consumption of a specific commodity composition will influence the level of the alternative measures. Among commodities accounting for an equal share of GDP, one that is capital-intensive (petroleum extraction) will normally account for a higher share of investments and a lower share of employment than another that is labor-intensive (coffee). All else alike, the share of government revenue will vary with the generation of rent in the production of a specific commodity. Even when dependence measured by the share of GDP or of employment is high, the export dependence could be limited if most of the commodity is consumed at home (rice in Bangladesh).

The difficulties in defining commodities in a uniform way, discussed in Chapter 2, tend to blur the assessments of commodity dependence. Such dependence is sometimes measured by considering raw material extraction exclusively. This is the practice when the share of agriculture or minerals in GDP is measured (United Nations, annual). In other cases the processing activity is also included. The export share measurements usually consider processed commodities like metals or butter and flour, along with their raw materials (GATT, annual). The inclusion of processed products will obviously increase the dependence figures. These ambiguities notwithstanding, it is usually not difficult to point out the countries that are heavily dependent on commodities.

Through most of the twentieth century, the division of work in the world economy was such that the industrialized market economies dominated manufactures production and raw materials imports, so the heavy commodity dependence typically occurred in developing nations. The latter then provided the industrialized world's import needs. This is no longer so. Taking nonfuel commodities as the measuring rod (GATT's definition), recent statistics (UNCTAD, annual a, 2015) reveal that this commodity group accounted for 17.1% of the developed countries’ total goods exports in 2014, which is only about three percentage points more than the corresponding figure for developing countries in aggregate. The picture changes if fuels are included, for then the commodity share of developed countries’ exports rises to 26.3%, while that of developing countries increases to 35.5%. Nonfuel commodities currently account for only 4.6% of China's goods exports, while manufactures account for almost 94%, a significantly higher share than recorded by the developed nations (70%). These Chinese figures are nontypical for developing countries. They are the result of China's extraordinarily fast growth and industrialization in the last 2–3 decades.

Reliable and systematic inter-country comparisons of the dependence on an individual commodity are hard to come by, except in the case of export shares, and even these figures can be misleading where reexports (sometimes after slight processing) are significant. Export shares is the measure applied in Table 12.1. The table lists all the countries where the leading nonfuel commodity exceeded 40% of total exports in 2013–14.Footnote ¹ This is the definition we employ for monoeconomies. Several reflections come to mind when the contents of the table are reviewed. First, all the 14 countries are poor and very small economies. This is not surprising. Figure 1.1 in Chapter 1 demonstrated clearly that poor countries tend to be heavily dependent on the primary sector. More developed, larger, or geographically more extended economies are usually more diversified, so a single commodity will seldom dominate any important aspect of the national economy. Second, many commodities of significance in international trade, like wheat, sugar, or maize, do not dominate the exports of individual countries. Third, the nonfuel monoeconomy phenomenon appears to have become less common and less accentuated over time. A table similar to Table 12.1, but related to exports in 1982–83 contained 19 nations, of which 14 exhibited over 60% dependence (Radetzki, Reference Radetzki1990a), compared to only seven of the countries listed below. Fourth, nations seldom stay as monoeconomies for a very long time. In 2002–03, 15 countries were defined as monoeconomies in a similar manner to Table 12.1 (Radetzki, Reference Radetzki2008), but only four of these countries have remained monoeconomies (Jamaica, Malawi, Mauritania, and Zambia).

Oil is exceptional among commodities. In 2011–13, the average annual value of crude oil and oil products exports was $2,200 billion (Table 2.2). No other commodity comes anywhere near this level. Even if we aggregate the value of all the following commodities ranked by export value in the table, we would still only reach about $1,800 billion. Commodities like copper (global export proceeds $126 billion), precious stones (140), iron ore (134), wheat (49), and coffee (32) appear as dwarfs in comparison to oil.

Given the exceptional size of the oil market, a number of the exporters of this commodity are monoeconomies par excellence. Table 12.2 lists the 11 countries whose oil exports exceeded 80% of overall goods exports. The countries whose exports are dominated by oil are more diverse than the nonfuel monoeconomies. There are some which are of considerable geographical size, e.g., Congo and Libya, and there are several (Kuwait and Saudi Arabia) which have been made quite prosperous by their oil resource wealth. In addition to the countries listed in Table 12.2, there are 15 more nations where oil and oil products account for at least 40% of overall exports, the guiding rod in constructing Table 12.1. The number of oil monoeconomies has risen over the past decade, primarily due to the sharp rise in oil prices. In 2002–03 the countries where the share of oil and oil products in total exports was above 90% were four in number, comprising Nigeria (93%), Libya (93%), Equatorial Guinea (90%), and Yemen (90%). Table 12.2 reveals that by 2013–14 this group had been expanded to six.

The leading commodity will not only dominate exports, but will also play other important roles in monoeconomies. Thus, its share of GDP or employment will often exceed 10%, and it will easily account for 25% or more of government revenue. A heavy dependence on commodities creates special complications – sometimes also opportunities – for national development. The resolution of these complications will require special policy actions that assist in avoiding the traps that a one-sided commodity reliance could involve, but which also help to realize the opportunities inherent in rewarding commodity production and trade.

12.2 Export Instability

We noted in the discussion on price formation in Chapter 5 that primary commodity prices tend to fluctuate much more than the prices of manufactures or services. Unless there are compensating variations in the quantities traded, one must expect greater variation in the export revenues of countries with a heavy commodity component in their exports, and for monoeconomies in particular.

This deduction is indeed corroborated by empirical evidence, at least at a high level of aggregation. Analyzing exports for the 1950s, 1960s, and 1970s for different country groups, MacBean and Nguyen (Reference MacBean and Nguyen1987) conclude that instability, measured as the mean absolute deviation from the trend value of export revenue, was much lower in the 19 industrialized countries than in the 89 developing countries included in their sample, both for the period as a whole and for each decade separately. They also notice a persistently higher instability among poorer countries with a heavy commodity dependence when the LDC sample is divided into two sub-groups. More to the point, Ghosh and Ostry (Reference Ghosh and Ostry1994) note a steady increase in the volatility of commodity prices from the early 1970s to the early 1990s, with an ensuing destabilization of the export earnings and the macroeconomy in commodity-dependent nations. However, commodity price instability was somewhat reduced in the 15 years to 2005, mainly on account of greater geographic diversification of agricultural production (IMF, biannual, 2006).

The IMF's finding is supported by a more recent study (UNCTAD, 2012b), which examines the volatility of commodity exports between 1960 and 2010, based on monthly prices of 48 commodities (covering 75% of the world's, and 85% of developing countries’ commodity exports). It is found that, overall, commodity price volatility has increased over the last 50 years, with some variations during the period. For example, price volatility was at its lowest between 1991 and 2002 and at its highest between 2003 and 2010. Unsurprisingly, the UNCTAD study notes that export volatility varies considerably depending on the basket of commodities on which a nation relies. The study also discusses the risks and difficult adjustment problems faced by monoeconomies after the collapse of prices at the end of commodity booms. The above nuances and reservations notwithstanding, it is a safe conclusion that price volatility is greater for commodities than for other product groups and export income volatility is more marked for countries heavily dependent on commodities compared with other countries.

To get a feel for the national significance of the instability in export revenue that can occur in monoeconomies, consider a case where the leading commodity accounts for 60% of exports and where total exports correspond to 25% of GDP. Then, if the price of the leading export doubles from one year to another, a not exceptional development in commodity markets, the increase in export revenue will correspond to 15% of GDP. If price then falls again to the old level, the decline in the export revenue will correspond to 13% of GDP on the assumption that the entire initial increase in export revenue was added to GDP, and more if the assumption does not hold. The impact will be even greater if export supply responds to the price changes.

Even for countries that are not monoeconomies on the definition adopted above, the export revenue changes due to commodity dependence can be quite important in relation to the national economy. These changes, caused predominantly by international price variations, are unpredictable and, in the main, outside the control of the exporting countries. A study by UNCTAD (1987), quite relevant despite its age, assessed the difference between actual nonfuel commodity export revenue in 1980–84, and projections of that revenue, based on an extension of the actual 1970–80 trend. The average annual shortfalls in the five-year period of depressed commodity prices corresponded to 2.6% of GDP in Chile, 5.8% in Costa Rica, 7.3% in Ghana, 8.4% in Guyana, 7.0% in Honduras, 8.9% in Ivory Coast, 4.2% in Jamaica, 10.1% in Liberia, 10.6% in Niger, 9.9% in Papua New Guinea, and 2.7% in Thailand. The shortfalls in individual years would of course be substantially higher.

Are these numbers big or small? An impression of their significance is obtained by comparing them with the rise of the OECD countries’ aggregate import bill as a consequence of the oil price increases in 1973 and 1979. On each occasion, this rise corresponded to between 2% and 3% of the area's GDP, and it was followed by drawn-out macroeconomic pains for the region, though of course the numbers were higher for individual OECD nations. In this perspective, the export instability experienced by many commodity-dependent countries, and the ensuing economic vagaries are extremely high.

A priori, there are a number of strong grounds for the belief that instability retards growth. Most of these were spelled out succinctly in a famous memorandum written in 1942 by J M Keynes (Reference Keynes1974). When producer incomes vary in an irregular and unpredictable way, they will hamper a rational investment pattern in the commodity-producing industry. What may seem a very good investment opportunity while prices are high can turn out to be a loss-making venture when the price level drops. Such experiences will tend to discourage total investments. Export instability can also be expected to have a negative impact on the macroeconomy, through such variables as imports, savings, employment, and government revenue. A number of studies confirm empirically a negative relationship between export volatility and growth. Blattman et al. (Reference Blattman, Hwang and Williamson2007) studied the impact of terms of trade volatility (arising from volatile commodity prices) on commodity-dependent nations’ economic growth performance, using a panel of 35 countries for the period between 1870 and 1939. The study confirms that countries which depend on exports of commodities with volatile prices grow slower compared to other countries. On a similar note, van der Ploeg and Poelhekke (Reference van der Ploeg and Poelhekke2009, Reference van der Ploeg and Poelhekke2010) provide evidence of a negative relation between volatility and growth. Since countries with a high share of natural resource exports (of GDP) are much more volatile, the authors conclude that volatility is the “quintessential feature” of the resource curse (not resource abundance).

Some other studies on this issue could not confirm a negative relationship between export instability and growth (Behrman, Reference Behrman1987; MacBean, Reference MacBean1966; Sachs and Warner, Reference Sachs and Warner1999). This could be because the research approaches used were not perceptive enough to reveal the relationship, or, as Behrman suggests, that the problems in empirical estimates have obscured the negative effects. But it might also follow from the existence of a positive relationship between export instability and the macroeconomy. Such a counter-intuitive result could follow from the observed asymmetry, with short commodity booms followed by extended periods of subdued prices. The price spike would then be merely a windfall, too brief to influence the longer run policy stance which would instead be determined by the subdued market conditions. In this way, instability could plausibly yield temporary benefits without destabilizing the macroeconomy (private communication with Graham Davis, Colorado School of Mines).

Despite the inconclusive analytical results, export instability was a very important policy issue to the international community for several decades after the Second World War. The merits of intergovernmental policy intervention through International Commodity Agreements and Compensatory Finance Schemes in fact dominated the international commodity debate in the 1970s and 1980s. These policy measures can be regarded as elements of the government activism characterizing the period between the 1930s and 1980s (see Chapter 1). Both efforts had serious inherent contradictions, which explains why they were, for all practical purposes, dismantled long before the turn of the century.

Stabilization of prices over the business or harvest cycle has been the proclaimed objective of commodity agreements. Buffer stocks, along with export restrictions, have been the main tools employed. Where prices fluctuate due to regular changes in demand, as is the case for metals, stabilization of price will even out exporters’ income, but often at a cost of lower average revenue over the cycle. This is apparent from the simplified diagrammatic representation in Figure 12.1. A stabilized price, P₂ will yield an average revenue equal to P₂Q₂, which is clearly less than the average of P₁Q₁ and P₃Q₃ that would be earned with fluctuating prices. If changes in supply due to varying agricultural harvest conditions cause the prices to fluctuate, stabilization of price may well destabilize export revenues. Figure 12.2 shows that with a meager harvest, a higher price P₃ will compensate for the limited quantity supplied Q₂, so that revenue will not be much different from P₁Q₃, earned with a lower price in a good harvest year. Stabilization of price at P₂ destabilizes income to P₂Q₁ and P₂Q₄ between good and bad harvest years. These perverse effects of price stabilization obviously reduced the developing exporting countries’ incentives for launching and operating commodity agreements.

Figure 12.1 Price stabilization with variable demand

Figure 12.2 Price stabilization with variable supply

An even more important fallacy of the commodity agreements has been the inability to correctly determine the equilibrium around which prices would be stabilized over the cycle. In practice, operations often came to aim at defending a price level above equilibrium, requiring ever greater funding, and collapse often followed given the importers’ unwillingness to support and fund this more ambitious goal. The international tin agreement broke down in the mid-1980s for precisely this reason. The failure of the economic provisions of the coffee and cocoa agreements in 1988 and 1989 shook fundamentally the belief of governments and development economists in commodity agreements. Over the following years, the agreements have been transformed, and their ambitions and goals have shrunk dramatically. In the early 2000s, none of the seven commodity agreements existing at the time (cocoa, coffee, cotton, grains, olive oil, sugar, and tropical timber) contained any economic provisions that attempted to regulate markets by supply or price managements. They had all developed into administrative fora for producer–consumer consultations, market transparency, and sources of statistics.

The results of a study by Gilbert (Reference Gilbert2011), covering the entire period since the Second World War, reinforce the doubts and reservations expressed above. Gilbert analyzed the tools (e.g., price bands and stockholding or supply control obligations) of different international commodity agreements whose stated objective was to stabilize commodity prices. The study covered six international commodity agreements with sharp economic (interventionist) clauses (cocoa, coffee, natural rubber, sugar, tin, and wheat). The main conclusion was that, in general, these agreements have not been successful in reducing volatility, which may explain why none of them is any longer in force. The sugar and cocoa agreements failed due to administrative inefficiencies, the tin agreement broke down because of managerial hubris, the coffee agreement lost support from both consumers and producers, and the natural rubber agreement failed as prices were difficult to revise downwards.

In contrast to commodity agreements, the international compensatory finance schemes established in the 1960s and 1970s were to respond much more pointedly to the problem of export revenue instability. Their aim was precisely to compensate for shortfalls in the export revenues of individual countries, with contributions from the schemes during export shortfall periods, and repayment when export revenues had recovered. But they had one serious shortcoming in common with commodity agreements. Stabilization requires that an equilibrium level (of export income in this case) be determined. This problem was never resolved, so that contrary to the schemes’ aims, the contributions and repayments often resulted in destabilization of the foreign exchange flows.

The Compensatory Financing Facility (CFF) of the International Monetary Fund (IMF) was established in 1963, but its activities became quantitatively important only after 1975. In 1980–86, the heyday period, 69 countries borrowed a total of about $10 billion under this facility. Of these countries, 52 had a nonfuel commodities share in total exports of 50% or more (UNCTAD, 1987). By the new century, the facility went into hibernation, and was finally abandoned, sometime after its last review (in 2004) when it was concluded that it had not been used since its last revision in 2000. The Exogenous Shocks Facility and the Trade Integration Mechanism, both programs within the Poverty Reduction and Growth Facility Trust of the IMF, followed the CFF. These new programs are not compensatory finance schemes like those introduced in the 1960s and 1970s; rather, they represent IMF lending facilities that contain a few of the characteristics of the former compensatory schemes.

Another scheme for stabilization of export earnings, STABEX, was established in the mid-1970s by the European Economic Community. It was much smaller than the IMF scheme, and its geographical reach was limited to 60 developing countries associated with the EEC under the Lomé conventions, nearly all former colonies of some EEC countries. The amounts set aside for STABEX payments in the 1980–84 period amounted to less than $1 billion, and actual payments exhausted all the available resources (UNCTAD, 1987). STABEX continued through the 1990s in reduced form, and was ultimately abandoned in 2003 as it was considered too unwieldy to operate successfully (private communication with Gino Debo at the European Commission, Sept 2006).

Disappointments with the intergovernmental commodity stabilization arrangements have prompted a number of commodity-dependent economies to establish financial buffer institutions of various kinds. State marketing boards were set up long ago in many developing countries with the objective to protect domestic producers of agricultural commodities from excessive price fluctuations in the international markets. Many of these agencies became statutory national monopsonies, and developed into fiscal instruments to extract public revenue from the agricultural sector (see Section 12.3), with stabilization evolving into an unimportant side objective. Since the 1980s, however, there has been a marked policy shift in many of the boards back to the original goal of stabilizing the prices paid to farmers.

Other domestic measures adopted by a growing number of countries have had the purpose of stabilizing the government revenue from commodity production. These measures have usually involved the investment of strongly fluctuating fiscal revenues from the commodity sector into a stabilization fund, with annual withdrawals into the government budget at levels that were considered sustainable in the long run. Canada, Chile, Ghana, Norway, Papua New Guinea, Venezuela, and Zambia, among others, have at times tried to improve the stability of their government budgets in this way (Davis and Tilton, Reference Davis and Tilton2005). At the sub-national level, Alberta and Alaska in Canada and the USA have done likewise. From the 1990s, some of these efforts have contained elements of private market-oriented efforts. The stabilization schemes have met with reasonable success, at least in richer economies.

Sugawara (Reference Sugawara2014) examined the effect of stabilization funds on the volatility of government expenditure in resource-rich countries. By using a panel data set of 68 countries (of which 32 used stabilization funds) over 25 years (1988–2012), he found that the existence of stabilization funds contributed positively to smoothing government expenditure. It was further revealed that the success of stabilization funds is related to the institutional framework in the economies and in particular to the avoidance of political meddling in the funds’ affairs. Similar conclusions are found in, e.g., Davis et al. (Reference Davis, Ossowski, Daniel and Barnett2001) and Bagattini (Reference Bagattini2011), while other studies fail to confirm the desired relationship, e.g., Crain and Devlin (Reference Crain and Devlin2003) and Ossowski et al. (Reference Ossowski, Villafuerte, Medas and Thomas2008). Thus, the analytical conclusions of the effects of stabilization funds on fiscal outcomes are mixed.

The marketing boards and stabilization funds are of course confronted with the same difficulties that the international measures had to face: The measures require the establishment of an equilibrium level of price or revenue, around which stabilization can be centered. If that level is wrongly set, the measures will not be sustainable and may cause serious dislocation when they break down. It could be that national decision makers, being closer to the issue, have a better feel for the equilibrium than international bureaucrats. Also, one may presume that national policies in this field exhibit greater flexibility and faster reaction patterns than international measures.

A simple and straightforward price stabilization measure that has come into much wider use since the 1990s is hedging with the help of futures on the commodity exchanges. Two developments have promoted the use of this stabilization tool. The first and most important is the proliferation of commodity exchanges and the extension, rising liquidity, and falling cost of futures trading (see Chapter 7). When considering this stabilization tool, one should nevertheless recognize that there is a cost involved, since futures prices always include a reward to the market maker for offsetting risk. The second development that has promoted hedging is the wide-ranging privatization that occurred in many resource industries in the 1980s and 1990s (Chapter 11). Private profit-maximizing firms have exhibited a greater readiness than government bureaucrats to use the exchanges for securing future prices.

Finally, there is evidence that developing countries have significantly increased their savings in response to export instability. Between 1974 and 1994, the external current account balances rose by 3.5% of average imports in nonfuel primary commodity-exporting countries, and by even more among fuel exporters (Ghosh and Ostry, Reference Ghosh and Ostry1994). These are quite significant amounts. Current account surpluses and growing exchange reserves were even more fashionable in developing countries, including the monoeconomies, in the decade after 1995. The developing world in aggregate improved its current account position from −2.2% of GDP in 1995 to 1.4% in 2000 and 4.1% in 2005. Shifts from sizable deficits to large surpluses occurred in all major developing regions (IMF, biannual, 2006). Growing foreign exchange reserves afford substantial protection against export instability, even though one may claim that, in the absence of instability, the resources could have been immediately employed for valuable development purposes. In the decade following 2005, the strong improvement of the current account balances in the developing world has not continued. The current account balances in these countries, in aggregate, fell from 4.1% in 2005 to 1.2% in 2010, and are expected to become slightly negative at −0.1% in 2015 (IMF, biannual, 2015). The decline in current account balances for countries dependent on commodity exports is not surprising in a situation of declining commodity prices since the 2014 end of the commodity boom.

The key problems of instability caused by high commodity dependence are as old as Joseph's advice to the Pharaohs, and simple to summarize: when harvests fluctuate, set aside from fat years for consumption in meager years. High reliance on commodities with unstable supply, demand, and price can seriously destabilize the national economy. Efforts to even out prices and revenues may therefore often be appropriate and worthwhile. Stabilization involves a significant cost, and if the actions are to gain credibility, considerable resources have to be set aside for the purpose. Furthermore, the averages and trends of the series to be stabilized are extremely hard to determine. Actions which ex ante may appear as purposeful for the attainment of stabilization can easily turn out to have effects quite opposite to their intentions. The costs and the disappointing results explain the limited enthusiasm in recent times for grandiose international measures to stabilize commodity markets and commodity revenues. Down-to-earth national efforts on a more modest scale may have a greater prospect of achieving the desired ends.

12.3 Extraction of Fiscal Revenue

An economy which is heavily dependent on the production and trade of a particular commodity will ordinarily have to rely on that commodity for a large part of its fiscal revenue. That heavy reliance calls for fiscal caution to avoid damage to the sector where the commodity is produced. The two issues that have to be resolved are (a) how much revenue can be obtained and (b) what should be the form of fiscal extraction in order neither to kill nor weaken the milking cow. When considering these issues, it may be instructive to keep two general rules applying to all fiscal systems in mind. The first is that the tougher the fiscal regime, the more likely it is to damage the activity to which it is applied, especially where the tax income is employed to lure capital to other sectors via tax holidays or subsidies (Davis, Reference Davis1994). A fiscal system that leaves little surplus to the owner will certainly discourage investments in expansion and, in the extreme case, even in capacity maintenance. The second rule is that stable fiscal conditions with predictable outcomes are of great importance to those considering involvement. With a given level of fiscal toughness, investors will be discouraged from involvements by fiscal instability.

The public sector share of GDP in most developing countries, including the major commodity producers, was quite low in the early 1960s. It experienced a very substantial expansion during the following decades, as the increasingly emancipated government administrations of these countries enhanced their ambitions to establish physical and social infrastructure facilities, promote national entrepreneurship, and contribute to development in other ways. The public expenditure expansion had to be financed by increased revenues. Where the commodity sector dominated the economy, it was seen as an obvious source for a large part of the growing revenue needs. For lack of experience or due to insufficient foresight, or simply because of short-run greed, the overall fiscal impositions became so onerous in many countries that they led to a stagnation or decline of commodity production and trade in absolute or relative terms. The extractable fiscal revenue ceased to grow or contracted as a consequence.

The maximum fiscal extraction policy compatible with unchanged output is one where all revenue above the variable cost of production is creamed away, leaving no return at all to the invested capital. So long as the variable costs are covered, it will be economical to maintain production in existing facilities. This policy is feasible only in the short run, however. Its consequence would be a complete cessation of capacity expansion and capacity maintenance, so output would soon start to contract.

In the long run, the resource rent is an important determinant for how much revenue the tax authority can take from the commodity sector without harming its tax base. The resource rent is that part of profit which is attributable to the superior quality of the land, climate, or mineral deposit over the marginal quality of these resources used in the global production of a commodity. Superior resource bases, consisting of conveniently located fertile soils which enjoy a favorable climate or rich mineral deposits, have provided a strong comparative advantage to a number of countries in the production of commodities. The resource rents generated by these activities have made them by far the most important sources of tax in many nations.

In principle, the entire resource rent can be taxed away without impairing the long-run viability of commodity production. When the relatively high-cost Canadian Tar Sand and Brazilian deep offshore oil deposits represent the marginal oil production, then any cost advantage due to the superior deposits in, say, Saudi Arabia or Nigeria, could be taxed away, leaving the investors in these countries with no more than the normal return on capital investments, i.e., about the same as that obtained by investors in the marginal resources. A moral argument in favor of fiscal appropriation of the entire resource rent has often been forwarded (Wenar, Reference Wenar2008). This is that the resource rent represents the superior natural endowment of the nation, a kind of patrimony. The state, as the representative of the nation, should therefore have the first right to this rent.

In practice, the determination and extraction of resource rents raises many difficulties. For instance, a reduction in global demand, or technical progress, which results in a price decline will normally lead to closure of the highest cost units and so diminish the size of rent throughout the industry. The existence of resource rents provides a strong attraction to private investors, and a policy of complete government appropriation will reduce their interest, with long-run consequences for the sector's growth. Furthermore, low costs and high profitability could be due not to a superior resource base, but to the monopolistic supply of superior management or technology which may cease to be available unless it is allowed to keep its returns. Partial extraction of the rent is therefore the most that can be accomplished if one wants to avoid causing long-run harm to the industry.

The fiscal regimes applicable to commodities in monoeconomies and other commodity-dependent countries tend to give an impression of complex and confusing structures which are difficult to disentangle and hard to compare. On closer scrutiny, however, most of the fiscal provisions can be categorized as variations of three alternative measures used by governments to obtain revenue from the commodity sectors (Kumar and Radetzki, Reference Kumar and Radetzki1987).

A first measure, the royalty, extracts the fiscal dues on the basis of the volume of production or the value of sales or exports. Royalties come in many different forms. They can be shaped as a levy per ton produced or per dollar sold. Especially for agricultural products, they have often been imposed by state marketing boards to which the farmers were compelled to sell at prices below those quoted in international markets. In the case of minerals, royalties often have the more straightforward form of export taxes.

Royalties are very widely used and regularly regarded as the prime tool for extracting the resource rent. Appropriation of resource rents with the help of royalties requires a differentiation of royalty rates between products and production units, depending on the quality of the resources that are being exploited. A “just” differentiation to reflect the superiority of the natural endowment in each case is complex and time-consuming. Royalties are therefore often applied at fixed rates, e.g., 5% on all copper sold and 10% on gold and cocoa. Such generalities create injustice for those who exploit inferior endowments.

Royalties have the important advantage of easy assessment and application. They also afford the government a relatively stable revenue, since production and sales ordinarily vary much less than profits. This advantage must be weighed against the harmful consequences of this fiscal tool. To producers, royalties basically constitute additions to cost which have to be paid irrespective of profit levels. A high royalty can easily wipe out the entire profit, or even impose losses when pretax profits are low. Producers will therefore avoid ventures with less than exceptional profits prospects, or with cyclical price and profit patterns, since the viability of such projects will be continuously or recurrently impaired by high royalties. The less outstanding resource endowments which could support commodity production with only normal profitability will not be developed at all when royalties are high.

Although we deal here with the imposition of royalties by individual countries on their own, it is important to note that royalties have been used on several occasions to implement international monopolistic coordination, most notably in the case of OPEC. Prior to the nationalization of the oil-producing installations, sales taxes were predominantly used by the OPEC countries to raise export prices. The same was true of the monopolistic effort by the Caribbean countries to raise bauxite prices in the mid-1970s.

The second measure for fiscal extraction, the profits tax, extracts the fiscal dues on the basis of profits, i.e., on the income that remains after deducting all costs of production. Withholding taxes (e.g., on dividends, or on professional fees paid abroad) are usually regarded as part of the profits tax system. A major variation among profits taxes concerns the specification of allowable costs. Another variation is between proportional and progressive profits taxes. One approach in designing a progressive profits tax is through an “additional profits tax.” By creaming off a substantial proportion of profits that are considered “above normal,” the additional profits tax can be employed as a substitute to royalties for extracting resource rents. A variety of additional profits taxes have come to use, in the UK and Russia amongst others, to appropriate part of the very high profits earned by oil companies after the sharp oil price increases during the 2000 decade (IEA, monthly). The commodity boom that evolved after 2004 again sparked a discussion of introducing excess profit taxes for mineral commodities in a number of commodity-producing countries. As was mentioned in the previous chapter, Australia in fact imposed an additional profits tax on the extraction of coal and iron ore in July 2012, but due to a number of difficulties, including ensuing price falls, it was abolished already in 2014. This illustrates the inherent difficulty in designing taxes. A tax structure that may seem quite constructive when price levels are soaring could become the opposite when they fall to depressed levels.

While avoiding some of the problems with royalties, notably that no tax is imposed when there is no profit, profits taxes are much more difficult to assess and impose, especially when producers are many and small, as is frequently the case in agriculture. The necessary estimation of profits requires accepted accounting standards, which often do not exist in poor countries. Since profits fluctuate much more than volume of output or sales, it follows that profits taxes yield a far greater variation in public revenue than royalties, a clear disadvantage to the public authorities. This variation will be particularly strong when an additional profits tax forms part of the fiscal structure.

The third measure for fiscal extraction is through provisions affording public ownership positions in the production activity, for free or on concessional terms. Public ownership for fiscal extraction is often employed when it is felt that neither royalties nor profits taxes provide adequate tools for capturing the resource rent.

The extent of fiscal extraction through public ownership depends entirely on the degree of concessionality through which that ownership is acquired. Confiscation of private property carries no direct cost to the public authorities, even though the indirect costs of ensuing mistrust felt by the former owners may be considerable. If the government pays for what it acquires, the extent of fiscal extraction will be inversely related to the price. No extraction will occur if a full market price is paid for the acquisition. A common government practice has been to demand a minority equity share for free at the time of the original investment decision as compensation for the resource rent inherent in the assets to be exploited. This practice has similarities with a royalty. In other respects, ownership participation resembles the profits tax in that it assures the government of a share of the profit, so long as a profit is earned. Ownership, however, is not always easy to transform into a fiscal income flow. A detriment is that it may expose the government to the costs involved in reinvestments and expansions.

Although public ownership may be desired on other grounds, it is an opaque tool for fiscal extraction, both due to uncertainties about the right commercial price for the acquisition, and because of the painful legal or moral obligations that may arise with an ownership role. Furthermore, as noted in the preceding chapter, because of the inefficiencies characteristic of many state enterprises, the involvement of government as owner often leads to a reduction in the size of the overall resource rent.

Private investors have had varying attitudes to public ownership acquisitions on concessional terms. In the 1950s and 1960s, when the mining multinationals still reigned supreme, they regularly regarded such government involvement as undesirable in principle, because of the perceived dilution of managerial control. After the much painful nationalization of the 1960s and 1970s, many investors became more favorably inclined to a degree of government participation, because they saw such partnership as an assurance of fair treatment to themselves.

Parenthetically it may be noted that the production-sharing agreements practiced by Indonesia, some of the republics of the former Soviet Union, and many other host countries in their relations with multinational corporations in the extractive sectors, are akin to concessionally acquired ownership positions. Under these, the government remains the sole owner, while the foreigners finance the investment and run the operations in return for a share of the output.

Where the commodity production is dependent on massive imported inputs, as is often the case in minerals, import duties may offer an additional and straightforward tool for fiscal extraction.

The producers face a tradeoff between the size and form of the fiscal burden. While they prefer one fiscal tool to another, a fiscal package using unpopular tools may nevertheless appear preferable if it involves a lesser overall tax burden.

Royalties, frequently imposed in the shape of price controls at which state marketing boards purchase crops, or overvalued exchange rates, have dominated the taxation of agricultural commodities. The primary reason is the administrative difficulties in imposing profits taxes on large groups of small-scale agricultural producers. The small scale and predominantly national ownership also explains why public ownership in agricultural production has been quite limited.

In many cases, the government impositions on agricultural commodity production have been excessive and have resulted in a shrinkage in the relative or even absolute levels of output. Many African governments overtaxed their agricultural producers in the 1960s and 1970s, and this led to a shrinking market share as production relocated, mainly to South East Asia and Brazil, but some African countries also did quite well in the ongoing change. The trends have not been equally clear between 1985 and 2000 (UNCTAD, annual a, 2005).

From the early 1960s to the early 1980s, Ghana's share of the world cocoa market shrank from 40% to 14% and that of Nigeria from 18% to 11% as a result of heavy export taxes. At the same time, Ivory Coast, with much more favorable fiscal treatment of its cocoa producers, expanded its share from 9% to 26%. Admittedly, part of this increase was accomplished through exports of cocoa that had been smuggled out of Ghana, but this too was an effect of excessive taxation. In the 1990s, Africa as a whole lost further cocoa market shares to Asia, but Ivory Coast continued to consolidate its market position. Mainly for fiscal reasons, the share of Nigeria and the Democratic Republic of Congo in the world palm oil market shrank from 48% to virtually zero in the 20 years to the early 1980s, while that of Malaysia expanded from 18% to 71%. In the following two decades the Asian share of the market continued to expand as Indonesia increased its share of exports (in 2014 the country accounted for over 50% of global palm oil exports). Overtaxing lost Egypt half its international market share in cotton in the two decades to 1985. Sri Lanka's tea exports dwindled from one-third to one-fifth of global exports, while Kenya, which treated its tea producers more fairly, saw its share triple to 9% during the 20 years to 1985, with a further expansion to become the world's largest exporter of black tea 2014 (World Bank, 1986b; UNCTAD, annual a, 2015). The declines in fiscal bases came as surprising disappointments to the governments of the high-tax countries.

In the case of minerals, the fiscal menu has been much more varied, but, for historical or other reasons, the emphasis on the respective tools has varied considerably among countries (Faber, Reference Faber1982). Royalties have been applied in some measure by most mineral-exporting countries. Public ownership positions acquired on concessional terms have been quite common, though the reasons for these acquisitions usually went beyond fiscal concerns (see Chapter 11). In contrast to the farmers, mineral enterprises possessed a degree of administrative sophistication which made the application of profits taxes practical.

Excessive fiscal ambitions slowed or arrested the expansion of the mineral industries in some countries. This was true, for instance, of Zambia and Peru, though, as discussed in Chapter 11, intriguingly the over-taxation often also applied to fully state-owned entities. An extreme case in this respect is provided by Peru's overtaxed oil sector (Aguilera and Radetzki, Reference Aguilera and Radetzki2016). Very high royalty impositions by some Canadian provinces in the early 1970s virtually arrested all mineral exploration efforts, but there was no visible impact on mineral output because the royalties were soon withdrawn. The internationally coordinated efforts of some bauxite producers to increase prices through export taxes substantially reduced the demand for their output, with a lag (Chapter 10). In the weak mineral markets of the 1980s there was a reversal of earlier fiscal trends in selected cases. Some leading mineral-exporting countries have attempted to attract foreign investments by offering internationally more competitive fiscal arrangements. Chile has been extremely successful in this respect, and has seen its share of world copper mining rise from 11.3% in 1975 to 31.0% in 2014 (Metallgesellschaft, annual; USGS, annual, 2015).

These experiences reveal that monoeconomies have to tread a difficult balance in designing their fiscal systems. On the one hand the governments need fiscal revenue to cover public expenditures, and the commodity sector is their major revenue source. Lax taxation of oil in the Middle East and bauxite in the Caribbean in the 1960s resulted in very meager national benefit to the countries producing these commodities. On the other hand, they have to be cautious in the determination of the overall fiscal burden and in the selection of fiscal instruments. The instances of agricultural shrinkage, listed above, point to the potential dangers. Wrong decisions have proved counterproductive in many cases.

Most of the instances of overtaxed and shrinking commodity production quoted above were the result of misconceived expectations about the primary sector's ability to generate public revenue. However, there may be cases where excessive fiscal burdens are imposed precisely for the purpose of diminishing what is considered an excessive commodity dependence of the national economy. The market instability of the dominant commodity may be felt to be overly onerous. The country's competitive advantage in the commodity may have contracted, or the commodity market may be in a structural depression, so that there is little likelihood of large and sustainable private or public revenue generation. In such circumstances, the fiscal policy could have the explicit purpose of speeding up a contraction of the sector through fiscal squeeze and of encouraging diversification by an expenditure policy that promotes, say, manufacturing, or other commodities with more dynamic market prospects.

Intriguingly, fiscal squeeze aimed at reducing commodity dominance and at promoting diversification is sometimes urged for precisely the opposite reason, i.e., when the commodity sector has an outstanding ability to generate resource rent and fiscal revenue. This is the subject of the next section.

12.4 The Dutch Disease and the Resource Curse

Two evils that are said to afflict economies heavily dependent on commodities, will be dealt with. The first, the Dutch Disease, arises from an export-oriented resource bonanza that can give rise to far-reaching macroeconomic reorientation, with ensuing sectoral adjustment. The second, the resource curse, is the purported tendency for nations heavily dependent on minerals and fuels to record slower economic growth than other countries at a corresponding stage of development.

12.5 Exchange Rate Policies in Monoeconomies

The main purpose of a standard exchange rate policy is to keep the domestic currency (e.g., peso) at an equilibrium level, defined as the dollar price for a peso that assures a balanced current account. An overvalued currency (more dollars per peso) regularly results in a current account deficit. Overvaluation often follows from peso inflation that is higher than dollar inflation. The current account deficit can be remedied through a devaluation which stimulates export demand by reducing the dollar export prices, and discourages imports by making them more expensive in peso terms. Conversely, an undervalued currency (fewer dollars per peso) typically yields a current account surplus, which can be symmetrically overcome through an appreciation of the peso.

The conditions in the market for the leading commodity and not relative rates of inflation are the main drivers of current account imbalance in monoeconomies. Years of high commodity prices will ordinarily yield a sizable current account surplus, indicating an undervalued peso, and vice versa for years of low prices. Is an exchange rate policy aiming at a balanced current account appropriate for economies whose dominant exports experience strong price fluctuations over the business cycle? The policy rule would require currency appreciation during the boom and devaluation during recession, not a very convenient policy stance, since it would destabilize conditions for other economic sectors.

The monoeconomies are special, and not only by their high dependence on a single commodity export. They are invariably also small economies. Size regularly involves economic diversification, so large monoeconomies are uncommon.

The small size has a bearing on the exchange rate policies. Monoeconomies face numerous intricate problems in their efforts to stabilize the current account and their choice of exchange rate policies. There are no straightforward solutions to these problems. The economies’ small size has a bearing on these issues. One effect of devaluation is that all import prices, including the prices of imported inputs in commodity production, will rise. The change in competitiveness after devaluation is dependent on reduced payments in terms of dollars to the domestic factors of production. But the domestic share in total production costs will be quite limited, given the smallness of the economy. Devaluation must then be quite sizable to have a perceptible impact on competitiveness. Furthermore, any gain in competitiveness is hard to maintain over time, since small trade-dependent economies will find it hard to resist inflationary pressures after devaluation. Domestic factors will demand compensation for the increased cost of imports, especially where trade has a heavy weight in total consumption. If compensation is granted, the initial competitive improvement will be depleted. The need for new devaluation rounds will then arise until the government succeeds in the difficult task of containing the upward price pressure by domestic labor and capital, which may not be easy.

A standard exchange rate policy would also have an adverse effect on the international stability for the dominant commodity and on its non-devaluing exporters. Devaluation during recession will lower the monoeconomies’ supply curve, so the market price will weaken even more than it did due to recession in cases where the devaluing countries represent a significant share of total supply. Lesser volumes will therefore be sold at even lower prices by diversified producers as a result of the monoeconomies’ exchange rate policy. The inverse will occur as a consequence of the monoeconomies’ currency appreciation during the boom. In this way, the exchange rate policy will accentuate the commodity price movements and destabilize export earning for other suppliers. For this reason too, the standard exchange rate policy advice may not be appropriate in the case of monoeconomies.

If the commodity business cycle is short and regular, a more appropriate and prudent policy might be to establish foreign exchange reserves of sufficient size to carry the country through the commodity cycle. Reserves buildup would then conveniently occur during the boom, with a subsequent drawdown during recession. A related, though somewhat less prudent, alternative would be to rely on borrowing from, e.g., the IMF or from private international financial markets.

We claim that borrowing from the IMF or the international market is less prudent because experience has shown that the commodity cycle is not as short and regular as suggested above. Most commodity prices experienced substantial declines in real terms throughout the 1980s, and they then remained depressed until the boom of the 2000s decade. A monoeconomy that borrowed in the 1980s to overcome the problems caused by commodity price declines in the expectation of a price recovery in the near future would have lost all its credit facilities due to extreme indebtedness long before the prices improved. The extended commodity price depression was certainly a contributory factor to the international debt crises of the 1980s and 1990s involving many commodity exporting nations. By encouraging capacity expansion in the commodity sector, international borrowing along with the expectation of an impending price recovery probably prolonged the period of low commodity prices. Eventually, devaluations became unavoidable as the indebted commodity dependent nations tried to come to grips with their persistent current account deficits. Ironically, this too suppressed commodity prices through the mechanisms explored above.

It is reasonable to assume that we will experience a similar development also in the decade after the most recent, somewhat prolonged, commodity boom that ended in 2014. Contemplating the depressed situation for many commodity prices today (December, 2015) there is no evidence that prices will improve anytime soon, so borrowing from international markets to overcome the price decline will be a doubtful investment.

12.6 Conclusion: A General Case for Economic Diversification?

This chapter has surveyed the problems that confront monoeconomies and other countries that are heavily dependent on commodity production and exports. The discussion of commodity instability, generation of public revenue, the Dutch disease, the resource curse, and the exchange rate policies in this country group clearly suggest that the problems they experience have a particular character and require special solutions. But while the one-sidedness of the commodity-dependent economies clearly involves risks, the coverage of which warrants signing an insurance and paying the premium, the above analyses have definitely not established a general and unambiguous case for diversification.

After all, commodity dependence is often the result of competitive advantage that normally yields above-normal returns to the commodity sector. These yields may well be more than adequate to cover the cost of instability and other monoeconomy problems. Conversely, part of the resource rents contained in the above-normal returns will be forgone when the country diversifies out of its reliance on commodities.

It is true that the global demand for many commodities has trend growth rates that are slower than for the aggregate of manufactures. Slow demand growth per se need not involve disadvantage. The market for the output of a monoeconomy can expand briskly if the supply from other sources stagnates. Besides, high profits can well be earned even when demand is stagnant.

Chapter 5 revealed that the aggregate price index for commodities has tended to lag behind that for manufactures. This, too, does not by itself constitute a case against commodity specialization for countries that benefit from a strong comparative advantage. Besides, the profitability of commodity production can well be maintained in the face of falling prices if technical advances reduce the cost of production in equal or greater measure.

Commodity dependence does not constitute a general trap into technical or other backwardness. Contrary to frequent perceptions, commodity production often requires as much advanced technology and human skills as manufacturing. Modern agriculture and mining make heavy use of microbiology, electronics, and the highly qualified labor that goes with these techniques.

Large and profitable primary commodity production, both agricultural and mineral, holds a prominent place in the economies of prosperous nations like Australia, Canada, Norway, Sweden, and the USA. This production would be even greater if the resource base permitted. The markets or governments would force a contraction of the raw materials industries if they were unprofitable or otherwise socially undesirable.

On these grounds, we conclude that a heavy concentration on commodity production in a national economy is not detrimental per se. Diversification out of a commodity sector that has lost its competitive advantage and superior profitability is certainly warranted. But it is much harder to find tenable arguments for a recommendation to, say, Zambia, or Venezuela, both heavily dependent on the exports of a few raw materials, that they should reduce their commodity reliance by a greater emphasis on manufacturing.