Mauricio Mesquita Moreira Principal Economist Integration and Trade Sector

1. Commodity prices: cycle, super-cycle or trend? Implications for Latin America. Mauricio Mesquita Moreira Principal Economist Integration and Trade Sector G-20 Workshop on Commodities May 19-20, Buenos Aires, Argentina

2. Motivation • The rapid increase of commodity prices initiated early this decade, and only briefly interrupted by the financial crisis at the end 2008, has been motivating a number of interconnected policy debates related to issues such as renewable energy, the poverty impact of higher food prices and “Dutch Disease” effects. • An effective policy response to those challenges hinges on a reliable diagnostic of the drivers behind these price increases and on the prospects for the medium to long-term. Is this a regular cycle, a super-cycle or a new upward trend? • Latin America, perhaps like no other region in the world, has its long term growth prospects closely tied to the answers to those questions. • Our policy “hunch”, based on still preliminary, but suggestive evidence is that the region is likely to face a super-cycle, if not an upward trend, driven by the emergence of giant Asian economies, whose scarcity of natural resources has no parallel among the economies that have led world growth. • If that is the case, LAC faces key challenges in (a) diversifying and adding sophistication to its exports and (b) generating jobs, both in the context of an inevitable specialization natural resources.

3. Putting the recent surge into perspective What is behind it? a review of the evidence available The role of the Asian giants and its impact on LAC’s growth prospects Making the most of the new trends Outline

4. Getting some historical perspective

5. The recent surge

6. The recent surge: determinants • increased demand • global growth, BRICs (India, China) • bio-fuel production • lax monetary policy (interest rates) • weak U$D • speculation, risk • constrained supply • input costs (crude oil) • shortfalls (draught Russia Aug.‘10, flood Thailand ‘10) • sluggish growth in production 1995-2003/1990s • policies (export taxes, import liberalization, bio-fuel subsidies)

7. Asia’s role

8. Asia’s role

11. Growing Asia demand is not just the result of higher growth but also increasing natural resource intensity Objective a) identify China and India income elasticity for imports of agricultural and mining products b) view its evolution over the past decade Methodology Gravity model with a two step estimator that controls both for extensive and intensivemargin, Helpman, Melitz and Rubinstein (2007) Sample 99 countries, 1992-2009 Usual gravity control variables (distance, area, colonial ties, etc.) “Religion” is the exclusion restriction

13. Growing Asia demand for natural resources is compounded by growing competition in manufacturing Source: Mesquita Moreira 2010 Source: Jaumotte and Tytell. WEO 2007. IMF

14. The competitive pressure: manufacturing

15. Conclusions • The world has been experiencing a surge in commodity prices since the beginning of the decade, which raises challenging questions about medium and long-term trends; • A number of supply and demand determinants are discussed in the literature and all of them seem to play part in the surge, but we argue that the dominant factor in the long-term is Asia’s demand, driven by the super, natural-resource scarce economies of China and India. • We believe that China’s and India industrialization will fuel a long-term upward trend in commodity prices, perhaps unrivaled in world history, particularly with respect to manufacturing prices (the “Prebisch reversal”?) • A scenario like that challenges LAC’s long-held beliefs that it is the industry that will make us developed and rich. • It calls for different priorities: All-out protection and subsidies for manufacturing seems hopeless. Instead, the region should focus on: • (1) maximize NR rents by improving regulatory frameworks and infrastructure; • (2) allocate rents to (a) create conditions for tech upgrade within the NR cone of diversification, i.e., investments in education and S&T; and (b) fund social programs to better distribute wealth and compensate for low job creation.