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Challenges and policy responses

Farmers and countries that depend on commodity exports have to contend with the long-term decline and short-term volatility of real commodity prices on international markets. The long-term decline in real prices reflects the tendency for productivity and production to grow at a faster rate than demand. Volatility reflects the impact of exogenous factors such as the weather. These problems are exacerbated by market distortions, arising from tariffs and subsidies in developed countries, tariffs in developing countries and the market power in some commodity supply chains of large transnational corporations. These distortions also limit access to lucrative markets and hinder attempts to secure a greater share of the final product price on the part of producers and exporting countries.

Production gains outstrip demand

Average yields for the major agricultural export commodities increased by almost one-third over the past two decades. At the same time, major new producers entered the market for several commodities - Viet Nam and coffee, for example.

While increased productivity and new producers fuel rapid increases in supplies, demand for commodities rises slowly, even in the face of falling prices and rising consumer incomes. In the 1990s, trade in primary commodities grew at less than one-third of the rate for trade in manufactured goods.

Volatility in international commodity prices can blur longer-term price trends that should lead to adjustments in supply and demand. Furthermore, on the supply side, farmers cannot scale production up or down quickly when prices change, especially where perennial crops are concerned. Production, therefore, can be maintained even in the face of falling prices, exacerbating problems of market imbalance. On the demand side, lower prices generally do not stimulate consumers in developed countries to increase their purchases of foods and other commodity-based products significantly. Many commodity-based products are viewed as necessities that must be purchased regardless of variations in the price. In any case, changes in commodity prices can be barely perceivable at retail, as the price of basic commodities typically represents a small fraction of the final retail price for processed goods. In developing countries, where the degree of processing may be smaller, demand for the basic product can increase more quickly in response to lower world prices. In many of these countries, however, a variety of policy interventions may imply that domestic prices do not reflect world price trends.

Coping with problems of oversupply

In the 1970s and 1980s, governments attempted to address commodity price problems through international commodity agreements (ICAs) to stabilize prices. The ICAs relied on export quota agreements or stock management, but are generally regarded to have failed in their mission of maintaining stable, remunerative prices. By the end of the 1980s most had disbanded or had shifted their focus to exchanging information and improving market transparency.

The collapse of commodity prices in the late 1990s revived interest in controlling supplies through "producer-only agreements". In the case of coffee, for example, producing countries forged an alliance that attempted to hold back exports and push up prices. Maintaining discipline among members proved difficult, however, particularly when faced with aggressive competition from non-member "free riders".

The difficulties of sustaining cooperative market interventions have stimulated interest in price insurance, forward-pricing systems and other schemes to manage the risks of commodity price volatility. While promising, the institutional arrangements for their widespread application remain to be established.

In the long run, oversupply of some commodities can best be eliminated by reducing production in highly protected and high-cost markets while simultaneously improving demand through poverty alleviation and income growth in poorer countries. In developed countries this implies taking land and labour out of production of oversubsidized commodities and enabling producers to shift to other sources of employment and income. In markets free of tariffs, subsidies and other distortions, the first producers to exit should be those with the highest production costs. In some cases, such as cotton, sugar, dairy and rice, these may be farmers in the EU or the United States who have benefited from ample subsidies, rather than farmers in LDCs who strive to produce high-quality products at lower cost. However, the elimination of OECD farm support will not automatically lead to increased exports from LDCs. The main immediate beneficiaries are likely to be non-subsidizing developed country exporters and some of the more advanced developing countries.

Diversification can provide producers in developing countries with a way to escape from dependence on commodities for which supplies have outgrown demand. However, this can happen only if farmers have a wide range of alternative options, including higher-value crops, processing of basic commodities into value-added forms, and non-agricultural activities. Furthermore, diversification requires access to the credit, training and other resources they would need to take advantage of these opportunities.

Several developing countries have become successful exporters of fruits, vegetables and other non-traditional products. For the most part, however, it has been large-scale commercial farmers in countries with more developed infrastructures who have benefited. Small producers and the LDCs have been less able to mobilize the investment and training required to shift to new crops and meet the high quality standards and strict delivery deadlines of supermarkets. Building the institutional structures that will help smallholders to participate in these developments is a challenge that remains.

Processing basic commodities into value-added forms is another way in which producers can diversify and increase their share of the final product value. The difference in value between the basic commodity and the consumer product can be large. However, opportunities for such vertical diversification are often blocked by tariff escalation, particularly in developed countries, and by barriers to entry arising from concentrated market structures.

Demand-side solutions for oversupply problems

Problems of oversupply can also be addressed from the other side of the market, with measures aimed at boosting demand in consuming countries.

Generic promotion campaigns have proven effective in stimulating demand for some commodities. Unlike advertising for specific products and brands, generic promotion aims to increase aggregate demand for a commodity such as bananas or tea. A long-running campaign promoting bananas as a source of energy contributed to a threefold increase in consumption in the United Kingdom, making them the most popular fresh fruit in the country.

Similar generic promotion campaigns could boost consumer demand for other commodities. Without careful analysis and planning, however, processors and retailers may reap most of the benefits, leaving little or nothing for farmers in developing countries. Finding an institutional manager for such programmes and a means of financing them that minimizes free-rider problems can also be a challenge.

Consumer concerns about food safety, environmental issues and social justice have created another niche of opportunity. Farmers selling certified organic and "Fair Trade" products tend to enjoy better market access and higher prices than conventional farmers. While the market share of certified foods remains small, sales of these products have been growing steadily and rapidly. Certification can also bring further benefits to farmers in enhancing their bargaining position and access to credit.

Despite these benefits, small-scale farmers in developing countries face many obstacles when trying to take advantage of social and environmental certification. Conversion to organic farming requires investment and training. At least initially, it may also raise production costs and reduce yields.

While farmers may be able to recoup their investment by selling to premium markets, the certification process itself can be costly, especially for small farmers in developing countries that lack local certification bodies and must rely on foreign agencies. Extensive requirements for record-keeping and traceability may also pose serious problems for small-scale producers. As a result, some certification programmes tend to favour large commercial farms. The Fair Trade system, which was established specifically to help small producers in developing countries, currently reaches a very limited market in developed countries.

Eliminating market distortions

Problems of oversupply on world commodity markets have been exacerbated by government policies and market concentration. High agricultural tariffs and producer subsidies in developed countries limit market access and depress commodity prices. Developing country markets for agricultural products are the fastest-growing but are also generally heavily protected.

In many cases, domestic support insulates farmers in developed countries from market forces, encouraging them to expand production even when prices are low and allowing them to export at prices substantially below their costs of production. The United States and the EU rank as the world's largest exporters of cotton, wheat, maize, skim milk powder and sugar. These commodities are exported at prices below those that would prevail under undistorted markets, and in some cases at prices below production costs.

With world market prices defined at these artificially low levels, farmers in developing countries suffer from lost market share and unfair competition in local markets. Subsidies also distort the cost structures in several producing countries and give less-efficient producers an incentive to expand production. The burden of oversupply is transferred to farmers in developing countries, even though they are able to produce at lower costs. At the same time, liberalization could have a negative impact on food-importing developing countries, as the removal of tariffs and subsidies would lead to higher food prices and import bills.

Control of commodity value chains by a small number of powerful corporations can also drive down commodity prices and erode the share of the final product price that goes to producers. When markets bring together large numbers of competing suppliers against a handful of large-scale buyers, the buyers are likely to have most leverage in setting prices. When the buyers are also linked to processors and retailers in vertically integrated commodity chains, they are in a strong position to capture a greater share of the value of the final product for traders, processors and retailers. On the other hand, it must be acknowledged that given, the substantial economies of scale present in most segments of the food industry, links between large transnational companies and small producers may offer a way out of marginalization for poor rural producers in LDCs.

Studies have shown that when commodity prices rise, the higher price is quickly passed along to consumers. But when commodity prices fall, retail prices rarely follow suit. Since the early 1990s, for example, even as coffee prices have plummeted, the value of global retail sales of coffee has more than doubled. The share of those sales received by coffee-exporting countries fell from around 35 percent to less than 10 percent.

An agenda for action

Addressing problems of oversupply and eliminating market distortions will require a variety of actions at the national and international levels.

In the context of the WTO negotiations, priority must be given to reducing agricultural tariffs, producer support and export subsidies in developed countries and to eliminating tariff escalation that penalizes exports of processed goods from developing countries. At the same time, developing countries should reduce tariffs in order to encourage trade among developing countries and to allow their consumers to benefit from lower world prices. Special attention must be given to the LDCs, many of which depend heavily on commodity exports and food imports. Measures that could be taken to help developing countries take advantage of commodity markets include:

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