Fighting drought with export bans: how effective is that?

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.