Boom or Bust: How commodity price volatility impedes poverty reduction, and what to do about it

Commodity price volatility is a big problem for commodity-dependent countries and producers. With 95 developing countries deriving at least half their exports earnings from commodities, the rollercoaster of commodity prices, which can rise or fall by 50 per cent in a year, makes sound fiscal planning extremely difficult for both countries and producers. Predictable incomes are critical if commodity-dependent countries are to escape the cycle of commodity dependence, which is in turn integral to wider economic stability and poverty reduction.

Since the turn of the millennium, the risks facing commodity producers have been partially disguised by strong prices for certain commodities. But the basic problem has not gone away. At its heart is the imperfect nature of commodity markets. The theoretical ideal of a supply-meets-demand market equilibrium is rarely, if ever, achieved because commodity supply and demand forces respond inflexibly to price fluctuations. But it is not price volatility per se that is the problem—rather it is the volatility of national and individual incomes that obstructs long-term planning, drives commodity dependence, widens inequality and leads to environmental degradation.

Commodity price volatility is a serious issue, but it is not a hopeless one. The basic economic tools necessary to help commodity producers get more predictable incomes are better understood than ever before. This publication looks at the experience, problems and promise of five different types of economic tools: supply management, national revenue management, market-based price risk management, compensatory finance and alternative trade initiatives.

Experience leads us to four conclusions:

• There is no 'silver bullet'—no one policy that will address all aspects of commodity price volatility.
• Price or income stabilization interventions can create their own moral hazards and market distortions.
• Supply-side constraints, such as limited access to knowledge and poor infrastructure, are enduring obstacles.
• But despite the challenges, we have options that will work—under the right circumstances.

Policy-makers need to tackle the very real risks facing commodity-dependent countries and producers. If the international community is indeed committed to reducing poverty, then thoughtful, decisive action is needed. Taking the following seven guidelines into consideration will help ensure that future policy responses are more coherent and successful than past initiatives:

• Look for complementary policies.
• Engage stakeholders at all levels.
• Do not underestimate the importance of the private sector.
• Keep it as simple as possible.
• Address the potential moral hazard by integrating income stabilization into a wider rural development or diversification program.
• Build flexibility into programs.
• Ensure that the reach of the implementing agency matches the scope of a policy's goals.