News analysis on rising food prices

In: Uncategorized

4 Mar 2008

There follows part of a news analysis by me on rising food prices from this week’s Fund Strategy.

While Borat enjoyed mocking America, last week’s news from that comedy character’s “home” country, Kazakhstan, was far from a joke. The price of wheat being exported from Kazakhstan, one of the world’s largest exporters of the grain, rose 25% in one day. Its government had introduced export tariffs to quell domestic inflationary pressures.

The surge in Kazakh wheat prices added to a more general surge in global food prices, which rose by 38% between September 2006 and January 2008, judging by the International Monetary Fund (IMF) Food Price Index (see graph). Food prices have more than doubled since their low in July 1999.

Such substantial price increases bring winners and losers worldwide. Possibly the biggest losers are the urban poor. The poor in cities have little disposable income and have to buy their own food. But three-quarters of the world’s poorest people, defined by the World Bank as those living on less than a dollar (50p) a day, live in rural areas. At least some of them could benefit from rising food prices. Farmers, even those working on a small scale, could be paid more for their produce. However, most poor households are net buyers of food.

For fund investors the surge in food prices has brought a particularly welcome bonanza (see box). With more conventional asset classes – such as bonds and equities – performing poorly, it has become more attractive to invest in assets related to agriculture. As a bonus, there are diversification benefits to be had from investing in the agricultural sector. No doubt many investors would contend that such investments play a positive social role by bringing much needed capital to the agricultural sector.

A more general impact will be the effect of rising food prices on inflationary pressures. It is likely to be greater in poorer countries, since they spend a higher proportion of their income on food. But the more food prices increase, the more inflation is likely to become a problem worldwide.

To examine the likely trajectory of food prices it is necessary to examine both supply and demand factors. It is also useful to distinguish between those that are relatively short term and longer-term effects.

On the demand side, there are several key long-term factors. First, there is population growth. More people means more mouths to feed.

Second, the developing countries are becoming richer and more urbanised. As people become wealthier they tend to eat more meat, which itself means more grain has to be used as animal feed. It takes several kilos of grain to produce one kilo of meat.

For example, China’s annual average meat consumption has risen from 34kg per person in 1997 to 50kg today, according to an authoritative study from the United Nations Food and Agriculture Organization and the Organisation for Economic Cooperation and Development*. India’s consumption is much lower, although also rising; increasing from 3.4kg in 1997 to 4.4kg in 2008. The average for the developed world is about 66kg. Overall, the World Bank estimates that global demand for food is likely to double within 50 years.

Finally, there is the rise of the biofuel industry. This is diverting food away from human consumption into energy production. America in particular has provided substantial subsidies to its farmers to produce biofuels.

However, demand side factors alone cannot explain rising prices. The first two factors in particular are long-term trends. Yet the surge in food prices is a relatively recent development.

Part of the explanation for recent price rises is in one-off or short-term factors such as extreme weather in Australia, Europe and north America. Many fear such problems will be made worse by climate change.

However, George Lee, the manager of the CF Eclectica Agriculture fund, also emphasises the time lag – or what economists call inelasticity – between rising demand and increasing supply. “The problem is it takes quite a while for new investment to come through,” he says.

When prices were low there was little incentive for suppliers to invest. Although more investment is likely, it can take several years to set up a fully functioning farm from scratch. Investments in technology, such as genetic modification, could also play a big role in raising agricultural productivity.

Other factors not directly related to food can also have a significant effect. For example, rising energy prices can bolster food prices since agriculture can be energy intensive. Also the weakness of the dollar can exaggerate the impact of rising food prices. If food is priced in, say, euros, the price rises would not look nearly as great.

* Available at

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