An element of market failure in the food prices crisis
How to restore confidence in global grain markets
October 11, 2008—While food grain and oilseed prices have dropped sharply in recent weeks—with slowing economic growth, falling oil prices, and improved supply—millions of poor will feel lasting impacts of the high food prices of 2007-2008.
A new report on malnutrition finds that the high food and fuel prices that prevailed until recently will increase the number of malnourished people in the world by about 44 million to a total of 967 million. Young children who do not receive proper nutrition will suffer the health effects of early malnutrition well into adulthood.
Also, many poor families have been forced to cut back on education costs in order to feed themselves. In Bangladesh, a recent study shows that about half of all households surveyed reduced spending on education to cope with rising food prices.
Clearly, the developing world—with 1.4 billion people living in extreme poverty, and a great many more hovering just above the international poverty line of $1.25 a day—cannot afford such harsh changes in the affordability of food.
Causes of the food crisis include increases in production costs due to high fuel and fertilizer prices, the decline of the dollar, the sharp increase in demand for biofuels, droughts in producing countries, and low stocks.
An element of market failure
At a recent roundtable at the Center for Global Development, Washington DC, World Bank Chief Economist Justin Yifu Lin pointed out an element of market failure in the crisis—due to rising expectations, hoarding, speculation, and grain export restrictions.
“The food crisis highlights the need to restore confidence in global grain markets,†said Lin, “The recent price fluctuations reflect a collapse in market confidence, not just a temporary imbalance in supply and demand.â€Â Read Lin
When grain prices surged in 2007, most countries had reduced their public grain reserves to almost zero, and so lacked the means to stabilize the grain market. A few countries that did have substantial reserves held on to them to protect domestic consumers, when even a few million tons freed into the global market would have prevented price surges.
This situation grew worse when governments in exporting countries adopted various measures to restrict exports, including high taxes on exports and even export bans, in order to stabilize their own domestic prices.
Responding at the global level
The World Bank Group’s response to the crisis so far has included policy advice, quick financial support, the creation of a multidonor trust fund, increased investment in agribusiness supply chains, and the use of financial market insurance products and risk management strategies such as weather-based index insurance.
Lin called for further long-term efforts at the international level to stabilize global grain markets, as well as to make existing international infrastructure for humanitarian aid—such as that provided by the World Food Program (WFP)—more effective.
A framework to restore confidence in global grain markets
Countries have been responding to high food prices and grain scarcity by scaling up efforts to achieve grain self-sufficiency and rebuild their public reserves.
“While each country’s motivation to stock up on grain is justifiable, this will lead to an inefficient global production system and a very thin global grain market,†said Lin. “To avoid another food crisis, what we need is global coordination of these efforts.â€
Lin suggested that one way to do this might be an agreement under the auspices of the United Nations, by which each country would hold some grain in reserve—likely only a modest fraction of annual domestic demand—in addition to privately-held pipeline stock.
Further, a global mechanism could be set up to release these individual reserves into the global market when future shocks in supply and/or demand cause global grain prices to increase beyond a certain limit.
“Virtual management of a network of public grain reserves will stabilize the market and prevent further price surges due to hoarding and speculation,†added Lin, “This type of agreement would be a win-win solution for consumers and producers, as well as for exporting and importing countries.â€
It would help strengthen international coordination if all grain exporting countries unconditionally pledged not to apply export bans or prohibitive taxes for exports.
Improving the effectiveness of existing international infrastructure
Strong institutional infrastructure already exists at the level of humanitarian aid. The WFP anticipates that its staff of more than 10,000 people will feed 70 million during 2008, distributing 4.3 million tons of food valued at US$3.3 billion.
Many donor countries also separately manage large bilateral food programs, providing food or money to dozens of needy countries. In addition, there are private agencies operating in the field.
“Within the complex array of food aid efforts, there is scope to improve the effectiveness of existing programs,†noted Lin. “The World Food Program needs more stable financing, and humanitarian agencies need help in periods of unforeseen high demand.â€
More stable financing for the WFP could come through agreement on multi-year support, by “earmarking†funding sources, or by using commodity price hedging and weather risk management strategies to potentially protect the organization’s budget from shocks.
Acting now
It is already widely known that climate change and water scarcity are likely to affect the supply and demand of grain in the years ahead. This makes adopting a strong global framework to protect against future food crises all the more important.
“There are no excuses for inaction when we know what we do about the effects of food crises on health, education, and poverty, and when we know what’s ahead of us in terms of increased floods and droughts,†concluded Lin.
