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CARTELS AND COMMODITY AGREEMENTS

Updated on May 13, 2012

An important characteristic that distinguishes developing countries from industrialized countries is the nature of their export earning. While industrialized countries rely heavily on the export of manufactured goods, technology, and services, the developing countries rely chiefly on the export of primary products and raw materials- for example copper iron ore, and agricultural products. This distinction is important for several reasons. First the level of price competition is higher among sellers of primary products, because of the typically larger number of sellers and also because primary products are homogeneous. This can be seen by comparing the sale of computers with for example copper. Only three or four countries are a competitive force in the computer market whereas at least dozen compete in the sale of copper. Furthermore while product differentiation and therefore brand loyalty are likely to exist in the market for computers, buyers of copper are likely to purchase on the basis of price alone. A second distinguishing factor is that supply variability will be greater in the market for primary products production often depends on uncontrollable factors such as weather. For these reasons, market prices of primary products--and therefore developing country export earning are highly volatile.

Responses to this problem have included cartels and commodity price agreements. A cartel is an association  of private firms, our interest is in the cartels formed by nations. The objective of a cartel is to suppress the market forces affecting its production order to gain greater control over sales revenues. A cartel may accomplish this objective in several ways. First members may engage in price competition among sellers. Second the cartel may allocate sales territories among its members, again suppressing competition. A third tactic calls for members to agree to restrict production, and therefore supplies resulting in artificially higher prices.

The most widely known cartel is he Organization of Petroleum Export in Countries (OPEC) which become a significant force in the world economy in the 1970s. Inn 1973, the Arab members of OPEC were angered by U.S. support for Israel in the war in the Mildest. In response, the Arab members declared an embargo on the shipment of oil to the United States and quadrupled the price of oil--from approximately $3 to $12 per barrel. Tactics included both price and production quotas. Continued price increases brought the average price per barrel to nearly $35 by 1981. The cartel experienced severe problems during the 1980s, however. First the demand for OPEC oil declined considerably as the result of conservation, the use of alternative sources, and increased oil production by nonmembers. All of these factors also contributed to sharp declines in the price of oil. Second the cohesiveness among members diminished. Sales often occurred at less than the agreed-on price and production quotas were repeatedly violated. The members of OPEC convened following the Persian Gulf war in early 1991 in an attempt to regain control over oil prices, but it remains to be seen whether OPEC will regain its influence as a major force in the world economy.

International commodity price agreements involve both buyers and sellers in an agreement to manage the price of a certain commodity. Often the free market is allowed to determine the price of the commodity over a certain range. However if demand and supply pressures cause the commodity's price to move outside that range an elected or appointed manger will enter the market to buy or sell the commodity to bring the price back into the range. The manger controls the buffer stock of the commodity. If prices float downward, the manager purchases the commodity and adds to the buffer stock. Under upward pressure, he manger sells the commodity from the buffer stock. This system is somewhat analogous to a managed exchange rate system such as the EMS, in which authorities buy and sell to influence exchange rates. International commodity agreements are currently in effect for sugar, tin, rubber, cocoa, and coffee.

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