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The prices of food and fuel have increased dramatically in the past few years after remaining low for most of the previous decades. Average food prices went up by 3% in G7 economies between July 2006 and July 2007, and by 10.5% in developing countries; over the same period, corn up 60% and wheat around 50% on US market. Moreover, World Bank estimates food production will have to rise nearly 50% and meat by 85%, from 2000 to 2030.
Food prices increase by comparison the prices from the past two years. For example, food grains prices increased by 150 percent between 2006 and 2008, and surprisingly the most amount of this increase has happened in 2008 alone (Figure 1). Moreover, prices of petroleum and related products, including nitrogenous fertilizer produced from natural gas, have also surged upward drastically. The World Bank's index of energy prices more than tripled from the average level in 2000 and June 2008. Crude oil prices have increased from less than US$20 per barrel in 2001 to more than US$140 per barrel in July 2008, with prices more than doubling since January 2007 and reaching higher real levels than at any time in the past century (Source: Guidance for Responses, Human Development Network, The World Bank).
Since food and fuel are the most critical commodities and resources for each country (developing and developed), understanding the reason and consequences of food and energy prices are important. In addition, several economic and social problems rises like poverty, monetary recession and etc. in country due to rising prices of food and fuel, finding solution to manage the problem is also critical issue and this should not been ignored.
The causes of the rise in food and fuel prices
Food and fuel prices may have increased because of some factors like rising in input costs, bio-fuels production, unfavourable price pressures, climate changes, economic policy. Following are the major reason of food and fuel crisis:
One of the reasons which causes an increase in prices of fuel and food in a country is due to demand drivers such as income, substitute product, change in consumer preferences and so on which can effect on prices of food and fuel. For example, when aggregate income goes up, definitely total spending will go up, therefore, in the market shortage or deficit budget will occur and due to this shortage, the price will be pushed up to meet the equilibrium. Moreover, this inflation in pricing may become worse by a slow supply response, leading to low spare capacity and tight market conditions. Therefore, shortage in the market happens and this causes to push up the prices. For example, rising biofuels production in advanced economies has boosted food demand. This has not only pushed up corn prices, but also prices of other food crops (source: Food and Fuel Prices-Recent Developments, Macroeconomic Impact, and Policy Responses)
The most important reason for increasing the prices of food is due to increase in cost of raw material and input. Evidence shows that production of the major food crops are the major bases for producing related food products and when the cost of producing these four increased, the price of other related food products would increase as well. Fertilizer costs also rising sharply and also linked to energy: e.g. nitrogen fertilizer (derived from natural gas) now three and a half times its 1999 level. On the supply side, by increasing the cost of raw material, they definitely increase the prices of their final products to cover the costs of producing. Furthermore, since energy has always influence on prices of other products such food, the recent rise in oil prices has boosted production costs of food commodities. This is what economist call it cost push inflation (figure 2).
Figure 2 illustrates the increase level of price in food and fuel. Obviously the input costs goes up, the supplier have to increase the level of price. Therefore, aggregate supply curve (AS) would shift to the left. The new equilibrium price is higher than the previous. Inflation happened in full employment area.
Figure 2: Price level based on GDP and changes in Supply side
Environment: Climate Change and Water Scarcity
Unfavorable weather conditions recently happened in a number of countries led to a bad wheat harvest in 2007 for two years and a sharp bidding-up of wheat prices, with spill over into other crops through substitution effects. Actually the effect of climate change likely influence on the prices of food and fuel in ling run. Rain dependent agriculture (=95% of African agriculture) may be halved by 2020; tropical harvests likely to fall; adverse impacts likely in temperate regions. Based on the study by William Cline of Center for Global Development concluded that developing countries would suffer average 10-25% decline in agricultural productivity by 2080s, assuming business as usual emissions, with some countries much greater (e.g. India 30-40%).
On the other hand, water scarcity is something which has always been a concern due to increase in global demand and almost 500m people in countries chronically short of water, likely to be 4 billion by 2050. Indeed 70 per cent of all water used by humans goes into food production. Therefore water scarcity is one the causes of increasing the prices of food.
Economy: Subsidies and Trade Policy
Government's new policy can be another reason for increasing prices of food and fuel. Government in each country changes some rule like cut subsidies in some principal products such as fuel and food due to its deficit budget. This is happened also in Malaysia in 2010. The government cut the subsidies in fuel, suddenly the price of fuel went up, because before the government put such subsidy for the fuel but now the consumer have to pay the full price of fuel. Inflations occurred because of cut in subsidies. Malaysia did this because they have deficit budget and the government was afraid of debt and asking money from another countries. This is exactly happened for Greece. Moreover, some commodity analysts apportion part of blame for recent price rises to US and EU agriculture subsidies, which have made agriculture unprofitable for various other countries. As a result due to decrease in subsidy by the government on the agricultural product, inflation happens on food and fuel prices.
On the other hand, some trade policy (importing and exporting) would boost the price level of food and fuel prices. For example, a growing number of food exporters and importers have begun to use trade policies to raise domestic food supplies and lower domestic prices, with lower exports of major producers putting pressure on world prices. In the case of rice, staff estimates suggest that recent export restrictions by some major exporters including India, China, Vietnam and so on, which together supplied around 40 percent of global rice exports in 2007 have likely accounted for a substantial part of the price surge in recent years.
What economic problems that may be caused by the rising food and fuel prices
Rising global food and fuel prices are contributing to high food and fuel inflation in many countries. Over the past year there have been significant surges in domestic food price inflation in countries such as Sri Lanka (34%), Costa Rica (21%), and Egypt (13.5%). In many countries and regions, food price inflation is higher than aggregate inflation and contributing to underlying inflationary pressures. For example, in Europe and Central Asia overall inflation in 2007 averaged 10%, food inflation 15% and bread and cereals inflation 23%. This compares to 6% overall inflation and 6.4% food inflation in 2006. (Source: Rising food prices: Policy Options and World Bank Response). Therefore, higher oil and food prices lead to substantial increases in overall inflation, particularly in emerging markets and low-income countries. Since fuel and food are essential and critical products in each country, and a lot of related commodities' prices depend on the price of them (food and fuel), therefore the price of other products go up. This can cause economic crisis in a country. Consumers cannot afford to buy their required products in the market, and black market become worse through the market. Dealers bid on their product at high price level and a lot of economic corruption may happen.
Since higher prices push many people into poverty and make them poorer (assuming the fix level of income), so poverty and malnutrition problem would occur in a country. Number of crimes and suicides will happen due to rise in food prices. People would die because of starving since their income level decreases (due to high level of food prices they may not afford to buy food). Because of shortage in human resources, the total GDP declines to the level below the current GDP. Since GDP in each country shows its development from previous year, therefore, declining in amount of GDP can be a disaster for the country. On the other hand, due to lack of human capital the other economic disaster can be occurred in the short run, meaning that households smooth their consumption by increasing their labour supply and drawing down their savings. Inadequate credit markets can make worse these constraints, as the poor are often forced to borrow from moneylenders at high rates of interest. Since labourers are becoming poor the moneylenders ask them to repay with high interest rate. This decreases the level of investment in a country since the interest rate is too high.
The terms-of-trade effects of higher food and fuel prices have basically been mitigated by the non-food and non-fuel commodity prices. Meaning that countries which are rich in food and energy resources by exporting food and energy become more richer, while other countries which are poor in food and fuel resources have to import theses highly priced products. The largest negative terms-of-trade impacts include countries such as Lesotho and Gambia.
In general, the poorer the country, the more likely an economic shock will lead to adverse school impacts. It is obvious, when the food prices increase, family are under pressure and therefore they pull out their children from the school because they can't afford even the cost their feeding. Therefore economic disaster is created by growing poverty ("Rising Food and Fuel Prices: Addressing the Risks to Future Generations", the World Bank). Evidence from previous studies shows that poor education has directly and indirectly impact on economic.
Possible effort to manage the problems that may arise from the rising food and fuel prices
In order to handle and manage the economic problem which may arise due to rising the food and fuel prices there are some recommendation and hints as follow:
Firstly, in the face of rising food and fuel prices, social protection programs can play a major role in preventing increases in poverty, with wider developmental, social and even political benefits. Meaning that by helping to prevent increases in poverty, social protection programs help households maintain access to food, energy, and essential services. Social safety nets can also reduce the impact of economic crisis on health and education. Furthermore, when social protection programs are perceived properly at the right time, they can be important in maintaining social equilibrium and preventing social unrest as well.
Secondly, since fuel and energy resources are scarce and becoming rare, so action is needed now to enhance the state of saving energy and investing more on agriculture. By using high technology, it is possible to make food products which as low cost as possible. On the other hand, if agriculture is to provide both sufficient food and energy in the future, its prospects are exciting, but many of the responses needed operate only with long lags. Thus, agricultural R&D investments, appropriate institutional changes to provide incentives and infrastructure enhancements are needed.
Thirdly, in cases of rising food and fuel prices, countries should also avoid general subsidies to the extent possible. Although this could be difficult decision for the government due to cutting subsidies, it is good policy to manage the price rising, since the country by cutting subsidies can invest more on production. Furthermore, by increasing GDP, the price would be stabilized in a satisfied level. Moreover, since export restrictions are harmful, not helpful, as are or direct price controls, therefore, helping by subsidies, definitely the production would be discouraged as well. For example, in several East Asian countries rice yields could increase significantly by shifting fertilizer subsidies to encourage smart nutrient use and post-harvest losses could be lowered by 25% through better use of post-harvest technology and infrastructure.
Finally, technical support is also needed to improve production incentives. Many countries set procurement prices for key domestic staples. It is important that these need to be adjusted to factor in higher input costs. The extent to which consumption is concentrated on one staple food commodity is an important variable influencing household vulnerability to unstable food prices. Crop diversification, including into non-tradeable crops (yams, cassava, sorghum), is therefore key to reducing the dependence on a narrow set of staples. Moreover, facilitating private investments in biofuel production in developing countries can help diversify energy sources and reduce volatility in both food and energy markets. Many developing countries, especially in Africa, have a comparative advantage in biofuel production, and potentially for second generation biofuels from sugar cane residue (Double Jeopardy: Responding to High Food and Fuel Prices).