CAS Commodity Professional: Basic Introduction & Geopolitical Dynamics

Textbook 2014 59 Pages

Business economics - Trade and Distribution


Table of Contents

Lecture 1: Commodities and the state

Lecture 2: Commodities, international order, and the matters of war and peace

Lecture 3: The shift power from West and North to East and South

Lecture 1: Commodities and the state

There has always been a close and intimate relationship between commodities on the one hand and political power or the state on the other hand. And the relationship has always been a deeply political one. This is true for all periods in history as well as across different cultures.

There is an easy explanation for this: commodities have always been a source of wealth and power; in the case of agricultural or soft commodities, they have always been essential for the feeding and clothing of people ruled by the government.

The format of the state and government has immensely varied over times and cultures, of course. And as you can see from this slide, the degree of government interference with the production, trade and consumption of commodities has always varied, in line with the technical utility of certain commodities. In pre-industrial ages and cultures, the influence of political power over the production, trade and consumption of commodities was biggest with precious metals - gold and silver were essential to demonstrate the power of the state and to pay armies and civil servants. Almost as important was the government's rule over grain. The beginning of the state very often goes back to keeping storage houses for grains, in order to regulate the supply of food, particularly in times of drought and famine or some other natural disasters. Less prone to government's influence were ferrous metals, out of which weapons and tools were manufactured - but given that weapons were critical to run armies, there sometimes still was some degree of government control when it came to the extraction and manufacturing of iron.

This order of commodities' vulnerabilities to the state's influence changed with the industrial age when technical progress gave commodities new utilities or, more importantly, gave certain commodities a utility for the first time. In the pre-industrial age, for instance, coal or oil were of relatively little use. With industrialisation, however, this changed, and energy, like oil, gas, or coal suddenly gained a very critical role in economies as fuel - fuel to drive engines, but also fuel for heating and for furnaces. As we are going to see, energy became the commodity most susceptible to state influence and interference in the industrial age. Next to it came ferrous and other industrial metals, because they were needed to manufacture goods, sometimes also weapons. Agricultural commodities, on the other hand, became less relevant, thus the state interfered less here than it did in the pre-industrial age. And interference with precious metals became even less needed after the abolition of the gold standard as the basis for currencies.

As technology progresses, and our economies are entering into what some have termed the post-industrial age, other commodities will climb up the ladder of becoming the main value drivers - and thus will become more susceptible to state interferences. In an age of mass mobile device usage, rare earth metals may gain an enormous importance - while only a few decades ago, these metals would have been thrown away as unusable garbage.

What is important to keep in mind, however, is that the formula of the relationship between the state or government and commodities is essentially always the same - and actually, it is the same for any kind of economic item and the state:

Now, as I said, this basically applies for any product of economic processes regardless whether we are dealing with commodities or with manufactured goods or services. Taxes as the simplest form of government interference with economic processes are raised on almost any product or service. But with commodities, or at least with some commodities, the determination of governments to interfere and to appropriate the proceedings derived from production or trade has been particularly strong, for a variety of reason: history and symbolism, as in the case of precious metals and currencies; technological advances as in the case of energy and industrial metals; the provision of basic human needs such as food or cloth as in the case of agricultural commodities.

Commodities play a critical role in many economies. According to the IMF, net commodity exports make up more than 10 percent of total exports in approximately half of the countries we have on this planet today. In 31 countries, commodity exports make up more than 10 % of GDP. Among them are, for instance, Russia or Indonesia, one a great power, the other the fourth largest country in terms of population. In the Middle East, commodity exports make up more than 25 % of the GDP, and in this case, it is often only one single commodity, namely oil.

Particularly among so-called developing countries, commodity exports make up the bulk of exports, for instance in Africa or the Russian-led Commonwealth of Independent States (CIS). As you can see, this share has been trending upwards over the last years.

Given the big share of commodity exports, they often also provide the bulk of government revenue in these countries. In fact, given the weak state structures in many developing countries, taxing commodity exports are often by far the most important revenue source for governments. No wonder that the relationship between commodities and the state is particularly intimate in these countries.

In order to exemplify the close and intimate relationship between commodities and the state, I would like to examine now one particular aspect of this relationship, namely the issue of ownership. To whom do commodities actually belong, and how has the issue of ownership influenced and shaped the relationship between the state and commodities over the course of the last two centuries?

In contrast to services, commodities are bound to physical spaces, because they are either buried in the ground and first have to be extracted before being put to any economic use, or they are grown on land where they first need to be sown and then harvested. Even livestock, though actually mobile, is subject to space, as it requires grazing land, for instance. Space, however, belongs to somebody - either to an individual or person, which makes it private property, or it belongs to a group and community, which makes it public property. In the extreme form, public property is state property.

So the question is whether the owner of the space is also the owner of the commodity that is either buried in this space, or grown on the land? If the answer is no, then we need to know who else then is the beneficiary of the production of these commodities?

The rules of ownership are, of course, determined by the state. In our societies of the West, most goods are in private hands, and not in the hands of collectives or of the state. There must be special reasons, so goes the consensus, why a particular good ends up as collective or state property.

So the next question then is whether there are any special reasons why commodities should be treated different from normal goods.

Property and ownership are concepts that are very much subject to temporal and cultural differences. Our own understanding of property and ownership was actually formed by Anglo-Saxon thinkers like John Locke and David Hume in the 17th century on the hand, and by the heritage of the American and French revolutions on the other hand.

This meant that in the early 19th century, ownership of land, at least when it was arable and accessible, in Europe and North America was for the most part in private hands.

Private land, however, also meant that the production of commodities in these areas was also in private hands and the beneficiaries of the proceeds of these commodities were private individuals, or early private companies. Actually, production was not subject to any special government interference.

This changed in the 19th and 20th centuries as the consequence of 4 developments:

1) First, there was the emergence of Marxism. The anti-thesis of capitalism, its core tenet is the collectivisation of the 'means of production', including the collectivisation of land and with this also the commodities embedded in the land. So Marxism does not preach the collectivisation of commodities only, rather it advocates the nationalisation of the entire economy and the abolition of any private property.

2) The second development was the emerging idea that commodities formed some sort of 'national patrimony'. Given the enormous value that was associated with the exploitation and sale of commodities, it was argued that they should not be treated like any other material merchandise or good, but as a separate category whose wealth should be to the benefit of the entire nation, and not only of private individuals. This idea of 'national patrimony' proved to be very powerful. In the 1960s, it was even enshrined in the UN Covenant on Civil and Political Rights. However, almost exclusively minerals, metals and later also hydrocarbons were regarded as 'national patrimonies', almost never soft commodities.

That commodities were managed as national patrimony could take two different forms: they were either nationalised or their production and sale was subject to a special tax regime, with higher tax rates than for other goods or economic activities.

3) A somewhat similar idea to that of commodities as national patrimony is that of commodities as 'strategic resources' to the nation. Here, the idea is less to share the wealth deriving from commodities, but to ensure the competitiveness, defence and survival of the nation by reserving the utility of a particular commodity to one's own nationals or government. This became especially true for commodities that had some military value, like metals, which were used to manufacture weapons.

These three ideas - Marxism, commodities as 'national patrimony' or as 'strategic resources - have one thought in common: they all depart from the idea that the ownership of property by individuals is an essential human rights and conducive to the creation of prosperity. Marxism and the concepts of commodities as national patrimony or strategic resources see private ownership of commodities as harmful to broader prosperity or national defence and survival. Hence, these commodities need to come under some sort of special regime, i.e., public control.

There is a fourth development with undermined the private ownership of commodities. It is the development in the European colonies around the globe in the course of the 19th century.

As you know, European powers seized large overseas territories in Latin America, Africa and Asia. Of course, most of these areas were inhabited, and they all had some sort of government and political-administrative structure. Yet, the arriving European powers often did not recognise these structures. A Swiss expert of international law, Emer de Vattel, who lived in Neuchâtel in the mid-18th century, declared a doctrine under which land in these colonial areas had no rightful owner. It was, in Latin, "terra nullius" - land belonging to nobody.

De Vattel's doctrine proved to be highly influential. It basically gave conquering powers carte blanche in terms of land policy and land distribution in the colonies. A regime developed under which the colonial governments would grant the right to extract commodities to European private individuals or companies. In the case of agricultural commodities, they simply lent or sold tracts of land for cultivation, be it for cereals or for cash crops. They also granted tracts of land to drill or prospect for metals, minerals and later hydrocarbon energy. Such rights to tracts of land were called concessions, often entailing a one-time payment. Then there were the fees once production of commodities had begun - the so-called royalties - literally "the king's cut", referring back to the fact that in the 19th century most of the European colonial powers were still monarchies. Hence the name. Finally, there were the taxes or duties as such, paid either on income or on exports.

This basic template to allocate land to commodity exploitation was not only adopted in European colonies, but also in those countries which eventually did not succumb to colonial rule, i.e., Iran, Ethiopia, China or Thailand.

A concession mostly meant de facto ownership regarding a tract of land though not quite. At least in theory, there remained a grey zone whether concessions really amounted to private property or not. In practice, however, concessions were that - private property. Moreover, while there were the payments for the concessions, the royalties, and the taxes, the financial burden for commodity producers proved to be relatively light in most colonies. Enormous wealth was created for the owners and shareholders of mines, plantations and oil rigs in the colonies and these owners for the most part were white-skinned Europeans of noble or bourgeois descent.

Over the course of the 20th century, the notion of private ownership of commodities, particularly when it came to hydrocarbons, metals and minerals, gradually eroded. Only in the US remained private property of commodities relatively undisturbed, also in parts of Europe - but already much less so than in the US.

The advance of the idea that commodities and their benefits belonged not to private individuals, but to the nation as a whole, and to the government in practice, became very pronounced during decolonisation.

Since World War II, the European colonial powers lost their grip over their overseas empires. Within 15 years, much of the previously colonised world became independent. An important aspect of this development was that European and sometimes American private ownership of commodities in most of these former colonies was abolished and transferred to the government.

The 1960s and 1970s saw a tidal wave of nationalisations, confiscations and expropriations in Latin America, Africa and Asia, peaking in the early 1970s, as you can see from the chart. Most prominent were the nationalisations and expropriations in the hydrocarbon and mining sectors. Nationalisations in these sectors caught not only the headlines, they also were the largest ones in terms of value of assets seized. Spread over geographies, you can see that initially nationalisations and expropriations were relatively even distributed, then peaked in Africa in the late 1970s and finally became an almost entirely Latin American phenomenon in the 1980s, though now at a very low level.

The prominence of hydrocarbon and mining during the nationalisations can be seen on this slide. 32 percent of expropriation acts between 1960 and 1979 were in hydrocarbons and mining. Of assets nationalised by different countries, you can see that oil and mining made up more than a third of total assets nationalised for the classical colonial powers France, UK and the Netherlands, plus the US.

Here on this slide you also see when nationalisations of oil took place in key production countries.

There is no clear dataset how much of foreign assets in the respective commodity sectors were nationalised in this phase. There are only rough estimates - which can vary widely. One estimate puts it that a fourth of foreign investment in the so-called Third World were nationalised between 1956 and 1972 - as foreign direct investments were concentrated in the commodity sector of many countries, we can safely assume that a disproportionate amount of nationalisations were with commodities. There also was a considerable concentration in geographical terms: 41 percent of nationalisations in the 1960s and 1970s took place in only ten countries.

Nationalisations and expropriations petered out in the 1980s. On the one hand, this was because in many countries the assets that were seizable from foreign owners had been seized by then. On the other hand, nationalisations and expropriations often had not led to the desired economic and wealth effects. On the contrary.

1) Nationalisations and confiscations did not necessarily accelerated the economic development in many countries where the government had seized assets. The national economy often bifurcated: on the one hand, a highly lucrative, foreign exchange-earning commodity sectors which provided the bulk of income for the government, on the other hand, a vast, mostly agricultural subsistence sector which supported the large majority of the population, but also kept them trapped in poverty and underdevelopment. The idea of commodities as a national patrimony turned into a fata morgana.
2) Very closely related to this is the fact that nationalisations and expropriations were often detrimental to the development of democracy and good governance. They only benefited a small elite, fostering a parasitic state class. Governments growing rich from producing and selling commodities saw little necessity to involve their citizenries in managing their country. The outcome were corrupt, politically unaccountable, intransparent regimes who wasted their income on prestige projects and armament.
3) Simultaneously, however, these governments became dependent on the price fluctuations for commodities on the world markets. This made their income to gyrate wildly, provoking social unrest. As a consequence, governments built a security apparatus to quell any discontent, enhancing the repressive nature of these regimes.
4) Last but not least, there was the economic phenomenon of the 'Dutch disease': the exploitation of commodities left governments with little incentive to promote other sectors of the national economy. This phenomenon was first observed in the Netherlands where the discovery of large natural gas deposits led to a negligence of the country's manufacturing sector. High inflation and overvalued currencies were other symptoms of the Dutch disease and the undermined the purchasing power of both the middle classes and the classes of the population included into the local monetary economies. Its most dramatic effects could be best observed in many developing nations with a nationalised commodity sector.

The combination of these phenomena gave rise to another term: the 'resource curse'. Although in theory the availability of commodities could make countries rich, in practice very often the opposite had been true. The access to easily exploitable commodities made the broad development of economies to stall, with the countries seemingly trapped in underdevelopment, inequality and poverty - and thus prone to violent outbursts of protest.

On the basis of this experience, a number of developing countries tried a new policy approach. The pendulum swung back in the 1990s - now commodities were no longer nationalised, but rather privatised and deregulated, as you can see on this slide.

The most prominent example in this respect of course were the liberalisations, privatisations and deregulations that took place in the former Communist states of Eastern Europe and, from a commodity perspective, in Russia. But also in Latin America and Africa were commodities now re-privatised, or at least partly so. The preference was rather with a more sophisticated approach: commodities very often remained nominally government-owned, but production was left to private companies who were taxed at very low rates, if at all. Only the Middle East, with its huge oil and gas assets in government hands was largely left out from this privatisation trend in the 1990s.



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Lucerne University of Applied Sciences and Arts – Institut für Finanzdienstleistungen Zug
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Title: CAS Commodity Professional: Basic Introduction & Geopolitical Dynamics