How to Cope with Volatile Commodity Export Prices: Four Proposals

Countries where exports are relatively concentrated in oil, gas, minerals and agricultural commodities experience terms of trade that are highly volatile. This volatility is one of the possible explanations for the famous Natural Resource Curse.1 The aim in this keynote address is to offer four policy proposals to help countries manage commodity volatility and thereby help make sure that commodity wealth is a blessing rather than a curse. Two of the ideas fall in the area of microeconomic policy: specific financial contracts structured so as to hedge risk. Two of the ideas fall in the area of macroeconomic policy institutions: ways to make fiscal and monetary policy counter-cyclical rather than pro-cyclical.2 It is always hard to make policy proposals that are convincing and at the same time are original. I will try to strike a balance between being convincing and being original. Of the four ideas, two are tried and tested. Two have not been tried much. The question then becomes: why not? Let us first pause to ask: Don’t commodity-exporters already use financial markets to smooth trade fluctuations? If international financial markets worked well, countries facing temporary adverse trade shocks could borrow to finance current account deficits, and vice versa. But they don’t work that well. Capital flows to developing countries tend, if anything, to be pro-cyclical. The appropriate theory usually builds on the assumption that borrowing requires collateral, in the form of commodity export proceeds. The important point for policy-makers is that some careful thought is required to design institutions that can protect against the volatility. Many other policies and institutions for dealing with commodity volatility have been proposed and tried in various countries, some successful, some much less so. Many of the ideas that tend to work poorly can be described as seeking to suppress price volatility rather than manage it. I see them as akin to King Canute commanding the tide not to come in. I am thinking, for example, of price controls, commodity marketing boards, and controls on exports. Better to accept fluctuations in demand and supply as a fact of life, and to devise policies and institutions to equip the economy to cope with them. 1 Brueckner and Carneiro (2016), Blattman, Hwang, and Williamson (2007), Hausmann and Rigobon (2003), Mendoza (1997) and Poelhekke and van der Ploeg (2007). Terms of trade volatility hurts growth in the presence of investment irreversibilities and credit constraints (Aghion, Angeletos, Banerjee & Manova, 2010). Frankel (2012a) surveys the Natural Resource Curse. 2 E.g., Kaminsky, Reinhart and Végh {2005).