"What’s Causing Global Food Price Inflation?"

This research argues that India, China, and speculators are not the cause of the food price explosion, the cause is biofuel support policies. Thus, since the "OECD’s recent report on the economic assessment of biofuel support policies has clearly shown that their effectiveness is disappointingly low," the conclusion is that governments should reconsider their biofuel support policies:

What’s causing global food price inflation?, by Stefan Tangermann, Vox EU: Global food prices have exploded since early 2007, causing major social, political, and macroeconomic disruption in many poor countries and adding to inflationary pressure in the richer parts of the world.[1] Concerns about high food prices have been expressed at the highest political level, including during the recent G8 summit on Hokkaido.

What has caused the explosion of food prices? Several culprits have been blamed.

• Newspapers have cited an internal World Bank document as having found that 75% of the price increase was due to biofuels.
• Several governments and commentators see speculation as a major driving force.
• A widely held view has it that rapidly growing food demand in the emerging economies is pushing up global food prices.

Which contributions have these or other factors made to rising food prices?

New evidence on the causes

The OECD has carefully looked at market developments and analysed the implications of biofuel support policies. The analytical framework used is a large-scale partial equilibrium model of agricultural commodity markets in all major countries and at the international level, with detailed representation of the multitude of policy instruments affecting these markets, including those targeting biofuels.

Results were published recently in the OECD-FAO Agricultural Outlook, a paper on the causes and consequences of rising food prices, and a report on the economic assessment of biofuel support policies. The evidence is pretty clear.

It’s not China’s and India’s demand

Food demand in China, India, and other emerging economies is rising as their incomes grow. However, domestic food production in most of these countries is growing in parallel. China, for example, has been a consistent and growing net exporter of cereals (including rice). The Agricultural Outlook expects China’s net cereals exports to decline only very gradually in the coming decade. For India, the picture is similar, though there was significant variability in its net trade position in the past. In short, growing food demand in the major emerging countries cannot be held responsible for the rise in world market prices for cereals.

Market panic, and more specifically “speculation”, may well have played a role on derivative markets for agricultural commodities. The amount of capital invested and the number of transactions observed in these markets has increased very significantly in recent times. Activity on futures markets may, to some limited extent, have spilled over into spot markets.

No hard evidence that “speculation” boosted the spot price

Yet, there is no hard evidence that “speculation” has added much to the price increase on spot markets. After all, it is only when “speculators” actually buy produce on the spot market that they can drive up the price, and this would have to be reflected in growing stock levels – but stocks appear to have declined throughout the period of rising prices.

A different type of panic, though, has without doubt contributed to food price inflation – the barriers to exports that some food exporting countries have imposed in order to keep domestic food prices under control. Yet, the precise effect that this form of government panic has had on short-term price movements is very difficult to quantify.

OECD analysis clearly shows that two factors external to agriculture and food have had, and will continue to have in the years to come, a significant impact on the rise of global food prices.

• The rapid increase in crude oil prices and energy prices more generally has significantly raised the costs of producing and shipping agricultural products.
• The weak dollar has contributed to driving up dollar-denominated commodity prices in international trade.

But there is also one policy-made ingredient in the story – the high and growing level of support provided to the production and consumption of biofuels.

Policy-made causes: Biofuels

The use of agricultural products, in particular maize, wheat, and vegetable oil, as feedstock for biofuel production has expanded dramatically in recent years. Between 2005 and 2007, i.e. in the period when food prices began to explode, nearly 60% of the growth in global consumption of cereals and vegetable oils was due to biofuels. Global output of cereals and vegetable oil did not decline during that period, but just grew slower than the rapid expansion of use.

In a situation of depleted stocks and very low demand and supply elasticities, this gap between use and output growth has pushed prices up very strongly. As a large part of the use expansion was due to biofuels, there cannot be any doubt that biofuels were a significant element in the rise of food prices. More specifically, in North America and Europe biofuels cannot be produced, and would be very little used, in the absence of government support through subsidies, tax breaks, tariffs, and use mandates. In other words, biofuel support policies have contributed greatly to the rise in global food prices.

Future price developments: High but not this high

With this perspective on what has happened in the recent past, it is clear that some of the factors identified will continue to play an important role in future developments on agricultural markets.

The OECD-FAO Agricultural Outlook expects prices on international agricultural markets will not remain at the extremely elevated level seen in the first half of 2008. However, prices are not expected to fall back to the low levels observed before the price hike either. For the 2008-17 period, average prices for major agricultural products are projected to remain some 10% to 50% higher in real terms than on average over the past ten years.

The contributions that individual factors are expected to make to this higher level of prices are clarified in the Agricultural Outlook through scenario analysis, the results of which are shown in Figure 1. Again it is evident that biofuels will be an important driver of future food prices. In the absence of further growth in biofuels production (not to speak of a decline), international market prices of wheat, maize, and vegetable oil could be some 6%, 12% and 15% lower than projected under baseline assumptions.

Figure 1 World food price projections

Source: OECD-FAO Agricultural Outlook, Chapter 2.

It is worth noting that the baseline for these projections does not even include the impacts of more recent biofuels policy initiatives such as the Energy Independence and Security Act of the United States and the European Union’s Directive on Renewable Energy. If the further expansion of biofuels production and use due to these initiatives were included, the impact of biofuels on global agricultural prices would be even higher.

Conclusion

In summary, several factors are behind the recent dramatic increase in food prices. But one of them is clearly a result of deliberate policy decisions, i.e. to support the expansion of biofuels production and use. The OECD’s recent report on the economic assessment of biofuel support policies has clearly shown that their effectiveness is disappointingly low, with public support costing between $960 and $1700 per tonne of greenhouse gas emissions saved. In a situation like that, governments have good reasons to reconsider their biofuel support policies if they want to help to calm food prices down.

[1] See Esther Duflo on winners and losers from high food prices, Arvind Subramanian on policy responses, and Guillermo Calvo on the causes of commodity price increases.

Comments

[Tejvan Pettinger]

Well balanced article. Also interesting how policy decision in West (bio fuels) have such a big impact on developing world (food prices)

Maybe the best form of AID for poor people at moment would be to rethink bio fuels subsidy.

[anne]

http://www.earthpolicy.org/Updates/2007/Update63_data2.htm#table5

December 13, 2006

U.S. Fuel Ethanol Use, Corn Production, 2000-2007

(Million Metric Tons - Percent)

2000 16 of 252 6.3
2001 18 of 241 7.4
2002 25 of 228 11.1
2003 30 of 256 11.6
2004 34 of 300 11.2

2005 41 of 282 14.4
2006 54 of 273 19.8
2007 81 of 336 24.1

2008 114 of 325 35.1 *

http://www.earthpolicy.org/Updates/2008/Update72_data.htm#table14

January 23, 2008

U.S. Fuel Ethanol Use, Grain Production, 2000-2007

(Million Tons - Percent)

2000 16 of 340 4.7
2001 18 of 321 5.6
2002 25 of 294 8.5
2003 30 of 345 8.7
2004 34 of 386 8.8

2005 41 of 363 11.3
2006 54 of 336 16.1
2007 81 of 414 19.6

2008 114 of 400 28.5 *

* Grain for fuel ethanol assumes 80 percent of ethanol distilleries currently under construction will be completed to draw from the 2008 harvest projection.

Note: Values are for crop years which begin in September of the calendar year.

[ken melvin]

Seems obvious that much of the run up in oil was due to blustering about Iran by Bush & Co and Israel. Other these bellicose bastards, the world understood that an attack would result in oil going $200, 300, 400, 450 ... a barrel. This all fed into the other commodities' prices.

[bakho]

Ethanol production affects mostly grain prices and their substitutes and foods that use grain to produce such as meat. Ethanol production does NOT explain the large increases in costs of vegetables and fruits that American consumers have noted.

Global markets for most food can drive up the price. Rather than "seasonal foods" being cheap because there is limited market (oversupply and lack of storage) for their peak supply, the global market has increased demand, keeping the price higher.

There has also been a shift to "organic" production of fruits and vegetables which is much more expensive and commands a higher price.

[bakho]

This says it better:

However, the declining value of the dollar is a two-edged sword relative to the agricultural industry. Although a lower currency value increases our competitiveness in selling agricultural products in global markets, it also increases the cost of imports. And an increasingly larger proportion of agricultural inputs are being imported rather than produced domestically. In contrast to 3-5 years ago when a vast majority of our fertilizer was produced domestically, almost two-thirds of our nitrogen is now imported and P&K are also increasingly sourced from outside the U.S. borders. The same is true increasingly of chemicals for pest control. A significant explanation for the dramatic increase in the cost of production for corn, soybeans and wheat in the Midwest (a 50 to 60 percent increase in production costs) is the increased dependency on imported raw materials and the higher cost due to increased transportation costs as well as the lower value of the dollar.

The food vs. fuel debate

The food vs. fuel debate is in reality not a serious debate in the developed countries of North America and Western Europe. Certainly, food prices have increased in the developed and developing world as a result of higher energy related transportation costs; weather related shortages of some products — particularly wheat; and increased bio-fuels demand for agricultural raw materials historically used only in the nutrition markets including sugar, palm oil, soybean and other vegetable oils and corn. Higher food prices faced in North America and Western Europe are likely to result in only small shifts in food consumption patterns. However, the prospects for a reduction in the growth of animal protein consumption in the developing countries is real. Prior to the growth in the energy driven demand for agricultural raw materials, the exciting longer-term opportunity for U.S. agriculture was the growing demand in the rest of the world for animal proteins. As consumers in China and Asia in general experienced growing real incomes, they were beginning to change their diets from a primarily vegetable-based protein diet to an animal protein-based diet. In fact, this dietary transition and the longer-term sustainability of income growth in the rest of the world was the growth story for U.S. agriculture prior to ethanol. But bio-fuels is changing and challenging that story. First, higher feedstuffs prices have and will continue to result over time in higher costs of production to produce animal proteins, and thus higher prices for a smaller animal protein industry. These higher prices for animal proteins are pricing that product out of the diet of many potential consumers in the developing world. Animal protein consumption is very responsive to higher prices i.e. the quantity purchased declines significantly with higher prices. And higher food prices in general are reducing the real purchasing power of those consumers who spend 60-70 percent of their disposable income on food compared to 10 percent in the U.S. The result in essence is a significant deceleration of the speed of dietary transition from vegetable to animal based proteins, and thus a slowdown in the growth in global demand for animal and meat products. To put this issue in context, one must remember that the growth in demand for agricultural products prior to ethanol was not from the domestic food market, but from the export market; and the fastest growing agricultural exports were in fact the animal protein complex. As noted earlier, income is growing rapidly in China and India, in particular, and they are using much of that increased income to buy food, particularly meat and animal products. But if the demand from the bio-fuels market for agricultural raw materials keeps feed costs and thus the cost and price of meat and animal products high, the concern is that the growth in global animal protein consumption may be stymied because of these higher prices.

http://www.agecon.purdue.edu/extension/pubs/paer/2008/may/boehlje.asp

[anne]

"There has also been a shift to 'organic' production of fruits and vegetables which is much more expensive and commands a higher price."

References please.

[Ritesh Shah]

Hey, Nice insights.... wrote a blog on agflation (food inflation) long back.... herez the link...
http://ritesh-thejoshmac.blogspot.com/2008/03/agflation.html
Inviting comments!!

[sceptical putz]

[This is the person who imitated anne... MT]

[george]

reminds me of the saudi's talking about the USD to describe oil prices

[David]

Interesting article, Mark. Thanks for the update on this issue.

Loss of arable land, notable crop failures, shrinking food stockpiles across the globe, and government imposition of food export restrictions should have been enough to explain why food prices are rising in most nations.

Add biofuel mandates and global money printing (inflation) to the picture and you have a real powder keg on your hands.

Here are two related posts on this issue from my site: "On rising food prices", and "Government meddling on food prices"

[anne]

http://www.earthpolicy.org/Updates/2008/Update72.htm

April 16, 2008

World Facing Huge New Challenge on Food Front: Business-as-Usual Not a Viable Option
By Lester R. Brown

On the demand side, the trends include the continuing addition of 70 million people per year to the earth's population, the desire of some 4 billion people to move up the food chain and consume more grain-intensive livestock products, and the recent sharp acceleration in the U.S. use of grain to produce ethanol for cars. Since 2005, this last source of demand has raised the annual growth in world grain consumption from roughly 20 million tons to 50 million tons.

Meanwhile, on the supply side, there is little new land to be brought under the plow unless it comes from clearing tropical rainforests in the Amazon and Congo basins and in Indonesia, or from clearing land in the Brazilian cerrado, a savannah-like region south of the Amazon rainforest. Unfortunately, this has heavy environmental costs: the release of sequestered carbon, the loss of plant and animal species, and increased rainfall runoff and soil erosion. And in scores of countries prime cropland is being lost to both industrial and residential construction and to the paving of land for roads, highways, and parking lots for fast-growing automobile fleets.

New sources of irrigation water are even more scarce than new land to plow. During the last half of the twentieth century, world irrigated area nearly tripled, expanding from 94 million hectares in 1950 to 276 million hectares in 2000. In the years since then there has been little, if any, growth. As a result, irrigated area per person is shrinking by 1 percent a year.

Meanwhile, the backlog of agricultural technology that can be used to raise cropland productivity is dwindling. Between 1950 and 1990 the world's farmers raised grainland productivity by 2.1 percent a year, but from 1990 until 2007 this growth rate slowed to 1.2 percent a year. And the rising price of oil is boosting the costs of both food production and transport while at the same time making it more profitable to convert grain into fuel for cars.

Beyond this, climate change presents new risks.... *

* http://www.earthpolicy.org/Updates/2008/Update72_data.htm

[bakho]

Per unit production costs for organic are higher than standard production costs when averaged over time. Organic produce commands a higher market price to compensate for the increased risk to the grower. While most organic typically has somewhat lower input costs (not always the case), organic yield is typically more variable than conventional practices with considerable downside risk of yield loss for organic. If an organic production practice becomes cost effective it is adopted as a conventional practice which seeks to maximize profit. If organic were more profitable than conventional practices, the conventional practices would quickly switch to organic since conventional practices are designed to maximize profit and reduce risk.

http://www.extension.iastate.edu/agdm/livestock/html/b1-80.html

Organic often increases labor costs and frequently substitutes fossil fuel use (plowing) for chemical control (herbicides)

http://aggie-horticulture.tamu.edu/alternatives/riskmanagementseries/organicproduction.html

http://www.maf.govt.nz/mafnet/rural-nz/sustainable-resource-use/organic-production/converting-to-organic-production/organic-production-11.htm

Here are costs studies:
http://www.cook.rutgers.edu/~farmmgmt/ne-budgets/organic.html

This explains the mixed bag. Organic=lower total input costs, much higher labor costs, yield and/or production is reduced to control labor inputs, and the premium price commanded for organic is used to offset the loss of yield.

http://www.sare.org/publications/organic/organic07.htm#table2

There are lots of cost summaries, commodity by commodity and it is difficult to summarize costs because of the variability in practices by individual growers.

A basic way to think about food production is that crops take nutrients from the soil. When crops are harvested and shipped to market, nutrients are exported. Those nutrients must be replaced or the soil will be depleted. Crops are not natural. Crops are plants that have been modified by human intervention over the past 5-10 thousand years. Modern production practices have yields that are many times higher than past practices.

Organic production is a cultural preference. Organic production has different costs and benefits (and external costs and benefits) than conventional practices. Organic is not a panacea and carries its own externalities. Overall, a shift to selling organic produce will raise the costs in the supermarket.

[Talent Maseko]

I thought maybe it was due to Africa's cocoa production of which the greatest suppliers are ever on strike and of course the ever increasing price of fuel,However I'm sure something can be done any help how we can view this differently.