The threats tied to opening up unfettered markets
by Paul-Florent Montfort, Analyst, momagri
On February 25 and 26, the Agriculture Ministers from the 30 OECD member nations, from countries in the process of joining the organization, and from those close to it1 met in Paris for a day and a half and concentrated on “Food and Agricultural Policies for a Sustainable Future: Responding to Global Challenges and Opportunities”. It was the OECD’s first agriculture ministerial meeting since 1998.
The ministers focused on food security in their debates. In this respect, some ministers argued that “thin” markets were contributing to volatility in international prices for agricultural commodities and that prices would be more stable if greater volumes were traded on “more liberalized” markets. In the meeting summary, co-chairs Nikolaus Berlakovich of Austria, and David Carter of New Zealand, wrote, “A successful conclusion of the on-going Doha Development Agenda negotiations was also seen as essential.”
The argument that easing restrictions in international agricultural commodity markets would stabilize prices is still leveled by many people, in particular in preparation of the conclusion the Round.
Yet, the rationale that underpins such argument is misleading, inasmuch as price volatility is an essentially endogenous phenomenon, that is to say generated by the market, as shown by the presentations of momagri’s Chief Economist, joined by those of renowned experts such as J.M. Boussard or M. Mazoyer.
If price volatility were exclusively generated by exogenous causes––such as climate hazard and epizootic diseases––we would have every reason to think that production shortage in one area would be compensated by another’s surplus2. Backed by the globalization of communications and transportation, such balance would thus smoothen global prices on international agricultural markets. Unfortunately, this is not the case, since agricultural markets differ from other markets due to two factors: rigid and irreplaceable supply and demand for goods traded on physical and future markets, and imperfect expectations.
As a matter of fact, farmers, like all producers, base their investment decisions for future production on sale price expectations. But when a farmer comes to a decision on crop rotation, he cannot know the volume he will get, or its quality, or even the price he will get for his products. This is why the agricultural production cycle cannot be time-compressed, unlike the manufacturing sector that can almost instantly adjust its production to demand. Because farmers do not command all the data when they make their production choices, crops differ from the potential demand they will face. Consequently, every year will show a supply surplus or a shortage against a demand that is more predictable. We have come full circle.
Let’s take an example. In 2007, 603 tons of wheat were produced while 617 tons were consumed. The gap amounts to only two percent, yet prices soared by over 100 percent3.
Thus, inasmuch as the instability of supply feeds on the instability of prices, market discrepancies cannot be corrected on their own. The price hyper-volatility in agricultural commodities experienced in markets is indeed proof that agricultural markets are not operating in a perfect manner.
As a result, there is good reason to believe that opening up markets will tend to have the opposite effect than the one promoted by the OECD. Besides, it is an assumption confirmed by the momagri model, whose latest simulations proved that in the case of complete liberalization of international agricultural markets, price volatility would be intensified. Consequences would be tragic for global agriculture, particularly in developing countries whose agricultural activities could not survive such price fluctuations. If we do not want to witness global food security getting even worse, we must proceed with caution. Yes, we must encourage trade, but we must keep in mind that it is necessary to implement market regulation policies to protect farmers from price fluctuations.
1 They include South Africa, Argentina, Brazil, Chile, Estonia, the Russian Federation, Indonesia, Israel, Romania and Slovenia.
2 According to the probability law of large numbers, it is in fact impossible for all areas in the world to suffer from a climatic or natural disaster at the same time. This law is actually the basis of insurance and reinsurance mechanisms.
3 To which we must add the impact of speculation rooted in this price fluctuation while intensifying it.