If we can’t prove that speculation drives food prices, should we regulate it anyway?

One of my more wonk-mind-blowing moments last year was refereeing a debate about financial speculation and commodity prices between Oxfam’s RobStephen_Spratt200 Nash and a UK Treasury wonk who wished to remain nameless. I couldn’t understand either of them (even by international development standards, the language is really weird – try ‘contango’ or ‘backwardation’).  I tried to get them to slug it out on the blog, but the Treasury type declined.

So it’s good news that Stephen Spratt of IDS (right) has written a blog post and 20 page paper on food price volatility and financial speculation – Stephen is a City poacher turned gamekeeper, and one of the clearest thinkers I’ve come across on financial markets.

The paper considers the case for and against the prosecution. Stephen sets out (and tries to answer) the key questions:

  • How has the relationship between financial actors and food commodity markets – particularly futures markets – changed in the last ten years?
  • What have been the benefits and costs of the increased role of financial sector actors in these markets?
  • How might the balance between benefits and costs change in the future?
  • What reforms, if any, are needed to ensure that benefits exceed costs?

The paper helpfully unpacks different kinds of ‘speculation’ – lumping them all together is really unhelpful, and assesses the impact of high prices and volatility on different groups (see table).

Spratt table

But the most valuable contribution is his thinking on complex systems. Sure there is a clear correlation between rising food prices, volatility and increased financial market activity in commodities, but proving the causal link between them is a different question. His conclusion: ‘Establishing cause and effect has proven to be impossible.’

The pro-market types consider this enough grounds to oppose regulation of speculation. Stephen disagrees. He argues that we need to think harder about the costs and benefits of action if the critics of financial speculation are right, and if they are wrong. If they are right, and speculation is driving food markets, then regulation would help prevent the extremely damaging social impacts of high and volatile prices. If they are wrong, and we regulate anyway, the damage would be limited. So in a version of the precautionary principle, he comes down in favour of regulation. Here’s his conclusion:

precautionary-principle‘The policy responses that different commentators favour are strongly influenced by two things. First, their view on the link between increasing financial speculation in futures market and price movements in spot markets. Second, their view on the relationship between financial market prices and underlying economic fundamentals. Reasonable people take different view on these questions, and it is not possible to answer them definitively. On the balance of evidence, however, we have proposed the cautious use of the precautionary principle, largely because of the fundamental importance of global food markets to the lives of billions of people.

Set against this, the ‘costs’ of placing greater curbs on financial participation in food markets seem relatively trivial. Some argue that reducing speculation would reduce market liquidity, increasing hedging costs. But there has been no reduction in hedging costs as financial engagement has grown. The only real cost, therefore, may be a reduction in the profitability of some financial institutions. Set against the potential benefits, this seems a price well worth paying.’

I’m convinced. You? The next step would be to apply the same precautionary principle/complex systems approach to different kinds of speculation and different forms of regulation – doubtless a very messy argument. Has anyone had it yet?

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5 Responses to “If we can’t prove that speculation drives food prices, should we regulate it anyway?”
  1. Liesbeth de Schutter

    Thanks for sharing this great paper. The relationship between ecology and financial markets (through complexity science) is more than interesting. The only thing that keeps me chewing (but I am not a financial markets’ expert) is the role of the physical traders and if they could become ‘super spreaders’ as the limited number of trading agents are both in physical trading, manufacturing as well as in hedge funds.
    I also would expect these traders to benefit from high volatility (as any trader) and that gives them a mutual interest with financial markets.

  2. Jodie Thorpe

    Strong case for the precautionary principle – found this really helpful and informative! The table of winners and losers particularly caught my attention. Interesting in what it says about development agencies: favour low prices despite the fact that high prices benefit rural farmers! But in particular, the same point jumped out to me as to Liesbeth. Physical traders – at least the big ones – generally benefit from volatility in their physical business, but are also involved in speculative trading. For more background see “Cereal Secrets: The world’s largest grain traders and global agriculture”.

  3. christian82

    I’m not yet convinced.
    Reduced liquidity is a major concern, since liquidity is needed to get an informative price. A market economy can only function when prices indicate scarcity. There are futures markets without transactions over long periods. Thus, their old prices do not tell anything about the current needs of consumers.

    I thought that the information function of prices is of particular value in developing countries. This was the idea behind Eleni Gabre-Madhins approach of establishing an Ethiopian commodity futures trading board. And as far as I have heard, this approached helped local farmers a lot. Futures market prices are communicated throughout the country, so Ethiopians now know how much their produce is worth when bargaining. I am not sure whether restricting liquidity would not simply make people blind for the severe fact that food becomes scarce from time to time. If prices are less informative on scarcity, policy measures to smooth food consumption might come too late.

  4. Chris Alford

    Thanks for sharing – definitely agree with Stephen’s conclusion here, reminds me of an amusing David Mitchell video I watched a while back on Climate Change doubters


    On a related note, isn’t there a much more established link between speculation and gasoline prices? From what I’ve read (and I could be wrong here, as the whole topic goes over my head a lot of the time), it seems to be a much more accepted cause-effect relationship amongst a much wider variety of circles than the link between speculation and food prices. But I wonder, what’s the difference between the two? Surely if people can accept that excessive speculation in petroleum markets can drive up oil prices then it’s not too big a jump from there to accept that it can also impact upon food prices? Or is there something that differentiates the two?