Public Policies and Rising World Food Prices Once Again-Becker

 

 

From 2002 to 2008 the prices of many foods, including corn, wheat, and rice, increased by a lot. For example, The World Bank’s index of food prices increased by over 100% from 2002-2008. Grains and other food prices fell rather sharply during the financial crisis, along with the fall in oil prices and those of other commodities. But food prices are rising once again. The UN’s Food and Agriculture Organization indicated that its food index rose in October to levels last seen during the peak in 2008.

Food prices are marching up again mainly because the world economy is recovering from the crisis. Fast growing economies like China are increasing their demand for wheat, meats (animals use lots of grain as animal feed) and other foods that were formerly out of reach of the typical family in these economies. Reactions to the food price increases include Russia’s and Ukraine’s banning of wheat and some other grain exports “temporarily”, and China’s threat this past week to impose price controls on various foods, such as ginger and garlic, that are important in the Chinese diet, and have been rising rapidly in price.

A little basic economics is useful in evaluating these and other proposals. The world price of grains essentially equates the world supply and demand for grains. An increase in world demand for cereals and other foods- perhaps because of economic development in poorer nations that raises the average family’s demand for wheat, corn, and meat- would increase both the prices of grains and the quantities produced and consumed. An increase in world supply-due perhaps to good weather in grain growing regions, or to greater agricultural efficiency, such as through the development of genetically modified foods- would also increase world consumption of grains, but supply increases would lower world grain prices.

A further complicating factor is the growing use of corn and cane sugar to produce biofuels as substitutes for gasoline. In particular, the United States now unwisely devotes a sizable fraction of its corn output to biofuel production. So it is necessary in using the supply-demand framework to distinguish production of corn from its consumption as foods either by humans or animals. According to the USDA, ethanol production in the U.S. has increased from less than 3 billion gallons in 2003 to over 6 billion gallons in 2007, and is estimated to exceed 12 billion gallons in 2020. In 2008, about one quarter of US corn production was used to produce biofuels, and that share has been rising since then to almost 35%.

Most of the current proposals to combat increasing food prices are counterproductive, and would reduce efficiency. For example, Putin’s banning of Russian exports of wheat supposedly only until the end of this year forces Russian farmers to sell all their wheat output in the domestic Russian market rather than to sell part in the world market. This lowers the price of wheat in Russia below the world price of wheat. This means that Russian wheat farmers get less for their wheat than if they exported some of it, and Russian consumers pay less since they have a greater supply of wheat available to them.

Such an outcome would be politically popular if urban consumers in Russia have greater political clout than Russian wheat farmers. However, Russia as a whole is made worse off by this ban since it gives up the higher prices from selling some of its wheat abroad. In addition, Russian farmers would plant less than the efficient amount of wheat because they would be getting a lower price of wheat than they could get in the world market. Russia would be better off if it allowed farmers access to world prices, and it could give income transfers to urban families that offset at least some of the resulting higher cost to them of wheat and other foods.

The price controls proposed by China on vegetables and other foods are if anything worse than Russia’s ban on exports. These controls would keep down prices to consumers, which encourages their demand for the foods affected, compared to demand at what the prices would be if the forces of supply and demand were allowed to operate freely. At the same time, Chinese farmers would shift some acreage out of the price-controlled foods. The result would be an artificial  “shortage” of ginger, garlic, cabbage, and other foods with controlled prices because of these responses to price controls by both consumers and producers.

Another set of bad policies are the restrictions that many countries, including but not limited to, the United States and other rich countries, impose on imports of foods from developing and other nations. These restrictions discourage greater food production in poorer countries, precisely the countries where food production is a major source of income. Import restrictions also cause a world misallocation of food production toward excessive levels in the EU, Japan, and the US, and insufficient production in Africa and other poor and developing nations.

The great advantage of prices in allocating resources is that they simultaneously give signals to both producers and consumers. Higher prices discourage consumption, and at the same time encourage greater production by profit-seeking farmers. To be sure, the demand for grains and other foods by consumers is not highly responsive to prices in the shorter run, although their degree of responsiveness grows as consumers have more time to adjust to higher prices. Similarly, supply is not so responsive to higher prices in the short run since farmers need time to make adjustments in planting, use of capital, and in various other production decisions.

In the long run, however, supply of food is very responsive to prices. Food is not like oil, natural gas, or copper, where supply is limited by the quantities of these resources in the ground or under water. Food production can be greatly increased with sufficient time by using more land to grow food, by greater use of fertilizers and capital to extract more output from a given amount of land, and by encouraging R&D on food output that would find new ways to increase productivity, such as happened with the “Green Revolution” and genetically modified foods.

For all these reasons it is reasonable to expect that the worldwide supply of food would be very responsive to food prices in the long run, as long as the forces of supply and demand were allowed to operate rather freely in the world market for foods.

Comments

[Hyena]

I think whether these policies are misguided depends on the capabilities of their respective governments. If neither China nor Russia can effectively rebate needy consumers, then price or distribution controls may be the only live options.

In China's case, the number of people needing food subsidies is likely to be far too high. Remember: this is a country with hundreds of millions living below two dollars a day. In that situation, the administrative overhead and its attendant inefficiencies might be worse than a temporary price ceiling, assuming that a food subsidy is even possible.

Russia may face similar issues, it may also rely primarily on a handful of large wheat concerns, making negotiation between producers and government over comprehensive price (market price + additional subsidy) possible.

[Michael Smith]

This is a nearly worthless item. It categorizes prior failures in policy making and market actions. So what? We know both can fail. An early question to be answered is how to provide incentives to decision makers in DC, Ottawa (a huge grain producer), Moscow, Delhi, and Beijing, to make good decisions in both long and short terms. The bigger question is how to send food now to many very hungry children in Africa and Asia. People who make decisions listen to the two of you. Please be careful and do your best. Our national interest -- and more importantly many hungry stomachs -- may depend on what you say.

Hints: The long run is of interest, in the long run. Urge policy makers to support building sustainable local food supplies, especially where population is high and growing. Reject long term solutions depending on long distance transportation of food. In the meantime, feed the hungry, clothe the naked, heal the sick.

[Pradeep Despande]

Price increases seem a lot more dramatic to Western world citizens because their growth in the last decade has lagged far behind the rest of the world. If you are Chinese, in terms of purchasing power, not much has happened in terms of food prices. At an annual growth rate of around 7%, Chinese per capita income has roughly doubled in the past decade. Same as the price increases. Therefore little change has occurred in terms of purchasing power. For Europeans, on the other end, with an anemic 2% annual average growth rate, per capita income only rose 20% in the last decade, so, of course, for Europeans there is a perceived and real erosion of purchasing power when it comes to food and other commodities. The effect is even more dramatic considering the fact that food commodity prices are denominated in declining US dollars.

More than a real increase in food prices, what the West is really witnessing, is the relative erosion of Western World purchasing power compared to the rest of the world, and, more specifically, the developing world. It is all consistent with overall Western World relative decline. Actually it is not that much Western decline as is Emerging World ascent. Unless Westerners re-establish personal incentives to produce that result in at least 4% annual growth (the worldwide average) they will keep fast loosing ground compared to the rest of the world.

[Perroud]

I would respond to this post by quoting Keynes: in the long run, especially in this case, we are all dead.

[Liam]

As you yourself point out, food markets are only responsive to these sorts of conditions on a longer-term scale, and can't react quickly because of the time constraints on production. If, then, these policies are explicitly only being enacted in the near term, such that food production cannot respond quickly enough to exploit or avoid the distortions, I fail to see why they are really that problematic.

[David Welker]

I think Becker's post overall is good. But I think in using basic Economics 101 level thinking, Becker has made a basic analytical error. Becker's conclusion might be right, but his analysis is incomplete. Becker asserts the following:

"Russia would be better off if it allowed farmers access to world prices, and it could give income transfers to urban families that offset at least some of the resulting higher cost to them of wheat and other foods."

So, what Becker fails to consider is that it not "free" to redistribute income.

First of all, those who earn extra income from accessing higher prices on international markets are very likely to fiercely resist redistribution on a political level. They are likely to succeed. Politically, it is much easier to adopt policies that result in more favorable distributions of income (even if there are some economic inefficiencies) than it is to redistribute income after it has been earned.

One might ask whether it should matter if there is a successful redistribution. Why should it matter whether the gains are distributed to a only a few? Isn't a $1,000,000 allocated to one person as good as $1,000 dollars allocated to a thousand people? Shouldn't Russia be indifferent between these two outcomes? And the answer is, of course not, due to the diminishing marginal utility of a dollar. That is, one person is not likely to derive as much utility out of a million dollars as a thousand people would out of a thousand dollars. Clearly, dollars that are spent on basic needs provide the most utility; only when one has enough quality food to eat and adequate shelter and adequate access to the other basic necessities, does one look to derive pleasure from luxury goods. One can much more easily do without a luxury good than one can do without a necessity. So, to the extent that the political failure to redistribute income would have the effect of depriving people of basic necessities, there would be a significant loss to Russian society.

Second, even if it is politically possible to redistribute income, government programs to redistribute income are potentially vulnerable to corruption. That is, there will be a temptation by those in charge of such redistribution to redirect wealth to themselves or to favored groups. Such corruption may not defeat a program to redistribute gains entirely, but their cost may in fact exceed the costs of the export ban that Becker is criticizing.

Third and finally, even if a program of redistribution is undertaken with minimal corruption, there is still administrative overhead involved with establishing a bureaucracy to oversee the redistribution, determining eligibility for redistribution, and prosecuting instances of fraud by those who falsely claim eligibility for benefits or attempt to claim benefits more than once. Perhaps such costs can be minimized by carefully structuring the government bureaucracy in charge of redistribution, but the challenges of doing so, both politically and logistically, should not be discounted. Also, newly established bureaucracies can sometimes be very difficult to disband politically when they have served their purpose.

So, in conclusion, maybe Becker's conclusion is right. But that would be more a matter of sheer luck than sound analysis. The universe of policy possibilities facing can be divided into three categories.

(1) Impose an export ban on wheat. This has enforcement costs as well as the increased income for farmers that is foregone by accessing international markets.

(2) Allow the export of wheat, but do not make any attempt to redistribute any of the windfall profits accruing to farmers due to unexpectedly high prices in international markets. This option has significant costs due to the diminishing marginal utility of a dollar and the fact that food is a basic necessity rather than a luxury item.

(3) Allow the export of wheat, but set up a bureaucracy to redistribute a portion of the windfall profits accruing to farmers. This option has significant costs in terms administrative expense, possible corruption, the establishment of new bureaucracy, and the political resistance of new bureaucracies to being disbanded when they have served their purpose.

So, what Becker has failed to do is try to compare these options and estimate the costs of the various choices. Implicitly, Becker waives his hand and says that the losers from the decision to allow the export of wheat can be more than compensated by the gains of the winners and everyone will be better off. But he fails to consider the costs of such transfer programs and whether it is even politically feasible. Basically, Becker's analysis proceeds as if the cost of transfer would be zero, when this is far from likely to be the case.

Finally, it should be noted that to actually do this analysis correctly, one would have to be something of an expert on the Russian situation. You cannot do the analysis completely based on abstract principles gleaned from an Economics 101 textbook. You have to know something about the political situation in Russia to determine whether a transfer is even politically feasible and you have to know something about the corruption situation to estimate the likely costs of administering such a program. It may very well be that a temporary export ban is in fact the best policy for maximizing the welfare of the Russian people, when one does a full analysis. (On the other hand, Becker might be right in his conclusion. But only through luck. since his analysis is woefully incomplete.)

[Jack]

A rapid (3 year?) phase out of corn ethanol subsidies could be a start for doing our part:

Corn ethanol subsidies totaled $7.0 billion in 2006 for 4.9 billion gallons of ethanol. That's $1.45 per gallon of ethanol (and $2.21 per gal of gas replaced).

Even with high gas prices in 2006, producing a gallon of ethanol cost 38¢ more than making gasoline with the same energy, so ethanol did need part of that subsidy. But what about the other $1.12. Not needed! So all of that became, $5.4 billion windfall of profits paid to real farmers, corporate farmers, and ethanol makers like multinational ADM. Why is it the farm states put up with this?!

Where did those subsidies come from:
1. 51¢ per gallon federal blenders credit for $2.5 billion = your tax dollars.
2. $0.9 billion in corn subsidies for ethanol corn = your tax dollars.
3. $3.6 billion extra paid at the pump.

That's quite a bit when you figure it only made us 1.1% more energy independent and only reduced US greenhouse gases by 1/19 of 1%.

++++++++ Yep! Quite a bit. How about diverting the $7 billion subsidy to energy conservation measures including speeding the adoption of plug-in electrics.

~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
Oil get's big subsidies, not ethanol. Wrong by 54 times!
"Ethanol Today," (8/'05) states "Five years ago, a US General Accounting Office report showed that ethanol had received $11.6 billion in tax incentives since 1968, while the oil industry had received over $150 billion in tax benefit over the same period.

+++++ Not a very wise "investment" eh? Considering the laws of physics prevent much improvement in the ratio of eth gained to other fuels consumed? Ha! at current levels of ethanol "efficiency" suppose only eth was used in the production of eth and the entire state of IL was devoted to the project -- it would not even power the cars of IL.

~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~

+++++++++++ Interesting? We export 2 billion bu. of corn while using 2.6 billion bu to (inefficiently) power our fleet of gas hogs.

http://docs.google.com/viewer?a=v&q=cache:ZG9gcf_88lIJ:www.ethanolacrossamerica.net/PDFs/09CFDC-004_VanderGriendWhitePaper.pdf+value+of+corn+ethanol&hl=en&gl=us&pid=bl&srcid=ADGEEShVz-LZXXu1TJd8E4FdmlIATycM2sgZd9kolocZZnuTXAVrPyjwPvhzu1VJGKvmvwdt1r4qjzcA0LIWdgvTAyAPkOs-XlS0QzNEjUpBiu_L_MLRJvB2z8DGTH_24eeK9CCOQLKG&sig=AHIEtbSUhgFyTlRsTbuA-tcx7PGB273A8Q

~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~

Corn is $5.30 per bushel. As there is something of a world corn price, coupled with the rising demand pointed out here, it seems fairly save to project that we could double our corn exports adding $13 billion to our export total.

http://www.quotecorn.com/

Becker sez:

and is estimated to exceed 12 billion gallons in 2020.

+++++++++ Great? If the subsidy does not fall from the $1.45 quoted the subsidy grows from $7 Bn to $17 billion. Progress?

How to make up for the (trivial) gallonage lost were we to quit ladling subsidies to ADM and corn producing mega-farms? Simple:

A. subsidize conservation efforts as above

B. per Boone Pickens "NG as bridge fuel", begin making heavy transport multi-fuel and take advantage of, now much cheaper than oil, domestically produced natural gas that produces about 1/3rd the pollution.

David sez:

....one would have to be something of an expert on the Russian situation.

+++++++++ Indeed. One thing Russia shares with my hone state of Alaska is that of being so far north that growing grains is tricky with weather dependent failures being fairly common.

A quick peek at corn production shows Russia not even making a list of the top 17 nations, of which US production is higher than the other 16 combined:

http://www.nationmaster.com/graph/agr_gra_cor_pro-agriculture-grains-corn-production

++++++++ and only Ukraine makes the list of top wheat producers, but only with a dab compared to the US.

http://www.nationmaster.com/graph/agr_pro_whe-agriculture-production-wheat

Posner is surely right that farmers would gain revenue from selling at "world prices" but at he touches on, how would any benefit accrue to consumers? Ha! another question of the tension between democracy and "the market". If one rich nation bids up corn prices to fuel their luxurious gas hogs, is it wise for a poorer nation to join in? I suppose so if they can (and will) use the proceeds to help those whose wages are not "world market" to feed themselves.

[Anne D.]

David Welker,
Indeed when you consider that marginal utility per dollar decreases with income, while at the same time marginal taxation per dollar increases with income, you can realize how distorted is a competent person’s propensity to work (invent, innovate add to GDP etc.).

This is the fundamental reason why there are a lot more competent people than there are rich people. Because most find mediocrity more appealing given the uphill battle they would face not only against the intrinsically decreasing marginal utility of money, but also an increasing marginal direct and indirect taxation, loss of subsidies, loss of entitlements etc. So most, understandably, prefer to use their brains on how to live a happy life within the more modest confines of subsidies and entitlements but also less effort put forward and less money earned, and BTW less contribution to GDP. Yet these are the people whose competence has the most leverage in the overall economy – and most of them, understandably, choose mediocrity.

If you want apt example of this, come to Europe. A continent with the most competent average citizens on earth, a great majority of whom choose mediocrity. Anybody seen the French iPhone?

I guess Americans too must have decided that they are growing so fast that they should also move to lower incentives to produce.

[Jack]

Anne -- I'm finding this litany of "incentives to produce" which only seems to be hauled out in regard to upper income tax rates. If you're in Europe perhaps you're not up on US stats?

So let's review: The US has one of the steepest income curves in the world:

http://lanekenworthy.net/2008/03/09/the-best-inequality-graph/

As you can see it's only the upper most tiers who benefited, at all, in the "rising tide" since the 80's.

Coupled with the rapidly widening income gap the Bush/Repub Congress tax breaks dealt further benefits to those of the topmost tiers.

I'm not sure how lazy or greedy those in the top percentiles have become, but in 1980 we could get CEO's to "lead us" for 60 times working folks pay, while today it takes the wages of 500 working folks to get a CEO to answer his alarm clock -- plus an assured parachute upon which to retire if he/she is mustered out for incompetence.

I wonder what those of your beliefs think about "incentives" at lower wage levels? After falling behind inflation much less having kept up with a doubling of per capita productivity the min wage pays less than half what the most modest of living stds would require, making welfare and Medicaid competitive options while even the numerous "help desk" jobs of $10-12 do not pay the bills and are hardly "incentives".

I note that you've little respect for those of the service sector tasks that often require being on one's feet all day to serve us and help Walmart continue to enjoy the fattest bottom line in world history, but really? if "they" are only worth $1500/month what are your brainy and ever so excellent bankers who plead "not understanding" the derivatives designed by their own whiz kids worth? My estimate is a free stay in the kind of prison were petty thieves are sent.

As we arise from the ashes of the era of negligent regulation and oversight, I too hope we'll have incentives to PRODUCE, not merely carve off fatted chunks for riding a false housing boom with 40% of our profits being skimmed off by a cabal of WS thieves. With me?

[Anne D.]

I agree. I once proposed that I do the job of one of the CEOs in my field of work for 1/2 the compensation. Next day I found a horse's head in my sheets.
So I got togehter with 3 of my friends and proposed that they could hire all 4 of us to do the job of one single CEO. Next day, we all 4 got horse's heads in our sheets.
So then I got together with other competent workers, investors and venture capitalists who were tired of seeing their profits trimmed by CEO compensation to see if we could just build a more profitable and more competitive company paying our CEO's and executives less. Well, by golly, we all got horse's heads in our sheets again.

[Jack]

Geez Anne -- a girl just can't win! BTW do you suppose they had their lobbyists get a bill passed so they could expense the horse parts and get a tax credit for the delivery costs?

BTW I'm available for just the 60 times working folk's pay of the pre-Reagan era. I think I prefer an insurance co position where there would be little to do after the meeting to tell the troops to "Do it about like last year.... but more vigorously." If they needed more for lobbyists and PACs to kill H/C reform, they could call me on the yacht so I could OK the premium increase amount.

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[Miguel]

Check out this graph showing the price of corn for the past 25 years:

http://www.indexmundi.com/commodities/?commodity=corn&months=300

Did the corn for ethanol craze start around May 2007?

[Jack]

Miguel: Good question but the ethanol thing began earlier. But "exuberance" was likely fanned by eth expectations. My take on the spike is either A. momentum based market mania or B. A enhanced by the manipulation I believe we see in oil futures.

And, Ha! I could easily be wrong. Perhaps the volatility -- mostly upward -- in commodities is due to there being too much money "on the side" that is not finding viable opportunities in productive enterprises.

With cheap and abundant capital available strategically "investing" in the typically zero sum game of commodity futures may be "rational" to take advantage of the upward bias, haha! until the tide changes!

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