Will restricting financial investment in agricultural commodities solve the food crisis?

Yesterday the Food and Agriculture Organisation of the United Nations (FAO) released the proceedings of the Ministerial Meeting on Food Price Volatility held in Rome late last year. Attending were over 30 agriculture ministers, including those of Germany, France and Spain, who all expressed support for new regulations restricting financial investment in agricultural commodities.

French Minister for Agriculture, Food and Forestry, H.E. Stéphane Le Foll:

German Minister for Food, Agriculture and Consumer Protection, H.E. Ilse Aigner:

Spanish Minister for Agriculture, Food, and Environment, H.E. Miguel Arias Cañete:

Apparently the ministers are unanimous in the belief that regulations will have a positive effect by reducing agricultural price volatility, yet this thinking flies in the face of free market theory on price discovery as well as recent evidence from similar regulatory experiments.

A recent Journal of Finance paper studying short-selling bans imposed in the wake of the financial crisis concluded:

It is also worth asking whether restricting financial investment in commodities markets will meet the regulators’ larger objective of addressing the increasingly apparent disconnect between supply and demand. At the very least a proper debate should be had before imposing potentially counterproductive regulations.

Are price spikes not a vital signal to the market that something needs to be done? Rising food prices and increasing volatility in the agricultural commodity markets tell:

• Young college graduates that farming might be a lucrative future career path.
• Governments to invest more in research which increases agricultural productivity.
• Farms in less developed regions to become more efficient and invest in modern technologies.
• Petrochemical companies to build more fertiliser manufacturing capacity.
• Governments and commodities traders to build more physical storage capacity.
• Investors to fund irrigation projects.
• The US government to finally start taking more seriously the issue of climate change and its effects on global food production.
• Food manufacturers and consumers to waste less food.
• Consumers to realise that they simply can’t consume as they do.
• Etc etc.

Price spikes are a sign that the market mechanism is working properly. Prices are the signal that precipitates change. They are the symptom, rather than the cause of supply shocks. Attempts to regulate prices will probably fail, and they certainly won’t address the underlying causes of those price shocks.

Taken to its extreme, regulation is about centralised control of food production and distribution being better than the mechanism offered by free markets. The famines and food queues of communism have tested that hypothesis (quite literally to death).

To steal from the famous Winston Churchill quote on democracy: “Capitalism is the worst way of regulating food markets except all the others that have been tried.”