The visible hand and the spikes in ‘soft’ commodities

Restrictions on property rights and inconsistent government action based on short-term political considerations not only hurt a country’s home food market, but also can boomerang

The black earth region is an area southeast of Moscow. It is some of the most fertile soil in the world. It is so fertile that the yields have propelled Russia into the third-largest wheat exporting country. The summer's drought may have changed all that. The drought has devastated at least one-quarter of Russia's grain crops. Now the winter wheat crop is threatened. To plant winter wheat the soil needs enough moisture to germinate before the frosts start in October. But moisture and frosts are not the main problem.
The farmers' real problem has to do with government regulations. Most sophisticated farmers above the subsistence level can deal with problems including floods, droughts, locusts and disease. These problems are an expected part of the cycle and risks of farming. These risks can be lowered by crop insurance or hedging on commodities markets. Investors all over the world are happy to help hedge these risks, bear the losses and reap the rewards. What is unexpected and what truly distorts the markets is government action.
When Russia imposed its export ban in August it was simply following a course of action that has been common throughout the world. During the last "food shortage" about 12 countries including India, Vietnam, Serbia and Ukraine imposed export taxes or quotas. Worse, over 20 countries imposed food price controls. The only thing that these controls did and the only thing that the present Russian ban will do, will be to make the process of growing more food to satisfy a larger demand less profitable, more difficult, more volatile and less attractive.
What is more ironic is that although governments have no compunction on restricting export markets, they seem to feel offended when foreign restrictions hurt them. For example, during the problems in 2008, countries were not only banning exports, they slashed tariffs on imports to zero. Of course such incentives were useless in the face of export bans around the world.
One egregious example is Argentina. With exports banned from Russia the price of wheat over the summer of course spiked. This normally would've been wonderful for Argentine farmers except that they have no incentive to plant. The amount of acreage in production in Argentina has fallen to a 111-year low and exports have been halved over the past five years.
The reason for this cutback is obvious. President Cristina Fernandez to satisfy her urban working-class constituency has placed export limits and a 23% export tax on wheat. So Argentina produces only 10 million tonnes of wheat instead of a potential of 17 million.
The idea that we can and you can't, create a lack of reciprocity in world trade that has created some bizarre assumptions. For example, many companies in more developed, but land-poor countries are buying or leasing property in Third World countries. A Korean company tried to contract with the government of Madagascar to lease almost half the country's arable land, to produce corn for South Korea. While an Abu Dhabi-based investment company has purchased big tracts of farmland in Morocco and Algeria, and was closing in on purchases in Pakistan, Syria, Vietnam, Thailand, Sudan and India. The idea behind these purchases is of course that the owners' home country will have property rights that supersede the local populations' need for food, which is absurd.
There is nothing wrong with investing in another country's agriculture. It has been very successful specifically in Argentina and the United States since the 19th century. It has helped local agriculture make spectacular increases in yields by introducing modern methods. Still for investment in agriculture to be successful, the process has to involve reciprocity between governments which is the basis for any successful trade.
Restrictions on property rights and inconsistent government action based on short-term political considerations not only hurt a country's home market, but also can boomerang. For example the Chinese attempts to purchase New Zealand dairy farmland were prevented because New Zealand investors do not enjoy the same property rights in China. The Chinese state owned company Sinochem's interest in mounting a bid for the Canadian company Potash Corporation would no doubt be subject to increased scrutiny and potentially prohibition by the Canadian government because of China's restrictions on rare earth exports to Japan during the recent diplomatic spat.
For investors, making money in food commodities or anything related to food commodities becomes exceptionally difficult. It is easier to predict the weather or even climate change than the timing or extent of government intervention. For consumers, especially in poor countries the problems are worse. Food makes up a very small percentage of the income of people in wealthier countries. So the increased prices caused by government restrictions will be absorbed. It is not quite so easy for people who eat only what they can spend.

(The writer is president of Emerging Market Strategies and can be contacted at [email protected] or [email protected]).

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