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BRAZIL. Açai fruit at a market in Belém.
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The State of Agricultural Commodity Markets 2022

Part 2 THE FUNDAMENTAL DRIVERS OF TRADE IN FOOD AND AGRICULTURE

KEY MESSAGES
  • Comparative advantage, trade policies and trade costs shape global food and agricultural markets. These fundamental drivers determine trade partners and the trade flows between them, the value of food and agricultural products traded and the gains from trade.
  • In agriculture, the influence of comparative advantage is significant relative to other sectors of the economy. Across countries, large differences in relative agricultural productivity strengthen the role of comparative advantage and increase the incentives to trade and the potential gains from trade.
  • High trade costs in food and agriculture can offset the influence of comparative advantage. These costs can be significant due to the bulk and perishability of food and the high costs of compliance with non-tariff measures, such as sanitary and phytosanitary standards.
  • Low-income countries face significantly higher trade costs than high-income economies. This affects the role of trade in ensuring food security and facilitating structural transformation and growth. Countries that face high trade costs tend to have expanded agricultural sectors to meet their food requirements.
  • The interplay between comparative advantage and trade costs shapes the geography of trade and countries select their trade partners balancing the gains from trade with its costs. Within sub-Saharan Africa, low strength of comparative advantage and high trade costs translate into low levels of intra-regional trade. Improving productivity and reducing trade costs are key for market integration and development.

The expansion of trade in food and agriculture since the beginning of the twenty-first century has strengthened the interdependence of agrifood systems across the world. New players have emerged as important exporters in the global market while several countries depend on imports from other regions. More food and agricultural products cross borders and trade is facilitated by multilateral and regional agreements. The globalization of food has provoked lively debates on what outcomes global markets generate and has raised significant concerns about the impact of trade on the environment, society, changing lifestyles and diets. Opponents of globalization maintain that trade is harmful to sustainable development. Switching to locally produced food and reducing trade is seen by many as providing better environmental and social outcomes.

Nevertheless, trade in food and agriculture has been an essential part of our societies and the discussions on the globalization of food often overlook the fundamental drivers that shape global food and agricultural markets. People have been trading food since the Neolithic period or possibly earlier. Archaeological evidence suggests that around 6 000 BCE, when agriculture was replacing the hunter-gatherer economy in southern Europe, wheat – a crop that was initially domesticated and farmed in Mesopotamia – was imported into the British Isles through social networks and trade routes that connected our ancestors. At that time, although it was consumed, the hunter-gatherer communities in Britain did not cultivate wheat. It took about 2 000 years more, for arable farming and the wheat cultivation technology to arrive in mainland Britain.81

Why do countries trade?

Nowadays, technology differences across countries still drive international trade in food and agricultural products. Technology underpins a country’s absolute advantage in trade – it determines how the factors of production, such as land and labour, are combined, making them more productive and reducing costs. In food and agriculture, technology includes anything that can influence the transformation of production factors into outputs. Improved seeds, fertilizers and machinery, digital technologies, innovations in organization and farm management practices and improvements in education and extension make up agricultural technology and shape absolute advantage (see Box 2.1 for definitions of absolute and comparative advantage).

BOX 2.1Absolute advantage and comparative advantage in trade

The principles of absolute advantage and comparative advantage are central in the theory of international trade.

Absolute advantage refers to a country having higher productivity or lower cost in producing a good compared to another country. In other words, it shows a country’s ability to produce a good at a lower price than its competitors and is one of the simplest measures of economic efficiency.

However, absolute advantage is neither necessary nor sufficient for shaping trade patterns that benefit all countries. For example, a country may have an absolute disadvantage in all goods compared to another country, yet it can engage in trade with other countries and gain from it, due to comparative advantage in some goods vis-à-vis other countries.

Comparative advantage is the ability of a country to produce a particular good at a lower opportunity cost than its trading partners. Even if a country has an absolute advantage in all goods compared with other countries, it will benefit from importing the good in which it has the higher opportunity cost – that is the good that uses more resources in production compared with other goods that are produced domestically. By importing the higher opportunity cost good, the country can allocate more resources to produce and export the goods that are characterized by lower opportunity cost and gain from this. In theory, the principle of comparative advantage implies that all countries become better off as a result of trade.

Both absolute and comparative advantage are determined by differences in the level of technology and the resource endowments in each country, but while the former refers to higher (absolute) productivity, the latter has to do with relative (comparative) productivity.

Countries engage in trade to export what they can produce at a lower cost relative to other countries, while importing what is relatively more expensive to be produced domestically. While a country’s absolute advantage is determined by its productivity level, comparative advantage reflects the opportunity costs of production and entails a comparison both across countries and across products. With food and agricultural trade increasing twofold in real value terms since 1995, with more countries participating more actively in global markets and more trade flows among them, the principle of comparative advantage is increasingly relevant in the modern economy (see Part 1 for a discussion on trends in international trade in agricultural products and food).

Together with technology differences, the uneven allocation of natural resource endowments across countries forms another key determinant of comparative advantage in food and agricultural trade.l Land and water are crucial factors in food production, and their availability can influence the relative cost of agricultural products and shape comparative advantage. For example, water-stressed countries rely on the import of water-intensive foods to complement domestic production and ensure food security. Countries with abundant land or water can export food and agricultural products that use these factors more intensively and capture large shares of global trade (Part 3 discusses the role of land and water in determining food and agricultural trade).

Given the available technologies and resource endowments, countries specialize in agricultural products in which they are relatively more productive. And by engaging in trade, countries can gain by exporting these products for which they possess a comparative advantage, while importing products in which they have a comparative disadvantage. This does not mean that countries should only produce and export the products for which they enjoy a high comparative advantage, but that they tend to produce and export relatively more of these products, as markets provide incentives to specialize in the form of price differentials.82

The gains from food and agricultural trade can be significant. Differences in technologies and the natural resources necessary for agricultural production, such as land and water, are substantial across countries. For example, agricultural land per capita in the United States of America is approximately 25 times higher than in Japan. Recent studies looking at how market integration helps allocate agricultural production according to comparative advantage, suggest that gains from trade can be significant. Without trade, such large differences would result in extremely high food prices in countries with few natural resources per capita and extremely low prices in countries with larger endowments of land and water.83 This would also have significant implications for food security (see Box 2.2 for a discussion on the linkages between trade, food security and nutrition).

BOX 2.2Trade, food security and nutrition

Trade in food and agriculture can help balance food supply and demand globally by moving food from surplus to deficit areas. Higher food imports can increase the availability of calories and nutrients in a country with limited natural resources to produce adequate food. Food prices would fall through increased food supply, thus improving access for net consumers. Decreasing food prices induced by import competition can also affect the incomes and livelihoods of domestic farmers (net producers). For a country, trade also allows for better access to the markets of other countries and promotes exports of agricultural products to these markets, thereby creating and expanding employment opportunities and raising farmers’ incomes.119, 120

At times of shortages, which might, for example, be caused by natural disasters or seasonal growing patterns, trade can also contribute to more stable food supplies and prices and thus to the stability dimension of food security. The exchange of foods produced under specific climate, soil and other natural conditions, can contribute to the diversity of diets121 and improve food utilization.122, 123

Although the theoretical pathways of how trade can affect food security and nutrition are well-established, the linkages between trade and food security and nutrition are complex and some of the impacts can offset each other. This makes the identification of the effects in empirical assessments difficult. In fact, there has been only scant empirical evidence on these relationships.124, 125

A relatively new strand of literature contrasts trade openness with direct nutritional outcomes, such as undernourishment. At the global level, it was shown that agricultural trade openness has, on average, a positive net impact on food security measured as dietary energy supply adequacy. It also increased dietary diversity measured as the share of calories from non-staple foods and protein consumption.126 However, the exact mechanisms and impacts can vary by context and stage of development.127 For example, in a sample of 52 developing countries, food trade openness was associated with an increase in the prevalence of undernourishment. In fact, it was found that food supply increased because of increased trade openness but, in net food-importing countries, the negative effect on agricultural producers caused by import competition prevailed. This result could point to technology and efficiency constraints in net importing countries with large agricultural sectors.128

Among the most-researched relations within the area of agricultural trade and food security are the linkages between trade and price volatility. Price volatility, that is episodes of large, unexpected price changes, can intensify and contribute to risks to food security. In particular, the food price crisis of 2007/08 has triggered a plethora of studies on its causes. While a whole set of macroeconomic and sector-specific drivers for the price surges have been identified,129 it is now well-established that trade restrictions that were imposed by many countries in response to rising food prices exacerbated food price volatility.

To insulate from sudden food price surges, countries tend to impose new or heighten existing export restrictions and/or lower import barriers so that the domestic price will rise less than the world market price with the effect that world markets become even thinner, market uncertainty increases and international food prices become more volatile.130, 131 Export restrictions, especially when applied by major exporters, can significantly harm their trading partners, in particular, net food-importing developing countries. For example, export restrictions implemented by various countries between 2006 and 2011 increased international price volatility for wheat and rice. In fact, the contribution of export restrictions to price volatility appeared to be in the same order of magnitude as that of key macroeconomic variables.132

Diet diversity is important for the adequate provision of nutrients and human health. As natural conditions do not allow for producing all foods everywhere, trade is an important means for diversifying diets. Since the beginning of the 1960s, trade in crops has expanded and diversified, and this process has been identified as the main driver of a globally diversifying supply of vegetable products.133 In fact, the diversity of foods produced is a strong predictor of food supply diversity only in low-income countries, which are less integrated into global markets. In middle- and high-income countries, food supply diversity was shown to be independent of production diversity, and other factors including international trade contributed more to a country’s supply diversity.134

Although lower-income countries are often not well integrated in global markets, a study found that they still tend to improve their nutrient supply through trade, in particular the supply of energy, protein, zinc, calcium, vitamin B12 and vitamin A.135 However, in another study it was found that, while trade distributes substantial volumes of nutrients, its role in bridging the nutrient adequacy gap was only marginal in low- and lower-middle income countries. International trade helped close the nutrient gap in most high- and upper-middle income countries, even where domestic production ensured only a very low nutrient adequacy.136

Combined, the evidence shows that trade is indispensable to ensure food security and nutrition. Without trade, the availability and accessibility of foods and nutrients would be more unevenly distributed, any form of domestic production disruptions would cause serious concern for food security, and diets would be less diverse. However, increased competition through rising imports may be challenging for farmers in developing countries that are characterized by low efficiency and productivity constraints associated with poor physical infrastructure, weak institutions and low skills.

SOURCE: Adapted from Zimmermann, A. & Rapsomanikis, G. 2021. Trade and Sustainable Food Systems. Food Systems Summit Brief prepared by the Research Partners of the Scientific Group for the United Nations Food Systems Summit.

Nevertheless, the gains from food and agricultural trade are not distributed evenly. Trade affects the prices of foods and production factors, including labour, and can result in winners and losers. In agriculture, a major concern relates to the ability of smallholder farmers in developing countries to compete effectively in global markets. For these farmers, market failures, such as poorly functioning land and labour markets and limited access to technologies, credit and insurance can erode any comparative advantage and dissipate the gains from trade.84

Analysing comparative advantage – the key determinant of food and agricultural trade – in a world of many countries and many products is difficult and it may not be possible to measure it precisely. Traditionally, practitioners measure the export performance of a country in a particular product relative to the global market to reveal comparative advantage.m Since a country with a comparative advantage can produce a good relatively more cheaply than its trade partners, high comparative advantage relative to the rest of the world would be associated with exports and low comparative advantage would be associated with imports.

However, using observed data in this way does not adequately reflect the fundamental comparative advantage. This is because agricultural and trade policies distort markets and relative prices and the observed trade patterns of a country are determined on the basis of these distorted prices, rather than by underlying relative productivity levels and the availability of resources. Developments in quantitative trade models provide a better connection between the theory and the data and, although they do not measure comparative advantage for each country, they explore its role in shaping trade flows between countries. In these modelling frameworks, the influence of comparative advantage is assessed by the heterogeneity of relative productivities across trade partners, which, in turn, can generate price differentials and thus provide incentives for trade. For example, in the global market the higher the heterogeneity of relative productivities across countries, the stronger the influence of comparative advantage.n

Agricultural and trade policies, such as subsidies and border measures, can weaken the underlying role of comparative advantage in determining trade flows. They could even reverse the relationship between comparative advantage and trade, causing particular goods that would have otherwise been imported, to be exported and vice versa.85 For example, this could happen with policy measures such as export subsidies, which have been eliminated for agricultural products by the Tenth WTO Ministerial Conference held in Nairobi in 2015 (see Part 4).

Other policies, such as non-tariff measures (NTMs), including sanitary and phytosanitary standards, could also affect the influence of comparative advantage on trade flows. Although many NTMs aim to improve the safety and quality of food, address environmental and health issues, or support social norms, they can increase costs related to trade as exporters have to comply with different standards in order to export to different destination markets. The increasing prevalence of NTMs in food and agriculture means increasing costs for trade but, at the same time, weaker regulations could result in negative environmental, health or social outcomes.86

Trade costs, in general, strongly influence trade flows. Transport costs are significant, increase with distance and influence food and agricultural trade between countries (see the discussion on regional trade flows in Part 1). Other costs include search and communication costs, or costs associated with documentation, procedures and clearance delays at the border. Trade costs are likely higher for agricultural products and perishable foods, such as fruit and vegetables. They are also significantly higher in developing countries where transport and communication infrastructure are relatively poor, thus limiting the opportunities to trade that would potentially arise due to comparative advantage.87, 88

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