SOAS Research Online

Abstract

KEY MESSAGES: ∙ Low-income countries (LICs) are highly vulnerable to fluctuations in commodity prices. Excessive price volatility complicates macroeconomic management and can worsen long-run growth and development prospects. ∙ Financial speculation has caused price volatility in the international markets beyond what could possibly be explained on the grounds of fundamentals of supply and demand alone. ∙ Field studies of the cotton and coffee sectors in Tanzania and Uganda show that sound market structures and institutions need to be in place for producers, households and villages to cope with price shocks. ∙ The case study of copper in Zambia highlights the extraordinary difficulties LICs encounter in devising appropriate monetary and exchange rate policies over the commodity price cycle. ∙ Overall, we reach the conclusion that LICs' vulnerability to commodity price volatility requires international support targeting supply-side constraints, together with the establishment of a financing scheme compensating the effects of price shocks. Of course, it is crucial that international support be premised on the pursuance of sound governance and macroeconomic policy at the domestic level. ∙ In support of our argument for an increased role of foreign aid as a temporary device to counter excessive price volatility, we outline the main features of our proposal for such a compensatory financing mechanism and show, in the case of Uganda, that its application would be highly effective and relatively cost-efficient in achieving the goal of increased protection from price volatility and trade shocks more in general.