Higher prices have been making headlines in Thailand. Although wages and farm incomes are up, so are the prices of eggs, milk and fried rice. I am definitely feeling the pinch: the price of my favorite beverage—coconut water—has surged following a beetle infestation.
As prices go up, so does the pressure on the government to reign in the spiraling cost of living. But as we discussed in the recently released Thailand Economic Monitor - April 2011, the current inflation challenge is especially tough to tackle.
First, higher prices are mainly a sign of input costs going up rather than the domestic economy overheating. It isn’t the case of too much demand for too few goods, which happens when wages increase and producers can’t keep up with consumer demand. Instead, prices have been increasing primarily because of factors outside of Thailand—the increase in global prices for energy (fuel) and agricultural commodities (including food).
Since the source of higher prices is, for the most part, external to Thailand, the standard medicine for inflation (higher interest rates) may not be that effective in slowing down price increases. In fact, higher interest rates may attract foreign capital and slow the recovery, which depends a great deal on the strength of the domestic market.
Second, it isn’t clear whether we are experiencing a temporary spike in prices, or whether the recent increases are part of a longer-term trend. It’s true that some of the factors that led to the recent spike in oil prices are temporary, such as the turmoil in the Middle East and North Africa. However, taking a longer-term view, energy prices are up over 200 percent in the 2000s vs. the previous two decades, partly reflecting a structural increase in demand from emerging markets such as China. The IMF has recently warned (260kb pdf) that “the persistent increase in oil prices over the past decade suggests that global oil markets have entered a period of increased scarcity.”
Agricultural prices tend to follow energy prices: World Bank research found that a 10 percent increase in fuel prices is associated with a 2.7% increase in the World Bank Food Price Index. This is because oil is a key input to agriculture (through fertilizers, fuel for agricultural machines and transportation), but also because it increases demand for biofuels. For example, demand for Thai cassava has been increasing because of biofuel demand in China.
Third, higher agricultural prices are generally positive for the Thai economy, but the benefits are not evenly distributed. Many vulnerable urban and rural households may be pushed into poverty when food prices go up. In 2008, poverty went up for the first time in Thailand since the Asian financial crisis. Although many of the poor were helped by higher agricultural incomes, poor households also spend most of their earnings on food. So on average, the price increases completely eroded what was a healthy income gain for the bottom 20 percent of the population.
So what should the government do about higher prices? Stay tuned to this space for the next entry…