Reducing trade distortions could ease food price volatility

Kym Anderson 13 November 2009

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Every decade or two, food becomes newsworthy globally. Mostly it is because of a price spike, either downwards (hurting farmers in open economies, as in 1986) or upwards (hurting food consumers, as in 1973 and 2008).

Most such price spikes are a consequence of major policy shifts, since demand does not change rapidly and local weather-induced supply shocks tend to offset each other in a many-country trading world. In 1986, for example, it was the food export subsidy war between Western Europe and the US that drove real international food prices to their lowest level since 1930.

The price hike of 2008 was also partly a consequence of policy changes in the US and EU, namely their decision to subsidise biofuels and set mandates/targets for their use domestically in response to rising fossil fuel prices. It led other governments to impose food export restrictions to insulate somewhat their consumers from the price rise, which pushed international food prices even higher and, domino-like, drove more exporting countries to follow suit. Some food-importing countries also lowered temporarily their import tariffs, to reduce the rise in their domestic food prices.

Certainly, world food prices are lower now than at their peak in mid-2008. However, since 2003 food prices in international markets had been rising steadily before trebling by mid-2008 and then falling by one-third, in parallel with energy prices (Figure 1). The coefficient of correlation between the two series since 2003 is 0.90.

Figure 1. Monthly international price indexes for food and energy raw materials, January 2000 to March 2009 (Jan 2001 = 100)

Source: World Bank, data accessed 30 October 2009

That parallel movement of food and energy prices is new; it is not at all obvious in the previous half-century (Figure 2). For those annual data, the coefficient of correlation between 1960 and 1999 is -0.18, compared with 0.84 for 2000-07.

Figure 2. Annual international price indexes for food and energy raw materials, 1960 to 2007 (2000 = 100)

Source: World Bank, data accessed 30 October 2009

So yet again, trade-related policies are contributing to agricultural market volatility. That is undesirable because volatility around the long-run-trend terms of trade slows national economic growth (Williamson 2008). Moreover, trade policy measures are very blunt instruments for dealing with volatility, especially in the modern era of myriad financial instruments for risk management by food buyers and sellers. Moreover, their beggar-thy-neighbour feature diminishes the international public good contribution of trade openness.
Less newsworthy to the mass media, but probably far more important in their effect on long-run economic growth and the international distribution of global welfare, are gradual policy developments in individual countries and their combined effect on other countries via the trend terms of trade in international markets.

New research on food trade policy

In a new book launched at the World Bank this month (Anderson 2009), I summarise a major empirical study of one such set of trade-related policy developments over the past half-century (indicators of which have been made freely available by Anderson and Valenzuela 2009). The study confirms the earlier findings of Krueger, Schiff and Valdés (1988), namely that governments of many developing countries harmed their farmers directly by taxing their exports and indirectly by encouraging manufactures and overvaluing their currencies. This meant that price incentives facing farmers in many developing countries were depressed by both own-country policies and the protective policies of high-income countries.

As for the most recent quarter-century, the new World Bank study provides both good and worrying news. The good news is that many developing countries have reduced hugely their anti-agricultural export policies, and even some high-income countries have lowered their trade-distorting assistance to their farmers – albeit replacing part of it with more-direct assistance to farmers that are only somewhat decoupled from production.

The bad news

There are three pieces of not-so-good news though.

  • One is that developing countries are increasingly providing protection to the import-competing sub-sector of their agricultural sector, and that since the 1960s the rate of growth of that protection has been almost the same as in high-income countries.

This suggests the switch from taxing to subsidising agriculture relative to other tradable sectors in the course of economic development that was clearly observed in the newly industrialised countries of East Asia (Anderson and Hayami 1986) appears to be spreading to other developing countries – and earlier and more so, the weaker those countries’ comparative advantage in farm products.

  • The second piece of not-so-good news is that, in both developing and high-income countries, the dispersion of assistance rates across industries within the farm sector has not diminished over time even though the sectoral average rate of distortion has been falling.

Even more worrying, it retains an anti-trade bias, if somewhat less so than in the past. This means there is still a great deal of waste within each farm sector, as countries support some of their least-competitive farm industries. Such support also diminishes the dynamic gains from trade stimulated by openness to the cool winds of competition, thereby contributing to the relatively slow productivity growth of the sector.

  • The third piece of worrying news – which relates directly to the recent food price crisis – is that both developing and high-income countries are continuing to insulate their domestic markets from the year-to-year fluctuations in international markets for farm products.

For major farm products, on average barely half the change in the international price is transmitted to the domestic market within the first year. This has the effect of “thinning” those international markets, so that they are less capable of providing the global public good of market smoothing. It is reflected in the relatively slow growth over the latest globalisation era of the share of farm production that is traded across borders. As of 2004, agriculture’s share of global production exported (excluding intra-EU trade) was just 8%, compared with 31% for non-farm primary products and 25% for all other merchandise.

Despite the reforms of the past quarter-century and the fact that the objectives espoused by governments for their interventions suggest domestic policy measures would be far more efficient than border measures, the latter continue to dominate. Even when decoupled payments are included in total support payments, trade policy instruments account for no less than three-fifths of agricultural assistance worldwide. That means they account for an even larger share of their global welfare cost, because trade measures also tax consumers, and welfare costs are proportional to the square of a trade tax.

The case for continued agriculture liberalisation

My study concludes with an economy-wide modelling assessment of global agricultural and other trade distortions in two parts. The retrospective part reveals that the reforms since the early 1980s have brought the world just over halfway towards free trade, whether measured in terms of its effects on economic welfare or on trade volumes.1 The prospective part of that modelling examines what would happen if policies as of 2004 were to be removed. The numbers are striking – 70% of the global welfare cost of remaining distortions to goods markets is due to farm policies (49% due to high-income country policies, 21% to developing country policies) – even though agriculture constitutes only 3% of global GDP and 6% of global trade and policy distortions have been halved over the previous 25 years.

Clearly there is a strong economic case for completing the trade reform process. Yet it is agriculture that has been holding up the Doha round of multilateral trade negotiations. And it is not only high-income countries that are resisting committing to further reform, as many developing countries also want to retain their capacity to raise trade restrictions when prices spike. More than that, developing countries are seeking a Special Safeguard Mechanism that would allow them to set tariffs even higher than their ceiling bindings should food prices collapse or imports surge. This would only add to the volatility of international markets for agricultural products, as each country’s actions spill over to other countries and related products.

We need further restraints on WTO members’ unilateral actions. Yet a recent proposal that the WTO negotiate disciplines on export restrictions was met with howls of protests from many developing country members. Evidently global solutions to this global challenge are not going to be easily found.

Footnotes

1 This general equilibrium modeling result is consistent with the partial equilibrium findings, using a variant of the trade restrictiveness index, presented in Lloyd, Croser and Anderson (2009).

References

Anderson, K. (ed.) (2009), Distortions to Agricultural Incentives: A Global Perspective, 1955-2007, London: Palgrave Macmillan and Washington DC: World Bank.

Anderson, K., Y. Hayami (1986), The Political Economy of Agricultural Protection: East Asia in International Perspective, London: Allen and Unwin.

Anderson, K. and E. Valenzuela (2009), Global Estimates of Distortions to Agricultural Incentives, 1955 to 2007, core database

Krueger, A.O., M. Schiff and A. Valdés (1988), ‘Agricultural Incentives in Developing Countries: Measuring the Effect of Sectoral and Economy-wide Policies’, World Bank Economic Review 2(3): 255-72, September.

Lloyd, P.J., J. Croser and K. Anderson (2009), ‘Global Distortions to Agricultural Markets: New Indicators of Trade and Welfare Impacts, 1960 to 2007’, CEPR Discussion Paper 7160, London, February.

Williamson, J. (2008), ‘Globalisation and the Great Divergence: Terms of Trade Booms and Volatility in the Poor Periphery, 1782 to 1913European Review of Economic History 12(3): 355-91, December.

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Topics:  International trade

Tags:  trade policy, food prices, agriculture liberalisation

George Gollin Professor of Economics and Foundation Executive Director of the Centre for International Economic Studies (CIES) at the University of Adelaide and CEPR Research Fellow

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