Thursday, August 6, 2009

Sugar prices and agriculture trade

This NYT graphic succinctly captures the volatile nature of the impact of globalization on agriculture and food security. Faced with a sharp drop in global sugar prices in 2006, farmers in India responded by switching to other crops, thereby turning the country into a net importer (to the extent of 20-30% of its sugar demand) this year from being an exporter of nearly 6 mt last year. As the example shows, maanging such risks poses numerous complex challenges for governments, especially in developing economies.

The Times has this account of the latest boom-to-bust cycle in sugar,

"The price of refined sugar on international markets has jumped 60% since the end of last year, to 23 cents a pound, even as other food commodities have stabilized or fallen. While all commodities move in cycles, sugar in India is a case study in feast-to-famine swings in which bountiful crops are followed by anemic harvests every two or three years... in 2006 when the government banned exports to bring down prices... Within a few months prices began falling as it became clear that farmers had planted too much cane... conditions were so bad in 2007 and 2008 that sugar mills, which usually arrange to have cane harvested, did not even bother to send out crews... The government then tried to help by subsidizing exports. At the same time, farmers began switching to other crops. The ground was being laid for the current shortage."

As the example of both US and Europe with their subsidy support for farmers and restrictions on imports shows, Governments across the world face a major challenge with managing their agriculture policies. I have blogged earlier on similar challenges faced in the context of trade in rice here and here. In this context, it is also important to draw a distinction between short-term price wiggles, which inflict large suffering on the poor and are therefore to be contained to the extent possible, and longer-term price trends, which may even be desirable and therefore to be left alone.

A relatively open global market in agricultural commodities, especially foodgrains, is bound to be vulnerable to supply-side shocks. Since the quantity traded is small (relative to the total demand, since most of the production in atleast the major consumers is local), the market dominated by a handful of producers, and demand and supply tightly matched with limited reserves or inventories (the perishable nature of these items limits the possibility of maintaining large longer-term reserves), even isolated events in any one of the producers can have a profound impact on the global commodity prices.

It is therefore commonplace for drought, hailstorms, frost bites, floods, pest attacks, and a host of other natural disasters to inflict supply-side shocks on agricultural commodities thereby constraining supply and driving up their prices. Unfortunately, the impact of such supply-side shocks is not limited to price spikes. It also sets the stage for farmers to shift cultivation to these crops in anticipation of a sustained trend in such price increases (despite enough recent history to the contrary). The result is a glut next season with attendant price swing to the bottom.

The Times article correctly identifies the problem as one of balancing between the interests of consumers and producers, especially in the developing economies. While net producers naturally prefer higher prices, consumers, especially the large numbers at the margins and below, are adversely afected by the higher prices. Further, the fact that most farmers in developing countries, except the small proportion of ones with large land-holdings, are aggregate consumers, means that that sudden price spikes invariably end up causing net suffering.

All evidence from the real world, both recent and historic, clearly indicates that governments may therefore be justified, both on political and economic grounds, to intervene in such markets, though the type and extent of such interventions is controversial. The bouquet of government interventions include price controls, export/import restrictions, minimum support prices based procurement, and direct payments to producers.

Just as in the context of the aforementioned example of rice, the export restrictions on sugar (when prices climbed) may have had the effect of attenuating the adverse impact of the rising prices on consumers. It is also necessary for governments to maintain a sufficient intervention buffer, especially of important foodgrain stocks, and keep all options open to contain short-term price fluctuations in these commodities. However, the success or otherwise of such policies depends on containing and minimizing the incentive distortions arising from such policies.

Update 1
See also this graphic form Economist on global sugar price movements.

Update 2
Global rice stocks are at a seven year high of 118 mt.

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