How America Can Shore Up Asian Order
A Strategy for Restoring Balance and Legitimacy
At the end of 2010 and beginning of 2011, world food prices rose sharply, hitting an all-time high in February 2011. The spike arose from an unlucky combination of increased consumer demand due to rapid economic growth in emerging markets in Asia; the diversion of food crops toward biofuel production in the United States and elsewhere; poor harvests due to bad weather in key grain exporting zones such as Australia, Russia, and South America; and increased speculation in agricultural commodity markets, as investors fled a weak dollar.
The sudden uptick in prices rightly concerned global leaders. In February, World Bank President Robert Zoellick correctly warned that “global food prices are now at dangerous levels” and that “recent rises in food prices are causing pain and suffering for poor people around the globe.” He went on to worry about “rising and volatile food prices.” Other world leaders’ remarks are similar: French President Nicolas Sarkozy said that, under his leadership, the G-8’s and G-20’s priority would be to push for policies aimed at curbing food price volatility, cautioning that “if we don't do anything, we run the risk of food riots in the poorest countries.” Likewise, in March, the Brookings Institution published an opinion piece by Homi Kharas stating that “the crux of the food price challenge is about price volatility rather than high prices per se” and that it is “the rapid and unpredictable changes in food prices that wreak havoc on markets, politics and social stability.” In late June, the G-20 released a ministerial declaration calling on members to end food price volatility.
It is well known that high food prices hurt consumers, especially the poorest, who routinely spend half or more of their meager incomes on food. The World Bank estimates that recent price spikes for foodstuffs have pushed an additional 44 million people into extreme poverty. The UN Food and Agriculture Organization (FAO) estimated that the previous high in food prices, in 2007-8, drove the number of undernourished people worldwide from 915 million to more than 1 billion, the highest number in more than 40 years. Although it is still too early to know how many people were driven into hunger by high food prices this year, a similarly large increase in the number of poor and undernourished people worldwide would not be surprising.
The hardships that rising food prices create sow discontent in developing countries. The 2008 food price spike helped bring down governments in Haiti and Madagascar. Recent political unrest in North Africa and the Middle East strikingly coincided with rising food prices as well. Protesters in Tunisia’s December 2010 demonstrations brandished loaves of bread as they launched a political movement that toppled a dictatorial regime that had been in place for almost 25 years.
Yet in their calls to help the poor and reduce political turmoil by stabilizing prices, Zoellick, Sarkozy, the Brookings Institution, the G-20 agriculture ministers, and many other global leaders erred. They conflated high food prices with greater food price volatility, which is best defined as variance around the food price level. The error is understandable, because the two phenomena are indisputably correlated. If demand outstrips production, food prices rise and sellers begin tapping their food inventories. Inventory management stabilizes prices by supplementing supply in times of scarcity and boosting demand in times of surplus. But if food inventories are excessively drawn down during periods of unusually high prices, carryover stocks will be insufficient to stabilize prices during further supply or demand. This can lead to price spikes.
But high food price levels and high food price volatility are not the same things. Food price levels are at historic highs, but food price volatility, although high these past few years, is not out of line with historical experience and is generally lower than it was in the 1970s. This means that the world does not necessarily face a price volatility problem. It faces a high food price problem.
The effects of each phenomenon on the well-being of the poor differ. Throughout the world but especially in low-income countries, the poor are overwhelmingly net food consumers, while farmers are generally better-off net sellers. Rising prices hurt consumers by reducing their purchasing power but benefit producers by increasing their profits. By contrast, volatility does not necessarily hurt consumers, because different food staples are often substitutable. Changes in the prices of one are not perfectly correlated with changes in the price of the other, so consumers can adjust their purchases to take advantage of relative discounts. But high price volatility does hurt producers, who make all their investments in seeds, fertilizer, and equipment at the start of the growing season, before the post-harvest price is known. If prices in the year ahead look unstable, farmers may invest less than usual, with the consequence that they no longer maximize profits and also produce less food to sell.
Since volatile food prices do not necessarily harm poor consumers, it does not make sense to blame volatility for increased poverty or political unrest. In a recent statistical analysis, the FAO food price index and an indicator of political unrest were positively correlated. But a measure of food price volatility and political unrest had a strong negative correlation. Although the food price spikes that occurred in the late spring and early summer of 2008, at the end of 2010, and at the beginning of 2011 coincided with political unrest, increases in food price volatility more commonly occurs after, not before, patches of political unrest. So, although commentators and politicians frequently blame food price volatility for human suffering and political unrest, they are either misunderstanding or misrepresenting the problem. Perhaps not coincidentally, their emphasis on tempering price volatility favors the same large farmers who already enjoy tremendous financial support from G-20 governments.
The way in which leaders cast the food price problem matters because it shapes policy responses. Policies aimed at curbing food price volatility, such as export bans, price stabilization schemes, and subsidies for farmers are misguided if policymakers aim to increase the welfare of the poor, or avert political unrest in developing countries. Instead, policymakers should consider measures that prevent increases in food prices, such as removing barriers to international agricultural trade and increasing investment in scientific research on crop productivity improvement, soil and water conservation, and renewable energy that does not compete with food for land. Policymakers should also focus on innovative ways to reduce post-harvest losses, which run to nearly 50 percent in many low-income countries, often due to insufficient or sub-standard storage, refrigeration, and processing facilities.
Such measures are the best long- and short-term policy response to high price levels. And by curbing sharp increases in food prices, they will temper price volatility as well. Expanded production, or a reduction of waste and diversion, will drive down prices and encourage the accumulation of food inventories, which will stabilize prices. Food prices pose a serious challenge to society at large. To meet that challenge, policymakers must first identify it accurately.
An extended version of this essay, with notes and tables of statistical results is available here.