Food prices are on the move once again as the world economy recovers from the financial crisis. The Commodity Research Bureau’s index of the prices of foods- including corn, wheat, steers, and sugar- doubled between 2002 and 2008, fell by 25% during the crisis, and has increased since the world recovery to a level beyond the prior peak.
Higher prices of foods mainly hurt the poor since poor countries and poorer families within a given country spend a much larger fraction of their incomes on foods than do rich countries, and then richer families within a country. For example, the share of national income spent on food is over 40% in India, less than that but still large in China, and under 15% in the United States. If families were spending 40% of their income on food, a 30% increase in food prices would raise by 12% the income they would need to maintain the same level of consumption of all goods. By contrast, a family spending only 15% of its income on food would only need a 4.5% increase in their income to maintain the same consumption basket.
This simple arithmetic explains why the current rapid price increase in foods and other commodities, and past large increases in these prices, often caused great distress among poor families of Africa, Asia, and elsewhere in the world. This distress led to food riots in many countries, and other protests by the poor against the large rise in their cost of living. Governments responded to these protests in various ways that often lowered the cost of food to consumers, but usually at the expense of inducing inefficient behavior by farmers and consumers, and often even at the expense of the poor.
For example, during the current sharp run up in food prices, several food-exporting countries, such as Russia and Ukraine, have banned, or greatly restricted, the ability of farmers to export their produce. This lowers the price of food to urban consumers in these countries, and thereby helps the urban poor. However, such bans reduce the prices received by poor farmers of these countries. This reduces their incentives to raise their production of food, and makes these farmers worse off. It also raises the cost of food to families in food-importing countries, and thereby hurts the poor in these countries. Since farmers in developing countries are generally much poorer than those who live in cities and other urban communities, the poor may overall be made worse off when countries greatly restrict their food exports.
Unlike the situation in rich countries like the United States, city dwellers and other urban populations in developing countries like China and India usually have more political clout than rural families. For example, the massive famines in China during 1958-61 that resulted from the Great Leap Forward were concentrated in rural areas partly because farmers were forced to supply much of their reduced food output to the cities. This greater political power of urban populations also explains the restrictions on food exports in developing countries, even though they discourage food production, reduce the national incomes of these countries, and also overall tend to reduce rather than increase the real incomes of their poor.
To contain the rise in the retail food costs, many countries, including China, have also imposed retail price controls on foods that figure most prominently in the diets of lower income families. This helps those poorer families that are lucky enough to be able to buy most of the food they desire, but such price controls are likely to hurt the majority of poorer families. The reason is that price controls on food prices reduce the incentives of farmers to grow more food since they cannot benefit from what would be higher prices. Artificially lower food prices not only discourage food production but also increase the demand for food. The resulting excess demand for food means that price controls cause food rationing at both the retail and wholesale levels. Richer families tend to gain from this rationing compared to poorer families since they can offer “under the table” payments and other inducements to retailers to give them a disproportionate amount of the limited available food.
Still another common policy in developing nations is to subsidize foods, such as bread and rice, which are important stables in diets of poor families. If implemented appropriately, this approach has the advantage of targeting the goods consumed more by poor families. Yet one weakness of the programs is that they also subsidize middle income and rich families that buy these staples. In addition, they discourage any efforts by consumers to shift some of their food purchases away from bread and other stables that would be rising a lot in prices without these subsidies, and toward other foods that would increase by smaller amounts.
Direct income subsidies are probably the best way to reduce the suffering by poor families due to big increases in food prices that take a sizable share of their total spending. If families below a specified poverty income level received an income supplement, then this level should be indexed to the cost of living by poor families. Especially in poorer nations this means indexing definitions of poverty to the cost of food. An income subsidy approach has the advantage of allowing prices of foods and other goods to be determined by the forces of supply and demand. As a result, it encourages famers to grow more food when food prices rise, and also encourages poor (and other) consumers to reallocate their spending away from foods that rise most in price, and toward other foods and consumer goods.