Food, inflation & recession

There is no economic issue that gets the Indian electorate as worked up as inflation does. Elections have been won and lost because of fluctuations in the price of onions. It is tempting for us to ask the government to do something about the problem and it is equally tempting for the government to pretend that knee-jerk bans of futures trading will bring prices down in the street-side markets. But the uncomfortable fact is that rising prices of food are a global problem.

Look at China. Its government is a past master at rigging the price of its currency to keep its export engine humming. But it has been able to do precious little to rig the price of a more basic commodity—pork. China’s consumer price inflation in May was at its highest in more than two years, partly because of a 26.5% rise in meat prices, which in China essentially means pork. One reason why the price of China’s staple food is shooting up is the rise in the price of corn, which is fed to pigs.

A few months ago, there was a similar problem in another part of the world. In Mexico, the prices of corn tortillas, that country’s culinary staple, quadrupled in a year. This tortilla crisis led to a political backlash and the Mexican government eventually pressurized food companies to hold the price of tortillas. Food prices in the UK are up 5%, which is twice the official inflation rate. In the first four months of this year, food inflation in the US was running at 6.7%.

Why are food prices suddenly jumping around like popcorn on a fire? The most immediate reason why corn prices have risen sharply is the world’s new-found love for green fuels. The US has offered subsidies for the use of corn-based ethanol, which ensures that corn is perversely diverted away from kitchens and into car fuel tanks. Hiroyoki Konuma, deputy regional chief for Asia and the Pacific at the Food and Agriculture Organization (FAO), said earlier this month that the upsurge in interest in biofuels is “the gold rush of the 21st century”. He estimates that 1% of the world’s arable land is already being used for biofuels; this could rise to 3.5% in the coming years.

The supply of quality land is shrinking for other reasons as well. Expanding cities, especially in China and India, are already eating up farmland. Meanwhile, rising prosperity in these two countries means that people are eating more and eating better. It takes more land to provide one unit of energy from meat than it does to provide the same amount of energy from corn or wheat. And, to this cocktail of factors, add the uncertainties to food production that can come from climate change. It’s not hard to see that volatile food prices are not an accident.

There are two core economic issues here. One, a sharp rise in food prices is always going to be a political hot potato. People are less upset about inflation in concentrated items that are bought infrequently—cars and television sets, for example. But if you walk to the market every day, and see that the price of tomatoes has gone up further, the sense of anguish is deeper. In other words, inflationary expectations tend to shoot up when items of daily or weekly purchase escalate in price. This could lead to demands for higher wages, and an inflationary spiral.

The other issue is a bit more long-term. What if there is persistent food inflation, perhaps running over many years? Chris Dillow, one of my favourite economist bloggers, has raised a pertinent question in a recent post. “Was Ricardo right after all?” he asks. David Ricardo, the 19th century English economist, famously predicted that as demand for food rose, so would prices. “This was simply because less fertile land would be brought under cultivation so the costs of production would rise; this is diminishing returns. Because wages couldn’t fall—they were set by subsistence needs—this, he forecast, would lead to a squeeze on profits generally,” writes Dillow.

Ricardo spoke of the inevitability of the stationary state, when higher food prices would squeeze profits to a level where economic growth is strangled. This never happened because of two factors: first, new land came into the market with the colonization of the Americas and then productivity improvements in agriculture kept a lid on the relative price of food.

Today, the supply of arable land is shrinking and there are no new Americas to be discovered. In fact, the land available for food is shrinking because of the growth of cities and the spread of biofuels.

A new green revolution is the only real way to keep a lid on food prices in the long term, but revolutions do not take place according to someone’s calendar. Till then, it will be worth watching what impact food prices have on inflation and profits.
So, don’t scoff at the lady next to you in the neighbourhood market when she launches into a harangue on the price of onions.