First published: Monday, 28 April 2008

The world economy has many problems but none more pressing than what is happening to food prices. 

There have been food riots in Haiti, the Philippines, Ethiopia, Indonesia and several other nations. 

Twenty thousand desperate textile workers in Bangladesh went on a rampage, giving rise to fears of wider instability, since the garment industry accounts for three-fourths of the country's exports. 

Global food prices have been rising over the last three years; but in the last few months they have spiralled out of control. 

Over the last 12 months the average price of food has risen by 56%, with wheat rising by 92% and rice, the staple of half the world, by 96%. 

This has given rise to the spectre of famine; and the crisis is being made worse through misdiagnosis. 

Some commentators have remarked how this is all a matter of supply and demand and if governments do not interfere in trade, the price rise will bring a supply response, which will cause prices to level out. 

Sure, demand and supply play a role, but there is much more to the current crisis. Understanding this is not easy since we have not seen a food-price surge like this in 30 years. 

There is no doubt that demand for food is rising as the world's population increases and there is new prosperity in India and China. Moreover, as people switch to greater meat consumption this causes greater demand for grain, since rearing cattle and poultry is a particularly grain-intensive activity. 

There is also the increase in the production of biofuels in industrialized nations. This has caused over 20% of corn and rapeseed production in developed countries to be diverted away from food. 

Small triggers

But all these changes have occurred over a long time and cannot explain the price spiral of the last few months.

A more proximate cause is the severe drought in Australia and shortfall in the production of staples in Ukraine and Kazakhstan. These are, however, not big enough to explain the large inflation. 

To understand the latter we have to analyse how these small triggers have caused speculative moves and given rise to a complex brew of corrective measures. 

India, Argentina and other food-exporting nations have, in response to global inflation and in order to protect their own consumers, imposed restrictions on exports. 

This is an understandable move, but it exacerbates inflation in food-importing countries. 

Moreover, the policy of holding prices down for the benefit of consumers can dampen farmer incentives. In Pakistan this year farmers have used about 600,000 tonnes of fertiliser, which is a drop of about 50% from earlier levels. This is bound to mean less on wheat production. 

Massive aid

In thinking about global policy, we have to distinguish between the short and the long run.

In the immediate scenario there is no escape from massive government and international agency intervention in the form of aid from rich nations and subsidies to at-risk consumers. 

If the state can bail out Bear Stearns, it surely can help poor consumers stave off famine. 

Many economists will tell you that the ideal intervention to help the poor is to simply give them money (a negative income tax) - that shores up their income - rather than directly controlling prices. In general, this is correct advice; but not in this case. 

Suppose we collect $1000 from the rich and hand this out to the poor. Since the rich spend a tiny fraction of their money on food and the poor a large fraction, this transfer will cause food prices to rise. 

In general, this would not matter since the price was being driven up by the greater purchasing power of the poor. But in the present precarious situation, the risk is that if the negative income tax does not reach all the poor, then the ones who are left out will see their position deteriorating as prices rise further. 

No escape

In the Bangladesh famine of 1974, it was the government's success in protecting the urban poor from food shortages that exacerbated the problems of the rural population. 

Therefore, in a crisis like the present one, there is no escape from holding consumer prices down. Ideally, we should drive a wedge between the price that producers get and the price that consumers pay. 

None of this can be a long-run policy, since it will cause food production to decline and governments to go bankrupt. Long-run policy has to be more market-oriented, creating incentives for producers to increase output and boosting the incomes of the poor. 

Relative price fluctuations are an unavoidable part of an efficient economy. This becomes worrying when some people are so poor that a small rise in price becomes a life and death question for them. 

This crisis therefore should also be a reminder that the level of inequality that prevails in the world today is untenable.

Dr. Kaushik Basu, Professor of Economics and Carl Marks Professor of International Studies at Cornell University

This article first appeared on the BBC News Column Monday, 28 April 2008.