By Erin Nealer
The price of commodities has seen a sharp decline over the last five years, and continued depreciation could leave developing countries vulnerable to economic and political shocks. Many developing countries rely on exporting raw materials like oil, grains, and metals, rather than focusing on service industries. This reliance on commodities, coupled with falling prices, could undermine development initiatives and set least developed countries (LDCs) back to square one.
The United Nations Conference on Trade and Development (UNCTAD) determined that commodity dependence among developing countries is increasing. In 2009-2010, there were 88 developing countries reliant on commodities, compared to 94 in 2012-2013. LDCs saw a similar increase, from 80 percent of countries dependent on commodity trade in 2009 to 85 percent in 2012.
Trade in commodities is attractive to LDCs for several reasons. While other industries are at the mercy of fluctuating demand, political stability, or technology, extractive industries – “hard commodities” – are consistently in high demand worldwide and can be stored for long periods of time without depreciating in value. “Soft commodities” such as grains, tobacco, and sugar, have a shorter shelf life and can fluctuate in price as weather conditions change, but are in increasingly high demand as the world’s population continues to climb. Stockpiling rubber, oil, or gold can become a commodity exporter’s insurance plan against future economic shocks that result from relying on the continued demand for raw materials.
Additionally, the commodity industry requires mostly low-skilled workers. Service industries are considered hallmarks of a more advanced economy, as a prosperous service sector requires higher levels of education and uses less natural resources than a country reliant on commodities requires.
However, the commodity trade is cyclical and volatile in nature. In the last century, demand for commodities has experienced regular booms and busts every few decades, known as “commodity super-cycles.” Because commodities can be bought in bulk and stored in warehouses, traders anticipate price hikes in the long run and raise demand by decreasing the supply of available commodities in the short run – which, naturally, raises prices in the short run and guarantees the predicted future price increase.
Historically, commodity super-cycles occur when major political or economic changes take place – the Great Depression, the 1980s financial crisis in Latin America, the 1991 fall of the Soviet Union, and the global financial crisis in 2008. Net commodity importers, which includes the majority of OECD countries, benefit from these falling prices. Since the financial crisis, commodity prices have continued to fall. Oil in particular has seen a sharp decline in prices, from $115 per barrel in 2014 to a low of $50 in January of 2015. David Jacks of the National Bureau of Economic Research (NBER) believes that plateauing, low commodity prices indicate the “beginning of the end” of super-cycles, suggesting that these boom/bust episodes will become less volatile – and more consistently low – over the coming decades.
LDCs have limited options for how to handle these floundering commodity prices. Wealthier developing countries can insulate themselves against economic shocks by stockpiling commodities and rationing their exports to keep their economy afloat until the market recovers, but LDCs may not have that luxury, needing to sell or consume any surplus raw materials they generate. Waiting until the market recovers, especially if NBER’s prediction holds true, would also result in insurmountable short-term losses for LDCs.
The path away from commodity dependency and toward a service-based economy is long and rocky. Countries regularly fall victim to the “resource curse,” a paradox in which countries with significant natural resources focus their efforts on that one industry – silver, for example – until they exhaust all naturally occurring reserves. The curse discourages growth in the remainder of the country’s industries, and stunts service industries in particular, which require significantly more investment and infrastructure than commodities and experience slower returns on initial investments.
Commodity-dependent LDCs face two primary challenges: first, they must prioritize education, develop infrastructure, and encourage international investment. While the transition from a goods-based to a service-based economy is expensive and slow, refining locally sourced raw materials in a strong manufacturing industry is a solid first step. Vocational training and education programs that encourage small business growth can offset the commodity trade’s deceleration by creating new jobs and new exports.
Second, LDCs must look to foreign direct investment (FDI) to finance the transition period. Developing strong institutions and a culture of entrepreneurship takes time, and FDI can foster technological growth in the interim. Turning away from exporting raw materials and toward finished products through a strong manufacturing industry requires technological advances that LDCs cannot finance by themselves. Investing in commodity exporters’ future will put local governments, not the commodities super-cycle, in charge of LDCs’ growth.
Erin Nealer is a Research Assistant with the Project on U.S. Leadership in Development at CSIS.