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ICO economic report: Shock to the system

From the January 2020 issue.

As coffee prices remain relatively low, concerns about the socio-economic impact on coffee producing countries continue. International Coffee Organization research uncovers the wider implications for sustainable development.

Low coffee prices are bad news for growers worldwide, many of whom struggle to break even. Lack of liquidity means investment in the modernisation of farms is severely hampered. International Coffee Organization (ICO) research has shown that in the high-cost origins of Central and South America, between 25 to 50 per cent of farmers cannot cover the full costs of production, negatively affecting farm incomes and putting livelihoods at risk. But what are the wider implications for sustainable development in the economies of coffee-producing countries?

The ICO’s new economic flagship publication, the Coffee Development Report 2019, sheds light on this question and provides new empirical evidence on the relation between fluctuations in international coffee prices and socio-economic indicators at country level.

We know that as an export commodity, coffee realised important foreign exchange earnings amounting to US$20 billion globally in 2017-18. However, while coffee may be an important sector in one country, its contribution in a well-diversified economy may be comparably small. This needs to be taken into account in any thorough analysis.

The economic significance can be measured, for example, by the share of coffee in total merchandise exports. Typically, the share varies across countries. Today, Brazil, Vietnam and Colombia – the three largest coffee-producing countries – show relatively low dependence on coffee with a share in total exports of 3, 2, and 6 per cent respectively. In some medium-sized producing countries such as Honduras and Ethiopia, this share exceeds 20 per cent. Other smaller producers, such as Burundi, Rwanda and Uganda, are also highly dependent on coffee exports.

A lack of diversification of the economy and an overreliance on coffee exposes countries to significant commodity market risks. At the macro level, fluctuations of capital flows resulting from changes in commodity prices can affect countries’ balance of payments and public revenues. Hence, the volatility of commodity markets can directly affect governments’ fiscal stability and scope for public spending. At the enterprise level, the unpredictability of highly volatile international prices makes financial planning for rural households and agricultural producers difficult. A drop in international prices for export crops can result in financial distress for farming households, the majority of which are smallholdings, due to lack of savings and limited access to finance.

Coffee-producing countries predominantly rank low in economic and social development metrics, with 18 out of 44 exporting members of the ICO falling in the category of Least Developed Countries. These countries are characterised by low per-capita Gross Domestic Product (GDP) and lag behind in United Nations Human Development Index scores. Around 20 per cent of coffee-producing countries record a low Human Development Index (less than 0.5), compared to 4 per cent of countries that do not produce coffee. This implies that coffee-producing countries are particularly vulnerable to commodity price shocks.

To trace the impact of price variations from farm level to rural communities and the wider economy, ICO economists have assembled a dataset based on ICO statistics and data from other sources for 56 coffee-producing countries over a period of 28 years, from 1990 to 2017 inclusive. Such a large dataset captures the diversity of coffee sectors between countries and across time, covering multiple phases of boom and bust in the coffee market. Statistical analyses are used to identify correlations between changes in the coffee price in one year and socio-economic indicators in the following year, filtering out ‘noise’ created by other factors including country- or time-specific characteristics such as level of development or the effect of a global recession. Furthermore, the analysis takes into account if the coffee price changes from a high or low level.

The socio-economic indicators analysed are grouped in three categories: economic and social impact, food security, and political stability. Each category comprises one or more indicators that can be easily linked to the United Nations Sustainable Development Goals.

Economic and social development
The analysis revealed a statistically significant relation between changes in the price of coffee and employment, value addition, as well as poverty rates. A 1 per cent increase in the price of coffee is associated with a 3 per cent increment in the rural employment rate (Figure 1a). This sizeable positive effect on the non-urban labour market suggests that the coffee value chain provides employment for workers at the farm level (e.g. during harvest) and beyond (processing, handling, export). A rise in international prices of 1 US cent per pound has a positive knock-on effect of the same magnitude on the contribution of agriculture to the GDP of producing countries. These effects on the rural economy translate into a reduction of poverty. A 1 per cent increase in coffee prices is correlated with a 4 per cent decrease in the World Bank poverty headcount ratio (at US$1.90 a day), thereby suggesting a relevant contribution to Sustainable Development Goal 1: End poverty in all its forms everywhere.

Food security
The quantitative analysis shows a significant positive correlation of higher coffee prices with food security in producing countries that are highly dependent on coffee (Figure 1b). A 1 per cent increase in the international prices of coffee is associated with a 10 per cent higher supply of animal-based protein, a proxy for dietary quality. The prevalence of some forms of hunger, as measured by the share of the undernourished in the overall population, would decrease by 9 per cent. The results are statistically significant only for the subset of countries that are highly dependent on coffee. The results confirm the critical contribution of the coffee sector in achieving Sustainable Development Goal 2: Zero Hunger.

Political stability
The ICO analysis reveals a significantly positive relationship between higher coffee prices and income equality as well as political stability (Figure 1c). The Gini coefficient, an indicator of statistical dispersion, measures income equality that ranges from 0 to 1, where 0 describes a state of full equality and 1 a state of absolute inequality. A 1 per cent increase in the international price of coffee reduces the Gini by 0.02 across all coffee-producing countries on average. This finding shows that the positive economic benefits of coffee production on employment and agriculture reach the poor, and thereby reduce inequality. Hence, higher coffee prices are associated with equitable outcomes, contrasting the potential benefits from price increases in other non-agricultural commodities such as oil, which are often accrued by elites, depending on the governance of states.

Political stability is expressed by an index of the Worldwide Governance Indicator family of the World Bank, which measures perceptions of the likelihood of political instability and/or politically motivated violence, including terrorism. The index ranges from -2.5 to 2.5 with lower values indicating less political stability. The empirical analysis finds a statistically significant relationship between coffee prices and political stability in producing countries. A 1 per cent increase in coffee prices is correlated with a 0.08-point increase in the political stability index. Hence, higher coffee prices – through their impact on economic development – are likely to have positive indirect effects on social coherence, that is, the rule of law and business environment, in producing countries. Falling coffee prices, on the other hand, could result in instability in those communities that are economically dependent on coffee sales.

With this analysis, we show that changes in international coffee prices represent an external shock to coffee-producing economies that has repercussions for economic and social development, including poverty and equality, food security, and political stability. Hence, policies that help increasing and stabilising income levels of coffee-producing households are a catalyst for broader growth and development. While sustainable coffee livelihoods are not a sufficient condition for a sector that is inclusive, fair, and environmentally friendly, they certainly are a necessary condition. If rural households engaged in coffee production are lifted out of poverty and obtain an income that allows a decent standard of living, social objectives such as gender equality and eradication of child labour are more likely to be reached. Environmentally detrimental practices, such as deforestation, would be significantly reduced.

About us
This article is written by Christoph Sänger, a Senior Economist at the International Coffee Organization (ICO) in London. He conducts research on coffee value chains in Africa, Asia, and Latin America. Prior to joining the ICO, Sänger was an economist at the European Bank for Reconstruction and Development.

The ICO is the main intergovernmental organisation for coffee, bringing together exporting and importing governments to tackle the challenges facing the world coffee sector through international cooperation. Its Member Governments represent 98 per cent of world coffee production and 67 per cent of world consumption.

For more information, visit www.ico.org

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