Monday, January 16, 2012

Optimal food price stabilization in a small open developing country

In poor countries, most governments implement policies aiming to stabilize the prices of staple foods, which often include storage and trade measures insulating their domestic market from the world market. It is of crucial importance to understand the precise motivations and efficiency of those interventions, because they can have consequences worldwide. This paper addresses those issues by analyzing the case of a small, open developing country confronted by shocks to both the crop yield and foreign price. In this model, government interventions may be justified by the lack of an insurance market for food prices. Considering this market imperfection, the authors design optimal public interventions through trade and storage policies. They show that an optimal trade policy largely consists of subsidizing imports and taxing exports, which benefits consumers at the expense of producers. Import subsidies alleviate the non-negativity of food storage. In other words, when stocks are exhausted, subsidizing imports prevents domestic price spikes. 

One striking result: an optimal storage policy on its own is detrimental to consumers, since its stabilizing benefits leak into the world market and it raises the average domestic price. By contrast, an optimal combination of storage and trade policies results in a powerful stabilizing effect for domestic food prices.
In developing countries, staple foods frequently account for a significant share of poor households’budgets. Many poor people have limited possibilities to insure against adverse price shocks. Price spikes are very problematic for poor households that are not self-sufficient, and often jeopardize their capacity to feed themselves. An important response of developing country governments to expressions of this concern is to implement food price stabilization policies. Yet, the study of these policies has been confined mainly to closed economy contexts, with an emphasis on the role of storage (see Wright, 2001, for a survey). From a theoretical standpoint, little is known about the role of trade policy in price stabilization programs, despite their widespread use. Recourse to trade policy to counter price volatility has been common in most Asian countries where stabilizing the domestic price of rice is a central objective (Timmer, 1989, Islam and Thomas, 1996, Dorosh, 2008), and also in Middle East and African countries in the case of wheat and to a lesser extent maize as well as rice (Dorosh, 2009, Wright and Cafiero, 2011). The question is probably less acute in Latin America, where most countries are net exporters of grains, but it is not irrelevant, as witnessed by the use by Chile of a price-band system for wheat and a few other food products (Bagwell and Sykes, 2004). More generally, based on a large-scale database on agricultural price distortions, Anderson and Nelgen (2012) show that countries tend to vary their nominal rate of assistance to agriculture so as to limit the effects of variations in world prices on domestic prices.

Trade and trade policies are key aspects that need to be taken into account in considerations of food security and price stabilization in developing countries. They raise numerous questions, the most important perhaps being: How should storage and trade policies be combined to achieve price stabilization? Increased reliance on national buffer stocks is frequently suggested as a remedy for developing countries faced with significant volatility in world prices. But is this a consistent policy per se, independent of trade policy interventions? Dorosh (2008) suggests that greater reliance on the world market allowed much more cost-effective price stabilization in Bangladesh than in India; the latter relied almost exclusively on huge public stocks and severe restrictions on imports. Can it be taken for granted that greater trade openness, or more reactive trade policy, would reduce the amounts of stocks needed to achieve a given stabilization target, and to what extent?

Export restrictions raise a number of additional questions. Most analysts of the 2007–08 food crisis agree that trade policies played a significant role in fueling international price spikes (von Braun, 2008, Mitra and Josling, 2009, Headey, 2011). In particular, export bans enforced by several rice exporters seem to have contributed greatly to the astonishing price levels reached (Slayton, 2009). Noting the similar situation in the 1973–74 crisis, Martin and Anderson (2012) emphasize the collective action problem created by export restrictions: their use by some countries to provide shelter from price spikes aggravates the problem for others (see also Bouët and Laborde Debucquet, forthcoming). The restrictions imposed by Russia on its cereal exports following a drought in 2010 can only add to this concern. A first step towards coping with this problem is to achieve a better understanding of the motivations and consequences of export restrictions. Based on Marshallian surplus analysis, many authors conclude that such policies are harmful to the countries enacting them. Is this really the case, or do export restrictions make economic sense for a small open economy? And, in this case, is refraining from the imposition of export restrictions an important sacrifice for the country concerned? Would specific flanking policies be preferable?

World Bank.Author:Gouel, Christophe ; Jean, Sebastien.Document Date: 2012/01/01.Document Type: Policy Research Working Paper.Report Number: WPS594

Optimal food price stabilization in a small open developing country x

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