"Food Prices: The Need for Insurance"

Esther Duflo says it's time to "make the international financial services actually work for the poor" by providing insurance against volatility in food prices:

Food prices: The need for insurance, by Esther Duflo, Vox EU: Throughout last week, violent riots in Haiti – provoked by Haitians’ fury over the increased price of basic foodstuffs – brought the issue of agricultural prices to the forefront. Other incidents occurred in Indonesia, Guinea, Mauritania, Mexico, Morocco, Senegal, Uzbekistan and Yemen. Several large rice producers (e.g. Vietnam, India, Egypt) put severe limits on rice exports.

After being stable for several decades, foodstuff prices began to rise again in 2005, and in 2007, their increase was phenomenal. From March 2007 to March 2008, the average world price for corn increased 30%; for rice, it increased 74%; for soybeans, 87%; and for wheat, 130% (the BBC has a nice summary of what is happening to food prices).

High prices Several reasons explain the upward trend in prices, including the demand for biofuels (which consume a significant part of the corn produced worldwide), and the growth and enrichment of the world population (particularly the increased demand for meat in China – paradoxically, it takes more grain to produce a calorie in meat form than it does to produce a calorie in grain form).

Several short-term factors also help to explain the recent price peak.

Because the main consumers of rice are also producers, the volume of rice traded is low compared to the volume of rice produced (only seven percent of produced rice is traded). Restrictions by big producers (such as India) can thus have large impacts on the world price of rice, since they affect a large proportion of the volume of rice traded. It keeps the prices in India relatively insulated from what is happening on the world market, however. Wheat harvests have been poor in several major producing countries, rice is suffering from a mysterious parasite in Vietnam, and following accusation of corruption and mismanagement in the last few years, there have been sharp declines in grain stocks maintained by governments to stabilise prices (they are at their lowest levels since 1984). As a result, prices are not only high in general, but also more volatile (another drop in rice prices is expected after the harvests in Indonesia and India); even the financial crisis plays a role: in the current meltdown, commodities offer an interesting betting opportunity.

Winners and losers Robert Zoellick (President of the World Bank), Jacques Diouf (the chairman of the UN Food and Agriculture Organization), and many others, have now rung the alarm bells. Zoellick even waved a loaf of bread at the annual meetings of the IMF and the World Bank to drive the point home. According the analysis of the World Bank Living Standard Surveys (which Abhijit Banerjee and I have exploited in our article “The Economic Lives of the Poor”[1] ), food accounts for between 50% and 77% of the budget for a family that lives on less than a dollar a day per capita (the world poverty line), depending on the country. This leaves these families very sensitive to food prices, and it is no surprise that the recent increase can make a serious dent in their budget.

Yet, two or three years ago, rich countries’ farm subsidies, and even food aid, were strongly criticised: by keeping prices artificially low, the argument went, they prevented African farmers from selling their products at a good price, keeping them in poverty.

These two arguments may seem contradictory at first. Unfortunately, they are not. An increase in food prices benefits net producers (those who produce more than they consume), to the detriment of net consumers. This is true at both the national and individual levels. Thus, at the national level, the rise in grain prices will improve the trade balance of exporting countries and worsen that of importing countries, including those of Sub-Saharan Africa. At the individual level, the poor who are most affected are in urban areas, but even in rural areas, a number of the poorest people are in fact net consumers of grain as well. A 1989 study of Thailand by Angus Deaton[2] showed that, on average, rural households benefited from an increase in the price of rice, but with large variations from one household to another. Those households who benefited most were neither too poor nor too rich.

So when grain prices rise, some of the poor gain, and some lose – in the short-term. In part, the uproar over food prices reflects a fundamental political economy reality: when some gain and some lose, the voice of those who lose is always louder. This is particularly true of an increase in food prices, which hurt primarily the urban poor. In the medium-term, however, an increase in price volatility is damaging for everyone. Poor families in developing countries are already facing enormous risks (they are often self-employed, they are subject to the uncertainties of weather, and their health is fragile), and there is very little insurance against such risks, apart from their own savings or informal solidarity. Furthermore, these risks are more serious for households struggling to provide the bare minimum. A setback might mean sacrificing the children’s education, or not being able to save a little girl from a diarrhea attack (on this, see a beautiful paper by Elaina Rose, which showed that during drought, the relative survival probability of girls dramatically declines).[3] A passing difficulty can leave a permanent scar.

Solutions Beyond emergency relief, which the world community is scrambling to organise at the moment, it is essential to establish effective insurance against variability in food prices for the poorest. Many argue now that the way to do it is to stop trade and encourage countries be “self sufficient” in food. This seems of course a third best solution, since the countries would then be entirely dependent on the vagaries of the weather at home. It is also not clear what countries that are net food importers would do (in the long run, the argument goes, they will improve their productivity… however, given Senegal’s climate, producing rice there will always be much more expansive than doing it in Thailand). The traditional method used by developing country governments – maintaining large stockpiles of grain by buying when the price is low and selling when the price is high – has its share of problems. In India, it was said that at some point that there were enough bags of rice in those storage facilities to go to the moon and back. The losses in storage and to corruption were important. Alternatively, the governments can manipulate prices using taxes and subsidies. Or perhaps it is time to be creative and make the international financial services actually work for the poor: governments could provide price insurance for the poor (in the form of transfers to some when price are high, and others when price are low). Countries that are neither net sellers nor net buyers could do this internally, and countries that are either net sellers or net buyers should be able to sell this insurance on the world market. There is nothing straightforward about these solutions. The key point, however, is that it is urgent to think of something.

Footnotes

1 Journal of Economic Perspectives 21(1): 141 – 167, Winter 2007

2 Angus Deaton (1989). "Rice Prices and Income Distribution in Thailand: A Non-parametric Analysis" Economic Journal, 99(395): 1 – 37.

3 Elaina Rose (1999). "Consumption Smoothing and Excess Female Mortality in Rural India," Review of Economics and Statistics, 81(1): 41-49, February.

Comments

[reason]

Does this get to the core of the problem? How does this financial solution increase the world stocks of food (and so increase real security). Merely having the money to buy doesn't mean that it will be available. Can somebody explain to me why this will stimulate the accumulation and holding of stocks of grain? If not it is useless. This is part of our problem today we all suffer from money illusion.

[reason]

To make this absolutely clear, lets imagine there was another Krakatoa, or a serious crop disease, so that the shortage of grain production was world wide. How would a financial solution stop starvation? You need large stocks to survive such a calamity.

says...

reason, the interactions between finance and commodity markets are well understood. To take your example of a worldwide disaster, what happens depends on whether the event was forecast in advance or not. If the event was forecast, market actors will build up stocks and deplete them as needed in order to smooth out the price fluctuations. When there is uncertainty, some price variation is unavoidable; even then individuals or governments can hedge their exposure and lock in their supply at a fixed price. Price increases in this instance are actually beneficial, since they stimulate more resilient supply.

[reason]

And if it is not anticipated? Food is not something we can just do without for a year or two. Please explain to me how the scheme above gives us real security in a worldwide emergency as against merely smoothing differences in intercountry agricultural fluctuations.

[reason]

... even then individuals or governments can hedge their exposure and lock in their supply at a fixed price.

You are assuming there IS such supply.

[reason]

I'm an insurance skeptic you see. I think insurance is great, until you really need it, then it disappears. The very poor will be the ones who cannot afford the extra cost of the insurance, and they are the ones who really need it.

[reason]

As far as I understand the paper it is just extending a futures market to poor countries by subsidising it. It still doesn't solve the fundamental problem that we have been running down stocks for years (partly because of low prices). If supply becomes tight, the poor will always be last on the queue and will starve. The way to help the poor IS to have a strategic reserve (perhaps under a UN mandant rather than in every country).

[reason]

It reminds me of problems with subsidies for home buyers. They just push up the price for land, they don't help home buyers, they help land developers. Similarly, if supply is tight for food the idea is to help people pay the high prices. It will work the first year, but the next year they won't be able to afford the premiums. You have to solve the fundamental underlying problems (in the first case by finding ways to create MORE desireable locations for people to live and in the second by increasing the supply).

[The Baron]

reason, part of the problem is that this really isn't a food supply problem. There is plenty of supply, it's just in the wrong areas and wrong commodities.

Where this idea would help is in the fact that it takes moments to destroy a food production system to reduce over-supply and drive prices higher, but years, or decades, to re-establish that system, when things re-stabilize.

Just two years ago, a vast milk surplus in Japan forced local dairy farmers to literally pour raw milk down the drain and kill off excess dairy cows.

The problem: You can pour milk down the drain in an instant, and kill off your herd of cows in a blink of eye. But you can't reverse the process so quickly. Building up a productive dairy herd takes years. The laws of supply and demand work slowly with food,

And so now we have record milk prices and a "shortage."

As you read: EDMONTON–In what is being called an unprecedented move, the federal government will pay Canadian pork producers $50 million to kill off 150,000 of their pigs by the fall as the industry teeters on the brink of economic collapse.

Most of the meat is to be used for pet food or otherwise disposed of, but up to 25 per cent of it will be made available to Canadian food banks.

So you see, it's not so much a lack of food, and in just a few years time we will be hearing about the crisis in the pork markets because there isn't enough Canadian Bacon for pizza toppings. How much, at zero profit, would a pound of Canadian Bacon cost in Haiti, and would it be low enough to avert food riots?

[reason]

I disagree, stocks of stapels have been running down for years. There IS a shortage of basic food for the poor, or the price wouldn't be so high. But this solution, doesn't solve that problem, it only restributes the problem among the poor and between years. The problem is that people think you can translate a basic calories problem into dollars and cents. There may be a surplus of pigs in Canada, but that won't solve the grain problems in the third world. (Typical money illusion situation - the money value of the pigs may well be higher than the value of the missing grain stocks, but is the calory value of the pigs high enough?)

[reason]

In fact getting rid of the pigs (and the dairy cattle) may actually have helped the situation because grain is a more efficient source of calories than pigs or cattle that are fed with grain.

[Storage]

A reasonable amount of food storage is probably a good idea, for all nations. In the short term, suspending the corn alcohol program would free up food for human consumption. Suspending the program to pay people not to grow food would help a bit. If China et al are eating more meat, more food will have to be grown to feed the animals. Otherwise the rich Chinese et al will outbid the poor emerging market customers.

Printing more money will not solve the food problem. That would make the problem worse by giving more food to the first in line to receive the newly created money (they will eat more meat), while giving even less to those who didn't receive the newly printed money (they will go hungry). Its just chaotic redistribution without regard to how to efficiently distribute calories.

[archie]

One useful thing to try would be weather insurance (not, N.B. crop insurance, which flopped). Pricing and underwriting would also serve as useful labor for the desperate proletariat of laid-off financial engineers.

[Spectator]

Whats been given short shrift in this discussion is the lax attitude towards energy prices and inflation by our incompetent Fed. With oil prices exploding, the Fed continued to argue for years that inflation would be contained.

It's almost criminal negligence. It does not take a genius to realize that would eventually flow to all prices.

[Patricia Shannon]

http://www.eurekalert.org/pub_releases/2008-04/idso-ssc042508.php

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