Prices of Raw Materials, Budgetary Earnings and Economic Growth: A Case Study of Côte d Ivoire

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1 Prices of Raw Maerials, Budgeary Earnings and Economic Growh: A Case Sudy of Côe d Ivoire Nguiakam Sandrine 1 and Kabore Augusin 1 Ciaion: CTA and FARA Agriculural Innovaions for Susainable Developmen. Conribuions from he Finaliss of he 2009/2010 Africa-wide Women and Young Professionals in Science Compeiions. Accra, Ghana : s.n., pp Keywords: GDP, cocoa, coffee, expors, impac, oil, rade shock ABSTRACT The objecive of his sudy was o evaluae he impac of he flucuaion of inernaional prices of raw maerials on he variabiliy of he gross domesic produc (GDP) in Côe d Ivoire. The sudy used he vecor auoregressive model on an inernaional daa se of primary producs and expor earnings; inflaion and GDP were seleced variables analysed in relaion o his variabiliy. From 1960 o 2005, flucuaions of coffee prices explained abou 15% of he variabiliy of he GDP, while expor earnings in oal explained approximaely 20% of his variabiliy. The exchange rae of he dollar and flucuaion of he peroleum price, which are exernal facors, also had a significan impac on he dynamics of he growh of Côe d Ivoire. These resuls confirm he dependence of he Ivorian economy on raw maerials. They illusrae he need for he coninuaion of effors aimed a diversifying he economy, in paricular of he agriculural secor, and encouraging he seing up of an observaory for a beer inerpreaion of he world economic environmen, in order o predic and weaher he various shocks. INTRODUCTION Côe d Ivoire conribues o global rade hrough a limied range of producs including cocoa, coffee, imber and oil. According o saisics (Naional Saisical Insiue of Côe d Ivoire) on Côe d Ivoire s exernal rade, hese few producs have accouned for more han half of he value of expors since he aainmen of independence. Like he majoriy of Sub-Saharan African counries, Côe d Ivoire is a price aker. For his reason, i does no wield any conrol over he level of prices of is expors or impors. Furhermore, is expors are quoed in foreign currency and i has no conrol over he exchange rae, which affecs he expor earnings quoed in naional currency. I herefore seems ha Côe d Ivoire s dependence on raw maerials makes he counry vulnerable. As an illusraion, beween 1980 and 2002, annual world prices dropped by 58% in nominal value. In real value (ha is, when inflaion for he enire period is aken ino accoun), he effec was a gradual decrease in he purchasing power of farmers he decline in prices observed was 80.8%. Issue Côe d Ivoire relies on he prices of raw maerials, like mos oher Sub-Saharan African counries, bu wha is he effec of he insabiliy of hese prices on budgeary earnings, and wha is he indirec effec on he economic growh of Côe d Ivoire? Is i 1 Ecole Naionale Supérieure de Saisique e d Economie Appliquée (ENSEA), 08 BP 3, Abidjan 08, Côe d Ivoire. 1

2 possible o evaluae he magniude of he effec? Finally, how can he effecs (since we can do away wih hem) of his insabiliy on our economies be cushioned? Objecives General objecive The purpose of his sudy was o demonsrae ha here is a high correlaion beween inernaional prices of raw maerials (coffee, cocoa, oil, ec.), he budgeary earnings from enry-poin axaion and economic growh. Specific objecives To analyse Côe d Ivoire s expor srucure in order o highligh he imporance of raw maerials in expor earnings; o analyse he coffee cocoa secor, he oil secor and sakeholders; o evaluae he influence of price flucuaions on revenue from enrypoin axaion; o highligh he impac of he variaions of his revenue on he economic growh of Côe d Ivoire. Lieraure Review There is a grea deal of lieraure relaing o variabiliy (insabiliy) of prices of raw maerials. Kose and Reizman (2001) demonsraed ha in Sub-Saharan Africa, rade shocks linked o flucuaions of inernaional prices accouned for almos 45% of GDP flucuaions, 87% of invesmen variaions and 80% flucuaion of labour supply. A sudy carried ou by he Cenral Bank of Wes African Saes (BCEAO, 2007) wih he Projecion Macro-Economérique e de Simulaion (PROMES) model on regional economic prospecs, proved ha, in general, oil shocks conribued o he worsening of financial sabiliy of he elecriciy secor in mos of he counries of he Wes African Economic and Moneary Union (WAEMU) in view of he fac ha a greaer par of he elecrical energy being produced is from hermal sources. Harvard economis David Dawe (1996) carried ou an economeric audi on he assumpion ha flucuaion in expor earnings leads o insabiliy in household incomes. Chambas (CERDI, nd) noes ha, in he 1970s, mismanagemen of he rise in inernaional prices of phosphae led o he appearance of he Duch syndrome in Senegal. 2 However, hese sudies are general and conceal he specificiies paricular o each counry. MATERIALS AND METHOD To aain he objecives of his sudy, he following ools were used: documenary research and economic analysis, descripive saisics and economeric analysis. Documenary research helped wih a heoreical analysis of he economic repercussions of a shock on he raw maerials. Graphical analysis and descripive saisics helped in he presenaion and descripion of he macro-economic magniudes used in he sudy. Economeric analysis, paricularly he vecor auoregressive/vecor error correcion model (VAR/VECM) modelling, helped in analysing he impac of 2 Duch syndrome is a paradoxical phenomenon: a boom in a secor ha produces a naural resource would sponaneously end o compromise any effor of indusrialisaion or diversificaion of expors, so aggravaing he vulnerabiliy of he economy. 2

3 an increase in prices of raw maerials on Ivorian macro-economic variables. This economeric analysis was subdivided ino hree pars. o Causaliy, which helps in he correc formulaion of economic policy and decision-making. In his sudy, Granger s (1969) noion of causaliy was used. According o Granger, an effec of X magniude causes a response of Y magniude, if he knowledge of X improves he predicion of Y. This definiion esablished he anerioriy of evens. o The funcions of impulse responses, which measure he consequences of a shock on he variables. o Analysis of he decomposiion of he variance of error predicion, he objecive of which is o elici informaion on he relaive imporance of innovaion in he variaions of each of he model variables. 3

4 RESULTS Economic Analysis The effec of inernaional prices on he GDP is no a direc one, bu comes by way of inervening variables. One can disinguish beween he following channels: axaion, disribuion of naional revenue, consumpion and invesmen behaviours. These shocks on he prices of raw maerials can race heir source o he supply and demand sides, or resul from a variaion in he exchange rae (for counries in he CFA franc zone, i will be he difference beween euro and dollar). On he supply side, i could be he resul of an overproducion crisis, a domesic supply shock (e.g. increase in he cos of inpus); whereas on he demand side, he shocks emanae from a decline in global demand, which is generally exernal. A negaive price shock of raw maerials mean for expor would resul in a decline in expor revenue. This decrease in revenue has an effec on all economic operaors. Households, paricularly hose of farmers, experience a decline in heir incomes and herefore also adjus heir consumpion paerns. Graphical Analysis and Descripive Saisics Imporance of Raw Maerials in Expors The engine of growh of Ivorian expors is coffee and cocoa, which conribue grealy in erms of expors. In 1960, expors of hese wo producs accouned for more han 80% of oal expors and remained above 55% of oal expors unil In 1999, he share of cocoa among he expor crops was sill 43.8% (Table 1, which gives an idea abou he concenraion of Ivorian expors on cocoa). Table 1 Disribuion of major expor crops, 1991 and 1999 No. producs expored Share of oal expors (%) Produc mos expored (cocoa) 4 Three major producs expored (cocoa, coffee, oil) Source: Gros e al. (2002). Developmens in he Prices of Coffee and Cocoa On he whole, he prices of he wo producs winessed similar developmens from 1960 o Two periods can be idenified in erms of developmens in prices of hese wo producs a he world level. The firs is from 1960 o 1977, characerised by an upward rend wih an all-ime record of 1977, corresponding o a posiive shock in prices of hese wo producs. In fac, he prices of cocoa and coffee increased from US$56.49/pound and $61.05/pound in 1975 o $17.96/pound and $233.75/pound in In 3 years, prices ripled for cocoa and quadrupled for coffee. The second period, from 1977 o 2002, was characerised by a very serious downward rend. During ha period, a very wide price variabiliy and wo negaive shocks (in 1982 and 1993) were observed, and prices reurned o he 1960 level (Inernaional Cocoa Organizaion, ICCO, Inernaional Coffee Organizaion, ICO, In erms of he comparaive developmens of enry-poin axaion revenue, Ivorian GDP and world coffee prices, i appears ha variaions in he price of coffee

5 correspond wih variaions in revenue and, in a similar vein, wih GDP (Fig. 1). One can herefore surmise ha here is a close link beween insabiliy of prices of raw maerials and an increase in GDP. Figure 1 Developmens in erms of GDP, expors and coffee price Source: our calculaions, wih daa from he ICO and he macro-economic daabase (Naional Saisical Insiue of Côe d Ivoire) Economeric Analysis Definiion of Variables of he Sudy The variables used in his sudy are as follows: DOLLAR = inernaional price of US dollar; COFFEE = inernaional price of coffee (annual average calculaed from monhly averages); OIL = inernaional price of oil (annual average calculaed from monhly averages); EXPORT = expor earnings (per year); INFL1 = rae of inflaion (annual average calculaed from monhly averages); GDP = gross domesic produc. In applicaion of he VAR model, all variables are considered in logarihms. Thus, he L before he raing variables is he logarihm. The logarihmic form can easily derive he elasiciy and funcion of growh rae. The difference in log Y and log Y ( 1) corresponds o he growh rae of Y. Therefore he firs log difference of each funcion gives an approximaion of he growh rae of he funcion. One sep in he VAR model is he saionariy es. We used he Dickey Fuller and Phillips Perron ess. (The use of hese wo ess is moivaed by he fac ha he firs akes ino accoun he exisence of a possible correlaion of residuals, while he second akes ino accoun he exisence of possible heerocedasiciy.) The resuls of hese ess show ha only he variable inflaion is saionary a a probabiliy level of 5%. So we differeniaed all he variables o make hem saionary. Differeniaed series are denoed by DL. 5

6 Causaliy As he developmens in he prices of coffee and cocoa were similar over he period under review, we use only coffee prices in his modelling (o do away wih he risk of muli-collineariy). Afer carrying ou he differen ess, he VAR model obained was: Y A A Y 0 j j (,,,,,, ) where (he vecor of sochasic error erms is called impulses or innovaions or shocks in he VAR language); Y is he saionary process; A j is he marix coefficien; and sands for any given year. The order of our model is 1, and in marix form, we used he following equaion: DLCDOLLAR c1 a11 a12... a16 DLCDOLLAR 1 DLCPETROLE c2 a21 a22... a26 DLCPETROLE 1 DLCCAFE c 3 a31 a32... a 36 DLCCAFE 1 DLEXPORT c4 a41 a42... a46 DLEXPORT 1 LINFL1 c 5 a51 a52... a 56 LINFL1 1 DLPIB c 6 a61 a62... a 66 DLPIB 1 where: DLDOLLAR a01 a11 a12... a16 1 DLOIL a02 a21 a22... a26 2 DLCOFEE a 03 a31 a32... a 36 3 Y ; A0 ; Aj ; DLEXPORT a04 a41 a42... a46 4 LINFL1 a 05 a51 a52... a 56 5 DLGDP a 06 a61 a62... a 66 6 Figure 2 provides a summary of he causaliy beween he variables obained from he esimaes of he seleced model: he Ivorian GDP growh rae is joinly influenced by he variaion in he price of oil, coffee and Côe d Ivoire s expor earnings. COFFEE EXPORTS GDP OIL Figure 2 Causaliy beween he variables Impulse Analysis The impulsive answer measures he consequence of a shock on variables. The graphs (Fig. 3) presen some of he essenial impulse funcions obained. We are ineresed in 6

7 he effec of a shock over 10 years. Generally, he shocks are ransiional since heir effecs disappear a he end of en (10) years. This horizon represens he necessary maximal imeframe for he variables o regain heir long-erm level. The shocks were simulaed on he basis of coffee prices. The effec of a posiive shock on coffee price ranslaes ino an increase in he GDP. Following his shock, he GDP increases in he firs year, hen decreases from he second year before gradually finding is long-erm level afer a period of 6 years. These resuls once again confirm he coffee price and growh dynamics in Côe d Ivoire. I mus also be noed ha he effec of coffee price shock on GDP goes beyond 4 years. 7

8 Figure 3 Impulse response Doed red lines are confidence inervals (±2SE). The effec of a posiive shock on coffee price is ranslaed insanly ino an upward adjusmen in expor revenue. In he afermah of his shock, expor revenue regains is long-erm level a he end of 3 years. Variance Decomposiion The objecive is o deermine he relaive imporance of he innovaions in he variaions of each of he variables of he model. Concreely, we wrie he variance of he error of forecas on a horizon, h (in our case h goes from 1 o 5) according o he variance of he error aribued o each of he variables. When an innovaion explains a significan proporion of he variance of he forecas error, we deduce ha he economy is sensiive o shocks affecing his series. In his secion, we analyse he decomposiion of he variance of DLGDP and DLEXPORT. 8

9 Table 2 Variance decomposiion of GDP Period SE DLCOFEE DLOIL (%) DLEXPORT (%) DLGDP (%) DLINFL1 (%) The variance of error predicion of he GDP in he firs year is 61% due o is own changes, 13% o coffee price changes, and 17% o expor changes. In oher words, he variaions of he GDP depend (on he horizon of 1 year) by 13% on he dynamics of he coffee prices and by 61% on is own innovaions (or variaions). I can herefore be said ha hese variables influence GDP flucuaions in Côe d Ivoire. These resuls once again reflec Côe d Ivoire s dependence on his raw maerial. Table 3 Variance decomposiion of expor earnings. Perio d SE DLCOFE E DLDOLLA R DLOIL (%) DLEXPORT (%) DLGDP (%) DLINFL1 (%) The variance of error predicion of expor earnings is aribuable by 26% o is own changes, and 10.8% o coffee price changes during he firs year. In oher words, Table 3 shows ha he dynamics of he expor earnings in Côe d Ivoire are due o he variaions of he coffee prices (by 34%), variaions of he exchange rae of he dollar (33%), and is own variaions (26%) on he horizon of 1 year. I herefore seems ha he shocks on hese variables are dominan in all aspecs over he flucuaions in expor earnings. I can be concluded ha, in Côe d Ivoire, he coffee price and changes in expor revenues have a very grea impac on expor revenue. DISCUSSION AND CONCLUSION The objecive of his sudy was o evaluae how world prices of raw maerials conribue o he explanaion of Ivorian GDP growh. In erms of impac of he simulaed shock, he sudy revealed ha, following a posiive shock of coffee prices, here would be a posiive growh reacion of he Ivorian GDP. Furhermore, he GDP would regain is long-erm sabiliy wihin a period of 4 and 5 years for a posiive shock of he dollar and coffee, respecively. On he oher hand, following a coffee 9

10 price shock, GDP and inflaion ake more ime o regain heir long-run equilibrium han in he afermah of any oher shock (oil, dollar). Wih regard o he conribuion of world prices in explaining flucuaions of growh in Côe d Ivoire, i seems ha here, oo, expor revenue has a role o play in he explanaion of he GDP represening over 17.68%. Thereafer, he price of coffee accouns for a leas 13.5% in he explanaion of GDP flucuaions. This sudy helps o confirm he dominan role of coffee and expors in he Ivorian economy, including oil, he developmen of which is very imporan o he growh of he counry. Diversificaion of he Ivorian economy appears o be crucial in order o release he counry from is dependence on coffee and oher expor crops such as cocoa by creaing processing indusries a local level. Also, as he need for diversificaion is a long-erm policy, in he shor erm i would be necessary o ensure a pruden budgeary managemen policy and a good undersanding of he inernaional economic environmen, for example hrough he esablishmen of an observaory. ACKNOWLEDGEMENTS We hank M. Bello Toyidi and M. Koffi Nguesan for he qualiy of heir advice and for being always aenive o he concerns of sudens. Advice received helped in he realisaion of his work. REFERENCES BCEAO Perspecives économiques des Eas de l UEMAO en Banque Cenrale des Eas de l Afrique de l Oues (BCEAO), Dakar, Senegal. CERDI. nd. L inégraion commerciale e financière à l économie mondiale. In Plan de classificaion des aciviés de recherche. [online]. Cenre d Éudes e de Recherches sur le Développemen Inernaional, Clermon-Ferrand, France. ( Dawe, D A new look a he effecs of expor insabiliy on invesmen and growh. World Developmen 24 (12): Granger, C.W.J. [1969]. Invesigaing causal relaions by economeric models and cross-specral mehods. Economerica 37 (3): Gros, J.-B., Leilly, G. and Marine, S Performances commerciales de l Afrique subsaharienne : une diversificaion nécessaire. DIAL (Développemen, Insiuions & Analyses de Long erme) Documen de ravail DT/2002/13. DIAL, Paris, France. Kose, M.A. and Reizman, R Trade shocks and macroeconomic flucuaions in Africa. J. Developmen Economics 65 (1):