By Philip Booth, Institute of Economic Affairs, 18 December 2015
Pope Francis has frequently described the present global financial system as an “economy that kills”. He often specifically criticizes speculation on food prices. Addressing the UN this year, he said: “Beginning in 2008 the trend of food prices has changed: doubled, then stabilized, but always with higher figures in comparison to the preceding period… We cannot overlook financial speculation: for example, the high prices of wheat, rice, corn, soy, which fluctuate on the stock market, perhaps they are linked to profits and, therefore, the higher the price the greater the profit.”
Yet wheat prices today are more or less the same as in 2005, 1995 and 1985. In real terms, food prices have been falling for a long time. It is factually incorrect to say that their prices always stabilise at higher levels. And it is difficult even to think of a mechanism by which prices can be driven ever higher by speculation. There are two sides to any trade. One side benefits from the price going up and the other side benefits from the price going down. There is no net gain to speculators from prices going up, just a different distribution of gains.
It is worth noting in passing that the system that Francis calls an “economy that kills” is responsible for the most rapid reduction in poverty and the fastest increase in life expectancy that the planet has ever known. Global inequality has fallen too. But the growth of free trade, which has linked a large number of previously very poor countries to global markets (and often protected them from localized harvest failures), has also led to a huge increase in cross-border finance which can be linked to speculation on commodities.
So it is certainly true that there has been an enormous increase in the so-called “financialization” of the economy. And it is, therefore, still worth asking whether speculation is responsible for serious temporary problems that especially affect the poor, perhaps by increasing food price volatility.
In fact, the instruments used for speculation are very important for farmers. Consider “futures”, financial contracts in which buyers agree to purchase a commodity at a future point in time. Cocoa and coffee futures, for example, allow farmers to lock-in prices before harvest so that they know they can cover their costs of production. Active trading in futures by others makes the market deeper, cheaper and more accessible. Indeed, Fairtrade tries to provide the same kinds of benefits and reaches farmers who cannot gain access to futures markets.
Futures prices also provide information to farmers and make it less likely that they will be exploited. With the rapid increase in mobile phone usage in Africa and Asia, farmers are able to obtain information much more easily and are less likely to be at the mercy of large, powerful buyers.
There is, in fact, no evidence that trading led to the food price increases of the late 2000s. Even the strongest critics of commodity speculation find weak and uncertain effects of speculation on food prices. Futures traders do not withdraw the raw product from the market in the hope that its price will rise, as is often supposed.
If speculation in futures leads to a rise in their value, it actually makes it more likely that farmers will bring forward production, because futures allow farmers to sell their produce for a guaranteed price. There are mechanisms by which speculation can increase prices at particular times or increase volatility, but speculation is at least as likely to smooth prices as to make them more volatile.
The scale and speed of the food price increases of the late 2000s was a tragedy. The crisis was caused by a number of factors. These included higher fertilizer and oil prices, widespread wheat harvest failures, maize being used for fuel as a result of the misguided policies of the US government, and the imposition of export controls and government hoarding of rice by many countries, especially India and the Philippines. According to one study, this last action, which was devastating for Bangladesh, was responsible for an astonishing 45 per cent of the increase in world rice prices in 2007-2009.
In individual countries, policy in relation to food markets is often terrible. In Indonesia, rice prices are 60 per cent higher than they should be because of government interventions in the market. In India, around 50 per cent of all food produce rots before it reaches markets because of transport and distribution problems mainly relating to internal customs points, poor infrastructure and regulation of the retail industry.
If the Vatican wishes to understand why so many people go hungry, then it needs to understand how real markets are prevented from working on the ground in difficult conditions in poor countries, rather than focusing our attention on financial markets which are easy to study but have little impact.
Prof Philip Booth is the IEA’s Academic and Research Director, and Professor of Finance, Public Policy and Ethics at St Mary’s University. This article was first published in the Catholic Herald.