Free Markets and Food Markets: The Good

In theory, a free market trade of goods, particularly foodstuffs, could ensure that goods get where the demand is greatest, ensuring a relatively stable supply with the fluid movement of food around the world, preventing spikes in prices.

This is the argument that is put forward by Tyler Cowen, a libertarian and economics professor at George Mason University, in a column in Sunday’s New York Times. All emphases are added.

Poor rice yields are not the major problem. The United Nations Food and Agriculture Organization estimates that global rice production increased by 1 percent last year and says that it is expected to increase 1.8 percent this year. That’s not impressive, but it shouldn’t cause starvation. The more telling figure is that over the next year, international trade in rice is expected to decline more than 3 percent, when it should be expanding. The decline is attributable mainly to recent restrictions on rice exports in rice-producing countries like India, Indonesia, Vietnam, China, Cambodia and Egypt.

I’m sure poor rice yields are a problem locally. For example, the rice crop in Australia, down 98% from what it was 6 years ago, has led Australian rice distributors to buy up rice in the Oceania region to make sure they will have rice to sell to the domestic market. Furthermore, those numbers only say how much rice is produced, not what the demand for rice is. Thus, they only look at half of the supply-and-demand balance.

At first glance, this seems understandable, because a country may not wish to send valuable foodstuffs abroad in a time of need. Nonetheless, the longer-run incentives are counterproductive.

Export restrictions send a message to farmers that their crops are least profitable precisely when they are most needed. There is little incentive to plant, harvest or store enough rice — or any other crop, for that matter — as a hedge against bad times. This tendency to skew supply and demand is also apparent in the Philippines, where the government is tracking down and arresting rice hoarders, who, of course, are simply storing rice for the possibility of even harder times to come.

Now, I am not an economist, but this presumes a primarily export/international markets-driven view of trade at the farm level. I don’t have any figures handy, but a lot of farmers worldwide, perhaps the majority, are subsistence farmers. That is, they live on what the farm produces, selling whatever surplus they have on the local markets. These farmers largely don’t participate in the export trade, because they don’t operate on the scale that farming for export needs. For larger, cash crop farms, export restrictions doubtless do have some effect.

However, this would seem to depend on the price on the domestic market compared to the international market. In a number of countries, the government is buying grains at market price and then subsidizing their sale at below-market price, ensuring that people will be able to buy them. In this case, it’s the government that’s taking the financial hit. Of course, if the government mandates the the purchase of the grains from the farmer at a below-market price, then the financial penalty is imposed on the farmer.

But this misses one thing: the current price of rice as reflected in the amount paid to the farmer, whether market-price or artificially low, as compared to past prices. Again, I don’t have the numbers, though I’m sure some commodities market and news digging can find them. But let’s think it through. If the price of rice on the retail market has doubled in a year, then the farmer is getting more for the rice than a year ago. The farmer sells his rice on the market directly, he gets all of that 100% price increase. If through a distributor or wholesaler, its less, perhaps 50%. Still a 50% increase from his income last year. If the government is mandating the sale of rice at below-market rates, say at 50% more, instead of at the current market price of 100% more, the farmer can still be making more on the rice than a year ago, and still has incentive to plant more rice, if he can. The catch comes if the price of production has also risen, which I don’t have the numbers for. Demand is not going to shrink too much; rice is a staple grain for billions.

In commodity markets, it’s not uncommon for high demand to cause sharp increases in prices; on short notice, it’s often hard to match the new demand with more supply. The question is whether supply, and trade, can grow to offset market tightness.

This is a major point. The demand for rice and other staple foodstuffs is pretty inelastic, and is growing. You can stop buying TV’s, or even cars. You can’t stop eating, though you can eat less. Moreover, the places in which you can grow rice are finite. You need fertile land, and steady access to water. It’s possible to convert other farmland to rice, though it takes time and money. This is unlikely to happen on a grand scale since prices for everything are up, lessening the financial incentive to switch to rice. It’s also possible to convert fallow ground to rice, though again, it takes time and money. And marginal farmland is harder to cultivate and produces lower yields. Furthermore, most of the best farmland is already in use, and in a lot of places where rice is a staple grain, there really isn’t any more good farmland.

Restrictions on the rice trade run the risk of making shortages and high prices permanent. Export restrictions treat rice trade and production as a zero- or negative-sum game where one country’s gain comes at the expense of another. That’s hardly the best way to move forward in a rapidly growing world economy.

This lack of support for trade reflects a broader and disturbing trend. An increasing percentage of the world’s production, including that for agriculture, comes from poor countries. Over all, that’s good for rich countries, which can focus on creating other goods and services, and for the poor countries, which are producing more wealth. But it can slow the speed of adjustment to changing global conditions. For example, if demand for rice rises, Vietnamese farmers — who remain shackled by many longstanding regulations of communism — aren’t always able to respond quickly. They don’t even have complete freedom to ship and trade rice within their own country. Poorer countries also tend to be the most protectionist. To make matters worse, about half of the global rice trade is run by politicized state trading boards.

The problem of a lack of surplus rice is exacerbated by little trade. If there was a lot of extra rice worldwide, then a few countries prohibiting exports wouldn’t make too much of a difference. But what happens if a country’s rice crops fail, due to flood, drought, disease, or devastation like a typhoon? There isn’t much extra rice, so there isn’t much extra rice to buy on the world market, so commodity prices spike higher. In this case, its clear that more international trade could mitigate a potential disaster.

Conversely, prohibiting exports or setting price caps, as is happening now, can stave off disaster the country of production by ensuring that the food needs of the domestic market are met. Many governments are also replenishing their rice reserves with the rice that would have gone on the export market. Rice reserves, like reserves of other grains, are at a record low, so replenishing them gives governments a crucial tool to mitigate price swings domestically. This can prevent price uncertainty, as the government can release extra rice on the market if prices get too high. If the price will remain within a reasonable range, there is less incentive for hoarders and speculators to buying up rice, either fearing that it will be unaffordable later or hoping to resell the rice later at a higher price.

But for those countries that aren’t food self-sufficient, like Mauritania, this drop in gain supplies is disastrous. Less than 2% of Mauritania’s land is arable, so the country relies almost wholly on imports for grain. With less supply and growing demand, Mauritania’s suppliers must struggle to secure grain against governments and companies that can outbid for the limited supply of rice on the global market.

The reality is that many of today’s commodity shortages, including that for oil, occur because ever more production and trade take place in relatively inefficient and inflexible countries. We’re accustomed to the response times of Silicon Valley, but when it comes to commodities production, many of the relevant institutions abroad have only one foot in the modern age. In other words, the world’s commodities table is very far from flat.

Again, food is unlike every other commodity in that its essential to life. Maybe a freer trade in rice would increase supplies and drive down prices and ensure access to rice for everybody, but you need some serious faith in the free market to believe it. I personally lack that faith.

The price of a commodity on the free market is the collective price that buyers are willing to pay and that producers are willing to sell at, given current supply and demand. It is NOT necessarily the price at which everyone can afford to buy. There are a lot of debates about the relationship of ethanol and other biofuels to the growing food crisis that touch on this issue. The gist of it is, if a rich country is willing to pay more for a grain to turn it into ethanol than a poor country can afford to pay for it to eat, the rich country will be able to buy the grain for non-food purposes. This also plays out in what types of crops are planted, and the debates about using corn to feed animals instead of people.

The rest of Cowen’s column deals with other restrictions to growing rice for the global trade:

Many poor countries, including some in Africa, could be growing much more rice than they do now. The major culprits include corruption in the rice supply chain, poorly conceived irrigation systems, terrible or even nonexistent roads, insecure property rights, ill-considered land reforms, and price controls on rice. The ability of a country to grow rice depends not just on its weather, but also on its institutions. Burma, now Myanmar, was once the world’s leading rice exporter, but it is now an economic basket case and many of its people go hungry

Of course, wealthy countries are partly at fault, too. Japan, South Korea and Taiwan all protect their native rice farmers; you’ll even see rice being grown in Spain and Italy, aided by European Union subsidies and protectionism. The United States spends billions subsidizing domestic rice farmers. In the short run, these domestic rice producers mean less demand pressure on the world market, which might seem like a good thing. But, again, the longer-term effects are pernicious.

Low-cost rice production in countries like Thailand isn’t geared to meeting higher foreign demand, as it would be in a freer market. When more rice is needed, capacity is limited and the grains are slow in coming. And the protected rice from wealthy countries is simply too expensive to alleviate hunger in very poor countries.

Overall, Tyler Cowen’s column raises some interesting points, even though I think his analysis is lacking some important considerations. This is a really thorny issue, particularly the balancing of the needs of particular countries with the rise in global demand. The tension between lowering the high price of rice worldwide via freer trade and ensuring that the very poor have access to rice really highlights the strenghts and limitations of a free market approach.

More details about his opinions, as well as a spirited series of counter-points, can be found on his posts about this issue on his blog Marginal Revolution.

One response to “Free Markets and Food Markets: The Good

  1. Pingback: Weekly Sausage Links « What Would Jesus Eat?

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