The Falling Commodity Prices, Global Recession and the African Economies
Dr. Wolassa L. Kumo
December 14, 2008
1. Introduction
The unprecedented commodity price boom that began in October 2001 and that lasted for more than seven years came to an end in July 2008 amid slowing global economic growth. According to the World Bank´s Global Economic Prospects 2009, overall, global GDP growth is projected to decline to 0.9 percent in 2009 while growth in developing countries will fall to 4.5% from 7.9% recorded in 2007.
Slower GDP growth and decelerating global trade, as measured by falling global export volumes, put heavy pressure on commodity prices. In addition to these, increased supplies and revised expectations played a significant role in pushing the commodity prices down. Commodity prices reflect forward- looking expectations. Therefore, the expectations of sharp decline in global economic growth in 2009 is believed to be the main driver behind falling commodity prices than the little changes in underlying demand and supply conditions (World Bank, 2008).
As a result, the prices of major commodities such as oil, metals and food have fallen sharply since June 2008. The most dramatic decline is observed in the price of oil which plummeted from an all time high of $144 during the boom to just below $40 in early December, 2008. The price of Brent crude fell to $39.57 on 5 December 2008 for the first time since January 2005. Currently, the price is hovering around $43-$46 range, which is a four year low.
Moreover, the prices of some metals have already fallen to pre-boom levels and the dollar price of many internationally traded foods has fallen back to their 2006 levels. While slowing economic growth is expected to exert further downward pressure on commodity prices in the short run, they should however, remain higher than they were in the 1990s. Real food prices are projected to decline by 26 percent between 2008 and 2010, energy prices to fall by 27 percent, and metals prices to decline by 32 percent (World Bank, 2008).
While the end of the commodity price boom is a relief to commodity importing African countries, it is a sad news for the African exporters. The higher and persistent GDP growth in sub Saharan Africa since 2001 has been anchored by the commodity price boom. The abrupt end of this boom, in mid 2008 could have serious consequences on the continents´ over all future growth performance.
2. The Falling Commodity Prices and the Prebisch- Singer Hypothesis
Prebisch and Singer argued in 1950 that the price of commodities relative to that of manufactured goods will tend to decline over time. The theories of declining commodity terms of trade maintain that commodities have a relatively low income elasticity of demand compared with the outputs of other sectors and hence that the relative price of commodities declines as world income increases; that technical progress in manufacturing tended to be raw material saving, lowering the demand for commodities over time and the pace of the productivity growth in agriculture and mining sectors has been higher than in other sectors. Based on Grilli and Young Index, which aggregates the prices of 24 primary commodities exported by developing countries, the updated index for 2006 indicated that real commodity prices have overall appeared to have declined over the past century (O´Connor and Orsmond, 2007).
Due to the unprecedented nature of the commodity price boom that just ended, it seemed that the time of declining commodity terms of trade was over. The unusual nature of the boom was behind such thoughts. For instance, Bryson (2008) stated that the length of the uptrend in commodity prices which has been in place since October 2001 was unprecedented and this upswing has coincided with a very strong global GDP growth that has been driven at least in part by the forces of globalization. The upswing continued even after global GDP growth has started to slow down since August 2007 until June 2008 when the commodity prices began their downward spiral.
Further more, O´Connor and Orsmond (2007) argued that the commodity price boom (just ended) was unusual in several ways. It has been large and rapid and in this respect is paralleled by only two other periods during the last century. One was the price boom in the mid 1930´s , which largely reflected the recovery from the sharp declines during the Great Depression – and the other the commodity price rise in the 1970s that was driven by world demand and the temporary supply shortages of certain food and non-food items at the time.
In addition, the World Bank (2008) states that the strength, breadth and duration of the current commodity boom have prompted speculation that the global economy is moving into a new era characterized by relative shortage and permanently higher (even permanently rising) commodity prices.
The Bank argues further that this outcome does not appear likely. Slower population growth and weaker income growth are projected to cause trend global GDP growth to ease and with it the demand for commodities. However, the extent to which the commodity demand does slow and how easily supply is able to keep pace with demand depends on the policy environment, the pace of technological change, and external factors such as climate change (World Bank, 2008).
Some argue that the current sharp downturn in the commodity prices may not be an end of the commodity price boom. It may be a temporary adjustment on the path of a boom that may continue for many more years to come. According to Rogers in Dorsch (2008) the 20th century has seen three secular bull-markets in commodities from 1906-1923, and from 1933-1955, and 1968-1982, spanning an average of 15-years and the current "Commodity Super Cycle" has many more years to run, albeit with some nasty corrections along the way.
This implies that the commodity price booms follow normal economic cycles and that when the global economy recovers the commodity prices will rise again. However, it is difficult to predict whether they will reach the level of their 2001-2008 "Super Cycle" any time soon. In any case, many agree that even if the commodity prices fall dramatically in the short run, they will never settle below the 1990s level due to an ever increasing cost of production.
This does not mean that commodity prices always rise during a boom. After WW I commodity prices were depressed despite the post-war booms. The reason is that the war had created an excess supply that that took years to balance out (Jackson, 2008). On the other hand, recent booms in China, the US, India have driven up commodity prices while the current global slum is pushing them down.
However, the casualty could be bidirectional and non linear. The increased commodity prices due to economic boom could lead to economic downturn, which could in turn depress commodity prices. Although the current global economic slum is caused by financial crises, increased input cost might have aggravated the economic problems of firms.
On the other hand, when improved technology keep commodity prices stable even as demand increases significantly the Prebisch-Singer theory of declining commodity terms of trade holds.
3. The impact of Global slump and falling commodity prices on the African economies
Due to the credit crunch and risk aversion, investment growth in the developing world is projected to fall from 13 percent in the 2007 to 3.5 percent in 2009, deeply significant because a third of GDP growth can be attributed to it while world trade will contract by 2.1 percent in 2009 for the first time since 1982 (World Bank, 2008).
All countries will be affected by this drop in exports, which reflects not only the sharp slowdown in global demand, but also the reduced availability of export credits.
In Sub-Saharan Africa, growth expanded to 5.4 percent in 2008, and is expected to fall to 4.6 percent in 2009. But the contribution of net exports to African GDP growth may fall, and many countries are exposed to terms-of-trade shocks. Higher food and fuel prices have also widened the poverty gap, raising the risk of social unrest (World Bank, 2008).
The global recession will also affect the African economies through a number of other channels. These include: lower commodity prices, slackening remittance receipts, falling FDIs and reduction in aid flows.
Focusing on the commodity prices, it is anticipated that the falling prices are bound to harm the African economies seriously. Coupled with the falling volume of exports (due to contracting global trade), the falling commodity prices may lead to a sharp rise in current account deficits and further depreciation of local currencies in the continent. This could offset the positive impact of falling commodity prices on domestic inflation and may push the African economies into stagflation- inflation with economic stagnation. This may happen if the current very low levels of oil and metal prices continue for a longer term.
On the other hand, the fall in the prices of food commodities will provide a relief to many African countries. High food commodity prices have had a profound impact on poverty, pushing 130 to 155 million people below the poverty line just between December 2005 and December 2007. The worst impact was in urban areas. While government policies reacted swiftly to offset the worst effects of the higher prices, many of these efforts were poorly targeted and expensive (World Bank, 2008).
The falling food prices therefore will improve the position of the African governments to tackle the scourge of poverty provided that the governments care about the people.
4. Concluding remarks
Globally, economies are facing credit-fuelled economic downturn which is accompanied by falling equity and commodity prices. In 2009, growth in developed countries is projected to be negative while developing countries will witness a significant decline in growth to 4.5% from 7.9% in 2007.
The global economic slump is bound to hit the African economies harder than other developing regions. The global recession will affect the African economies through a number of channels. These include, falling commodity prices, slackening remittance receipts, falling FDIs and reduction in aid flows, among others.
The sharp fall in non-food commodity prices may lead to a sharp rise in current account deficits. This could in turn trigger further depreciation of already weakened currencies and may offset anti inflationary gains resulting from falling commodity prices. A prolonged global slump may lead to stagflation in Africa.
While developed and emerging economies are willing and capable of bailing out their beleaguered financial and real sectors with billions of tax payers funds, sub Saharan Africa can not think of any substantial bail out for any sector due to limited funds. The only practical bailout for the African economies is the faster recovery of the global economies.
References
Bryson, JH. 2008. Commodity Prices in Historical perspective. Wachovia Economics group. May 2, 2008. http://www.wachovia.com/
Dorsch G. 2008. Commodity Super Cycle: Ready to Rumble in 2008. January 3, 2008. http://seekingalpha.com/article/58881
Jackson, G. 2008. US economy, commodity prices and the trade cycle. April 7, 2008. http://www.brookesnews.com/
O´Connor J and Ormsond D. 2007. The recent rise in commodity prices: a long run perspective. RBA Bulletin, April, PP 1-9
World Bank, 2008. Global Economic Prospects 2009: Commodity Markets at the Crossroads, December 11, 2008. http://www-wds.worldbank.org/
The unprecedented commodity price boom that began in October 2001 and that lasted for more than seven years came to an end in July 2008 amid slowing global economic growth. According to the World Bank´s Global Economic Prospects 2009, overall, global GDP growth is projected to decline to 0.9 percent in 2009 while growth in developing countries will fall to 4.5% from 7.9% recorded in 2007.
Slower GDP growth and decelerating global trade, as measured by falling global export volumes, put heavy pressure on commodity prices. In addition to these, increased supplies and revised expectations played a significant role in pushing the commodity prices down. Commodity prices reflect forward- looking expectations. Therefore, the expectations of sharp decline in global economic growth in 2009 is believed to be the main driver behind falling commodity prices than the little changes in underlying demand and supply conditions (World Bank, 2008).
As a result, the prices of major commodities such as oil, metals and food have fallen sharply since June 2008. The most dramatic decline is observed in the price of oil which plummeted from an all time high of $144 during the boom to just below $40 in early December, 2008. The price of Brent crude fell to $39.57 on 5 December 2008 for the first time since January 2005. Currently, the price is hovering around $43-$46 range, which is a four year low.
Moreover, the prices of some metals have already fallen to pre-boom levels and the dollar price of many internationally traded foods has fallen back to their 2006 levels. While slowing economic growth is expected to exert further downward pressure on commodity prices in the short run, they should however, remain higher than they were in the 1990s. Real food prices are projected to decline by 26 percent between 2008 and 2010, energy prices to fall by 27 percent, and metals prices to decline by 32 percent (World Bank, 2008).
While the end of the commodity price boom is a relief to commodity importing African countries, it is a sad news for the African exporters. The higher and persistent GDP growth in sub Saharan Africa since 2001 has been anchored by the commodity price boom. The abrupt end of this boom, in mid 2008 could have serious consequences on the continents´ over all future growth performance.
2. The Falling Commodity Prices and the Prebisch- Singer Hypothesis
Prebisch and Singer argued in 1950 that the price of commodities relative to that of manufactured goods will tend to decline over time. The theories of declining commodity terms of trade maintain that commodities have a relatively low income elasticity of demand compared with the outputs of other sectors and hence that the relative price of commodities declines as world income increases; that technical progress in manufacturing tended to be raw material saving, lowering the demand for commodities over time and the pace of the productivity growth in agriculture and mining sectors has been higher than in other sectors. Based on Grilli and Young Index, which aggregates the prices of 24 primary commodities exported by developing countries, the updated index for 2006 indicated that real commodity prices have overall appeared to have declined over the past century (O´Connor and Orsmond, 2007).
Due to the unprecedented nature of the commodity price boom that just ended, it seemed that the time of declining commodity terms of trade was over. The unusual nature of the boom was behind such thoughts. For instance, Bryson (2008) stated that the length of the uptrend in commodity prices which has been in place since October 2001 was unprecedented and this upswing has coincided with a very strong global GDP growth that has been driven at least in part by the forces of globalization. The upswing continued even after global GDP growth has started to slow down since August 2007 until June 2008 when the commodity prices began their downward spiral.
Further more, O´Connor and Orsmond (2007) argued that the commodity price boom (just ended) was unusual in several ways. It has been large and rapid and in this respect is paralleled by only two other periods during the last century. One was the price boom in the mid 1930´s , which largely reflected the recovery from the sharp declines during the Great Depression – and the other the commodity price rise in the 1970s that was driven by world demand and the temporary supply shortages of certain food and non-food items at the time.
In addition, the World Bank (2008) states that the strength, breadth and duration of the current commodity boom have prompted speculation that the global economy is moving into a new era characterized by relative shortage and permanently higher (even permanently rising) commodity prices.
The Bank argues further that this outcome does not appear likely. Slower population growth and weaker income growth are projected to cause trend global GDP growth to ease and with it the demand for commodities. However, the extent to which the commodity demand does slow and how easily supply is able to keep pace with demand depends on the policy environment, the pace of technological change, and external factors such as climate change (World Bank, 2008).
Some argue that the current sharp downturn in the commodity prices may not be an end of the commodity price boom. It may be a temporary adjustment on the path of a boom that may continue for many more years to come. According to Rogers in Dorsch (2008) the 20th century has seen three secular bull-markets in commodities from 1906-1923, and from 1933-1955, and 1968-1982, spanning an average of 15-years and the current "Commodity Super Cycle" has many more years to run, albeit with some nasty corrections along the way.
This implies that the commodity price booms follow normal economic cycles and that when the global economy recovers the commodity prices will rise again. However, it is difficult to predict whether they will reach the level of their 2001-2008 "Super Cycle" any time soon. In any case, many agree that even if the commodity prices fall dramatically in the short run, they will never settle below the 1990s level due to an ever increasing cost of production.
This does not mean that commodity prices always rise during a boom. After WW I commodity prices were depressed despite the post-war booms. The reason is that the war had created an excess supply that that took years to balance out (Jackson, 2008). On the other hand, recent booms in China, the US, India have driven up commodity prices while the current global slum is pushing them down.
However, the casualty could be bidirectional and non linear. The increased commodity prices due to economic boom could lead to economic downturn, which could in turn depress commodity prices. Although the current global economic slum is caused by financial crises, increased input cost might have aggravated the economic problems of firms.
On the other hand, when improved technology keep commodity prices stable even as demand increases significantly the Prebisch-Singer theory of declining commodity terms of trade holds.
3. The impact of Global slump and falling commodity prices on the African economies
Due to the credit crunch and risk aversion, investment growth in the developing world is projected to fall from 13 percent in the 2007 to 3.5 percent in 2009, deeply significant because a third of GDP growth can be attributed to it while world trade will contract by 2.1 percent in 2009 for the first time since 1982 (World Bank, 2008).
All countries will be affected by this drop in exports, which reflects not only the sharp slowdown in global demand, but also the reduced availability of export credits.
In Sub-Saharan Africa, growth expanded to 5.4 percent in 2008, and is expected to fall to 4.6 percent in 2009. But the contribution of net exports to African GDP growth may fall, and many countries are exposed to terms-of-trade shocks. Higher food and fuel prices have also widened the poverty gap, raising the risk of social unrest (World Bank, 2008).
The global recession will also affect the African economies through a number of other channels. These include: lower commodity prices, slackening remittance receipts, falling FDIs and reduction in aid flows.
Focusing on the commodity prices, it is anticipated that the falling prices are bound to harm the African economies seriously. Coupled with the falling volume of exports (due to contracting global trade), the falling commodity prices may lead to a sharp rise in current account deficits and further depreciation of local currencies in the continent. This could offset the positive impact of falling commodity prices on domestic inflation and may push the African economies into stagflation- inflation with economic stagnation. This may happen if the current very low levels of oil and metal prices continue for a longer term.
On the other hand, the fall in the prices of food commodities will provide a relief to many African countries. High food commodity prices have had a profound impact on poverty, pushing 130 to 155 million people below the poverty line just between December 2005 and December 2007. The worst impact was in urban areas. While government policies reacted swiftly to offset the worst effects of the higher prices, many of these efforts were poorly targeted and expensive (World Bank, 2008).
The falling food prices therefore will improve the position of the African governments to tackle the scourge of poverty provided that the governments care about the people.
4. Concluding remarks
Globally, economies are facing credit-fuelled economic downturn which is accompanied by falling equity and commodity prices. In 2009, growth in developed countries is projected to be negative while developing countries will witness a significant decline in growth to 4.5% from 7.9% in 2007.
The global economic slump is bound to hit the African economies harder than other developing regions. The global recession will affect the African economies through a number of channels. These include, falling commodity prices, slackening remittance receipts, falling FDIs and reduction in aid flows, among others.
The sharp fall in non-food commodity prices may lead to a sharp rise in current account deficits. This could in turn trigger further depreciation of already weakened currencies and may offset anti inflationary gains resulting from falling commodity prices. A prolonged global slump may lead to stagflation in Africa.
While developed and emerging economies are willing and capable of bailing out their beleaguered financial and real sectors with billions of tax payers funds, sub Saharan Africa can not think of any substantial bail out for any sector due to limited funds. The only practical bailout for the African economies is the faster recovery of the global economies.
References
Bryson, JH. 2008. Commodity Prices in Historical perspective. Wachovia Economics group. May 2, 2008. http://www.wachovia.com/
Dorsch G. 2008. Commodity Super Cycle: Ready to Rumble in 2008. January 3, 2008. http://seekingalpha.com/article/58881
Jackson, G. 2008. US economy, commodity prices and the trade cycle. April 7, 2008. http://www.brookesnews.com/
O´Connor J and Ormsond D. 2007. The recent rise in commodity prices: a long run perspective. RBA Bulletin, April, PP 1-9
World Bank, 2008. Global Economic Prospects 2009: Commodity Markets at the Crossroads, December 11, 2008. http://www-wds.worldbank.org/
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