The Surge in Food Prices: What’s Different This Time? ::Carnegie Endowment for International Peace

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By Shimelse Ali , Vera Eidelman

International Economic Bulletin, April 21, 2011 Though global food prices have now passed the record highs reached in 2008, important differences between the two surges have prevented today’s crisis from having as severe of an impact on the world’s most vulnerable populations.

Global food prices have surged since June and are now at record highs, surpassing the levels of the last great food crisis in 2007/08. Already, the dramatic rise has dragged millions of people into extreme poverty and stoked inflation in China and India. However, the effects of this round of food price hikes are not as severe as last time. Several of the factors behind today’s increase parallel those that drove the 2007/2008 food-price crisis—including export controls, biofuels production, high oil prices, and poor harvests. But the prices of cereals, particularly rice, have increased less than in 2008 and domestic prices in some of the world’s poorest countries have actually fallen amid better local harvests. The lower incidence of harmful policy responses, which amplified the crisis last time, likely helped as well. Although these factors have lowered the surge’s impact, prices are likely to remain elevated and volatile for the next few years. Policy makers must heed the lessons of the past if they are to prevent more hunger now. Parallels with the 2007-08 Crisis In January, the UN Food and Agriculture Organization (FAO) food price index surpassed its 2008 peak. By March, the prices of maize and wheat—which together account for more than half of world cereal food consumption—had increased by 85 percent and 60 percent, respectively, over the previous year. With the exception of a few crops, such as rice (discussed below), cereals are facing a tight market again, driven by many of the same factors that led to the food-price crisis three years ago. Yield (output/hectare) growth—which has stagnated in recent decades, falling from 2.4 percent per year over 1960–1990 to 1.6 percent since 1990—was further limited by weather-related events, including last summer’s drought in Russia. Meanwhile, demand growth has held strong at 2 percent per year, driven by continued population growth, rising incomes, and changing diets, especially in emerging economies.1 As a result, cereal stocks have fallen by one-third since 2000 and the FAO expects an additional 9 percent contraction this year, though rice stocks are expected to grow by 4.4 percent. Biofuels production—which played a role in the last food-price crisis and is supported by subsidies and import tariffs in several advanced countries—has also added to the demand-side pressures, diverting staples like maize, sugarcane, and cassava away from food and feed. The U.S. Department of Agriculture expects 40 percent of the U.S. maize supply to go to biofuels this year—up almost four-fold from six years ago. Combined with agriculture’s rising energy intensity, biofuels production has also increased the correlation between food and oil prices over the last decade.2 As in 2007/2008, this relationship has far-reaching implications for global nutritional and poverty levels, particularly as oil prices rise, reflecting lost production in Libya and uncertainty related to the Middle East turmoil. In addition, dollar depreciation (8.3 percent since June)3 helps account for part of the increase in the dollar price of commodities, much as it did during the last food-price crisis. Meanwhile, adverse policy responses, such as export restrictions and import tariffs, have exacerbated the situation in the wheat market. Wheat prices have surged by more than 80 percent since last June due to export restrictions in Russia and rising imports in the Middle East as countries aim to boost reserves. These policies may appear individually appropriate but, collectively, they disrupt world markets, raise prices, and add to price volatility. What is Different This Time? Despite the parallels, today’s price rise differs in important ways from the 2007/2008 crisis. Most importantly for global hunger, the rise has been led by sugar and oils, and good harvests have kept the international price of rice—a major staple for more than 60 percent of the population in developing countries—relatively stable. Moreover, the domestic prices of staple foods in many developing economies have fallen, in contrast to the increases seen in 2007/2008. As a result, the poverty impact of this crisis has been more limited. Sugar is up by 66 percent from last June and 80 percent above 2008 highs amid supply disruptions in major exporting countries such as Brazil. On the other hand, cereals are 8 percent below their 2008 peak. This contrasts sharply with 2007/2008, when cereals led the rise, sparking riots across the developing world. Furthermore, prices are at record levels because they started from a higher base—not because they surged by more than (or even as much as) in 2007/2008. Since last June, the FAO global food price index has increased by 37 percent, compared to about 70 percent in 2007/2008. Rice in particular has seen a lower increase. International Food Price Increases, 2007/08 and Now   Current June 2010-March 2011 2007/2008 January 2007-2008 peak Food Price Index 37% 67% Rice 31% 215% Soybeans 42% 113% Wheat 82% 131% Maize 90% 73% Source: FAO Domestic staple food prices have suffered less this time. While some major developing countries, notably China and India, are experiencing high food-price inflation, fourteen of the 20 developing countries4 with the largest populations living in poverty actually saw average domestic staple food prices fall in 2010 (y/y). The drops were particularly large in many African countries, which saw maize prices fall by 13 to 52 percent. As a result, today’s crisis has had a more limited impact than the one in 2007/2008. Together, the less dramatic international price shock and lower domestic prices in developing countries have forced fewer people into extreme poverty so far—44 million people from June to January,5 compared to 105 million people during the previous crisis. Explaining the Differences What explains these differences? Robust rice harvests in Asia and strong maize harvests in Africa account for much of the limited international rise and lower domestic prices. Last year, cereal production increased by about 12 percent (y/y) in 40 food-deficit, African countries, up from a 0.7 percent increase in 2009. Favorable weather conditions were partly responsible for these favorable harvests. Fewer harmful policy responses may have limited the rise of prices as well. According to the World Bank, adverse policy responses accounted for about half of the increase in the price of rice in 2008. But, while more than 20 countries imposed export restrictions that year, only a few countries, including Russia and Ukraine, have done so this time. Meanwhile, the limited transmission of high global prices to key domestic staple food markets in developing economies may have helped lessen the impact of the crisis. The degree of price transmission varies across countries and depends on domestic trade policies, such as import tariffs and price subsidies, the volume of internationally traded commodities in food consumption, and exchange rate movements (i.e., appreciation of the local currency). In Africa, for example, countries depend more on international trade for rice than for maize. As a result, the limited rise in the import price of rice—combined with lower local prices for maize amid good harvests—may have helped temper the poverty effect. Meanwhile, countries with sharp increases in domestic prices, such as Pakistan, saw significant increases in poverty. Looking Ahead Good harvests in many developing countries could also lower import requirements this time, putting less strain on the trade balance. But some poor countries—especially those where fiscal space is limited and dependence on food imports is high—will still face macro vulnerabilities, such as increases in trade deficits. The FAO expects the total cereal import bill of low-income, food-deficit countries6 to increase by 20 percent this year due to the high international price of imports. And, while net food exporters could benefit from improved terms of trade, supply-side constraints—including the fixed supply of land, poor infrastructure, and the limited availability of inputs—will limit their response to the higher prices in the short run. In the medium term, cyclical factors will continue to pressure food prices to rise. Oil prices are expected to stay elevated—driven by unrest in the Middle East—and demand will likely grow as the global recovery continues. Moreover, these cyclical forces will occur against a backdrop of unfavorable structural factors—from low yield growth to population growth and a rising incidence of extreme weather events. If the global price increase is sustained, it may spread to domestic prices, with significant poverty impacts. Furthermore, domestic prices remain highly vulnerable to weather-related shocks. Already, maize prices in Uganda and Kenya, which fell sharply in 2010, have increased by 43 percent and 30 percent, respectively, over the past three months, partly due to poor weather conditions. This makes the need for policy action clear. Policy Today’s food price increases reinforce several aspects of what is by now common wisdom among food policy analysts. First, given the role good local harvests played in limiting the surge’s impact, global food security depends on well-functioning global markets. Policy makers must ensure markets are not disrupted or distorted by trade restrictions. The G20 can play an important role by establishing a better framework for monitoring and increasing accountability in the global food system. Providing information on stock levels, for example, could prevent panic buying. The G20 could also develop parameters that define extreme circumstances under which export restrictions for humanitarian purposes are justified. Moreover, the current episode shows the need to protect the poor against volatility in the prices of their most important budget items—food and fuel—which are increasingly moving in tandem. This highlights the need for policy makers in developing countries to provide conditional, targeted safety nets, such as cash and in-kind transfers, to their most vulnerable citizens. Provision of micro-credit can also help. In designing these interventions, policy makers in different countries should look to one another for best practices. Longer-term policy measures are also crucial. Increased investment in agriculture, more research and development around increasing yields, diminished incentives for biofuels production in the United States and Europe, and limits on export restrictions, as well as agricultural trade reforms (as envisaged in the Doha Agenda), will make markets work better. All of these steps are needed to moderate increases in global prices, limit the transmission to domestic prices, and mitigate the impact on the most vulnerable. They will help prevent food crises in the future. Shimelse Ali is an economist in Carnegie’s International Economics Program. Vera Eidelman is the managing editor of the International Economic Bulletin. 1. GDP per-capita in developing countries grew by more than 20 percent over 2005–2009, pushing consumers in countries like China to increase their meat intake. This increase in meat consumption requires more cereals per calorie than does direct cereal consumption, by as much as 250 percent from 1990 to 2007. 2. A simple regression shows that the correlation has increased from a coefficient of 0.5 over 2000–2005 to 1.2 over 2006–2011. The R2 on the regression—which estimates how much of the variation in food prices is explained by oil prices—from 2000–2011 is 86 percent. 3. This refers to the depreciation in the U.S. Dollar Index, which measures the performance of the U.S. dollar against a basket of currencies. 4. Countries were ranked according to the size of their population living under the $1.25 a day poverty line. The list includes India, China, Nigeria, Bangladesh, Pakistan, Ethiopia, Vietnam, the Philippines, Mozambique, Nepal, Uganda, Brazil, Madagascar, Malawi, Niger, Burkina Faso, Zambia, Kenya, Colombia, and Guinea. 5. This number reflects 68 million people who fell below the $1.25 poverty line and 24 million net food producers who rose above it. 6. The Low-income Food-Deficit Countries (LIFDC) are net food-deficit countries where annual per-capita incomes are below the level the World Bank uses to determine eligibility for international development association (IDA) assistance (i.e., $1,855 in 2008).