The Economic Role of Commodity Storage

Abstract

One of the earliest, and most successful, exainples of economic policy is the oftquoted Biblical account of Joseph's interpretation of the Pharoah's dream. Joseph foretold that seven years of abundant harvests would precede seven years of drought, and recommended that the Pharoah accumulate grain during the good years. Since that time the central role of storage in stabilising the economy in the face of exogenous disturbances has been obvious, but our understanding of the nature of that role has not greatly advanced. Without divine assistance in forecasting stochastic production, the storage decision is considerably more complex than the one Joseph faced, and the role of storage quite different. In fact, several commonly held impressions about the role of storage of commodities such as grains are incorrect. Rather than stabilising production, storage actually accentuates its variability. Rather than causing a mean-price-preserving decrease or a mean-output-preserving decrease in the dispersion of price, storage generally causes a more complex modification of the distribution of price. Rather than being most effective at eliminating short-falls in consumption, storage actually is more effective at eliminating the incidence of exceedingly high consumption. In this paper we explore the role of storage in a model where production is stochastic and both production and storage are performed by competitive profitmaximisers who form rational expectations about the returns to their activities. We derive the subtle but very important interactions among production, price expectations, and storage, which simpler models cannot capture. Finally, we make a comparative statics assessment of the distributional implications of storage. These results, while confirming the importance of the specification of the demand function and the supply elasticity identified in recent analytical studies (e.g. Wright (I979) and Newbery and Stiglitz (I979)), are surprisingly favourable to consumers, considering the asymmetric nature of the effects of storage on consumption and price. Storage is simply a productive activity, one that transfers a commodity from one period to the next. Like other forms of production, it is costly. The total cost of storing an amount St from period t to period t + i is as of period t + i