Can free markets solve the food crisis?

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The food crisis rages on. Though prices overall are a bit off their record highs reached earlier this year – the much-watched global food price index calculated by the Food & Agriculture Organisation dipped slightly in May – they are still way above the level a year ago. And with new fears of bad weather creating bad harvests, the FAO warned on Tuesday in its latest Food Outlook report that lofty prices may not be going away:

In a remarkable turn of events, earlier prospects for more comfortable supply situations and stable prices gave way to increasingly worrisome outlooks and to an escalation of international prices to levels not seen in decades…Given the sharp run down on inventories and only modest overall global production increases for the majority of crops, world prices are likely to remain high and volatile.

That’s bad news for everybody – the poor who spend so much of their meager incomes on basics, the unemployed in the developed world struggling to make ends meet, and central bankers desperately fighting inflation. It’s also another reason why we should worry about the entire global recovery, which already appears to be losing some momentum. Higher food prices mean consumers have less money to spend on other stuff, and that leads to reduced demand and growth.

You’ll often hear criticism that free markets are a cause of today’s high food prices. The notion here is that prices are driven up by speculators looking to make a quick buck with all that cash sloshing around the world from easy-money policies in the U.S. and Europe, like the Fed’s QE2. The trading of food staples on international exchanges sometimes feels even immoral. How can we trust profit-greedy financial markets to deliver food to the world at prices everyone can afford?

But if you talk to agriculture experts and commodity analysts, most of them will tell you that the role of speculation in high food prices is overstated. The problem isn’t the free trading of food, but, in fact, that free markets aren’t working efficiently enough.

What do I mean? First, lots of food that is actually produced out in the fields never makes it to markets, at least not in any condition to be eaten. That’s because in some developing countries the physical elements of a functioning market – usable roads, efficient transportation and storage facilities – simply haven’t received sufficient investment. Secondly, politicians often make matters much worse by attempting to restrict markets when they get nervous about supply. Export bans — on rice during the 2008 food-price spike, for example, or on wheat during the most recent crisis — restrict supply and create uncertainty, driving prices higher.

Then there’s the information problem. Farmers in poor countries often don’t have real-time access to reliable information on prices and forecasts, so, for example, they can’t so easily respond to higher prices or make sound investment decisions. That’s why Internet access for the rural poor is so important. The feeble quality of information extends to the entire global food market. I was a bit shocked when I began reporting on agricultural markets that statistics on the amount of food being produced and the level of reserves on a global level are not reliable. Many commodity experts use figures from the USDA, but even those are considered somewhat suspect. That leaves government officials and commodity traders guessing about the true amount of wheat, corn, rice and other staples is actually out there for sale. And that uncertainty leads to panicky purchases of grain, driving prices skyward. No one, after all, wants his country to be left short of affordable food.

On that problem we’re seeing some progress, and from an unlikely source. The G20 is actually doing something productive and launching an initiative to create a system to more comprehensively collect and collate information on global supply and reserves of grain staples. It could be in place by the end of the year and would probably help reduce price volatility in agricultural markets.

Such improvements will help free markets do what free markets do best – meet demand. High prices combined with more efficient markets will induce more farmers to invest in more production, and more investors to put their money into agriculture. That, in the end, is really the only way to solve the food crisis.