Friday, April 25, 2008

Food Crisis

MIT's Esther Duflo has a nice summary of  what's happening in food markets:

Several reasons explain the upward trend in prices, including the demand for biofuels (which consume a significant part of the corn produced worldwide), and the growth and enrichment of the world population (particularly the increased demand for meat in China – paradoxically, it takes more grain to produce a calorie in meat form than it does to produce a calorie in grain form).

Several short-term factors also help to explain the recent price peak. Because the main consumers of rice are also producers, the volume of rice traded is low compared to the volume of rice produced (only seven percent of produced rice is traded). Restrictions by big producers (such as India) can thus have large impacts on the world price of rice, since they affect a large proportion of the volume of rice traded. It keeps the prices in India relatively insulated from what is happening on the world market, however. Wheat harvests have been poor in several major producing countries, rice is suffering from a mysterious parasite in Vietnam, and following accusation of corruption and mismanagement in the last few years, there have been sharp declines in grain stocks maintained by governments to stabilise prices (they are at their lowest levels since 1984). As a result, prices are not only high in general, but also more volatile (another drop in rice prices is expected after the harvests in Indonesia and India); even the financial crisis plays a role: in the current meltdown, commodities offer an interesting betting opportunity.

Winners and losers

Robert Zoellick (President of the World Bank), Jacques Diouf (the chairman of the UN Food and Agriculture Organization), and many others, have now rung the alarm bells. Zoellick even waved a loaf of bread at the annual meetings of the IMF and the World Bank to drive the point home. According the analysis of the World Bank Living Standard Surveys (which Abhijit Banerjee and I have exploited in our article “The Economic Lives of the Poor”1 ), food accounts for between 50% and 77% of the budget for a family that lives on less than a dollar a day per capita (the world poverty line), depending on the country. This leaves these families very sensitive to food prices, and it is no surprise that the recent increase can make a serious dent in their budget.

Yet, two or three years ago, rich countries’ farm subsidies, and even food aid, were strongly criticised: by keeping prices artificially low, the argument went, they prevented African farmers from selling their products at a good price, keeping them in poverty.

These two arguments may seem contradictory at first. Unfortunately, they are not. An increase in food prices benefits net producers (those who produce more than they consume), to the detriment of net consumers. This is true at both the national and individual levels. Thus, at the national level, the rise in grain prices will improve the trade balance of exporting countries and worsen that of importing countries, including those of Sub-Saharan Africa. At the individual level, the poor who are most affected are in urban areas, but even in rural areas, a number of the poorest people are in fact net consumers of grain as well. A 1989 study of Thailand by Angus Deaton2 showed that, on average, rural households benefited from an increase in the price of rice, but with large variations from one household to another. Those households who benefited most were neither too poor nor too rich.

So when grain prices rise, some of the poor gain, and some lose – in the short-term. In part, the uproar over food prices reflects a fundamental political economy reality: when some gain and some lose, the voice of those who lose is always louder. This is particularly true of an increase in food prices, which hurt primarily the urban poor. In the medium-term, however, an increase in price volatility is damaging for everyone. Poor families in developing countries are already facing enormous risks (they are often self-employed, they are subject to the uncertainties of weather, and their health is fragile), and there is very little insurance against such risks, apart from their own savings or informal solidarity. Furthermore, these risks are more serious for households struggling to provide the bare minimum. A setback might mean sacrificing the children’s education, or not being able to save a little girl from a diarrhea attack (on this, see a beautiful paper by Elaina Rose, which showed that during drought, the relative survival probability of girls dramatically declines).3 A passing difficulty can leave a permanent scar.

I think this points to the interconnectedness of the global market and how supply and demand for seemingly disparate goods is actually intricately linked. Similarly, I read in the Willamette Week an article that linked food prices in Oregon to the Beijing Olympics because of herbicide production in China and their goal to reduce air pollution for the competitions.
This presents an interesting spin on incentives for environmental concern, but again, the burden falls heavily on consumers rather than industry. Hopefully the increase in prices will cause some farmers to scale back on their herbicide use.
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