All Commentary
Monday, March 1, 1965

The Failure of International Commodity Agreements

Dr. Brandt, former Director of the Food Research Institute of Stanford University, is Senior Research Fellow and Economic Con­sultant at the Hoover Institution on War, Revolution, and Peace. This is a slight con­densation of the English version of his first address as a foreign member of the Académie d’Agriculture of France, delivered in Paris in French, May 27, 1964.

It is, if I am not mistaken, the goal of all free countries with gov­ernment by law to diminish pov­erty, squalor, and drudgery for the greatest number of their citi­zens, and to expand opportunities to all self-respecting, responsible citizens to develop their personal potential. This goal includes the obligation of the nation to respect the dignity and integrity of all men of good will.

If this national goal is accepted, the economy must have the in­stitutional framework to promote the gradual improvement of the real income of the people by im­proving the productivity of hu­man, natural, and man-made re­sources. This requires, in the pro­duction of goods and services, more division of labor, specialization, and increased efficiency from research, innovation, and better management. But in order to have some orientation for such endeavor it is essential to give the consumer the sovereign power to allocate resources to the satis­faction of his needs and of his more and more refined wants. This provides the powerful incentive to all people to make the effort to earn the money to get the goods and services they want. Such an arrangement is ideally guaranteed in the market with freely moving prices by the daily plebiscite in which housewives and the con­sumer in general express their preference in francs and centimes, or dollars and cents.

In the modern economy, in which this allocation of resources applies to all goods, durable and nondurable, to houses and motor vehicles, and to all services — edu­cational, medical, culinary, artis­tic, and to entertainment, travel, insurance, recreation, and multitudes of others — economic growth is bound to accelerate and to be­come all-pervasive. Such dynamic growth, to be stable and contin­uous, requires a high degree of mobility of human resources, such as shifts from the production of goods to the performance of serv­ices.

Such economic growth or de­velopment, which requires above all stability of the national cur­rency and the discipline of mone­tary and fiscal policies to keep in­flation in check, calls also for an optimum of foreign trade. It is generally agreed that the promo­tion of peaceful relations in this turbulent and dynamic world re­quires economic development in all countries, particularly those with still predominantly rural living conditions. This develop­ment in formerly colonial and other industrially retarded coun­tries is definitely needed for the healthy development of the ad­vanced nations, because industrial economies maintain growth and stability by a reliable flow of es­sential raw materials.

The Need for Leadership

Of all the conditions for in­creasing the income of the people in the world’s rural countries, by far the most strategic are con­tinued healthy and stable growth of the leading industrial countries and their avoidance of prolonged economic stagnation or contrac­tion. Any idea of accelerating growth in underdeveloped coun­tries by sapping the strength of industrial nations belongs in the moth-eaten fabric of ideas of Marxian determinism and the fata morgana of the dictatorially-ruled “paradise for all proletarians.” Since these grand ideas have been tried for close to 40 years in a laboratory experiment with sev­eral hundred million people, they have lost their luster and gaudy colors.

Today, the economies of indus­trial and developing countries are mutually interdependent, as is the guardianship of peaceful cohabita­tion of nations. Hence, while the industrial countries need an ade­quate and growing flow of pri­mary material from developing countries, they will pay for these, as well as for manufactured goods from light industries, by export­ing to those countries an increas­ing volume of manufactured pro­ducer and consumer goods, and will also help them to industrialize gradually.

If this mutually beneficial ex­change is to flourish, all nations must act in accordance with their optimal comparative advantage, i.e., the opportunity to produce and sell at lower unit costs. To let this principle work requires optimal diminution or removal of hindrances to trade expansion, not only import quotas and cus­toms duties but the whole arsenal of nontariff trade impediments in lieu of duties.

All the proposed solutions have one common denominator. They suggest that, by setting up inter­national and regional world-wide administrative machinery to con­trol and regulate prices for opti­mal financial liquidity of develop­ing countries, the pace of raising the income of the poorest people in the most agrarian countries can be accelerated at will, and that more perfect equity and justice in distribution among independent nations can be attained.

A Dubious Device

Perhaps the most persuasive and yet the most dubious proposal to remedy the instability of for­eign exchange earnings of devel­oping countries is the device of international commodity agree­ments, abbreviated in the litera­ture as ICA. This form of inter­vention in the international mar­ket for primary commodities is an excellent example that makes clear where the generating power orig­inates that drives a national econ­omy, and how complex and delicate a self-adjusting system the market economy actually is. When I speak of the market economy, I do not mean a laissez-faire system with no rules, but a competitive private enterprise economy with effective enforcement by the government of regulations, quality standards, and rules for competition.

International commodity agree­ments are arrangements between contracting governments, aimed at preventing precipitous price de­clines of a primary commodity on the world market, in order to avoid serious balance of payment and illiquidity problems for the gov­ernments of the exporting coun­tries. But the attempt to forestall disastrous price declines also de­mands that brakes be put on too steeply rising prices, because such increases may unduly stimulate expansion of production, with re­sulting sharp price declines later.

This remedy for price instabil­ity consists basically of a type of market intervention that was adopted in the late twenties and early thirties on the European continent, in the United States, and in other parts of the world: farm income support through guaranteed minimum prices for specified agricultural commodi­ties. These price support policies amount to a compulsory govern­ment-controlled cartel, with in­numerable variations in detail. Since more than 30 years of ex­perience with this policy have ac­crued in the industrially advanced countries and in the world market, it is relevant for our discussion to summarize the modus operandi and the economic results of this remedial counteraction to price instability.

Once the government supports the price of a commodity, the price can theoretically still move, but only above the so-called “floor” or guaranteed minimum. By political compromise this level is deliberate­ly set above equilibrium, which by definition is the price that would clear the market. The polit­ically set level is meant to be re­munerative to the high cost or marginal producers, the low in­come farmers on whose behalf price stabilization is mainly es­tablished. It is therefore unavoid­able that the price, and the elimi­nation of any risk of its change by government guarantee, will act as a forceful incentive, especially to efficient producers, to expand the area for the specific crop. To counteract this the government imposes an area limit, the so-called “acreage allotment.” Some sort of base is needed for its determina­tion; usually a historical base is chosen, such as each farmer’s ac­tual average acreage of the crop cultivated in several base years. However, the common experience in all countries is that the combi­nation of a profitable guaranteed price with the acreage allotment acts as a still more effective in­centive for increasing output per unit of land on limited acreage by more intensive farming. More fertilizer, better seed, more irri­gation, better pest and weed con­trol, more cultivation, and various other methods are used. Hence, the government has to buy and store more grain to keep the price at the support level.

The Sorry Results

Up to this point the results of this intervention are already re­markable:

1.      There is no longer any mobil­ity of the geographical location of production. It is frozen from the moment the allotments are estab­lished.

2.      The unintentionally subsi­dized intensification of production has created surpluses that exceed effective demand.

3.      Therefore, the government has to finance and operate storage of commodity stockpiles.

4.      Hence, the government at taxpayers’ expense has entered the commodity business.

5.      The price can no longer move upward but is tightly pinned to the “floor.” Instead of a price sup­port or the guarantee of a mini­mum price, one has a fixed, totally inflexible price.

6.      This fixed price still governs producers, processors, everybody in the trade chain, and consumers. The price signals are set in false position for all of them. Although an excess supply exists, everybody can act only according to the price which indicates shortage, namely by consuming less, by substituting other commodities. The processors and the speculative trade reduce stock carrying because the gov­ernment keeps the excess stocks at public expense.

7.      In other words: without any intent to do so, the government has socialized stock carrying.

8.      As a further result, the most effective commodity price and sup­ply stabilizing institution, the com­modity exchange with its trading in future delivery contracts, is made idle.

However, even those are by no means all the side effects. The Treasury has to pay for moving the commodity into and out of storage and for storing it, as well as for losses when the surplus is disposed of. Thus, there are in­numerable secondary beneficiaries of stockpiling excess output, such as railroads, truckers, labor union members, and many others. All these receivers of windfalls ac­quire a vested interest in main­taining farm price supports. Much worse is the fact that the market in farm real estate discounts the subsidy-earning value of the acre­age allotment. Hence, price stabili­zation of farm products boosts the value of farm land; in due time higher land prices and rents on leased land increase the costs of farming and force more intensive use. This is another unintentional side effect.

Marketing Quotas Assigned

When the excess production be­gins to bleed the Treasury too bad­ly, the next step is to tighten the cartel by efforts to control the supply in the market. In addition to the acreage allotment the gov­ernment imposes on all farms a marketing quota, which is estab­lished by subdividing a national quota prorated in accordance with individual acreage allotments. This national quota is fixed by a pre­carious government estimate of how large the domestic consump­tion and the net export may be one year later. Since the market­ing quota tends to be smaller than the output, it immediately poses the problem of a black market and the necessity of suppressing it by heavy penalties. Output that ex­ceeds the marketing quota can be stored, converted, or consumed by the farmer, but it cannot be mar­keted legally. Even in countries with a customarily law-abiding farm population, the temptation to profit by disposing of such illegal supply by barter or other black deals is strong, and actual enforce­ment is difficult.

The cartel price-fixing for agri­cultural commodities also unin­tentionally subsidizes increased production of the same commodity in other countries. Price-fixing thus creates effective competition abroad. Since it is politically un­popular and difficult to lower the guaranteed price level even when costs of production are declining, stabilization by political decision is practically identical with “sta­bilizing upward.”

Finally, the greatest ordeal for the government agency responsible for operating the cartel is the ob­ligation to dispose of the accumu­lated excess stocks so as not to un­dermine the fixed price. Such dis­posal would be simple if it were done by destroying the supply. Grain could be burned or dumped in the ocean, although even this costs money. But powerful social, moral, and political taboos prevent this solution for any major non­perishable food commodity. Only in the case of coffee in Brazil was destruction used as a market-cor­rective action. Therefore, the gov­ernment must seek to release the excess of staple food commodities in foreign countries as gifts, on credit, or with lowered prices. Ex­cept for the gifts, this amounts to dumping, and has a deleterious impact upon producers in the re­cipient country, and secondarily on the exporting country’s foreign markets and on its foreign eco­nomic relations.

A Commodity in Quarantine Still Affects the Market

It is a psychological fact that a commodity kept off the market by a government, in quarantine, so to say, is still a powerful factor influencing both the price and the actions of all parties in the mar­ket. Grain “in jail” is still grain, because if it is not destroyed it will in due time appear as market supply.

National commodity markets are a remarkably effective system of communicating vessels in which millions of interested consumers, retailers, wholesalers, speculators, and farmers keep the flow going. The idea of inserting into the mar­ket, via detours, major quantities of supply, under perfect quaran­tine or segregated from the or­dinary supply, belongs in the realm of fiction. Only private charity distribution can minimize the im­pact on the market. Even the ably administrated food stamp plan of the late thirties in the United States proved that free food did not cause additional consumption of food, but actually subsidized consumption of other goods and services. To change the determined consumer’s preference in his fam­ily budget decisions takes far more than free distribution of goods, the more so the poorer and prouder he is.

The cartel operation produces still other undesirable side effects. In many instances, particularly for industrial raw material products in agriculture such as cotton, jute, hemp, and sisal, the raised fixed price gives the greatest incentive to producers of substitutes. This exerts pressure on consumption of the original product, say cotton, at the expense of the farmer, whose marketing quota will be cut if national consumption shrinks.

The industrial temperate zone countries, which make a virtue out of the backwash of domestic polit­ical necessity and subsidize ex­ports of agricultural raw ma­terials such as cotton, thereby slide to the next necessity of granting more subsidies. Manufacturers of cotton textiles, who have to com­pete in the foreign market as well as in the domestic one, now need a subsidy to restore equal raw ma­terial costs. And so there are three recipients of subsidies: the farm­er; the exporter of the farm prod­uct; and the manufacturer who uses the raw material.

However, I have not nearly ex­hausted the appalling record of unforeseen and unwanted distor­tions of economic processes caused by government intervention that attempts to remedy instability of commodity prices. Subsidized sur­plus disposal by gifts diverted to other countries can assist private charity that reaches the destitute, the sick, and helpless widows and orphans. But it cannot cure the causes of poverty. Only increased productivity on farms, in craft-shops, in factories, and in the wholesale and retail trade can do that. It is here that the disposal of surpluses from abroad does its greatest harm. The majority of people in underdeveloped countries are small farmers who earn their cash income by selling farm com­modities. Dumping such commodi­ties in their market may be a boon to some of their customers in the cities, but the farmers resent it, and it diminishes the incentive for them to produce more.

One Control Leads to Others

I have yet to give the reasons why I believe that, whatever ac­tion may be taken to mitigate the impact of unstable commodity prices on the balance of payments of developing countries, the In­ternational Commodity Agreement method is not only inadequate and dubious but outright harmful to the best interests of the developing countries and to world trade in general. Basically, the sobering experience of sovereign govern­ments of advanced nations with this enigmatic cartel policy in their national markets applies also to the immeasurably more difficult situation in the international com­modity market.

The worst feature of all market intervention with price fixing is that, while dealing with one com­modity or a few closely related commodities, this inevitably changes the relations between the price of the regulated commodity and the prices of all other com­modities and services. The inser­tion of one rigid price into a range of flexible prices for some 160 or 170 agricultural products is like a boy who knows nothing about the meaning or the effects of the different positions turning switches at the control board of an automated factory. The far-reaching adjustments that farmers and all other affected parties must make to the accidental price rela­tionships caused by fixing the price of one commodity are un­predictable. Therefore, such iso­lated treatment of the price mech­anism for one country contributes more uncertainty tomorrow than there was instability prior to price fixing. The case for all such trou­ble-multiplying cures rests on the assertion that the adjustment of supply and demand under the rule of flexible prices does not func­tion — an assertion that contra­dicts all evidence and economic experience.

The intent of stabilization is realized so long as the stabiliza­tion is upward. When, however, larger stocks have been accumu­lated and their disposal is unavoid­able, the same consequences arise as in the case of price supports in domestic markets. Necessity com­mands that besides regular com­mercial sales, concessional sales be undertaken, or part of the sup­ply be given away. This procedure leads to serious disorganization and corrosion of markets. The United States, with $6 billion worth of agricultural exports, dis­poses of over 30 per cent in the form of concessional deals. This is not done on principle. Far from it. It is simply the accumulated backwash of an ill-chosen method of social income support.

Enforcement of ICA regulations is even more difficult than is en­forcement in single countries. When one begins to speak of “po­licing the markets of coffee beans,” I wonder how one dares suggest the feasibility of such control in vast areas where the United Na­tions is faced with the problem of preventing the murder of rural people by armed bands.

Problems of the Board

Aside from the dubious state of effective government administra­tion, a serious question is whether competing countries can possibly agree on export or production quotas and thus freeze the geo­graphical location of production, or administer shifts in location. The board of an ICA must try to achieve principles of equity and justice for all signatory parties to the multigovernment cartel. Originally, commodity agreements included exporting countries only and thus represented producer in­terests exclusively. They led to de­fensive policies by importing coun­tries and their effect was nullified. Naturally, the enthusiasm of pro­ducers diminished as consumers won equal representation on ICA boards. Yet, without importing governments, such cartels are doomed.

Today, all such agreements in­clude major importing as well as exporting countries. This demands far more wisdom than the fairest and ablest board possesses. Sup­pose one exporter earns 80 per cent of foreign exchange from the commodity, another 20 per cent. When quota restrictions are neces­sary to raise the price, will the ex­ports from both countries be cut by the same percentage? If not, what principle shall determine the degree of discrimination and the number of years it shall last? If drastic changes in costs of pro­duction or handling or transporta­tion of the regulated commodity occur, which apply to one or more countries but not to all, shall all nevertheless receive the same price? If the commodity comprises a range of qualities, with lower grades produced at disproportion­ately lower costs, shall quotas treat all the same? Such questions indicate that ICA’s are bound to end up with all kinds of soft politi­cal compromises on the main points of control over supply, and even of price arrangements.

Subsidizing the Competition

As soon as there is a serious contingency of substitution for the commodity by other natural, proc­essed, or synthetic products, ICA price stabilization begins to sound the death knell for the original commodity. I indicated earlier that in many cases price supports operate, via detours of economic processes, to the long-run detri­ment of the cartelized producers. To prove my point that ICA’s may become deadly poison I have only to mention the cases of rubber, wool, linseed oil, or tungnut oil.

Natural rubber was one of the commodities on which price sta­bilization ideas were tested in a world-wide experiment under Dutch and British management. The attempted producer-exporter cartel was mainly instrumental in pushing rubber plantations into other tropical areas, in stimulating experiments with other latex-yield­ing crops, and in boosting synthetis production of plastomers with large government subsidies in in­dustrial countries. To kill the remaining industrial use of lin­seed oil, tungnut oil, or soybean oil, one need only fix the prices internationally.

Five ICA’s are at present in existence: on wheat, sugar, coffee, olive oil, and tin. Only four, ex­cluding olive oil, are important. The one for wheat is proclaimed by its supporters the outstanding success. It can be proved beyond discussion that the ICA’s for wheat, sugar, and coffee amount to no more than sanctimonious declarations of good intentions. They have neither stabilized the incomes of the exporting countries nor avoided the whole range of unintentional distortions of world trade that do far more harm than good. Insofar as the wheat agree­ment has given some semblance of stabilizing price — though not in­come — it was due to the fact that the governments of the United States and Canada shouldered the burden of carrying the gigantic excess stocks. But both govern­ments have had to enter into a multitude of noncommercial dis­posal arrangements that violate the principles of truly competitive international trade.

There is one little defect in all plans for administering economic progress at specified growth rates, which the econometricians usually fail to mention: no genius, no power in this world, has the abil­ity to forecast the future supply, the demand, or the price for any commodity, or to predict the per­formance of one or of many na­tional economies one, three, or five years from now. The most fabulous computers have not changed this situation one bit. We now know much faster and more accurately what has hap­pened up to today. But as to the future, we get the wrong guess­timates also much faster, and with more scientistic trimming.

Restrictive compulsory cartel policies that raise prices to bene­fit high cost producers and arti­ficially throttle output and supply to maintain such arbitrarily fixed prices, belong in the tool chest of the static society and its dirigism. Such policies are technically pos­sible, but they are the antithesis of what the dynamic economy of an open and free humane society requires.

I expect much sound develop­ment in those primary material exporting countries that succeed in taming the monster inflation and, relying on their producers’ ability to compete, pave the way for sound private investment of foreign capital, as the transfer of funds from government to govern­ment diminishes.