If we can’t prove that speculation drives food prices, should we regulate it anyway?
One of my more wonk-mind-blowing moments last year was refereeing a debate about financial speculation and commodity prices between Oxfam’s Rob Nash and a UK Treasury wonk who wished to remain nameless. I couldn’t understand either of them (even by international development standards, the language is really weird – try ‘contango’ or ‘backwardation’). I tried to get them to slug it out on the blog, but the Treasury type declined.
So it’s good news that Stephen Spratt of IDS (right) has written a blog post and 20 page paper on food price volatility and financial speculation – Stephen is a City poacher turned gamekeeper, and one of the clearest thinkers I’ve come across on financial markets.
The paper considers the case for and against the prosecution. Stephen sets out (and tries to answer) the key questions:
- How has the relationship between financial actors and food commodity markets – particularly futures markets – changed in the last ten years?
- What have been the benefits and costs of the increased role of financial sector actors in these markets?
- How might the balance between benefits and costs change in the future?
- What reforms, if any, are needed to ensure that benefits exceed costs?
The paper helpfully unpacks different kinds of ‘speculation’ – lumping them all together is really unhelpful, and assesses the impact of high prices and volatility on different groups (see table).
But the most valuable contribution is his thinking on complex systems. Sure there is a clear correlation between rising food prices, volatility and increased financial market activity in commodities, but proving the causal link between them is a different question. His conclusion: ‘Establishing cause and effect has proven to be impossible.’
The pro-market types consider this enough grounds to oppose regulation of speculation. Stephen disagrees. He argues that we need to think harder about the costs and benefits of action if the critics of financial speculation are right, and if they are wrong. If they are right, and speculation is driving food markets, then regulation would help prevent the extremely damaging social impacts of high and volatile prices. If they are wrong, and we regulate anyway, the damage would be limited. So in a version of the precautionary principle, he comes down in favour of regulation. Here’s his conclusion:
‘The policy responses that different commentators favour are strongly influenced by two things. First, their view on the link between increasing financial speculation in futures market and price movements in spot markets. Second, their view on the relationship between financial market prices and underlying economic fundamentals. Reasonable people take different view on these questions, and it is not possible to answer them definitively. On the balance of evidence, however, we have proposed the cautious use of the precautionary principle, largely because of the fundamental importance of global food markets to the lives of billions of people.
Set against this, the ‘costs’ of placing greater curbs on financial participation in food markets seem relatively trivial. Some argue that reducing speculation would reduce market liquidity, increasing hedging costs. But there has been no reduction in hedging costs as financial engagement has grown. The only real cost, therefore, may be a reduction in the profitability of some financial institutions. Set against the potential benefits, this seems a price well worth paying.’
I’m convinced. You? The next step would be to apply the same precautionary principle/complex systems approach to different kinds of speculation and different forms of regulation – doubtless a very messy argument. Has anyone had it yet?