Can Food Prices Be Stabilized?

CAMBRIDGE – Under French President Nicolas Sarkozy’s leadership, the G-20 has made
addressing food-price volatility a top priority this year, with member states’
agriculture ministers meeting recently in Paris to come up with solutions. Small
wonder: world food prices reached a record high earlier in the year, recalling a
similar price spike in 2008.


Consumers are hurting worldwide, especially the poor, for whom food takes a major
bite out of household budgets. Popular discontent over food prices has fueled
political instability in some countries, most notably in Egypt and Tunisia. Even
agricultural producers would prefer some price stability over the wild ups and downs
of the last five years.


The G-20’s efforts will culminate in the Cannes Summit in November. But, when it
comes to specific policies, caution will be very much in order, for there is a long
history of measures aimed at reducing commodity-price volatility that have ended up
doing more harm than good.


For example, some inflation-targeting central banks have reacted to increases in
prices of imported commodities by tightening monetary policy and thereby increasing
the value of the currency. But adverse movements in the terms of trade must be
accommodated; they cannot be fought with monetary policy.


Producing countries have also tried to contain price volatility by forming
international cartels. But these have seldom worked.


In theory, government stockpiles might be able to smooth price fluctuations. But
this depends on how stockpiles are administered. The historical record is not
encouraging.


In rich countries, where the primary producing sector usually has political power,
stockpiles of food products are used as a means of keeping prices high rather than
low. The European Union’s Common Agricultural Policy is a classic example – and is
disastrous for EU budgets, economic efficiency, and consumer pocketbooks.


In many developing countries, on the other hand, farmers lack political power.


African countries adopted commodity boards for coffee and cocoa. Although the
original rationale was to buy the crop in years of excess supply and sell in years
of excess demand, thereby stabilizing prices, in practice the price paid to cocoa
and coffee farmers, who were politically weak, was always below the world price in
the early decades of independence. As a result, production fell.


Politicians often seek to shield consumers through price controls on staple foods
and energy. But artificially suppressing prices usually requires rationing to
domestic households. (Shortages and long lines can fuel political rage just as
surely as higher prices can.) Otherwise, the policy satisfies the excess demand via
imports, and so raises the world price even more.


If the country is a producer of the commodity in question, it may use export
controls to insulate domestic consumers from increases in the world price. In 2008,
India capped rice exports, and Argentina did the same for wheat exports, as did
Russia in 2010.


Export restrictions in producing countries and price controls in importing countries
both serve to exacerbate the magnitude of the world price upswing, owing to the
artificially reduced quantity that is still internationally traded. If producing and
consuming countries in grain markets could cooperatively agree to refrain from such
government intervention – probably by working through the World Trade Organization –
world price volatility might be lower.


In the meantime, some obvious steps should be taken. For starters, bio-fuel
subsidies should be abolished. Ethanol subsidies, such as those paid to American
corn farmers, do not accomplish policymakers’ avowed environmental goals, but do
divert grain and thus help drive up world food prices. By now this should be clear
to everybody. But one cannot really expect the G-20 agriculture ministers to be able
to fix the problem. After all, their constituents, the farmers, are the ones
pocketing the money. (The US, it must be said, is the biggest obstacle here.)


It is probably best to accept that commodity prices will be volatile, and to create
ways to limit the adverse economic effects – for example, financial instruments that
allow hedging of the terms of trade.



What the G-20 agriculture ministers have agreed is to forge a system to improve
transparency in agricultural markets, including information about production,
stocks, and prices. More complete and timely information might indeed help.



But the broader sort of policy that Sarkozy evidently has in mind is to confront
speculators, who are perceived as destabilizing agricultural commodity markets.
True, in recent years, commodities have become more like assets and less like goods.
Prices are not determined solely by the flow of current supply and demand and their
current economic fundamentals (such as disruptions from weather or politics). They
are increasingly determined also by calculations regarding expected future
fundamentals (such as economic growth in Asia) and alternative returns (such as
interest rates) – in other words, by speculators.


But speculation is not necessarily destabilizing. Sarkozy is right that leverage is
not necessarily good just because the free market allows it, and that speculators
occasionally act in a destabilizing way. But speculators more often act as detectors
of changes in economic fundamentals, or provide the signals that smooth transitory
fluctuations. In other words, they often are a stabilizing force.


The French have not yet been able to obtain agreement from the other G-20 members on
measures aimed at regulating commodity speculators, such as limits on the size of
their investment positions. I hope it stays that way. Shooting the messenger is no
way to respond to the message.



Jeffrey Frankel is Professor of Government at Harvard University's John F.
Kennedy School of Government.



Copyright: Project Syndicate, 2011