Talk to a farmer about the high prices for commodities these days, and it’s likely you’ll hear how much more a combine or other farm equipment now costs.
The relationship between the prices of raw materials and manufactured goods was long a subject of debate between economists, one that played a large role in shaping many developing economies around the world in the last half of the 20th century.
One group thought prices of the raw materials poor countries exported were falling, while prices of the manufactured goods they imported were rising. They saw this as a trend that would continue indefinitely. The other group saw pendulum swings in commodity prices, rising during some periods and falling in others, but without a long-term trend.
Which of these conclusions was true affected the policies poor countries should adopt to make their economies grow as fast as possible.
The low commodity prices that prevailed during much of the 1980s and 1990s supported the first group. But $3 a pound copper, $8 per bushel wheat and other high prices validate the arguments of the second.
This controversy began after World War II. Raul Prebisch, an Argentine economist who headed the United Nations’ Economic Commission for Latin America, argued that over the long run, countries exporting raw materials suffered.
Poor nations in Latin America, Asia and Africa depended on exporting things like copper, tin, jute, coffee, and wheat, he noted. Rich nations in Western Europe and North America produced manufactured goods. Rich countries had the upper hand, Prebisch argued, because they were able to charge more for their manufactured exports to the poor countries while paying less for imports of raw materials from those nations.
Prebisch was not alone. Hans Singer, a German economist, came to the same conclusion independently, and Julius Nyerere, a prominent independence leader and long-time president of what is now Tanzania, based his system of “African socialism” on the same thinking. In a famous speech he noted that 15 tons of jute exported from his country would pay for one imported tractor in 1965, but by 1972 it took 46 tons.
Those who believed that this trend would continue indefinitely argued for an economic development strategy that would encourage poor countries to produce more of the goods they had been importing. This was called import-substitution industrialization.
This approach, similar to that advocated in the U.S. by founding father Alexander Hamilton and 19th-century congressional leaders Henry Clay and John C. Calhoun, involved erecting high tariff barriers to imports.
Import substitution was politically popular, but there were unexamined issues. A country isolating itself from the rest of the world with tariffs limits its economic growth to the growth of its own internal demand. Moreover, the superiority of this strategy depended on prices for raw materials continuing to decline in comparison while the prices of manufactured goods rose.
There was a clear ideological split among economists. Market-oriented ones, largely in the English-speaking countries, rejected the assumption that raw materials prices would always decline. In most of Europe and the developing world, however, the majority bought into it.
The establishment of the United Nations Conference on Trade and Development, or UNCTAD, in 1964 was based on this thinking, with Prebisch as its first head. UNCTAD became a permanent organization working for better trade conditions for exporting poor countries.
Controversy over commodity prices continued, however, and in 1974, UNCTAD itself formed a special commission to settle the matter. Headed by Hendrik Houthakker, a Dutch-American professor at Harvard who died in April, the commission included members from countries like Argentina, Algeria and Poland that had policies based on the idea that the long-term price trend would continue to be decline.
In 1975, it unanimously rejected the idea that the terms of trade were worsening for the developing countries. Their conclusion probably changed few minds.
More importantly over time, Asian economies like South Korea, Taiwan, Hong Kong and Singapore that based their industrialization on promoting exports grew faster and longer than those like Brazil, Argentina and Mexico that focused on import barriers.
In the meantime, countries like Brazil and Argentina that chose import substitution because they thought commodity prices were doomed to fall are earning tons of money exporting grains, oilseeds and iron ore. Brazil’s industry has grown enormously, but high farm prices are about all Argentina has going for it right now.
Some see current high prices as the harbinger of growing scarcity and an era of permanently high raw-materials prices. We heard the same thing in the 1970s. That turned out to be a flash in the pan. We will see what happens this time.
© 2008 Edward Lotterman
Chanarambie Consulting, Inc.