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July – December 2018

The impact of food prices on the welfare of households in South Africa

food prices

Roscoe van Wyk and Cliff Dlamini

  • OCT 2018
  • Tags Features, Finance
18 minutes to read

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Roscoe van Wyk and Cliff Dlamini
About food prices, affordability and food security

It has been shown that a 1% increase in food prices can reduce household welfare by over 20%. This confirms a negative correlation between food prices and welfare.

The global food price surge of 2006 to 2008 has negatively impacted South African households. In addition, ever-increasing food prices and lack of access to finance make it difficult to strengthen food security among households in this country.

Global trends suggest that food prices will increase year on year, affecting the welfare of households – in particular poorer households. The instability caused by price hikes is not a short-term problem. In fact, it can have a lasting effect on poverty. Whether consumers are poor or wealthy, the contents and quality of a consumer’s food basket depend on its affordability relative to the consumer’s income.

It has been shown that a 1% increase in food prices can reduce household welfare by over 20%

According to the World Bank, rising food prices affect macroeconomic stability as well as the welfare of net buyers of food. This has a significant impact on poorer households that use a larger proportion of income for food. In South Africa, rising living costs force households to use their income for consumption expenditure rather than savings.

The overall aim of the study was therefore to establish the relationship between household welfare and food prices in South Africa between 1990 and 2015, and to determine what measures can bring about sustainable food prices. The secondary objectives were to:

  • Examine the relationship between food prices and household welfare in South Africa by determining how real household welfare responded to a shock in food prices
  • Analyse the long-run relationship between food prices and household welfare in South Africa by determining how real household welfare responded to a shock in food prices
  • Provide recommendations for a conceptual framework mitigate the impact of high food prices on households in this country.

In South Africa, rising living costs force households to use their income for consumption expenditure rather than savings

Taking a closer look at food prices and food insecurity

Clarity on the causes of market failure by policymakers is important. It is critical for the government to understand the correlation between market and price behaviour in times of food crises. The government is the custodian of policymaking and implementation, and thus needs to support remedial action in order to address the welfare impact of rising food prices.

Some researchers say food insecurity should be included as a market failure as it occurs when free markets are seen to be socially inefficient, when the market outcomes prove social benefits to be below the costs of society in respect of that outcome, or when benefits are not fully utilised via social resources. Hence, the market clearing variables do not maximise net social benefits. The presence of public goods and negative externalities are the two most important causes of market failure in food security.

The relationship between relative and nominal prices forms the causal nature of changes in food prices and can be attributed to relative demand and supply conditions of both non-food and food commodities, resulting in a net increase in relative food prices. Rising food prices increase the risk faced by lower-income households and subsequently transfer real income from lower-income consumers. Rising food prices have an adverse effect on purchasing power. Poor households spend most of their household income on food, making food prices an important factor in their well-being.

Food prices are influenced by, among others, supply and demand, inventories, macroeconomic factors, exchange and interest rates, global economic activity, oil price volatility, global weather patterns, financial investment and agricultural policy.

Approximately 70% of the global poor population reside in rural areas and are dependent on agriculture for the possibility of improving their livelihoods, welfare and decreasing poverty rates.

South African urban households spend more on food than do rural households. One study from 2001 has shown that rural households’ food expenditure was approximately 23% of their total household expenditure whereas urban households’ food expenditure was approximately 15% of their total household expenditure. The difference between urban and rural food expenditure can be expected, as rural households may supplement their food with subsistence farming or own food production.

The government is the custodian of policymaking … and thus needs to support remedial action in order to address the welfare impact of rising food prices

The impact of rising food prices in other countries

How do other countries respond to rising food prices and how effective are their reforms?

To find out, a literature study was undertaken to gain a clearer understanding of food security and food prices in Ghana, India and the USA. These countries differ in terms of income distribution, poverty levels and food security. However, each country has developed policy reforms and programmes to enhance food security and the welfare impact associated with food prices.

In 2008, Ghana imposed import duties on yellow corn, rice and wheat in an effort to lessen the burden on consumers from the adverse impact of further increases in food prices. One study in Ghana suggested that the current policy reform of protecting domestic rice producers by means of import taxation did not contribute to the reduction of national poverty, as there is a tendency for rice growers in Ghana to remain poor. It is challenging for Ghana’s government to implement an effective policy due to tight market conditions for important agricultural commodities. For the government to make sound policy decisions, it needs to understand the causes and implications of rising food prices, and how members of society are impacted by these. An understanding of these variables will allow governments to improve decision-making which contributes to effective policy formation.

India has one of the highest rates of rising food prices in the developing economies. Researchers have shown that from 2006 to 2013, India experienced food inflation at an average rate of over 9%, which was nearly double than during the previous decade. Given that the poor households in rural India spend large portions of their total income on food, they are unable to divert additional resources to suppress the impact of rising food prices. This increases food insecurity in the country.

Three patterns can be distinguished in India’s food price trends:

  • The first pattern of inflated food prices emerged when global food prices increased in 2005 to 2007. The rate at which food prices were inflated was significantly lower in India at the time.
  • The second pattern saw India’s food prices decrease from 2007 to 2008 compared to 2006 to 2007, which is when global food prices significantly increased.
  • The third pattern illustrated that global food prices declined at the end of 2008, but India’s food prices escalated during this time. This indicated that global food price increases had a marginal impact on India as a result of less exposure.

The Indian government has adopted a wide range of policy instruments to combat rising food prices. From 2007 to 2008, the Indian government divided its intervention measures into two categories: economic policies (which included pricing policies, trade policies, stock management policy and public distribution) and social programmes. The social programme policy instruments included cash transfers, food for work, food rationing, school feeding schemes and rural employment schemes. The programmes and policies targeted trade and consumption, with little emphasis on a supply response. According to the World Bank, high rising food prices turned the political economy of food into an important catalyst for short-term economic policy in South Asia and highlighted the transformation of food security into an important strategic tool for policymakers.

The USA relies heavily on food subsidies and tariffs for food security. Empirical evidence illustrates that more than 22% of children living in the USA live below the official poverty line. Also, half will be on food stamps before they reach the age of 20. Food subsidies are included in price supports by the government, which guarantees a price for a farmer’s crops because the state would purchase the excess crops. The USA Farm Bill of 2002 introduced payments for certain crops that are independent of price, also known as direct payments. The USA has experienced lower food tariffs on fruit and vegetable imports and higher tariffs from food-exporting countries around the world. As a result, export growth did not keep pace with import growth. The increase in imposed tariffs could impact food prices, which in turn will impact food security and the welfare of citizens of the USA.

The poor are vulnerable to food price hikes. However, policymakers can alleviate the burden suffered by the poor.

What is the role of policy interventions in alleviating the plight of the poor?

The poor are vulnerable to food price hikes. However, policymakers can alleviate the burden suffered by the poor.

Market information is a key factor when trying to correct price instability, especially in food markets. Without market data on the value of the damage caused by price hikes to markets, the state cannot determine its effect on households.

Researchers have different opinions on the causal relationship between food price increases and the adverse impact on households. Some studies have indicated a positive correlation between food price increases and adverse welfare effects on the poor. However, literature has also indicated that long-term price increases support agricultural development, which in turn impacts positively on employment and poverty relief.

Literature confirms that prices in agricultural food markets are much more inclined to volatility than in other industries. This is due to the supply of food commodities being inelastic in the short term, the demand for food being price inelastic and the unpredictability of food supply due to climate change. In 2008, South Africa had a projected total transfer cost, inclusive of agricultural subsidies, of between 2% and 4.5%. This means a substantial proportion of gross domestic product (GDP) is allocated to help alleviate the burden suffered by the poor. Literature suggests that approximately 80% of South African rural households are unable to afford a basic basket of nutritional food, which would cost approximately R262.00 per person per month.

Today, policymakers are increasingly using innovative mechanisms and legislation to accommodate rising food prices. This includes demographical or geographical targeting in order to direct limited resources to households whose welfare is largely impacted by food price shocks.

Globally, the current economic environment is characterised by sharp increases in food prices. Policymakers have attempted to lower food prices while also limiting the signalling of higher global prices to domestic markets. Since the 1980s, governments have tried to manage risks without affecting the prices of food commodities, which has an effect on variables such as crop insurance, future markets and the trade behaviour of food commodities.

There is a desperate need for government intervention to curb seasonal food insecurity that affects the rural poor by deepening and widening social safety net programmes. Policymakers require strong legislation and policies to assist the poor in this regard. The state must intervene when there is a lack of credibility in food market liberalisation due to a shortage of effective policies to protect the poor. Policies should build confidence in global markets and develop positive relationships between private and public agents.

long-term price increases support agricultural development, which in turn impacts positively on employment and poverty relief

How was this study conducted?

A deductive and/or inferential approach to research was used in this study. The study employed annual time series data derived from secondary sources such as the World Bank and the Organisation for Economic Co-operation and Development, covering the period 1990 to 2015. Due to the lack of welfare measurement in South Africa, the study employed household disposable income as a proxy. The Vector Error Correction Modelling (VECM) econometric approach was used to analyse the relationship between household welfare and food prices in South Africa. The study also performed stability and diagnostic tests, and the variance decomposition and General Impulsive Response Function to detect the behaviour of shocks in the variables used to determine household welfare in South Africa.

What did the study find?

In essence, the study found that a 1% increase in food prices would reduce household welfare by 21.3%. The study, therefore, confirms a negative correlation between food prices and welfare.

… approximately 80% of South African rural households are unable to afford a basic basket of nutritional food

Similar studies in other countries came to the same conclusion. This includes several studies on the decline in household welfare in Ethiopia due to excessive increases in food prices.

The policy options in the short run to address the impact of food prices on household welfare in South Africa could include:

  • Subsidising staple food baskets for households in South Africa
  • Reducing the prices of staple foods through the reduction of food tariffs
  • Reducing household expenditure on basic needs through subsidisation.

These policy options could lessen the burden on households when there is a rise in the prices of staple foods and therefore improve household welfare. Long-run policy recommendations include:

  • Improving the unemployment rate in South Africa
  • Improving access to finance and credit for South African households.

By addressing rising unemployment rates, improving access to finance and credit through job creation and improving micro-credit strategies, an environment can be created where South African households can improve their disposable income.

There is a desperate need for government intervention to curb seasonal food insecurity that affects the rural poor

The successful implementation of policy options – such as food subsidies and tariffs for staple food sources – by the South African government will help to provide the country’s households with:

  • Sustainable food prices
  • The improvement of household welfare by reducing staple food prices
  • The reduction of total household expenditure.

The government is hesitant to engage in projects that will take up large amounts of fiscal resources. However, agriculture and food security are government priorities within the National Development Plan. Hence the recommendations of this research provide a provisional strategy to create an environment for sustainable food prices in South Africa.

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