We're only three months into it, but it's already clear that 2011 will go down as one of the most tumultuous years of this young millennium. Poor crops in grain-exporting countries, including Canada, Australia, Russia and Ukraine, have driven up prices for staples such as bread and pasta. Fears of shortages have caused hoarding by governments in many countries, pushing prices even higher. The latest figures released by the UN Food and Agricultural Organization show the average price of a basket of food (containing meat, dairy, cereal grains, edible oils and sugar) rose a whopping 36 per cent in the 12 months ended in February. And last month's multiple disasters in Japan destroyed important food-producing regions, necessitating a long-term increase in food imports for that country.
Rising bread prices were a major factor precipitating the revolts in Tunisia and Egypt, which in turn inspired the Libyan crisis and unrest in other oil-producing states, driving oil prices skyward. Many countries provide subsidies to keep food and fuel prices far below world market levels. Now, the cost of those subsidies is spiralling out of control.
For example, Egypt's new administration has little choice but to honour deposed president Hosni Mubarak's riot-pressured promise to return the price of bread to a few cents a loaf; this will cost the country more than $2-billion (U.S.) per year. Last year, Egypt's oil minister said providing gasoline at the rate of 31 cents a litre cost the country a staggering $13-billion. As the country prepares for democracy, the new government will face a bankrupting wave of higher prices driving even more costly subsidies.
Earlier this year, Bolivian President Evo Morales met with violent demonstrations after he tried to reduce financially draining subsidies on gasoline, flour and sugar. He backed off, but as the clock ticks, national insolvency nears.
And rising fuel prices seem to be making countries less, rather than more, resolved to cut fuel subsidies. After passage of a law last December to reduce fuel subsidies by 40 per cent over three years, the Indonesian government recently announced the cutbacks would be deferred.
The International Energy Agency estimates that fuel subsidies in 37 of the largest developing countries totalled $557-billion in 2008, a year in which oil prices were roughly the same as current levels. Artificially low fuel prices cause consumption to keep growing even as world market prices rise, driving subsidy costs even higher.
Then there's the huge black market problem. Last year, an estimated $380-million worth of subsidized Bolivian fuel was pirated and resold at huge profits in Chile, Peru and Brazil. India subsidizes kerosene for household use, but more than a third of that fuel is resold on the black market as higher-priced transportation fuel. And a lot of subsidized Mexican fuel crosses the border into the United States.
Food subsidy data in developing countries is shrouded in a labyrinth of complex systems, but there's no doubt it amounts to tens of billions of dollars annually. Controlling food prices below world market levels also has the perverse effect of reducing the price that local farmers receive. The net effect is higher consumption and lower production from local farmers. This drives the most perverse result of all: Poor countries that keep food prices artificially low end up importing more food from comparatively wealthy farmers in developed countries. (Those farmers not only get the full market price, but often government subsidies as well.)
This doesn't mean it's wrong to soften the blow of high food and fuel prices for the poor. But subsidies almost always increase consumption of something already in short supply, and keeping prices artificially low subsidizes the rich as well. All too often, administration of the subsidies enriches corrupt officials and black market traders. It would be less costly and much more helpful to direct the money to the needy as social welfare.
Countries that subsidize are gambling that food and fuel prices will return to "normal" before national insolvency forces politically explosive price increases. But subsidies were financially unsustainable long before the current confluence of global events. It has been more than 200 years since Adam Smith wrote that the "invisible hand" is the lone force that balances supply with demand. The only way the invisible hand can work its magic is through free-market prices.