The world's poor people face unprecedented challenges. The combination of a collapsing financial market, speculation in agricultural futures and ad hoc trade policies have all combined to raise the level and volatility of market prices for staple foods. Because the financial crisis has further lowered the real wages and purchasing power of the poor, they are less able to adapt to future international economic shocks. Scarcer capital and lower consumer spending have also led countries to cut short new agricultural production to address the food crisis. At the same time, purchases of food for emergency aid have grown and food is more difficult to procure.
Only concerted action at the global level can protect poor people from economic shocks and volatile food prices. Researchers at the International Food Policy Research Institute (IFPRI), in collaboration with Justin Lin, senior vice president and chief economist at the World Bank, propose three global collective actions to meet these goals: the creation of a small emergency physical food reserve; an international co-ordinated global food reserve; and a virtual reserve. These actions bring together developed and developing countries for a sustainable policy response to a global crisis.
Unfortunately, the food price crisis will continue for the foreseeable future. Although at time of writing, prices had eased from their 2007-2008 spike, IFPRI projections for the year 2020 show the trend will be towards more expensive food. If agricultural investment and productivity decline in a depressed economic climate, which is likely, by the year 2020, maize, wheat, and rice prices would be 27, 15, and 13% higher, respectively, than a scenario in which current investment and productivity levels are maintained. Consumers in poor countries would bear the brunt of changing staple food prices, as they rely on these foodsfor most of their daily calories and spend between 50 to 70% of their income on food.
Causes and consequences
While the overall trend of rising food costs causes hardship for poor consumers, extreme fluctuations make the problem much worse. Many factors triggered the recent food price spike, including rising demand for food and biofuels, drought, and high oil prices. However, speculation in grain markets has also been drastic, and grain futures trading may have intensified the volatility of food prices between 2007 and 2008. IFPRI research finds that speculative activity, in particular, could have affected the prices of wheat, rice, maize, and soybeans.
In the context of food markets, speculators are relatively risk-tolerant individuals who are rewarded for accepting price risks from more risk-averse hedgers. For example, a farmer who has a crop of wheat approaching harvest may sell now at a pre-determined price for future delivery, and thereby hedge against risk. This is in contrast to a speculator, who enters the futures market only to secure a short-term profit.
Between May 2007-2008, the total volume of globally traded grain futures rose substantially. The ratios of volume to open interest for both rice and wheat were increasing at 19% in 2008 and were shown to have an impact on their market prices. Soybean and maize market prices may also have risen due to the significant growth in volume of short positions for these two commodities.
During the crisis, developing countries also began urgently rebuilding their national food stores and re-examining the merits of self-sufficiency policies for food security. When governments buy up and store grains solely for domestic use, unintended consequences ripple both inside and outside the country. These include distorted grain prices for farmers and reduced market incentives for future investments by farmers. Additionally, reserves at the country level lead to a highly inefficient global production system, and countries facing high food prices and financing their own food programmes are finding it difficult to meet their food needs.
By blocking the free flow of food to where it was most needed, these market failures imposed enormous efficiency losses on the global food system and hit the poorest countries hardest.
The latest food crisis not only revealed extreme market failures, but also a critical lack of global institutional arrangements to deal with them. The IFPRI and World Bank three-pronged action proposal could help countries respond to immediate food emergencies and help prevent food price spikes in the future. Through an independent emergency physical food reserve, a "club" of major grain-producers and participants, including the Group of Eight Plus Five (G8+5) countries, would supply an emergency reserve of 300,000-500,000 metric tons of basic grains, or about 5% of current food aid. The global community would deposit the reserve across major developing-country regions and use it exclusively for emergency response and humanitarian assistance.
For a new international co-ordinated global food reserve, there would be an agreement under the auspices of the United Nations that each member country (from the "club") will hold a certain amount of public grain reserve in addition to the pipeline stock that the private sector holds for commercial operations. Although the exact amount of public reserve that each country holds is a subject for study, it will not be too large a percentage of its annual domestic grain demand. These reserves would be drawn upon by a high-level technical commission only when needed for intervention in the spot market. This co-ordinated response will stem domestic and possibly global price surges, thereby preventing a collapse in confidence in the international grain market that has led countries to unproductively construct their own public reserves.
Members of the club would also jointly commit to a virtual grain reserve and agree to intervene in the futures market when absolutely necessary. A global intelligence unit established by the club would forecast prices by assessing changing supply and demand conditions, define a broad range for market prices to fall within, and alert a club-appointed commission if prices are nearing a spike. The commission would then initiate progressive short sales of futures at market prices until a speculative attack is virtually eliminated.
This three-pronged approach will not only build the world's capacity to protect poor people, but also restore confidence in the global grain market and help prevent globally self-defeating responses in the name of national food security. Without price distortions from speculation and ad hoc trade policies, goods can flow in response to changes in market supply and demand, and more freely reach consumers who want, and need, them. This approach is a viable option that could protect the functioning of a market that is so central to the livelihoods of the world's 2 billion poorest people.
Robles, M., M. Torero, and J. von Braun, (2009), "When speculation matters", Issue Brief 57, Washington, DC: International Food Policy Research Institute, available at http://ifpri.org/pubs/ib/ib57.pdf
von Braun, J., (2008),, "Food and fi nancial crises:Implications for the poor", Food Policy Report 20,Washington, DC: International Food Policy Research Institute, available at http://ifpri.org/pubs/fpr/pr20.pdf
von Braun, J., J. Lin, M. Torero, (2009), "Eliminating drastic food price spikes - a three pronged approach for reserves", Note for discussion, Washington, DC: International Food Policy Research Institute, available at: http://ifpri.org/pubs/reservenote20090302.pdf
For more IFPRI research, visit: http://ifpri.org/pubs/reservenote20090302.pdf
©OECD Observer No 274, October 2009