International trade in commodities is characterized by excessive price fluctuations, declining export earnings for producer countries, vulnerability to fluctuations in export earnings, restrictions on access to markets, reductions in the variety of commodities produced, limitations on the degree of processing of commodities by the producers, declining competitiveness of natural products, inadequate market structures, marketing and distribution systems.
Instability of commodity prices, and associated fluctuations in earnings, pose a number of problems for developing countries. Price instability may make it difficult for producers to take rational investment decisions and may therefore lead to losses of real income through misallocation of productive resources. It may also weaken the competitive position of natural products against synthetic or other substitutes supplied at more stable prices. Fluctuations in producers' incomes and foreign exchange earnings may destabilize the economy through their influence on savings and consumer spending and through their disruptive effects on import budgets and development plans. The effects are usually self-cancelling except in the case of countries highly dependent on only one or two unstable commodities.
The greater concentration of developing countries production and exports in primary products makes their economy more vulnerable to external factors than that of industrialized countries. The world economic recession of 1980s has been transmitted from the developed countries to the developing countries to the large extent through commodity prices. Declining prices of commodities have increased the debt burden and impaired the ability to both maintain imports and service their debt.
Primary commodities account for most of the total exports of developing countries. Unlike world demand for processed foodstuffs and manufactured goods, demand for most primary commodities is relatively price-inelastic, with the consequence that prices of these commodities tend to be highly sensitive to changes in supply. The supply of primary commodities, moreover, is generally much less responsive than that of processed commodities to change in prices in the short run. For these reasons, and also because of the influence of random factors such as variations in harvests and strikes, prices of primary commodities often show considerable fluctuations both in the long and short-term. All these factors make the economies of developing countries extremely vulnerable to conditions outside their control. In addition, the primary commodities face a sluggish import demand in the countries that constitute their major markets, particularly where substitutions may be made, such as synthetics for natural commodities.
Trade in primary commodities has long been characterized by market instability. In post-war years, the value of trade in individual commodities has been subject to year-to-year fluctuations. Instability indices for price and export earnings of non-fuel primary commodities of developing countries are about 12 and 14% respectively for 1961–1980. Agricultural products experienced higher instability in both price and value. Since the early 1970s, instability has been intensified drastically. Gross shortfalls in export earnings for the basket of primary commodities exported from developing countries amounted to about $45 billion during 1973–1982. World Bank calculation in the mid-1980s showed that the price of all groups of commodities from foods to metals has been declining by about 1% a year in real terms over the last 35 years. Since the early 1980s, commodity prices have fallen to their lowest levels in 50 years with little hope of any improvement.
The instability of world markets for primary commodities is a general phenomenon; although there are significant differences in its incidence and magnitude, it is not confined to commodities of a particular nature nor to the trade of particular countries. Thus, among the commodities whose value on world markets has been least stable in recent years are many which only come to a relatively small extent from the developing countries: tallow, lard, wool, zinc, lead, soya beans. Nevertheless, many of the commodities of which the developing countries are the sole or chief suppliers (natural rubber, fibres, cocoa, coffee) have been among the least stable in terms of export value movements. The degree of instability is appreciably greater than is evident in markets for other products.
The instability in commodity export earnings is higher for individual countries and is caused mainly by volume instability. The instability may cause variations in incomes and, hence, in domestic expenditure on consumption or investment. It may also give rise to fluctuations in external purchasing power and, hence, in supplies of imports available for consumption or investment. These consequences pose numerous difficulties for national policy formulation extending beyond the immediate impact of the fluctuations in export proceeds upon public revenue. The fluctuations may result in immediate hardship to the small producers characteristic of many of these commodities, creating socially unacceptable inequities in distribution of income. Importation of supplies of capital equipment for integrated development programmes may be interrupted. The incentive to invest may be weakened or switched from long-term industrial ventures to short-term commercial investments. The credit-worthiness of the country, in the eyes of foreign governments and international banks, tends to be weakened as instability in the commodity market could lead to debt default and thus to destabilization of the world financial market.
Developing countries' long dependence in primary product exports and their lack of human and financial capital weakens their position vis-Ã -vis developed countries in processing domestically and externally locally-produced primary commodities. The development of commodity-related manufacturing and services sectors by developing countries is needed in view of the declining terms of trade of primary commodities vis-Ã -vis those of manufactured commodities, in view of the need to increase value added and in view of the state of the international trading and financial system characterized by protectionism and by obstacles to access foreign capital. This is particularly important for the cases of coffee, cocoa, tea, bananas, rubber, iron ore, bauxite, phosphates, sugar, manganese, hard fibres, hides and skins.