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Food Price Policy in an Era of Market InstabilityA Political Economy Analysis$

Per Pinstrup-Andersen

Print publication date: 2014

Print ISBN-13: 9780198718574

Published to Oxford Scholarship Online: January 2015

DOI: 10.1093/acprof:oso/9780198718574.001.0001

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The Political Economy of Food Price Policy

The Political Economy of Food Price Policy

Key Policy-related Lessons

Chapter:
(p.479) 22 The Political Economy of Food Price Policy
Source:
Food Price Policy in an Era of Market Instability
Author(s):

Per Pinstrup-Andersen

Publisher:
Oxford University Press
DOI:10.1093/acprof:oso/9780198718574.003.0022

Abstract and Keywords

This chapter aims to highlight lessons to assist governments in designing and implementing policies to deal with future increases in food price volatility. There is no unique definition of what is better or worse policy in a political economy framework. What is good for one stakeholder group may be bad for another. In theory, policies could be guided by the goal of maximizing a social welfare function in which each of the stakeholder groups is assigned a relative weight. While such a goal may be implicit in some policy-making, the assignment of relative weights tends to be subjective, and could be an obscure and non-transparent process. Although improved food security was the stated overall goal of several of the study-country governments, the choice of policy interventions points towards the protection of government legitimacy as the ultimate goal.

Keywords:   food price volatility, policy intervention, political economy framework, food security

22.1 Introduction

This brief concluding chapter addresses the most important general policy-related lessons learned from the research reported in the previous chapters. Many more lessons are reported in the syntheses shown in Chapters 2 to 5.1 Recommendations for specific policy interventions that national policy makers may wish to follow are context specific and should be made within the relevant country context. They are found in Chapters 6 to 21.2 Eight policy recommendations expected to be relevant for many countries are presented in this chapter.

The aim of this chapter is to highlight lessons that may assist governments in designing and implementing policies to deal with future increases in food price volatility. Contrary to a world in which policies are made exclusively on economic efficiency grounds, there is no unique definition of what is a better or worse policy in a political economy framework. What is good for one stakeholder group may be bad for another. In theory, policies could be guided by the goal of maximizing a social welfare function in which each of the stakeholder groups is assigned a relative weight. While such a goal may, in fact, be implicit in some policy-making, the assignment of relative weights—if (p.480) attempted—tends to be subjective depending on who does the assignment and would be an obscure and non-transparent process. Furthermore, since as demonstrated in the country studies, most governments do not operate as unitary decision-making units, attempts to assign relative weight by different government agencies are likely to result in very different outcomes. Although as mentioned by Watson in Chapter 5, improved food security was the stated overall goal of several of the study-country governments, the choice of policy interventions points towards the protection of government legitimacy as the ultimate goal.

As mentioned in Chapter 1, rapid increases in the world market prices for rice, wheat, and maize beginning in 2007 and followed by large price fluctuations, attracted much attention in both high- and low-income countries. The news media and some international organizations and non-government organizations (NGOs) were particularly vocal. Doomsday-Sayers had a field day because they finally got support for their view that the world was rapidly moving towards a situation of not being able to feed itself. They were often supported by exaggerated reports and speculation by the news media. Some NGOs and national and international organizations called for more attention and—sometimes self-serving—financial support for agricultural development and other food-security-related activities. The Food and Agricultural Organization (FAO) reported that the food price increases in 2007–8 caused a large increase in the number of undernourished people, a claim it subsequently revised. The spill-over from the world market food price fluctuations to developing countries through the news media and other information sources made policy makers nervous and feel they should take action even if the ‘crisis’ was not visible in their domestic markets.

In fact the impact of the world market price increases and volatility was much less than expected in most developing countries, including the study-countries, because a relatively small fraction of the world market price change was transmitted to these countries (Chapter 2). While the price transmission varied among study-countries and food commodities, on average about one-third of the world market food price changes were transmitted to developing countries and the transmission may take place over an extended period of time.

The low price transmission from the world market and the much larger impact of national factors, such as extreme weather events, poorly functional domestic markets, and limited international food trade, on domestic prices in most developing countries, meant that the behaviour of food prices in the domestic markets of many developing countries during the period of the so-called ‘food crisis’ was not very different from the behaviour in prior periods with price volatility. Developing countries experience high food price volatility with great frequency. What was different in 2007–12 was that the (p.481) price volatility occurred in the world market and therefore got much more international attention.

However, irrespective of whether price volatility in domestic markets is a result of food price volatility in the world market or caused by national and local factors, governments are faced with demands for policy interventions. Of course, the choice of specific interventions and their impact will depend on what brought the volatility about. There are no signs that the food crisis led to enduring shifts in food policy or significant policy reforms. In fact, most of the policy interventions were aimed at bandage solutions such as short-term price subsidies for food and fertilizers. This is understandable because it was a crisis response and most of the interventions were similar to those used in previous food price fluctuations. Lip service was paid to structural changes with expected long-term impact, such as structural changes in the agricultural sector, but as soon as the food prices came back down, few of the countries implemented them. There is reason to believe that the countries are in no better position to deal with future food price fluctuations than they were in 2007. Some of the countries considered policy interventions aimed at a higher degree of food self-sufficiency and reduced dependence on the world market but these interventions were primarily focused on higher prices to farmers, which were short-lived because of high fiscal costs and the accumulation of food surpluses in the hands of governments. However, price subsidies to farmers did result in production expansions in some countries.

It is important to differentiate between food price increase and food price volatility. An increasing food price trend is likely to require different policy interventions than fluctuations around the mean. As mentioned in Chapter 1, much of the literature concerning food price increases and increasing volatility since 2007 fail to make such a distinction and it is unclear whether policy recommendations and design were aimed at reducing food price increases, volatility, or both. What seems clear from the country studies reported in this volume is that, except for countries with politically powerful agricultural sectors such as Brazil, governments were much more likely to take action on the up-side of a food price spike than on the downside, reflecting a consumer-bias. However, some countries, including India and Zambia, introduced agricultural price support aimed at the dual purpose of increasing farmer incomes and expanding food supplies on the downside. Several other countries introduced fertilizer subsidies, presumably for the same reasons although some of those subsidies were initiated prior to the food crisis. However, both price and fertilizer subsidies quickly became an unacceptable fiscal burden. The rest of this chapter focuses on policies to deal with volatility although some of the interventions are likely to also serve to deal with longer term price trends. The extent to which these policies can be implemented in a particular country context will depend on the (p.482) existing political economy, including the goals and relative power of the various stakeholder groups participating in the policy formation.

The choice of intervention will depend on political economy factors, e.g., perceived gains and losses by various stakeholder groups and the relative power of each of them. In its most simplistic version, we can conclude that policies to keep food prices from increasing would hurt farmers and benefit consumers while the impact of policies to reduce price volatility is tenuous. Attempts to keep food prices from increasing without reducing price volatility would send two signals to farmers not to increase production: lower prices and higher risks. This, in turn, would reduce supplies and increase prices to the consumer, thus countering the efforts to keep food prices low. At the same time, failure to reduce volatility would increase risks of transitory food insecurity and malnutrition among low-income consumers although the impact on chronic food insecurity is less clear. Thus, a single-minded policy focus on the price level while ignoring the negative effects of price volatility may not have a positive food security outcome unless it is accompanied by effective risk management tools for farmers and consumers.

A more complete political economy analysis needed to guide national policies would include several other stakeholder groups such as traders, millers, and other food processing agents and different groups of farmers and consumers, each of which would be affected by both price increases and volatility.

One of the overriding issues facing governments in a situation of either increasing food prices or increasing price volatility is whether to intervene in the prices or leave price formation to the market and redistribute gains and losses through taxes, subsidies, and transfers. Interfering with price signals may have perverse results, e.g., attempts to keep prices low are likely to reduce supply and increase demand thus putting more upward pressures on prices. Transfers to low-income population groups with high-income elasticity for food may expand demand which also adds to the upward pressures on food prices.

Leaving prices resulting from market fundamentals (changes in demand and supply) alone and compensating losers from price fluctuations instead of intervening in price formation is usually preferable because it permits the correct signals to be sent to producers and consumers to change production and consumption. However, price stabilization may be justified to deal with price spikes of a duration shorter than a growing season because farmers will not be able to adjust production. A much better information base will be needed to predict the length of a price increase with acceptable accuracy.

Notwithstanding the above suggestion that the choice of specific policies should be made within a context-specific framework, some recommendations, including those shown below, are likely to be relevant for most countries.

(p.483) 22.2 Strengthen the Policy-related Evidence Base

Although most of the countries had experienced periods of very significant food price volatility in the past, the response to the 2007–8 volatility appears not to have been well-organized. Many of the governments responded to the food price volatility in an ad hoc manner. Policy reversals were common and delayed policy action reduced the effectiveness of the interventions. Failure to coordinate action by various government agencies added to the problem. Repeating past policy interventions was common and very little policy innovation was observed. Policy makers in most of the countries did not have access to relevant, reliable, and timely information about policy options and expected impact of each of such options on the various stakeholder groups. There is an urgent need to enhance access to such information within each country. This would include an improved data base, timely monitoring, and projections of food prices and those variables most likely to influence them. Projections and policy advice should be made within a political economy framework.

Strengthening the capacity to provide and make available to policy makers timely market information including high-probability forecasts is key to prepare orderly policy interventions and to manage a situation in which the access to relevant information is likely to vary among stakeholder groups. Such strengthening should take place between crises as exemplified by South Africa’s introduction of a price monitoring board. Furthermore, there is a need to enhance the exchange of such information across countries. Expectations about impact in one country may be more realistic if knowledge is available about the results from similar policy options pursued in other countries. International organizations such as the International Food Policy Research Institute (IFPRI) and the United Nations FAO could strengthen their role in this regard. The recently created Agricultural Market Information System (AMIS) is a step in the right direction.

22.2.1 Appropriate Use of Trade Policy and Interference in Price Signals

Trade policy was widely used by the study-countries to reduce price transmission from the world market and stabilize domestic prices. In response to increasing world market prices, traditional exporters introduced export bans and other trade restrictions and importers removed import tariffs. Reducing world market supplies and increasing demand contributed to continued price increase in the world market. Such ‘beggar-thy-neighbour’ policies are common to meet domestic policy goals at the expense of orderly trade. Before the next round of high food price volatility hits the world market, negotiations (p.484) are needed within the World Trade Organization (WTO) to strengthen the rules for abrupt and large changes in exporting countries’ trade policies. Such negotiations have been tried before with very limited success and it is unclear whether the food crisis and the contributions the introduction of export restrictions will make will render such negotiations more likely to succeed. Permitting the transmission of world market prices to domestic markets and maintaining unrestricted trade would greatly reduce the magnitudes of price fluctuations in the international market. It would also send the right signals to producers, consumers and traders to adjust supply and demand. Attempts to keep prices from increasing, whether through trade policy or price controls, would do the opposite. Farmers and consumers would not be enticed to produce more and consume less.

Since, as mentioned above, most of the food price volatility in developing countries is caused by national and local factors and not by the world market, maintaining open trade would reduce price volatility in the domestic market. The impact of fluctuations in domestic production on domestic supply and prices would be dampened by changes in import or export. Sharing national production fluctuations with the rest of the world would help in stabilizing domestic prices. Some stakeholders would lose and others would gain from such policies, depending on whether prices without stabilization would have been higher or lower. Compensating losers may be a more effective way to meet government goals than interfering in the price signals in countries where the institutional framework for transfers and subsidies is in place.

International coordination of domestic policies, particularly trade policies, with well-defined rules and binding commitments might be mutually beneficial to exporters and importers. Uncertainty about individual countries’ next move may encourage other countries to make moves that in the end would make all participating countries worse off. Without such coordination, the beggar-thy-neighbours policies we saw during the food crisis are likely to be repeated.

22.2.2 Reduce Fiscal Costs of Short-term Interventions

Export bans and other restrictions as well as elimination of import tariffs and reductions or elimination of value added taxes (VAT) on food caused significant fiscal revenue losses in many of the countries. Furthermore, some countries incurred large costs from the introduction or expansion of food and fertilizer subsidies and transfer programmes. Strengthening international agreements about export bans and restrictions might provide the support needed by national governments to withstand pressures from stakeholder groups for interventions in exports. This would maintain the revenues from export taxes and together with taxing some of the windfall gains captured by (p.485) producers and exporters would make funds available for transfer programmes for consumers to compensate for the higher prices.

To help keep costs down, subsidies and transfer programmes such as fertilizer and food subsidies and safety net programmes should be targeted to those stakeholder groups that the government wishes to compensate. Low-income people who spend a large share of their income on food and are at risk of food insecurity and malnutrition would be a logical target group for governments that claim that improved food security and nutrition is an important policy goal. Some countries did in fact target food transfers and safety nets on these groups, but many others focused on lower-middle-class urban consumers, presumably because they are more likely to threaten the government’s legitimacy. Except for fertilizer subsidies, which most often were targeted on smallholder farmers, subsidies, and transfers were targeted on consumers, primarily but not exclusively urban consumers.

22.2.3 Investments to Increase Food Supply Elasticity

Policies to facilitate the transmission of food price changes to farmers will only result in appropriate supply changes if farmers are able to respond. Investments to increase the supply elasticity, i.e., making the supply more price sensitive, of single food commodities and the total farm output is critically important to keep domestic food price fluctuations within reasonable margins. The specific measures to make this happen are context specific but in most developing countries the most important government action would be to invest in the public goods needed to develop a rural infrastructure that supports well-functioning input and output markets, competitive supply chains, and private investment. That includes rural roads, particularly feeder roads, as well as irrigation infrastructure, contract enforcement, institutions of various kinds, and other public goods. Policies to promote a competitive supply chain are important to avoid barriers to price transmission between producers and consumers.

A large share of the poor in all the study-countries is smallholder farmers. Most are net buyers of some food. Food price changes would affect them the same way other consumers would be affected. That was used by some governments to justify policies to keep food prices from rising. After all, it would be good for poor farmers as well as urban consumers. However, pursuing a policy of low food prices is unlikely to be sound in the longer run. First, while smallholders may be net buyers of some foods they are likely to be net sellers of others. Second, the main reason why many smallholders are net buyers of food is that low and falling prices between the middle of the 1970s and the end of the century made investment in farming unproductive and forced the smallholders into off-farm employment. Higher prices and investments in (p.486) rural infrastructure, domestic markets and unit-cost and risk-reducing agricultural research and technology may bring them back to become net sellers. Thus, governments wishing to strengthen the agricultural sector on the basis of smallholders should reassess policies to keep food prices lower than the export or import parity prices.

22.2.4 Facilitating Effective Risk Management Tools

More effective risk management tools are needed by farmers, traders, and consumers to cope with extreme weather events and market fluctuations. Governments can play an important role in facilitating the development and maintenance of such tools. Much of what has been mentioned above, such as better market forecasts, timely dissemination of weather-related information, and research to develop risk reducing technology such as drought-tolerant and pest-resistant crop varieties may help managing risks and uncertainties. Effective monitoring of the domestic and international food supply, demand, and prices, and related factors such as weather patterns, market development, and timely dissemination of the results is key to strengthen resilience to food price volatility.

22.2.5 Improve the Management of Public Sector Grain Stocks

Several authors of country studies found that poor management of government grain reserves contributed to food price volatility. Untimely release of grain on the domestic market aimed at slowing price increases failed to do so and government purchases during periods of price increases put further upward pressure on prices and resulted in accumulation of surplus stocks in excess of storage capacity. While faulty forecasts undoubtedly played a role, deliberations among stakeholders and difficulties in arriving at a timely decision appear to have delayed the release. Untimely government purchases may have been a result of faulty expectations about future prices.

To avoid these problems in the future, it would be useful to create an institutional arrangement that, independent of stakeholder interests, would manage government grain reserves including the timing and quantity to release and purchase. The political economy process would be used to set guidelines for such an institution but the release and purchase decisions would not be subject to political deliberations.

22.2.6 Make Demand for Raw Materials for Biofuel Price-related

As mentioned in Chapter 1, the rapid expansion of biofuel production based on food commodities or resources used for their production was an important (p.487) contributor to food price fluctuations in 2007–8. Blending mandates that are unrelated to the price of maize and other raw materials for biofuel, such as those currently found in the USA and the European Union, contribute to food price volatility because the quantity needed to comply with the mandate is removed from the maize market irrespective of its price. If food commodities, such as maize and soybeans, are to be used for biofuel, the impact on food price fluctuations would be reduced by replacing the mandate to a market-based programme in which the quantity demanded would be influenced by the market price. As the appropriate technology becomes available, biofuel production should be based on resources and commodities that do not compete with food supplies.

22.2.7 Improve Collaboration between the Public and Private Sector

Mutual mistrust between the public and private sectors was identified by several authors of the country studies as contributing to food price volatility. Large, abrupt, and unexpected policy interventions in the food and agricultural markets make it difficult for the private sector—whether farmers, traders, or processors—to operate efficiently. A higher degree of predictability and transparency in the behaviour of governments and the private sector is called for. Corruption in the public sector and anti-competitive behaviour in the supply chain contribute to food price volatility. Preparation of policy interventions to be implemented in future periods of increased food price volatility should be made before such periods occur. The preparations should be undertaken in a public-private partnership with participation by all relevant stakeholder groups. While this may sound naive, steps in that direction might reduce the problems associated with delayed, ad hoc interventions taken in a crisis mode as illustrated by action in some of the study-countries.

Irrespective of food price volatility, sustainable food security for all will only be achieved with both the public and the private sectors doing their jobs. Creative tension between the two sectors may be useful but mistrust, conflict, and attempts to undermine one another will make food security for all an illusion. (p.488)

Notes:

(1) See in particular Baltzer’s four categories of countries and their price transmission based on a synthesis of trade status (Chapter 2); Bryan’s classification of the study-countries into three categories on the basis of the extent of policy intervention (Chapter 3); Babu’s 12 lessons drawn from an analysis of the policy processes (Chapter 4); and Watson’s 11 political economy claims based on a synthesis of the country studies (Chapter 5).

(2) A list of potential national policy responses to food crises and likely effects is shown in Benson (2008).