Distorted Prices in Commodity Markets

The volatility in commodity prices continues. Sure, they have come down in the last few days on Eurozone crisis fears but, all in all, they remain volatile, and in the case of food, very high. One of the reasons for this is that world commodity markets -- particularly those for agricultural commodities -- have become highly distorted.

"So what?" you may ask. Well, distorted price levels and excess price volatility are detrimental to producers and consumers alike. In particular, expensive food has a negative impact on the poor as they tend to spend more than half their income to feed themselves. As a result, price distortions can pose a serious threat to development.

Despite the wave of liberalization that has swept world trade since the 1980s, price distortions in agricultural commodities persist, according to "Reducing Distortions in International Commodity Markets," the latest edition of the World Bank's Economic Premise note series. These distortions are not only caused by trade policies, such as export and import rules, but also by imperfect competition, the existence of monopolies, and policies related to the private sector.

The issue is particularly relevant as the use of export restrictions is expected to increase amid high rates of economic growth in emerging markets, which generates greater demand for food products and raw materials. Therefore, it is imperative to find a more comprehensive approach to deal with policies affecting commodity markets, as Bernard Hoekman and Will Martin argue in the Economic Premise note.

Many of the policies that affect commodity markets are subject to the multilateral rules under the World Trade Organization (WTO). But the WTO has mainly focused on the import side, and on export subsidies in agriculture. Since many of the distortions are caused by market-related issues, such as the dominance of monopolies, any global approach to address distortions should also cover issues related to access to resources, like land, Foreign Direct Investment (FDI) policy rules, and private sector behavior.

Likewise, we should all better understand the unintended consequences of many of the measures put in place by policy makers in the interest of their own countries, without taking into account the negative effects they can have on their neighbors and in the global system as a whole. Take the case of the upsurge of export barriers in response to rising world prices of food staples. While a particular country might put in place such a barrier to keep food at home and prices low, the effects in importing countries are negative. This has a global impact of distorting prices and, therefore, creating further volatility -- none of which can be good for the country who instituted the export barriers in the first place.

That's exactly why a comprehensive agreement addressing the policies that generate distortions is needed. It will be in the benefit of all.