Ghana and Ivory Coast cocoa supply chain – Opec to Copec

Ghana and Ivory Coast produce nearly 2/3 of the global supply of cocoa. Most of the 2m cocoa farmers in west Africa are smallholders and therefore have little influence on the world price. Why is it so difficult for poor countries to command higher prices for cocoa and controlling more valuable areas of the supply chain?

Ghana – supplies 20% of all cocoa beans – earns $2bn a year which is less than 2% of the value of chocolate that is manufactured, branded and sold. It seems that cocoa producers are in a colonial style relationship with chocolate manufacturers.

Chocolate – $100bn industry and Ghana and Ivory Coast who produce 65% of the raw material only earn $6bn – see image below. But why couldn’t these two countries have earned more money by processing the cocoa into liquor, cocoa butter or chocolate. One reason is the electricity costs and the industry likes to keep most of the added value near the western markets that it serves.

Who gets what in the cocoa supply chain – Breakdown of costs for wholesale cocoa (%)

Opec to Copec

From October 2020 Ghana and Ivory Coast will have a fixed premium of $400 a tonne over the benchmark futures price. Opec controls 30-40% of global oil supply and have a significant role in influencing prices. Ghana’s vice-president Mahamudu Bawumia refers to this in the cocoa industry as Copec. The premium known as the ‘living income differential’ (LID) is intended to increase farm-gate prices so that farmers can have a much higher standard of living than they presently have. However unlike oil wells, cocoa trees cannot simply be turned off to reduce supply. Even if prices go up, say traders, that will encourage farmers to grow more which will increase supply and reduce the price.

Being a bigger part of the supply chain. As well as seeking higher cocoa prices, Ghana wants to add value to its product and give tax breaks to chocolate manufacturers to grind cocoa beans domestically. However there are issues:

  • mechanised factories employ few people so tax breaks have a low return
  • Ghana has a small dairy industry forcing manufacturers to import
  • Electricity prices are high
  • The climate requires greater refrigeration which means costs go up

Costs are always going to be more in Ghana than in Europe – also manufacturers are closer to their market in Europe. If consumers want to help poor farmers trading houses and big companies need to be cut out of the loop. At the moment there is a monopsony market.

Source: The African farmers taking on big chocolate – FT – 16-12-19

China no longer a manipulator of its currency

Here is a very good explanation from the FT on China’s exchange rate and the fact that the US no longer sees China as a manipulator of its currency – the Renminbi.

  • In May 2019 with the threat of US tariffs on Chinese goods the Renminbi depreciated in value – notice the chart is inverted which means that 1 US$ buys more Renminbi and the value of the currency falls. To look at it another way it takes more Renminbi to buy 1US$. This makes Chinese exports cheaper in the US.
  • In August 2019 when the US came good on their threat to impose tariffs the Renminbi fell below 7 Renminbi / US$ in order to protect its exports to the US. Below 7 Renminbi / US$ is seen as a major threshold – the last time this happened was after the GFC.

How do China authorities intervene to manipulate the Renminbi?

The Renminbi is not a floating exchange rate which it is not determined by supply and demand. The government manages its exchange rate in two ways:

  • Peoples Bank of China (Central Bank) can or sell US$ on the foreign exchange market – this depends on what they wish for the value of the Renminbi against the US dollar
  • People’s Bank of China permits the Renminbi to trade 2 per cent on either side of a daily midpoint set by the. Basically at 9.15am the Peoples Bank of China and the SAFE (State Administration for Foreign Exchange) issues a circular to all the trading banks stating that this is the exchange of the Renminbi to the US$. It is then permitted to trade 2 per cent on either side of the midpoint rate.

But is China a currency manipulator? According to the US Treasury a country is a currency manipulator when it does the following 3 things:

  • A significant bilateral trade surplus with the US.
  • A material current account surplus of more than 3% of GDP.
  • Persistent one-sided intervention in its currency market.

But in August the Chinese economy was slowing down and the Peoples Bank of China (Central Bank) provided stimulus to the economy which would depreciate the currency anyway. However with more trade talks between the US and China and both agreeing to no more tariffs and phase one of a trade deal, the value of the Renminbi against the dollar starts to appreciate. Although the US has no longer called China a currency manipulator it seems that it didn’t have the grounds to do so. This must be a concern for other trading partners with the US.

New Zealand’s unemployment and wages

In the September quarter New Zealand’s unemployment rate was 4.2% which was up 0.3% from the June quarter. Since the global financial crisis unemployment figures have been trending downwards since it peak of 6.7% in the September 2012. Despite the quarterly rise in unemployment, the underutilisation rate, which is a broader measure of spare capacity in the labour market, has fallen to the lowest level in over eleven years. The fall in underutilisation this quarter was driven by a drop in the number of underemployed people, those who work part time but are looking to work more hours.

Source: Economic Overview – Westpac November 2019

During 2019 the labour market appears to have tightened but it does appear to lag behind the growth cycle meaning that with the slowdown in growth in 2019 higher levels of unemployment will be apparent early this year. It is interesting to note that as labour becomes more scarce with lower levels of unemployment wage growth usually follows – see graph.

Annual wage growth is at its highest level since the 2008 global financial crisis, after which wage growth remained largely flat. The percentage of wages that increased is at its highest level since March 2015, at 59%. This shows there has been more broad-based wage growth across the Labour Cost Index* (LCI). Salary and wage rates for the public sector increased 3.0 percent annually, the highest rate since June 2009. This compares to a 2.2 percent increase in the year to the June 2019 quarter. Public sector wage rates have been driven by collective agreements for teachers, nurses, and police over the past year. With these three largest occupations excluded, public sector wages would have increased 1.8 percent annually.

*The labour cost index (LCI) measures changes in labour costs. These costs consist of base salary and ordinary-time wage rates, overtime wage rates, and non-wage labour-related costs. The index essentially covers all employees aged 15 years and over, in all occupations, and in all industries except domestic services.

Sources:
Department of Statistics NZ
Westpac Quarterly Overview – November 2019

What sectors made up the GDP of New Zealand – 1972-2018

Statistics New Zealand produced a great interactive graphic showing which industries have contributed to New Zealand’s GDP. It takes the top 10 industries that contributed most to the production measure of gross domestic product (GDP) in a given year. Industries are coloured based on four broad industry groups:

  • Goods-producing industries: manufacturing; electricity, gas, water, and waste services; and construction industries.
  • Primary industries: agriculture, forestry, fishing, and mining industries.
  • Service industries: wholesale trade; accommodation and food services; retail trade; transport, postal, and warehousing; information, media, and telecommunications; finance and insurance services; rental, hiring, and real estate services; professional, scientific, technical, and admin support services; government administration; health; education; and other service industries.
  • Taxes on production: includes GST, import duties, and stamp duties.

Below the doughnuts show the changes from 1973 to 2018.

Components of GDP in New Zealand – 1972
Components of GDP in New Zealand – 2018

Things to note:

  • The contribution from the goods sector has fallen from 33% to 19%
  • The service sector has increased from 51% to 65% over the period
  • The primary sector has halved over the period from 14% to 7% – agriculture was the biggest industry in 1972 at 11.2 but by 2018 this figure was 4.3% and the industry was relegated to10th in 2018

Click here to go the interactive – well worth a look and great for Macro at NCEA Level 2 and 3.

EU’s uncommon Common Agricultural Policy

At the outset of the EU, one of the main objectives was the system of intervention in agricultural markets and protection of the farming sector known as the common agricultural policy – CAP. Throughout most of its four decades of existence, the CAP has had a very poor public relations image. It is extremely unpopular among consumers, and on a number of occasions it has all but bankrupted the EU. The EU’s seven year budget (2021-2027), also known as the ‘multi-annual financial framework (MFF) is currently being discussed and agricultural subsidies are once again a controversial issue although have been reduced from previous years – 70% of the EU budget in 1980 to 37% in 2018 – see graph right from The Economist.

The aim of discussions is to reduce the amount to between 28% and 31% of the MFF. EU support levels are very high when compared to other countries. The graph below shows the support that other countries receive – producer support estimate (PSE), as a share of total farm income. EU is 20.% (2018) above the OECD average and well ahead of China, USA, Russia, Canada, Brazil, and Australia. Norway is at 62.36% whilst New Zealand is 0.48%.

Source: https://www.cgdev.org/publication/new-estimates-eu-agricultural-support-un-common-agricultural-policy

Who gets what from EU farm subsidies?

Source: https://www.cgdev.org/publication/new-estimates-eu-agricultural-support-un-common-agricultural-policy

There is wide variation in the support provided to agriculture within the “Common” agriculture policy. Latvia does the best of any country in the EU with a lot of other more recent eastern European entrants into the EU – of the top 10 Greece and Finland are the only non East European countries. The Netherlands gets a mere 7% of their income from EU support and traditional supporters of agriculture spend like Ireland, Luxembourg, Italy, and Poland are all below the EU average

  • Despite being a vocal critic of the CAP (and receiving a separate rebate) UK support is broadly the same as the EU average
  • France’s support is only just above average, while Germany’s is in the bottom quarter
  • In terms of the “market price support” element—which inflates EU food prices—Belgium, Hungary, Malta, Poland, and UK producers benefit most

The variation seen here reflects a combination of factors, few of which relate to a policy objective. Most payments are distributed on the basis of a farm’s size in hectares—though per hectare rates vary and were often based on the historical value of production. Other payments relate to sustainability of farming methods, numbers of young farmers, or how much farms produce. With agriculture seen as a significant contributor to global emissions should subsidies be tied to those farmers reducing their impact on climate change?

The economics behind CAP intervention price

An intervention price is the price at which the CAP would be ready to come into the market and to buy the surpluses, thus preventing the price from falling below the intervention price. This is illustrated below in Figure 1. Here the European supply of lamb drives the price down to the equilibrium 0Pfm – the free market price, where supply and demand curves intersect and quantity demanded and quantity supplied equal 0Qm. However, the intervention price (0Pint) is located above the equilibrium and it has the following effects:

  1. It encourages an increase in European production. Consequently, output is raised to 0Qs1.
  2. At intervention price, there is a production surplus equal to the horizontal distance AB which is the excess of supply above demand at the intervention price.
  3. In buying the surplus, the intervention agency incurs costs equal to the area ABCD. It will then incur the cost of storing the surplus or of destroying it.
  4. There is a contraction in domestic consumption to 0Qd1
    Consumers pay a higher price to the extent that the intervention price exceeds the notional free market price.

Figure 1: The effect of an intervention price on the income of EU farmers.

The increase in farmers’ incomes following intervention is shown also: as has been noted, one of the objectives of price support policy is to raise farmers’ incomes. The shaded area EBCFG indicates the increase in the incomes of the suppliers of lamb.

Sources:

  • https://www.cgdev.org/publication/new-estimates-eu-agricultural-support-un-common-agricultural-policy
  • The Economist: 23-11-19 – Milking taxpayers

Brexit and ‘Yes Minister’?

In light of what has been happening regarding Brexit here is a very amusing clip from the BBC series “Yes Minister” in which Sir Humphrey and Jim Hacker discuss Brussels and the notion of the UK trying to pretend that they are European. Also discusses why other European nations joined the common market in the first place.

I am off to the beach and out of internet range – will be back around 6th January. Merry Christmas and a Happy New Year.

Holiday reading – Rowing – Economics – Psychology

Here are some books that are on the list to read this holiday. There is a mix of some new, some old and some rowing. Thanks to Leith Menzies for the rowing books:

  • Mind over water: lessons on life from the art of rowing – I am told that this book is a combination of rowing and life lessons. Rowers will recognise the technical side of things but the book does address the aspects of our world whatever challenge you set yourself.
  • The Kiwi Pair – Another rowing book following the double olympic champions and numerous world champions Hamish Bond and Eric Murray. Very different personalities and also interesting to read how coaches got the best out of them – a lot of psychology in achieving consistent elite performance.
  • Narconomics – I’ve had this book for awhile – like 3 years and it has been lent to numerous students who have said it is very good. Tom Wainwright – who was Central American correspondent for The Economist – argues that most successful drug cartels operate like Wal-Mart in that they have a virtual monopoly on the product at the source of supply.
  • The Economists’ Hour – A recent publication that how economists who believed in the power and the glory of free markets transformed the business of government, the conduct of business and, as a result, the patterns of everyday life. It explains how globalisation failed to deliver on its central promise of increased prosperity.
  • Messengers – The review in The Economist got my attention. With the amount of information available to people these days why is it that self-confident people are believed over experts in their field. Stephen Martin and Joseph Marks look at variables such as appearance and financial status that influence our trust in these people.
  • Licence to be bad – Modern economics dismisses ethics in favour of a narrow focus on self-interest – they have applied the same reasoning in the law courts, leading to the doctrine that bargaining by parties achieves the optimal outcome. However it doesn’t favour behavioural economics which suggests that we are not calculating machines.

Economics Podcasts

Here are a couple of podcasts that I have found useful

  • FT – News Briefing – each podcast is usually around 10 minutes in length – a good summary of the issues of the day
  • IMF Podcasts – longer podcasts with leading economists discussing topics such as climate change, development economics and a recent one on monetary theory with Mervyn King.
  • Project Syndicate – a hub for conversation on the world’s most pressing issues. Elmira Bayrasli sits down with leading economists, policymakers, Nobel laureates, academics.
  • BBC Radio 4 – Today Programme – daily summary of business and economics and longer documentary type podcasts.

Aristotle was right: Disappearing middle class = Increasing inequality = Disappearing democracy.

Around the globe the size of the middle class is diminishing and with it societies are becoming more unequal. The Greek philosopher, Aristotle, 2,400 years ago summarising his analysis of the Greek city states pointed out that democracy depended on the size of a country’s middle class. With a proportionately bigger middle class a democracy tends to work well as it promotes social mobility, encourages aggregate demand which in turn leads to economic growth. Notice in the graph below how the Scandinavian countries have higher social mobility compared to the other extreme of the US and the UK.

Source: FT – How to reform today’s rigged capitalism

Aristotle warned that when inequality – see graph below – reaches a certain point it becomes very damaging to society. He refers to the importance of the middle class in his book Politics:

The best constitution is one controlled by a numerous middle class which stands between the rich and the poor. For those who possess the goods of fortune in moderation find it “easiest to obey the rule of reason” (Politics IV.11.1295b4–6). They are accordingly less apt than the rich or poor to act unjustly toward their fellow citizens.

A constitution based on the middle class is the mean between the extremes of oligarchy (rule by the rich) and democracy (rule by the poor). “That the middle [constitution] is best is evident, for it is the freest from faction: where the middle class is numerous, there least occur factions and divisions among citizens” (IV.11.1296a7–9). The middle constitution is therefore both more stable and more just than oligarchy and democracy.

“The best political community is formed by citizens of the middle class, and that those states are likely to be well-administered in which the middle class is large, and stronger if possible than both the other classes . . . ; for the addition of the middle class turns the scale, and prevents either of the extremes from being dominant.”

Source: Why Inequality Matters – Aristotle and the Middle Class

Source: FT – How to reform today’s rigged capitalism

Heather Boushey in her book ‘Unbound’ argues that inequality subverts growth and democracy in three ways:

  • Inequality creates barriers to the supply of talent, innovation and finance as wealthy families monopolise educational and workplace opportunities. This is done by the cost of education and the influence of social networks.
  • It overturns private competition and public investment as powerful corporations force out competitors and suppress wages. Also the government underfund public goods which are essential for social mobility.
  • Lower wages reduce consumer demand and lead to less buying power which in turn encourages more borrowing and pushes the economy toward financial instability.

Paul Volcker – 1929-2019 – the slayer of inflation.

I first came across Paul Volcker in the ‘Commanding Heights’ series produced by PBS. Appointed to the position of Chairman of the US Federal Reserve in 1979 by the then President Jimmy Carter, Paul Volcker understood the problems of the Great Inflation in the US economy which was at around 11.5%. Up to this point Carter had attempted to follow Keynes’s formula to spend his way out of trouble by dropping taxes and increasing government spending. However this was not working. Below is an extract from the PBS series.

It came to be considered part of Keynesian doctrine that a little bit of inflation is a good thing. And of course what happens then, you get a little bit of inflation, then you need a little more, because it peps up the economy. People get used to it, and it loses its effectiveness. Like an antibiotic, you need a new one; you need a new one. Well, I certainly thought that inflation was a dragon that was eating at our innards, so the need was to slay that dragon. Paul Volcker

Volcker’s policy to tighten the money supply with increasing interest rates, which peaked at 21.5% but was not popular with Jimmy Carter who lost the election to Ronald Reagan. But in order to get prices down the economy had to experience a recession and the longer the inflation was out of control the worse the recession would be. Unemployment did hit 10% but could have been much worse. As Ronald Reagan said referring to a recession – ‘if not now when? If not us who?’

He saw the primary focus of central banker was to control inflation and preserve the value of money whether is be keeping prices stable or ensuring that there is not easy access to credit. Below is a tribute from Paul Solman of PBS.