Price and Revenue Volatility: What Policy Options and Role for the State?

By Luciani, Giacomo | Global Governance, April-June 2011 | Go to article overview

Price and Revenue Volatility: What Policy Options and Role for the State?


Luciani, Giacomo, Global Governance


Price volatility is a major problem for all commodity exporters because it translates into direct or indirect volatility of government revenue. Should a developing country's state be responsible for isolating the domestic economy from the consequences of fluctuating international commodity prices? This article argues that this is an essential function of the state and a crucial component of its legitimacy. Recently, the establishment of stabilization funds has been regarded as an essential component of good governance, notwithstanding the persistence of major problems. As an alternative, this article proposes the use of resource revenue for establishing endowments of autonomous public institutions with well-defined developmental goals, or furnishing the equity for strategically important commercial corporations. The latter opens the door to an interesting perspective on the potential path toward progressive democratization of the rentier states. Keywords: price volatility, stabilization funds, democratic institutions, financial policies, rentier states.

Volatility of Commodity Prices and Development

Price volatility is a major problem for all commodity producers in developing and developed countries alike. Price volatility is the result of rigidity of supply and demand in the short term, which prevents mutual adjustment with more gradual price movements.

In agriculture, producers do not fully control the volume of production in the short term because of droughts or other meteorological events, plant diseases, the gestation period that is required for new plants to become productive, and so forth. Seasonal and yearly storage and the development of credit facilities specifically aimed at helping farmers through times of low revenue are common features.

For minerals, the volume of production is normally more directly under control, but the financial profile of projects--where capital expenditure dominates operational expenditure and debt service is an important component of running costs--encourages high levels of capacity utilization independent of market prices. For oil, both supply and demand have been shown to be extremely rigid to prices.

Price volatility is a well-recognized problem for all economies that are fundamentally dependent on commodity production and export. If the commodity is of a kind that is produced by a large number of decentralized units and exports are not directly controlled by the state, the immediate effect of commodity price volatility will be felt on the economy, and government finance will be affected indirectly through the effect that prosperity or poverty has on tax receipts. If on the other hand, the production of the commodity is concentrated in a few hands that the state can easily control or the state directly controls exports, then price volatility will immediately affect government revenue, and the economy at large will be affected only to the extent that government expenditure follows revenue.

The damaging effects of commodity price volatility on economic development have been measured statistically.(1) Indeed, price volatility has been identified as the main culprit of the negative effect of commodity dependence on economic development (in this view, the resource curse should be revised; abundant resources are a blessing, but the instability of their prices is the curse). (2) The exact mechanism that links price instability to low growth has not been conclusively determined.

Whether price instability primarily affects the private sector or public finances, the negative effect on growth always requires an assumption that the relevant actors make the wrong decisions. Private investors are assumed to be likely to react to uncertainty by investing relatively less and requiring relatively higher rates of return (a premium for the risk implicit in instability). This means that an economy in which instability is pronounced will display higher savings and lower investment and innovation than an economy blessed by stable relative prices. …

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