Monthly Archives: November 2010

178 – Betting on wheat prices

The ‘real’ price of food (the price with inflation factored out) has fallen through much of recent history. Back in 1995, there was a view around that agricultural commodity prices had reached a turning point and were going to stay high and rise further. I tried to have a bet with a grain price forecaster that real prices would not rise, but he refused. Would I have won?

In 1995, we were doing some modelling of future agricultural production trends based on forecast prices over the following 10 years. The International Food Policy Research Institute (IFPRI) had recently published a forecast that grain prices were set to turn the corner and rise in real terms over the coming decade.

Given what had occurred historically, this was a pretty remarkable prediction. For example, the figure below shows the history of real wheat prices in England since 1300 — they’ve been falling steadily for 200 years.

Source of graph: Lomborg, B. (2001). The Skeptical Environmentalist, Cambridge UP.

 

The wheat price forecaster at the Western Australian Department of Agriculture was persuaded by the IFPRI analysis, and was providing us with bullish predictions to use in our modelling. I was very sceptical, and offered to bet him $100 that “The real price of wheat will be lower on December the 1st 2005 than it was on December the 1st 1995”. The price was to be for US winter wheat, using the Australian CPI as a deflator.

This proposed bet was actually favourable to him, since his forecast was for real prices to be quite a bit higher in 2005. If he believed his own prediction, the bet was far from being a 50:50 proposition. When he hesitated, I made the terms even more favourable to him by offering that the the payoff would be the price of one tonne of wheat in December 2005. If he won, the payoff would be higher than if I won, potentially much higher.

I got a good feel for how confident he was in his predictions when he refused to take even this highly skewed bet. I was pretty frustrated, especially since we had to keep using his price forecasts in the modelling! (It wasn’t our choice — our client, the Department of Agriculture, specified the numbers to use.)

So, if we had had the bet, would I have won? Yes, easily. The real price in December 2005 was only 62% of the price in December 1995.

If I had specified a different time span for the bet, would I have won? Almost certainly. Figure 4 shows that only for a brief period in early 1996 and for 12 months over 2007-08 (the “global food crisis”) have subsequent real prices exceeded those in December 1995. I would have been really unlucky to lose, and if I had lost it certainly would not have been because food prices had reached a turning point and risen steadily. It would have just been the coincidental timing of a spike in prices.

Figure 2. US wheat prices relative to the price in December 1995 (both prices deflated using Australian CPI as deflator). If the line is above 1.0, it means that wheat price at that time is higher than in December 1995.

 

In December 1995 I had a big advantage; I knew that prices were at a high compared to recent history, so there was a good chance that future prices would be lower, maybe even if the trend line was actually upwards. What if I had made the same bet (over 10 years) starting at different points in time?

Figure 3 shows the ratio of real wheat price 10 years later to contemporary wheat price. At times when this ratio is below 1.0, I would have won the bet. It turns out that, even without the advantage of starting from a high price, I would have won almost 70% of the time for this period. The impact of the 2007-08 price spike is obvious in the results for 1997-98, but the ratio stays above 1.0 after that, not because prices were high in 2009-10 (they weren’t), but because prices plummeted after mid 1996 and were very low from 1997 to 2002. So much for steadily rising prices!

Figure 3. US wheat price 10 years later relative to current US wheat price. For example, the number for August 1987 shows the wheat price in August 1997 divided by the wheat price in August 1987 (both deflated using the Australian CPI). If the value on the graph is greater than 1.0 it means that wheat price was lower at that time than it was 10 years later.

 

A key lesson from this is not to get carried away by high commodity prices. In 2007, just like in 1995, people started predicting that it was the start of an era of continuing high food prices. However, economics says that the best cure for high prices is high prices. People respond to high prices in all sorts of helpful ways so that an acute mismatch of supply and demand is rapidly overcome, and prices fall. Even if people don’t understand economics, they too easily forget history, which says exactly the same thing.

Would I propose the same bet again? During a price spike, absolutely! Otherwise, probably not. Given that the world seems to be under-investing in agricultural research, and that China and India are developing rapidly, I would not expect a falling trend for real grain prices over the next decade.

One way it might fall is if governments in major countries reform their biofuel policies. Currently these are contributing to higher food prices by increasing the demand for certain grains. In some cases they are reducing supply by diverting land from food production to non-grain biofuel feedstocks. They are controversial and very inefficient policies in terms of mitigating climate change, so perhaps governments will decide to abandon them at some point.

David Pannell, The University of Western Australia

177 – Split infinitives

I’ve been pulled up a couple of times recently for using split infinitives in my writing, once by a co-author and once by an editor. However, the idea that a split infinitive is an error is a myth. Grammar experts agree that split infinitives are acceptable and can be good.

What is an infinitive? Two words, consisting of “to” and a verb. To go. To guess. To hide.

What is a split infinitive? An infinitive with another word (usually an adverb) in the middle. To quickly go. To cleverly guess. To furtively hide.

The rule not to split infinitives didn’t exist before the 19th century, and wasn’t widely applied until an English churchman named Henry Alford included it in his Plea for the Queen’s English in 1864. After that, the rule spread rapidly and in the 20th century was sometimes ruthlessly enforced in schools (which is perhaps the reason some people feel so strongly about it).

The basis for Alford’s objection was simply that split infinitives were not used in the Queen’s English. Others objected that it had not been used in older forms of English, so we should not start now. Some (such as the Oxford Dictionary) have claimed that the prohibition was “based on comparisons with the structure of Latin”, but according to Wikipedia, this is another myth. Of the people “who ascribe the split-infinitive prohibition to Latinism, none cite an authority who condemned the construction on that basis”.

So there you have it. The reason not to do it is that it’s not done — there is no logical linguistic reason to avoid it. But hold on … it is done. Particularly in spoken English, it’s very common. The only reason it’s not done more in written English is this silly baseless rule.

The Oxford Dictionary (among many other authorities) says there is no real justification for any prohibition on split infinitives, and points out that the rule can actually have adverse consequences by changing the meaning of a sentence. For example, they note that the sentence:

You really have to watch him. [i.e. ‘It’s important that you watch him’]

doesn’t have quite the same meaning as:

You have to really watch him. [i.e. ‘You have to watch him very closely’]

Interestingly, the Oxford Dictionary concludes that, even though there is nothing wrong with splitting infinitives, some people object to it strongly, so it’s safest to avoid it. I say phooey to that. What a terrible reason! I care about correct, not about safe.

To me, just about the strongest argument in favour of allowing split infinitives is the obvious stupidity of allowing the first four of the following sentences, but not the fifth.

I always strictly enforce good grammar.

I should strictly enforce good grammar.

I will strictly enforce good grammar.

I might strictly enforce good grammar.

I like to strictly enforce good grammar.

The split prohibitionists would require me to say “I like to enforce strictly good grammar” or “I like strictly to enforce good grammar“, but they both sound rubbish. I won’t do it!

David Pannell, The University of Western Australia

176 – The Murray-Darling Basin Plan

A couple of weeks back I attended a very good workshop in Brisbane on the Murray-Darling Basin Plan, which is causing so much political controversy at the moment. Here I’ll summarise a few key points from the workshop.

The workshop, organised by John Quiggin’s group at the University of Queensland, pulled together a who’s who of Australian water economists, including Mike Young, Jeff Connor, Lin Crase, Quentin Grafton, Jeff Bennett, Peter Gooday and Alistair Watson. In addition there were presentations from other social sciences, from ecology, and from the Murray-Darling Basin Authority.

The workshop came only a few weeks after the release of the “Guide” to the draft Plan, and in the wake of big public protests against the Plan by communities throughout the Basin.

The key point of the plan is that there needs to be a reduction in the amount of water taken from the rivers for irrigated agriculture. This has been obvious for a long time, and has been, on its own, a point of relatively little controversy. The recommended reduction is 3000 to 4000 GL, which amounts to 27 to 37% of current diversions. This size of reduction has clearly been a concern to many people.

Part of the controversy seems to be that farmers object to the government taking away their water. Given the media coverage that has occurred, most people who aren’t close to the issue assume that Government is going to forcibly acquire water rights from farmers, maybe even without compensation. This is completely wrong. To the extent that the protests are meant to protect agriculture per se, they reflect a total misunderstanding of the proposals in the Plan.

The proposal is for Government to buy back water from willing sellers only. This means that those farmers who end up with less water will be, by their own judgment, better off than they would have been without the plan. If they don’t think they’ll be better off, they won’t sell, and nobody will make them sell. Thus, farmers are protesting against a program that would make the farmers who sell better off.

Increasing Government purchases of water amounts to increased demand, which will result in a higher market price of water. This will obviously affect farmers who wish to buy water. I don’t think they are protesting about this, but even if they were, the protests would have little merit. The higher price would simply reflect that there are competing uses for the water, some of which are more valuable than some of the agricultural uses. It is just a better reflection of the true scarcity of water. The problem is not that water prices will be too high, but rather that they have been too low.

The other cause of consternation has been the predicted loss of non-agricultural jobs that depend on agriculture. Predicting the level of such job losses is extremely difficult, but the several different economic modeling teams who presented results at the workshop had a strong consensus that it would be small. The total loss of jobs attributable to the Plan over 20 years would probably be less than the daily turnover of jobs in Australia. John Quiggin notes that “For most towns and cities in the region, the ‘job loss’ estimates will be similarly notional. Total population in the Basin is growing, and so is employment.”

There are some communities in the basin where job losses are likely to be more significant locally. It would not be sensible to walk away from the whole Plan as a whole on their account. Rather, strong Government support for social and employment programs would be well justified.

Under the Howard government, billions of dollars were assigned to upgrading irrigation infrastructure in the Basin, as a way of saving water and limiting the need to purchase of water from irrigators. Given the controversy, this strategy probably looks tempting to the current government. Another point of strong consensus among the water economists was that this strategy is a bad idea, costing 2 to 4 times as much as purchasing water from willing sellers. Back-of-the-envelope calculations show that investing in infrastructure as a way to limit job losses would cost millions of dollars per job saved.

We heard about one very reasonable sentiment that is coming from people in the Basin community: if the Government is going to do this, they had better fix it! One could not blame people for being very unhappy if there are large, expensive, disruptive changes but they don’t achieve the hoped-for environmental results. There is a big risk for the Government here. If they aren’t very careful, they could easily find that they spend the money without getting worthwhile environmental benefits. The risks include:

1. Program failure. Past experience with large natural resource management programs does not give one much confidence about the likelihood of success. The Natural Heritage Trust and especially the National Action Plan for Salinity and Water Quality spent billions for very disappointing outcomes (see PD174). The Government will need (a) a real determination to pursue outcomes, not just activity, (b) to take the science and economics seriously, and (c) allow the time and resources to undertake good quality analysis to support decisions about how the money is spent on environmental assets.

2. Uncertainty about cause and effect. There is always a lot we don’t know about the relationship between particular changes in resource use and the resulting impacts on the environment. Even with the best will, and with very good analysis, there is still a risk that our poor understanding of the system will lead to poor results.

3. Ambiguity about the objectives. At the workshop, Hugh Possingham highlighted that, when we invest in the environment, we typically don’t know what we are trying to achieve or why. My experience strongly reinforces this point. This ambiguity makes it impossible to evaluate and compare different investment options.

Unusually for a long-term policy problem, it appears that we actually do have enough money on the table to achieve worthwhile outcomes. Whether we do actually achieve them will be a huge test.

David Pannell, The University of Western Australia

Note: the article has been edited to delete a comment about the effect of the past decade of drought on non-agricultural jobs. I accept a comment that was sent to me that this is complicated. Drought is not the same as permanent reduction in water — some business activities that are maintained at a loss during a drought would be shut down if there was less water permanently.