Drought: A natural disaster made worse

The economic impact of the drought will be more severe in emerging markets. With the global economy slowing, the bad harvests could not have come at a worse time. India has had trouble taming its inflation and now it will get worse

The world’s food supply is in danger. Droughts around the world have slashed harvest forecasts. This time the problem is especially severe in the United States. Two consecutive La Niñas, cooler than average water temperatures in the eastern equatorial Pacific, have pushed the polar jet stream to the north opening up a large sections of the agricultural rich Midwestern US to temperatures in excess of 37°C and little rain. It has been the warmest 12-month period in the continental US since record keeping began in 1895. The effect on crops has been a disaster.

It is the worst drought in 55 years. As of late July nearly two-thirds of the US is experiencing some precipitation deficit. As of this week, the American Agriculture Department (USDA) declared 1,369 counties in 31 states as disasters. The designation is important because it allows the local farmers to qualify for aid. This is the largest number in the history of the program. The USDA also reported that 45% of US corn fields were in ‘poor’ or “very poor” condition up from 38% a week before. While 35% of the soyabean crop was in ‘poor’ or “very poor” condition, up from 30% a week ago.

Of course, the markets have reacted. The price of corn has hit a record high at $339 per metric tonne, 6% above its previous high in March 2011. Soyabean is not far behind. It is now selling at $662 per metric tonne, 20% above its all-time high reached in June 2008.

But the drought is not just a problem for the US. American corn represents 52% of the global exports in that commodity and 43% of the exports for soyabean. And the weather is not just bad in the US. Droughts and sometimes floods have also hit the Chernozem, the black earth belt that includes parts of Serbia, Bulgaria, Romania, Ukraine and Russia all the way into western Siberia. In Kazakhstan the world’s sixth largest export, the crop will be only 48% of last year’s record harvest. The price of wheat has risen 35% from May and is now selling for $356 a metric tonne. While this is still 18% below the record price of $439 reached in February 2008, it is certainly not really good news. 

The weather is also bad in India. Two months into the monsoon and the season rainfall is 22% below normal. In the significant agricultural areas of Maharashtra and Punjab it is only 30% to 40% of average. Brazil’s soyabean crop was hit by dry conditions and was 13% below prediction. Western Australia, its biggest wheat growing region, had below average rain in April to June and an exceptionally dry July. Only France and Germany expect good harvests.

The economic impact of the drought will be wide spread. With the global economy slowing, the bad harvests could not have come at a worse time. Food inflation will complicate stimulus efforts. The US is expecting food prices to rise by 4% to 5%. The impact on emerging markets will be far more severe. Food makes up a far greater part of the budgets for the poorer populations in emerging markets. India has had trouble taming inflation and now it will get worse. Inflation was slowing in China, but the rise of global food prices and recent efforts to prevent a hard landing may reverse that trend. In addition, many more people are dependent upon agriculture for their incomes. In India half of the population is dependent upon agriculture for their income. Although urban populations are rising, even in China, 49% still live on farm incomes.

Government planning for famine has been common since the Egyptians, but more recent well meaning efforts have exacerbated the problem rather than solving it. Almost all countries have some sort of subsidy programme in place. They subsidize cheaper food or inputs like fertilizers. Some countries subsidize agricultural prices. Other countries use more drastic means like price controls or export bans. Often farmers’ profits are restricted to benefit the urban poor, who are more likely to riot and possibly overthrow governments. The result is often the same. These attempts to manipulate the market do not encourage farmers to grow more food. Often they simply bankrupt governments’ budgets.

Another more destructive form of subsidy has been the use of crops to create bio-fuels. Food margins are quite narrow and the difference between a surplus and shortfalls are small. In the US 40% of the corn crop has been artificially diverted for the production of ethanol. The reason for these programmes is all the same. Although economically inefficient, they are politically useful.

Government planning for disaster is certainly well within the purview of good policy. Perpetuation of a particular party by distorting the market is simply the recipe for more disaster.

(William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and has spoken four languages. Mr Gamble can be contacted at [email protected] or [email protected].)
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