16 01 2016

And now comes the hangover

There have been good prices for commodities during the last decade: oil, gas, minerals, agricultural products. Now prices have plummeted. This implies a sea change as commodities are again a buyers' market, as it has been the case for most of the second half of the last century. It tips the correlation of forces in favour of the developed countries against the developing countries, which are generally heavily dependent of the export of commodities. But some developed countries are suffering too.

Norway, Canada, Australia and Russia are all developed countries, which have benefited from the good prices for commodities during the last decade. They have been awash in cash from the windfall profits on commodities. Now they have fallen on hard times as prices have fallen dramatically. Not only oil, gas and coal, but most minerals (iron, copper etc.) have fallen too, as have agricultural products as soy beans, wheat etc. How can they adapt to this new situation?

The first thing that gives in is almost always the exchange rate. When easy money flowed into these countries, the currencies appreciated, they became high cost countries where all other sectors, particularly the industry, struggled to stay competitive (what is often called “Dutch Disease”). Even when they tried hard to avoid it, as Norway has done, they have inevitably become increasingly dependent on the commodity sector. Not only are their main exports commodities, but other parts of the economy have focussed on delivery of services and equipment to the booming (and extremely profitable) commodity sector too. So the Norwegians have become experts in off-shore oil extraction, the Canadians have become experts in environmentally (and now economically) unsustainable Tar Sands, the Australians are world champions in dirty coal mining, and the Russians have become experts in remote on-shore oil and gas exploration and mining. So the hangover is not limited to the commodity sector only, it goes much deeper into the economy and society.

The most stupid reaction a country can have in these situations is to ignore it. “This is just a market adjustment, then we are back to the good times again.” So they will try avoid a devaluation of their currency. The Russians did that for almost a year, making a heavy dent in their foreign currency reserves, before they let the Rouble float in second half of 2015, leading to a precipitous (but absolutely necessary) decline in the value of the rouble. The other countries had already freely floating currencies, so they devalued more gradually.

The devaluation brings immediate pain. Imported goods become more expensive so inflation tends to go up. Not necessarily with much, however, as some of the imports come from other countries, which have devalued their currency too, and the falling commodity prices in themselves (particularly the oil price) tend to keep a lid on the price level. Actually, the only country of the four experiencing serious inflation is Russia (almost 13% in 2015).

But, alas, even if devaluing the currency brings some balance back to the economy, the structural changes that have to take place is a longer process: they have to learn how to live from doing something else than just extracting oil and minerals. Some sectors that have survived the commodity craze, will of course benefit immediately from the more competitive currency. But during the boom, many industries could not survive the high cost level and disappeared and these do not easily come back.

How this affects the population varies. Norway is the most notorious example of prudence and thrift, as the country used the oil boom to build up a USD 840 billion savings fund (corresponding to some 170% of the GDP). Norway has now started to dip into this fund, which makes it possible to alleviate some of the pain in confronting the new reality. Russia had a relatively smaller savings fund and it has all but been depleted by now. The Russian government has decided not to run deficits that are higher than 3% of GDP, so public expenses are cut heavily back. In both Canada and Australia some cuts have been made, but for the moment the budget deficits will increase (and thus be debt funded).

And of course the balance of payment is coming under strain in all four countries. Export earnings are plummeting, and even if imports are also reduced, the effect is noticeable. Norway, which for years has had enormous balance of payment surpluses has seen these reduced, even if they still are running a considerable surplus. Canada and Australia have been running deficits the whole time through, but not alarmingly high, and with easy access to international finance, they are not (yet) in a squeeze.

Russia is a different story. The country has been running a surplus for many years, which has helped it accumulate considerable international reserves. As the country, as part of the international sanctions for its role in Ukraine, is cut off from most international financial markets, it seems to be decided to run a surplus, even in this difficult economic situation. This is one of the reasons that it is the only of these countries to actually experience a contraction of the economy in 2015. So the country is presently paying off its (private) international debt (the public debt is negligible) despite the unfavourable economic situation, without dipping into its still impressive international reserves.

So, the conclusion is that none of these four countries are headed for an economic collapse. But they all face a difficult task of restructuring their economies, and as prices of oil keep falling in the beginning of 2016, this challenge increases. Canada has to learn to export something else than tar sands and minerals, and Australia has to realize that the coal boom is over – for good. Norway has to find other things to do too. Even its enormous savings fund is not enough for the coming decades, and its deep-sea and Arctic oil and gas resources may never become profitable enough to pump up. The Russians are no doubt in the biggest squeeze, but they have at least a big internal market, which can benefit from the extreme devaluation of the rouble. However, this requires much more than just devaluing the rouble. The future will tell us whether they have the capacity to do that.


1. The data on dependency on commodity exports are calculated from: UNCTAD Handbook of Statistics 2015. It includes food exports.

2. Data on GDP growth are from IMF. Forecasts for 2016 may be too optimistic as commodity prices continue to fall in the beginning of 2016.

3. Data on the Balance of Payments are from different sources. Also these may be too optimistic.

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Thorbjorn Waagstein

Thorbjørn Waagstein, Economist, PhD, since 1999 working as international Development Consultant in Latin America, Africa and Asia.

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