Food Trade Policy and Food Price Volatility

Food trade barriers in many countries change systematically to insulate domestic markets from world price changes. In this study, policymakers are assumed to minimize the political costs of changing domestic prices and deviating from political-economy equilibria. Error correction techniques applied to price data for rice and wheat collected to measure trade policy distortions allow estimation of policy response parameters. The results suggest that systematic short-run price insulation reduces shocks to domestic prices but magnifies world price volatility and the costs of trade distortions. However, idiosyncratic domestic price shocks increase domestic price volatility relative to the magnified volatility of world prices. The results change our understanding of price insulation—from a zero-sum game where some reduce price volatility at the expense of their neighbors, into a negative-sum game with higher price volatility in most countries. Policy reforms could lower costs, reduce price volatility, and facilitate reform of international trade rules.