international commodity agreements to promote aid and efficiency: the case of coffee: a comment

International Commodity Agreements to Promote Aid and Efficiency: The Case of Coffee: ACommentAuthor(s): Alton D. LawSource: The Canadian Journal of Economics / Revue canadienne d'Economique, Vol. 2, No. 4(Nov., 1969), pp. 612-618Published by: Wiley on behalf of the Canadian Economics AssociationStable URL: http://www.jstor.org/stable/133849 .

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ALTON D. LAW ALTON D. LAW

FIGURE 1 FIGURE 1

S S I=o FIGURE 2

I=o FIGURE 2

for a learning by doing model with disembodied technical progress. The present article applies Ramsey-optimality criteria to the vintage learning by doing model originated by Arrow. It shows also that these results can be reached with less sophisticated mathematical methods than those employed by Sheshinski.

INTERNATIONAL COMMODITY AGREEMENTS TO PROMOTE AID

AND EFFICIENCY: THE CASE OF COFFEE:' A COMMENT

ALTON D. LAW Western Maryland College

In the May 1968 issue of this JOURNAL Irving B. Kravis produced a provocative article on commodity agreements of the International Coffee Agreement type.' He gave some history and analysis of that agreement and put forward a sug-

*The author wishes to express appreciation to James H. Street and Tony Killick for com- ments and encouragement. lIrving B. Kravis, "International Commodity Agreements to Promote Aid and Efficiency: The Case of Coffee," this JOURNAL, I, no. 2 (May 1968), 304.

Canadian Journal of Economics/Revue canadienne d'Economique, II, no. 4 November/novembre 1969. Printed in Canada/Imprime au Canada.

for a learning by doing model with disembodied technical progress. The present article applies Ramsey-optimality criteria to the vintage learning by doing model originated by Arrow. It shows also that these results can be reached with less sophisticated mathematical methods than those employed by Sheshinski.

INTERNATIONAL COMMODITY AGREEMENTS TO PROMOTE AID

AND EFFICIENCY: THE CASE OF COFFEE:' A COMMENT

ALTON D. LAW Western Maryland College

In the May 1968 issue of this JOURNAL Irving B. Kravis produced a provocative article on commodity agreements of the International Coffee Agreement type.' He gave some history and analysis of that agreement and put forward a sug-

*The author wishes to express appreciation to James H. Street and Tony Killick for com- ments and encouragement. lIrving B. Kravis, "International Commodity Agreements to Promote Aid and Efficiency: The Case of Coffee," this JOURNAL, I, no. 2 (May 1968), 304.

Canadian Journal of Economics/Revue canadienne d'Economique, II, no. 4 November/novembre 1969. Printed in Canada/Imprime au Canada.

612 612

01.

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01.

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gestion for the improvement of aid-oriented commodity agreements. His proposal was, in brief, to interpose an international tax on certain commodities to

separate a higher consumer price (to transmit aid) from a lower producer price (to remove incentives to worsen over-production). Such a proposal could, if effected, improve resource allocation and efficiency and reduce the

scope and difficulties of diversification problems. It could thereby improve development prospects. It may surely be claimed that his suggestion con- stitutes a clear improvement over the present nature of the coffee agreement by its elimination of several of the drawbacks of traditional quota-type restrictive agreements.2 Several points in his article merit further examination.

I / The historical record of the Coffee Agreement

According to Professor Kravis, the International Coffee Agreement shows "the influence of the provisions of the Havana Charter, ... an important source of

guidance in the conduct of commercial policy." He lists, among other Havana Charter influences on the agreement, "the achievement of long-run equilibrium between supply and demand" (p. 304); supposedly he means this as a goal of the agreement. Chapter VI of the Havana Charter indeed calls for efforts to reach such an equilibrium as it does for the other objectives Kravis lists.3 However, it should be equally clear that such a goal is not actually being pursued by the coffee agreement.

As Kravis notes, the agreement calls explicitly for keeping minimum prices at the 1962 level or higher. In actual operation, the price has been kept at 15 to 25 per cent higher than that level, despite the fact that even 1962 prices were far above the level that would have prevailed if supply and demand had been allowed to come into balance.4 This may be concluded from the fact that Brazilian farmers were getting only about half of the export price5 and that there were already enormous surpluses being withheld from the market. As for the movement of supply and demand "toward equilibrium," Simon Hanson quotes the International Coffee Organization's 1967 statement to UNCTAD regarding the outlook in the fifth year as follows: "production could continue to run ahead of consumption by 10 million bags per year and it is

possible that ... stocks in exporting countries would total 100 million bags by 1970."6 There clearly is no significant attempt to equate supply and demand.

2A fuller analysis of his proposal may be found later in this comment. 3See, Havana Charter for An International Trade Organization, US Department of State (Washington, 1948), 93, article 57. 4J. W. F. Rowe, Primary Commodities in International Trade (Cambridge, 1965), 181. 5According to Kravis' figures, they now receive about 31 per cent of the export price. 6Simon G. Hanson, "International Commodity Agreements," Inter-American Economic Affairs (Autumn 1967), 59. Surplus stocks, primarily in Brazil, had been about 60 million bags in 1962. Kravis himself notes ("International Commodity Agreements to Promote Aid and Efficiency," 316) that the agreement "has not progressed very far in coping with a number of fundamental problems, notably over-production." He indicates that between 1957 and 1965, while Brazilian coffee was being controlled, consumption grew 29 per cent while production was growing at 38 per cent (p. 299). Nevertheless, he concludes that the coffee agreement has had "a degree of success unusual in the field of commodity agreements." See p. 317.

Notes 613



Although some small diversification effort was being undertaken, the 1965-6 and the 1967-8 crops were among the four largest in history.

Similarly, Kravis' explanation of the 1964 price jump as being attributable to frost and drought is in error.7 In fact, in 1964, the following circumstances existed: (i) world surpluses estimated at over 60 million bags were being withheld; (ii) world output in the 1963-4 crop year was approximately 600 thousand tons greater than exports had ever been;8 (iii) a quota for the first

year's combined exports had been set at 5 per cent below the US Department of Agriculture's report of world trade of the previous year; and (iv) there were larger world carryovers in 1964 than in 1963.9 Despite these evidences of ample market supply, when prices began to rocket toward 50 cents per pound in early 1964, efforts by consuming nations to increase the permissible quotas were at first blocked by the exporters. The 1964 price jump must be considered the direct result of the coffee agreement, with only minor - if

any - assistance from the weather. In discussing the history of quota adjustment, Kravis asserts, "the countries

that did not stay within their original quotas have already benefitted at the

expense of those who did. On the other hand, it can be argued that the

original quotas based largely on past production were unfair to new low-cost

producers and that the waivers only rectified the inequities and injustices."10 If the latter justification of shifting quotas represented the actual case, it would be an encouraging note regarding prospects for preventing or correcting misallocation through the process of adjusting quotas under the Coffee Agree- ment. However, the waivers and quota shifts have largely been toward African - or at least non-Brazilian - producers. Since Brazilian producers received only 12.7 cents per pound out of the 41 cents price, it is most unlikely that the adjustment is toward the low-cost producer, or that the new producers are more efficient than the old. Kravis has implied that Brazil is a low-cost producer due to the small percentage of export price going to the producer. However, he ties this conclusion to whether "farmers' profit margins ... (are) the same in all countries.""1 Elsewhere he again indicates doubt, stating that "the present organization of the world coffee market makes it difficult to know which countries are really the low-cost producers."'2 Surely the differences between producer prices either as a percentage of the export price or in absolute amounts does not tell us all we would like to know about either cost of production or profitability. However, the spread between export price and producer price in Brazil is a very clear indication either that Brazilian farmers are producing at very low costs (lower than most other nations unless Brazilian farmers are suffering great losses) or that most other nations have huge profit

7Kravis, "International Commodity Agreements to Promote Aid and Efficiency," 301, 307. 8FAO, Monthly Bulletin of Agricultural Economics and Statistics (various issues) show output that year at 3,530,000 metric tons - exports had never been over 2,933,000 tons (1963 figure). There are 16%3 bags (132 lb each) in a metric ton. 9These last two items are from Edward J. Derwinski, "The Cost of the International Coffee Agreement," Inter-American Economic Affairs, (autumn 1964), 94. 1Kravis, "International Commodity Agreement to Promote Aid and Efficiency," 306. "Ibid., 302. l2Ibid., 310.

614 ALTON D. LAW



margins. The former is more likely; Brazil is a low-cost producer.13 Still she has seen the continual erosion of her quota, at least as a percentage of the world market. To the extent that this has occurred, quota adjustments have not improved allocation, but may have worsened it.

This is also indication that if the Brazilian producer still finds coffee profitable at 31 per cent of the export price, the case for aiding the poor producer, and his employees, is greatly weakened. Further, it is indication that massive diversification efforts may be needed to prevent continued worsening of the imbalance between supply and demand - unless prices are greatly lowered. It is granted, of course, that it was not Kravis' intention to defend the coffee

agreement, but to suggest ways to improve it. It is necessary, however, to state carefully the record of that agreement.

11 / Movement of commodity agreement emphasis toward aid

Kravis correctly notes that the emphasis in commodity agreement objectives has shifted in recent years from stabilization of prices to concern with price levels and trends and their effects on economic development in the producing countries.14 He has neither expressed his views on the validity of the terms of trade argument (and its importance in evaluating the case for or against commodity-oriented aid) nor adequately justified reversing his own recogni- tion that "commodity agreements are inferior means of providing aid ... ."15 Instead he either assumes that the new emphasis is justified or that its pursuit will continue in any case and concentrates on a particular form believed best if that direction is to be taken.

Even if the well-known limitations of restrictive quota-type commodity controls are lessened, as Kravis has tried to do, the tenets of this approach to aid are subject to serious question. Among the very significant objections to

using commodity agreements to promote aid is the doubt that commodity price relationships are a satisfactory indication of the proportions in which foreign aid should be distributed. Many deserving nations who have never been fortunate in exports would be denied at least some portions of assistance which

they would otherwise get. Killick points to the lack of attention to such key considerations as absorptive capacity, balance of payments positions and reserves, and effective development planning. Furthermore, he calls attention to a direct relationship between amounts of aid and the balance of payments positions of the donor countries'6 (which likely will be worsened by price- boosting devices). None of these objections is adequately answered by Kravis. Unless we accept the assumption that commodity activity on an aid basis will 13Kravis' footnote regarding the Kaldor plan supports this position, stating that "the size of the export tax would provide an indication of the relative efficiency of each country's coffee industry ...." Ibid., 312, n. 24. So would the size of the spread between producer price and export price. 14Several writers have noted and evaluated this shift in emphasis. Among them are Rowe, "Primary Commodities," 215ff., and Tony Killick, "Commodity Agreements as International Aid," Westminster Bank Review (Feb. 1967). 15Kravis, "International Commodity Agreements to Promote Aid and Efficiency," 296. 6Killick, "Commodity Agreements," 28-9. This relationship is not held to be one to one.

Notes 615



surely continue, these objections may be more basic considerations than how best to design agreements.

Additionally, the indication that "the failure of the developed countries to

expand their aid or to give adequate market access have led to a renewed interest in commodity agreements as a second best alternative [form of aid],"17 is dangerously misleading. In fact, the flow of bilateral official funds from

developed to developing countries still shows a sizable growth18 and the General Assembly passed a resolution regarding ICAs and price levels in

developing countries as early as 1954.19 This was several years before US official aid was to undergo paring, thereby casting further doubt that pressure for commodity price boosting is determined by the level of aid.

III / Evaluation of the Kravis plan as an alternative to the "coffee-type" agreement

The proposal set forth by Kravis would be, from an economic point of view, a substantial improvement over the traditional quota-type agreement. It would

help to free such agreements from their most objectionable features of inter- ference with optimal allocation and efficiency in use of resources. It would lessen the stimulus to overproduction - thereby reducing diversification problems. Regarding diversification, however, the view taken by Kravis may be

unduly optimistic. For example, we have seen that even though Brazilian

producers receive only 12.7 cents of the 41 cents price, they still find coffee

production profitable. Yet the Brazilian government, which receives the remainder (perhaps more than Kravis would recommend) has made only limited positive diversification effort, and has asked the United States government to help finance that which was undertaken.20

Where diversification is to be introduced on a sizable basis, Kravis seems divided over two goals. Both his title and his general emphasis stress efficiency, yet he laments the tendency of Brazilian farmers who "may use eradication subsidies to uproot relatively unproductive trees and retain the high-yield trees."21 That is of course exactly what they should do. Hopefully they would be further encouraged to do it under his plan. It may not speed reduction of

surplus output but it is essential to economic rationalization. The high price to consumers, moreover, would reduce the amount of coffee

17Kravis, "International Commodity Agreements to Promote Aid and Efficiency," 296. 18Committee for Economic Development, Trade Policies Toward Low-Income Countries (New York, 1967), 40, table 5. 19United Nations Organization, Commodity Trade and Economic Development (New York, 1954), 1. 20Hanson, "International Commodity Agreements," 67. Part of the share going to the Brazilian government is for handling and distribution costs which would be lessened under Kravis' proposal. It is true that Brazil has given some disincentive through the price spread discussed above. Much of this was achieved through multiple exchange rates which were unfavourable to coffee. (The free market of course would have provided a similar disincentive, and would have done so without encouraging the massive expansion in other areas, some of which is high-cost.) The reference here is to lack of significant positive diversification effort. Perhaps under provisions of the coffee renewal in October 1968 more diversification effort will be forthcoming. 21Kravis, "International Commodity Agreements to Promote Aid and Efficiency," 309.

616 ALTON D. LAW



demanded even more and would stimulate the search for synthetic substitutes. This effect would tend to maintain the imbalance between supply and demand. The resort to substitutes and changing consumption patterns, which might result from higher prices, also tend to enlarge the price elasticity over time, and may well result in smaller foreign exchange receipts for exporting countries if the longer period view is taken. (In coffee specifically even longrun price elasticity is possibly a bit less than -1.0.)

Professor Kravis believes that ICAs, including the interposed tax, would be more acceptable to importers because they could see where it was going and that the funds would not be used to further worsen the surplus output. It is questionable whether importers are willing to pay a higher tax or price boost when they can see where it is going. In fact, Hanson and others have

argued that it was actually the intent of the US State Department in its sup- port of the coffee agreement that the Congress and the US public not be

enlightened about the amount and nature of the transfer.22 Even if it is assumed that the political difficulties are to be smaller in con-

suming countries, there is little indication that such would be the case in

producing lands.23 The negotiation difficulties which have historically arisen

regarding quota shares might well be increased in such a plan. The high-cost producers (particularly if they constituted the entire industry in a given country) would fight even harder to avoid a scheme which would likely com- pletely eliminate their interest.24 Reimbursements over a phasing-out period would be inadequate to prevent this, even if the end may be desirable from a world viewpoint. It is still very doubtful that such a country would be willing to participate; and if it did there is little evidence that adequate diversification efforts would be undertaken. If "taxes levied unwillingly might find their way back to coffee producers in one way or another ..,.25 might not these fees when distributed to producing nations do the same thing, especially where coffee interests have a strong political voice?26 Even if such a country, with all high-cost producers, were willing to eliminate its industry altogether, this does not fit particularly well with the intended goal of aid.27

Kravis also mentions the possibility that there would be a transition period when governments might "lose export proceeds and in some cases revenues from coffee taxation as well."28 This, he believes, can be handled by turning 22Hanson, "International Commodity Agreements," 55ff. One could speculate that, if this allegation is true, the State Department might also have as a goal the establishment of a procedure that would force a greater share of the aid burden upon the other developed countries, for all consuming countries pay the higher price, whereas the US taxpayer alone might be asked to contribute to direct aid. 23Kravis recognizes some of this ("International Commodity Agreements to Promote Aid and Efficiency,"' 310). 24His idea of bribing the losers (ibid., 297) does not foreclose bribing an entire country. Politically, however, this approaches an impossible negotiating point, particularly where (as is often the case) the producers in the established exporting countries have substantial political force. 25Ibid., 311. 26Kravis mentions dangers of "grosser forms of subsidization." Ibid., 313. 27Neither is there any prospect that funds collected in this manner might be used for general aid, as in World Bank possibilities mentioned in ibid., 315. The producing countries simply would not stand for it. 28Ibid., 315.

Notes 617



ALTON D. LAW

over of fees collected under his plan to the governments involved in an initial transition period. Unless the interposed tax is to be nearly as large as the price spread in Brazil, the government of the largest producer would stand to lose substantial amounts of revenue. Brazil would resist accepting a much smaller amount, while consuming nations would not be willing to negotiate a tax so large for all imported coffee.

The plan of letting market price determine what is received by the producers, does not include any consequential provision to adjust for problems of price instability - truly the most justifiable basis for commodity control activity. If it is to be argued that the exporting nations could handle the stabilizing of price or export earnings from their alloted share of the tax money, serious

question may be raised as to whether they would or could adequately accom-

plish this. To the extent that they attempted to do so, it would leave smaller and less stable amounts of the tax fund (earned by the Kravis plan) for use in such adjustment measures as diversification. In the absence of adequate attention to stability, the interest of the writers of the Havana Charter in control as a relief for "widespread unemployment" is likewise not given adequate attention.29

Despite the several limitations noted here, there is still much to be said for the Kravis proposal. As already indicated, on economic grounds it is consid- erably superior to the current coffee agreement, and others of its type which

may follow. The greatest contribution of the Kravis plan is in offering a positive alternative to the mistakes of other procedures. This most worthwhile feature saw its forerunner in the British buffer-stock proposal at the Hot

Springs Conference in 1943. A proposal for a system of purchase guarantees, put forth by Benoit30 in 1959, was another alternative, as was that offered by Kaldor and mentioned by Kravis.31 Although these plans were not all designed to accomplish the same end, they have in common that they offer positive alternatives to the less justifiable procedures. If we join Kravis in the assumption that control activity is going to be expanded, we must give every effort to make it as economically rational as possible. There is no better time to make such effort than following the UNCTAD Conferences and prior to the establishment and implementation of less desirable controls. 29Havana Charter ... , 105, article 62. Kravis does mention some stabilization possibilities ("International Commodity Agreements to Promote Aid and Efficiency," 314 n.). 30E. Benoit, "Purchase Guarantees as a Means of Reducing Instability of Commodity Export Proceeds," Kyklos, no. 3 (1959). 31Kravis, "International Commodity Agreements to Promote Aid and Efficiency," 312.

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international commodity agreements to promote aid and efficiency: the case of coffee: a comment

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