The surge in corn prices over the past two years has been remarkable--prices have roughly doubled both in the US and worldwide, although they have fallen slightly in recent months.

Australian wheat, Chinese meat, US corn. What do these three specific goods have to do with macroeconomics? Unfortunately, right now, a great deal, and in ways that are globally interconnected. Over the past 12 months, the world has experienced a substantial inflationary shock in the form of higher food prices. This shock doesn’t necessarily translate into higher sustained inflation; monetary policy in most countries appears to be responding appropriately. But it will have adverse effects, particularly on relatively poor urban residents in low-income countries.
As reported by the International Monetary Fund (IMF), there are also two potential silver linings: direct benefits for farmers in low-income countries and potential policy space for removing agricultural subsidies in rich countries.
The increase in food prices is a shock that originates largely in rich and middle-income countries. For some time now, commodity prices have been increasing, and this has been particularly apparent in fuels and metals. A major driver of these increases has been high rates of global growth--the last half decade has seen the world’s best run in growth rates since the 1960s. Of course, a big part of what has sustained global growth is the strong performance of emerging markets.
Higher commodity prices should elicit a supply response, with some lag, and almost all developing countries have benefited on net from the increase in global economic activity. So part of what we’re observing is perhaps an unavoidable side effect of rising prosperity worldwide.
And then there’s the effect of weather. There’ve been serious droughts in some parts of the world, and animal disease has had an impact elsewhere.

Biofuel Policy
But more recently food prices have jumped sharply, at least in part because of an attempt to encourage the use of so-called biofuels in industrial countries. Biofuels are a type of renewable energy source; that is, you make ethanol from corn, mix the ethanol with gasoline to drive your car, and also grow more corn. As an approach to energy security, this has some appeal--it’s a diversification of energy sources.
Unfortunately, although the benefits of biofuels are sometimes exaggerated, their side effects have become all too apparent. Making ethanol from corn doesn’t generate much net energy--you use almost as much oil producing and transporting the ethanol as you’d use to generate the equivalent amount of gasoline. It also doesn’t significantly reduce carbon emission. But it does drive up the price of corn.

Knock-on Effects
The surge in corn prices over the past two years has been remarkable--prices have roughly doubled both in the United States and worldwide (although they have fallen slightly in recent months). This then has knock-on effects on other crops, as land is switched from wheat on the margin, for example, into corn or, as has been most marked in Europe, out of dairy production and into crops used for biodiesel (for example, rapeseed, whose prices have also increased sharply). In the IMF staff’s assessment, a significant part of the latest jump in food prices can be traced directly to biofuels policy.
A key part of this approach to biofuels is agricultural protectionism. A number of countries, including Brazil, can produce ethanol much cheaper, with a greater saving of nonrenewable energy and lower emissions, for example, by using sugar. But this sugar-based ethanol is subject to a prohibitive tariff in the United States (and there are similar barriers in Europe).
In addition, production subsidies in rich countries, which are intended to encourage innovation in this sector, seem to have led to excessive entry into the US ethanol distillery business. It’s a good idea to encourage innovation--for example, the use of Jatropha trees in India shows great potential but needs considerable investment to become fully viable--but there are more effective ways to encourage research and development in this sector.
So if the food-price shock is driven in large part by biofuels policy in industrial countries, who faces the consequences? First of all, the industrial countries themselves are not immune from the effects of such a shock. The Federal Reserve does not include food prices in its measure of core inflation (which guides US monetary policy actions), but this is because food prices are typically volatile. However, if there is a likely permanent rise in food prices, because of the shift to biofuels or for some other reason, there’s a case for including these prices in core inflation.
Nevertheless, the effect in rich countries will be limited for a simple reason. Food is a relatively small part of what people consume in most advanced economies--about 10-15 percent on average, and some of that relates to processing and distribution rather than the cost of the raw materialÑand is therefore a small part of the consumer price index.

Global Increase
Food is a much larger component of the consumer price index in many poorer countries. For example, in China and other emerging markets, food is about 30Êpercent of what consumers buy, and, in many low-income developing countries, it is 50Êpercent or more. This means that the same global increase in the prices of corn, wheat, milk, and meat immediately becomes higher inflation in poorer countries.
Still, the implication is that monetary policy in middle-income and developing countries will need to be tighter--with higher interest rates--than it would otherwise be (of course, there may also be non-market-based policies, such as price controls, that lead to distortions). This will tend to increase the interest rate differential between poorer and richer countries, which are tending toward lowering interest rates. This will, in turn, tend to increase the so-called global carry trade, in which people borrow in a currency with a relatively lower interest rate (for example, yen) and invest in a currency with a relatively higher interest rate (for example, developing country currencies).
There’s nothing wrong with capital flowing from rich to poor countries--in fact, if it happens in the right form and with deliberate speed, it can definitely help development. But the IMF’s work on financial globalization emphasizes a very important health warning: if you get too much capital, too fast, and in too footloose a fashion, there can be serious consequences for your economic stability and growth.

Back in 2001, the European Union committed itself to phasing out all forms of subsidies that help its farmers sell food abroad.
New figures suggest that despite recognizing how its policies can harm small-scale farmers in developing countries, who are unable to compete with lavishly-supported imports from the richer world, the EU spent 2.5 billion euros ($3.7 billion on export subsidies during 2006.
That represents a sharp reduction from the almost 10 billion euros allocated to export subsidies in 1988. Yet Mariann Fischer Boel, the EU’s agriculture commissioner, says that scrapping them entirely will depend on whether other rich countries--in particular the United States--take similar steps.
“Although there is no international obligation to eliminate them, the EU has committed itself in the framework of the ongoing Doha round negotiations to phase them out by 2013, provided that our trading partners are doing the same with their trade-distorting export support measures,“ she says.
Some anti-poverty campaigners suggest that the EU must lead by example, regardless of what happens with the Doha round, which has so far failed to deliver an international trading system more sensitive to poor countries.
“If the Doha round doesn’t succeed, does that mean that export subsidies won’t be eliminated by 2013?“ asked Sara Rogge from Debt AIDS Trade Africa (DATA), an organization set up by the rock star Bono. “That’s an important question.“
“People are reluctant to support their agricultural support systems, until they see others doing so,“ she told Ipsnews.net. “When is the reform in the EU, the US, Japan really going to take place? We thought for years that the Doha round would be a vehicle for that. But if the Doha round lowers a gear or doesn’t go anywhere at all, is the reform going to continue?“
Export subsidies are, however, just one type of support that is considered inimical to the interest of poor countries. The Organization for Economic Cooperation and Development in Paris calculated that farmers in rich countries received $279 billion in subsidies. That sum is the equivalent of 60 percent of the combined gross domestic product of all countries in Sub-Saharan Africa.
For next year, the European Commission has proposed that 42 billion euros should be spent on agriculture out of a total budget of 129 billion euros. Just four of the EU’s 27 countries--France, Germany, Italy and Spain--receive 58 percent of its agricultural subsidies.
That high level of expenditure is likely to be unaffected by the “health check“ on the Union’s agriculture policy announced by Fischer Boel earlier this month.
The health check proposes that a ceiling of 100,000 euros ($147,000) should be placed on the amount that large landowners can draw in subsidies but does not recommend a root-and-branch reform of the EU’s farm support system.
In a new study, DATA cites estimates that tomatoes exported in cans and as paste and sauce benefit from a subsidy rate of 65 percent in the EU. “These subsidies enable processors to purchase tomatoes cheaply and export the processed product to Africa at low prices, undercutting domestic producers and making it difficult for a value-added tomato industry to develop,“ says the report.
“Eliminating the EU tomato subsidy would increase the world price of tomato paste by approximately 5 percent and create greater opportunities for African tomato producers to compete in domestic, regional and global markets.“
In Ghana, imports of tomato paste--largely from a coterie of European countries--rose from 3,269 tons in 1998 to almost 25,000 tons in 2003. Over the same period, domestic production stagnated and in some cases fell. Similar problems have been reported in Burkina Faso.
Jack Thurston, an agricultural reform advocate who runs the website farmsubsidy.org, says that the EU appears to be on target to eliminate its export subsidies. “There is definitely a downward trend,“ he told IPS. “And on the rate of decline we have seen, they are going to go down further.“
Yet progress is not as impressive in dealing with other forms of support--such as the EU’s “single farm payment“--that have a bearing on developing countries.
Changes to agriculture policy approved by EU governments in 2003 pivoted to a considerable degree around a concept known as “decoupling“. This meant that the amount of payments a farmer received is no longer linked to the amount of food produced.
Despite this innovation, the EU is still “shoveling a lot of money into the farm sector“, Thurston argued. He predicts that the number of challenges mounted by developing countries in the World Trade Organization against EU farm policies could climb.
“Countries like Brazil are having a hard look at the EU’s single farm payment to see if it is really decoupled,“ he said. “There may well be cases brought against the EU.“

This decade will be about companies, funds and individuals in developing markets buying into western markets.

In August, with the private equity industry all but paralyzed by the early throes of the credit crisis, Houston-based oil company Pride International (PDE) managed to find a buyer for some of its drilling business. Pride sold its Latin American land-drilling operations and its exploration and production services unit to a private equity firm in a $1 billion deal.
But the buyer wasn’t one of the US megafunds that had dominated the business headlines during the private equity boom. Instead, it was GP Investments of Sao Paolo, which has emerged since its formation in 1993 as the largest private equity firm in Latin America.
According to Businessweek.com, the deal was among the largest in Latin American history and a coup for GP, which has raised $2.5 billion over the years.

Reversing Capital Flows
The deal illustrates an important new trend in the global flow of investment dollars. Until a few years ago, it was unheard of for a buyer in a developing market such as Brazil to acquire $1 billion worth of assets from a US-based company.
Virtually all of the investment dollars flowed from the developed world into the developing world. Now a new era is taking shape, in which the flow of global capital is moving from the developing world back to established financial centers such as the US and Europe.
The deals have been in everything from mining to finance to media. In May, the Saudi investment fund SABIC acquired General Electric’s (GE) GE Plastics business for $11.6 billion. The same month Russia’s OAO MMC Norilsk Nickel Group acquired Canada’s LionOre Mining International for $6.3 billion.
Then late last month, the Abu Dhabi Investment Authority bought a $7.5 billion stake in troubled banking giant Citigroup (C), following an investment of the same amount earlier this year in private equity firm Carlyle Group.
Earlier this year, China invested $3 billion in private equity leader Blackstone Group (BX). And last week, the government of Dubai took a 5 percent stake in media giant Sony (SNE).
“This is the next chapter in the M&A story,“ says Ravi Chanmugam, a partner at consultant Accenture (ACN). “This decade will be about companies, funds, and individuals in developing markets buying into Western markets,“
Accenture says the volume of such deals is growing at a pace of 35 percent to 40 percent a year. The firm expects volume to hit $96 billion in 2007, up from $7 billion in 2003. Five years from now, volume is likely to hit $250 billion to $300 billion.

Rising Expectations
That’s still a small fraction of the global M&A market. The value of deals announced so far this year has hit a record $4.5 trillion, according to researcher Dealogic (DL.L). But as the deals get larger, and as familiar brands are acquired by buyers from the developing world, the social, political and business implications will be considerable.
The public will be confronted with new evidence of its position in what Accenture calls “a multipolar world,“ and companies will have to learn how to manage cross-border deals of increasing complexity. “It’s a trend I think you will see accelerate over the next year,“ says Ivan Schlager, a partner with law firm Skadden Arps. “It’s an inevitable outgrowth of globalization.“
Chanmugam says there are several reasons for the rise of such deals. The falling dollar has made US assets cheaper for buyers in Brazil, Russia, India, and China, the so-called BRIC nations. A huge amount of investment capital is available in those countries, thanks to growing economies, trade surpluses, and petro dollars.
These countries are also home to a growing number of global 500 companies such as Huawei (the China-based maker of Internet equipment), Russia’s Lukoil (LUKOY), and Brazilian mining giant CVRD.
Then there is the evolving mentality of business people in developing economies. Chief executives of such companies increasingly think of themselves as being in the same league as their US and European counterparts--and they’re eager to do deals on the same scale.
Buyers in developing countries are focused on certain kinds of markets. In China, there’s a strong demand for tech deals, such as Lenovo’s acquisition of the IBM PC business.
In India, there’s a strong demand for steel and auto deals, as evidenced by reports that the leading bidders to acquire Land Rover and Jaguar from Ford Motor are Indian stalwarts Tata Motors and Mahindra & Mahindra.
Russian buyers are often looking for steel deals. And Chinese acquirers are getting increasingly aggressive in Africa, in a search for raw materials and financial reward.