It is a physical reserve of grain that is owned by the government and is used to moderate the volatility of the price of food.
The government sets a price band for grain. This consists of a maximum price for consumers and a minimum price for farmers. The governments monitors the market price. If the market price starts to rise and there is a risk that it will rise above the maximum price, the government offers to sell grain from the buffer stock on the open market. This expands the supply of grain on the market and prevents the market price from rising above the maximum price. If the market price starts to falls and there is a risk that it will fall below the minimum price, the government offers to buy grain from the farmers. This expands the demand for grain and prevents the price from falling below the minimum price.
Yes. The government uses the market forces of supply and demand to keep the free market price within its pre-determined price band. There is no need for the government to create any ‘administrative’ prices. The government buys and sells grain at the free market price.
Yes, a buffer stock is fully compatible with international trade. Trade between countries in food and agricultural commodities is, in principle, beneficial and should be encouraged. A buffer stock enables a government to keep the domestic price of food within its pre-determined band if the world market price rises above the maximum price or falls below the minimum price.
Those countries that have a memory of famine tend to have a buffer stock. In some countries, the horrors of famine have faded from the collective memory and these countries no longer have buffer stocks. They believe that they will always be able to buy enough food from the world market. But this is naïve – if there is a world-wide shortage, the price of food on the world market may well become unaffordable, even for countries who consider themselves rich. Buffer stocks can prevent world food crises.
In principle, it is better to have a regional buffer stock, shared by several countries. This is cheaper (economies of scale) and provides a greater degree of food security. The participating countries have to agree how to share the costs and benefits.
A government has to procure the grain in the first place. It also has to build storage facilities. Those are the initial capital costs. Thereafter the government has to meet the annual running costs: management and the maintenance of the storage facilities. On the revenue side, the government should be able to make a profit, because it buys low but sells high.
A price stabilisation policy aims to reduce the amplitude of fluctuations in price, in other words to moderate price volatility. To do this, the government establishes a price band, defined by a minimum price and a maximum price. By means of a buffer stock, the government buys grain when the market price falls to the minimum price and sells grain when the market price rises to the maximum price, thereby keeping the market price within the price band. Among the beneficiaries of price stabilisation are consumers (food remains affordable) and farmers (farming remains profitable).
A price support policy aims to increase the price that farmers receive for their products. The government sets a ‘support price’. If the market price falls to the support price, the government buys grain to prevent the price falling below it. The government may find that it buys up large quantities of grain and has no profitable way of disposing of these ‘surplus stocks’. The beneficiaries of price support are farmers. Consumers do not benefit – they have to pay higher prices for their food.
We are of the view that price support should be avoided, unless there are very special circumstances such as an urgent need to quickly boost farm output. The problem with price support is that it can over-incentivise farmers, stimulating them to produce more food than consumers are willing to buy at the support price. This can result in an wanted surplus of food. We believe that farmers should receive free market prices. Free market prices tend to be volatile which can disorientate farmers and, if the price plummets, can wipe out their profits. To reduce the amplitude of price fluctuations, the government should keep the free market price within a pre-determined band. It can do this with a buffer stock.