Matthew Kahn has a more optimisitic view

I guess Wolfram Schlenker and I have become the modern day Malthusians and doomsayers when it comes to potential impacts of climate change on agriculture.  I often try to emphasize that we are not in fact doomsayers; we are simply laying out the range of possibilities, and show strong evidence that the downside is indeed bad.   But we also maintain that there is room for adaptation in ways we cannot yet model or cannot yet anticipate.  We're a long ways from Malthusians--he had a different kind of doom in mind and was much more certain about it that we are. Uncertainty is large.   But, as Brad Delong often points out (and with whom I agree on this point), uncertainty is not our friend when it comes to climate change.

Matthew Kahn, esteemed professor at UCLA, leading specialist in environmental economics, and author of the new book Climatopolis, recently wrote about our work and offers a more optimistic view.  He argues that our work provides a clear incentive for innovation.  It shows us that we need more heat tolerant crops and that those who invent such crops will profit from inventing them. Thus, pointing out such potential problems lets us "escape" from the impending catastrophe.

Maybe Kahn is right.  I believe similar credible arguments have been made about past doomsayers: they showed the then-current paths to be unsustainable and thereby allowed our society to avoid the doom they had once prognosticated.  Maybe Rachel Carson made our water cleaner.   Maybe worries about resource shortages in the 50s and 60s pushed Norman Borlaug to foment the Green Revolution.

But what if it's not possible.  What if growing enough grain at low enough cost to feed a world with as much income inequality as we will surely have is not physically possible.  What if it's as difficult to grow crops in 33+ C temperatures as it is to currently grow crops in Siberia?

Human innovation and technological change has been stupendous.  But also quite varied.  In some ways productivity grows at seemingly interminable exponential rates, as Ray Kurzweil likes to emphasize.  But somethimes innovation looks like innovation in battery technology--stubbornly slow and halting.  Erk.

It is also important to note that some of the human response to social problems like pollution comes from policy. Libertarians often point out how much cleaner our air and water in the US are today compared to 30 or 40 years ago, which is true.  But at least some of that improvement surely came about from the Clean Air and Clean Water Acts.

So.  Maybe Kahn is right and we shouldn't worry about climate change. The problems will take care of themselves.

The question you may want to ask yourself is: Do you feel lucky?

Coping with High and Volatile Food Prices

So high and volatile food prices may be with us for awhile.  What should we do about it?

At the end of my Room for Debate column I wrote:

The best immediate response to these problems would be to reduce barriers to international agricultural trade, and to develop mechanisms to protect the world’s most vulnerable from inevitable price spikes. Such protections, if credible, might convince markets that crude market interferences like export bans were less likely, which would reduce speculative inventories and prices today.

Economists almost always favor free trade.  I'm not quite as ideological about this as the headline "Open Up Trade" may have suggested (NYT chose the titles).  But in this case I think free trade is the right answer, but with an important caveat:  I think the international community (UN, FAO, rich nations, etc.) need to develop a clear, credible, anticipatory mechanism for delivering aid, perhaps in the form of food subsidies, for the poorest people in the most vulnerable places in the event prices do spike.

What I'm suggesting here is a form of market intervention.  Call it a conditional cash transfer that depends on food price levels.  Such commitments from the international community might be offered in exchange for commitments not to interfere with trade in other ways, like tariffs, export quotas, taxes or bans.  I think these kinds of conditional transfers would be a more efficient way of dealing with the problem than other policies being suggested, like public storage projects.  And they would likely have fewer unintended consequences.

For example, I worry that public storage projects would be managed in erratic and unpredictable ways, and thus attract private speculators and storage in addition to public storage, no matter the size of public storage projects.  The more we store, the more eventually spoils, which ultimately means higher average prices.   And in the process of building up public inventories we would effectively be increasing demand even more.  This would be an easy thing to screw up and make the food price problem worse than it is already.

Furthermore, I don't perceive any evidence that commodity markets are storing in insufficient quantities.  Indeed, commodity markets look remarkably efficient to my eyes.

Now, by guaranteeing low food prices for the poor we would, in effect, cause demand to be artificially  more inelastic than it is already.  Thus, guarantees could, indirectly, cause larger price spikes.  I believe private markets would quickly recognize this and respond by developing larger inventories on their own--a speculative bet that would pay off when price spikes do happen (and they *will* happen).  Guarantees for the poor would mean that prices would have to rise to the point where the relatively more wealthy would have to reduce quantity demanded.  But the relatively wealthy can afford it.  We can find other things to eat besides grain fed beef and chicken.

Most importantly, however, such a policy might do a lot to stave off the most destructive policies, like export bans.

Right now, this is the best idea I have.

Debating Food Prices at the New York Times

We're live at the Room for Debate:

Bad weather is clearly influencing food commodity prices. So is demand growth, most notably from rapidly emerging economies like China, where people like grain-fed meat and dairy products as much as we do, and many now have incomes to afford them. Then there is the increased demand from subsidized and mandated ethanol production.

Price spikes like the current one can and will happen regardless of whether the climate has changed or will change. It is just the nature of these kinds of markets: bad weather shocks draw down inventories, which make prices higher and more volatile. A few good weather years could replenish inventories and bring prices back down.

Thankfully, rice prices haven’t spiked -- yet. Historically, market forces have caused spikes in rice prices to follow those of corn, soybeans and wheat. These four crops provide the caloric basis for most food worldwide.

Here in the U.S., we won’t notice high commodity prices in the price of food we buy at stores and restaurants. The price of our food is comprised mainly of the labor involved in processing, transporting and marketing. Indeed, this fact helps explain why commodity prices can increase so much so fast -- we’ll buy little less even if commodity prices double or triple from current levels.

High commodity prices matter mainly for the two billion or so living on $2 a day or less and spend the bulk of their income on food. Some of these people will buy less food as prices rise, because they simply won’t be able to afford as much. I wouldn't be surprised to see more civil conflict as more people go hungry.

Productivity growth will need to accelerate from historical trends to keep up with F.A.O.’s predictions for population and income growth. If it doesn’t, prices will trend higher, perhaps a lot higher.

Markets must be worried that the weather shocks we have recently experienced are not transitory, but rather tidings of more permanent and significant changes. Climate models predict that extreme weather events, like the ones recently experienced in Australia, Russia, the United States and China, and potentially much worse, will begin happening with greater frequency, and possibly much sooner than many people expect. Looking ahead, we need to start dealing more realistically with the risks posed by climate change.

The greatest hopes against truly catastrophic declines in crop production are a possible boost from CO2 fertilization and improved productivity through breeding or genetically modified crops. But there is increasing skepticism that these factors can compensate for the negative effects of a warmer climate and growing demand.

Trade restrictions remain pervasive and help to keep commodity prices high. Recent research by Jeffrey Reimer and Man Li indicates prices could fall by 57 percent if all countries were as open to trade as the United States. Particularly acute examples, like the recent ban of wheat exports by Russia, India’s rice export ban in 2008 and subsequent Philippine hoarding, can greatly exaggerate the effects of weather shocks on world prices. Such policies likely come about from efforts to keep food affordable for a country’s most disadvantaged. Their ultimate effect, however, is to keep food prices higher worldwide, and make more people hungry. To make matters worse, market speculators likely hold greater inventories in anticipation of possible future export bans or hoarding.

The best immediate response to these problems would be to reduce barriers to international agricultural trade, and to develop mechanisms to protect the world’s most vulnerable from inevitable price spikes. Such protections, if credible, might convince markets that crude market interferences like export bans were less likely, which would reduce speculative inventories and prices today

My piece was a lot longer than they requested, and they still kept nearly all of it with only minor and helpful edits.  The one key piece that was cut in editing was my dig at those tying to tie commodity price increases to monetary policy and fears of broader inflation.  One of the links makes that point, so I guess that's okay.

The first debater, Raj Patel, makes no sense to me whatsoever.  Knorr seems thin.  But I see little to disagree with from anyone else.

Update:   To the tireless inflation mongers out there:  Today is different than the 70s.  There's more than I have time to get into at the moment, but the two big differences are:

1) Commodity prices make up a much smaller share of our economy today than they did back in the 70s.  The one place to look at to see this is energy consumption expenditures as a share of the economy.  That's the big one, and it's still much smaller today.  Food commodities were trivial back then and are much smaller now.

2) Unemployment.  It's higher today than when prices spiked in the 70s while the natural rate is probably lower.  If you think wages are going up any time soon in this country you are smoking some really strange grass.  Without a wage-price spiral, we're not going to have inflation.

If you don't believe me, then by all means, go short on traditional treasuries and long on inflation-indexed treasuries, and if you're right and I'm wrong, wake up next year a very rich man or woman.

I think the market has this about right: historically low inflation for the next 5 years or so.  Which is too bad. I think a bump up in inflation to 3, 4 or 5 percent would do our economy a heck of a lot of good.

It's not about us.  Really.  It's about poorest 1-2 billion in the world, and those folks don't live in this country.

The price of cotton in your shirt

Yesterday the near month futures price of cotton closed at $1.83/lb.  That's pretty high, more than double the price of just a year ago.  Before this year, I'm not sure cotton prices ever exceeded $1.20.  But that's in nominal dollars. Adjusted for inflation cotton prices were a good clip higher back in the early 80s.

How much do these high prices matter for the prices we pay for clothes?

Not so much.  Consider that there is about 0.6 lbs. of cotton in a typical man's shirt.  So that $1/lb increase in cotton prices over the past year means it costs an extra 60 cents to make the Brooks Brothers shirt for which I paid $40.  On sale.

Would it be so hard for the news media to put this kind of perspective on things?

Aw shucks, Hoss... It's so much more fun stoking inflation fear and general hysteria.

Take the New York Times, for example, one of our last and best shining stars of high-quality media.
Stephanie Clifford, Mokoto Rich and William Neuman:

A package of Oscar Mayer cold cuts. A pair of Nine West boots. A Whirlpool washing machine.

By the fall, people will most likely be paying more for each of them, as rising prices hit most consumer goods, say retailers, food companies and manufacturers of consumer products.

Cotton prices are near their highest level in more than a decade, after adjusting for inflation, and leather and polyester costs are jumping as well. Copper recently hit its highest level in about 40 years, and iron ore, used for steel, is fetching extremely high prices. Prices for corn, sugar, wheat, beef, pork and coffee are soaring. Labor overseas is becoming more expensive, meanwhile, and so are the utility bills to keep a factory running.

“There are cost pressures from virtually everywhere,” said Wesley R. Card, the chief executive of the Jones Group, whose brands include Nine West and Anne Klein. After trying to keep retail prices flat or even lower during the recession, Jones says prices for its brands will climb 15 to 20 percent by autumn.

When commodity prices started to rise last summer, many manufacturers and retailers absorbed the costs, worried that shoppers would not pay higher prices during the competitive holiday season or while the economy was still fragile.

Many big companies, including Kraft, Polo Ralph Lauren and Hanes, say they cannot hold off any longer and must raise prices to protect some profits..... 

I don't think so.  Especially not for name brands like these.  They have a lot of market power and the profit maximizing thing for them to do is to absorb much of this (quite modest) cost increase.  The price of my Brooks Brothers shirt will probably go up less than 60 cent cost increase from higher cotton prices.

Their nod to reality-based journalism comes at the bottom of page one.

The cost of raw materials accounts for a small portion of the cost of most consumer goods, as labor, processing and packaging tend to make up a larger share of the price at the cash register. Foods like coffee, meat and milk, which are closer to raw materials, will probably show some of the biggest price jumps.

But no facts to put this in perspective.  Too little, too late.

There is, in fact, another and far more plausible reason why firms will raise prices this year: increasing demand.  Especially for brand-name companies like the ones mentioned in this article, prices will be more sensitive to demand than they are to cost.  They've probably been holding down prices due to the recession.  Now that we're recovering (albeit slowly), demand is somewhat higher and they can raise prices a bit.

Update: A lot more on commodity prices here.

Climate Change and Elasticity

 Elasticity---the responsiveness of production and consumption to price---is important to keep in mind when thinking about potential climate change impacts on agriculture.  Sadly, much of the profession doing empirical work on potential climate impacts seems to ignore this part of the equation.  I'm thinking particularly of this paper and this paper, both of which have other issues (see here and here).

On a global scale, supply and demand of staple commodities are highly inelastic.  Demand is inelastic mainly because commodity expenditures comprise a small share of the price of most consumption goods. Supply is inelastic because there's only so many places where it makes sense to grow certain crops. As a result, commodity prices can be very sensitive to shifts in supply or demand.  If climate change causes a big inward shift in supply, it could cause a huge loss in consumer surplus.  But if climate change were to cause a big outward shift in supply, the welfare change would be modest.

This is a key reason why uncertainty with climate change matters: the potential downside is so much bigger than the potential upside.

Sadly, what we often see from economists are references to the tiny share of agriculture in world GDP Thomas Schelling is a famous example (he makes good points about the bargaining problem). But GDP is no welfare measure.  And the difference between GDP and welfare is going to be large, mainly because it doesn't count a huge consumer surplus.

Elasticity and Climate Change
Now, it is true that a lot of the loss in consumer surplus will be offset by gains to producer surplus.  The U.S., with its large land base, excellent soils and climate, produces and exports more than anyone else in the world.  A doomsday scenario for food production doesn't look so bad for us--we'd be the ones gaining a lot of that producer surplus.

But in other places, particularly in certain developing countries with large urban populations, demand is not quite as inelastic. This is because the urban poor spend a large share of their income on staple food commodities, and when prices change a lot, it changes their real incomes a lot, and they spend less. So a lot of the loss in consumer surplus is likely to land on the people who most value that surplus---a dollar of surplus to a typical person in India is worth a lot more than it is to us.

A contemporary case in point: As I recall, Egypt imports about half its wheat and about half the people live on $2/day or less.  Today's high wheat prices must be doing a lot of damage to their real incomes.  And they are letting the world know about it.

Update:  I'm not the only one thinking about commodity elasticities.  I think I posted mine first. But the other guy always puts things much better than I do...

Update 2:  Krugman made this issue a headline column.  He's basically outlined my current research agenda.