Blog Post

Regional Trade and Food Price Volatility

A new book by the Center for Development Research (ZEF) and the International Food Policy Research Institute (IFPRI) , with support from the CGIAR Research Program on Policies, Institutions, and Markets (PIM) , examines the stability pillar of FAO’s four pillars of food security , focusing specifically on price volatility and extreme price events in food markets. Food Price Volatility and Its Implications for Food Security and Policy uses both microeconomic and macroeconomic analyses to look at how market volatility impacts politics, agriculture, climate, and food and nutrition security.

The book contains several chapters relevant to the topic of food price volatility in the context of Africa. Chapter 13, Transmission of Food Price Volatility from International to Domestic Markets: Evidence from Africa, Latin America, and South Asia , investigates whether food price volatility in developing countries is in fact transmitted from international agricultural commodity markets or is more determined by domestic factors. Price volatility is particularly important in these countries because low income consumers spend a large share of their income on food. For example, in Tanzania, low income households allocate more than 60 percent of their budgets to food purchases. In addition, smallholder farmers in developing countries who rely on food sales for their income often have limited ability to time their sales, meaning that they may be forced to sell their goods even if prices have unexpectedly dropped rather than waiting for prices to return to a higher level.  Thus, both poor producers and poor consumers are particularly vulnerable to sudden changes in food prices.

The chapter examines the effect of the global price of maize, rice, wheat, and sorghum on 41 prices of grain products in 27 countries across Latin America, Africa, and Asia. Monthly price data from January 2000 to December 2013 were used, and the study compared the volatility of domestic prices (using the standard deviation of domestic price returns) with the corresponding predicted volatility from the study’s estimated model. The authors expect that transmission of price volatility from world to domestic markets will be greatest when: i) international trade in a particular commodity is large relative to domestic production or consumption of that commodity; ii) trade restrictions are low; iii) the country’s government does not intervene to stabilize the domestic price of the commodity; and iv) transport costs between domestic and global markets are low.

The authors find that estimated volatility in food prices was twice as high in Africa as compared to the other regions. However, the study finds that for maize, most African countries do not see statistically significant volatility transmission because many of them are virtually self-sufficient in maize production; net trade in maize among these countries is only less than 9 percent of domestic production. However, Ethiopia, Nigeria, and Benin did see significant volatility transmission of maize prices at the 5 percent level. For rice markets, volatility transmission is significant in Senegal, whose rice imports equal 82 percent of its domestic production; Mali, on the other hand, imports no more than 16 percent of its domestic production and so volatility transmission is low in this country. Similarly, Ethiopia, which imports 32 percent of its domestic wheat output, saw high levels of transmission in the wheat market.

Overall, the chapter finds that international food price volatility is generally not transmitted to domestic markets if the ratio of traded volume to domestic production is less than 40 percent. The authors also conclude that in cases in which trade is minimal but volatility is still transmitted to domestic markets, this could be explained by the transmission of anxiety or market panic from international to domestic markets; however, more research is needed on this alternative explanation.

Chapter 16, Regional Trade and Volatility in Staple Food Markets in Africa , discusses how cross-border trade flows will influence the level and stability of African countries’ domestic food supplies. Intra-African and intra-regional trade is increasing and African markets are becoming larger destinations of agricultural exports by other African countries; these changes could have important implications for price levels and price stability in the region.

Regional trade can entail lower transport costs, more foreign exchange availability, and more consideration of local populations’ dietary preferences than trade on the international market. The authors note that this makes increasing regional trade an important complementary policy to increasing global trade as a way to boost stable food supplies by smoothing the variability of countries’ domestic food production.

The study measures production volatility (sudden, unexpected changes in the amount of food produced) at both country and regional levels in three economic groupings (SADC, ECOWAS, and COMESA) and finds that SADC has the highest level of aggregate volatility (more than two and three times that of ECOWAS and COMESA, respectively). Across all regions, national production volatility is considerably larger than regional volatility for most countries (with regional production generally more stable). However, there are exceptions (such as the Democratic Republic of Congo and Côte d’Ivoire). Burundi and Uganda have relatively low volatility, less than twice the regional average, while Malawi, Zambia, and Zimbabwe have high volatility, at least five times higher than the regional average. Kenya has moderate volatility, falling between these two previous groups, while Mali, Liberia, and Senegal have volatility more than three times higher than the regional ECOWAS average. Clearly, countries with moderate and high domestic production volatility would benefit the most from increased regional trade to stabilize domestic food supplies.

The study finds that countries will also benefit more from regional trade if their domestic production fluctuates more (is more volatile) and is weakly correlated with production of other countries in the same region. Countries in the most volatile region in the study, SADC, were found to have the highest concentration of weakly correlated country production levels. This combination of high production volatility and weak correlation with other countries’ production suggests that SADC countries would benefit greatly from increased regional trade.

Having determined that increased regional trade would be beneficial for domestic food stability, the study then turns to the question of whether the potential currently exists to increase cross-border trade in these regions. Despite recent growth in trade, the level of intra-African and intra-regional trade remains very low; intra-African markets only accounted for 34 percent of total agricultural exports from African countries between 2007 and 2011. SADC had the highest share of intra-regional trade among the study regions during this period, at 42 percent, while ECOWAS had the lowest at only 6 percent. COMESA’s share of intra-regional trade was 20 percent during these years.

As the authors point out, the goal of increasing regional trade supposes that countries have sufficient room for product specialization; while countries in the same region may have similar production patterns due to similarities in resources, different levels of technological investment, distance to and ease of trade with other markets, and differences in dietary patterns and consumer preferences can all lead to specialization within a region. Thus, the study looks at a series of indicators to assess countries’ actual degree of specialization in agricultural production and trade in these regions to determine whether there is the potential to expand cross-border trade.

The majority of countries appear to have sufficient dissimilarity in their production and trading patterns, suggesting there is in fact room within each of the three sub-regions to increase regional trade. The authors suggest that policies to promote regional trade, such as removing trade barriers and reducing tariffs, can help protect domestic food markets against production and related price shocks.

By: Sara Gustafson, IFPRI