Hedge Funds

Nourishment is one of the most fundamental requirements for survival and quality of life. But in recent years food prices have increased dramatically due to a combination of high fuel prices and the effects of speculation in commodity markets. The World Bank reports that food prices hit a peak in 2008 and have remained high ever since. Between June 2010 and April 2011, an additional 44 million people fell below the $1.25 poverty line, chiefly because of high food prices.

Food price shocks occur when a country experiences a sharp and sudden increase in food prices. In their March 2012 IMF Working Paper “Are Foreign Aid and Remittance Inflows a Hedge against Food Price Shocks?,” authors Jean-Louis Combes, Christian Ebeke, Mireille Ntsama Etoundi, and Thierry Yogo discuss the relative effectiveness of two methods of relief following a price shock: foreign aid and remittances, which are money sent from friends and family members working abroad. They conclude that while both aid and remittances help reduce the effects of a food price shock, remittances appear to be a more potent tool for recovery.

The authors examine the effects of food price shocks on a large sample of countries between 1980 and 2009. They find that a country’s vulnerability to food price shocks is a function of its GDP per capita, its dependence on food imports, and the ratio of household food purchases to total household consumption. Unsurprisingly, low-income countries are the most vulnerable to food price shocks, particularly countries in Sub-Saharan Africa. The authors find that, among the most vulnerable countries, foreign aid increased by 13.6 percent following a food price shock while remittances increased by an incredible 143.9 percent.

Combes, Ebeke, Etoundi, and Yogo consider the effects of these increases by examining household consumption per capita in a country following a food price shock. Their analysis shows that increases in foreign aid and remittances do indeed stabilize consumption rates. In order for a highly vulnerable country to completely absorb a food price shock, they conclude, foreign aid must amount to at least 29 percent of the country’s GDP. However, remittances need only reach nine percent of GDP to completely absorb the shock. Explanations for the comparative effectiveness of remittances include the difficulty of mobilizing foreign aid and the tendency for households to apply remittances to consumption.

Most countries, however, receive nowhere near these levels of foreign aid or remittances. From 1980 to 2009, only two countries, Mozambique and Nicaragua, had an average rate of foreign aid above the 29 percent threshold. Furthermore, according to the World Bank, the average country had only a 4.3 percent remittance-to-GDP ratio in 2010.

While Combes, Ebeke, Etoundi, and Yogo recommend an increase in both foreign aid and remittances to the most vulnerable countries, they point out that increasing the flow of money is only a short-term solution. The larger issue is not how a country can best recover from a food price shock, but how to reduce a country’s vulnerability to such shocks in the first place.