One-Note too Many: A Thought on Commodity Dependence of Economies

I thought about this blog's next theme/topic and went blank. You see, it's more of a habit now, although I enjoy every bit of it. I was thinking of writing about the 'Resource Curse' theory and how we can adopt it on a broader scale by tweaking it and increasing the domains it encompasses. It felt too dull, but I started thinking of the energy crisis in Europe at this time, and the theory just kept revolving in my mind, though it's not entirely related. I was also thinking about how certain countries, especially developing ones, depend highly on their exports and imports. I would hardly argue that they could rely on a single region or commodity. Finally, I thought of just maundering my thoughts on how globalization might be different than how people perceive it, the ongoing energy crisis, and the idea of over-dependence on a single entity or commodity. Excuse me for this one, as having a structure is not my forte and will never be.

The continent of Europe has been going through an energy crisis for a decent amount of time now. Gas and electricity prices are soaring, and the continent is just trying to get hold of cheaper imports and alternatives apart from Russia. The world was already facing a crisis in the form of the pandemic, leading to high prices for most goods and services and disrupting various chains worldwide. Europe was not opposed to any of this, and the crisis started deepening when Russia attacked Ukraine and has been facing the wrath of Western nations since then. Russia has made it clear that due to the sanctions imposed by the US and some European countries, they are unwilling to supply natural gas to Europe. Russia also clarified that they would stop the entire supply if any other import caps and sanctions were imposed. The question is not about Russia's decision to stop the energy supply or the US's actions to condemn the invasion of Ukraine. It is about Europe's dependency on a single nation. Surprisingly, it's not only the continent of Europe that is facing such issues, as several countries are overly dependent on either the import of a single resource or the export of one. Over-dependence has never benefitted a country. With the system of globalization changing and evolving continuously, such situations will always be disastrous for various countries, especially developing and emerging ones.

INTRODUCTION

The world still needs to shift towards renewable energy sources and adopt the changes on an overall level. Till then, the energy resources are limited. They are primarily concentrated in some areas of the world, which means a lot for the country having the resources, and the countries being excessively dependent on that country. This situation can be classified as a revamped and restructured version of the 'Resource Curse.' The Resource Curse theory states that the country that is deemed to be highly resource-rich often ends up being the poorest as well. The central hypothesis for the idea is the assumption that the economy having an excess of one resource will be highly volatile to the changes in the resource's price, primarily oil and gas. This theory can be extended to the countries dependent on resources, especially the ones dependent excessively on one country or region. Unstable prices will affect the exporters, the importers, and even more. If there is a situation like what we had in the last two and a half years, and to top it with another shock, it will increase the misery of many countries. In the European Union, for example, countries like Estonia, Latvia, Finland, and Slovakia depend on Russia for 100% of their natural gas imports. Several other regional economies still import more than 50% of their natural gas from Russia. When Russia stopped supplying the resource to Europe, the crisis intensified, and the whole region got sucked into this energy turmoil. The exciting part is that only 2% of Russia's GDP comes from natural gas exports, but the same country is responsible for 50% of Europe's natural gas requirements. On the other side, nearly half of the Middle-East region and some parts of Africa have their economies dependent on a single resource like oil, making up close to 90% of their total exports and 15-35% of the GDP. Think about how the Organization of Petroleum Exporting Countries (OPEC) controls the flow and prices of oil in the global economy or how dependent the Australian economy is on its fossil fuel exports, which in turn has made it a commodity currency for a long time now.

Interestingly, it is not only about energy resources, but the same is true with several commodities such as copper and wheat. The dollar value of copper ore that China imports is nearly the same as that of the rest of the world. The price of wheat shot up by almost 25% after Russia invaded Ukraine, as the world became unsure of its wheat exports. These are technically a few examples of how integrated or disintegrated the world is; at the same time. On one side, the global supply chain is so-called 'integrated,' and the world is connected through these trade agreements and the free flow of communication, services, and people. Apparently, only half of it is accurate, and the world is at this unwonted juncture. 

GOING BEYOND DEPENDENCE 

Globalization does not mean several countries trading with one another and developing a so-called integrated world; it also needs to consider how certain countries depend on a single country or a commodity for their imports or exports. What would one say when Angola's 30% GDP comes from its petroleum exports and 75% from China. That would qualify as being globalized, but what happens when China stops importing from them. That would be a $13 billion shock to their GDP until they find another buyer, which is a strenuous task. Venezuela was just dependent on exporting oil, and look what happened when the oil prices plummeted in 2015 and crude was trading in the $30-$40 range for more than a year. Oil did not go up for the next two and a half years; this is precisely where the economy tumbled. This is not about implying that only the dependence on oil as an export made it happen.

The management and capital investments should be worth mentioning and were disastrous. It is not a coincidence that the top ten countries dependent on agriculture as their primary export are Kiribati, Guinea-Bissau, Solomon Islands, Malawi, Maldives, Somalia, Uruguay, Gambia, Tonga, and Tuvalu. Most of us will only recognize half the countries in the list, and there are probably one or two countries in the list of the top forty countries that depend on agricultural exports. The situation is similar, with countries exporting energy as the primary commodity. South Sudan, Iraq, Nigeria, Angola, Algeria, Libya, Brunei, Chad, and many underdeveloped and least-developed countries (LDCs'). The state of economic efficiency and development for these nations is linked heavily to the price of commodities in the international market, which makes them highly volatile and overfilled with risk. A country like Saudi Arabia has been trying to make a shift towards other sectors that will be able to support the GDP and is moving its dependence away from oil. In 2014-15, Saudi Arabian's GDP collapsed by 14% when the oil prices plummeted, whereas countries like China, US, and India were unflinching and benefitted from it. The attempt has been there, but the transition is taking a lot of time as it is a near-impossible task to move away from something that has been the essence and identity of your country, especially when there is an abundance of a particular natural resource. Similarly, with other countries having such dependence on commodities, it will become even more onerous as the ramifications keep piling up in the coming years. 

Another potent issue in the world of trade is the issue of not diversifying the buyers and sellers of exports and imports, respectively. China's 17% of exports go to the US, 11% to Hong Kong, 5% to Japan, and about 4.5% each to South Korea, Vietnam, and Germany. The US is obviously a big importer of Chinese goods, and rightly so due to the cheaper materials. Still, China is also not primarily dependent on one country for its exports. Trading with several countries has proved to be a good move for all countries, whether net-exporter or net-importer.

On the other hand, nearly 50% of Algeria's exports are to three countries. 40% of Chile's exports are to China and almost 17% to the US, making it entirely dependent on these two markets. The focal point of all this is that global diversification is not something that many economies are considering, and success can never be bestowed upon these nations. Having certain endowment factors or natural resources might be a blessing or a curse, but how a particular economy uses them is the core to consider. Turning to certain countries for trade and using them as a feeder in the future can be disastrous. Diverse exports or imports can be achieved through effective government policies and can also be used to establish a position in the geo-political scenario around the world. 

 

THE FALL OF ONE-NOTE NATIONS

When I talk about one-note nations, I am referring to economies that are solely dependent on commodities and whose economies are highly correlated to the price of these commodities. Whether or not these economies survive is different, but the growth rates can be contested. Some big names are out there, and I am referring to the so-called developed nations of Australia, Norway, and Canada. Australia's major exports are iron ore, coal, and petroleum. Norway and Canada primarily deal with oil, with Canada also exporting gold in substantial quantities. These economies experience growth when the price of commodities increases in the open market and spot demand increases globally. Predictably, looking at the correlations between the vital commodity prices of these economies and their GDP, the pattern is definitely there. The correlation between the price of crude oil since 1988 and the GDP of Canada and Norway is 91.5% and 95.4%, respectively. On the other hand, the correlation between the prices of iron ore and Australia's GDP is also high at 87.2%. All these correlations also yield a high R-Squared, 84% for Canada, 91% for Norway, and 76% for Australia. Correlation might not be the best metric to evaluate the relationship between commodities and economies, but the numbers must be addressed. The movement between these economies' commodity prices and the nominal GDPs' has been uncanny, and the action practically takes place simultaneously. More so, oil price changes are deemed to economic growth, especially for the countries that depend primarily on manufacturing. When the economy tends to rise with a rise in commodity prices, it can mean two things. First, the economy is not mainly dependent on the commodity for its manufacturing processes and does not have commodity exports or imports as a significant part of the GDP. The second situation is that an economy's tertiary or services sector is dominant and compensates for the losses incurred in the manufacturing segment. Nearly 75% of Australia's GDP comes from the services sector, but $160 billion of exports comes from commodities. With the wave of climate change and achieving net-zero emissions, it will be even more difficult for Australia to compensate for the volatility in the commodity prices and the production levels they must maintain. Looking at the other part of the world, Norway has 6% of its work population working in the petroleum industry, taking the volatility part to another level.

A significant point is how some of these economies have transitioned to the tertiary sector and are consistently redefining themselves. Australia has made a tectonic shift from a mining economy to a nation with substantial finance, health, and education base. Something similar is being done by Canada and Norway, with nearly 70% and 52% of the GDP comprising the services sector, which is substantially different from the situation thirty years back. However, the central aspect to consider is the share of exports comprising the above-mentioned commodities. Even though an economy has a substantial income from the services sector, the central notion of an economy in global trade has to be redefined. Everybody sees these economies as commodity suppliers. These nations will only be considered service-based and genuinely diversified when services make up most of the exports. Coming to the point about these economies being heavily dependent on commodities, the concept of 'commodity currency' kicks in. The Australian Dollar, the Canadian Dollar, the New Zealand Dollar, the Norwegian Krone, and several of these currencies are considered commodity currencies because their currencies move with the commodity prices. An economy's currency is perceived to be an indicator of the economy to a great extent, which has been the issue with these economies. The only few years when the AUD/USD has been more than 0.9 in the last forty years was 2011-2014. Coincidentally, the same period when iron ore and oil, two of Australia's biggest exports, were soaring at all-time highs. The same is true for the Norwegian Krone (NOK/USD), which rose to a high of 0.18-0.20 around 2011 when oil prices were soaring. This makes these economies risky and their currencies a perfect hedge when the commodity prices are expected to plummet, indicating their actual position in global trade. 

CONCLUSION

As I mentioned earlier, globalization has undoubtedly made the world an integrated place, but scrutinization and cognizance have also seen a meteoric rise. Countries have depended on other countries that rely on other countries, and the chain continues. The question about what happens when this chain experiences a halt like we saw in COVID is being asked, and the answers are apparent to a great extent. Disruptions and absolute chaos ensure that the effect is multi-fold since it is an established network. Countries in Northern or Central Africa often do not have the option to immediately break free and change their outlook and position in the global economy. Countries like Algeria, Sudan, or even Columbia, and Venezuela are nothing without their core commodity, which ultimately makes them feeders, not prosperous economies. Such economies also often depend on a single buyer nation for their exports, giving the largest buyer a semi-monopsonistic status. China can import oil from anywhere, but they buy it from Algeria, Bolivia, and Angola; why? For China, those imports might account for 2% of their senses. Still, for an economy like Angola, it can be up to 40% of its exports, pushing China into unprecedented power over these smaller nations. The only out for the smaller nations is to diversify their trade to several countries and try to make diplomatic ties beyond a single country. If the biggest buyer pulls out, the government won't struggle to find a new one or worry about the considerable export value. 

For the developed nations, I discussed how these countries have been reduced to being feeder economies, and their only purpose is being suppliers of commodities. Their currencies are a bet against entities and are traded on that basis itself. The exports hardly consist of services and are stuck with commodities like iron ore, gold, and oil, which can experience nearly 20% volatility annually. The solution for these developed countries is to get away from the commodities and start transitioning to exporting services. The GDP might consist of the services sector, but consumption is one thing and exporting the services is another. It might be confusing how services account for more than 75% of the GDP, but exports are just 11% of services? Even if it is, what exactly is the problem, as the currencies would also reflect the internal strength of the economy? The answer is straightforward. The world is only concerned with what a country trades with and its position in the global market. Everybody will look at the imports and exports of Australia or Canada, especially the exports. You see nearly 70% of your exports in oil, iron ore, and gold, and you know that these nations are there to provide energy. With the net-zero emissions plans kicking in and a rise in the acceptance of renewable energy, it would only be possible for several countries to rectify the situation they have created for themselves.