Last updated on January 15, 2011
This afternoon, the Overseas Development Institute (ODI) tweeted a link to a new post of theirs by Steve Wiggins that discussed how rising food prices are not necessarily bad news:
“Last Thursday The Guardian ran with the headline “World food prices enter ‘danger territory’ to reach record high”. Is this right?
Not quite: there’s a difference this time.
It is not just cereals prices, nor just food prices, that are rising, but almost all agricultural prices — including those of the main tropical exports: cocoa, coffee and tea; cotton; palm oil; sugar; and rubber. Most low income countries, leaving aside the few with minerals and oil, depend heavily on these for their export earnings. Often much of the production comes from small farmers. Higher prices mean windfall gains for them, gains that are likely to be spent on local goods and services, with strong multipliers in additional jobs and incomes for others on low incomes.”
The post goes on to explain that rising food prices may actually improve the trade balances of countries like Burkina Faso, Ghana, Indonesia, Kenya, and Nicaragua, which is good for those economies.
In the comments section of the ODI post above, however, Mike Warner writes:
“Isn’t the point that VOLATILITY is bad for everyone (except speculators)? (…) So, perhaps more useful to focus on helping poor people/nations find ways to cope with increasing price VOLATILITY (whoever the net gainers and losers might be in the short term)?”
This is a very good point, and one I have been working on with coauthors Chris Barrett and David Just over the last few years. What we have found will most likely surprise you, but it is a bit technical, so I will put it under the fold.
One important thing to keep in mind is that rising food prices and food price volatility are two very different things. When we talk of rising food prices, what we really are saying is that the mean of the distribution of food prices is increasing. When we talk of food price volatility, what we really are talking about is the variance of the distribution of food prices.
Taking maize as an example, there is a considerable difference between talking about rising maize prices and maize price volatility. The former means that the actual price of maize is increasing; the latter means that there is uncertainty around what that actual price is going to be. And just as rising food prices create winners and losers, price volatility — what my coauthors and I also call “price risk” for technical reasons — creates winners and losers.
In our paper, we study poor rural Ethiopian households. Using common statistical techniques, we hold the level of prices constant so as to focus on price volatility and we find that the average household would be willing to give up about 20 percent of its income to eliminate food price volatility.
Not everyone stands to benefit from price stabilization, however, as there is a good proportion of households who actually benefit from price volatility.
Contrary to conventional wisdom, it is the poorest households who actually benefit from price volatility, while it is the richest households who lose out the most from price volatility. In other words, price stabilization would actually be a regressive policy in Ethiopia!
Why this counterintuitive result? A (very) simplified argument is that poor households are for the most part consumers of all commodities, so they can make last minute adjustments to their consumption bundle once they have a better idea about prices. It is in this sense that they could be called speculators over food prices (but this does not mean that they actively seek to make themselves better off by speculating like, say, a trader on the stock market would!)
Richer households, however, are for the most part producers of some if not most commodities, and production decisions are taken long before they have an idea of what prices will look like. It is in this sense that they could be called hedgers against food price volatility, as they tend to produce less than they would if they knew with certainty what future prices will be.
I have just spent the week revising my paper on food price volatility, the previous version of which is here. Stay tuned for a link to the revised version in the coming few weeks, which will not be any less technical but should paradoxically be more readable.