Download Security Scenarios And The Global Economy

NS4540
Winter Term 2017
Latin America: Commodities
Commodities: Overview
• Commodities have played a key role in the development
of Latin America
• They are also going to be an important part of the future
• If commodities are a significant percentage of total
exports and GDP, then changes in commodities markets
can have ramifications for the entire economy
• For a country that possesses commodities, there may be
noticeable differences in economic policy from those
countries that are not commodity based
• Commodities can potentially distort the entire structure
of an economy
• For middle income countries of Latin America
commodities can be like dynamite
• Useful if handled with care but
• Potentially dangerous
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Boom and Bust Cycle I
• Commodities in Latin America has a tendency to follow a
boom and bust cycle
• Commodity booms have two sources
• Discovery and widespread use – coffee and tobacco
• Discovery of a new source of supply – gold and silver
• Booms and busts have made economic management and
economic development more difficult
• Price volatility also important factor complicating
economic policy-making and development .
• (% change previous year)
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Commodity Booms in Latin America
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Boom and Bust Cycle II
• Price volatility largely due to inelastic supply and demand
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Commodity Shares
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Boom and Bust Cycle III
• For Latin America as a whole, commodity exports make
up around
• 60% of total exports
• 15% of GDP
• Commodity price volatility translates into volatility in
overall exports
• Since exports represent a relatively high percentage of
GDP, the rate of real GDP growth in many of region’s
countries can be substantially impacted by changes in
commodity prices
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Commodities and Economic Development I
• Successful Process of Commodity-based Development
• First production of commodities can be quite profitable
and a major source of revenues
• In turn revenues can be used to finance infrastructure, schools,
and other development related activities
• Can allow country to grow faster
• Second faster growth may require imports that will
require foreign exchange from commodity exports
• Third country with commodities may find it easier to
transition to manufacturing than country without such
resources
• Some manufacturing activities can add value to existing
resources
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Commodities and Economic Development II
• In practice this scenario has been fraught with difficulties
so common that they are often referred to as the resource
curse
• Since Latin America is a large heterogeneous region not
all of these problems apply to all countries
• However, elements of the resource curse are part of the
economic history of Latin America
• Colonial times motivation for Spanish settlement gold
and silver – little wealth used for economic development.
• Post-Independence era issues center on division of
resource profits between public and private sectors
• Even under ideal circumstances, using commodities to
finance development can create tensions between
producers and the government.
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Commodities and Economic Development III
• Producers of commodities vulnerable to the ability of the
government to take part of the profits earned.
• Governments often see taxing commodities as a relatively easy
way to raise revenue
• Once the revenue has left the private sector, no guarantee it will
be wisely used
• Aside from outright corruption, the problems may be more subtle.
• Revenues from commodities may be used to purchase support
from the population that might not otherwise exist
• Government employment increases faster than if commodity
revenues did not exist
• In short, the production and export of commodities may
not lead to faster economic growth
• Not difficult to image commodity earnings leading to
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relatively slow growth
Commodities and Economic Development IV
• Can see this in Latin America, despite being rich in
commodities region is poor in
• Infrastructure,
• Education and
• Health care
• Things become even more complicated with the
involvement of foreign firms in the production of
commodities.
• Development of commodity may require capital and
technical expertise the country may not possess, and FDI
is needed
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Commodities and MNCs I
• Negotiations between multinational corporations (MNCs)
and the host country may be very difficult
• Especially difficult if the commodity is an exhaustible resource.
• Conditions of entry, tax rates, and other variables can all
influence the final outcome.
• In the Golden Age (1870 to 1914) negotiations were based
on national treatment.
• Foreign firms faced similar taxes and regulations as domestic
firms.
• However with relatively weak governments in region combined
with low taxes and light regulation, national treatment became an
increasingly unacceptable form of regulation
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Commodities and MNCs II
• In other cases export enclaves developed, where MNCs
were receiving preferential treatment rather than national
treatment.
• In the 20th century the balance of power has shifted from
the MNCs to the governments of the region
• Taxes and regulations became stiffer.
• In some cases local assets of the MNCs were expropriated with
varying degrees of compensation.
• Many countries have opted to produce their own
resources using state-owned enterprises (SOEs)
• In theory SOEs allow the country to extract all the value from its
commodities, but in practice this has been proven to be difficult.
• PEMEX in Mexico going through difficult period with high debt
levels and falling production – same in Venezuela and Brazil
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Commodities and Manufacturing I
• Finally, difficult for Latin America and other regions to
leverage their commodities into manufacturing based on
these resources
• Primary problem has been the level of tariffs and in some
cases quotas in developed countries set up to encourage
processing of commodities there
• Done by escalating the tariffs according to the stage of
processing
• Raw commodities often have low or zero tariff
• If the commodity is processed into an intermediate commodity,
the tariff rate rises
• If the commodity is further processed into a finished product the
tariff is even higher
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Commodities and Manufacturing II
• The point of this tariff structure is to import commodities
as cheaply as possible
• The tariff then encourages the processing of the
commodity in the developed country rather than the
developing country
• Makes it difficult for Latin American countries to
establish manufacturing industries based on their
plentiful commodities.
• Not the only factor inhibiting industrial development in
Latin America, but historically it has been an important
factor
• In recent years with trade liberalization tariff rates are
much lower and less focused on value added
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Summing - Up
• For Latin America the possession of commodities has no
doubt made the region better off
• However, it is difficult to say that the potential benefits of
these commodities have been used to their fullest to
enhance economic development
• The resource curse has not afflicted the region as badly
as in other parts of the world.
• On the other hand, traces of this effect are not difficult to
find in the region.
• Two related factors have impacted manufacturing in Latin
America
• The rise of China
• The commodity based Dutch Disease
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Latin America and China I
• The rise of China has been a mixed blessing
• Rapid economic growth in China has created a strong demand
for Latin American commodity exports
• Include oil, iron ore, soybeans, copper, meat, and pulp and
paper
• Until recently China’s demand for raw materials grew at double
digit rates
• Resulting rising commodity prices have had a favorable effect on
the terms of trade for the region
• In this regard the rise of China has been a positive
development
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Latin America and China II
• In another respect, rise of China has created an uneasy
feeling in the region
• China’s growth has been fueled by booming exports of
labor-intensive manufactured goods
• While exports of manufactured goods from Latin America
have grown significantly over the last several decades,
this growth pales in comparison to that of China
• Situation not zero sum, but there is the sense that the
relative success of China has come partially at the
expense of growth in exports from Latin America
• Clearly however, China has benefitted Latin America as in
the past: booming commodity prices
• Cost may be another lost opportunity for the region to
diversify out of its traditional pattern of development.
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Commodities and Dutch Disease I
• If a country has a significant production of commodities
this can affect its industrial structure, not just by using
resources that may have gone to industry, but in more
subtle ways.
• During a commodity boom, profits are high in this sector.
• Acts as a magnet for resources in other parts of the
economy
• Other sectors of the economy may not be able to
compete for capital land are “crowded out” as the price
of capital rises
• Same thing happens with Labor –makes wages outside of
the commodity sector higher and products less
competitive.
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Commodities and Dutch Disease II
• In the boom, scarce resources such as capital and human
capital are being diverted to one part of the economy
• Wages may rise in the entire economy.
• While things are going well in the booming commodity sector,
other parts of the economy are having a more difficult time
growing
• When the bust comes, difficult to reverse the process
when resources released from the commodity sector
• Other parts of he economy cannot grow fast enough to absorb
these resources
• In addition many of the physical and human resources may have
become sector specific and not easily transferable to the noncommodity sector
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Commodities and Dutch Disease III
• How important these effects are depends on how
important a commodity is to the economy
• The effect of an oil boom would be much greater in
Venezuela than in Mexico which has a much more
diversified economy
• Commodity boom can also affect the exchange rate
• Increases in the demand for the commodity during a a
boom translates into a demand for the local currency
• Causes exchange rate to appreciate – makes
• Imports cheaper – increases the relative prices of domestically
produced goods that compete with imports
• Exports of goods and services other than commodities become
more expensive for foreign buyers
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Commodities and Dutch Disease IV
• In total, a commodity boom means a more difficult
environment for the tradable goods sectors of the
economy
• Booming commodity sector leads to more imports and
lower domestic production
• Effect can be exacerbated if the booming sector is also
pulling FDI into the country for its development
• This puts additional pressure strengthening the
exchange rate
• Process referred to as the Dutch disease, because
happened in that country with natural gas in the late
1950s
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Commodities and Dutch Disease V
• To a greater or lesser extent, the effects of the Dutch
disease are easy to find in Latin America.
• Commodity booms have attracted more resources into
those parts of many economies with lasting effects on
industrial structure
• Adjusted for productivity, wages in Latin America tend to be high
• Latin America has a history of overvalued exchange rates
• This has encouraged imports and discouraged exports of
products other than commodities
• These effects have been felt most strongly in the manufacturing
sector of he region
• Dutch Disease can’t account for all the problems in Latin
American industry, but is an important component.
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