Blame it on the speculators, why don’t you?

Catching up on what’s been on the Guardian’s Development Matters blog, I’m surprised that no-one else has yet chimed in on the dodgy economics on show by Christian Aid’s Alex Cobham when he points the finger at pension funds for helping drive up world food prices. Now I’m not an expert economist, so I will gratefully defer to anyone who can point out that the error in the following.

One of the basic principles of economics is that prices rise when demand exceeds supply, but then these price rises should stimulate further production thus taking the edge off price rises. So before we get to the pension funds, we have to ask ourselves, are there external factors driving up the price of food globally, to which we answer yes: rising populations, increasing prosperity (richer people eat more and eat more protein which takes a significantly larger land area to produce per unit than arable crops) and climate change are all at work, meanwhile yield improvements are tailing off a bit. This is why rich Arabs and others are buying up large tracts of Africa, and equally why the pension funds are investing in agricultural commodities.

The more important question, in my mind, is why has production not responded to these clear price signals? Farmers are better able to respond to incentive price increases than suppliers of other commodities: new mines and oil rigs take a while to come on stream, whereas farmers can easily up production the following year. Global food prices have been high for a few years now – albeit with plenty of volatility – long enough for farmers to respond. That they haven’t done so sufficiently suggests to me that there is something wrong with the operation of global food markets, which there is; they must be the most highly subsidised in the world and are also subject to various price controls and periodic export bans by twitchy governments.

That is not to say farming is not a risky business: it is, and global price volatility is ample evidence of this. However, commodity derivative markets can actually help a poor farmer who is weighing up whether or not to invest in additional seed or fertiliser this year: they allow the farmer to enter into a contract now to deliver at a fixed price later. (Since bad weather can easily wreck the best such laid plans, the farmer would be well-advised to buy some insurance too.) This is one thing often forgotten about financial derivatives: most (I hesitate to say all) were first devised to ameliorate risk for producers and consumers, not for the benefit of speculators.

However, in the developing country where I live and work, the state controlled marketing boards and cooperatives are extremely poorly run. I suspect very few people working in them even have any idea as to what a commodity derivative is, let alone how they could use them to support their farmers. It is a fine idea to provide floor price support to farmers, but these cooperatives do so so inefficiently that one really has to question their raison d’être. Simply closing them down over night without any replacement, as happened in some countries under IMF-led structural adjustment strictures during the 1990s, would probably leave farmers bereft of any support, but allowing them to be replaced gradually by private sector players, who at least have clear commercial incentives to boost production, would seem a sensible option to me, with governments reduced to a buyer of last resort to provide a guaranteed floor price protection that should insulate farmers from the worst kind of exploitation by the ‘evil’ middle men of agricultural commerce.

Although there may be fortunes to be made and lost along the way, speculative bubbles that do not have any foundation in market fundamentals will play themselves out in time. Moreover pension funds are not your average speculator; they tend to invest for the long run. If they thought there was a problem of over-supply in world farming they simply would not invest. Global agricultural markets must be massive; that speculators – whoever they may be – can have an impact speaks to me more of a tightness in supply coupled with artificial narrowing of the market by price controls and export restrictions.

I doubt that full market liberalisation is the optimal solution to agricultural commodity price volatility, and in any case it is clear that politically this is currently out of the question. But a lot could be done to make markets operate more efficiently, and to allow developing country farmers to benefit more from rising demand. Blaming pension funds and other speculators, however, is akin to shooting the messenger. Christian Aid should be capable of better than this kind of base populism.

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2 responses to this post.

  1. [...] Original Blog, May 30, 2011 Posted by admin at 20:15 [...]

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  2. [...] Blame it on the speculators, why don’t you? – http://bottomupthinking.wordpress.com/2011/05/30/blame-it-on-the-speculators-why-dont-you/ Is development a city, a corporation, or something completely different? – [...]

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