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 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 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.

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