From 2002 to 2008 the prices of many foods, including corn, wheat, and rice, increased by a lot. For example, The World Bank’s index of food prices increased by over 100% from 2002-2008. Grains and other food prices fell rather sharply during the financial crisis, along with the fall in oil prices and those of other commodities. But food prices are rising once again. The UN’s Food and Agriculture Organization indicated that its food index rose in October to levels last seen during the peak in 2008.
Food prices are marching up again mainly because the world economy is recovering from the crisis. Fast growing economies like China are increasing their demand for wheat, meats (animals use lots of grain as animal feed) and other foods that were formerly out of reach of the typical family in these economies. Reactions to the food price increases include Russia’s and Ukraine’s banning of wheat and some other grain exports “temporarily”, and China’s threat this past week to impose price controls on various foods, such as ginger and garlic, that are important in the Chinese diet, and have been rising rapidly in price.
A little basic economics is useful in evaluating these and other proposals. The world price of grains essentially equates the world supply and demand for grains. An increase in world demand for cereals and other foods- perhaps because of economic development in poorer nations that raises the average family’s demand for wheat, corn, and meat- would increase both the prices of grains and the quantities produced and consumed. An increase in world supply-due perhaps to good weather in grain growing regions, or to greater agricultural efficiency, such as through the development of genetically modified foods- would also increase world consumption of grains, but supply increases would lower world grain prices.
A further complicating factor is the growing use of corn and cane sugar to produce biofuels as substitutes for gasoline. In particular, the United States now unwisely devotes a sizable fraction of its corn output to biofuel production. So it is necessary in using the supply-demand framework to distinguish production of corn from its consumption as foods either by humans or animals. According to the USDA, ethanol production in the U.S. has increased from less than 3 billion gallons in 2003 to over 6 billion gallons in 2007, and is estimated to exceed 12 billion gallons in 2020. In 2008, about one quarter of US corn production was used to produce biofuels, and that share has been rising since then to almost 35%.
Most of the current proposals to combat increasing food prices are counterproductive, and would reduce efficiency. For example, Putin’s banning of Russian exports of wheat supposedly only until the end of this year forces Russian farmers to sell all their wheat output in the domestic Russian market rather than to sell part in the world market. This lowers the price of wheat in Russia below the world price of wheat. This means that Russian wheat farmers get less for their wheat than if they exported some of it, and Russian consumers pay less since they have a greater supply of wheat available to them.
Such an outcome would be politically popular if urban consumers in Russia have greater political clout than Russian wheat farmers. However, Russia as a whole is made worse off by this ban since it gives up the higher prices from selling some of its wheat abroad. In addition, Russian farmers would plant less than the efficient amount of wheat because they would be getting a lower price of wheat than they could get in the world market. Russia would be better off if it allowed farmers access to world prices, and it could give income transfers to urban families that offset at least some of the resulting higher cost to them of wheat and other foods.
The price controls proposed by China on vegetables and other foods are if anything worse than Russia’s ban on exports. These controls would keep down prices to consumers, which encourages their demand for the foods affected, compared to demand at what the prices would be if the forces of supply and demand were allowed to operate freely. At the same time, Chinese farmers would shift some acreage out of the price-controlled foods. The result would be an artificial “shortage” of ginger, garlic, cabbage, and other foods with controlled prices because of these responses to price controls by both consumers and producers.
Another set of bad policies are the restrictions that many countries, including but not limited to, the United States and other rich countries, impose on imports of foods from developing and other nations. These restrictions discourage greater food production in poorer countries, precisely the countries where food production is a major source of income. Import restrictions also cause a world misallocation of food production toward excessive levels in the EU, Japan, and the US, and insufficient production in Africa and other poor and developing nations.
The great advantage of prices in allocating resources is that they simultaneously give signals to both producers and consumers. Higher prices discourage consumption, and at the same time encourage greater production by profit-seeking farmers. To be sure, the demand for grains and other foods by consumers is not highly responsive to prices in the shorter run, although their degree of responsiveness grows as consumers have more time to adjust to higher prices. Similarly, supply is not so responsive to higher prices in the short run since farmers need time to make adjustments in planting, use of capital, and in various other production decisions.
In the long run, however, supply of food is very responsive to prices. Food is not like oil, natural gas, or copper, where supply is limited by the quantities of these resources in the ground or under water. Food production can be greatly increased with sufficient time by using more land to grow food, by greater use of fertilizers and capital to extract more output from a given amount of land, and by encouraging R&D on food output that would find new ways to increase productivity, such as happened with the “Green Revolution” and genetically modified foods.
For all these reasons it is reasonable to expect that the worldwide supply of food would be very responsive to food prices in the long run, as long as the forces of supply and demand were allowed to operate rather freely in the world market for foods.