Macroeconomic Effects of Commodity Price Shocks in a Low‐income Economy: The Case of Tobacco in Malawi

• Author: Bertha Chipo Bangara,John Paul Dunne
• Date: 01 March 2018
• Published date: 01 March 2018
• DOI: http://doi.org/10.1111/saje.12186

MACROECONOMIC EFFECTS OF COMMODITY PRICE

SHOCKS IN A LOW-INCOME ECONOMY: THE CASE OF

TOBACCO IN MALAWI

BERTHA CHIPO BANGARA*AND JOHN PAUL DUNNE

†

Abstract

A major concern for developing economies is a dependence on commodities when their prices are

volatile as a major change in the international commodity price can have important implications for

economic growth. While some cross-country studies exist, there is lack of country specific studies that

take into account the different characteristics of low-income economies. This paper contributes to the

growingliteraturebyconsideringthecaseofMalawiandthemacroeconomicimpactofpriceshocks

in its major export crop of tobacco. Using a structural vector autoregression (SVAR) approach on

quarterly Malawian data from 1980:1 to 2012:4, the paper establishes that a positive tobacco price

shock has a significant positive impact on the country’s gross domestic product, decreasing consumer

prices and inducing real exchange rate appreciation. The results are robust to alternative specifications

of a SVAR on difference stationary data and cointegrating VAR. The cointegrating VAR confirms the

existence of a long run-relationship among the variables and causality that runs from tobacco prices.

JEL Classification: E3, F18, F31, F35

Keywords: Tobacco, commodity price shocks, low-income economies, SVAR

1. INTRODUCTION

There has been considerable debate over the implications of developing countries’ depend-

ence on commodity exports for growth (Diao et al., 2002). Little attention has been paid

to the effects of commodity price shocks and their dynamics in developing economies

which is surprising given that that low-income economies (LIEs) may be prone to instabil-

ity in international commodity prices due to an over-dependence on commodity exports.

This is true in mono-crop export countries, which typifies most low income Sub-Saharan

African (SSA) economies (Addison and Ghoshray, 2013). A large empirical literature that

argues that commodity exporters face a decline over time in the relative prices of their

products, with the resource curse literature depicting a negative relationship between a

country’s resource wealth and dependence and their economic growth (Sachs and Warner,

1999, 2001), and the “Dutch disease” literature showing how the resource sector can drive

up the value of the local currency, damaging the competitiveness of manufacturing exports

* Corresponding author: Post Doctoral Research Fellow, School of Economics, University of

Cape Town, Cape Town 7701, South Africa. E-mail: berthabangara@gmail.com

†

School of Economics, University of Cape Town

I would like to acknowledged Carnegie Corporation which sponsored the last part of my PhD and

are sponsoring my Postdoctorate Research Fellowship, the African Economic Research Consortium

(AERC) which offered me a PhD scholarship and Dr. Amos C. Peters for his valuable comments.

[Correction added on 09 March 2018, after online publication: The Acknowledgement sec-

tion was previously omitted and has been added in this current version.]

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C2018 Economic Society of South Africa. doi: 10.1111/saje.12186

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South African Journal of Economics Vol. 86:1 March 2018

South African Journal

of Economics

(Adam and Bevan, 2003; Fielding and Gibson, 2012; Linklater, 2013). These findings

suggest that commodity price shocks might be used as an early signal for potential insta-

bility in the macro-economy that might need immediate intervention. For example, the

oil price shocks of 1973–1974 and 1979–1980 were visible events that preceded the tur-

moil in various markets in both developed and developing economies, with shocks were fol-

lowed by worldwide recessions. The coincidental timing of the shocks and macroeconomic

disturbances were too close to ignore a possible causal link (Jones and Leiby, 1996). More-

over, the 1986 Organisation of Petroleum Exporting Countries (OPEC) members’disagree-

ments and the Iraqi invasion of Kuwait led to collapses in the price of oil and economic

recession, which was preceded by a 9% reduction in world oil production due to uncer-

tainty in the oil markets (Hamilton, 2005, 2009; Kilian, 2005; Kilian and Park, 2009).

Most of the existing literature on commodity price shocks focuses on the effects of com-

modity prices when explaining business cycles of high-income economies (Hamilton, 2005,

2009; Kilian, 2005; Kilian and Park, 2009; Iwayemi and Fowowe, 2011). Those studies

that do focus on developing economies are based on cross country datasets, especially on

resource curse and Dutch disease issues. Despite the fact that cross country studies fail to

address problems of heterogeneity within and between countries, there are only a few case

studies of small open economies (Sachs and Warner, 1999, 2001). There is a clear need to

incorporate the characteristics of LIEs in macroeconomic models to forecast properly the

effects of commodity price fluctuations. Factors such as the structure of the economy, the

effectiveness of the domestic policy-making process and the ease in handling price fluctua-

tions have a greater impact on the responses of macroeconomic variables to price shocks

and need to be taken into account (Deaton and Miller, 1996; Kose and Riezman, 2001).

This paper contributes to the literature by providing a case study of a developing

economy and LIE of Malawi and investigating the interaction of positive tobacco price

shocks with selected macroeconomic variables and determining their effects on the econ-

omy. This entails the identification of selected policy options that channel the effects of

tobacco price shocks in the economy.

The remainder of the paper is organised as follows: Section 2 briefly discusses the

importance of tobacco crops and their production and marketing in Malawi, and reviews

the related literature on the future of tobacco production in Malawi. Section 3 reviews

the empirical literature on commodity price shocks, followed by a discussion of the cho-

sen theoretical model. The estimation, identification and data issues are presented in sec-

tion 4, with section 5 providing the estimation, inferences and model results, and finally

section 6 presenting the conclusion.

2. TOBACCO PRODUCTION IN MALAWI

The commercial cultivation of tobacco in Malawi dates back to the 1890s, and by the

1920s, the crop had assumed a significant position in the economy (FAO, 2003b). The

expansion and contractions of tobacco production remained a major aspect of the colonial

economy. In 1964, soon after Malawi’s independence, the Malawian President established

the Agricultural Development and Marketing Corporation (ADMARC) to prioritise the

development of estate growing of Burley leaf tobacco when production was shifting glob-

ally from the developed to the developing countries (ibid). Tobacco then took on a more

central role in the country’s political economy (FAO, 2003a,b). In the 1970s, the interna-

tional tobacco manufacturing companies identified Malawi as a possible ally in the fight

54 South African Journal of Economics Vol. 86:1 March 2018

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