29 May Primary Products: Advantages and Disadvantages
What are the advantages and disadvantages for a developing economy, such as Ghana if it is dependent on primary products?
Definition of Primary products: Raw materials and resources used in the productive process. Examples include metals, agricultural products and minerals.
Advantages of Producing Primary Products
- For many developing economies, their main comparative advantage will be in producing primary products. The industry becomes an important source of economic growth, employment, tax revenue and export earnings. Without primary products, countries would be worse off.
- Developing economies have a large and elastic supply of labour willing and able to work in these industries.
- Doesn’t require costly investment and borrowing to finance investment. The industries can be managed by local workers. Developing economies which have tried to switch to manufacturing have not always been successful because they lack the relative infrastructure, education and human capital
- An important source of export revenue and foreign currency.
- Can attract foreign direct investment. China has been investing in Central Africa to improve access to raw materials. This has involved building roads and railways – infrastructure which will have wider benefits to the economy – from beyond exporting primary products.
- Primary product industries can be a stepping stone towards economic development – if export earnings are invested in improving different aspects of economic infrastructure.
Disadvantages of Relying on Primary Products
- Prices are often volatile due to inelastic demand. e.g if there is a ‘good harvest’, supply will increase and there will be a fall in the price of primary products. However, because demand is inelastic, this would lead to a fall in revenue.
The volatile price of coffee – can make planning difficult.
- Supply can also be volatile due to weather and disease. For agricultural crops, there is always a risk of crop failure, which could cause economic hardship in one particular year.
- Limited resources. One day developing economies may run out of its finite primary products, e.g. precious metals could become scarce. Without diversification, this would leave the economy with a void.
- Discourages investment in other aspects of the economy. Concentrating on primary products does not always help the long-term development of an economy because it can contribute towards a lack of investment in other aspects such as education and industrial production. Comparative advantage can change over time. It’s important to not just look at the present comparative advantage, but prospects for next 10 or 20 years.
- There is a low-income elasticity of demand for primary products. With a rise in global income, there is a proportionately smaller percentage rise in demand for primary products. (agricultural products tend to be income inelastic). Therefore, if you produce primary products, you may see lower rates of economic growth than countries who produce manufacturing goods – which are more income elastic. The Prebisch-Singer hypothesis suggests that countries who concentrate on primary products are vulnerable to a declining terms of trade.
“World Bank estimates suggest that between 1970 and 1997 declining terms of trade cost non-oil-exporting countries in Africa the equivalent of 119 percent of their combined annual gross domestic product (GDP) in lost revenues: [1. State of Agricultural Markets FAO]
- Resource Curse This is the argument that a country rich in natural resources can struggle and achieve poor levels of economic welfare. This resource curse can occur for various reasons
- Expensive resources can create tensions which cause corruption and war, as rival groups fight for control of diamond mines.
- Monopoly power. Often resources are owned by small section of society and there is a poor distribution of a nation’s resources
- ‘Easy wealth’ from resources can discourage economic development in other areas. See also: Dutch disease
Primary products have their limitations but it can provide a starting block for a country to earn export revenue. It depends on whether the country is able to use this export revenue to invest and diversify into other areas of the economy.
Buffer stocks. In theory, a government can try to stabilise prices of volatile agricultural products by running a buffer stock scheme. There have been efforts to run buffer stock schemes for wool, coffee and other products. However, in practice, it is difficult for a government to intervene and stabilise prices as other countries may take advantage and increase supply, making it impractical to keep buying the surplus.