Stephen King: Scarce resources should give all governments serious food for thought

We live in a world of ultimately scarce resources. The increase in global demand for the basics of human life is likely to outpace any increase in supply

Sunday 23 October 2011 06:13

'Food, glorious food." In Lionel Bart's celebrated musical version of Dickens' Oliver Twist, the boys in the workhouse can only dream of indigestion. The reality, of course, was rather different. "Is it worth the waiting for? If we live till 84, all we ever get is gruel." 19th century Britain may have delivered tremendous economic advances but, for the vulnerable, life was cruel and miserable. The same is true today for the poorest people in the world. Globalisation may have delivered huge economic gains but those gains have been unequally distributed. Riots in Mozambique in response to a 30 per cent increase in the price of bread are hardly surprising given that so many people are – literally – on the breadline.

The price of bread has increased because wheat prices have surged higher, in part in response to Russian supply disruptions. At the global macroeconomic level, these gains probably won't do too much damage. As Karen Ward, Fred Neumann and other colleagues at HSBC note in a recent research report,Wheat's Up, higher food prices today don't carry the inflationary dangers associated with the last food price spike in 2008.

Back then, policymakers couldn't quite decide whether inflation or recession was the bigger risk. The European Central Bank (ECB) raised interest rates, which, in hindsight, appears to have been misguided (I admit that, at the time, I thought the ECB had done the right thing). Now very few central banks are worried about inflation. Admittedly, activity in the emerging world is a lot more buoyant than in the developed world but no one seriously believes the inflation genie is about to make a reappearance soon: most central bankers are more concerned about double dips and deflation.

The good news, then, is that there is less policy ambiguity about the latest food-price spike. There's no need to raise interest rates because the likelihood of a surge in inflation is remote. But that's only because economic activity is sufficiently weak to prevent higher input prices from feeding through to higher output prices. That's a rather hollow victory, reminiscent of Japan's deflationary experience over the past two decades where occasional increases in oil or food prices did more to crimp activity than to fuel inflation.

More disturbing than the economics of this food-price scare are the politics, where there are plenty of similarities with the 2008 crisis. Rising food prices create difficulties for all sorts of nations, whether they happen to be net food producers or consumers. At first, this seems like a rather unlikely conclusion. Those nations generating food surpluses should be genuinely better off as a result of rising food prices: their exports rise in value, allowing them to import more and consume more. Only net food importers need be under threat. But this is too hasty a conclusion. Gains in global food prices also redistribute income within nations away from food consumers towards food producers. Unless the tax and benefit system is able to counter this effect – an implausible outcome in almost any country – the consequence is an arbitrary, unfair and politically unacceptable separation of winners from losers, threatening social instability. No one, after all, wants to go hungry.

The easy way to deal with this is to assert national interest. This is how Russia has behaved in recent months. Faced with rising global wheat prices, Vladimir Putin, Russia's Prime Minister, has imposed severe restrictions on Russian exports of wheat. The proximate cause is the Russian drought which has led to a dramatic reduction in crop yields and, hence, a rise in wheat prices. The Russian response is simple enough. Russia is a net exporter of wheat and, therefore, produces a surplus. But if the surplus falls as a result of a drought-related fall in production, Russia has a choice: either it supports the global market or it looks after its own national interest.

The latter implies safeguarding supplies at a reasonable price domestically while restricting exports. It's a blatant act of protectionism which supports Russian food consumers at the expense of consumers elsewhere in the world. Russian wheat prices end up lower than the prevailing global price and, because of the Russian restriction, the global price ends up higher than it needs to be.

Even worse, Russian producers end up being paid the local, rather than global, price and therefore have little incentive to expand production even though an increase would be in the interests of the world economy as a whole. It may well be that the recent spike in wheat prices doesn't last (although it has already triggered emergency meetings at the United Nations).

Whether or not wheat prices subside, however, a truth has been revealed about the 21st Century global economy. As emerging nations become richer, so their claims over the world's scarce resources – most obviously food and energy – will increase. Unless supply responds to this higher demand, the chances are that prices of the most basic human needs will tend to rise.

Yet the likelihood of supply rising to meet demand is dwindling. Oil exploration in challenging environments is suddenly looking a lot less attractive given BP's experiences in the Gulf of Mexico. Climate change and urbanisation, meanwhile, are slowly reducing the supply of fertile agricultural land. And as people in emerging nations switch from vegetarian to meat-based diets – which they almost certainly will do as they become richer – so demand for crops will increase, as meat production requires many more crops than the vegetarian alternative.

It's often forgotten that we live in a world of ultimately scarce resources. Productivity gains can overcome these scarcities from time to time – advances in technology can produce more outputs for given inputs – but the increase in global demand for the basics of human life in years to come is likely to outpace any increase in supply. If, for example, incomes in China rise at anything like their current pace, China would be attempting to consume the equivalent of all of today's global oil output by the 2030s. That won't happen, of course. Hopefully, we'll be enjoying the benefits of new technologies which will reduce our dependency on fossil fuels. Yet the price of oil will probably need to go up a long way in the meantime if only to persuade people to change their gas-guzzling ways.

With prices of food and energy more likely to rise than fall in the years ahead, the incentive for countries to overrule the free market with various brands of "state capitalism" will surely intensify. As I note in my recent book, Losing Control: The Emerging Threats to Western Prosperity (Yale University Press): "Globalisation creates winners and losers. The benefits of globalisation are randomly distributed by the market's invisible hand across and within sovereign states. State capitalism...can be seen as an attempt to overrule this process. It offers a chance to exert government control over resources that might be lost through market forces to higher bidders elsewhere."

Russia and China are already heavily involved in this game – think gas pipelines and investments in sub-Saharan Africa. Yet it was Britain, through its East India Company in the 18th and 19th centuries, that paved the way. Market forces may be great most of the time but, when it comes to genuine resource scarcity, governments always step in. They rig markets, they seize resources and, all too often, they go to war.

Stephen King is managing director of economics at HSBC

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