On food prices and the nature of government

(Please see the Daily Star link for the three charts mentioned in the article).
http://www.thedailystar.net/story.php?nid=33134

AMID the intense suffering and pain generated by food inflation, our understanding of its causes is getting murkier. This issue is, predictably but unfortunately, getting increasingly politicised.

Any sound and sustainable solution requires a sound understanding of the issue.

Food inflation is now a macro and global phenomenon. Global price developments are pushing food prices higher all over the world. But vocal and populist, and often fact-free, debates at home are suggesting otherwise.

At a macro-level, how much of overall food inflation can we empirically and directly attribute to our current government? How much of it is just bad-luck or bad-karma? A good way to answer these questions would be to compare food inflation in Bangladesh with that in another relatively well-managed economy.

Here, I compare food inflation in Bangladesh with that in Vietnam. This article, of course, is premised on the assumption that Vietnam is a well-managed economy.

I picked Vietnam as a comparator for the following features:

1. Vietnam has a large rice-eating population like Bangladesh.
   
2. The country is one of the largest producers and exporters of rice.
   
3. She has a fairly successful and cautious macro-management of the economy.
   
4. Last but not least, similar movement of the Vietnamese currency, Dong, and Taka against the Dollar in the recent past.

The comparability of exchange rate movement makes it easier to interpret the domestic food price movement against the backdrop of global price developments. Since food is a tradable good (i.e. you can export or import it), under stable exchange rates, any change in foreign prices is likely to show up in the domestic prices.

In this article, I argue that the evidence suggests that most of our food inflation is likely due to bad-luck. Of course, sufferings from bad luck were perhaps worsened by bad karma (e.g., disrupting supply chains by populist campaign against hoarding or dictating prices by command and control).

I will present three simple charts to make my points.

Both Vietnam and Bangladesh heavily stabilise their foreign exchange rates (Chart 1), because of which, as global rice price goes up in Dollars, import cost in terms of Taka will also be higher. If you import at higher prices, you will charge higher prices from domestic customers. So higher global prices translate into higher domestic prices.

In theory, given the stability of both Taka and Dong against Dollar, we would expect domestic food prices in Vietnam and Bangladesh to move "broadly" similarly. Do we see that in practice? Yes, we do.

Global food prices have been rising very rapidly in recent years (Figure 2). As expected, Vietnamese and Bangladeshi food prices also moved very closely with global food prices. In fact, Vietnamese food prices have recently been rising faster.

This is despite the floods and cyclone last year. During January 2007-January 2008, food inflation in Vietnam was higher than in Bangladesh (Figure 3). This does not necessarily mean that we have had better policies.

There are possibly other domestic forces at play in Vietnam. Vietnam has been growing rapidly, with its domestic demand growing faster than ours. Money supply and private credit have also been growing faster in Vietnam, supported by massive capital inflows during 2007.

Caveats: Of course, these charts are not good at capturing the distributional impact of food inflation on the poor (especially urban) and the people with fixed income. Given that we have higher poverty rate than Vietnam and that the poor tend to spend most or all of their income on food, our pains are possibly more acute than Vietnam's.

True, understanding the causes does not immediately ease the pains. Policies might, at least should, try to. The sad truth is that immediately effective solutions are few and unbearably expensive. Especially when the country is large and crowded like ours and the government is poor (Bangladesh government's revenue as a share of GDP is one of the lowest in the world). (Reminder here: we need to pay our taxes).

To devise credible and sustainable solutions to our food insecurity, we as a society should focus our debates and energy on the following questions:

What are the appropriate and affordable safety nets for the worst affected? Should we finance safety nets by reducing fuel subsidy? How to increase the agricultural supply response? How does food price inflation affect future inflation? What are the roles for monetary and exchange rate policies so that inflation does not get entrenched?

Hopefully, in the short run, a bumper boro harvest will provide some relief. Over the medium term, we should hold thoughtful discussions on the importance of improving agricultural productivity. But, in the meantime, don't let the pundits, politicians, or even populist economists seduce you with the promise of a quick fix guided by fact-free diagnosis. Food inflation is global, and cheap political solutions simply don't exist.

From democratic India and the Philippines to communist China, all developing countries have been hit. Regardless of the nature of the government, the challenge of tackling global food price surge will remain the same.

Let's not trivialise the pains of our people by politicising the debate and short-selling economics.

Faisal Salahuddin is an actuary and macroeconomist.