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Fighting drought with export bans: how effective is that?

Hans Timmer's picture

An unrelenting heat wave scorches parts of Russia. The capital is suffering: smoke from wild fires chokes Moscow, where temperatures in July exceeded the norm by over seven degrees Celsius (a record for 130 years of weather monitoring) and the mortality rate doubled in July as well. And the countryside is equally suffering: because of drought, Russia’s grain production could fall by as much as a quarter from last year.

Against this emergency backdrop, the Russian government has announced that it will ban all grain exports starting August 15, provide financial support programs for farmers, and is contemplating the release of government grain stocks. 

At one level, this seems a resolute response to a true emergency situation. When the countryside is burning and crops are drying up and dying off, it would seem to make little sense to ship what is left of the harvest out of the country. Especially if you plan to try to keep domestic prices under control with releases from government stocks, you don’t want these new supplies to flow immediately over the border. Even the WTO, which Russia is close to joining, allows temporary export restrictions on basic foodstuffs to relieve domestic shortages. And Russia is not the only country that uses export restrictions.

But in economics, one frequent lesson is that what often seems to be common sense stops making sense when spillover effects are taken into account. However logical export bans seem on first sight in the current situation, they instead are more likely to make the situation much worse, including perhaps for Russia itself. To understand this argument, we must first look at what has happened since the government’s action. In reaction to the announced export ban, international prices soared (and will likely continue to rise, despite some easing last Friday) more than is necessary. That was especially true for wheat prices. Wheat prices jumped around 10 percent immediately on the day of the announcement, and are now some 60 percent above their June levels. Over the last couple of years, Russia exported 28 percent of its wheat production, which made it the fourth largest exporter, after the United States, the European Union, and Canada. During the last three years, Russia’s share in world wheat exports averaged more than 12 percent.

Why do prices increase more than is necessary? The announced export ban causes three reactions. First, by trying to keep domestic prices low, the export ban means the shortfall in Russia’s supply has to be completely absorbed by the rest of the world, initially by vulnerable importers. Second, the ban can lead to panic, causing other exporters to contemplate export restrictions, vulnerable importers to search desperately for alternative supplies, and possibly triggering excessive hoarding. These reactions, combined with the fact that existing contracts have become less reliable, will boost international prices higher. The more countries try to keep their domestic prices under control, the higher the prices of internationally traded quantities will surge. Third, the export ban discourages optimal substitution across grains, which would dampen the ex ante price rises of wheat.

What started as about a 2.25 percent drop in global wheat supply (a direct consequence of Russia’s 25 percent drop in output relative to its average share of 9 percent of global supply over recent years) ends up as a much larger shortage in segments of the global market. What does that mean for Russia’s attempt to keep domestic prices under control? That attempt could actually turn out to be counterproductive. Ultimately, it implies that it will be very hard to keep domestic prices low, while international prices soar at the same time. Even if the export ban can be completely enforced, there will be a tendency by Russian farmers to hoard grains until they can benefit from high international prices once the export ban is lifted. The simple lesson is that banning exports while at the same time making exports much more lucrative is not an easy policy to implement.

In the longer run this policy can backfire even more as Russia’s grain suppliers could be hit hard. During the last five years, Russia had achieved impressive increases in wheat production, and built up new export networks. Importers will turn now to other suppliers, who will have been given a further competitive advantage because they can directly benefit from the higher international prices. Only a year ago, at the St Petersburg grain summit, the Russian government announced a policy of doubling expanding grain exports, partly for commercial reasons, and partly to fight global grain market volatility and world hunger.

Unless quickly reversed, the embargo is likely to do very long term damage to this goal by damaging importers’ confidence in Russia as a reliable supplier.

In the case of a supply shock in one or a few countries, it is a far better strategy to use global markets rather than ban them, as it is much easier to absorb such shocks at a global scale than in local markets. In the current situation, the global wheat supply remains sufficient. The harvest in the United States is very good, as it was the previous two years. At the beginning of this season, global stocks were 55 percent higher than in 2008. There should be no problem in absorbing shortfalls related to the current drought in Russia, if one allows the global market to allocate surplus production.

In fact, Russia itself has used the global market effectively to bridge the differences between domestic production and domestic consumption in recent years. Figure 1 shows that Russia’s insufficient wheat production during the 1990s shifted to excess production in more recent years. The data are based on PSDonline. Figure 2 shows that the gap was mainly bridged by changes in net exports (in other words, relying on global markets), more than by stock accumulation.

The bottom line is that closing global markets in response to a severe local shock, as Russia has just done, is understandable, but will ultimately prove onerous for everyone, including the Russians. And in the short run, it may quickly make things worse.

 

Source:  U.S. Department of Agriculture

 

 

Source:  U.S. Department of Agriculture

 

 

Note:  This blog benefitted from interactions with my colleagues Mark Cackler, Jeffrey Lewis, William Martin, and Dominique van der Mensbrugghe. But this remains a personal note on difficult policy choices after catastrophes as are now unfolding in Russia.

Comments

Submitted by Irina on
The restrictions on export, such as on import, bring to economic imperfections, as we all know. Now, in a competitive market the outgoing supplier could be replaced in the relatively short time by a new incoming one; but this is an inflexible market, therefore, in my opinion, it will be difficult for the importers to find a new grain supplier at least for this year. Furthermore, the restriction of the supply means the rising of the price; the consequence is that the importer countries will purchase less quantities at a higher prices. Will this bring to the rise of the hunger in the world? Nobody knows. The alternative supplier (wealthy) countries will continue to stay good, if not better, either if the global demand withdraws or it remains the same making prices, not only of the grain, surge; but this accordingly increases the average price level, in other words the inflation. Could this be seen as a positive effect, on the outsider front, for the exporter countries, giving them more purchasing power against the importer ones?

Submitted by Tim Miltz on
Perhaps Hans Timmer will write another article reflecting the impact of China's grain crisis resultant from the worst drought in 60 years. As China is the world's largest grain producer and yet it's not even in the top 4 exporters ? To me this spells disaster with it's nearest most convenient exporter Russia unable to help. This means China will put stress on global grain supply. Sure this may help US exports in 2011, but this goes against the grain in that US currency is inflated right now and other nations have been excessively conservative in valuation of their currencies. I honestly wonder if China can afford to buy from the US. All I can see if China will finally be forced to adjust their currency at perhaps the worst time for US consumers who they so need for their exports- last I checked, every item in MY house is Made in China. Just about everything. I keep looking for 'Made in China' on my currency in the US- but it's not there yet. China's drought should really slam grain markets hard - I wish I had money - I'd buy futures now on grain, Timmer points out it jumped 10% in one day on Russia's announcement that it would be holding back exports. Gee, just last thursday we find China is going to be in serious deficit of having enough grain. Math there isn't too hard. On the dark side- it doesn't seem to be 'right' - or moral to seek profits from volatile markets. It seems it only fuels the volatility to do so. I wonder what Goldman Sachs will be doing on Grain futures before March 2011 hits. Sad at some level everything is profit driven for numbers on a piece of paper. BEST PART ? Canada and US Farmers can't replant their own seeds anymore - the patents on genetically altered seeds prevent them from doing so, over 660 billion has been harvested from farmers since 1997 in US and Canada. So, TOPPING IT ALL OFF ? US and Canada won't be there FOR China's grain crisis. Drought and global catastrophic climate change unfortunately can't be 'written off' on paper. I do hope Hans Timmer ads some more insights on China here. He's one of my my guiding lights on matters of global economy and futures. Tim Miltz

Submitted by Tim Miltz on
Just as Russia's export bans can, will and have affected world grain prices, I anticipate China - the world's largest grain producer facing it's worst drought in 60 years will be exercising a grain IMPORT mandate and anticipate this too will seriously affect world grain prices. China isn't in the top 4 grain producers even though it's the world's largest grain producer. So, China's new demands for grain will bring a rise in grain prices. With US Central Bank chairman Ben Bernanke - my opinion - as usual missing the delicate intricacies of the mesh of fluid intercommerce interchange we call the global economy - to be fair - as Alan Greenspan points out - incomprehensible by any one person - Bernanke I believe has left no room for such error as a global grain crisis stemming from - in this case China. US inflation will hurt China's ability to import from the US. This will likely cause China to inflate their currency to trade at the same 'quality' of currency- which will decimate the Chinese real estate sector already in US terms of real estate excessive valuation- the year 2005. China will have their own problems when they face a real estate collapse of their own, but right now they're facing an agricultural crisis looming and you just can't change the facts about drought. Short OR long term - China is facing serious new dependencies on their food supply. If the US is unable to help - and Canada grain farmers are facing unrealistic costs for patented genetically modified grains ? I don't see China doing so hot, hmm - wrong word, so well in the near future. China will have to inflate it's currency to get on par with US and then US consumers will realize that the missing middle class which is really the new third world lower class can't even afford the Chinese imports at Walmart, as they price goes up from US inflation AND Yuan inflation, double whammy. What's the way out here ? Maybe South America and Africa can come to the aid here - Ethiopia, Tanzania, Sudan, Uganda, Congo, Brazil, Uruguay, Paraguay in particular. If we can move from feeding the cattle grain, to growing grain for export ? (by we, I typically refer to humanity collectively, which is the 'real' in the long term, as opposed to abstract political ideologies that come and go over the centuries) ? Maybe there is a way to sustain the current 7 billion people on the planet - which will reach 10 before you can say we were not too little and not too late to bring in proper regulatory mechanisms on powerhouses such as Goldman Sachs to prey upon and manipulate grain futures- or oil for that matter (but that was Lehman) leaving profits on paper for the select few who operate without any regulation at a global level (hello world bank ? might you take interest in this ? WB would be a great place to start for global regulatory measures if you ask me on globally systemic financial corporate powerhouses), but people suffering as members of the human race. We need less beef, and we need more regulation on futures manipulations, and we need some means of advancing emergency food growth mechanisms as we face these more common climate changes - such as Russia last year, China this year (worst in 60 years). I hope Canada and US don't face flooding this year, but with 1/2 the Greenland ice sheet gone ? I do like to ponder, that water HAD to have entered the water cycle - I'd expect heavier rains, and in places where it's hotter ? greater evaporation processes leaving lakes dry as a bone, as we are witnessing in China right now. Tim Miltz I'm not an economist - I'm just a software engineer who likes to problem solve.

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