Para alumnos:

http://clasemonetaria.blogspot.com/

The Governmental inference in Agricultural Profile in Jalisco

The agricultural production in México is more diverse now than two decades ago. Institutional changes allowed a major diversification of food supply. Using Herfindahl–Hirschman concentration index with data of planted area in Jalisco (1980-2006), we find that concentration has fallen as is shown in the follow figure. The range of index is [0, 1], where in the limit of zero there is absolute diversification and one is absolute concentration (one unique product is planted).


However the concentration still is high, principally by selective prices and other kind of governmental interference, despite of the downtrend in the concentration index. In Jalisco the 55% of planted area in 2006 was still concentrated in products influenced mainly by agricultural policies; principally corn, sugar cane, and sorghum. For example, the area planted with corn wouldn’t be financially sustainable without “diesel agropecuario”, a program to sell diesel to farmers with a price 30% below market price; Procampo, a scheme to give liquidity during planted period, equally to 10% of production total costs; plus a coverage scheme in prices, reducing the price volatility inherent to commodity products.

However other products don’t have this kind of government support, mainly those products with more add value, high productive potential and better social outcomes, in the case of Jalisco, products such as artichoke, tomato, flowers, garlic, blackberries, and strawberries. ¿What are the kind of supports that farmers need to be more diverse in their area planted? I think in two very important: credit access and risk coverage tools.

Speculations, Bubbles and Corn Price

The spot price obviously doesn’t always match with future price, particularly in price of corn. During summer cycle the data in future market of corn prices are volatile, principally because the future prices is sensible supply expectations, and given that supply is relate to climate conditions, the market develop into a weather market: with a behavior very erratic. Eventually the market future prices become less speculative because the corn output is more predictable (we know with more certainty corn yields in September than June; because there are more information about climate damage or goodness), causing that prices in future contracts and spot prices are more related than previous periods.

In the current period, it’s possible relate the eased in future price in corn contracts with less speculative positions by investments funds in this market as consequence of a co-movement associated to oil market (some say it is out of any rationality investments). But we can also relate it to fundamental factors, principally unexpected supply positive shocks in recent weeks: the wet weather associated with secondary effects of hurricane Gustave, causing exceptionally positive rains in the “corn belt” of United States.

However, in the next quarter of the year we can’t only associate the easing of future corn price by the correction of irrational positions of financial intermediaries (bursting the bubble) or as result of narrowing the credit by central bank actions. I think there are also real factors that would give support to the current still high prices (in fact the markets think in this way) and supported expectations of high prices in recent periods (historical low levels in corn inventories). And at the end of the day, inventories, demand and supply conditions will be matter most.

In fact, the total funds invested in commodity markets reached $400bn at the end of the first quarter of 2008 (including all commodities such as Oil, Copper, Gold, Wheat, Corn and Zinc); the market value in one market, the biggest, The New York Stock Exchange reached $25 trills in 2006, 62 times larger than commodity markets; and the value of international bond market; reached in 2006 a value estimated in $45 trillion, more than 100 times all commodity markets; this is the reason why small movements, small influx from this market during the weather market period can affect the valuation of future prices. However, the spot price is determinate by fundamental factors as we’ll see in the coming months.

The graphs added invite us to infer about the outlook in corn market, now when the market will face the facts directly during harvest period in the last quarter of the year.

The lack of agricultural insurance in Mexico

The last weekend I visited Buenos Aires Ejido near to Ameca, my hometown in Jalisco, México. I wanted to take a look over the beautiful corn fields that I had seen previously. However, the situation was sad; the ejido was hit by a frozen storm that changed suddenly the yield expectations. Three weeks ago the expectations reached 10 tons per hectare in average (almost the yield obtained in U.S.), but after the storm the expectations were reducing by half. Weather conditions is one kind of risk that corn peasants face continually; drought, floods, biological diseases, and volatile input prices are also production risks that corn peasants face during summer cycle, the most planted in Mexico.

The problem to corn peasants is that they face large fixed costs; the quantity of inputs is more related to the area planted than the yield. The costs in the surface damaged by the storm will be the same than the area not affected; however, in the last the income will be twice as low as the affected even though the inputs employed in both cases were the same. To see the differences, in 2007 the production cost estimated by a state financial agency called FIRA was $10,824 per hectare in Jalisco and the farmer corn price was of $2,500 per ton; considering this information we see in average the net income in the region of Ciudad Guzman was of $186 (a ratio income/costs of 2%), and the net income in La Barca was of $7,126 (a ration income/costs of 66%), very different results not seen typically in the most of economic activities.

These eventualities are part of the agricultural cycles, making highly risky be peasant. In the period of 1996-2006 the difference between the maximum yield and the minimum yield in Jalisco was 2.9 tons (Minimum in 1997=2.25; 2005=4.54); 2.12 in Guanajuato (Minimum in 1997 =3.27; Maximun in 2004= 5.39); and 1.71 in Nayarit (Minimum in 2005=2.17; 2002=3.88). These kinds of changes are not observed in other economic activities; imagine aggregate manufacture production in any region suddenly fall 50% year to year; in fact during the 1994-95 recession in Mexico the manufacturing production index fall, from its peak 108 (November 1994) to its lowest point of 92 (April 1995), a decline of 15%, the worst fall in the last two decades; a typical negative rate in any cycle and any area of corn production in Mexico.

Considering these eventualities, insurance mechanisms provided by governmental and private organizations are the usual solution; and in other countries, the operation of future markets or access to one of them is a solution pursued by producers and governments. However in Mexico the producers don’t have access to this kind of financial tools to minimize the risks. ASERCA (www.aserca.gob.mx) have attempted modulate the price risks faced by producers through indirect price coverage; however the production risk is not adequately tamed or covered, this is the main risk and the direct subsidies have not been the solution. Given the importance of agricultural in the political debate and in fighting against the poverty in Mexico, find a market solution must be considered as way to improve the production conditions as way to mitigate poverty in Mexico, elevate food supply, and reduce the income volatility of our farmers.

The Problems with Inflation Projections by Bank of Mexico

Bank of Mexico increased its 2008 inflation projection due the higher prices expected in commodity prices; the superior interval changed to 6% in the second quarter from 4.75% in the first quarter, published in the quarterly report of inflation. The central bank said in its statement: “The revised forecast reflects, […] the trajectory upward in recent months of food, energy and metal in international markets, which was more pronounced that the anticipated in future markets at the end of the previous quarter”. This announcement affected economic indicators in México: it lead an five days-appreciation of the peso against the dollar to 9.90 from 10.05 pesos per dollar, given the expectation of further monetary tightening; and the survey of inflation expectations by professional economists shown an average expectation of 2008 inflation above 5%, a level never estimated before.

The relevant point is that commodity data employed to forecast inflation come from future markets. The central banks, investors and other organizations take data from futures markets as source in inflation projections. It makes sense because it is expected that in future market participants use efficiently the information from supply and demand side to incorporated in their decisions shaping the future prices. However, during the last months these markets shown a volatile behavior, particularly an unusual uncertainty from the expectations of demand side, causing that the market reacts broadly with new information related to prospects of world growth; in fact, the economic data of sluggish international demand released recently, has dropped commodity prices in the last four weeks; principally oil (18%), corn (26%), and wheat (5%).

¿What are the implications for monetary policy make decisions with information from future markets that has under-predicted prices?, ¿What are the consequences of release projections in a inflation targeting framework? I think that the central bank needs to make an assessment of the implications of employ information with high volatility like the data from futures markets to release inflation projections; principally by two reasons: First, because the information is public, and in a framework of monetary policy with target inflation, the expectations matter, then we could see some influence over inflation expectations from a sources with high volatility like financial markets. Second, the decisions of monetary policy is based largely with projections; therefore, it is quite possible to make policy errors extracted from such kind of information, at least in this kind of environment we’re seeing. If these implications are true, the central bank must persist in improve their methods in forecast inflation and the way how the Bank communicate these projections.

There are not such Bubbles in Agricultural Prices

High prices in energy and agricultural products have caused economic problems in the world economy. The consumer prices in OECD area rose by 4.4% in the year to June, the highest inflation rate since March 2000; consumer prices for energy were up by 19.3% year-on-year and consumer prices for food by 6.5%. As consequence, purchasing power of world population has been affected, and the central banks face problems to deal simultaneously with high consumer prices and sluggish economic activity. A hypothesis to interpret this fact is that the increases are as consequence of bubbles in the financial markets.

In Mexico, the first public worry is the rise of food. The prices of bread, cereals and tortillas in the national index consumer prices (published by the central bank) showed a twelve-monthly increased of 12% in June. Bank of Mexico (the central bank), in order to deal with these inflationary pressures, changed its stance of monetary policy to be more restrictive (the central bank rose its target rate 50 base points in the last two months), even though the peso is strong and it seems that economy will expand below its potential.

The hypothesis of high prices by speculative investments in the financial markets consists in that investors buy large quantities of future contracts of agricultural goods, believing that agricultural prices will be high in the future or at least that this investments are less risky. According with the hypothesis, this behavior has pressed agricultural prices to rise above its equilibrium level (those prices shaped by the interaction of supply and demand forces in the market); the spot prices in international markets of wheat and corn rose annually to 56% and 74% respectively. I will attempt to use basic tools of economic theory and some facts to deduce if this increased are result of a bubble in financial markets or if they correspond to fundamental changes.

Increases in prices of agricultural products don’t lead to an automatic increase on supply. Commodity markets have rigidities in supply because their productive cycles are wider than the cycle of other products and services. For example, Jalisco has one period of corn harvested during the year; therefore, an increased in prices as we saw in the last January will affect platend area plans in May-June and hence it will affect the supply ten months later, during the harvest period. These circumstances are replicated in other markets; increases in oil supply take time, for example: according to the Energy Information Administration in United States, open to investments on offshore drilling, given the political pressure to open these areas to produce oil, could take twenty years to reach its production peak, a clear delayed supply response to high prices.

In agricultural markets is expected that in the long run their prices are near to their production cost, and there are temporal variations around the equilibrium price because supply interruption or overproduction causing that producers don’t produce what the consumers want to buy. However, higher costs drive prices to higher level of equilibrium because the supply responds negatively to higher costs. I think it happens even with rational expectations because the future supply, the principal determinant of prices in the short run, has a random component; is unpredictable, causing the prices are unpredictable too. This situation leave to current price as the principal information taken by producers during their production planning. On other hand, I think that this economic fact is enhanced by financial constraints, because the lack of credit in presence of higher cost and even higher increased prices, limited the possibilities of investment to respond positively to higher prices; particularly in Mexico, we haven't a Banrural anymore.

In Mexico the agricultural producers face unfavorable circumstances even though the spot prices in international markets are higher because its costs have grown too. In June urea, one of the principal fertilizers, climbed 46% annually. The volatility of corn prices rose, affecting prices expectations; for example the coefficient of variation of corn price rose to 0.11 from 0.05 in the first semester of 2008 against the first semester of 2007 in international markets, twice in its degree of volatility. And in the last productive cycle, the average salary of agricultural workers registered in IMSS rose 8.3%. These circumstances; higher prices of fertilizers, higher labor costs, and volatile prices, make that at least in the supply in Mexico would not rise at the same rate as higher prices did. In fact, in corn market of Mexico the corn area planted this summer is not considerably higher than other cycles even with high prices; the area planted this summer is 16% below its decade record in 2004.

Under this approach we could conclude that spot prices are result of changes in fundamentals factors in agricultural markets. However, a link between future markets and agricultural prices would be possible given the long run relationship between prices and production costs. If oil prices is the principal cause of high inflation in the world, because it is causing high labor costs (trough inflation expectations) and higher prices in fertilizer and other agro-chemicals (given they are derivates of oil and gas), then oil price above its fundamental caused by speculation is affecting the prices by this channel: a byproduct of the bubble in the oil market. But affirm it definitely requires tested if the presence of this transmission channel is real, beginning with find if the current price of oil is above its fundamental, inflated by excessive speculation.

Agricultural Policy Failures in Mexico

During the last decades, the institutional framework of the agricultural sector in Mexico was transformed. The reform of Article 27 altered the property regime of farmland, allowing the creation of private farms instead of the ejido (a form of governmental property over the land). Through NAFTA, the domestic agricultural market was opened to international markets, increasing the correlation between internal prices with external ones. The structure of subsidies changed from indirect subsidies (low prices in inputs and fixed prices to producers) to a scheme of direct support (monetary subsidies and liberalization of prices in inputs and agricultural products).

It was expected that these changes could reduce the rural poverty by the improvement of the agriculture activity; one of the most important economic activity in these regions. The policies designers expected that the agricultural yields of poor states (namely, Chiapas, Oaxaca and Guerrero) would eventually converge with those states more efficient (as Sinaloa and Sonora), and even more, reduce the gap with those yields obtained in United States; increasing the productivity and so, the income of the farmers. This expectation was based on three factors: Technological access, decreasing returns in agricultural yields and markets of farmland.

The new regime of property rights in the farmland promoted by the reform of article 27 had a completely different approach than the ejido. The farmland, before to the reform, had a form of private property with limitations; it was almost impossible to use the land in any mercantile operation, not only in buying-selling operations but as collateral in loan credits. After the reform, the farmers gained plenty private rights, allowed them to sell, buy, or use as collateral their properties. Through this measure it was expected that the agriculture could have access to credit, and more important, allowing the consolidation of small agricultural units (minifundios) to wide agricultural surfaces, letting the introduction of new technological advances to exhaust the opportunities of scale economies.

It was expected that trough NAFTA it could be possible to have access to technologic advances, and therefore, reduce the technological gap not only intra-regions, but with the yields achieved in agricultural sectors of United States and Canada. The green revolution experimented in Asian countries, was driven principally by genetically improved seeds, fertilizer, machinery and equipment, and other chemical products; improvement importantly the yields, it was a key factor in poverty reduction of these countries, principally in China and India. It was expected a green revolution in Mexico.

In agricultural activity is very clear the law of increasing relative costs, which said that with fixed and variable inputs (say surface and labor) beyond some point, each additional unit of variable input yields less and less additional output. In this way, the policies forecasted that regions with low agricultural yields were more plausible see gains in its yields than the rich ones. This assumption was supported by the other policies, principally technological advances and the change in the property rights.

However, despite of these policies, there is not evidence of convergence. An analysis based on compound indexes, found that while Sinaloa was 14% more productive than the national average in 1980, in 2006 was 97% more productive. On the other hand, while Chiapas was 19% more productive in 1980 than the national average, in 2006 was 5% less productive than the national; these results are also observed in Guerrero, Oaxaca and Michoacán. The presence of divergence rather than convergence finds that the expected outcome was not reached, at least in the improvement of production conditions.

Recognizing the failures of these policies is important to promote a debate to redesign the agricultural policies. However, that is complex; the political economy of the agricultural sector limited the possibility of a discussion with objectivity. The way of doing politics in Mexico has led to farmer organizations as extensions of political parties; therefore, organizations are more linked to political platforms than a structure of economic interests themselves. The delayed this discussion can mean loss a opportunity to fight effectively against the high rates of poverty in Mexico.

Salvador Omar Rodríguez Hernández

salva.rguez@gmail.com