The Hindu Business Line : ‘Agflation’ — reversal of a global trend

‘Agflation’ — inflation caused by the rise in global agricultural prices — presents an opportunity to rich country governments to get rid of some of the current farm subsidies and import restrictions.

Alok Ray

“Stagflation” is a term coined by economists to describe the coexistence of recession (or stagnation) and inflation in an economy. The coinage of the term became necessary in the 1970s when OPEC-induced sharp hikes in the price of oil caused a global situation which was the worst possible combination of rising inflation and rising unemployment – the nightmare of macroeconomic policymakers everywhere. This was different from the conventional text-book model of inflation, which is usually associated with a booming economy and falling unemployment.

Recently, the global economy has been facing another new development. According to The Economist, food prices in the global markets fell by about 75 per cent in real terms over the period 1974-2005. But this trend is now being reversed. Since 2005, global food prices in real terms have gone up by 75 per cent. Another new term – “agflation” – is now creeping into the economists’ vocabulary to refer to the recent inflation caused by the rise in global agricultural prices.

No doubt, agricultural prices have always been more volatile than industrial prices as far as seasonal fluctuations are concerned. This is primarily because agricultural production is much more subject to natural calamities (like floods, droughts and pests) beyond the control of human beings. But the broad trend over the last three decades has been a fall in the relative (or real) price of agricultural products. So, the question is: What has caused this reversal of trend?

Several factors may have combined. First, the rising prosperity in huge populous countries like China and India is causing a gradual shift in food habits as people are consuming more meat and less grains. According to The Economist, an average Chinese was consuming about 20 kg of meat in 1985. This has gone up to 50 kg in the current year. Paradoxically, this is leading to a rise in the demand for grains.

For example, production of one kg of meat needs about 8 kg of grain as feedstock. At the same time, the fall in the global price of grains — relative to the prices of fruits, flowers and vegetables — over the last few decades has induced farmers in many parts of the world to switch from the production of grains to the more remunerative alternatives. Thus, demand for grains has tended to outstrip the supply, causing grain prices to shoot up.

Demand for bio-fuels

The second important factor is the rising price of oil. This is making alternative energy sources like bio-fuels more attractive – especially ethanol made from sugarcane or corn. Ethanol is being mixed with conventional petrol for running cars.

As a result, the demand for sugarcane and corn has got a big boost causing a rise in their prices. Further, as the production of sugarcane and corn becomes more profitable, farmers would divert land from other crops (like wheat) to sugarcane and corn, leading to the rise in the prices of other agricultural products.

The upshot of these developments is that the recent rise in the prices of many agricultural products has come to stay for some time. Eventually more investment and technological development in agriculture may take care of the problem through increasing supply but that is not going to happen within the next few years.

How about the consequences? For any price rise, the producer gains and the consumer loses. So, farmers will benefit and bigger farmers will benefit more. The losers will be the consumers of farm products. The hardest hit would be the urban poor and the rural landless labour who do not produce any food.

As a result of rising food prices, the average standard of living of consumers in developing countries would be affected more than that in the developed countries since the percentage of expenditure on food in the budget of a typical consumer is higher in developing countries. By the same logic, poorer urban consumers would feel the pinch more than their more affluent neighbours as the poor spend a much higher fraction of income on food.

Protecting farmers

Agriculture is an area where lots of restrictions exist on imports in many countries — both developed and developing — in the interest of protecting inefficient domestic farmers against cheaper imports. Farmers in developed countries, even if numerically small (for example, only 2 per cent of workforce in the US), exert a disproportionately large political influence in dictating policies.

For instance, the price of rice in Japan is at least five times above the international price. The US has a sugar import quota which keeps domestic price of sugar two-a-half times the international price.

In addition, there are huge subsidies for farmers — especially in the European Union (EU) and the US — in the form of guaranteed prices and export subsidies. Artificially higher prices for farmers (by production and export subsidies) encourage overproduction, which in turn depresses world market prices. This particularly hurts poor farmers in many poor countries whose governments cannot afford to pay comparable subsidies to their farmers.

Subsidy of the rich

The “agflation” presents an opportunity before the rich country governments to get rid of some of the current farm subsidies and import restrictions. If farmers get higher prices though the market forces, the governments may feel a less compelling need to subsidise their farmers in order to maintain a given level of income for them.

In any case, farm subsidies have become a huge source of budgetary drain in the EU. Nearly 40 per cent of the EU budget is used up for agricultural subsidies. In addition, this is the main issue on which the Doha trade negotiations broke down.

The US is also pressing harder on the EU to reduce its agricultural subsidies which, as a percentage of value of production, are about double that in the US. So, if the governments — especially in the developed countries — can use this opportunity to withdraw some of the present subsidies, a “fairer” trade (that is trade less distorted by taxes and subsidies) may prevail in the world market for agricultural products.

This would benefit the poor farmers in many poor countries and would help to restart the international trade talks. The question, then, is: Would the governments be able to muster enough political will to use this opportunity to bring about the much needed changes in their policies?

Subsidy of the poor

Of course, there will be the problem of protecting the really poor consumers in the developing countries against the rising food prices. This is a political and a humanitarian issue. So, governments in those countries would need to pay more food subsidies to the poor.

The best that an economist can suggest here is that the subsidy should, as far as possible, be in the form of an income supplement, rather than supplying food at subsidised prices, which in many cases do not reach the targeted people in distant areas and get diverted to black markets to be sold at higher prices.

An income supplement (say in the form of food coupons) would enable the poor to buy food from the open market instead of relying on the corrupt, inefficient and erratic public distribution system run by the Food Corporation of India. The problem of identifying the ‘poor’ is no more difficult for income subsidy than for distributing BPL (below poverty line) ration cards. So, that cannot be an argument against income subsidy.

(The author, a former Professor of Economics at IIM Calcutta, is currently a visiting Professor of Economics at University of Pittsburgh, US. He can be reached at alokray15@yahoo.com)

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