By EYASU SOLOMON
Governments in both oil-rich countries had imposed controls on food prices, with the usual consequences. Such controls have been surprisingly widespread response to one of the most remarkable changes that food markets.The world price of wheat rose to over $400 a tonne, the highest ever recorded. Earlier this year the price of maize (corn) exceeded $175 a tonne, again a world record. It has fallen from its peak, as has that of wheat, but at $150 a tonne is still 50% above the average.
As the price of one crop shoots up, farmers plant it to take advantage, switching land from other uses. So a rise in wheat prices has knock-on effects on other crops. Rice prices have hit records this year, although their rise has been slower. Normally, sky-high food prices reflect scarcity caused by crop failure. Stocks are run down as everyone lives off last year's stores. This year harvests have been poor in some places, notably Australia, where the drought-hit wheat crop failed for the second year running. And world cereals stocks as a proportion of production are the lowest ever recorded. The run-down has been accentuated by the decision of large countries (America and China) to reduce stocks to save money.
Yet what is most remarkable about the present bout of “agflation” is that record prices are being achieved at a time not of scarcity but of abundance. According to the International Grains Council, a trade body based in London, this year's total cereals crop will be 1.66 billion tonnes, the largest on record and 89m tonnes more than last year's harvest, another bumper crop. That the biggest grain harvest the world has ever seen is not enough to forestall scarcity prices tells you that something fundamental is affecting the world's demand for cereals.
Two things, in fact. One is increasing wealth in China and India. This is stoking demand for meat in those countries, in turn boosting the demand for cereals to feed to animals. The use of grains for bread, tortillas and chapattis is linked to the growth of the world's population. It has been flat for decades, reflecting the slowing of population growth. But demand for meat is tied to economic growth and global GDP is now in its fifth successive year of expansion at a rate of 4%-plus.
Higher incomes in India and China have made hundreds of millions of people rich enough to afford meat and other foods. In 1985 the average Chinese consumer ate 20kg (44lb) of meat a year; now he eats more than 50kg. China's appetite for meat may be nearing satiation, but other countries are following behind: in developing countries as a whole, consumption of cereals has been flat since 1980, but demand for meat has doubled.
Not surprisingly, farmers are switching, too: they now feed about 200m-250m more tonnes of grain to their animals than they did 20 years ago. That increase alone accounts for a significant share of the world's total cereals crop. Calorie for calorie, you need more grain if you eat it transformed into meat than if you eat it as bread: it takes three kilograms of cereals to produce a kilo of pork, eight for a kilo of beef. So a shift in diet is multiplied many times over in the grain markets. Since the late 1980s an inexorable annual increase of 1-2% in the demand for feedgrains has ratcheted up the overall demand for cereals and pushed up prices.
Because this change in diet has been slow and incremental, it cannot explain the dramatic price movements of the past year. The second change can: the rampant demand for ethanol as fuel for American cars. In 2000 around 15m tonnes of America's maize crop was turned into ethanol; this year the quantity is likely to be around 85m tonnes. America is easily the world's largest maize exporter—and it now uses more of its maize crop for ethanol than it sells abroad.
Ethanol is the dominant reason for this year's increase in grain prices. It accounts for the rise in the price of maize because practice waded into the market to mop up about one-third of America's corn harvest. A big expansion of the ethanol programme in 2005 explains why maize prices started rising in the first place.
Ethanol accounts for some of the rise in the prices of other crops and foods too. Partly this is because maize is fed to animals, which are now more expensive to rear. Partly it is because America's farmers, eager to take advantage of the biofuels bonanza, went all out to produce maize this year, planting it on land previously devoted to wheat and soyabeans. This year America's maize harvest will be a jaw-dropping 335m tonnes, beating last year's by more than a quarter. The increase has been achieved partly at the expense of other food crops.
This year the overall decline in stockpiles of all cereals will be about 53m tonnes—a very rough indication of by how much demand is outstripping supply. The increase in the amount of American maize going just to ethanol is about 30m tonnes. In other words, the demands of America's ethanol programme alone account for over half the world's unmet need for cereals. Without that programme, food prices would not be rising anything like as quickly as they have been. According to the World Bank, the grain needed to fill up an SUV would feed a person for a year.
America's ethanol programme is a product of government subsidies. There are more than 200 different kinds, as well as a 54 cents-a-gallon tariff on imported ethanol. That keeps out greener Brazilian ethanol, which is made from sugar rather than maize. Federal subsidies alone cost $7 billion a year (equal to around $1.90 a gallon).
In theory, what governments mandate, they can also scrap. But that seems unlikely with oil at the sort of price that makes them especially eager to promote alternative fuels. Subsidies might be trimmed, of course, reducing demand occasionally; this is happening a bit now. And eventually, new technologies to convert biomass to liquid fuel will replace ethanol—but that will take time. So demand for grain will probably remain high for a while. Demand, though, is only one side of the equation. Supply forms the other. If there is a run of bumper harvests, prices will fall back; if not, they will stay high.
Harvests can rise only if new land is brought into cultivation or yields go up. This can happen fairly quickly. The world's cereal farmers responded enthusiastically to price signals by planting more high-value crops. And so messed-up is much of the rich world's farming systems that farmers in the West have often been paid not to grow crops—something that can easily be reversed, as happened this year when the European Union suspended the “set aside” part of its common agricultural policy. Still, there are limits to how much harvests can be expanded in the short term. In general, says a new report by the International Food Policy Research Institute (IFPRI), which is financed by governments and development banks, the response, tends to be sticky: a 10% rise in prices yields a 1-2% increase in supply.
It is risky to predict long-run trends in farming—technology in particular always turns out unexpectedly—but most forecasters conclude from these conflicting currents that prices will stay high for as much as a decade. Because supplies will not match increases in demand, IFPRI believes, cereal prices will rise by between 10% and 20% by 2015. The UN's Food and Agriculture Organization’s forecast for 2016-17 is slightly higher. Whatever the exact amount, this year's agflation seems unlikely to be, as past rises have been, simply the upward side of a spike.
If prices do not fall back, this will mark a break with the past. For decades, prices of cereals and other foods have been in decline, both in the shops and on world markets. The IMF's index of food prices in 2005 was slightly lower than it had been in 1974, which means that in real terms food prices fell during those 30 years by three-quarters. In the 1960s food (including meals out) accounted for one-quarter of the average American's spending; by 2005 the share was less than one-seventh.
In other words, were food prices to stay more or less where they are today, it would be a radical departure from a past in which shoppers and farmers got used to a gentle decline in food prices year in, year out. And its effects would be felt everywhere, but especially in countries where food matters most: poor ones.
In emerging markets an income gap has opened up between cities and countryside over the past few years. As countries have diversified away from agriculture into industry and services, urban wages have outstripped rural ones. Income inequality is conventionally measured using a scale running from zero to one called the Gini coefficient. A score of 0.5 is the mark of a highly unequal society. The Asian Development Bank reckons that China's Gini coefficient rose from 0.41 in 1993 to 0.47 in 2004. If farm incomes in poor countries are pushed up by higher food prices, that could mitigate the growing gap between city and countryside. But will it?
In every country, the least well-off consumers are hardest hit when food prices rise. This is true in rich and poor countries alike but the scale in the latter is altogether different. As Gary Becker, a Nobel economics laureate at the University of Chicago, points out, if food prices rise by one-third, they will reduce living standards in rich countries by about 3%, but in very poor ones by over 20%. Not all consumers in poor countries are equally vulnerable. In Ethiopia, teff: neither is traded much across borders, so producers and consumers are less affected by rising world prices. As the World Bank's annual World Development Report shows, the number of urban consumers varies from over half the total number of poor. But overall, enormous numbers of the poor—both urban and landless laborers—are net buyers of food, not net sellers. They have already been hard hit. According to IFPRI, the expansion of ethanol and other biofuels could reduce calorie intake by another 4-8% in Africa and 2-5% in Asia by 2020. So it is no good saying “let them eat cake”: there are strong welfare arguments for helping those who stand to lose. But the way you do it matters. In general, it is better to subsidize poor peoples' incomes, rather than food prices: this distorts price signals the least and allows farmers to benefit from higher prices. Where it is not possible to subsidize incomes (because to do so requires a decent civil service), it is still possible to minimize the unintended consequences if food subsidies are targeted and temporary. At the same time, it cut tariffs on food imports to increase competition. In contrast, Russia shows how not to do it. It imposed across-the-board price controls on milk, eggs, bread and other staples, benefiting everyone whether they needed help or not. Food is disappearing from shelves and farmers are bearing the brunt. As Don Mitchell of the World Bank points out, “if you want to help consumers, you can do it without destroying your producers but only if you go about it in the right way. There is one last important knock-on effect of agflation. It is likely to help shift the balance of power in the world economy further towards emerging markets. Higher food prices have increased inflation around the world, but by different amounts in different countries. In Europe and America food accounts for only about one-tenth of the consumer-price index, so even though food prices in rich countries are rising by around 5% a year, it has not made a big difference. There have been clucks of concern from the European Central Bank and a consumer boycott of pasta in Italy, but that is about all. In poor countries, in contrast, food accounts for half or more of the consumer-price index. Here, higher food prices have had a much bigger impact. Inflation in food prices in emerging markets nearly doubled in the past year, to 11%; meat and egg prices in China have gone up by almost 50%. This has dragged up headline inflation in emerging markets from around 6% in 2006 to over 8% now. In many countries, inflation is at its highest for a decade. Governments are determined to ensure that what could be a one-off shift in food prices does not create continuing inflation by pushing up wages or creating expectations of higher prices. So they are tightening monetary policy. The indirect effect of food-price rises has therefore been to widen the interest-rate differential between rich and emerging markets. And all this is going on as the economic balance of power is shifting. Growth in America and Europe is slowing; China and India are going great guns. Financial confidence in the West has been shaken by the subprime-mortgage crisis; capital flows into emerging markets are setting records.
Eyasu can be reached at EYASOL@AOL.COM
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