The world financial, food and hunger crisis

Lane Vanderslice

(Updated November 11, 2008) The world food crisis has been replaced in large part by the world  financial crisis.  Both crises have resulted principally by the operation of the world economic system and have great impact on people who are poor and hungry.  The major new element is the financial crisis. Financial (and other) institutions all over the world took risks that were not prudent financial risks, and when, instead of continued growth in asset prices such as real estate, oil and food, there began to be a decline in prices for housing and other items, these institutions such as banks (e.g. Wachovia), insurance firms (such as AIG), investment banks (such as Lehman Brothers and Merrill Lynch) did not have enough capital to meet their obligations.  They thus would have had to go into bankruptcy and default on their obligations.  Many other institutions hold their obligations, so that they would have to revalue downward the financial instruments issued or insured by faltering companies, thus in turn throwing the financial stability of many other institutions in question.  

This financial crisis is having a great impact on the world's economies.  Demand for goods is falling--US automobile sales have fallen by 25 percent from last year's levels, for example.  This has affected developing country economies, as demand for their products has decreased, reducing employment and incomes in these countries.  The one bright spot is that commodity prices, including the price of agricultural commodities such as rice, have fallen substantially.

(May 8, 2008) The facts: food prices have soared. To take the key example: rice, the staple food of billions of people, more than doubled from 2003 through March 2008.¹

This is a crisis for the poorest people in the world.  2.6 billion people live on $2 a day or less. They spend approximately 50 percent of their income on food. Thus a person living on $2 a day spends $1 a day on food. When food prices go up by 100 percent, s/he must spend $2.00 a day on food or purchase less food. The result is s/he purchases less food, leading to increased hunger, and has much less left over for other necessities such as housing.

(This is a crisis that is really pretty much unimaginable for most people living in the United States.  If you do want to imagine it--or live it--imagine yourself living in your garage--you definitely cannot go in your house for anything--with $2 a day to spend on everything.  How much do you live on a day now?  If you are a student, don't just think of your allowance.  The basic way to calculate how much you are living on is to take your entire family's income, divide by the number of people in the family, and then divide by 365 days per year. How much is this for your family--and how many times greater is it than $2 per day? The median family income in the United States was $48,201 and the average family size was 3 people (rounding slightly).  So the average income per day per person in the United States was $44 or 22 times greater than the poorest people in the world. So it is very difficult for our human imaginations to grasp what it would be like to live on 5 percent of our current income.)

Recognizing that there is a crisis for most poor people in the world, it must also be recognized that higher food prices represent a significant opportunity for a substantial fraction of the world's poorest people--perhaps 30 percent?--that are farmers with enough land--at least several acres--to earn most of their living from working their land.

What are the causes of the increase in food prices and the crisis?

Economists (I am one)  would say demand is growing faster than supply.  What are the factors affecting the demand for food?  What are key factors affecting the supply of food?

Demand side:

There has been strong economic growth for the world economy over the past 10 years or so. There has been considerable economic growth in China and India, two key countries that have very large, and  relatively poor populations.  This has pushed up the demand for food in these countries, and this has happened as well in other developing countries.

The demand for food is (what economists call) price inelastic.  That is to say, the quantity people demand of food does not vary much with changes in prices.  If a one percent change in price leads to a less than one percent change in quantity demanded, then the demand is said to be price inelastic. (Wikipedia definition of price elasticity) Price times quantity demanded = total amount spent on food.  Supply has tended grow faster than demand over the past 50 years or so, which has worked in the food consumer's favor, as the percentage of the budget that each consumer spends on food has tended to decrease. (Now however, for some period of time at least, the tables have turned.) With price inelasticity, changes in the quantity supplied will lead to large (percentage) changes in the price. 

Speculation  Commodity speculation has been widespread.  Speculation can be good or bad, and in fact it can be good and bad at the same time. Speculators are basically institutions with money that try to buy a particular commodity such as rice at a low price and sell it at a higher price.  The reason why this  is good is that it diverts commodities from a low value use to a higher value use.  The bad  is that it may well take away commodities from poor people (see fuller explanation below under production for export),  it can introduce a certain panic leading to hoarding and higher prices than would otherwise be the case, and there may well be ways that the markets can be 'gamed' (manipulated) leading to higher prices.  (Enron and other companies manipulated prices in the California electricity market (see Wikipedia's California electricity crisis), and this may well be true for food commodities as well.)

Supply side: