A post on the International Centre for Trade and Sustainable Development’s (ICTSD) blog last week discussed a draft confidential report to the G-20 on food prices that was leaked:
“A confidential draft report from leading international agencies (…) aims to lay out ‘a blueprint for a systematic and internationally coordinated response’ to food price volatility in response to an explicit request from G-20 leaders at their November 2010 meeting in Seoul.”
The report, which can be found here, discusses price volatility as follows:
“In a purely descriptive sense volatility refers to variations in economic variables over time. Here we are explicitly concerned with variations in agricultural prices over time. Not all price variations are problematic, such as when prices move along a smooth and well-established trend reflecting market fundamentals or when they exhibit a typical and well known seasonal pattern. But variations in prices become problematic when they are large and cannot be anticipated and, as a result, create a level of uncertainty which increases risks for producers, traders, consumers and governments.”
For once, price volatility is accurately defined by the report. But based on both economic theory as well as on my own empirical findings, price volatility itself is not the problem.
Rising Food Prices Are the Problem
I have often written about this over the past few months, but the more immediate problem is the rise in food prices. Rising food prices, although they benefit food producers, hurt consumers by weakening their purchasing power. This is all the more so for consumers in developing countries, who devote a much larger share of their budget to food than consumers in industrialized countries do.
Food price volatility (i.e., food price variability, holding the food price level constant) has an opposite effect, however: it hurts wealthier households in rural areas of developing countries (those are usually food producers, who must take production decisions long before knowing how much their crops will go for once they are harvested) while the poorer households in the same rural areas of developing countries (those are usually food consumers) benefit slightly from it.
This last finding is counterintuitive. Most people would expect consumers to be hurt by food price volatility, and I’m afraid that that’s what drives the mistaken policy response. Because foodstuffs are substitutes for one another, however, and because consumers can adjust their food consumption bundle as a response to price changes up until the very last minute when buying food at market, price volatility means that consumers can take advantage of unexpected, last-minute discounts.
Indeed, my coauthors and I found that poor households in rural Ethiopia slightly benefit from food price volatility, whereas relatively wealthier households are hurt by it. Again, this is all done holding the food price level constant so as to focus purely on food price volatility.
Why Policy Makers Must Tackle the Right Problem
I understand why policy makers might be tempted to think that food price volatility is the problem. Episodes of food price volatility are highly correlated with episodes of rising food prices. Indeed, when food prices remain somewhat constant, food price volatility is low. I also understand that food price volatility today, because it pushes producers to hedge against price risk by producing less than they otherwise would, may well cause rising food prices in the future.
But policy makers (and the consultants they rely on to write reports such as the one cited above) need to realize that words have precise meanings, and that food price volatility itself is not the problem if one cares about the poor, who are more often than not net consumers of food — rising food prices are. Any claim to the contrary is both misleading and mistaken.