It is interesting to see how the current financial crisis is changing the way that we think about the world. This point was driven home for me when I had the opportunity to attend a symposium last week in Berkeley, Calif. entitled “Causes and Consequences of the Food Price Crisis.”
Sponsored by the Giannini Foundation, the symposium featured faculty from the agricultural and resource economics departments at the University of California, Berkeley and the University of California, Davis.
There was a reasonable consensus from the speakers that the rapid price increases in corn and soybeans (and by extension, wheat and canola) that we have witnessed over the last two years are the result of increases in demand because of increased ethanol production in the United States and a decrease in supply because of droughts in countries such as Australia.
Increases in food demand in China and India are argued to have played much less of a role. Why did an increase in demand due to ethanol production have an impact when an increase in food demand in China did not?
The reason is expectations. Food demand in China and India has been rapidly increasing since the early 1990s. As a result, the continued growth over the last two years was expected and had already been built into prices a number of years ago. In contrast, the increase in demand from ethanol production – and the decrease in supply due to droughts – was not expected. As a consequence, these shocks had a major influence on price as the market tried to adjust.
The speakers held a wider variation of opinions on the question of whether future corn and soybean prices would settle back to their historical levels, or whether they would settle at some higher point. Of these two views, the latter one likely had a few more adherents.
One reason is input prices – if oil prices remain higher than they have been historically, then commodity prices will have to rise to cover the increased cost of production. There is also a concern that agricultural research investments have been slowing, with the result that yield increases are also slowing.
The picture is different for rice (although, interestingly, unexpected shocks again are critical). One of the key factors behind the rapid rise in rice prices at the beginning of this year was that exporting countries began to a play a game with each other.
Lack of information
Given that there was a lack of information on world stocks, each country became worried that prices were going to rise and that their consumers would rebel. In the case of India, the situation was made worse because of the election underway.
Each country reacted by closing its borders to exports, thereby keeping the domestic price low. However, since these border closures were not expected, the international consequence was that prices rose rapidly, so rapidly in fact that world trade was endangered. One speaker described how close the world market for rice came to collapsing because of a lack of rice to trade.
Hoarding by rice-consuming countries and individuals, who also were unsure of stocks and supply, exacerbated the problem.
One part of the solution to this problem, of course, is greater communication among exporters and importers about the levels of stocks. However, communication is not enough. What is also required is agreement by all the exporting countries that they will not panic and close their borders when price looks like it will rise, while importing countries must agree not to hoard supplies when the market gets tight. Thus, what is needed is co-ordination and cooperation – if all countries can agree to keep borders open and trade flowing, price increases can be softened and world trade can continue. In short, countries have to have the expectation that borders will remain open, and this expectation needs to be fulfilled.
The idea of co-ordination and co-operation of the sort described above would have been heresy even a month or two ago. However, with events in the financial markets showing how critical it is for a coordinated approach to international finance, it is now time to once again think about international co-operation in the food area. (International cooperation was an integral part of the grain trade in the 1960s, and was suggested as an option following the dramatic rise in prices in the 1970s).
Indeed, one of the symposium speakers suggested that now is a good time for some serious thought on how international co-operation could be structured around food security. In fact, efforts in the food area could and should be linked to efforts in the financial area.
On that note, Britain’s Prime Minister is now suggesting the need for a new Bretton Woods agreement. The Bretton Woods system was an agreement among world industrial leaders to negotiate rules for financial and commercial relations among independent nation-states.
Time is now
Now is the time to start thinking about how agriculture fits into the global trading system. Given its severity, the financial crisis will have a profound impact on the institutions that govern international trade and finance. It is critical that agriculture begin the process of thinking about how it will structure itself as it attempts to fit into this new environment.
Murray Fulton is an agricultural economist with the University of Saskatchewan. The Illiative Blog is an initiative by the Knowledge Impact in Society (KIS) project at the University of Saskatchewan: