How the CAP contributes to world market food price volatility

The contribution of export bans to the world food price spike in 2008 is now well-established, particularly for commodities such as rice (for example, see Abbott, 2012 and Sharma, 2011). Martin and Anderson (2012) have calculated that over the 2005-2008 period more than 45 per cent of the explained change in the international price of rice was due to changes in border restrictions that countries used in an attempt to insulate themselves from the initial increases in price.

Countries resort to export bans in an attempt to keep down the price of food to domestic consumers. When undertaken by countries whose level of trade is big enough to influence the world market price, then an export ban also has ramifications for other countries.

Not only does an export ban, such as the Russian grain export ban in August 2010, by restricting supplies to the world market have an immediate impact on world prices. But by making everyone jittery about the security of future supplies it makes it more likely that importers will begin to panic and start to stockpile thus adding to demand while other exporting countries, in turn, also become more likely to restrict their exports – what Giordani, Rocha and Ruta (2012) call the multiplier effect of export policy. The policy of stabilising prices for domestic consumers makes the world market price more volatile for everyone else.

Not surprisingly, when the G20 asked a panel of international organisations to advise them on potential policies to prevent future price spikes, the group were tempted to propose a ban on export bans. However, recognising that this advice was politically unrealistic, their report recommended instead developing an operational definition of a critical food shortage situation that might justify consideration of an export restricting measure.

The meeting of G20 Agricultural Ministers in Paris in June 2011 failed to agree on any measures to limit export restrictions on food. Their communique which noted that “the first responsibility of each member state is to ensure the food security of its own population” was even seen as an implicit backing of export restrictions.

The only outcome was an agreement to exclude humanitarian purchases by the World Food Program from such export restrictions. This proposal was subsequently taken to the full World Trade Organisation membership for approval at the Geneva Ministerial Council meeting in December 2011 but even this limited measure failed to achieve consensus.

The EU’s use of varying import levies

Variable import levies have exactly the same destabilising effect on world markets as export restrictions. When world market prices are rising due to a global supply shortfall, a country using a variable import levy lowers the size of the tariff it levies, often down to zero, in order to protect domestic consumers by preventing the pass-through of higher world market prices.

The EU made widespread use of variable import levies prior to the WTO Agreement on Agriculture in 1995. In principle, this required the EU to convert all its variable levies into fixed tariffs. However, there remain some loopholes.

First, many of the EU’s agricultural tariffs contain a specific, or fixed, component which is often the largest element of the tariff. A specific tariff of, say, €20/tonne on wheat is equivalent to a 20% ad valorem (or percentage) tariff when the world wheat market price is €100/tonne but drops to the equivalent of a 10% ad valorem tariff if the world wheat market price increases to €200/tonne. Thus, implicitly, a specific tariff functions as a type of variable import levy and directly contributes to increased volatility on world markets.

The EU makes the situation worse, not least for key food grains, by varying its applied tariffs within its agreed bound rate (maximum) ceilings. The last WTO EU trade policy review described the operation of the CAP import regime for cereals as follows:

In response to fluctuations in world prices, the EU has, within the limits of its bound tariffs, changed its MFN applied tariffs. It reduced tariffs on cereals to zero in January 2008 in response to high world prices, and reintroduced them at the end of October 2008. For wheat, the tariff is based on the difference between world prices and 155% of the intervention price, up to the bound rate of €95 per tonne for high quality wheat and €148 per tonne for high quality durum wheat with similar systems for other cereals. The resulting duty has been set at zero for: durum wheat and high quality soft wheat since 1 July 2010; maize since 17 August 2010; and sorghum and rye since 19 October 2010. In February 2011, the Commission announced that the in-quota tariff for low and medium quality soft wheat and feed barley would be suspended until end-June 2011. Such changes in duties in response to world market prices can reduce predictability and exacerbate fluctuations in world market prices.

While the reduction of duties on imported grains to zero is, in principle, to be welcomed, the EU reserves the right to, and no doubt would, reintroduce duties on grain if the world price were to drop. It is precisely this counter-cyclical behaviour to stabilise the domestic grain price which contributes to the destabilisation of international grain prices.

Looking ahead to the G8 Camp David meeting in May

In the non-agricultural negotiations in the Doha Round, the EU has been a staunch supporter of stronger disciplines on export taxes, seen as a way of getting around the general WTO prohibition on export restrictions (though there is a general exemption for export prohibitions or restrictions temporarily applied to prevent or relieve critical shortages of foodstuffs or other products essential to the exporting contracting party).

Global food security will be on the agenda of the forthcoming G8 Summit to be held at Camp David in the US on May 18-19 2012. The EU could make an important political contribution to this meeting by declaring that it intended to keep its applied tariff on grains at zero per cent regardless of what might happen to the level of world grain prices in the future. Whatever arguments there might be for poor developing countries to use trade policy to stabilise domestic prices do not apply in the case of the EU.

This post is written by Alan Matthews.

Photograph © Copyright Trish Steel and licensed for reuse under a Creative Commons Licence.

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4 Responses to “How the CAP contributes to world market food price volatility”

  1. Simon Ward
    April 15, 2012 at 09:15 #

    I suggest that EU behaviour pre 2006 was a major cause of the current imbalance and price volatility since 2007. Export restitutions were applied and stocks run down during years when global consumption was greater than supply. EU action lowered prices in a time of shortage and producers responded by reducing production below potential acerbating the shortage when it did arrive. Classic Forest economics of a stock holder.

  2. Alan Matthews →
    April 15, 2012 at 15:47 #

    @Simon

    You are right to suggest that the EU’s use of export subsidies has also been destabilising for world markets (although I suspect you meant to write they were applied when global supply was greater than consumption, as when dairy subsidies were reintroduced in 2009). I wanted to highlight in the post that the EU’s use of varying import tariffs has the same effect.

  3. George Potter
    May 1, 2012 at 12:21 #

    How exactly are EU tarrifs (the things you identify as the cause of the problem) anything to do with the CAP? They’re completely separate!

  4. Alan Matthews →
    May 1, 2012 at 13:43 #

    @George

    Interesting comment. Legally, you have a point, in that tariff policy is part of the EU’s Common Commercial Policy and not part of any of the CAP regulations (unlike export subsidies, for example).

    However, in practice, border protection has long been seen as part of agricultural policy as its main objective is to support agricultural production and farm incomes within the EU. This linkage is recognised in the WTO Agreement on Agriculture where market access (i.e., tariff policy) is one of the three pillars of agricultural support to which disciplines apply in that Agreement. Tariff simplication, including the proposal that up to 90% of all developed country bound tariffs should be expressed as simple ad valorem tariffs, is one of the issues under discussion in the agricultural part of the WTO Doha Round negotiations.

    When the EU lowers the applied tariff rate on particular imports to zero, it does this for agricultural policy and not trade policy reasons. Nonetheless, a more accurate heading on the post would be how EU tariff policy, or EU agricultural policy, contributes to world price instability, rather than the CAP per se. Well spotted!