Food glorious food prices threatened by speculation

ECONOMICS:The poorer the country the greater proportion of income spent on food. In Ireland, this rate of spending is just 15%, writes DAN O'BRIEN

AN ELECTION will be held shortly and people are angry and worried about economic issues. Peruvians have things in common with the Irish. On a recent trip to the country, where election posters adorn walls and plazas are filled with noisy rallies, I found conversations frequently turned to economics and politics.

But there is a big difference between us and them. Here, collapsing property prices and falling employment levels are the cause of woe; there, soaring food prices are generating real fear. And their plight is infinitely worse. However bad things are in Ireland, many Peruvians worry about being able to afford to put food on the table.

This is because they are poor and we are (still) rich. There is a universal trend as countries develop that smaller shares of incomes are spent on food because one can only eat so much. Therefore, even in recession-ravaged rich countries with welfare systems, people don’t fear hunger.

The difference is to be seen in figures published by the Economist Intelligence Unit. In Ireland, according to this source, only about 15 per cent of consumer expenditure goes on food; in Peru, half of the average household spending is devoted to basic nutrition, a proportion that rises to as high as 70 per cent in the world’s poorest countries.

What is causing international food prices to rise to historic highs and what does it mean for Ireland? In 2007, food prices globally began to soar. By the second quarter of 2008, they were close to historical peaks – which were registered, in real terms, during the mid-1970s commodity boom.

The international recession that began in the second half of 2008 had a demand- dampening effect on almost everything, including food. Prices fell rapidly, and most of the spike that had occurred in 2007-2008 was reversed by early 2009.

But from the middle of last year, commodity price inflation began rocketing. By December, prices surpassed the highs reached in 2008 according to the global food price index of the UN’s Food and Agriculture Organisation (FAO). The result has been a reigniting of the global food crisis, with serious consequences for the basic nutrition of billions of people.

High prices are also fuelling social unrest. The overthrow of the Ben Ali regime in Tunisia last week was partly as a result of heightening tensions caused by sky-high food prices. The reasons for the spike in prices are many and a fierce debate raging about the role of speculators in pushing up prices.

On the supply side, underinvestment in food production over the past decade has resulted in capacity lagging growth in demand. In large part, underinvestment was the result of unusually low prices in the first half of the last decade – as in any business, lower prices mean lower returns, which reduce incentives to invest. Costs of production also rose because of another commodity price spike – oil. A sharp increase in price can have a significant impact on the food production supply side.

Bad harvests were also a factor in the previous price spike. There are concerns the frequency of extreme weather events will result in greater disruptions to supply.

Supply problems easily feed on themselves in the global marketplace. Fear of a supply crunch can cause countries to impose export bans to hoard domestic production for home consumption. In 2008, the second most important rice-growing country – India – banned the shipping abroad of that staple. Last year, the world’s fourth-largest wheat producer – Russia – prohibited that commodity’s export. Although understandable from a national food security perspective, export bans further impair the functioning of the global market in foodstuffs and often lead the weakest and least-prepared to suffer most.

On the demand side, rising prosperity in many parts of the developing world has boosted incomes allowing access to better nutrition for those who were impoverished. The world’s most populous country, China, has been particularly relevant in this regard.

But other, less unambiguously positive factors have also boosted demand. One has been the shift to biofuels as an energy source. In 2008, in the world’s largest corn producer – the US – more than one-fifth of the crop ended up in engines rather than bellies.

The most controversial aspect in the debate on understanding very high and volatile food prices – and the crisis these create in poor countries – is the role of those not involved in the food industry placing bets on price movements for speculative gain. This has been described as the “financialisation of food”.

As with all price movements, it can be very difficult to determine what, if any, effect pure speculative plays have on price levels and volatility. But the negative correlation between commodities and financial assets, such as equities and bonds, has made them an attractive investment, if only for portfolio diversification purposes.

But motive and means do not constitute proof. Even the Rome-based FAO, far from a neo-liberal hotbed, concluded in a report last summer the evidence on whether speculation is a real problem was “inconclusive”.

Whatever the relative importance of different factors, and however threatening high prices are to so many people, Ireland appears to have benefited – last year at least. Agricultural output, exports and operating surpluses all recovered very strongly in 2010 according to the CSO.

A key reason for the net benefit is because Ireland has historically been a large net exporter of food. CSO figures going back to 1973 show that, up to a decade ago, the value of food exports annually was between two and three times greater than that of imports.

The food trade gap, however, has since narrowed sharply. In 2009, the ratio reached a record low, with exports exceeding imports by just over 40 per cent. Although the ratio increased again in the first nine months of 2010 (owing to strong export growth), it is possible that Ireland will not be self-sufficient in food in the foreseeable future.

With so many threats to food security internationally, that may not be a good thing.