Rising world food prices have been a public policy issue for the past six months and grabbed additional attention when the food price index from the Food and Agriculture Organization (FAO) of the UN surpassed the previous high set in the June of 2008. What that means and how to respond is subject to interpretation as market conditions have changed in the last 3 years. Rethinking export restrictions and import tariffs is needed to avoid a repeat in a few years.

 

The FAO index (2002-04 = 100) increased from a plateau of about 120 in 2006 to a peak of 214 in June 2008, a 78 percent increase. It then dipped to a low of 140 in early 2009 before settling at about 165 in late 2009 and early 2010, 38 percent higher than the previous plateau. Looking back to the 2006 situation, the index at 120 was not sustainable long-term because it was not high enough to cover increasing energy costs and attract needed research and development to increase long-term commodity productivity to serve a growing world population.

The increase in the index from 165 to the current 215, a 30 percent increase, has resulted from natural weather variations, monetary policies, rising commodity demand, including biofuels, and individual country trade policies. Weather is at the heart of much of recent price increases. Wheat production problems in Russia and other Black Sea countries touched off a 75 percent increase in price of wheat in the past year, with wet weather in Canada and first dry and then wet weather in Australian adding to price pressures. Dry weather hurt the sugar crop in Brazil, Thailand and Russia, while floods disputed production in Pakistan; sugar prices have doubled. U.S. corn production in 2010 was 7 percent smaller than earlier expected and prices are 80 percent higher than the depressed year earlier level.

Monetary policy can influence market prices within countries and cause shifts in the relative value of currencies. Many agricultural products are traded in U.S. dollars, and the decline in the value of the dollar compared to the Brazilian real has cause the price of sugar in dollars to increase. The Reserve Bank of India has increased interest rates a seventh time in less than a year to slow the rise of wholesale prices (the primary price indicator) of 8.4 percent for December over a year earlier and the food price indicator increase of about 16.0 percent. India’s problems are deeper than just commodity food price increases. China and South Korea have taken similar actions to control overall market prices and food prices.

Increased trade is central to relieving price pressures in countries with supply shortfalls and signaling producers in exporting countries to increase production. As WTO Director General Pascal Lamy said recently, “Trade becomes the transmission belt through which supply adjusts to demand. It allows food to travel from the land of the plenty to the land of the few. When that transmission belt is disrupted through trade barriers, unexpected turbulence arises on the market.”
Russia started the trade policy disruptions by banning exports of all grains and other Black Sea countries followed by restricting trade flows. That resulted in a major scramble of buyers to other countries like the EU and the U.S. Black Sea region farmers did not receive true market signals to plant wheat more aggressively last fall as government policy focused on holding down domestic consumer prices rather than expanding future output. Some importing countries are now reducing tariff barriers to reduce the cost of food imports to offset price increases. That is a continuation of past policies of shutting out imports when supplies are plentiful and prices are low to protect domestic producers and expecting import supplies to suddenly appear when prices are high. These countries are attempting to shift the cost of stocks holding to other countries, while protecting their domestic producers and consumers. That is the wrong policies to pursue; it is equally as wrong as exporters who impose export restraints to protect their domestic consumers.

Physical markets cannot solve rising prices that are caused by monetary policies of the U.S. and other countries. President Sarkozy of France, leader of the Group of 20 major developed and developing countries this year, has pledged to pursue policies on speculators and bring transparency to commodity markets. FAO and OECD (Organization for Economic Cooperation and Development) officials have voiced similar concerns. While those are nice sentiments, they will not solve monetary policy problems.

Market supplies will likely remain tight for at least nine months. Dry weather is impacting growing summer corn and soybean crops in Argentina, while conditions appear to be more favorable in Brazil. The northeast portion of Australia has seen summer crops hurt by too much rain while Western Australia continues to need more rain in the months ahead to plant it next wheat crop. The northern hemisphere is three months from beginning to plant summer crops and several additional months from harvesting the winter grain crops planted last fall. Recent report of dry weather in China’s winter wheat areas have added to the uncertainty.

Policy makers are being further influenced by recent studies on the long-term need for food production to double between now and 2050 to feed a growing world population better than the current population is fed. Those are critical policy issues that will have an impact on future supplies, but they are not today’s problem, next year’s, or the year after.

The Doha Round of WTO trade policy talks should be expanded to include these vital trade flow issues. The Round has become bogged down in details that political leaders are not willing to resolve. Perhaps if they addressed serious immediate issues it would provide some perspective for what have become minor issues for now. Importing and exporting countries should phase out export and import tariffs and not re-impose them when markets are unfavorable from their perspective. Exporters and importers have a shared interest “in the transmission belt” when commodity supplies are plentiful and when they are short. Trying to manage market prices and complaining about speculators makes good politics, but they are just the opposite of the market driven policies needed to encourage production and stocks holding for the short supply years that inevitably come.