Policy Towards Commodity Shocks in Developing Countries


WP/96/84-EA

Policy Towards Commodity Shocks in Developing Countries
by Paul Collier and Jan Willem Gunning


Twenty years ago the policy advice of the international financial
institutions on commodity shocks was that governments should use stabilizing
taxation. On the basis of a comparative study of 23 shock episodes, this
paper argues that governments usually have proved to be rather bad at coping
with revenue volatility. By contrast, private agents respond much more
appropriately than governments in their custodial role have presumed. In
particular, private agents have remarkably high saving rates from windfall
income.

While the case for custodial fiscal policy is weak, there is an
important role for active monetary policy if the windfall is left with the
private sector. During windfalls the private demand for real money balances
first rises and then falls, reflecting predictable portfolio changes in
response to transient income. Public policy should focus on accommodating
private sector responses rather than confiscating the windfall. Despite
generally high public and private savings from windfalls, this has not
translated into sustained increases in output. The paper considers whether
it would be better to reverse the custodial argument and transfer public
shocks to the private sector. It concludes that the difficulties of such
transfers make them only partially appropriate.