ANNEX III. ESTIMATES OF SUPPORT TO AGRICULTURE BY COUNTRY, 1991-2001 (continued)
ANNEX 1: AN OVERVIEW OF THE ECONOMETRIC TECHNIQUE FOR QUANTIFYING PRICE TRANSMISSION
3. Price instability and the persistence of low prices
The issue of the measurement of price instability in world agricultural markets is a relatively well- researched area. In recent years the work on measurement of Alexander Sarris, for example, has been comprehensive in the case of cereals. He arrives at several conclusions: With respect to the question of whether or not there has been an increase in inter-year and intra-year price variability for cereals, the evidence shows no trend toward greater world price instability. Harwood comes to the same conclusion for corn, using data from 1920 to 1996. To our knowledge, no other comparable studies have been applied to other commodities of interest to the developing world.
Table 1 presents the coefficients of variation of world prices for four selected commodities for 1960 through 1997 (reproduced from Quiroz, Foster and Valdés, 1999). The results show that sugar is considerably more unstable than the three cereals throughout the period. Also notable is that the sub-period 1973-1985 shows a much higher coefficient of variation than the preceding and following sub- periods. Evidently the coefficient of variation of these commodities changes with time, and moreover, for wheat and sugar, there has been a decline in price instability for the period 1986-1997 (consistent with the conclusions of Sarris, 1999).
5. See OECD (2001), A Forward-Looking Analysis of Export Subsidies in Agriculture, and the ERS/USDA study edited by Burfisher (2001).
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Table 1. Coefficients of Variation of World Prices of Selected Commodities
Period Corn Rice Sugar Wheat
1960-1972 0.11 0.09 0.60 0.25
1973-1985 0.31 0.44 0.81 0.42
1986-1997 0.18 0.20 0.22 0.17
1960-1997 0.37 0.46 0.90 0.44
Source: Quiroz, Foster and Valdés, 1999
A related question: is instability due to the “system” of protection? (See for example Josling.) Certainly variable levies and quotas with a targeted domestic price on importables results in a shift of domestic instability to world markets. With the move toward removal of quantitative restrictions and variable levies, one would expect that the contribution of developed countries’ distortions on world price instability would be less. A result of the Uruguay Round tariffication by developed and developing countries, one expects to see reduced instability but increased transmission of instability to domestic producers and consumers. Tyers and Anderson conclude from policy simulations of tarrification in industrial countries that “[t]he effect of tariffication is to reduce [world] price volatility substantially” during the 1990s for (p. 264). Tariffication in developed countries contributes to less instability in wheat, dairy products, and beef, among others. For some commodities, however, reduced instability would derive primarily from the tariffication policies of developing countries, such as is the case for rice and sugar.
Instability per se is one issue, but more important for our focus on the agricultural producers in developing and transition economies is the question of the persistence of low prices. In the context of an open economy, a central problem of the design of policy instruments to deal with instability is the understanding the nature and duration of price cycles in world markets. Do shocks to international prices dissipate rapidly, or are they phenomena that persist for several years? There is now a rich literature on the times-series properties of commodity prices. Early research, often framed within the context of unit-root analysis, led to the conclusion that prices exhibited a significant degree of shock persistence. The results presented by Gersowitz and Paxon (1990) show that the hypothesis of a unit root could not be rejected for a number of commodity prices of African exports. Later studies have been more cautious in coming to the strict conclusion of unit roots deduced from simple measures of persistence (Caner and Hansen, 1997; Perron, 1989; and Zivot and Andrew, 1992). Leon and Soto conclude real world prices do not exhibit unit roots, but rather they are trend stationary processes.
Nevertheless, there remains the stylised fact that commodity prices exhibit considerable shock persistence (see also Deaton).
Especially pertinent – and in our opinion most convincing – is the 1999 study by Cashin, Liang and McDermott on the half-life of shocks to world commodity prices. In the case of wheat, for example, international price shocks have a median half-life of 44 month, with a 90% confidence interval that implies a range from an extreme low half-life of 14 months to an extreme high of “infinity.” It is significant the there is a probability of 50% that prices prevail below the expected value (declining over time) for more than 44 months. The empirical evidence from Cashin, Liang and McDermott (see also Table 2) is that the distribution of prices is not symmetric – low prices endure for more months than high prices.
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Table 2. Statistics of Commodity Prices
Corn Rice
Period Skewness Kurtosis Jarque-Bera Skewness Kurtosis Jarque-Bera 1960-72
1973-85 1986-97 1960-97
-0.34 1.01 1.14 0.65
2.34 3.58 4.73 3.77
5.87 28.50 47.76 42.60
-0.51 1.59 1.25 1.21
1.87 5.53 4.73 6.30
15.14 107.30
51.64 310.64
Sugar Wheat
Period Skewness Kurtosis Jarque-Bera Skewness Kurtosis Jarque-Bera 1960-72
1973-85 1986-97 1960-97
1.88 2.05 0.62 3.25
6.47 8.51 3.12 17.66
170.7 306.98
8.85 4835.00
0.35 1.69 0.43 1.41
1.65 6.06 2.22 6.10
14.39 134.79
7.86 325.08 Source: Quiroz, Foster and Valdés, 1999.
As Figure 1 amply demonstrates, the nature of price movements is such that low prices have the tendency to persist for many months, with occasional spikes of shorter duration. These characteristics of world price movements lead to notable difficulties in the design of policies. The use of futures markets would reduce the effect of short-term uncertainty but could not guard against the effects of consecutive years of low prices. In the past, minimum import price schemes were popular, and several developing countries still have in place systems of price bands. Safeguards are always an applicable contingency measure, but under WTO rules they are limited in duration, involve compensation, and are restricted in their frequency of application.
Figure 1. Real price of selected commodities: 1960-97 US$ of July of 1997
&RUQ
5LFH
6XJDU
:KHDW
US¢/bu US¢/cwt
US¢/lb US¢/bu
Source: Quiroz, Foster and Valdés, 1999.
168 4. What do we know about price transmission?
The degree of world price distortion and the nature and magnitude of price instability set the stage in which price transmission becomes a relevant question in the context of policy controversies in developing countries. There has been a lively debate in the literature regarding the degree of price transmission. For European producers, Tyers and Anderson demonstrate a transmission rate of world price variation less than 10% for the short run, and 20% for the long run. More generally, Sarris mentions transmission coefficients of 0.24 and 0.58 in the short and long run. In a controversial paper, Mundlak and Larson (1992) conclude, “the deviation from unitary elasticity is, on the whole, surprisingly small” (p. 419). In their judgement, while policies affect price levels, they appear ineffective at insulating to a great degree domestic prices from world price changes. The authors also note that variations in world prices are the major contributor to variations in domestic prices, a conclusion discordant with the evidence from the price decompositions presented below.
In contrast to Mundlak and Larson, Quiroz and Soto (1995) made use both of spot prices (in place of the Mundlak and Larson approach based on the FAO average unit export values), and of an error- correction specification of the relationship between world and domestic prices. Covering 78 countries, Quiroz and Soto conclude, “In an overwhelming majority of cases transmission of international price signals in agriculture is either non-existent or low, by any reasonable standard.” But the degree of transmission, of course, ranges across countries. For Australia, Canada, New Zealand and Uruguay, 50% or more of any given shock from world prices is transmitted within a year. But these few countries are in contrast to 30 countries that exhibit price transmission characteristics such that it takes five years or longer to transmit half of any world price shocks. Surprisingly, another group of 30 countries appears “virtually isolated from international price signals.”
One major caveat of these mentioned studies is that the data correspond to trade regimes that applied before the Uruguay Round. So with tariffication and the removal of QRs transmission could be higher today, and this offers a rich area of study.
5. But what is the practical relevance of enhanced price transmission to the determination