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African Commodity Dependence and Performance Since 2011

Discussions

African Commodity Dependence and Performance Since 2011

John Stuart, tralac Associate, discusses African countries’ commodity-dependence and adjustment in the wake of a post-commodity price boom

Theory and experience has taught us that over-reliance on the production and export of primary goods, or commodities, can lead to a complex of economic problems and retard development. Economic theory talks about the condition known as the ‘Dutch Disease’, which affects countries that are relatively well endowed with natural resources. In the course of extracting and exporting these resources, the country – rather than experience increasing levels of prosperity – instead experiences a loss of competitiveness in its non-traded and traded manufacturing sectors with consequent deindustrialization.

There are other potential pitfalls of commodity specialization, immiserizing growth occurs when the rapid exploitation of a resource-based export drives down its world price enough to worsen the exporter’s terms of trade (TOT) and reduce its potential domestic consumption levels. Another driver behind falling TOT for commodity exporters is the fact that demand for manufactured goods tends to rise faster with prosperity than the demand for commodities. Technology simply permits ever-increasing efficiency of the productive use of commodities, or even allows the creation of synthetic substitutes, and this tends to depress commodity prices relative to those of manufactured goods.

Looking at the data over time, it does appear as if there is a loose relationship between commodity specialisation and growth potential relative to manufacturing specialists. The classic example is that of the South-East Asian ‘Tigers’ – nations such as Taiwan and South Korea that transformed from commodity exporters to manufacturers in the 1980s, emulating Japan’s path to prosperity. By contrast, nations that remained as commodity exporters over the same period tended to grow far more slowly as a group.

Besides being less ‘dynamic’, commodity specialists also face far greater price volatility for their exports. Commodity prices have tended to demonstrate two major characteristics over time – a long run deteriorating trend and regular episodes of volatility. In other words, instead of maintaining a stable (if declining) rate of growth, commodity prices go through periods of strong positive growth followed by strong negative growth – a price cycle where each ‘up’ or ‘down’ phase lasts several years. The recent oil price spike of the 2000s is a good example, albeit an extreme one. This destabilises the export earnings of commodity exporters and tends to lead to a ‘hangover’ when prices come off the boil and start to decrease. Sometimes the exporting country has used the price windfall to splash out on domestic expenditure and has not built up reserves or run a budget surplus (or even a balanced budget). This then results in a crunch period following the price boom, where fiscal budgets go strongly into deficit, borrowing costs rise, taxes must be raised, balances of trade go into deficit and foreign exchange reserves come under pressure.

Many African countries are commodity specialists and have experienced exactly these conditions; some are experiencing them as we speak. The question could be asked as to why these patterns repeat so often, as indeed the data shows. Usually when markets go into boom phases, market players ‘forget’ that the boom is necessarily temporary and do not hedge against a future reversal of the current conditions. Failing to learn from history mean history is destined to repeat itself and so it often does.

Certain factors exacerbate the pain of adjustment to a post-commodity price boom. These relate to the export and industrial structure of the country. The adjustment costs tend to be higher:

  • The greater is the proportion of commodities in total exports

  • The fewer commodities there are in the export bundle (the degree of concentration)

  • The less diversified is the economy overall, ie the narrower the range of domestic industry types

  • The more dependent the country is on imports, ie the less ability the country has to switch out of imports, when foreign earning drop, into locally-produced substitutes.

Unfortunately many African countries exhibit exactly these listed characteristics. Figure 1 below provides some data for Africa for the period since 2011, which was when the commodity price cycle was observed to reach a turning point. The left-most bar shows that Africa’s average share of primary commodities is 77%, the highest average in the world. Africa, as a continent, is effectively the world’s commodity specialist.

The second bar shows that on average, Africa’s TOT deteriorated 3% from 2011 to the end of 2014. This appears to be a relatively small change, but the third bar shows that Africa’s export unit value (a type of export price deflator) fell 8% in the same period – a relatively large fall. This implies that Africa’s import prices also fell over this period, but to a lesser extent than export prices. Given the general slowdown in the world economy since the ‘second’ recessionary dip in 2011, this is to be expected.

The fourth bar is also of concern. It shows the average deterioration in the merchandise balance of trade over the period 2011 to 2015. At 21% this is a large deterioration, putting countries under pressure to cover their imports and sometimes necessitating interest rate hikes as we have seen here in South Africa.

Stuart Figure 1 June 2016

Finally, GDP growth for Africa over the period 2011 to 2014 has been approximately 15%, meaning just over 3% compounded annually. This shows the impact of the commodity price cycle downturn on general economic progress. Trade’s effect on growth is important, with Africa being relatively open to trade – openness for the continent, for goods and services trade in total – is around 84% of GDP.

To better understand these patterns, it is possible to break the data down by main industrial sector. Although this requires some averaging, the countries of the continent can be roughly divided into fuels specialists, mining specialists and the remainder – which although they are still majority commodity specialists, export a wider range of items and are therefore called ‘diversified’. This data is shown below in Figure 2. The diversified countries’ exports are made up of 57% commodities, as opposed to 85% for mining specialists and 95% for fuels specialists. The latter two groups are therefore ‘extreme’ specialists and face risks as a result of this lack of diversification of their exports.

Stuart Figure 2 June 2016

The fuels group has clearly experienced a large drop in the value of their exports, evidenced by the very large worsening of the average BOT deficit - by 97% over the period 2011 to 2015. The other two groups have shown much smaller BOT deterioration, despite deterioration in their TOT and export unit values. All countries, though, have experienced muted growth in this period. It is also interesting that the diversified group has not performed better than the specialist groups, despite having a smaller overall share of commodities in their exports. This group is the most open to trade, and could have been expected to have done better if only commodities were impacted by lower global demand. However, the unit value aggregate for the diversified group also indicates falling prices over the period, suggesting that demand for their exports has fallen. Secondly, it is not enough to be less concentrated on commodity exports; a country also needs to pay attention to the type of alternative industries it invests in. These need to show higher value added performance than commodities, or else the impetus needed to accumulate capital domestically, for reinvestment into infrastructure, divers industry and human capital, will not be generated.

The structural characteristics of economies cannot be changed overnight and the risks to growth faced by the economies of Africa remain for now. However, there are certain policy tools available to governments to help mitigate commodity dependence and the commodity price cycles. Ultimately, the poor recent performance of Africa’s commodity specialists might be a blessing in disguise if it can refocus policy on developing secondary and tertiary industries. Rather than a ‘one size fits all’ approach, policy for the countries of Africa should be finessed to the specific needs of each unique country. This issue will be addressed in a forthcoming tralac working paper by this author.

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