April 17, 2011
Commodity Price Inflation
Commodity Price Inflation—Posner
Becker's focus is the impact of food price inflation on the poor, and I have no disagreement with his analysis. I want to discuss commodity price inflation in general, and its political consequences, but I want to begin my discussion with Becker's point about the effect on food policy of the greater political clout of urban than of rural populations. That greater political clout has been a factor in government policies since Rome provided its citizens with free bread. The concentration of population in a city, especially in a nation's capital, makes urban residents a potential threat to political stability. It does this by facilitating large-scale demonstrations, riots, and other mob action (not only because there are many people to fill the streets, but also because information spreads very rapidly in a city, facilitating the coordination of a large group of people), with consequences—which can include bringing down the government—that we are seeing in the Middle East and North Africa today. Hence it makes political sense for a government to provide more generous food subsidies to urban than to rural residents even though the latter are needier.
It appears that rapidly rising food prices have been a major factor in the recent and continuing unrest in the Arab countries. As Becker emphasizes, food prices are a big part of the budget of families in poor countries, even of urban residents, with their higher incomes. In fact the demonstrators who brought down the Tunisian and Egyptian governments were complaining vociferously about surging food prices, though they had other serious complaints as well. During the Egyptian crisis Mubarak promised higher subsidies in an (unsuccessful) effort to quell unrest. Other governments in what used to be the Third World will doubtless take the hint, and increase food subsidies particularly for city people, who are far more likely to bring down a regime than rural people; and so the inefficiencies and hardships that Becker points to as consequences of economically unsound food policies are likely to become even greater.
The broader point is that commodity price inflation has inescapable political consequences. A characteristic of commodity prices is that they can and often do change very rapidly and steeply, and if the commodities are consumer commodities these changes are quickly observed and cause alarm. A notable example is gasoline. Prices of gasoline change rapidly, and like other consumer commodities purchases are frequent, so that the consumer is kept continuously aware of price instability. Prices for food and fuel are excluded from the usual measures of inflation because of their instability, but they contribute to measured inflation (if they continue rising) indirectly because they are inputs into other goods and services, as are many other commodities whose prices have also been rising. The rise in these prices reflects worldwide increases in demand, especially in rapidly growing economies such as those of China, India, and Brazil, and concerns with inflation, against which investment in commodities is a hedge.
If food prices keep rising, we can expect more unrest in the Third World and slower economic growth. The increased unrest, however, need not diminish long-run economic growth or long-run political stability, if it is the catalyst for the replacement of authoritarian regimes with more-democratic ones—though that can only be a hope, and not a prediction. Rising food prices thus may—or may not—have a silver lining.
How to (and not to) Help Poor Families in Developing Countries Cope with Rising Food Prices-Becker
Food prices are on the move once again as the world economy recovers from the financial crisis. The Commodity Research Bureau's index of the prices of foods- including corn, wheat, steers, and sugar- doubled between 2002 and 2008, fell by 25% during the crisis, and has increased since the world recovery to a level beyond the prior peak.
Higher prices of foods mainly hurt the poor since poor countries and poorer families within a given country spend a much larger fraction of their incomes on foods than do rich countries, and then richer families within a country. For example, the share of national income spent on food is over 40% in India, less than that but still large in China, and under 15% in the United States. If families were spending 40% of their income on food, a 30% increase in food prices would raise by 12% the income they would need to maintain the same level of consumption of all goods. By contrast, a family spending only 15% of its income on food would only need a 4.5% increase in their income to maintain the same consumption basket.
This simple arithmetic explains why the current rapid price increase in foods and other commodities, and past large increases in these prices, often caused great distress among poor families of Africa, Asia, and elsewhere in the world. This distress led to food riots in many countries, and other protests by the poor against the large rise in their cost of living. Governments responded to these protests in various ways that often lowered the cost of food to consumers, but usually at the expense of inducing inefficient behavior by farmers and consumers, and often even at the expense of the poor.
For example, during the current sharp run up in food prices, several food-exporting countries, such as Russia and Ukraine, have banned, or greatly restricted, the ability of farmers to export their produce. This lowers the price of food to urban consumers in these countries, and thereby helps the urban poor. However, such bans reduce the prices received by poor farmers of these countries. This reduces their incentives to raise their production of food, and makes these farmers worse off. It also raises the cost of food to families in food-importing countries, and thereby hurts the poor in these countries. Since farmers in developing countries are generally much poorer than those who live in cities and other urban communities, the poor may overall be made worse off when countries greatly restrict their food exports.
Unlike the situation in rich countries like the United States, city dwellers and other urban populations in developing countries like China and India usually have more political clout than rural families. For example, the massive famines in China during 1958-61 that resulted from the Great Leap Forward were concentrated in rural areas partly because farmers were forced to supply much of their reduced food output to the cities. This greater political power of urban populations also explains the restrictions on food exports in developing countries, even though they discourage food production, reduce the national incomes of these countries, and also overall tend to reduce rather than increase the real incomes of their poor.
To contain the rise in the retail food costs, many countries, including China, have also imposed retail price controls on foods that figure most prominently in the diets of lower income families. This helps those poorer families that are lucky enough to be able to buy most of the food they desire, but such price controls are likely to hurt the majority of poorer families. The reason is that price controls on food prices reduce the incentives of farmers to grow more food since they cannot benefit from what would be higher prices. Artificially lower food prices not only discourage food production but also increase the demand for food. The resulting excess demand for food means that price controls cause food rationing at both the retail and wholesale levels. Richer families tend to gain from this rationing compared to poorer families since they can offer "under the table" payments and other inducements to retailers to give them a disproportionate amount of the limited available food.
Still another common policy in developing nations is to subsidize foods, such as bread and rice, which are important stables in diets of poor families. If implemented appropriately, this approach has the advantage of targeting the goods consumed more by poor families. Yet one weakness of the programs is that they also subsidize middle income and rich families that buy these staples. In addition, they discourage any efforts by consumers to shift some of their food purchases away from bread and other stables that would be rising a lot in prices without these subsidies, and toward other foods that would increase by smaller amounts.
Direct income subsidies are probably the best way to reduce the suffering by poor families due to big increases in food prices that take a sizable share of their total spending. If families below a specified poverty income level received an income supplement, then this level should be indexed to the cost of living by poor families. Especially in poorer nations this means indexing definitions of poverty to the cost of food. An income subsidy approach has the advantage of allowing prices of foods and other goods to be determined by the forces of supply and demand. As a result, it encourages famers to grow more food when food prices rise, and also encourages poor (and other) consumers to reallocate their spending away from foods that rise most in price, and toward other foods and consumer goods.