Crisis Averted? How Government Actions Keep Food Prices High

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Although global food prices have fallen somewhat from theirsummer 2008 peaks, they are still high by historical standards. Thebest way to encourage moderation in food prices is to allow marketsto function so that price signals can be transmitted efficiently.That should translate into less extreme fluctuations in commodityprices, as supply and demand will be able to adjust more quickly.In the longer term, reform and liberalization efforts through theWorld Trade Organization will allow markets to function moreeffectively.

In early 2008, before the subprime mortgage crisis causedfinancial upheaval, the "crisis" on everyone's mind was the rapidgrowth in food prices. The spike was fueled by a "perfect storm" ofhigh oil and fertilizer prices, ethanol mandates that encourage theuse of feedstuffs such as corn and soybeans in fuel production,adverse weather events in major food exporting countries, adownward trend in agricultural investment because of rich-worldsubsidies that depressed prices and closed markets, an increase indemand from rapidly growing developing countries, and depreciationof the dollar (in which most commodities are priced).1More than 40 countries experienced riots (and, in the case ofHaiti, the downfall of a government) inspired by high food prices,and important agricultural exporting countries from Argentina toUkraine introduced misguided policy responses ranging from exporttaxes to outright bans in an attempt to fix the problem. India, ahuge global player in many commodity markets, extended bans onexports of rice, wheat, and other crops until April 2009.

Since the early months of 2008, when food prices were constantlyfront-page news, the world seems to have moved on. First, theglobal financial crisis and general economic slowdown is a greaterthreat, and certainly will have more impact on voters in richcountries than do food prices, which are a relatively small part oftheir household spending. Second, commodity prices, though stillhigh by historical standards, have fallen from their June recordhighs (see Figure 1). Corn was then selling for about $7 a busheland pushed toward $8 in midsummer, but has since fallen back toabout $4. Similarly, soybeans are selling for just under $9 abushel as of late October, well below the $16-plus price inJune.

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These dramatic declines have not yet translated into substantialfalls in the prices that American consumers pay at the grocerystore. The U.S. Bureau of Labor Statistics' index for food preparedat home (i.e., the prices that consumers pay at the grocery stores)had increased 7.6 percent during the year leading up to September2008, although the pace of acceleration slowed to a 0.6 percentincrease in the month of September, down from a 0.8 percentincrease in August.2 The general economic slowdown mightsee these increases decelerate somewhat, but the general consensusis that grocery prices are sticky downwards because firms arereluctant to be the first to cut prices in their category(ingredient prices are locked in months in advance). Americanconsumers should not expect significant relief soon.

Likewise, international relief agencies and intergovernmentalorganizations insist that the crisis is still a major one, despiterecent price falls. Indeed, Table 1 shows that global stocks ofmany commodities are still low, and Oxfam estimates almost 120million more people are at risk of starving than before the recentprice surge. Although the FAO Food Price Index dropped 13 percentin October 2008 and by 6 percent over the year since October 2007,it was still 28 percent above its October 2006 level.3Food aid agencies' budgets are still stretched thin, and historysuggests that "surplus disposal" of food stocks from developedcountries will fall, too. On the other hand, agricultural exporters(potentially mainly developing countries, if comparative advantagewas allowed to work its magic) will gain from higher prices.

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To be sure, the historically low stocks of many food commoditiessuggest that food prices will remain above their historicalaverages for a time, even if stocks have rebounded somewhat sincelast year (see Table 1) and demand growth seems to have moderated.The slowing growth in demand for commodities is expected tocontinue, judging by recent falls in the Baltic Dry Index (morethan 80 percent since early summer), which tracks prices forshipping bulk cargo and is considered a leading indicator ofinternational trade activity. But there is much that governmentscan do-or refrain from doing-to ameliorate the price spikes and toallow the price signals to encourage farmers to invest in farmingand increase production.

The WTO's Role?

Restrictions on exports of the type enacted by governments inthe wake of this crisis may reduce their domestic price, but theyalso increase the world price of those commodities if the exporteris big enough to move the market. That harms importing countriesand reduces agricultural investment and farmers' incentives toincrease production (because the domestic price is held downartificially). Export restrictions therefore have the potential toexacerbate high food prices in the long run.

Can the WTO play a role in preventing the types ofcounterproductive export restrictions implemented by governments inthe wake of soaring food prices? Certainly it is a problem that theWTO is unaccustomed to: when the Doha round of multilateral tradenegotiations was launched in November 2001, the focus inagriculture was on long-run declines in commodity prices and theeffect of high import barriers on poor farmers abroad and subsidiesof rich-country governments that artificially depress prices.

Indeed, export restrictions were not explicitly part of theoriginal Doha mandate at all, although Japan and other countrieshad expressed concern about them before the Doha round waslaunched.4 Events have changed the emphasis, though: theproblems facing the world at the current stage of the round arevastly different from those facing the global trading system whenthe round was launched: for example, food commodity pricesincreased by about 98 percent from 2001 to July 2008.5If prices remain relatively high, agricultural trade negotiatorswill be forced to address agricultural trade policies that seemedalmost moot a few years ago. The likely resistance by some WTOmembers to new issues outside of the mandate will come up againstpressure to do something for poor net food importers.

Unfortunately, the scope in the existing WTO rules to restrictthe use of policies designed to keep domestic goods inside a borderare not necessarily helpful, either; they are certainly lessdeveloped than those relating to (more common) policies to keepimports out or to promote exports. Article XI:2 of the GeneralAgreement on Tariffs and Trade places a general prohibition onquantitative restrictions on imports and exports of goods, butmakes an exception in subparagraph (a) for

export prohibitions or restrictionstemporarily applied to prevent or relievecritical shortages of foodstuffs or other productsessential to the exporting contractingparty

(emphasis added, to show the conditions that WTO members wouldneed to satisfy in order to exercise this clause, and which woulddoubtless be subject to legal interpretation in the event of adispute).

In order to set some rules for this relatively new terrain, netagricultural importing countries Japan and Switzerland proposed newrules on export restrictions in an informal (and not publiclyavailable) document on April 30, 2008. They suggested that WTOmembers limit export restrictions "strictly to the extentnecessary," notify other WTO members before institutingrestrictions (the current draft language requires members to notifyothers within 90 days after the restrictions are implemented) andto give due consideration to the effect on importers and food aid.They also proposed time limits on restrictions (in an attempt todefine the "temporary" condition in GATT Article XI:2(a))and binding arbitration in the case of a dispute.6 Thecurrent draft agriculture text in the Doha round contains arequirement to lift all current restrictions on exports within oneyear of a Doha deal coming into effect.7 But theseproposals are languishing with the rest of the Doha agenda.

Another way in which the WTO talks could influence food pricesis by encouraging an increase in the amount of biofuels that can betraded under the "in-quota" tariff rate (many agricultural goodsare traded according to tariff rate quotas, whereby a certainamount of trade is covered by one tariff level called the "in-quotatariff" and any trade above that quota is covered by a higher rate,the "out-of-quota tariff"). There is currently some uncertaintyaround trade in alternative fuels. Ethanol destined for use as abiofuel does not have a specific customs classification, but ittends to be classified by customs officials as an agriculturalproduct. Biodiesel (diesel fuel made from vegetable oils), on theother hand, is classified as an industrial good and so it will besubject to the formula reductions agreed on as part of thenegotiations on nonagricultural market access. Tariff reductionsfor alternative fuels are therefore subject to a degree ofjurisdictional overlap in negotiating committees on industrialproducts, agricultural goods, and trade in environmental goods.Leaving aside the merits of agricultural-based fuels as analternative to fossil fuels, free trade in these products willensure that they are produced in the lowest-cost manner.

A successful conclusion to the Doha round could contributepositively to agricultural trade flows if it reduced the legal capson tariffs (called "bound rates") to their current applied rates,and preferably below. That limits backsliding when and if pricetrends change. For example, it might be tempting-althoughwrongheaded-to increase import tariffs to protect farmers in Indiaas prices fall again. Bound limits to tariffs will preventpoliticians from increasing import tariffs if they feel it would beexpedient. More certain market access would also increase theincentive to invest in agricultural production.

Reform in food aid programs would do much to alleviate the painto the poorest people from food price increases. The Bushadministration, for example, proposed in its 2008 Farm Bill packageto increase the proportion of aid that is given in cash rather thanU.S.-grown crops, so that more food could be bought in the localdeveloping country market or region. That would save money onshipping costs (inflated because of U.S. requirements that food aidbe shipped using U.S. flagged and manned ships) and support localand regional producers. But the bipartisan coalition of farm-statepoliticians ignored that initiative along with other needed reformsto U.S. farm programs.

There is reason to hope that export restrictions may be eased asfood stocks recover and prices come down. Farmers do indeed respondto incentives when they are allowed to do so: rice fields haveexpanded globally by almost 2.5 billion acres since lastyear.8 But if governments prevent the valuable signalgiven by high prices from getting through to producers, or if theyhoard any increases in products from the international market, thenprices will not moderate and the food price crisis will continue,with predictable and tragic effects worldwide.


Notes

  1. Sallie James, "Food Fight," Cato Institute Free Trade Bulletinno. 31, January 31, 2008.
  2. Bureau of Labor Statistics, "Consumer Price Index: September2008," October 16, 2008, www.bls.gov/cpi.
  3. Food and Agriculture Organization of the United Nations, "FoodPrice Indices: November 2008," www.fao.org/worldfoodsituation/FoodPricesIndex/en/.
  4. For more information about efforts in the Doha round todiscipline export restrictions, see www.wto.int/english/tratop_e/agric_e/negs_bkgrnd09_taxes_e.htm.
  5. International Monetary Fund, Indices of Primary CommodityPrices, 1998-2008, October 8, 2008, www.imf.org/external/np/res/commod/table1a.pdf.
  6. International Centre for Trade and Sustainable Development,"Japan, Switzerland Propose Stronger WTO Curbs on Use of FoodExport Restrictions," BRIDGES Weekly Trade New Digest 12, no. 15,April 30, 2008, http://ictsd/net/i/news/bridgesweekly/11075/.
  7. World Trade Organization Committee on Agriculture SpecialSession, Revised Draft Modalities for Agriculture, July 10, 2008,document number TN/AG/W/4/Rev.3, www.wto.org.
  8. "Global Rice Market Seen to Remain Tight in 2009,"International Herald Tribune, October 20, 2008, www.iht.com/bin/printfriendly.php?id=17093549.