While the attention of the international community is presently focused on the crisis in financial markets, the world’s poor are still trying to manage the effects of the food crisis. Food prices have fallen in recent months, but they are still well above the levels seen historically. Cereal prices are still twice as high as they were in January 2006 (Figure 1). This keeps the world’s poorest countries in a very vulnerable position, with worsening balance of payments, inflationary pressures, and a large proportion of their population struggling to survive.
Figure 1. Real agricultural prices 2006-2008
Source: Bruegel calculations based on IMF Commodity Price Index
High commodity prices, exacerbated by a slowing global economy, mean that the challenges for low- and middle-income countries are still great, as highlighted recently by the IMF in the update of their work on the macroeconomic impact of food and fuel prices (IMF, 2008). With commodity prices projected to remain higher than the average of the past two decades, these are times for global action. Increasing acreage worldwide and raising productivity – especially in developing countries – should be at the top of the agenda. But the global environment also requires the adaptation of existing EU policies.
Rethinking EU policies
As described in Bruegel’s Policy Brief “The New Food Equation: Do EU Policies Add Up?” (Delgado and Santos, 2008), food prices will remain high in the medium term due to permanent demand and supply shocks. This new equilibrium changes the context in which EU policies, particularly those related to biofuels, trade and development, are developed.
The EU proposal to increase the share of biofuels in transport to 10% of total fuel consumption has become controversial on two counts. First, the impact of biofuels on food prices has driven some to advocate the abandonment or postponement of the target. Second, recent scientific evidence casts doubt on the effectiveness of biofuels in reducing greenhouse gas (GHG) emissions on account of land-use change.1
EU biofuels targets aim to reduce oil dependence and GHG emissions. Should the EU relax its biofuels targets in order to reduce pressure on food prices? Before answering this question, it should be clarified whether biofuels actually contribute to the objectives set.
Biofuels do not contribute to energy security. Biofuels might reduce oil dependence but at a cost above that of oil. The cost of biodiesel is expected to be above the cost of fossil diesel for the next decade.2 Subsidising biofuels risks being an expensive insurance policy to hedge high and volatile oil prices.
Biofuels are a costly way to reduce emissions. It is not possible to generalise about the contribution of biofuels to emissions reduction. While sugar cane-based ethanol produced in Brazil reduces emissions by 90% compared to use of petroleum, corn-based ethanol produced in the US saves only 10-30%.3 Adding the impact of land-use change, transport to the point of consumption and other indirect emissions, the total balance can be negative. In order to guarantee a positive balance, the European Commission has proposed an “environmental sustainability” principle, which entails that biofuels comply with certain minimum requirements in order to qualify towards achieving the targets.
However, even if the sustainability criteria were strictly applied, the question is whether it is cost-efficient to reduce emissions by using biofuels. The estimated cost of carbon abatement through biofuels in 2020 will be on average €132.6/tCO2 (with wide variations depending on the crop), which is well above the 2020 shadow price of carbon of €41.9/tCO2 in 2020.4,5 Having a specific target for biofuels will substantially increase the cost of reducing emissions and therefore constitutes an obstacle to reaching the EU global emissions reduction target.
Leaving aside the unintended impact on agricultural prices, biofuels are thus not the most effective and cost-efficient tool to secure energy supply and reduce emissions. Thus, ambitious biofuels targets can be counterproductive in terms of tackling climate change.
Targets should be abandoned. This does not imply that research and innovation in alternative sources of energy should be dropped. Furthermore, if oil prices stay high, biofuels will develop naturally without any need for government support. For example, Brazilian bioethanol constitutes a competitive alternative to oil at current prices. Ending subsidies to biofuels does not necessarily mean the end of biofuels and, consequently, their impact on agricultural markets will be long-lasting.
Trade and development policy
Food security does not mean self-sufficiency. In a world of global scarcity, we need to make the best use of land and other resources. This implies producing where it is most efficient as well as liberalising trade so that accurate price signals can be sent worldwide and so products can reach markets. Global integration, not regionalism, is the way to make the most from scarce resources.
Free trade increases global welfare. Free trade would imply a shift of production from rich countries to less developed countries where production is, in global terms, more efficient. Free trade would also lead to an overall increase in global welfare as production becomes more efficient (Figure 2). It is estimated that developing countries would collectively gain 0.8% of GDP, while the gain will be 0.6% of GDP for developed countries. This figure might look modest, but it is close to the unfulfilled 0.7% development aid commitment made six years ago.
Figure 2. Welfare gains from free trade in agriculture
Note: Gains by 2015 from eliminating tariffs and subsidies existing in 2001 as a percentage of real GDP in 2015.
Source: Anderson et al, 2006
However, poor food-importing countries may be worse off. Agricultural trade liberalisation would push prices up on average, owing mainly to the removal of subsidies in developed economies. Large net exporters like Brazil would gain via higher exports and revenues. Rich countries would gain via lower subsidies to agriculture. But net food importers such as Mozambique and Bangladesh would lose out. The food price surge has dramatically increased their import bill. Bangladeshis and Mozambicans today pay $1.5 billion more for their food imports than in 2005. Under free trade, welfare would fall in these countries by 0.3% and 0.5%, respectively (Figure 3).
Figure 3. Distribution of gains from free trade
Source: Hertel et al, 2007
This makes the case for aid stronger. Uneven distribution of the gains from free trade and the food price hike call for increased international aid for those low-income countries that are adversely affected. Such international aid should target the most vulnerable consumers in poor countries and should assist developing countries in finding ways to increase productivity in the agricultural sector. In the summer FAO high-level summit on food prices, governments committed to an additional $1.2 billion in aid for all developing countries to cope with the crisis. Merely compensating Bangladesh for the recent rise in food prices would absorb this entire amount. Hence, this additional assistance is not nearly enough.
In short, we need more trade liberalisation to secure food provision and increase welfare. But we also need more aid at the international level to help the poorest countries deal with the current negative price shock and with the potential effects of liberalisation. Also, assistance should be provided to increase substantially the efficiency of the agricultural sector in developing countries. This would not necessarily require additional commitments – several EU countries are still far below their development assistance target of 0.7% of gross national income.
May the crisis of the wealthy not overshadow the crisis of the poor.
Anderson, K., W. Martin, and D. van der Mensbrugghe, 2006, ‘Distortions to World Trade: Impacts on Agricultural Markets and Farm Incomes.’ Review of Agricultural Economics 28(2):168–94.
Deconti, M., 2008, ‘Estimating the Cost-effectiveness of Biofuels.’ Economics Group, Defra.
Delgado, J. and I. Santos, 2008, 'The New Food Equation: Do EU Policies Add Up?', Bruegel Policy Brief 2008/06.
Hertel, T.W., R. Keeney, M. Ivanic and L.A. Winters, 2007, ‘Distributional Effects of Agricultural Reforms in Rich and Poor Countries’, Economic Policy, April, pp. 289-337.
IMF, 2008, “Food and Fuel Prices – Recent Developments, Macroeconomic Impact and Policy Responses. An Update” IMF Board Paper
OECD-FAO, 2008, Agricultural Outlook 2008-2017.
Searchinger, T., Heimlich, R., Houghton, R., Dong, F., Elobeid, A., Fabiosa, J., Tokgoz, S., Hayes, D., Yu, T., 2008, ‘Use of U.S. Croplands for Biofuels Increases Greenhouse Gases Through Emissions from Land-Use Change.’ Science, Vol. 319. no. 5867.
1 See Searchinger et al, 2008.
2 OECD-FAO Agricultural Outlook 2008-2017.
3 World Development Report 2008. Focus B, Biofuels: the promise and the risks.
4 See Deconti, 2008.
5 The shadow price of carbon is an estimate of the costs of the damage caused by one additional tonne of carbon being emitted into the atmosphere.