Saturday, May 3, 2008

Let them swim in rice pudding!

The first serious piece of art I ever bought was a photograph of naked, weightless, visually confounding body parts. Human body parts! To be specific, it was female human bodies, of all sizes and shapes, swimming naked in a pool of… rice starch—the visual result of which is a collection of disconnected body fragments floating in a whitish ethereal medium and conveying a sense of “zero gravity” (the name of the series).

The artist, a soul-searched Austrian with the inevitable sense of irony that Europeans seem to be born with, spent days cooking the rice starch, in order to fill up a two-thousand-gallon tank he set up for the photo-shoot at the rooftop of his New York loft.

That was early 2003. Turns out my piece was a tremendous investment, considering how much it has appreciated in value since then. And this for more than one reasons: First my artistic acumen, as the Austrian is gradually rising to international acclaim; secondly, the phenomenal increase in art prices in recent years, as floods of “new” money rushed to anything that bore the banner “store of value,” from stocks and bonds, to real estate to gold to, yes, art.

But when it comes to my photo, one more crucial factor is at play: The price of rice! Rice prices have more than quadrupled since 2003, for reasons ranging from declining productivity, skyrocketing costs of fuel and fertilizers, the battle for acreage as more land is dedicated to ethanol production, drought here and there or the simple fact that the world’s erstwhile poor are discovering the benefits of three meals a day. The outcome? A nice $4,000 windfall to the value of my photo, strictly on a “production cost” basis!

Yet, what is a boon for me, is a hefty blow for billions (repeat, billions) around the globe. Rice is a staple food for more than half the world’s population. It’s no accident that the Japanese describe “luck” as “having a rice dumpling flying into your mouth!” And it’s no wonder that faced with shortages, inflation and social unrest, governments are getting anxious. And many are reacting! What are they doing?

Bashing free trade: Not that it was ever out of fashion, but free-trade bashing is back in force. Indeed, some "quarters" are blaming trade liberalization, and the concomitant reliance on imports to meet local food needs, as a reason for today's woos. Hmmm.. Let's see why.

You may have heard that import tariffs are bad. Here is why. Import tariffs make goods at home more expensive than the same goods sold abroad. For example, a low-cost Thai rice producer may be willing to sell me one ton of high-quality rice for around 1,100 dollars. But if my government imposes, say, a 30% tariff on imported rice, the total price I pay is $1,430—$1,100 to the Thai exporter and $330 to the government. Evidently, I’ll pass this higher price on to consumers—penalizing all of you, from the simple, rice-and-veggies types to those who love swimming in rice pudding!

But tariffs are bad for another very important reason: They impede the efficient allocation of resources such as land, labor and capital. By (artificially) raising the price of, say, rice, they create incentives for entrepreneurs to shift their resources to rice production. Why use my land to breed cattle or build a semi-conductor factory when selling rice is now at least as profitable a business? Why go through the painstaking (and expensive) process of college education, if I can earn a decent living operating a rice miller? Tariffs therefore help “cosset” a small number of producers at the expense of the consuming majority and, importantly, of productive efficiency and scientific progress.

Countries that saw the advantages of free(er) trade moved to lower their tariffs (at least selectively), and have enjoyed lower prices and a more efficient resource allocation ever since… Up till now. As commendable as it is, free trade works provided countries are willing to trade: If I cut my tariffs on rice, give up on rice production and shift my resources to electronics, I implicitly trust that you, the efficient rice producer, will always sell me your rice. But what if you suddenly decided to cheat?

The cheaters: While you might not think of yourself as a natural cheater, think again when, as a government, you’re faced with skyrocketing world rice prices and food riots on the streets. Allocative efficiency no longer looks like the right priority. The burning issue is self-sufficiency.

And so you "cheat," like a slew of countries have done recently, including India and Vietnam, two of the largest rice exporters in the world. In violation of their “gentlemen’s agreement” under free trade, these countries have restricted their exports in an effort to shield their domestic rice prices from world developments. How does this work?

Export taxes have the opposite objective from import tariffs. Whereas the latter aim at increasing the domestic price relative to the world price (to protect domestic producers), export taxes are imposed to keep the domestic price below the world price.

The “mechanics” is simple: Let’s say I am a rice producer in Thailand and the price I can fetch for a ton of rice in world markets is $1,100. But if the Thai government puts a $550/ton tax on my exports, the price I receive in the end is just $550—the rest goes to the government. In this case, I am indifferent between selling my rice to Americans for $1,100 or to my fellow Thais for $550. The domestic price is thus kept (artificially) low. This sounds good for Thai consumers but it discourages rice production and resources are, once again, diverted to less efficient business activities.

So are the "cheated" right to compain? Take a look at the Philippines: The world’s second largest rice importer and a rice-loving nation, the country has recently had trouble meeting its target for rice imports, managing to cover only half of its needs. I'd certainly complain myself in this case, though slamming free trade (as opposed to the violation of free trade rules) might be somewhat misplaced.

Indeed, export taxes contribute to the problem: In principle, soaring world prices should encourage higher production, helping meet part of the additional demand. But with export taxes keeping prices low, local rice farmers no longer have the incentive to raise their production. Worse, the cheaters have now created a precedent that others might follow. Thailand for example, the world’s largest rice exporter, has so far refrained from imposing export taxes, allowing its exporters to expand their production and benefit from the boom. But if I am a Thai exporter, I may be suspicious about what the government might do next. And this uncertainty may prevent me from taking the risk of investing in facilities to raise production. Production is thus kept low, prices high, most of us lose.

So what next? Rice cartels? Unlikely to work—too many producers, too hard to get them to coordinate, too tiny the rice exports as a share of global production (only 6-7% of global rice production is exported), too difficult to adjust rice supply up or down fast enough in response to world price developments (problems ranging from weather, availability of acreage and lack of storage facilities, to name a few).

A return to autarky? Not really, though with food security the word du jour, governments are spending billions of taxpayer money to promote domestic agriculture and, as Malaysia put it, convert entire regions into “rice bowls.” Unclear where this can end and what will imply for debt accumulation, as rice is only one of the staples facing climbing prices, not to mention fuel and energy. The sustainable solution lies in encouraging private investment to be directed to agricultural research and production, which in turn requires the removal of uncertainty over the investor's horizon--and export taxes can't help!

In the meantime, one thing is certain… it might be some time before the Austrian can have an encore of his rice-pudding party in his loft!

Glossary: import tariffs, export taxes, free trade, autarky, cartels, rice pudding.

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