Understanding markets and their instability in an increasingly globalised food system

Trade creates connections between different regions of the world such that production—and its impacts—is separated from consumption. The separation between world producers and consumers will probably expand, making world food systems rely ever more intensely on international trade (although other scenarios are possible, as indicated by the World Economic Forum work³³ discussed in Chapter 2). In principle, markets can allow more efficient allocation of resources (that is, where resource inputs confer the greatest advantage) and enable sharing of the burden of supply shocks, so reducing price volatility (Steering Committee of the EU scientific programme for Expo 2015). Recent literature shows that trade flows are increasingly more resilient and exhibit ample capacity to change. For instance, Sartori and Schiavo (2015) conclude that ‘the structure of international trade has evolved in a way that makes the benefits from the dissipation of shocks through the network outweigh the potential costs of shock propagation and magnification, at least from a systemic point of view’. However, other research concludes that there is a systemic risk associated with a wider trade network (see, for example, Puma et al., 2015) and, following the financial and food price crises of 2007–

2008, market instability, and the implications of price volatility for food insecurity, have been a topic of major concern to agricultural economists and to policymakers.

The issues have been studied in detail in the FP7-funded ULYSSES project⁷⁴, and comprehensive analysis and conclusions have been published (Garrido et al., 2016). Excessive price volatility can pose serious risks to food security in developing countries and poorer households anywhere (see section 3.1) but some level of volatility is the normal reaction of markets to information and expectations. In general, though, poorer households are much more vulnerable to higher food prices than to more volatile prices. Evidence shows that instability is agricultural commodity-specific and it is difficult to generalise for the major crops. Usually, there is a relationship between change in crop prices and food product prices, for example a 1% increase in wheat price transmits into 0.3% increase in bread price. However, in urban areas where there may be competition between supermarkets, differing pricing policies may confound the interpretation of the impact of national changes in market stability on households.

Research with supermarket large datasets shows that value chains are extremely dynamic (McCorriston, 2015).

Although market fundamentals are the primary causes of price volatility, on a global scale it is clear that food

market instability cannot be managed by agricultural policy alone. That is, there are significant intersections with monetary policy and financial fundamentals (money supply, interest rates and exchange rates).

Global projections predict that an increasing proportion of countries will depend on food supplies from

abroad such that their populations will be increasingly dependent on international food markets (Puma et al., 2015). Moreover, an increasing homogeneity in global food supplies, with ever-greater reliance on a limited number of staple commodities, may be associated with loss of resilience to perturbations, introducing systemic risk for an increasingly monolithic food system.

Policymakers need to recognise, therefore, that there is a pivotal role for the World Trade Organization to manage globalisation in food markets and the associated issues for water and land resources, and the potential environmental barriers to trade. With regard to projections for specific impact, most models predict only small changes in agricultural prices globally in consequence of climate change but this finding is controversial and, in particular, the potential effect of extreme weather events on future volatility deserves much more assessment. The increasing reliance of international markets on a small number of commodities brings concerns that multiple commodity failure as a consequence of extreme weather events would generate greater market instability. A case can be made, therefore, for crop diversification in Europe to build in more resilience if imports are reduced in such an eventuality.

Analysis (Garrido et al., 2016) also suggests that biofuel policies contribute to higher volatility spillovers from the oil market to key agricultural products. In episodes of amplified volatility, the impact of oil price volatility on agricultural markets, which are already experiencing higher price levels and uncertainty, may exacerbate the situation. Issues for bioenergy production are considered further in section 7.1, but we emphasise that the situation is complex, and will be influenced by recent EU initiatives on land use and bioenergy production and by the strategic interventions of other groups such as OPEC.

There are options available for more specific regulation of agricultural commodities but the EASAC Working Group concluded that state intervention should be kept to the minimum possible. The food price volatility experienced in 2007–2008 was probably exacerbated by application of export bans, and these should be avoided (for example as discussed in GOS, 2011 and the Global Food Security report cited previously⁴¹, which highlights numerous trade-reducing policy interventions), unless there are serious prospective domestic food crises.

74 http://www.fp7-ulysses.eu; see, for example, their Policy Briefing number 04 (March 2015) ‘Analysis of material and food deprivation in the EU under food price volatility and rise’ (and the discussion in section 3.1 of this EASAC report).

Other recommendations to improve governance of food markets and develop roles for the World Trade Organization, from the perspective of one EU Member State, have been presented in detail elsewhere (GOS, 2011). The comprehensive discussion by Pretty et al.

(2010, as input to GOS, 2011) covers a range of policy research questions for food supply chains, prices, markets and trade to help design mechanisms and instruments to minimise or alleviate the effects of market failure. The EASAC Working Group emphasised science issues linking trade with regulation, standards and with food safety, and advised that the nuances and difficulties of implementing adequately resilient mechanisms should not be underestimated.

Whatever policy framework is considered, it is vital that improved data collection and focused research inform global governance⁷⁵ and regulatory actions for risk management. In consequence of lessons learnt, markets are now operating more transparently, exemplified by the Agricultural Market Information System⁷⁶, established at the request of the G20 agriculture ministers. The World Bank and others are also now creating early warning systems, based on improved modelling, to render markets more predictable. These and other initiatives may reduce the chances of a new food crisis, similar to 2007–2008, but do not eliminate the possibility that market tensions would evolve into periods of intense instability.

The research agenda should consider new modelling and analysis, making use of the massive databases, with a view to gathering evidence about how markets work, how shocks occur and propagate, and what effects are likely to evolve as a result. Other research priorities identified in Expo 2015 include understanding the role of EU production in global markets and assessing the balance of economic, environmental and social effects of foreign direct investment in land and other production assets within and outside Europe.

Further comprehensive analysis of food price volatility and its implications was published recently (Kalkuhl et al., 2016). Among the general implications for policymakers identified in this work are the following.

• Considering options to reduce excessive volatility—

including open trade, flexible bioenergy policies, grain reserves and regulation of commodity markets.

• Introduction and extension of social protection and nutrition policies to alleviate chronic and acute undernutrition.

• Opportunities for re-designing international institutional arrangements and institutions for food security to address failures in collective action.

Taking account of Kalkuhl et al. (2016) and points made in the previous paragraphs, the EASAC Working Group summarised that the policy actions require progress in several research areas:

• To examine linkages between extreme events and excessive volatility with social and human welfare.

• To facilitate modelling of cooperation in food security.

• To analyse the effects of regulatory policy instruments in agricultural commodity markets.

• To analyse network and trade flow data, with a view to understand how trade evolves, what natural resources underpin it and how transportation and logistics affect the flow of calories and proteins around the world.

• To understand expectations of the value of information.

• To underpin integration of risk and volatility into models with longer time horizons.

• To understand price transmission between global commodity prices and local food systems—price and availability—and from this to food intakes.

The EASAC Working Group also discussed how the issue of price volatility should be better incorporated into the CAP farmers’ strategy, to support policy interventions to manage, rather than prevent, price volatility⁷⁷. Approximately 40% of the EU budget is currently expended on the CAP⁷⁸ (although this is anticipated to continue to decline), 50% of farmers’ profit comes from the CAP subsidy and it is increasingly important for the CAP budget to be used effectively in a central role for EU food and nutrition security.

75 Issues for global governance were not addressed directly by the Working Group and come more within the remit of the IAP global phase of this work. However, relevant issues have been described in detail elsewhere, for example Howard (2016).

76 www.amis-outlook.org.

77 The role of the CAP is also being addressed in the work of the European Parliamentary committee on agriculture (COMAGRI), ‘Draft report on CAP tools to reduce price volatility in agricultural markets’ 2016/2034(INI), on http://www.europarl.europa.eu/sides/getDoc.

do?type=REPORT&reference=A8-2016-0339&language=EN.

78 Thirty-nine per cent in 2014 (data from April 2016) on http://ec.europa.eu/agriculture/sites/agriculture/files/cap-post-2013/graphs/graph1_

en.pdf.