The resurgence of high food prices in 2010
awakened fears of a repeat of the 2007-08 food crisis, threatening increasing
food insecurity, rampant food price inflation and civil unrest. While, fortunately,
the worst fears have not materialized generally, high and volatile agricultural
commodity prices seem to be the current norm and have challenged the ability of
consumers, producers and governments to cope with the consequences. The issue
of agricultural price volatility and how to deal with it has been at the top of
the G20 agenda and in June this year, agricultural ministers agreed on an
action plan. But why has volatility increased, what are the implications and
what can be done to reduce it?
Higher
and more volatile international prices
For many years, real agricultural commodity
prices followed a downward trend with occasional short-lived peaks and extended
price troughs. Since 2000 prices seem to have departed from their downward
trend and become increasingly volatile. Prices increased between late-2006 and
mid-2008 to their highest level in 30 years, fell sharply through 2009 with the
world recession, but then regained their 2008 peak in late-2010 to early 2011.
Prices are expected to remain above historical trend levels and to continue to
be volatile in the medium term.
Many factors have contributed to price increases
and volatility. The downward trend in the past reflected a tendency for
technical improvements to increase yields and production faster than population and
income growth increased demand. Recently, markets have tightened as investment
and supply growth have slowed while demand has continued to grow rapidly,
reducing stocks to uncomfortably low levels. High rates of economic growth in emerging
economies have increased commodity demand. There has
also been increasing demand for certain agricultural products as feedstocks for
biofuel production, which has expanded significantly as a result of subsidies
and mandates. Biofuel production links agricultural prices and markets more
closely to energy markets and volatile oil prices.
Some price volatility is typical of
agricultural commodity markets as a result of their fundamental
characteristics. Production is subject to natural shocks from weather, pests
and diseases. Since agricultural product demand and supply are inelastic in the
short-run, wide price adjustments are needed to clear markets, especially where
stocks are low. The current higher prices and increased volatility have their
origins in such fundamental factors – weather shocks in key producing and
exporting countries coinciding with low stock levels. However, they have been
exaggerated by the closer linkages between agricultural and energy markets and
the ‘financialization’ of agricultural commodity markets, which has forged
closer links between the prices of agricultural commodities and those of
financial assets. While speculation does not instigate agricultural price movements,
it may exaggerate their magnitude and duration. Trade policy measures introduced by some countries have also made volatility worse. Export
restrictions imposed by major exporters to safeguard supplies for domestic
markets and to keep domestic prices down have pushed international prices up even
higher.
Why
volatility matters
The poor, who often spend up to 75% of their
income on food, suffer most. High food prices reduce the quantity and the
quality of the food they can consume, worsening food insecurity and
malnutrition and pushing more households below the poverty line. The high
prices of
2007-08 pushed an estimated 80 million additional people into hunger. The
impact of high and volatile food prices on consumers is clearly negative, but
what about the impact on agricultural producers and exporters? In principle
higher prices should be good news for them. Provided that the rents arising
from higher prices are not taxed away by government but rather go to producers,
they should provide both an incentive and the finance for increased investment
and a positive supply response. However, in practice the incentives and a
positive supply response may not materialize. Input prices, especially for
oil-based fertilizers, can increase faster than output prices, leaving
producers no better off. Supply-side constraints such as transport and storage
limitations or lack of access to inputs and credit can prevent producers from
capitalizing on higher prices. Price volatility also means uncertainty and
increased risk, which deters investment. As a result of these problems, most
developing countries saw a muted supply response to the high prices of 2007-08.
Governments need to ensure that such opportunities
for increased export revenues and growth are not squandered. They need to
create an enabling environment that supports the channelling of increased
producer revenues into investment and growth. But this may not be
straightforward given other policy claims and constraints, such as defending
food security and controlling inflation. Targeted input subsidies, investments
in productive infrastructure, such as storage and irrigation, risk management,
research and extension, all have a role but involve significant budgetary cost.
Where agricultural commodity exports are significant, price volatility on international
markets can be transmitted to government revenues and the rest of the economy.
Furthermore, many agricultural commodity exporters, especially least developed
countries, are net food importers, so higher international agricultural prices
can actually worsen the balance of payments and threaten foreign exchange
reserves as well as fuel domestic inflation and increase budgetary outlays on
protecting poor consumers. Micro-
and macro-economic management in the face of
international commodity price volatility poses unique problems for developing
country agricultural exporters.
Information
and transparency can reduce volatility
Past experience suggests that intervention in
international markets to stabilize prices is problematic. Buffer stocks, for
example, involve significant costs to defend a target price and their effective
management needs to overcome a variety of informational and practical
difficulties. The biofuel subsidies and mandates used by some countries have
also been criticized for raising prices on international markets as supplies of
certain commodities are diverted into biofuel production. Calls have been made
for more flexible policies that take account of their impact on availability
and prices, especially of sugar, corn and oilseeds.
Similarly controversial is the issue of whether
futures markets should be regulated to limit the extent to which they might
exaggerate price movements. Futures markets play a vital role in price
discovery, risk management and providing liquidity, and the evidential base is
weak so caution is needed. Comprehensive trading data are needed to enable
regulators and participants to monitor information about the frequency and the
volume of transactions to understand what is driving commodity prices.
While there is little consensus on whether
futures markets should be further regulated, there is broad agreement that more
transparency is needed. The same goes for physical markets. Volatility is
exacerbated by a lack of accurate information on the international supply, demand and stocks situation. Increasing information on global markets
and enhancing transparency will reduce the incidence of panic-driven price
surges of the kind seen in rice markets in 2008. It should also permit better
informed and coordinated policy decision-making to prevent the responses of
individual countries from making international prices even more volatile.
The imposition of export
restrictions by major exporters is particularly damaging and existing trade
rules regarding export measures are relatively weak. Not surprisingly,
improving market information and transparency are key elements of the G20 Plan
of Action. While price volatility cannot be eliminated, the better information
and greater transparency offered by the proposed
Agricultural Market Information System will help eliminate some of its
sources.