Emergency reserves, private storage, or trade? How to prevent extreme grain prices in a two country setting

After the world food crisis in 2007/2008, calls for international grain reserves (ACTION, 2013) or public emergency reserves of grain (ICTSD, 2011) have increased. Despite a large amount of literature on optimal grain reserves in a single country (compare e.g. Gouel, 2013; Williams & Wright, 1991), there is currently a research gap in modeling the benefits from cooperation of different countries with respect to emergency reserves. This work provides a theoretical analysis of the conditions under which storage cooperation is beneficial for both participating countries. The analysis uses the competitive storage model for three countries. The model specification follows Gouel (2011) and Gouel and Jean (2012) but differs in explicitly including three countries. Stockholders and producers are risk-neutral and profit maximizing, act competitively and have rational expectations. Competitive trade occurs until there are no more possibilities for spatial arbitrage while consumption is isoelastic. The simulations are conducted in Matlab and to solve the model, the CompEcon toolbox (Fackler and Miranda, 2011) and the RECS solver (Gouel, 2013b) are used. An individual and a common emergency reserve of two countries are included as well as private storage based on rational expectations. The latter is crucial to analyze crowding out effects whereas the third country is needed to investigate how the two countries are affected by the rest of the world. The stock releases may be triggered by high prices or production shocks with, in practice, the former being more easily observable and less independent of global trends and dynamics than the latter. We expect trading costs and the correlation of production shocks to be the crucial parameters which influence the benefits obtained from a common reserve. When the emergency reserve is touched because of a world-wide supply shortage, we expect that the countries have to insulate themselves through tariffs from the world market to ensure the benefits from the reserves do not leak into the world market. In contrast, when no or only local supply shocks arise, countries benefit from free trade and may be willing to commit to long-term free trade agreements.