Sunday, April 27, 2008

Rice trade and lower prices

Tyler Cowen feels that the solution to lowering foodgrain prices is to have more trade in foodgrains. In view of the recent restrictions on rice exports in rice-producing countries like India, Indonesia, Vietnam, China, Cambodia and Egypt, global trade in rice is expected to decline by 3%. Cowen feels that restrictions on rice trade, which sees trade and production as a zero-sum game (one country's gain is another's loss), distorts the long run incentives for producers and chokes production.

He writes, "Export restrictions send a message to farmers that their crops are least profitable precisely when they are most needed. There is little incentive to plant, harvest or store enough rice — or any other crop, for that matter — as a hedge against bad times."

Cowen also argues that the very fact that an increasing proportion of major foodgrain production comes from poorer countries itself contributes to an inability to adjust quickly to global demand-supply mismatches. These poor countries are more likely to be protectionist, have stifling regulations, have restrictions on internal trade, and Government monopolies in trading.

These poor countries are also constrained by corruption in the rice supply chain, poorly conceived irrigation systems, terrible or even nonexistent roads, insecure property rights, ill-considered land reforms, and price controls on rice. Cowen argues that these countries could easily increase their production manifold, if they could adopt many of the aforementioned practices and institutions, and thereby incentivize their farmers to respond quickly to global demand-supply mismatches.

I am inclined to believe that Cowen has got this one wrong on many counts. In the first instance, the article has little to illuminate as to how the central problem, that of higher rice prices, can be controlled by merely opening up economies to trade.

Secondly, the trade in agriculture commodities is very low not because of lack of incentives to trade, but because all these commodities have large captive domestic markets. In fact, in many countries, the domestic demand itself is too large to be covered by domestic production alone.

Third, rice and other staple food grains like wheat, especially in the poorer countries, are unlike other commodities. They exhibit inelastic characteristics - both from the supply and demand sides. On the demand side, these staple food grains do not have any substitutes and will have atleast the same demand, whatever be the price rise. On the supply side, it is very difficult to increase production significantly in the short term by bringing more land under cultivation or shifting from other crops or introducing technology and innovative practices to increaswe productivity.

Fourth, most countries and their farmers do not need the incentives of global trade to increase their production. The internal demand itself is booming in countries like China and India and their producers are not able to keep up with the growing demand. It is true that easing the internal restrictions and constraints that Cowen writes about, will help in incentivizing farmers to produce more.

Fifth, even higher production need not necessarily lead to lower prices, given the large and complex factors that determine global food prices - weather, bio-fuels, energy prices, agriculture policies in developed countries etc. Historically, foodgrain prices have fluctuated sharply in response to many of these aforementioned factors.

Sixth, even if global agriculture trade is deregulated and farmers have the full freedom to shift production in response to price signals, it will not ensure that the poor consumers in Asia and Africa are insulated from price rises for their staple grains. In fact, a free and unregulated market will exacerbate the crisis. Imagine what it would do to food security in India and across the world, if the wheat producers in the Gangetic plain and rice producers in the Krishna-Godavari basin in India shift to sugar cane, in response to a massive demand for sugar cane based ethanol bio-fuel!

Seventh, the major demand for rice and similar staple foods are mainly in the poorer developing countries, whereas the major demand for competing substitutes like bio-fuel crops etc come from the developed world. In an open global market in agriculture commodities, the price signals will always incentivize farmers to cater to the developed markets.

Finally, the whole objective is not to have, as Cowen claims, trade in rice "flow to the places of highest demand", but to have food security for all. It is undoubtedly true that trade will ensure that rice will flow to the countries with highest willingness to pay. Translation, the rich and well off will get their rice, while the others starve!

It is therefore critical that there be pro-active Government intervention to both ensure that staple foodgrain production is increased and these grains are available to the poorest at affordable prices. The answer to food security surely does not lie in Milton Friedman.

7 comments:

Ivo Cerckel said...

The price of rice is at present going out of hand
because on international markets,
rice is being traded for worthless US dollars.

There is no rice supply shortage.
There an overabundant supply of US dollars.

Milton Friedman was a radical advocate of cutting all current ties, however weak, with gold, and going onto a total and absolute fiat dollar standard,
http://www.lewrockwell.com/rothbard/rothbard43.html

Yes, we need quite the opposite of what Friedman advocated.

We need a 100-percent gold-backed currency to trade rice on international markets.

The US has been gaming the system for decades; sucking up two-thirds of the world's capital to expand its cache of Cadillac Escalades and flat-screen TVs; giving nothing back in return except mortgage-backed junk, cluster bombs, and crummy green paper. Nothing changes; it only gets worse. But this is different. The world is now facing the very real prospect of "completely avoidable" famine because twelve doddering old banksters at the Federal Reserve would rather bailout their sketchy friends and preserve their spot at the top of the economic food-chain then save the lives of starving women and children. Bernanke now has an opportunity to do more damage than Bush with one swipe of the pen. If he cut rates; the dollar will fall, commodities will spike, and people will starve. It's as simple as that.
(US Fed To Blame for Global Food Crisis
Apr 26, 2008 - 03:09 PM
By: Mike_Whitney
http://www.marketoracle.co.uk/Article4486.html

The mainstream media prevent us from thinking in a logical way.
If you want to think, you must start with the facts
which you must analyse.

And on these facts you can try to apply your ideas
(but this presupposes that you have ideas).

You must not start with your ideas
and then distort the facts
in such a way that they suit your ideas.

Let me repeat,
the price of rice is at present going out of hand
because on international markets,
rice is being traded for worthless US dollars.

You want pro-active Government intervention to solve that?

Henry Hazlitt, 1946
http://jim.com/econ/chap01p1.html
The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups.

gulzar said...

Ivo,
That a weak dollar may also have contributed to higher food prices has also been pointed out by Gary Becker, and I do not dispute it.
http://www.becker-posner-blog.com/archives/2008/04/rising_food_pri_1.html#comments

But if a weak dollar was to be the biggest contributor to higher rice prices, how does you explain the rice and foodgrain inflation in closed and fairly self-sufficient rice economies like India? Further, rice (and other foodgrain) prices started rising even before dollar started its fall.

The objective of my post was not to identify the reasons for rise in rice prices, but to only highlight the reality that prices of agriculture commodities are and have been inherently volatile. Therefore there is need for public policy intervention to cushion atleast the poorest from its adverse effects. More about the public policy reponses in a later post.

Ivo Cerckel said...

Gulzar,

No economy on this planet is self-sufficient.
Guv’mint cannot prevent individuals from having contacts, and indeed moving, abroad.

Can you show me one, only one, “public policy intervention” which has been effective in the past?

“Public policy intervention” is financed through taxation rupees.

The difference between taxation and theft is
that the thief does not come back periodically
and
that the thief does not pretend to be stealing in the public interest.

Guv’mint is fraud.

And yes, it's the poor who suffer most because of this fraud.

Mike Huben said...

Ivo, have you caught smallpox lately?

Smallpox killed hundreds of millions in the 20th century. It was eradicated by tax-funded vaccination programs, and sometimes they were physically coercive as well.

Anonymous said...

You state:
Third, rice and other staple food grains like wheat, especially in the poorer countries, are unlike other commodities. They exhibit inelastic characteristics - both from the supply and demand sides

But then go on to say:

Fourth, most countries and their farmers do not need the incentives of global trade to increase their production. The internal demand itself is booming in countries like China and India and their producers are not able to keep up with the growing demand.

and

Fifth, even higher production need not necessarily lead to lower prices, given the large and complex factors that determine global food prices - weather, bio-fuels, energy prices, agriculture policies in developed countries etc.

Maybe I have a different definition of inelastic, but what you're describing seems elastic to me

Karthik/SK/wimpy/SKimpy said...

"trade" doesn't necessarily mean foreign trade. it can also stand for trade within the country. and this is essential in order to "send out the right signals".

basic thing is that we need to ensure that farmers receive a fair price for the rice they grow. given that the total demand for rice is increasing, it is only fair that the farmer sees this increasing demand by way of higher rice prices. higher rice prices (as realized by hte farmer) will lead to increase in production which can combat the growign demand.

international trade is one thing. the bigger problem lies with the procurement of goods such as rice by the governments. a number of countries don't allow the farmer to sell to the open market. procurement is highly controlled, and despite the rising prices, the farmer gets none of it. and thus has no incentive to grow more.

yes, a country might ban exports because it feels that the rice available is enough only to feed its own population. however, this shouldn't be done at the farmers' cost. and they should be able to see the right demand for the commodity so that they can adjust.

gulzar said...

By inelastic, I meant that the demand and supply of rice would not change by much in repsonse to price variation in the short and even medium-run. I fail to see the inconsistency that Anon points out.

I agree with Karthik that a lot more can be done to free up internal trade, though the situation has improved considerably in the recent years.

In any democracy, especially a competitively populiust one like in India, Government procurement (MSP etc) will surely ensure that the farmer gets a good price for his rice. One only needs to study the MSP increases for wheat farmers. Though, it is true that wheat farmers have benefitted more than rice farmers (for obvious reasons)!

And yes, about the benefits from higher prices being denied to farmers, in my next post.