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September 9th, 2010

Commodities alone are not enough to sustain flourishing economies

Abstract:
A special report on Latin America
It's only natural
Commodities alone are not enough to sustain flourishing economies
Sep 9th 2010

IT MAY seem a safe bet that billions of Asians will continue to gobble up oil, iron ore, copper, soyabeans and meat as they get richer. But one day they may not; and one day, too, the world will surely come up with alternatives to fossil fuels that emit less carbon. Indeed Brazil already has, in the form of ethanol from sugar cane, and Colombia and Central America are following suit.

Latin America is uncomfortably dependent on commodities. In the past decade they accounted for 52% of the region's exports, according to the World Bank. That is down from 86% in the 1970s, but over the same period the figure in East Asia and the Pacific fell from 94% to 30%. Chile, Peru and Venezuela still rely on raw materials for more than three-quarters of their total exports. In all, as the World Bank notes in a report published this month, more than 90% of Latin Americans live in countries that are net exporters of commodities, the exceptions being in Central America and the Caribbean. Governments have also become more reliant on raw materials for their tax revenues (see chart 1).

There is nothing wrong with producing raw materials. The rise in world prices for Latin America's commodities, and the related increase in their output, may have accounted for between one-third and half of the region's growth over the past decade. And thanks to Asia's economic vigour, commodity prices fell only briefly during the recession and remain at historically high levels. Over the past decade a region that has habitually suffered from balance-of-payments troubles has benefited from the foreign exchange that commodities bring in. This bonanza seems to refute the thesis put forward by Raúl Prebisch, the founding director of ECLAC, that the price of commodities is bound to decline in relation to the price of manufactured goods.

In this special report
Societies on the move
So near and yet so far
Two centuries of hopes and fears
» It's only natural «

Efficiency drive
The jet set
Democracy, Latino-style
A Latin American decade?
The dark side
Sources and acknowledgments
Offer to readers
Related items
A special report on Latin America: The jet set
Sep 9th 2010Even so, relying on raw materials carries a series of risks. One is volatility: their prices are more variable than those of manufactures. Second, many economists worry about "Dutch disease", a term coined by this newspaper in 1977 to describe the impact of a North Sea gas bonanza on the economy of the Netherlands. This malady involves commodity exports driving up the value of the currency, making other parts of the economy less competitive, leading to a current-account deficit and even greater dependence on commodities. This matters all the more because mining and hydrocarbons are capital-intensive businesses, generating relatively few jobs.

The commodity boom, together with capital inflows attracted by better economic prospects, has already pushed up the value of some of the region's currencies. For example, São Paulo seems extraordinarily expensive to any visitor. The strength of the Brazilian currency, the real, worries officials and industrialists.

A third concern is that many non-agricultural commodities are not renewable (although high prices encourage new discoveries), so governments should invest the tax revenues they generate in infrastructure and training to diversify the economy. Producing commodities may also involve local environmental damage. In parts of Latin America mines and oilfields are in areas inhabited by people of indigenous descent and have caused cultural clashes.

A fourth problem is the potentially corrosive effect of commodity production on political institutions. Many commodities incorporate rents (ie, excess profits derived from the fact that supply is usually limited in the short term). It is in the state's interest to capture those rents, but corruption often follows when it does. Mines and oil- and gasfields often involve high sunk costs and low variable costs, making them a tempting target for expropriation. Venezuela provides the clearest evidence of these ills.

Given the risk of price volatility and depletion, it is sensible to save some of the bonanza from commodities for a rainy day. That is what Chile has done. The price of copper, its main export, has been high for the past few years, allowing the country to accumulate $20 billion, equal to about 12% of GDP, in a stabilisation fund by the end of 2008. It was able to draw on this fund to pay for a big fiscal stimulus, equal to about 3% of GDP, during the recession. On a smaller scale, Mexico, Peru and Bolivia too have saved part of their windfall gains from high commodity prices. Brazil's Congress is considering a bill under which part of the revenues from big new deep-sea oilfields will be placed in a special social fund. But most of the money will be spent on education and anti-poverty programmes rather than saved.

Where innovation flourishes

Agriculture in Latin America shows clearly that commodities can be a blessing, not a curse. Much of the region enjoys fertile soils and sunshine, but it has also made the best of that natural bonus. Since 1990 productivity in farming in Latin America has risen faster than in East Asia or the United States, according to a study by the IDB. Colombia's Federation of Coffee Producers has managed to extract a brand premium for its product through clever marketing, and has successfully diversified into retailing with its international chain of Juan Váldez coffee shops. Chile has created new export industries for fruit and vegetables. In Peru the spontaneous privatisation in the 1980s of state farms set up by a left-wing military government has spawned labour-intensive commercial farming on the fertile coastal strip. Argentina's farmers, and its agricultural-research institute, are consistently innovative.

Brazil has the most impressive record of agricultural innovation. In 1973, when the country was still a net food importer, its military government set up Embrapa, an agricultural-research institute. Within six months it had sent 1,200 young Brazilian graduates abroad to obtain further qualifications. When they came back, they adapted plant and animal varieties so that they could thrive in the tropics and especially in the acid soil of the cerrado, the vast, largely flat savannah of the interior. This green revolution hugely increased productivity: over the past 30 years only 20% more land has come into agricultural use but production has risen by 150%, says Pedro Antonio Pereira, Embrapa's director.

Brazil is now the world's biggest exporter not only of coffee, sugar, orange juice and tobacco but also of ethanol, beef and chicken, and the second-biggest source of soya products. It is exporting fruit and wine from the São Francisco river region, close to the equator. Its goal, says Mr Pereira, is to become the world's leading food exporter by 2025, displacing the United States, without inflicting damage on the environment. That means pushing up productivity further, and in particular putting some 70m hectares (173m acres) of degraded pasture to better use. Much of that pasture supports just one cow for every two hectares. With better breeding and improved techniques, each hectare could accommodate three cows as well as some grain and trees.

In São Carlos, in São Paulo state, Embrapa has the world's only laboratory deploying nanotechnology for agriculture, creating plant varieties that absorb fertiliser more efficiently. Embrapa has a research centre in Central America and is planning to open one in Peru.

Unfortunately there is little of this kind of innovation in other parts of Latin America's economies. Latin American firms invest only 0.5% of gross revenues in research and development, compared with the 2% spent by companies in the rich world. To help encourage innovation, there is now a revival of interest in industrial policy—partly because of worries about Dutch disease and commodity dependence.