Oil, Food, and Inflation: How they are Interlinked

Singapore, 27 Aug 2008. In the last decade, the world has seen tremendous growth, and in the past five years, the world GDP has outpaced inflation. Much of this can be attributed to the new global economy that allows for freer

Singapore, 27 Aug 2008. In the last decade, the world has seen tremendous growth, and in the past five years, the world GDP has outpaced inflation. Much of this can be attributed to the new global economy that allows for freer trade than ever, a vast pool of able-but-cheap labor in developing countries, unprecedented amounts of capital, and of course more advanced technology.

The irony is that this globalization is also what is contributing to the inflation being felt worldwide. No country is an island. Well, some are, but no country can operate independently from the rest of the world (except maybe North Korea, but it doesn’t really “operate”).

One may argue that globalization results in more economic production, and therefore consumers can acquire these goods and services for less money. This is true. But also true is that international trade spreads inflation from one nation to another – as products spread their prices follow.

So in this transfer of price, who is most affected? The everyday people, the workers? Inflation is not only characterized as an increase in prices, but also an increase in wages. Surely, wage increases would protect those who receive them. But the prices of some items cannot be contained, as they are scarce.

Scarcity is the essence of economics. If oil and gas were not scarce, 90% of our economic woes would be gone. But oil and gas reserves are finite, as are rice, grains, and other foods. So as demand rises, so does price, while production remains limited. Moreover, to produce mostly everything requires energy in the form of carbon-based fuels. This is exacerbated when one scarce item (oil) is needed to produce another (rice).

In some countries, trade barriers are being imposed by their governments in the form of export bans – all to protect homegrown food supplies for domestic consumption, in the face of higher prices. And this then affects supply to needy foreign buyers who cannot produce their own food, causing inflation abroad.

These higher domestic food prices then mean that more producers enter the market to take a slice of this lucrative pie, while the lower-income consumers can’t afford the products. So the poor people starve at home, the low-end producers go out of business, and the third world import-dependent starves as well.

US farming may not be the most efficient, especially during a food crisis. This can be seen in the sugar and ethanol industries. Louisiana sugar producers are guaranteed their sugar will sell at a certain minimum price, through price floors set by the government. This is no surprise, considering that in 2006, these sugar growers contributed more to House and Senate incumbents than any other group of food producers, according to the Center for Responsive Politics.

So the US government buys sugar at a set price, regardless of whether or not the market demands it at that price. This is called a price floor, and it is higher than the demand price. As a result, growers produce enough sugar to meet this high price: More sugar than the market is willing to buy or consume. This surplus is then destroyed. Not efficient, unless you are a Louisiana farmer.

The US government could, however, ship all this excess, free sugar to third-world countries that need sugar. It may sound nice, but we would then undercut their local sugar market and put other sugar producers and traders