December 15, 2011

Less Volatile than Meets the Eye

Contrary to popular wisdom, commodity prices can be more stable than those of manufactured products

MOST economists think economic development requires the reallocation of resources from low-productivity to high-productivity uses. The commodity, or primary, sector is seen as a low-productivity area, whereas the manufacturing, or secondary, sector is considered high productivity. Historically, as economies developed, the size of the commodity sector tended to shrink and the noncommodity sectors grew (Kuznets, 1966). Although there are a few exceptions, such as Norway, this apparently consistent relationship between development and the relative size of the commodity sector suggests that an economy will develop successfully if it relies less on commodities and diversifies into other—generally, manufactured—products.

Development economists cite several reasons for encouraging such diversification. A major argument is the perceived greater stability of manufacturing prices than of commodity prices, whose volatility chokes efficiency and makes life difficult and unpredictable for consumers, businesses, and government. Our research suggests otherwise. Overall manufacturing price indices are less volatile than those for commodities, but when those indices are broken down into their individual parts (there are about 18,000 different manufactured items) a dramatically different picture emerges.

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