Cash for Clunkers failed

Remember how Cash for Clunkers worked (even though it was really expensive)? Actually it didn't. Sucks.

China's rare earth monopoly: long-term and short-term

In the wake of China's alarming decision to block rare earth exports to Japan, FP Passport published a longer and richer than usual post on whether China is making a rare earth power play, which is a helpful update on the latest global scenario.

As usual, some of the most insightful and prescient commentary came from Geoff Styles, a month ago already:

China's efforts to capture higher returns and more of the value-added for these scarce materials shouldn't surprise anyone; it's basic economics. OPEC tried this strategy in the 1980s, when it built export refineries in the Middle East and bought existing ones elsewhere. This didn't work out very well, because it contributed to a persistent glut of global refining capacity that, with the exception of a few standout years, generally benefited consumers more than producers. China could experience something similar in rare earths, once new, non-Chinese sources are brought online--assuming they are. Mining and processing such deposits entails large capital costs that, once invested, can set up a classic boom-and-bust commodity cycle. Unfortunately, the prospect of a future rare earth glut will be of little comfort to makers of wind turbines, advanced car batteries, and thin-film solar cells for the next several years, at least.

The OPEC comparison is interesting and relevant for the long-term view on rare earths, which are physically not that rare, just difficult and expensive to process. But Geoff is also right that in the short term, China may have a genuine squeeze. And if you believe this report (referenced by FP) that rebuilding the U.S. domestic industry would take 15 years, the short term doesn't look that short after all.

Nile water politics

This NYT article nicely captures the latest on Nile water politics. In sum:

• The current treaty guaranteeing 80% of the flow to Egypt and Sudan is a legacy of British colonialism


• Egypt views any reduction of flow to itself and its 80 million people as an existential threat, and rejects any such proposals out of hand


• Five of the seven upstream countries have signed a new Nile accord which requires a simple majority to approve projects, while Egypt insists on retaining veto rights over any project in any country


• Egypt believes it has the World Bank in its pocket on dam approvals, but worries that agricultural projects will not only soak up more water but also bring Arab and Chinese investors with their own clout into the fight


• Experts believe there is large water efficiency upside both upstream and downstream

It's hard not to be sympathetic to the seven countries who are still holding the short end of the stick imperialism handed them; on the other hand, in Egypt it's, if not life and death, a matter of the utmost political importance. Ethiopia's prime minister is right that it's not a zero-sum game, given the efficiency upside, but as in so many other parts of the world, at a market price of free, not enough stakeholders will be incentivized to capture it.

Moon shots and electric vehicles

Thomas Friedman on "moon shots":

China is doing moon shots. Yes, that’s plural. When I say “moon shots” I mean big, multibillion-dollar, 25-year-horizon, game-changing investments. China has at least four going now: one is building a network of ultramodern airports; another is building a web of high-speed trains connecting major cities; a third is in bioscience…; and, finally, Beijing just announced that it was providing $15 billion in seed money for the country’s leading auto and battery companies to create an electric car industry...

Not to worry. America today also has its own multibillion-dollar, 25-year-horizon, game-changing moon shot: fixing Afghanistan.

I'm not the biggest Friedman fan - he too often glances over important nuances - but he has a gift for stating core ideas in powerful ways, like the above. He devolves into simplicity here too:

The country that replaces gasoline-powered vehicles with electric-powered vehicles — in an age of steadily rising oil prices and steadily falling battery prices — will have a huge cost advantage and independence from imported oil.

If the economics were such a home run, it wouldn't take so much publicly funded start-up R&D to get this going - in fact, while I agree the prices of oil and batteries are moving in different directions, they're starting from such divergent places that they may well not cross any time soon. Batteries currently cost ~3x what they'd need to to be competitive, and Exxon - not the world's likeliest electric car revolutionary - has the world's best technology for the thin-film plastic separators that are the main components.

Especially given China's latest rare earths antics, we should also be worried about trading strategic energy dependency on one commodity (oil) for dependency on others.

That said, I believe Friedman's overall point on moon shots is spot on. My father (a scientist) and I disagree over the extent to which publicly funded basic science research enabled the technological boom of recent decades (think computers, the Internet, cell phones, biotechnology, etc.), but it certainly played some part, and skimping on this type of investment is a short-term decision with unpleasant long-term implications.

Hat tip Chris Blattman.

More food price volatility drivers

Upon further reflection on Chris Blattman's rare dud, here are a few more (slightly overlapping) potential drivers of food price volatility in the future. Please note that I'm not saying these will definitely cause higher food price volatility in the future, only that it is very easy to believe that they might.

• Biofuels and bioenergy: An additional source of demand growth - potentially very large - that could keep demand at the very edge of supply capacity.


• Stronger links to energy prices: Energy prices have always been linked to agricultural input costs since the most widely used fertilizer (nitrogen) is generally made from natural gas. More recently ethanol has become at times the marginal buyer of corn (Bruce Babcock at CARD did some nice research demonstrating that ethanol was the marginal buyer from late 2007 to mid 2008; I couldn't find a link to the paper, but all you need to do is look at the high correlation between actual corn prices and break-even prices for ethanol production). If this continues - and it may well, particularly when oil prices are high - then volatility in oil prices will be transmitted to food prices more than in the past.


• Speculation: That old bugbear; I personally am more skeptical about this one, as longtime readers will know, but the former head of IFPRI isn't, and objectively I'm no more likely to be right than he is.
  

Update: Michael Roberts responds and reprimands:

Here Chris seems to talking as much about climate science as economics or politics. He has also stepped onto a pet peeve of mine, common among some economists, which is ascribing personal views as truisms stemming from the branch of social sciences in which one specializes. It's not quite as bad as Steven Levitt pontificating about global cooling, but it reeks of that kind of professional arrogance. If you're an academic and are going to start asserting scientific truisms you need to be more specific about the underlying science.

He also points out a few factors not yet on my list, which I'll paraphrase here:

• Globalization is not irreversible: Think about how surprisingly globalized the world became during 1870-1914, only to regress drastically following World War I and the Great Depression.


• Shifts in comparative advantage due to climate change, which Michael is "convinced" of:
  

  That is, [climate change is] going to shift where things are grown. A lot. It's also likely to change global quantities, but that's hard thing to put a finger on (i.e., model convincingly). With that much change going on, we should worry at least a little bit, and probably a whole lot, about how the kind of turmoil these changes will cause. Loss of comparative advantage is just the kind of thing that brings about bad policy response.

• Uncertainty itself can exacerbate market volatility, and uncertainty about the future is high, not just about long-term commodity prices, but also about the direction of the world economy and shifts in agricultural production due to climate change.

Do food prices cause "food riots"?

The usually outstanding Chris Blattman has posted some spotty analysis of the recent journalistic coverage of food riots in Mozambique, which he finds "shallow and alarmist." I would have commented, but many have already done so, so rather than pile on I'll just articulate my own take here. Like commenter @Jonomist, I think his punchline that we should be more careful attributing causality is probably defensible, but some of his arguments are not.

Here’s what a closer look at your economics and political science can tell you.

Expect price volatility to fall over time. Globalization and growth should reduce price spikes in future. More countries are producing crops. Climate shocks in Argentina are not that tied to climate shocks in Russia or China, and so price volatility from supply shocks should be going down. Falling transport costs also mean that more substitutes are available, further reducing price volatility. So things should be getting better over time, not worse, especially if trade allows countries to diversify their diet. Envision a future of diminishing instability.

This is a dangerously superficial argument, reminiscent of arguments that a more integrated global financial system would mitigate systemic risk - remember how that turned out? It's what a textbook analysis would say, but lacks grounding in the realities of these markets.

• Empirical data (most recently the price spikes of 2008 and now 2010) don't bear this out, at least in retrospect to date.


• Many agricultural stakeholders - including private companies both producing and buying food, as well as multi-laterals such as the FAO and the World Bank - are deeply concerned with price volatility in the future. (My own view is that we can't yet tell if average volatility will increase to a higher permanent plateau, but most players believe this is much more likely than the opposite.)


• Growth in both population and income is driving strong growth in agricultural demand that is unlikely to abate soon, and pushing the world toward the edge of its current supply capacity. Production can grow too (Ehrlich and Malthus were wrong) through increasing yields through research and bringing more land under cultivation, but the former is longer-term and the latter runs into seriously diminishing marginal returns. My personal belief is that we will be able to feed 9 billion people a more modern diet by 2050, but there will be bumps along the way, and any time demand nears supply capacity, the potential for price volatility increases significantly.


• Climate may become more unstable as climate change progresses, and climate change could also adversely affect baseline agricultural productivity, as Michael Roberts' excellent paper has shown and the market seems to believe.


• As several commenters noted, national policies play a substantial role in agricultural prices (notice how the wheat market responded to the Russian wheat export ban), and this intervention seems unlikely to diminish (especially in light of the above factors) - if anything it is likely to exacerbate any increases in underlying volatility caused by long-term demand growth and short-term supply shocks.

A few smaller nits:

Look to local policy, not global markets, for the real instability. Bread prices climbed 30% in Maputo, apparently due to Russian wildfires. But global wheat prices have only risen 5%. Why the disproportionate effect? I wish I knew, except I haven’t a single report from the ground that points out the disparity, let alone one that searches for an answer.

Yes, global wheat prices have risen 5% "during August" - and more than 50% since June, as commenter Bernhard Brummer points out. Some of the blame goes to the NYT writer for not picking a better baseline, but it's not a hard thing to double-check.

Chris: For riots, look to poor policing, not poverty.
@Jonomist: Are fires caused by insufficient fire marshaling?

Exactly.

Chris' track record is too strong for him to need to redeem himself, but he does so anyway (I'm not sure if intentionally) through his next post on the quality of his commenters (who came through rapidly here).