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This report reassesses the causal link between domestic agricultural policies and world price instability, using the case of the rice market. Specifically, the report develops a framework for analyzing the effects of domestic policies on international price stability, identifies the conditions required for government policies to destabilize world markets and econometrically examines whether these conditions apply to the trade behavior of seven major rice trading countries over the period 1960-87. This is done by comparing the estimated transmission and absorption effects with those implied under free trade, by incorporating several behavioral restrictions drawn from standard trade theory. Sensitivity analysis is then used to discern how robust the results are to changes in domestic and international price elasticities. The report also identifies major structural and behavioral factors that account for the great degree of price instability in world rice markets relative to other major grain markets, and examines the dynamic effects of these factors on the organization and performance of international rice trade. The analysis indicates that while stabilization policies in some countries have exacerbated world price instability, this was not usually the case. Thus, the link between domestic price stability and world price instability appears, in the case of the rice market, to be exaggerated. Therefore, contrary to conventional wisdom on the subject, movements toward free trade may not contribute greatly toward stability in world rice trade. If domestic agricultural policies have been overemphasized as sources of instability in world rice trade, an explanation is still required for the high degree of volatility in this market. The major factors include: (1) the geographic concentration of world rice production in an area of unstable weather; (2) a persistently thin and fragmented market where price information is difficult to obtain, and where the development of coordination mechanisms to reduce trade uncertainties are thwarted by major traders' tendency to sporadically float in and out of the market; (3) very low consumption responsiveness to domestic prices in the countries examined, which means that the ability of domestic demand to absorb world price instability, even under free trade, is limited; (4) the emerging relationship between the world rice and petroleum markets; and (5) low world stockholdings relative to production, and the absence of a major actor that stabilizes world rice prices through stock and trade policies, as in the wheat and corn markets.


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