Rising Food Prices Series: Part I

Posted by Patrick O'Connor on 5/15/08 8:01 am

This article is the first part of a multi-part series about rising global food prices. In this installment, we explain the factors that are contributing to a rise in global food prices. In the following weeks, we will discuss each factor in more detail.

Consumers tighten their belts as food prices soar

A sharp rise in food prices has developed into a global crisis, according to the United Nations. The situation has become increasingly desperate, with the prices of many food staples—including wheat, corn, and soybeans—approximately doubling over the past year. The result: Political tensions in less-developed regions, from North Africa to Southeast Asia, with riots in several countries, including Egypt, Haiti, and Somalia. What’s driving prices up, and how is the food crisis impacting the global economy?

The fundamental reason for soaring food prices is simple: the law of supply and demand, which is one of the most fundamental economic concepts and the backbone of a market economy. Demand is the quantity of a product or service desired by buyers. Supply is how much of those goods sellers can provide. When supply and demand are equal, an economy is said to be at equilibrium, because sellers are selling all the goods they have produced, and buyers are getting all the goods they have demanded, and everyone is satisfied. But sometimes the equilibrium tips, and there is too much supply or too much demand. When there’s too much supply, prices tend to fall, because producers need to unload their extra goods. But when there’s too much demand, prices tend to rise, because producers can get more for their goods.

In the case of the global food supply, demand is currently outpacing supply, so prices are rising. But there are many reasons why this is happening. As noted above, we will provide an overview of those reasons today, then discuss them in more detail later.

Part II: Demand from developing countries is rising and changing

Many developing countries are experiencing dramatic growth rates. At the same time, the populations are growing wealthier. And when people have more money to spend, they typically spend it on foods they haven’t been able to afford in the past, such as animal proteins. This is certainly true in China, where animal protein consumption has increased significantly since 1980. But eating meat is not the most efficient way to consume food, because farmers have to grow grain crops to feed the animals first. As a result, there isn’t just more demand for meat; there’s more demand for grains to produce the meat. Read More.

PART III: Developing and developed countries are experiencing food production challenges

It’s easy to understand why developing countries may have difficulties producing food: They tend to have poor technologies and skills, which lead to inefficient production. Questionable property rights, poorly developed irrigation systems, and impassable roads make crop production and transportation difficult. Selling a product is also challenging, as developing countries also tend to be the most protectionist; many don’t even have the freedom to trade within their own borders.

But many wealthy countries are also finding it difficult to produce enough food, for a different reason: They have been diverting their own arable land and food crops (most notably corn in the United States) to biofuel production.

Traditional fuels, such as coal, are fossil fuels, meaning they’ve been derived from long-dead biological material, such as plants. In contrast, a biofuel is fuel derived from recently dead biological material. One example of a biofuel is ethanol, which is made from sugar cane or corn.

You’ve probably heard a lot about ethanol in the news. Just last year, it was being touted as a green fuel that could help nudge the United States away from fossil fuel dependence.
As a result, an increasing amount of the corn crop in the United States—which exports 66% of the world’s corn—has been diverted to ethanol production. And again, we come back to supply and demand; because there is less corn available, corn prices have skyrocketed, as have the prices of other foods used in place of corn. Read More.

Part IV: Changing climate conditions have led to problems in agricultural conditions

While the increase in Earth’s temperature is making some places wetter, it’s making some places dryer, leading to more erratic flood and drought cycles. This is having a dramatic effect of food production. Read More.

Part V: Rising energy prices have forced the cost of transporting foods up

In April 2007, it cost $60 per ton to ship grain from the Gulf Coast to Japan and $38 per ton to Europe. Today it costs $110 a ton to ship to Japan and $75 a ton to ship to Europe—83% and 97% more, respectively. These rising fuel prices are being passed onto consumers. Read More.

Part VI: Many major exporters of food have implemented trade restrictions

Many Asian countries, including China and India, restrict the export of rice. Russia and Kazakhstan restrict the export of wheat. And Argentina restricts the export of corn, wheat, and soybeans. As a result, when prices rise, supply can’t flow to the places of highest demand. This may seem understandable: Why send food abroad when it’s needed at home? But longer term, trade restrictions make crops least profitable when they are most needed—and leave little incentive for farmers to plant, harvest, and store crops in case hard times arise. Read More.

Part VII: Opportunities and outlook

According to the law of supply and demand, when the price of a good exceeds equilibrium, a surplus of the good will result (because buyers can no longer afford it), and producers will be motivated to lower the price. However, reaching equilibrium can take time. In the meantime, while the global food crisis presents challenges for developing populations, it presents opportunities for investors. As agricultural production has increased to meet demand, for example, a number of companies could benefit: biotech companies involved in the genetic modification of crops to improve quality and yield, pest resistance companies, fertilizer companies, farm equipment companies, and climate advisory services. Read More.

Sources: Bloomberg; Food and Agriculture Organization of the United Nations; Food and Agricultural Policy Research Institute; International Grains Council; Renewable Fuels Association; U.S. Department of Agriculture; World Bank.

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Posted by aWriter on 6/9/08 3:38 pm

Relative to parts III and VI, it ain’t just supply and demand. It’s governments screwing with the invisible hand. Power to the politicians, never to the people. Supply and demand don’t cause food riots or any other kind of riots. Politicians and their power-grabbing decisions do.

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