Oil, Food and Economics - Sumita Kale

If the subprime crisis wasn’t bad enough, the oil price spike has unnerved the world this year. And with food and fuel prices soaring in all countries, the policy prescriptions are back to the standard myopic solutions of interest rate hikes, duty cuts, export curbs etc. But if we step back and try to see the larger picture to decipher what these prices are signalling, what do we find? One theory that has finally got the prominence it has deserved is the Peak Oil Theory. In fact, for Matt Simmons, energy investment banker and ‘Peak Oil’ theorist, the signs that crude was entering danger zones have been clear since 1989, but it was only post 2002 when China kick started its explosive growth that the situation became bleak. For most of the world though, peak oil has become a keyword only recently because of the rapid rise in the oil price this year. According to Simmons, it was the unplanned for growth from developing countries that has taken up 99 percent of spare capacity and which has continued despite a ten fold rise in prices. Of course, to a large extent consumers are insulated from international oil prices : Price increases from about the $60 level have not been passed on to consumers, especially in the developing countries. State revenues are being sacrificed and/or consumers are being insulated by subsidies. To begin with, the true extent of oil reserves in the world remains an unknown; the rising share of state-owned oil companies has led to secrecy on reserves data. Spare supply capacity is fuzzy and this explains the frenzied rise in prices currently as there is a paranoia that is gripping the market. In short, supply constraints are more than likely to stay, than disappear. There are also various industry issues such as aging oil wells, rising costs of extraction, chronic rig and skilled manpower shortages etc. – the list is long. 80% of oil infrastructure needs to be rebuilt; the fresh demand for steel will in turn impact inflation. Simmons who has been anticipating this for long now says that the world has to go on a ‘war footing’ now and force a change in consumption pattern – the current trend is just not sustainable. What about food prices? At a symposium convened in March by the Banque de France, Martin Redrado, Governor of the Central Bank of Argentina, was spot on when he said that the rising inflation is to a large extent due to the ‘convergence’ of consumption levels – the developing countries are catching up in consumption patterns (growth in auto demand etc.) and change in dietary habits at a time when there is a delicate balance between production and demand. Two unanticipated impacts on the already delicate balance between supply and demand have had an impact on prices. The first is climate change reducing global grain output (droughts in Australia and Ukraine etc.); and the second is the impact of high crude prices in diverting grain for bio-fuel production that has triggered off the rising prices in corn, soya, wheat etc. Since food contributes a significant portion of consumer budgets in emerging economies, this will show up in forthcoming wage revisions, putting more pressure on prices. Higher energy and food prices will impact growth via higher interest rates that are being forced upwards in an attempt to curb the price rises. Redrado’s paper has interesting policy implications as it throws a spotlight on the social and political tensions that will arise as countries are forced into a period of lower growth and higher inflation. Per capita consumption of food and crude oil is much lower in China and India, than in the US- to bet on a slowdown in these economies, therefore, has social ramifications as well. On the other side, high oil prices are causing prosperity in oil-rich countries, the recent debate over sovereign wealth funds is just one instance of the political implications of this growing wealth. Prices may settle this year or the next, already there is relief coming in on the wheat front with better output forecast in Australia this year. Relief on the oil front though at this point seems doubtful. But all these problems hitting the world today highlight one important signal : you ignore the environment and natural resources at your peril. Would this have been the case if economics didn’t try so hard to distance itself from geography, sociology and other ‘soft’ disciplines? Trying to go deeper into this, I came across this interesting piece on Ecological Economics by Robert Constanza from the University of Vermont. “Ecological economics is a transdisciplinary effort to link the natural and social sciences broadly, and especially ecology and economics (Costanza 1991). The goal is to develop a deeper scientific understanding of the complex linkages between human and natural systems, and to use that understanding to develop effective policies that will lead to a world which is ecologically sustainable, has a fair distribution of resources (both between groups and generations of humans and between humans and other species), and efficiently allocates scarce resources including “natural” and “social” capital. This requires new approaches that are comprehensive, adaptive, integrative, multiscale, pluralistic, evolutionary and which acknowledge the huge uncertainties involved. For example, if one's goals include ecological sustainability then one cannot rely on the principle of "consumer sovereignty" on which most conventional economic solutions are based, but must allow for co-evolving preferences, technology, and ecosystems (Norton et al. 1998). One of the basic organizing principles of ecological economics is thus a focus on this complex interrelationship between ecological sustainability (including system carrying capacity and resilience), social sustainability (including distribution of wealth and rights, social capital, and coevolving preferences) and economic sustainability (including allocative efficiency in the presence of highly incomplete and imperfect markets).” Sounds familiar to my previous post on Mukherjee’s ideas on what Economics should include. Clearly the need of the hour for us economists! Looking forward to a debate on this one! ********************** PS: This post includes valuable inputs from Suyodh Rao, (an economist based in Hyderabad, India)- thanks Suyodh, for all your mails about oil, food and water!

Bush, Rice and the Global Food Crisis

by Ashwini Deshpande George Bush and Condoleezza Rice recently suggested that the global food crisis is in large part due to the rising prosperity and the consequent increase in the demand for food by the Indian and Chinese middle classes. Coming from Bush, the likelihood of any statement being a smokescreen is extremely high (the world is still reeling from the devastating consequences of the WMD lie and its aftermath). In this case too, their argument is a smokescreen for some of the factors that the US leaders would prefer to not have under public scrutiny. One wonders why, though, since the US leaders and their policies have shown precious little regard, if any, to any international public opinion. In contrast to the ‘prosperity and rising food demand’ theory, consider this. The 1996 World Food Summit resolved to reduce the number of hungry people in the world by half by the end of 2015. By 2006, there were more hungry people in the developing world (820 m) than in 1996. According the FAO, instead of decreasing, the number of hungry people in the world is increasing at the rate of 4 million a year. Keeping the 1996 pledge would require decreasing the number of undernourished by 31 million every year, which would mean increasing the food consumption of the hungry. The World Bank has estimated that approximately 100 million people have fallen into poverty in the last two years due to rising food prices and that this trend is unlikely to be reversed any time soon. Food prices are expected to remain high through 2015. High prices threaten to increase malnutrition, already a cause of premature death of children in many countries. The worst-hit are the countries of sub-Saharan Africa, as they collectively import 45% of their wheat needs and 84% of their rice. But according to Bush and Rice, the food shortage in the world is being caused by the fact that two large developing economies are eating more and more. How true is this? According to the FAO, of the projected 582 million undernourished in 2015, 203 would be in South Asia alone, i.e. close to 35 percent. So, for every Indian who, by eating more, is supposedly pushing up food prices, there are hundreds who remain undernourished. Mr. Bush and Ms. Rice, just imagine the horror that would unleash if their hunger was either reduced or eradicated altogether! Indians and Chinese are not merely consumers of food grains, they produce them too. Take rice. India is the second largest rice grower in the world behind China. Rice being the staple of over 65% of the Indian population, much of the production is consumed domestically. Rice prices in India have been rising and due to the low purchasing power of the poor, even a small increase can cause a decline in their real incomes. The fact is that agricultural growth has not kept pace with overall rate of growth and it is believed that there might be other factors such as overuse of fertilisers and so forth that might put a question mark on the sustainability of rice production. Thus, while a section of the Indian population might be prospering (but not necessarily consuming more rice), it is certainly true that large sections of the poor would join the ranks of the malnourished due to increasing rice prices, especially, if current levels of rice production are unsustainable. Now let’s look at the other side of the picture that Bush and Rice are completely silent about. Rising oil prices and fears of climate change have led to a massive increase in the production of bio-fuels. The World Bank, by no means radical or left-wing, provides figures that establish how the encouragement of production and use of bio-fuels has led to increased demand for raw materials such as maize, wheat, soy and palm oil and increased competition for cropland. Almost all the increase in global maize production from 2004-07 (the period in which prices have been rising) went for bio-fuels production in the US. From 2004 to 2007, global maize production increased 51 million tons, bio fuel use in the US increased 50 million tons and global consumption for all other uses increased 33 million tons, which caused global stocks to decline by 30 million tons. Finally, when prices rise, just as many are hurt, some benefit. The World Bank has divided countries into large and moderate gainers (and conversely, losers) in terms of the impact of the food price increase on their trade balance. Large gainers would be those countries whose trade balance would improve by more than 1 percent of their 2005 GDP as a result of rising prices. Moderate gainers would be those countries whose trade balance would improve by less than 1 percent of their 2005 GDP. It turns out the largest losers are going to be several African countries. India and China are among the moderate losers. The USA, incidentally, would be moderate gainer. Of course, the distributional impact of high food prices can be serious even in countries where the balance of payments has not been adversely affected. A study for eight countries indicates that an increase in food prices between 2005 and 2008 has increased poverty by 3 percentage points. For several countries where the progress in poverty reduction has been slow, the increase in food prices threatens to wipe out gains in poverty reduction made in the last 5-10 years. Thus, the overall picture of the food crisis is a far cry from the “prosperous Indians and Chinese eating more” theory. Weather related shocks (drought in Australia) and rising oil prices have contributed to the rise in prices. But in large part, the crisis is due to the needs of the energy intensive US economy that Bush is committed to protect – even if millions have to go hungry in the rest of the world in order to sustain those needs.

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Ashwini Deshpande is Professor of Economics at the Delhi School of Economics, University of Delhi, India.

ashwini.desh@gmail.com