ChainWhat it assumes · how to break it
Start
The world economy falls into recession and demand falls for the primary commodities that many developing countries export, such as copper, coffee and oil.
1
As a result, world demand for commodities falls, and because supply is price inelastic in the short run, commodity prices fall sharply.
price elasticity of supply (PES) · primary commodities
price elasticity of supply (PES) · primary commodities
Assumes: Supply of commodities is price inelastic in the short run.
But: Some commodities are stored, and producers may hold back stocks, which limits the fall in price.
2
This means export revenues fall in countries that depend on a few primary commodities, and their terms of trade worsen.
primary product dependency · terms of trade
primary product dependency · terms of trade
Best link to attack
Assumes: The country depends on a narrow range of commodity exports.
Assumes: The country depends on a narrow range of commodity exports.
But: More diversified economies, with manufacturing or services exports, are affected less.
3
Consequently, government revenue from commodity taxes and royalties falls, and remittances from workers abroad and foreign direct investment fall too.
remittances · foreign direct investment (FDI)
remittances · foreign direct investment (FDI)
Assumes: Other sources of foreign currency fall at the same time.
But: Aid flows may be maintained or increased during a global crisis, partly offsetting lost revenue.
4
Therefore, governments cut spending on health, education and infrastructure, and household incomes fall, so progress in life expectancy, schooling and living standards slows.
Human Development Index (HDI) · development
Human Development Index (HDI) · development
Assumes: Governments cannot borrow to protect spending.
But: Countries that saved revenue in a sovereign wealth fund during the boom, such as Chile with its copper fund, can protect spending in a downturn.
End
Development slows as export revenue, government revenue and household incomes fall in commodity-dependent economies.
Evaluation chain
- E1However, the impact on development depends on how dependent the country is on a narrow range of commodity exports.
- E2If the country has diversified into manufacturing or services, or saved commodity revenue during the boom, then its export earnings and government spending are more stable.
- E3As a result, the fall in commodity prices reduces income less, and spending on health and education can be maintained.
- E4So the damage to development is greatest for countries with high primary product dependency and no fiscal buffers, and much smaller for diversified economies.
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Questions this answers
- Assess the impact of a global recession on developing countries that depend on primary commodity exports.
- Explain why primary product dependency makes an economy vulnerable to world recessions.
- Discuss the policies a developing country could use to reduce its exposure to global economic shocks.
Diagram
Commodity market diagram: inelastic supply curve, demand shifts left, price falls by a large proportion; revenue (P × Q) falls.
Reverse and related
Global boom → commodity prices rise, export revenue and government revenue rise, which can fund development if managed well.