Wednesday, December 8, 2021

Commodity dependence: Developing countries’ nightmare

CDDCs need to go through a process of technology-enabled structural transformation whereby new sectors such as manufacturing and high-value services become more important, making commodities less central to the economy.

The UNCTAD Commodities and Development Report 2021 titled “Escaping from the Commodity Dependence Trap through Technology and Innovation” acknowledge that in 2018 – 2019, 64 percent of developing countries were commodity dependent compared to 53 percent for transition economies and 13 percent for developed countries.

The report laments that “the prevalence of commodity dependence does not seem to improve over time. If anything, commodity dependence increases over time. In 2008 – 2009, 60 percent of developing countries were commodity dependent, four percentage points lower than for the period 2018 – 2019.

“Over the same period, commodity dependence increased also in transition countries from 47 percent to 53 percent, and in developing countries from 10.5 percent to 13 percent, even though the absolute number of commodity dependent countries is much lower in developing countries”.

According to the report, a country is commodity-dependent when it derives at least 60 percent of its merchandise export revenues from the commodity sector. At current contribution of around 70 percent of Botswana national revenues coming out of the diamond sector, Botswana is classified as a commodity-dependent country.

Commodity dependence is not simply about being dependent or not. The extent to which a country is commodity-dependent matters. A country deriving more than 80 percent of its merchandise export revenues from the commodity sector is more exposed to the challenges of commodity dependence than one that derives 60 percent.

The analysis of commodity dependence is important for two major reasons. First, CDDCs seem to be in a trap: once a country is commodity dependent, it is difficult to develop a productive sector out of commodities and export non-commodity products.

If countries were able to move in and out of commodity dependence seamlessly, being commodity dependent would be a less issue. Hence, trying to understand how countries could get out of the commodity dependence trap is relevant for development policy.

Secondly, relative to non-commodity dependent countries, CDDCs suffer from unpredictable export revenues due to high commodity price volatility; declining terms of trade over the long term; macroeconomic instability due to high trade and budget deficits and unstable exchange rates.

Moreover, an overvaluation of the exchange rate following commodity discoveries or commodity price booms has led to Dutch disease in many commodity dependent developing countries.  

Dutch disease renders non-commodity exports, particularly manufacturing exports, less competitive, making the affected country even more reliant on the export of a single commodity or a limited number of commodities.

According to the report, between 1995 and 2017, the average share of manufacturing in the total value added of CDDCs declined from 11.5 percent to 10.4 percent.

It is also reckoned by the report that macroeconomic challenges associated with commodity dependence have led to difficulties for households and firms. For instance, due to macroeconomic instability in commodity dependent developing countries, firms operate in a difficult economic environment, resulting in low profitability.

Commodity dependent countries that depend on agriculture commodities suffer from low producer prices, negatively affecting household incomes and aggregate demand in countries where most of the population live in rural areas.

Commodity dependent countries are also less integrated into commodity value chains. In fact, the role of most CDDCs is limited to the production of a raw commodity, with all value adding activities taking place outside the countries..

This may explain why CDDCs that produce strategic commodities, such as oil and cobalt, remain some of the poorest in the world, even though the commodities they produce generate billions of dollars for other value chain participants, such as importers, refiners, retailers and so on.

CDDCs are also vulnerable to shocks, including shocks related to climate change. Indeed, commodity dependence has been shown to amplify the negative effects of climate change, as documented by a recent UNCTAD report.

Of the 40 countries vulnerable to climate change, 37 (92.5 percent) are commodity dependent developing countries. Moreover, most recently, the coronavirus pandemic has highlighted the vulnerability of commodity dependent developing countries to an international health shock.

A simulation analysis carried out by UNCTAD and the Commonwealth Secretariat assessed the impact of the pandemic on commodity exports from Commonwealth countries, show that, compared with business-as-usual, commodity exports to Australia, China, the USA, Great Britain and Northern Ireland and the European Union were expected to fall by between US$72 billion and $98 billion in 2020, representing an export loss of 16.5 percent to 23.8 percent relative to the benchmark.

Given the commodity dependent trap, transition analysis confirms that CDDCs are indeed “trapped in commodity dependence state. Unless there is strong action at the highest political level in commodity dependent developing countries to do things differently, the analysis shows that they will remain trapped for centuries”.

Secondly, econometric analysis suggests “that technology and innovation could, indeed, help commodity dependent developing countries to diversify their economies and become less dependent on the commodity sector.

“This could strengthen productivity growth, which has been stunted in CDDCs. Technology and innovation could lead the way to economic and structural transformation in CDDCs.

A careful space product analysis shows that some non-commodity products that CDDCs could indeed start to produce competitively to help diversify their export basket.

The analysis also shows that there are available technologies from the third and fourth technological revolutions, as well as digitalization that could help CDDCs to move out of the commodity sector trap.

Producing more technologically advanced goods would “imply access and adoption of new technologies, as well as embracing innovation”, which would require international cooperation.

To enable CDDCs to escape from the commodity dependence trap, “there needs to be stronger cooperation between commodity dependent developing countries and their trading partners, as well as development partners, in terms of technological acquisition and domestication”.

Hence, a conducive framework for technology accessibility and technology transfer to commodity dependent developing countries is needed at the international level. With respect to CDDCs, “they would need to initiate or strengthen their institutional capacity to absorb and domesticate new technologies.

“It is, therefore, clear that finding an answer to the ills of commodity dependence afflicting CDDCs is just not the responsibility of this group of countries. Left alone, as has been the case in the recent past, they will not succeed”.

However, the study has also found that breaking away from commodity dependence is difficult. It requires strong political will and long-term commitment, with adequate human, financial and institutional resources.

Using several technology indicators, suggestive evidence is provided that the adoption of relevant technologies, as well as innovation, may help CDDCs “to develop a productive sector beside the commodity sector, diversifying the economy and reducing these countries’ strong dependence on commodities”.

As a potential long-run driver of rising real incomes in developing countries, labour productivity growth is an important development indicator that is firmly rooted in the Sustainable Development Goals (SDGs) framework.

Improvements in labour productivity across sectors and productivity-enhancing structural change are key determinants of economic diversification and economic growth in CDDCs.

Empirical results show that commodity dependence is associated with low levels of labour productivity, slow productivity growth – particularly in the manufacturing sector – and a high frequency of negative productivity shocks.

Hence, breaking away from the commodity dependence trap “can help spur economy-wide labour productivity growth, for which there remains a large potential in CDDCs, it is necessary to strengthen broad-based drivers of productivity growth, such as technological upgrading, but also use targeted measures to remove sector-specific obstacles for productivity growth”.

For example, technological upgrading and innovations that can spur productivity growth need to be enabled and promoted through the development of adequate infrastructure, including digital infrastructure.

It is reckoned by the report that the distribution of export production complexity of CDDCs shows the technological capabilities available in those economies and finds that CDDCs are indeed very far from the technological frontier.

Given that CDDCs have made minimal gains in terms of technological development, “large jumps in product complexity are needed to close the technological gap from which they are suffering

“This will require strong government intervention to build absorptive capacity and put in place the required conditions to introduce higher-technology productive systems in the economy. Seen from a different perspective, the large technological gap between CDDCs and other groups of countries is an indication of the substantial opportunity the former could take advantage of to increase their technological capabilities”.

The report further acknowledges that technological revolutions offer the possibility of new combinations (innovations), sometimes leading to new technological-economic paradigms.

The current (digitalization) and emerging (Industry 4.0) technological revolutions are expected to change commodity sectors and related global value chains, with a potentially significant impact on CDDCs.

Even though CDDCs may not be ready to deploy 4.0 technologies, there are ways of taking advantage of them. Harnessing these technologies could help CDDCs to diversify and structurally transform their economies.

For example, every technological revolution has been associated with specific commodities, with the current 4.0 fuelling industries, such as renewable energy, robots, drones and the like, that rely on commodities including cobalt. Lithium, rare earths and so on.  

CDDCs have an opportunity to gainfully play a bigger role in the value chains of these strategic commodities. Digitalization has the potential to drastically reduce transaction costs associated with commodity trade, enabling CDDCs to become more efficient and capture more value out of their commodities.

Moreover, blockchain technologies can increase transparency in commodity value chains, helping to increase product information, accountability and risk management and fostering responsible consumption and production.

By increasing traceability, blockchain can also link consumers and producers more directly, potentially increasing the tangible value of a product. Product traceability made possible by blockchain cal also help to differentiate “high quality” from “low quality” products, allowing price differentiation that benefits producers who invest in the production of high-quality commodities.

“Should CDDCs miss these opportunities, they will be left behind and remain trapped in commodity dependence and underdevelopment”, concludes the report.

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