The Long Term Trend (?) in Cocoa Prices

1. The Long Term Trend (?) in Cocoa Prices Christopher L. Gilbert (University of Trento, Italy) christopher.gilbert@unitn.it Presentation prepared for the First Conference on the Economics and Politics of Chocolate, University of Leuven, Belgium, 16-18 September 2012.

2. Prebisch-Singer • Starting from Singer (1950) and Prebisch (1952, 1962), there has been a concern that the purchasing power of primary commodity prices has been declining and that that this decline might be expected to continue. • The Prebisch-Singer debate has focussed almost exclusively on indices of overall primary commodity prices or sub-indices thereof (agricultural prices, metals and minerals etc.). Much less attention has been given to the specific components of these indices even though producers or countries are interested in specific products and not the prices of baskets of commodities. (The exception is Kim et al, 2003). • There is no reason to expect a trend in an aggregate if there is no trend in the component prices. • Furthermore, if trends in at least some individual prices are stochastic, that property will be inherited by the aggregate index unless there is cointegration between those prices with stochastic trends. • It therefore makes sense to look at the prices of individual commodities and not aggregates both from a practical and a theoretical perspective.

3. Cocoa prices, 1850-2011 I use a number of different sources with the objective of obtaining a consistent annual price series extending from 1850 to 2011. • ICCO, Quarterly Bulletin of Cocoa Statistics (from 1990, but I now have from 1957). • IMF, International Financial Statistics (1948-56, source stated as ICCO but this is incorrect). • Weymar (1968), 1948-63, Accra beans in New York • Grilli and Yang (GY, 1988), 1900-47. This is an index set at 1977-79=100. The source is a 1987 working paper for which no copy appears to exist. • Clarence-Smith (2000) reports the average price of cocoa imports through Hamburg from 1850-1896 and reproduced from Mitchell (1992). • There is a problem in joining the GY and Hamburg series. I have used a series from Clarence-Smith (2000) for the highest price paid by Cadbury for São Tomé cocoa, yearly, from 1880-1911.

4. Real cocoa prices, 1850-2011 The trend, if any, in “real” cocoa prices will depend in part on the choice of deflator. Grilli and Yang (1988), in common with most others, deflate by developed country export unit values to give a terms of trade measure. Cocoa producers will be interested in other prices - such as those of oil and grains as well as of manufactures – and in any case, that deflator is not available back to 1850. I deflate by the US Producer Price Index (all items) which is available from the start of the C19. The result is a (cif) price for cocoa relative to a basket of all wholesale prices.

5. Six cocoa epochs We can visually distinguish six cocoa epochs. • Mixed low and high prices from 1850-80. • 25 years of high prices from the mid 1880’s until 1910. • A sharply declining trend with high volatility from 1910-20 • 20 years of low prices from the mid 1920s to the end of WW2. • 25 years of moderately high prices from the end of the WW2 until 1980 (punctuated by a briefer period of low prices in the 1960s). • 30 years of low and non-volatile prices from 1980 to the present. Estimates of the cocoa price trend are likely to have varied according to the epoch.

6. The cocoa price is non-stationary Standard ADF tests show that the real cocoa price is neither stationary nor trend-stationary. The failure to reject trend non-stationarity, i.e. the conclusion that the price is non-stationary even allowing for a deterministic trend, implies that any estimated trend will be non-constant.

7. Trend estimates in different periods The graph shows the recursive least squares estimate of the cocoa price trend from 1865-1900. These are the estimates of the slope from the regression of the log real cocoa price on a deterministic time trend from 1850 to the year in question. The broken line gives the boundaries of the 95% confidence interval. A significant negative trend estimate would have resulted for samples terminating in 1937-58 and 1985-2011. A significant positive trend estimate would have resulted for samples terminating in 1881-1922.

8. If no trend, what does explain long term price movements? • There is no trend in cocoa prices – simply a shifting equilibrium between production and consumption. • The missing element in the story is the cocoa investment function. Investment in the stock of trees determines the position of the cocoa supply curve over the decades that follow. • High cocoa prices are certainly one factor which induce new planting, but decisions are also made by governments, in some cases motivated by more general developmental concerns.

9. The “Great Chocolate Boom”, 1880-1910 • Clarence-Smith (2000) defines the period 1880-1914 as “the great chocolate boom”. He states, “The explosive growth of a mass market for chocolate from the 1880s transformed world consumption more radically than at any other time in history. • Over this period, cocoa was primarily a Latin American and Caribbean crop. The Portuguese colonies of Angola and São Tomé and Prìncipe were the sole significant African exporters. • Reported exports from cocoa-exporting territories grew at an average annual rate of 4.85% over the 25 years 1880-1914 as compared with only 1.9% over the 25 years 1850-74. I interpret this as a rightward shift in the demand curve with an upward sloping supply curve with only limited investment in new planting.

10. What caused the boom to end? It is tempting to believe that high prices ended through a decline in demand brought about by the First World War. This is a possible factor but the price decline set in well before 1914. 1907 was the last high price year. By 1910 the price was only slightly more than half that of 1907. Clarence-Smith (2000) makes much of 1907 cartel action led by producers in São Tomé who withheld supplies from the market. I interpret the cartel action as a (temporarily successful) attempt to hold up prices in a falling market. I argue that the price falls in the first decade of the C20 resulted from new planting mainly in British colonial territories, and in particular in the Gold Coast (Ghana)., but also Nigeria, Kameroun and Equatorial Guinea. The chart shows African (light blue) and non-African cocoa exports from 1850-1914.

11. Low prices, 1910-45 • The cocoa trees planted in the 1890-1910 decades will have been productive up to the Second World War. The cocoa supply curve had therefore shifted sharply right. African, not Caribbean, producers became the marginal suppliers. • At the same time demand growth was slow and possibly negative in the 1930s. This substantial supply overhang set the stage for the political economy of supply management. • The colonial authorities, particularly the British, established marketing boards with the objective of smoothing prices over time but also, by restricting exports, of avoiding “burdensome surpluses” and hence maintaining prices to producers (and margins in the supply chain).

12. The post-WW2 period • The post-1945 European recovery led to renewed growth in chocolate consumption and hence of cocoa grindings. The 1953 ending of confectionary rationing in Britain was particularly important since Britain was responsible for around 15% or world cocoa imports. • African supply was now unresponsive, particularly in Gold Coast-Ghana, because of the tight grip of marketing boards and the high wedge they drove between fob and producer prices. Prices rose strongly in the early 1950s and, although volatile, were not low again until the 1980s. • Côte d’Ivoire, under Houphoüet-Boigny, emphasized agriculture as the route to development. Government allowed families, often Burkinabé, to farm tropical forest where population densities were low. Substantial intra- and international migration resulted in Côte d’Ivoire overtaking Ghana as the world’s major cocoa exporter. The resulting downward pressure on the cocoa price was offset by the simultaneous collapse in Ghanaian exports caused by an excessive wedge between producer and fob prices.

13. 1980-2011 The 1980s and 1990s saw two important developments, both of which put downward pressure on the cocoa prices. • Ghanaian cocoa production recovered. • Marketing chains were liberalized. Marketing boards and caisses de stabilisation were dismantled or substantially reformed. These reforms reduced costs in the marketing chain, allowing farmers to obtain a higher share of the fob price. However, there was a fallacy of composition in supposing that all countries could benefit in this way – world-wide reform shifted the supply curve down reducing the fob price. Farmers obtained a higher share of a lower price (Gilbert and Varangis, 2004).

14. What are the origins of cocoa investment? • Cocoa is a smallholder crop. It is relatively easy for farmers to plant new trees in a zone where cocoa production is already established. It is much more difficult to establish cocoa in a new area where there are no supply chain intermediaries and where farmers have no experience of drying and fermentation. • The major increases in cocoa investment in the periods 1890-1910 (primarily Gold Coast) and 1960-80 (primarily Côte d’Ivoire) were only partially driven by high prices. Expansions resulted from policy decisions by the governments or colonial authorities to develop cocoa. • Similarly, market liberalization was politically driven. • Once these new developments have been undertaken, the trees are productive for 40 years ore more. It is seldom profitable to grub up trees when prices are low – they are simply left and merge into the forestbut can be harvested again when prices justify this. • I contend that it is these major developmental and policy decisions which drive long term shifts in cocoa prices – not some inexorable trend.

15. Conclusions • There is no trend in cocoa prices – simply a shifting equilibrium between production and consumption. • Once planted, cocoa trees remain productive for over 40 years. The result is that over-supply can persist for up to 20 years. • Major expansions of cocoa production are seldom simply a response to high prices, although high prices may be a necessary precondition. Governments are also, and perhaps necessarily, involved. Absent such developmental decisions, periods of high prices can also be highly persistent. • Cocoa consumption is likely to grow in the future as in the past, particularly if Asian consumers develop a taste for chocolate. A major expansion of demand will require a supply response. The future path of cocoa prices will depend on whether the required expansion of cocoa production follows the demand growth or whether governments instead attempt to anticipate this growth by developing their own cocoa production and chocolate manufacturing capabilities.

16. Thank you for your attention