Tuesday, April 29, 2008

Why rice trade will not solve the problem?

This post is in continuation to my previous post on the role of trade in lowering global rice prices. Globally rice prices have risen spectacularly, with the FAO figures showing that the price of medium-grade Thai rice is up 120% since February, from $310 to $795 on 2nd April, 2008.

Experts argue that the major reasons for high rice prices include rising long-term demand in as continent sized numbers of Asians emerge out of poverty every year, weather and pest induced supply shocks in some large rice exporters, urbanization and diversion of land for industrial purposes (SEZs etc), and increased demand for alternate staples like rice due to biofuel induced higher corn prices. The relevance and relative importance of each reasons can be verified only with more controlled studies.

This post is from a largely Indian perspective. India is the 2nd largest producer, 3rd largest exporter and one of the biggest consumers, and is currently experiencing foodgrain price inflation. Indian rice production though has been robust, and is estimated to grow to a record 94 mt in 2008. The Government of India had recently responded to the rising inflation by imposing an export ban on all non-basmati category rice grains. The Government hopes that this will keep rice inflation under control here.

Too many of the arguements in the ongoing blog debates has been about how higher prices will incentivize farmers to expand their rice production. It is also felt that farmers will get a better deal from this. And international trade will facilitate all this. However, arguements that price signals will incentivize farmers to move into expanding their rice farmlands is not borne out by reality. Unlike other commodities, rice farming has many distinct characteristics that are likely to come in the way of the aforementioned simple benefit transmission.

1. Farmers do not automatically get higher prices merely by producing. In the absence of adequate access to credit, storage facilites, markets, and other linkages like commodity futures, the major share of the higher prices is skimmed off by the traders and middlemen. The overwhelming share of farmers in developing Asia face this dismal scenario. And breaking this stranglehold is not a simple issue of more investments in agriculture. More about this in a later post.

2. The returns from other produce intended mainly for the rich country markets are much higher, while that from farm diversion to other activities is many times higher and immediate. Thanks to contract farming and the presence of the major export companies, the production of export crops are more organized. But unfortunately, these organized groups prefer the larger farmers, and see limited utility in the smaller farmers.

3. The incentive of higher prices is not likely to expand rice production also because, unlike other foodgrains and agriculture commodities, the overwhelming share of rice is cultivated by farmers in small landholdings. They have limited resources and flexibility to respond to higher price signals.

If higher prices translated into better deal for farmers, then Thai and Vietnamese farmers ought not be giving away their valuable farmlands at alarming rates. For example, land under cultivation in Thailand fell 13% in the 1995-2005 period, and Vietnam is losing about 1 lakh acres of rice growing lands to construction activites every year. Merely promoting trade without addressing these more deeper issues will only lead to a deepening of the crisis. As I wrote earlier, it will only get "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".

There is an interesting analogy here with the sub-prime crisis. The US Fed and a number of commentators treat it as a liquidity crisis and have been inclined to keep lowering the interest rates, so as to ease the financial sector out of the crisis. However, the more important and serious issue of solvency which dictates that somebody has to, at some time, own up these massive losses on their balance sheets, (unless we can roll over indefinitely from one bubble to another) has been quietly sidelined. Similarly, ignoring fundamental issues and focussing on rice trade will only fuel the party further, till the spectre of starvations looms large!

Theoretical principles rarely give simple solutions to complicate socio-ecconomic problems. There is a lot of distance to be travelled between theory and solutions. Economic trade theory needs to be distilled in light of the specific contexts of each commodity and country, for drawing meaningful conclusions.

Food security (and energy security) is too important an issue to be left to the workings of a long-term strategy that promotes trade. The present food crisis only highlights the fact Governments need to have clear policies on food security issues. Democratic governments, especially those facing elections, can apply logically consistent economic principles, without any tangible short or medium-term results, only at their peril. If not, in the real world, ruling parties will lose elections and as Keynes said, "in the long run, we are all dead"!

Update 1
Gary Becker traces the current price pressure on foodgrains to "the boom in petroleum prices and subsidies to ethanol and other biofuels". During the past year, one quarter of American corn production, and 11 percent of global production, was devoted to biofuels, and the acreage devoted to corn in the United States increased by over twenty percent in 2007-8, while that devoted to soybean production declined by more than fifteen percent.

He argues against export restrictions like those imposed by countries like India, Argentina, Russia and Vietnam. He feels that while these controls help in temporarily keep a lid on domestic prices, it harms domestic farmers and prevents them from getting the best deal for their produce.

Prof Becker's contention that these restrictions adversely affect the farmers and favor the urban consumers may be off the mark, especially in the context of the developing countries. Unlike in the developed economies, the overwhelming share of rice and other foodgrain farming in countries like India are done by small farmers, on smaller land holdings. In the absence of adequate upstream linkages, the predominant share of farmers - small and marginal farmers - are likely to benefit little from higher global prices. The middlemen knock away these benefits. In any case, the domestic foodgrain procurement policies, as that involving the Minimum Support Prices (MSP) in India, most often reflect the rising international market prices.

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