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Stephen King: Food protectionism could provoke a crisis on a par with 1970s oil shocks

Monday 21 April 2008 00:00 BST

The biggest threat to the world economy isn't the sub-prime crisis. Nor is it the credit crunch or the US recession. It's food.

Food prices are soaring. Not since the early 1970s have we seen wheat prices jump so dramatically. Rice prices have also spiked upwards.

For the rich developed countries, the rise in food prices is, so far, not much more than a minor inconvenience. For other nations, though, the recent gains in food prices threaten severe economic and social distress. Rice, after all, is the staple food for half of the world's population. What should they do if prices suddenly go through the roof?

The oddity of this story is that food prices, alongside energy and other commodity prices, are incredibly high at a time when the developed world seems to be succumbing to recession. In the past, weak growth in the US and Europe would have secured much lower commodity prices. That, though, no longer seems to be the case.

Why, then, are food prices so high? Supply, demand and policy factors are all important.

On the supply-side, agricultural productivity has made only modest progress over the last couple of decades. The green revolution of the 1960s and 1970s led to the introduction of higher-yielding crop varieties which, in turn, allowed large numbers to escape the trap of rural poverty. Many economists believe, for example, that India's economic renaissance owes a lot to these enhanced yields.

But the pace of improvement wasn't maintained. Newer technologies were created but didn't find favour. The rich west, in particular, chose to turn its nose up at genetically modified crops, fearing the introduction of "Frankenstein foods".

Competition for land usage, meanwhile, has become more intense. Emerging economies have become increasingly urbanised and, in the process of doing so, have in many cases seen a reduction in land devoted to agricultural use. Soaring energy prices have seen a switch away from food production to the cultivation of biofuels, again limiting food supplies.

On the demand side, emerging economies have grown extremely quickly. Rising per capita incomes have led to significant dietary shifts. Wheat and rice are out, meat and dairy are in (branches of Starbucks, replete with their excessively milky coffees, are commonplace in many of the major cities of the emerging world). The production of meat and dairy products, however, is an inefficient way of feeding people. A lot more grain is required to feed the human via the cow or goat than through the more direct route. As more people have been able to afford "western diets", the strains on cereal production have become even larger.

Taken together, these various supply and demand factors have left inventories of wheat and rice at remarkably low levels. Throw in a couple of policy errors and it's not so surprising that food prices suddenly go through the roof.

The first policy error comes from the world's central banks. Too many of them chose to ignore higher food prices. They assumed that higher food prices were, from one year to the next, simply a case of bad luck. Surely, they reasoned, what goes up must, eventually, come down.

Unfortunately, this view confuses cyclical and secular influences. Sometimes, a bad harvest will cause a temporary increase in food prices which won't leave a lasting impression on inflation. The recent bout of food price gains is, though, not just a case of bad luck. We're seeing, instead, a pernicious and persistent increase in food prices, supported by a range of supply and demand factors. Central banks have all too frequently chosen to turn a blind eye to these gains, in much the same way they ignored the oil price shocks of the 1970s.

This is particularly a problem for the world's emerging economies. Their per capita incomes are, of course, relatively low. The weight of food within their consumer spending baskets is, as a result, correspondingly high. Confusing cyclical and secular influences is, in these circumstances, a sure-fire way of debauching the currency. Seen this way, higher food prices themselves aren't causing higher inflation. Rather, overly loose monetary conditions are causing higher food prices.

The second error – understandable at the national level but disastrous at the global level – is the recent reaction of the world's food producers. Whether it's China or India, Vietnam or Cambodia, Egypt or Argentina, food-producing nations have become increasingly alarmed about the impact on their local populations of rising global food prices. In response, they've chosen to limit exports in the hope that more of their production can be devoted to local needs.

This is, at first sight, a noble sentiment. It's also, though, likely to lead to still higher world food prices. By lowering the domestic price relative to the global price, the incentive for domestic producers to increase supplies is reduced, thereby exacerbating the global food shortfall (Argentina's farmers have been on strike for weeks in response to the government's attempts to limit exports). This is protectionism through the back door.

Food importing nations, understandably, have started to panic. Riots are breaking out all over the place. The Philippines and Haiti provide two recent examples. Hungry tummies (and greedy speculators) do not make for happy populations.

Even worse, the economic success of many emerging markets serves to camouflage widening domestic social strains. From the favelas of Sao Paulo to the slums of Mumbai, the emerging market economic revolution is leaving many behind. This, in turn, exposes one of the great ironies of globalisation: while income inequality is reduced across countries, it increases within countries. Income inequality in China and Brazil, for example, is greater than in the US.

Indeed, in many emerging economies, there is now a yawning chasm between the newly affluent and the remaining poor. For the affluent, higher food prices might simply mean the purchase of one fewer DVD this week. For the poor, higher food prices may prove to be a matter of life and death. In these circumstances, social strains are likely to get worse.

What can be done? An obvious short-term strategy is to taxthe affluent and the food producers to support those on low incomes. For many emerging markets, however, the taxsystem is, at best, rudimentary and, hence, not fit for purpose.

Another option would be for the west – which sickeningly chooses to subsidise its own farmers, thereby depriving farmers in other parts of the world their fair share of the agricultural spoils – to offer more in the way of aid and less in the way of domestic subsidies (protectionism in agriculture is certainly not confined to the emerging world).

Ultimately, though, there is no substitute for higher food production. That's what higher food prices are telling us. If, though, governments prevent producers from receiving the right price, the producers won't produce any more, leaving food prices excessively high. For the emerging world, this has the potential to turn into an economic shock on a par with the oil price increases which hit the western world in the 1970s.

Stephen King is managing director of economics at HSBC

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