Wednesday, January 4, 2012

Reducing distortions in international commodity markets:an agenda for multilateral cooperation

Global commodity markets are affected by a variety of government policies that may expand or lower overall supply and as a result affect world prices for the specific products concerned. Market failures and market structures (market power along the value chain) also affect supply. This paper briefly reviews a number of factors that may distort international commodity markets with a view to identifying elements of an agenda for multilateral cooperation to reduce such distortions. Much of the policy agenda that arises is domestic and requires action by national governments. But numerous policies -- or absence of policy -- generate international spillovers that call for the negotiation of international policy disciplines. Independent of whether distortions are local or international in scope, the complexity of prevailing market structures and their impacts on efficiency call for much greater monitoring and analysis by the international community.

World commodity markets—and particularly the markets for agricultural commodities—remain highly distorted despite the wave of liberalization that has swept world trade since the 1980s. These markets are distorted on both the export and the import side, with serious implications for world prices and their volatility. Market failures abound in the production of many commodities. These include inadequate pricing of many common-pool resources, externalities associated with the extraction and use of commodities such as fossil fuels, and massive externalities associated with the production of many agricultural, forestry and fish products. Very few of the price distortions found in commodity markets can be justified as dealing with such market failures, although ex post justifications along these lines are sometimes offered. Rather, most of these distortions are designed to achieve redistributions of income by raising or lowering prices in a way that will transfer resources to favored groups. To the extent that they do contribute to reducing any of the problems of market failure, this is typically coincidental.

There remains much that can be done at national, regional and global levels to reduce the existing distortions and improve outcomes worldwide—ideally in conjunction with introducing policies to reduce the adverse consequences of the profound market failures existing in many markets. However, without an understanding of the forms, objectives and effects of the various interventions by governments, it will be very difficult to secure reform that will enhance world welfare. The objectives of these national policies are frequently quite complex and nontransparent. In many cases, there are multiple objectives, such as raising or lowering the average level of a commodity price, but also reducing its variability. Tracing through the effects can also be complex, with ultimate impacts frequently quite different than they might at first appear. Since the effects of various measures are often interdependent and instruments may be strongly substitutable, we take a broad approach in inventorying the policies used. Reform efforts require a good understanding of the objectives and political economy forces influencing policies in a particular area, or reform is likely to encounter unexpected resistance. The same applies to efforts to design and negotiate new international disciplines that aim to reduce the negative cross-border pecuniary spillovers created by national policies.

In this paper, we first provide a description of the broad types of intervention prevailing in and affecting global commodity markets. We begin in Section 1 with a discussion of the most common type of intervention in commodity markets: actions designed to affect the domestic price of a commodity relative to its international price. Most attention with this type of measure has focused on interventions designed to increase the level of the domestic price relative to the international price using instruments such as tariffs. However, there are also many types of intervention designed to reduce domestic prices relative to international prices in order, for example, to lower the price of an input used in a politically powerful industry. In Section 2 we discuss another politically-important type of intervention: measures aimed at reducing the volatility of domestic prices relative to world prices. In Section 3 we turn to a discussion of the implications for multilateral cooperation and rule-making efforts. Section 4 concludes.

Author: Hoekman, Bernard ; Martin, Will.Document Date: 2012/01/01.Document Type:Policy Research Working Paper.Report Number: WPS5928


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