Streetwise Professor

January 31, 2011

A Year of Living Dangerously

Filed under: Economics,Energy,Financial crisis,Politics,Russia — The Professor @ 1:16 pm

Inflation is picking up in Russia–and elsewhere.  This presents a policy quandary for Russia.  Sadly, some Russian policymakers are considering the worst response: price controls.

Deputy Economics Minister Andrei Klepach said on Monday that the Economics Ministry may consider resorting to the tried-and-tested price control system to contain prices, but added that there were no plans to implement this in the near future. “This is a tool which can be used, and I do not rule out that such restrictions will have to be used this year,” Klepach told Interfax in an interview. Price caps, if and when introduced, are expected to affect staple foodstuffs like buckwheat, potatoes and other fruits and vegetables, he said. According to this seldom-used regulation, the government can impose price controls on certain food items for a period not exceeding 90 days if there is an increase in retail price of 30 percent or more in one or more regions.

Fortunately, however, some policymakers and market observers recognize the folly of these controls:

However, many economists, including the Russian Economics Minister Elvira Nabiullina, have rejected direct price control as a method to stabilize rocketing food prices. Nabiullina suggested during a one-to-one meeting with Prime Minister Vladimir Putin in September that the government could use other non-distortive means, such as market intervention from reserves, to keep prices down. Alfa Bank economist Natalia Orlova supports such views, adding that price control has never been an efficient way to keep down inflationary pressure. “Price control is a stop-gap measure meant to postpone the worst till later years,” Orlova said. “As Russia enters the election season, government officials believe such measures could provide temporary relief by keeping inflation below ten percent. But would it last?” The best that can be expected, she said, is a worsening of Russia’s trade relations with other countries. “For many companies, it will be no longer attractive to buy certain items from abroad – and even in the domestic market,” Orlova said. Ideally, Russia simply needs to increase the level of local competition in order to combat high prices, Orlova said. “One of the explanations for a high level of inflation in the country in recent years is that there is still a lack of competition in a number of markets,” Orlova said. “In both the construction and consumer markets, for instance, there are only a handful of big players and these players are able to dictate prices.”

Nadorshin, who heads market research at Jones Lang LaSalle, said placing price caps is hardly the most productive measures to contain rising inflationary pressure. “We have applied this method before in 2007 and again in 2008, and the effects on prices were quite negligible,” Nadorshin said. “Price control in the past has also led to hoarding by farmers and there is no guarantee that farmers would not do so this time around.”

Another hurdle before policymakers is that rising prices on staple foods is not peculiar to Russia, he said. Many developing countries including India, China, Malaysia and Indonesia are all facing similar problems. “If the problem is global, homebrew solutions can only exacerbate the situation,” Nadorshin said.

Overall, Russian macro policies have been reasonably sane in recent years.  The reluctance to employ price controls is a sign of good sense.

Russia, of course, is not the only nation struggling with food price inflation.  Emerging markets in particular are facing acute problems.  Food price inflation is arguably the issue that caused the widespread dissatisfaction with the governments in Tunisia, Yemen, and Egypt to coalesce into mass protest and revolt.  China is very uneasy about the political implications of rising food prices.

Some of this is driven by bad harvests in Russia, Argentina, and Australia.  But especially in emerging markets QE2 is a major factor.

On Friday I gave a talk at the Argus Americas Crude Oil Conference.  The title was “A Year of Living Dangerously.”  The basic theme is that there are many sources of uncertainty that will buffet economies and policymakers in the coming year.  A major one is QE2.  Although it appears to be having only limited success–if any–at achieving its stated purpose of spurring employment growth in the US, it is having huge collateral effects around the globe.  Again, in emerging markets in particular, hot money is putting pressure on governments and central banks; they don’t want to let their currencies appreciate relative to the dollar, which means importing inflation.  The policy responses are unpredictable.  There is gaming between countries.  Policy errors are more likely in such an environment.

And perhaps most importantly, as Sherwin Rosen said to my rather startled Econ 300 class at Chicago in the early-80s, “inflation F*CKS UP relative prices.”  Of currencies.  Of goods and services (most notably, of commodity prices relative to other stickier prices.)  This leads to distortions, resource misallocations, waste.

Some of the consequences are economic.  Others–pace Egypt–can be social or political.  And who can foretell what the consequences of monetary and policy gamesmanship between China and the US?

On its own terms, I think QE2 is dubious policy.  As I wrote soon after it was launched, it is designed to fight deflation, and prevent a Fisherian deflationary spiral–but who ever saw a deflation with spurting commodity prices across the board?  But its unintended consequences are ominous.  Bernanke is the Sorcerer’s Apprentice to top all Sorcerer’s Apprentices.  Just what will get inundated?

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  1. The drought in Russia this past summer was forecast months back to take a significant toll on cereal grains this year, so that part is unsurprising. I agree price controls are a stopgap measure at best, and tend long-term to hurt those who can least afford it, like so many temporary fixes.

    In, “The Politics of Hunger”, Paul Collier highlights the resistance to GM crops and seeds as a major factor in the clumsy attempts to manage global demand for food. He suggests “The first giant that must be slain is the middle and upper-class love affair with peasant agriculture” – which boasts clout-rich supporters such as Prince Charles – instead arguing for regulatory changes (as you evidently agree) for short-term increase, fundamental organizational change that can raise production in the medium term and technological innovation for sustained production growth. He supports the argument for GM seed by pointing out that major innovator Monsanto has committed to never market a seed that cannot reproduce itself. Against this vision, he warns that climate forecasts which track global warming indicate that as Africa gets hotter, at some point the staple food – maize – will become non-viable. A genetically-modified seed might well permit viability for another generation, or indeed until some other solution could be found. Africa’s example could happen anywhere, it’s only a matter of scale.

    What are your thoughts on the potential impact of GM foods?

    Comment by Mark — February 1, 2011 @ 11:45 am

  2. @Mark–Re GM, I haven’t thought about it deeply, but here are some initial reactions.

    1. GM can effectively speed up evolution, thereby permitting more rapid response to shocks (e.g., climate–which I am somewhat skeptical about, pests) that could otherwise threaten more widespread food shortages and even starvation. This can be a very great benefit.

    2. I definitely do not romanticize peasant agriculture, and agree that the victims of the “love affair” are the same peasants–who are quite obviously not all that thrilled about their lives, given the lengths to which many go to escape it. Think the favellas in Rio are bad–well, a lot of people chose to go there because life in the countryside is even worse. Therefore, doing things that increase agricultural productivity have some appeal. But it must be recognized in the short run to medium term even the effects on per capita income will be limited due to population growth.

    3. I would have less concern about GM if I were confident that liability systems provided the right incentive to avoid adverse consequences. I think that it provides the right incentives regarding some risks in some markets, like in the US. But even a Monsanto can be judgment proof for certain big tail risks, so has too little incentive to avoid them.

    Also, outside of the US I doubt the regulatory and liability systems are effective.

    And the effects might be indirect. For instance, a lot of GM is directed at making crops insensitive to pesticides and herbicides. If misuse of pesticides and herbicides is not deterred in some way–and that’s likely to be the case in many developing areas–the introduction of such crops can lead to overuse of these chemicals. The supplier of the GM seed would almost certainly not be liable for this.

    Also, attributing adverse environmental effects to GM might be extremely difficult even if they exist. This also undermines reliance on liability systems, and would make direct regulation of the use of GM more attractive–although the regulators would also be hamstrung by the inability to establish causation.

    Given these considerations, I could make an argument for taxing GM. Though how high the tax would be is a question that I cannot answer.

    So I would not rule out GM altogether, certainly. In many ways it is qualitatively similar to traditional methods for creating new varieties with certain desirable traits. It has the prospect of speeding and targeting such innovations. Prince Charles-like opposition is the stock of upper class twits who don’t have to face the grinding poverty and backbreaking work that is the true lot of the rural poor. Improved productivity can help relieve that lot, and GM can help improve productivity, but it is not magical. My main concern is getting GM innovators to internalize all the costs of their innovations. That will require institutional innovations, and I think those institutional (liability, regulatory) changes are lagging the scientific change.

    Rather rambling reply, for which I apologize. Just sort of thinking out loud, working my way through the economics of the (excellent) question.

    The ProfessorComment by The Professor — February 1, 2011 @ 9:36 pm

  3. […] This post was mentioned on Twitter by johnjhodges and Roy Cam, R. R said: Prof Pirrong takes on Russia's attempt at price controls But best bit in comments re GMO's & Monsanto. Must read. […]

    Pingback by Tweets that mention Streetwise Professor » A Year of Living Dangerously -- — February 1, 2011 @ 10:35 pm

  4. I remember seeing a documentary suggesting that Monsanto’s most lucrative innovation is legal extortion from traditional farmers who failed to prevent cross-pollination with Monsanto crops.

    Comment by Ivan — February 2, 2011 @ 1:28 am

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