Monday, March 29, 2010

Arab Investing Food in Foreign Land

From Al Majalla

Investing in Foreign Land

A food-security calculus or sound commercial logic

The food crisis of 2007 has raised awareness of the potential consequences that a more potent sequel might have. However, instead of waiting for governments to break promises regarding investment in food supplies, developing countries stand to profit much more from opening to private investment. FDI transfers not only bring money to the receiving country but also technology and knowledge, and productivity improvements often spill over to local production. Investment in food supplies should therefore be handled like other investments by independent companies looking at economic fundamentals and not by state-owned funds and companies driven by a strategic food-security calculus.

Suddenly, the world food markets spilled out of control. Within a year, prices for wheat doubled, those for soybean and sugar even tripled. The drivers behind this surge were stock decreases during the preceding years, a disappointing harvest due to bad weather in several countries and growing demand for feedstuff. Once prices soared, governments of exporting nations curbed the outflow of food, thus exacerbating the crisis. Merely two years later, prices had come down roughly to previous levels—the affliction had ended.

This is not the account of the infamous 2007/2008 price spikes; it is the half-forgotten story of the early 70s. At least for developed countries, this earlier crisis was worse than the recent one. Real food prices—corrected for inflation—climbed higher, and food expenditures absorbed a much greater share of households’ income, so that any increase was felt more harshly. This episode nonetheless takes a backseat in our collective memory because OPEC limited oil production soon after the food prices had started to rise. Higher oil prices proved to be the more lasting and pernicious impediment to global growth.

So there is a historical precedent of a food price surge that did not destabilize the world economy. Instead, it was eventually followed by a quarter of a century of low food prices beginning in 1980. But the 2007/08 episode was not perceived from this bird’s-eye perspective. Even in emerging and industrialized countries, much less affected than the poorer nations, the crisis has changed the thinking of the powerful. The fear was born that the next food crisis may be waiting for us, one that will dwarf anything the world has seen before. The world might cast off its multilateral, liberal veil in the merciless scramble for food.

Under this lens, the purchase or long-term lease of fertile farmland abroad appears to be a hard-nosed move of Realpolitik without humanitarian disguise. Non-governmental organizations attack the neo-colonial land grab of Arab and Chinese investors that uproots local communities and undermines the self-sufficiency of poor nations. It’s smart but contemptible, so the common judgment goes—which may be wrong on both counts.

The receiving countries may actually win. Investment in developing countries’ agriculture is direly needed: the Food and Agriculture Organization (FAO) estimates that an annual US $ 30 billion of additional funds will be required over the next 10 years. This is hardly a sum governments will muster. Often the significant pledges made by donor countries during the crisis are just that, pledges. Making a promise is not the same thing as signing a check. Private investment is necessary to fill the gap.

Foreign direct investment (FDI) has long been considered as the most desirable form of capital inflow. It transfers not only money but also technology and knowledge to the receiving country, and productivity improvements often spill over to local production. Furthermore, FDI involves heavy transaction costs for the investor—in this case, selecting suitable land, negotiating agreements, setting up production and organizing transportation. Direct investment is therefore much more stable than the billions of speculative money that may trigger a bonanza today and dry up tomorrow. The very idea of farm land contracts for food security is long-term reliability.

What about the food security gains of the investing country? What happened if world food prices skyrocketed? Pressures in many producing countries would be tremendous to scale back or stop exports. Certainly, investments are generally protected by investment treaties that guarantee the right to export and prohibit expropriation without compensation (which would be difficult for developing countries to pay, especially with high food prices that increase the value of the investment). Cynics say treaties are made to be broken, and they are likely to be right when it comes to food security. If it is either do or die, one government will inevitably cede to popular demands, others will find it convenient to follow suit and the entire system will unravel.

Arab and Asian governments that pour billions of dollars into farmland FDI—whether through Sovereign Wealth Funds of state-owned enterprises—must be aware of the fragility of these contracts. The market outlook may nevertheless justify these investments on commercial grounds. The world population will continue to rise during the next decades and income growth per capita in developing countries will further add to the demand for food. Also, non-food uses of agricultural produce are expected to expand, especially for bio-energy.

The supply equation is more complicated. Since the end of the Second World War, world food supply has grown even more rapidly than the population—which underwent a growth spurt unseen in human history. Increasing investments into agricultural research and development suggest further productivity increases down the road.

More important than new high-tech solutions are the gains to be had from ending the disastrous inefficiency rampant in many developing countries. The first challenge here is to improve the input, credit, land, and output markets on which farmers rely. It is plain to see that a farmer who lacks clearly established and enforced property rights will undertake only minimal effort to maintain or improve soil fertility and irrigation systems. The other challenge is to enhance farmers’ knowledge of production techniques. Quite tellingly, the application of organic farming often raises farm output in developing countries even in the short run, though this technique is by no means geared at quickly maximizing yields. Still, it performs better than the outdated piecemeal approaches currently found in many places of Africa, Asia and Latin America. Taken together, inefficient markets and lacking knowledge go a long way to explain why Africa produces only 7% of world cereal supplies on 22% of the world’s agricultural area. A tremendous potential thus lies untapped.

Food production will also benefit from further trade liberalization as agriculture is the most protected sector of the world economy. While the Doha negotiations of the World Trade Organization are deadlocked and its ambition is watered down, more and more countries unilaterally lower tariffs and remove their heavily distorting subsidies. This facilitates greater specialization of production: less sugar from the EU and more from Brazil.

Climate change is the wildcard in this market forecast. The threats include heat stress and droughts, soil erosion and salinization, the spread of pests and diseases and more frequent extreme weather events. This will be partly offset by greater productivity of agriculture in colder climate zones and higher CO2 concentration in the air, spurring plant growth.

Most likely, we will see a reversal of the decade-long trend of lower food prices but no dramatic shortages in world food supplies. Buying farmland and ramping up production may simply be a good investment given this market outlook. In this case, it should be handled like any investment: by independent companies looking at economic fundamentals and not by state-owned funds and companies driven by a strategic food-security calculus.

Valentin Zahrnt - Research Associate at the European Centre for International Political Economy (ECIPE)