What to do about rising food prices

The world is living through another major upswing in food prices. Food prices surged to a new historic peak in January, for the seventh consecutive month, as the FAO Food Price Index reached 231 points, up 3.4 per cent from December 2010. The accumulated increase in food prices during 2010 amounted to 25 per cent relative to the 2009 level. Starting with a sharp increase in wheat prices in July in reaction to production shortfalls and export prohibition in Russia and followed by uncertain crop prospects in other parts of the world.

The current price spike is different from the previous incidence in many ways. The 2008 upswing was driven by escalating grain prices in a situation where cereal stocks had been declining over the years, reaching dangerously low levels in 2007.

The price spike of 2010 is partially explained by production shortages due to poor weather. Moreover, the current increases are more pronounced for sugar and oilseeds, while rice and maize markets remained relatively stable. Transmission of price signals to local markets has been highly heterogeneous. Carry over stocks help keep prices down in many countries.

Uncertainty

Despite the different characteristics of the two price upswings and the short time elapsing between them, both are highly indicative of the fact that we are living in an environment of much greater uncertainty than 10 years ago.

Price movements are no longer determined only by the basic driving forces of supply and demand: agricultural commodities are attracting excess liquidity in international markets and other factors, such as expectations and appetite for risk, start to play an important role in determining the direction of the prices.

Furthermore, food markets are more and more intertwined with financial and energy markets, both of which are characterised by greater volatility. Facing these multiple sources of uncertainty, agricultural commodity markets tend to overreact to any changes in the demand or supply projections.

Although grain stocks are higher today, this is not the time to be complacent. If production shortages persist, stocks will dwindle and sooner or later world price increases will probably trickle down to local markets. Climate change also plays a role in this, as extreme weather conditions result in unpredictability to agriculture.

Excess volatility of food price is undesirable not only because it places a disproportionally high burden on the most vulnerable consumers but also because it results in suboptimal levels of production as farmers are typically risk averse.
What should be done to alleviate this worrisome situation?

First of all, it is clear that a coherent and coordinated worldwide response is needed to bring greater stability to global markets, while the sum of individual actions in an environment of elevated risks could result in a worsening of an already difficult situation.
The countries have the options of trying to minimise the risk of price swings or deal with their negative consequences ex-post. One possibility is to try to control the prices directly through stabilisation schemes, but these imply high fiscal costs and are very difficult to run. Another is to apply an array of border measures and domestic subsidies, but both can distort prices and be very difficult to dismantle once they are no longer justified.

Finally, there are policies to counteract the negative implications of price spikes, which include expanding the existing safety nets to compensate for loss of purchasing power by consumers.

Other mitigation strategies include increasing emergency stocks to avoid shortages, encouraging diversification of consumption to include traditional and locally produced products, improving the efficiency of domestic markets and helping vulnerable population to grow food for own consumption. These measures can help soften the negative impacts of price increases affecting foods that are traded on international markets.

These measures can provide immediate results but in the long run the only lasting solution to high food prices lies in securing ample and stable supply. Although the world produces enough food, global production needs to be gradually increased to keep pace with the growing population. Chronic underinvestment in agriculture throughout the years, in developing countries in particular, made them more vulnerable to risks associated with the new dynamics that rule the world market. Investment in agriculture, which would allow to increase productivity and improve resilience to climatic risks, together with strengthening of rural institutions and better governance of commodity markets, are needed to reduce the incidence of price spikes.

IPS

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