Copper is the predominant export product of Zambia and the copper mining industry contributes significant proportions of the gross domestic product and government revenues. Zambian copper is sold in world markets at prices ased on the London Metal Exchange (LME) copper price quotation which is notorious for its short-term volatility. The consequence of the variability of the copper price is that export earnings and government tax revenues from the industry fluctuate considerably. This study employs dynamic simulation experiments with a simultaneous equation-econometric model of the Zambian economy to analyze the impact of changes in the world market price of copper on gross micro (copper industry) as well as macro domestic product, employment, real and nominal stability, international financial position, and the sectoral distribution of output. The study tests the effects of copper price variability on the economy by comparing the results of a model solution with a smooth trend pattern of copper price with solutions obtained assuming various fluctuating patterns of copper prices. Finally the effectiveness of fiscal and monetary policies, and commercial policies in the copper industry, in counteracting any negative effects of the variability of copper prices is explored. The econometric model used in the study features a detailed copper sector sub-model (micro-model) embedded in a macroeconometric model of the economy (macro-model) with explicit two way links between the two models. The micro-model explains production, investment, employment and wages of Zambian and expatriate labor, and the use of intermediate inputs. Copper production is estimated in two ways, the first assumes that output decisions are based on profit maximization, and the second assumes that in each period, full capacity is produced, implying output maximization. It is assumed that Zambia is a price taker, thus the world price of copper is exogenous in the model. The macro-model is a multi-sector model that explains supply and demand for goods and services, employment, wages, prices and foreign transactions. The model assumes non-market clearing conditions with the supply side determining gross output. The major short-run effect of copper price changes are on output in the copper sector, investment in copper and non-copper sectors, and on the domestic price level. In the long run, changes in copper prices affect output in the non-copper sectors. Fluctuations of copper prices reduce output from the copper sector, increase the domestic price level and its variance, and raise the instability of real variables such as gross domestic output, consumption and employment. An increase in the variance of copper prices tends to increase the instability of real output, the domestic price level and its variance. The level of output from the non-copper sectors is not affected by copper price fluctuations mainly due to weak direct linkages between the copper and other sectors. The policy simultations show that monetary policy can be effective in offsetting the inflationary impact of copper price variability. Fiscal policy can be used to offset the decline in economic activity when copper prices fall but this depends on the availability of domestic and foreign financial reserves. Stable long-term growth of government spending and/or money supply policies reduce the level and variance of the price level. Contrary to expectation, stabilization of money supply or government spending does not reduce the instability of real variables. A policy of output maximization in the copper industry can be used to reduce the real instability of gross domestic output engendered by copper prices variability.
