Before the frenetic pace of the G20 summit in Los Cabos, and before the latest breathless announcement of a breakthrough to resolve the crisis in Europe, CIGI co-sponsored a panel discussion at the Conférence de Montréal with the Asian Development Bank on food security. This issue was of considerable importance prior to the global financial crisis, which both explains why it was put on the G20 agenda and why it has been relegated to one of those issues that requires some pro forma acknowledgement in official declarations. The panel was a genuine learning opportunity for me (albeit, given my lack of expertise in this area, this was not a particularly high bar).
The discussion by the panel was very good. Of most interest to me was the observation that there are enormous productivity differences in agriculture, with the resulting "yield gaps" between field trials and actual production levels in some countries running as high as 50-60 percent. Reduce that gap, and global agricultural production will jump.
This is easier said than done.
The problem is that to close these gaps requires a range of investments — in physical capital (irrigation systems); in human capital (training and education); and in research and development (to develop drought resistant and alkaline resistant strains). Unfortunately, the countries in which there are greatest opportunities for increasing yields are also some of the poorest. Making investments for the future requires saving more, or alternatively consuming less. But if you are already at the subsistence level, that is not a particularly attractive proposition. Moreover, given the high share of food in consumption baskets (on the order of 60 percent in developing countries compared to, say, 10 percent in advanced economies), higher prices, which should elicit more investment, may actually result in fewer resources available for investment. And, given the current state of the global economy and public finances in most advanced countries around the world, resources to fund these investments are in short supply. At the same time, the prevailing uncertainty with respect to the global outlook, demand and prices creates an option value of waiting with respect to investment — people are reluctant to commit to investment if they are uncertain how that investment is likely to payoff.
As a result, while there is some reason for optimism with respect to food accessibility, there are also serious obstacles requiring international action to overcome.
A key challenge is to understand the factors behind price changes, particularly the price spike prior to the global crisis. To some extent, this is a theological question: people either "believe" that speculation caused the price increases observed before the crisis, or believe with equal fervour that efficient markets rule out the possibility of de-stabilizing speculation.
Given the quasi-religious overtones of the debate, some historical perspective is useful. In this regard, real (adjusted for inflation) commodity prices are about where they were in the early 1980s and below where they were in the 1970s. In addition, there are periods of low volatility, such as 1955-1970, and, equally, periods of high volatility, for example, between 1955 and 1985. Viewed in this light, current experience somehow seems less unique. Prior to 2007-2008, meanwhile, empirical work strongly supported the theology of efficient markets. Subsequent developments have shown that this faith may be questioned, however.
It is true that a series of factors undoubtedly influence food and commodity prices more generally in the run up to the global crisis. These include:
- Demographics and growth, as rising middle-classes in rapidly-growing economies with consumption preferences for more protein put upward pressure on foodstuffs;
- The bio-fuels fad, particularly the increase in ethanol production, which accounted for three-quarters of the increase in global corn consumption in 2006-2007 with spillover effects on other foodstuffs;
- Supply-side effects, as production lagged growing demand and inventory levels declined to their lowest levels since the 1970s; and
- Trade practices, particularly the "beggar-thy-neighbour" export restrictions that went up as food prices began to increase exacerbating weather effects and spreading the impact of shortages of some grains to other commodities as individuals attempted to substitute away from the foodstuff in short supply.
All of these factors came together resulting in a "perfect storm" of higher prices. And, yet, financial factors can't be fully discounted. Most significantly, some of the increase in food prices since 2001 can be attributed to the depreciation of the U.S. dollar (price increases are much less dramatic when expressed in an alternate unit, the SDR for example). Moreover, the low-interest rate environment that followed the dot.com collapse likely also had an effect, as the opportunity costs of hoarding of non-interest bearing assets was reduced.
Price bubbles are a theoretical possibility, as speculation drives futures prices higher and, through arbitrage, spot prices move above levels justified by fundamentals. But, by providing necessary liquidity, increased investor activity could simply be the means by which changing views about fundamentals are translated into changing prices. And, interestingly, causality tests suggest causality goes from spot prices and futures prices to speculative activity; not vice versa.
In this respect, careful empirical work done at the IMF shows that between 1995-2009 U.S. Inflation volatility increased from 0.5 percent to 2.3 percent , while U.S. dollar volatility rose from 3.5 percent in the 1990s to 10 percent in 2009. Food prices seem to be sensitive to U.S. inflation and dollar volatility as foodstuffs are used as a hedge against U.S. inflation and dollar depreciation. This was also the case in the 1970s.
It is tempting to conclude, therefore, that the high, volatile food prices that have raised concerns of food security and accessibility are one more manifestation of the New Age of Uncertainty.