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  Food Prices

  Author:	Lee Hudson Teslik, Associate Editor

  June 30, 2008

  • Introduction
  • The Structure of the Global Agriculture Market
  • How Food is Traded
  • Factors Affecting Food Prices
  • Geoeconomic Trends
  • Demand
  • Supply

  ---

  Introduction

  By just about any measure, global food prices rose significantly over the past two years. The consumer price index (CPI) measuring inflation for retail foodstuffs in the United States is expected to rise from 4.5 percent in 2007 to 5.5 percent in 2008. Those figures pale in comparison to the price increases faced by consumers in the developing world, who more often purchase non-packaged food directly (i.e. corn, not cornflakes) and thus are more exposed to the prices of individual food commodities. The prices of rice and wheat, for instance, have more than doubled in twelve months; for someone subsisting mainly on rice and purchasing it directly, that means food inflation of roughly 100 percent in a year. This jump in prices has led to riots in dozens of poorer countries.

  The Structure of the Global Agriculture Market

  According to data from the United Nations' Food and Agriculture Organization (FAO), the world grows overwhelmingly more grains than any other crop type. Grains—which are also known as cereals and include maize, rice, wheat, barley, and oats, among other varieties—account for about 40 percent of all global agriculture production, measuring by total metric tons produced. Behind grains, which in 2004 accounted for roughly 2.3 billion metric tons of production, the most prevalent categories of agricultural products are vegetables and melons (866 million), roots and tubers (715 million), milk (619 million), fruit (503 million), and meat (259 million).

  

  In terms of specific crops, by far the most prevalent is sugar, with 1.3 billion metric tons grown annually. Sugar is followed by the three leading grains, maize (721 million), wheat (627 million), and rice (605 million)—which combined account for about 87 percent of all grain production. Potatoes, at roughly 328 million, are the fifth most grown individual crop.

  Geographically, production varies substantially by crop type. For instance, according to data from the FAO, in 2005 the United States led the world in maize production, growing more than twice as much as its nearest competitor, China, and more than eight times as much as the third leading maize grower, Brazil. Rice production, by contrast, is overwhelmingly concentrated in East and South Asia. Nine of the ten top rice producing countries are Asian nations. The only non-Asian country in the top ten is Brazil, which ranks ninth.

  Climatic factors or strategic market-based decisions often mean that production of specific foodstuffs can be focused very narrowly. The vast majority of the world's mangoes, for instance, are grown in India. Brazil grows nearly twice as much sugar cane as its nearest competitor. Apricot production is dominated by Turkey and Iran.

  How Food is Traded

  Global agricultural markets, in economics lingo, are "thin," meaning that most of the food produced on Earth does not cross national boundaries. Only about 5 percent to 7 percent of all rice, for instance, is traded internationally. Other food types are traded more heavily, but very few see international trade rates higher than 20 percent of what is grown globally. This means the number of transactions is not high enough to guarantee consistent pricing throughout the world, because some countries are overwhelmingly dependent upon specific other countries for particular imports. For instance, according to data from the U.S. Department of Agriculture, the 2007 price for a ton of rice in the United States and the price in Thailand differed by $133—or more than 10 percent—with U.S. consumers paying more. The effects of this dynamic are exacerbated by government policies blocking trade where it might otherwise exist, in order to safeguard supplies at home.

  Given its overwhelming geographic concentration, the rice market provides a good case study on how market thinness can affect specific countries. The Asian continent's rapidly growing population, combined with government focus on investment in urban infrastructure and services rather than agricultural modernization or irrigation, has led to spiking rice demand. In 2008, several factors—including drought in Australia, flooding in Myanmar, and rising commodity prices across the board—exacerbated these preexisting strains (though total global rice production in fact increased, marginally, during that time). In a twelve-month period, the price of rice more than doubled. Although experts say the world has enough rice supply to meet total demand, some countries experienced major shortages, while countries with rice surpluses in many instances imposed export bans and restricted trade. The result, writes the economist Tyler Cowen, is that rice shipments did not necessarily flow where demand was highest, and the international rice market became highly distorted. The effect was particularly stark in the Philippines, the world’s leading rice importer, which brings in over 2 million metric tons of rice imports per year (about 15 percent of its rice consumption). The country felt a major pinch as exporters including China, India, Cambodia, and Vietnam curbed exports to guarantee domestic supplies. Simultaneously, other major rice producers including Japan balked at opening up rice stockpiles. The Philippines, in turn, was forced to seek out small import shipments wherever it could find them—pushing up global rice prices in the process and worsening its own plight.

  Similar effects have been seen in other food markets, including the wheat and corn markets. They have been felt most pressingly in developing countries. David Orden, an economist and senior research fellow at the International Food Policy Research Institute (IFPRI), explains that the dichotomy stems from the fact that people in developed countries buy much more of their food through retailers. "The price of corn is only going to show up so much in the price of corn flakes, whereas if you are in India and you are buying wheat and taking it home and grinding it in your own grist mill, the price of wheat is very directly related to your food costs," says Orden. Other factors, too, come into play. In some conflict-stricken regions, particularly in Africa, simply getting food to market poses a major challenge, so the market does not work efficiently, even assuming adequate agricultural production and wealth within a given population.

  Factors Affecting Food Prices

  A complex combination of factors defines the food market—which at least in part is not a "global food market," but a messy amalgam of regional markets (or, if you look at it a different way, a messy amalgam of international markets for specific foodstuffs, each reacting independently). Within the “food market” there are thousands of individual markets—kiwis, pistachios, pork, honey, pepper, etc.—each responding to different factors. Then, within each of these markets, there are submarkets. Consider the corn market. It comprises the market for unprocessed corn itself; retail markets for goods produced using corn; commodities markets where you can buy a piece of paper that says you own a certain amount of corn; and futures markets through which you can buy a piece of paper that gives you the right to buy a certain amount of corn at a certain price at a certain date in the future. Sometimes these markets track one another, but sometimes they move independently. Yet each feeds back into corn prices, and thus also food prices.

  Despite this messiness, it is possible to identify geoeconomic trends that have had a broad impact on food prices. The popularity of biofuels, a burgeoning global middle class, dysfunctional trade and aid policies, weather, and market speculation all play a role. Pressures outside the food market itself, like rising global commodity prices and currency concerns, have also exacerbated price pressures. The following is a summary of relevant factors.

  Geoeconomic Trends

  Before considering factors like supply and demand within food markets, it is important to understand the umbrella factors influencing costs of production and, even more broadly, the currencies with which and economies within which food is traded.

  • Energy Prices. Rising energy prices have direct causal implications for the food market. Fuel is used in several aspects of the agricultural production process, including fertilization, processing, and transportation. The percentage of total agricultural input expenditures directed toward energy costs has risen significantly in recent years. A briefing from the U.S. Department of Agriculture notes that the U.S. agricultural industry’s total expenditures on fuel and oil are forecast to rise 12.6 percent in 2008, following a rise of 11.5 percent in 2007. These costs are typically passed along to customers and are reflected in global spot prices (i.e. the current price a commodity trades for at market). The input costs of electricity have also risen, furthering the burden. Though it isn’t itself an energy product, fertilizer is an energy-intensive expense, particularly when substantial transport costs are borne by local farmers—so that expense, too, is reflected in the final price of foodstuffs. (Beyond direct causation, energy prices are also correlated to food prices, in the sense that many of the same factors pushing up energy prices—population trends, for instance, or market speculation—also affect food prices.)
  • Currencies/Inflation. When food is traded internationally—particularly on commodities exchanges or futures markets—it is often denominated in U.S. dollars. In recent years, the valuation of the dollar has fallen with respect to many other major world currencies. This means that even if food prices stayed steady with respect to a basket of currencies, their price in dollars would have risen. Of course, food prices have not stayed steady—they have risen across the board—but if you examine international food prices in dollar terms, it is worth noting that the decline of the dollar accentuates any apparent price increase.

  Demand

  Demand for most kinds of food has risen in the past decade. This trend can be attributed to several factors:

  • Population trends. The world’s population has grown a little more than 12 percent in the past decade. Virtually nobody argues that this trend alone accounts for rising food prices—agricultural production has, in many cases, become more efficient, offsetting the needs of a larger population—and some analysts say population growth hasn’t had any impact whatsoever on food prices. The shortcomings of a Malthusian food-price argument are most obvious in the very recent past. Richard Posner, a professor of law and economics at the University of Chicago, argues this point on his blog. He notes that in 2007 the food price index used by the FAO rose 40 percent, as compared to 9 percent in 2006—clearly a much faster rate than global population growth for that year, which measured a little over 1 percent. Nonetheless, experts say population trends, distinct from sheer growth rates, have had a major impact on food prices. For instance, the past decade has seen the rapid growth of a global middle class. This, Posner says, has led to changing tastes, and increasing demand for food that is less efficient to produce. Specifically, he cites an increased demand for meats. Livestock require farmland for grazing (land that could be used to grow other food), and also compete directly with humans for food resources like maize. The production of one serving of meat, economists say, is vastly less efficient than the production of one serving of corn or rice.
  • Biofuels. Experts say government policies that provide incentives for farmers to use crops to produce energy, rather than food, have exacerbated food shortages. Specifically, many economists fault U.S. policies diverting maize crops to the production of ethanol and other biofuels. The effects of ramped-up U.S. ethanol production—which President Bush called for as part of an initiative to make the United States “energy independent”—was highlighted in a 2007 Foreign Affairs article by C. Ford Runge and Benjamin Senauer. Runge and Senauer write that the push to increase ethanol production has spawned ethanol subsidies in many countries, not just the United States. Brazil, they note, produced 45.2 percent of the world’s ethanol in 2005 (from sugar cane), and the United States 44.5 percent (from corn). Europe also produces biodiesel, mostly from oilseeds. In all cases, the result is the diversion of food products from global food markets, accentuating demand, pinching supply, and pushing up prices. Joachim von Braun, the director general of IFPRI, writes in an April 2008 briefing (PDF) that 30 percent of all maize produced in the United States (by far the largest maize producer in the world) will be diverted to biofuel production in 2008. This raises prices not only for people buying maize directly, but also for those buying maize products (cornflakes) or meat from livestock that feed on maize (cattle).
  • Speculation. Many analysts point to speculative trading practices as a factor influencing rising food prices. In May 2008 testimony (PDF) before the U.S. Senate’s Committee on Homeland Security, Michael W. Masters, the managing partner of the hedge fund Masters Capital Management, explained the dynamic. Masters says institutional investors like hedge funds and pension funds started pouring money into commodities futures markets in the early 2000s, pushing up futures contracts and, in turn, spot prices. Spot traders often use futures markets as a benchmark for what price they are willing to pay, so even if futures contracts are inflated by an external factor like a flood of interest from pension funds, this still tends to result in a bump for spot prices. Still, much debate remains about the extent to which speculation in futures markets in fact pushes up food prices. “In general we [economists] think futures markets are a good reflection of what’s likely to happen in the real future,” says IFPRI’s Orden. Orden acknowledges that more capital has flowed into agricultural commodities markets in recent years, but says that he “tends to think these markets are pretty efficient and that you shouldn’t look for a scapegoat in speculators.”

  

  Supply

  Even as demand for agricultural products has risen, several factors have pinched global supply. These include:

  • Development/urbanization. During the past half decade, global economic growth has featured expansion throughout emerging markets, even as developed economies in the United States, Europe, and Japan have cooled. The economies of China, India, Russia, numerous countries in Southeast Asia, Latin America, and Eastern Europe, and a handful of achievers in the Middle East and Africa have experienced strong economic growth rates. This is particularly true in Asian cities, where industrial and service sector development has clustered. The result has often been a boost for per capita earnings but a drag on domestic agriculture, as discussed in this backgrounder on African agriculture. Farmland has in many cases been repurposed for urban or industrial development projects. Governments have not, typically, been as eager to invest in modernizing farm equipment or irrigation techniques as they have been to sink money into urban development. All this has put an increased burden on developing-world farmers, precisely as they dwindle in number and supply capacity. Production capacity in other parts of the world has increased by leaps and bounds as efficiency has increased, and, as previously noted, total global production exceeds global demand. But urbanization opens markets up to other factors—transportation costs and risks, for instance, which are particularly high in less accessible parts of the developing world—and prevent the smooth functioning of trade, even where there are willing buyers and sellers.
  • Weather. Some of the factors leading to recent price increases have been weather-related factors that tightened supply in specific markets. In 2008, for instance, two major weather events worked in concert to squeeze Asian rice production—Cyclone Nargis, which led to massive flooding and the destruction of rice harvests in Myanmar; and a major drought in parts of Australia. Estimates indicate Myanmar’s flooding instantly destroyed a substantial portion of Myanmar’s harvest, limiting the country’s ability to export rice. Meanwhile, Australia’s drought wiped out 98 percent of the country’s rice harvest in 2008, forcing Canberra to turn to imports and further straining Asia’s rice market.
  • Trade policy. Agricultural trade barriers have long been faulted for gumming up trade negotiations, including the Doha round of World Trade Organization talks. But in the midst of the recent food pinch, a different kind of trade barrier has emerged as a problem—export bans. As discussed before (in the instance of the Philippines meeting difficulty in its efforts to import rice), several exporters have tightened the reins in light of domestic supply concerns. According to the UN’s World Food Program, over forty countries have imposed some form of export ban in an effort to increase domestic food security. India, for instance, imposed bans on exporting some forms of rice and oil in June 2008—a move that took food off the market, led to stockpiling, and brought a spike in prices. China, Kazakhstan, and Indonesia, among other countries, have introduced similar bans. The distorting effects of these barriers are particularly troubling in the developing world, where a much larger percentage of average household income is spent on food. The African Development Bank warned in May 2008 that similar moves among African countries could rapidly exacerbate food concerns on the African continent. A group of West African countries, meanwhile, sought to mitigate the negative effects of export bans by exempting one another.
  • Food aid policy and other policies. Experts say flaws in food aid policies have limited its effectiveness and in some cases exacerbated price pressures on food. CFR Senior Fellow Laurie Garrett discusses some of these factors in a recent working paper. Garrett cites illogical aid policies such as grants for irrigation and mechanization of crop production that the Asian Development Bank plans to give to Bangladesh, a densely populated country without “a spare millimeter of arable land.” Garrett also criticizes food aid policies (U.S. aid policies are one example) that mandate food aid to be doled out in the form of crops grown by U.S. farmers, rather than cash. The rub, she says, is that food grown in the United States is far more expensive, both to produce and to transport, than food grown in recipient countries. Such a policy guarantees that the dollar value of donations goes much less far than it would if aid were directed to funds that could be spent in local markets. Other experts note additional policies that limit supply. In a recent interview with CFR.org, Paul Collier, an economics professor at Oxford University, cites European bans on genetically modified crops as a prime example.

   

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