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Commentators blame rising populations and affluence for soaring food prices but the causes include a weak dollar and inefficient biofuels production. Growth in consumption should be welcomed and demand can be met by bolstering technology and improving infrastructure in developing countries, writes Daniel Ben-Ami.
Probably the most striking thing about the discussion of rising food prices is that it is transparently wrong.
The most common explanation for the surge in food prices is that developing countries are becoming more populous and more affluent. A spectre of the Chinese and Indians devouring food like locusts is routinely conjured up. It should be apparent that such images, apart from being insulting, are fundamentally flawed.
If it was simply the case that rising demand could push up food prices then they would constantly increase. Humanity has grown steadily in population, affluence and meat consumption since at least the Industrial Revolution. Yet over the past two centuries the trend is for food prices to plummet in real terms rather than to rise. Indeed, it is an achievement that, for the first time in history, large sections of humanity are not threatened by famine. The 45% increase in food prices since the end of 2006 cannot be explained in relation to long-term trends (see graph, page 29).
It is necessary to examine supply in relation to demand. Rising demand is not a problem if it can be counter-balanced by an increase in supply. The reason the Malthusian nightmare of mass starvation has failed to materialise is precisely that food supply has outstripped rising demand in the longer term (see 1st box below). Despite a steadily rising world population the amount and quality of food consumption per head has risen.
Of course the more sophisticated proponents of the threat of imminent food shortages acknowledge that supply plays a role. They talk about such factors as adverse weather, worsened by climate change, and land shortages. But even here there is a tendency to exaggerate rising demand and understate the potential to increase supply.
To understand the trend in food prices it is vital to take a systematic approach. Short-term and long-term factors must be separated. The reasons prices have surged are not necessarily indicative of the secular trends in food production and consumption. It is then necessary to examine the interaction between the supply and demand of food, rather than simply consider each in isolation. Finally, it is worth questioning why the popular view on the food crisis emphasises consumption in such a one-sided way.
In this context it is important to remember that agriculture is overwhelmingly a domestic business. Chris Barrett, professor of agriculture at Cornell university in Ithaca, New York state, estimates that more than 90% of agricultural production is domestic. As a result international trade in many commodities is relatively thin. In other words a small change in circumstances can have a big impact on the global market price for a commodity.
In its latest "World Economic Outlook" the International Monetary Fund concedes that biofuels only account for a small percentage of global food production. However, they represent a high proportion of the increase in food crop use: "Although biofuels still account for only one and a half percent of the global liquid fuels supply, they accounted for almost half the increase in the consumption of major food crops in 2006-07, mostly because of corn-based ethanol produced in the United States" (available at www.imf.org).
However, it is misleading to attribute this effect simply to the rise of biofuels as a new technology. To be more precise the problem lies with the environmental policy of the Bush administration. It has given multi-billion dollar subsidies to farmers to move into what is a relatively inefficient form of biofuel production. The European Union is also following a similar path. In contrast the production of biofuels from sugar cane in Brazil is far more efficient. In the future second generation biofuels, such as lignocellulose, which is more efficient than corn ethanol and need not be based on plants grown on agricultural land.
However, there is a danger of tautology if the inputs argument is taken too far: rising prices are used to explain rising prices. Agricultural prices and energy prices are not independent. Common factors, such as financial pressures, can push up both sets of prices.
An additional financial impact is what is referred to, somewhat misleadingly, as speculation. It is not simply that some investors are piling into agricultural futures or trading indices to make a quick profit. For many fund managers the problems in the mainstream equity and bond markets mean that non-correlated assets look attractive. This no doubt adds to the appeal of agricultural funds.
In this sense the rise in agricultural prices can be seen as, at least in part, a financial bubble akin to the technology bubble of the late 1990s or the more recent housing bubble. Agricultural commodities seem to be experiencing their own "irrational exuberance" as investors rush into the market.
A counter-argument on speculation is that agricultural inventories are at historical lows. If speculation was a key factor there would, so the argument goes, be a lot more hoarding going on. However, given the increasing distance between futures trading and the physical exchange of commodities it would be that this relationship has broken down. The new forms of speculation do not necessarily need inventories in the same way as those of the past. In any case there is an element of irrationality in surging prices so in this sense investor behaviour is not necessarily entirely logical.
On the demand side rising population, affluence and urbanisation all play a role. Often most attention is simply given to the fact that rising population means more mouths to feed. But more affluent lifestyles also have a big impact.
Typically poorer populations will get most of their calorie needs from cereals. But as time progresses not only do they get more calories but their food is provided by a wider range of sources. People start to get a higher proportion of their food consumption from fruit, vegetables and meat (see bar chart, page 30).
Meat is the most popular example of this trend. The point that is often made is that it takes several kilogrammes of grain to produce just one kilo of meat. So rising affluence has a disproportionate impact on the demand for agricultural products.
The rising consumption of food is generally linked to the rise of the middle class in China and India. For example, the annual meat consumption of the average urban household in China rose from 25kg in 1990 to 32kg in 2006. In rural areas the rise over the same period was even greater: from 12kg to 21kg. But it is important to recognise that such factors represent a gentle push rather than a sudden shift. China, for example, has steadily become more affluent since the onset of reform in the late 1970s. Indeed the modern history of humanity can be seen as one of rising consumption and affluence.
Some would argue that the scale of the transition is different from in the past. After all China and India together have about 2.5 billion people out of a global total of about 6.5 billion. But this ignores the fact that agricultural yields have increased substantially over time. Demand may have risen sharply but so has supply. Many commentators also seem unaware that China imports relatively little food. As a recent briefing by the United States Department of Agriculture noted:
"For a country with nearly 1.3 billion consumers and limited natural resources, China's level of food imports is surprisingly low. China is nearly self-sufficient in food and is a major net exporter of many food products, including manufactured food and beverages, animal products, vegetables, fish and seafood, tea, and fruits." ("China at a glance". Available at: http://www.ers.usda.gov/publications/aib775/aib775e.pdf ).
This brings us back round to the question of production. It is true that global production has suffered some glitches recently. For example, the United Nations Food and Agriculture Organization (FAO) points out that food production rose by less than 1% in 2006. As a result food production per head fell by about 0.2%. This was the first such decline since 1993.
But the long-term potential to increase food supply must be tremendous. Robert Paarlberg, a professor at Wellesley College in Massachusetts and author of "Starved for Science: How Biotechnology is Being Kept out of Africa" (Harvard University Press), estimates that American yields are three times those of developing Asia on average and 10 times those of Africa.
He paints a vivid picture of the low productivity of African agriculture: "Africa's food crisis grows primarily out of the low productivity - year in and year out - of the 60 percent of all Africans who plant crops and graze animals for a living. The average African smallholder farmer is a woman who has no improved seeds, no nitrogen fertilizers, no irrigation, and no veterinary medicine for her animals. Her crop yields are only one third as high as in the developing countries of Asia, and her average income is only $1 a day. One third of these poor African farmers are malnourished." ("International Herald Tribune", April 22, 2008).
The chronically low productivity of African agriculture also offers the potential for enormous improvements. If Africa could acquire modern agricultural technology - along with the necessary infrastructure such as airports, an electricity grid, roads and telecommunications - it could enjoy an enormous rise in agricultural productivity. Even developing Asia, although not nearly as poor as Africa, has substantial scope for huge improvements.
The orthodox view, put forward by the likes of Professor Jeffrey Sachs of Columbia university in New York and Professor Michael Lipton of Sussex university, is that better technology can be provided to small scale farming. For them there is no need for fundamental land reform. It is more a question of giving small farmers appropriate technology so that they can produce more.
However, Paul Collier, director of the Centre for the Study of African Economies at Oxford university, has taken a different view. He argues that large scale commercial agriculture is necessary to solve Africa's food problems. Scaling up is, in his view, the best way to secure productivity gains. ("The Times" (London) April 15, 2008).
Collier argues, with considerable justification, that the West is afflicted by "longstanding agricultural romanticism" which is "compounded by new-found environmental romanticism". In other words many in the West laud organic farming while decrying nitrogen fertilisers, modern pesticides and biotechnology. Such romantic notions are generally the preserve of people who have never gone hungry. Most African agriculture is organic - through poverty rather than choice. The huge rise in agricultural productivity has brought enormous benefits to the developed world and could help feed the poorest parts of the world too.
Against those who argue there is enormous potential to raise yields there are many who point to environmental problems. They raise the spectre of climate change and water shortages to suggest that agricultural output is coming up against natural limits.
However, technology should be able to play an important role in helping to resolve such problems. Biotechnology aids the production of drought and salt water resistant crops. Irrigation can help store and distribute water as well as use it more efficiently. Desalination can be used to produce huge amounts of usable water where necessary.
Much, although not all, of such technology is already available. Until now developments in biotechnology have focused on products suitable for farmers in the temperate developed countries. Many experts in agriculture, such as Professors Barrett and Paarlberg, are calling for research in biotechnology to focus on developments more suitable to tropical farmers.
The huge potential to bolster global agricultural yields leaves open one big question. If there is so much scope to bolster production why is there so much gloom about rising consumption? Surely the growth of consumption of both quality and quantity of food should be welcomed as a positive achievement.
Failure to appreciate this fact is an indictment of the culture of low expectations which pervades contemporary society. Humans are one-sidedly seen as voracious consumers of the earth's natural resources. They are viewed as locusts on the body of the planet. At the same time the productive and creative side of humanity is underestimated. The capacity of human ingenuity to bolster food output, while also raising other forms of production, is viewed with disdain.
Fortunately the historical record suggests that another route is possible. The huge increase in the quantity and quality of the global food supply over the past two centuries is an enormous achievement. By raising the whole of global agriculture to what are the highest levels of productivity could produce a massive rise in food production. Indeed, it is likely that much land could be put to other uses as enough food could be produced for more people from a smaller area of land. The use of modern technology, from genetic modification to advanced telecommunications, could raise yields even higher. The promise of cornucopia could be more than a dream.
Discredited miserabilism makes comeback
Much of the discussion of surging food prices bears the unmistakeable imprint of Thomas Robert Malthus (1766-1824). Malthus's basic argument was that population tended to grow faster than food supply. Population generally grew geometrically (1, 2, 4, 8, 16 and so on) while food supply grew arithmetically (1, 2, 3, 4 and so on). As a result a limited food supply was likely to act as a check on the rise of population. If the population grew too fast it would be brought back to an equilibrium level by famine and starvation.
Malthus's "An Essay on the Principle of Population", first published in 1798, was a direct attack on the optimistic thinking of 18th century Enlightenment figures such as William Godwin and Condorcet. In their view the power of reason gave humanity the ability to overcome the problems it faced. Malthus, in contrast, took a much dimmer view of human potential.
Adam Smith was also in the Enlightenment tradition (See Fund Strategy book review, July 10, 2006). Smith had a much more upbeat view than Malthus on the power of economic growth to raise living standards. According to the "New Palgrave Dictionary of Economics" (Palgrave Macmillan 2008): "Malthus doubted whether economic growth has always been, or will always be, advantageous to the mass of society. Malthus criticized Smith's view that the economic growth of Britain during the 18th century had improved the living standards of the labouring classes; he recognised that investments in trade and manufacturing had benefited individual capitalists, but argued that they were of less benefit to society as a whole."
History has decisively vindicated Smith's view rather than that of Malthus. The world's population is far larger than it was in Malthus's time yet people are also enormously better fed and richer. Malthus at least had the excuse of living at the dawn of the modern era. In more primitive economies it was more difficult to raise productivity to bolster the food supply. The experience of modern technology and agriculture is entirely different.
Some will claim that Malthus was right but premature for his time. They will say his arguments may have been flawed in 1798 but they do apply today. This is, in essence, what many contemporary environmentalists argue.
But such arguments have to contend with at least two objections. First, how was it that Malthus got his arguments so wrong? Second, why is it not possible to use the power of reason to bolster agricultural yields and increase output? As the main article points out, average yields in America are three times those of developing Asia and 10 times those of Africa. It is hard to see why it should not be possible, at the least, to bring African and Asian yields up to American levels. The technology to raise yields enormously exists. If it is not being harnessed properly it represents a failure of nerve rather than a fundamental inability to resolve serious problems.
Agricultural funds
Until not long ago it was impossible for British retail investors to invest in specialist agriculture portfolios. However, with a rash of launches (see table) numerous such funds are available. The area is so new that some funds are not yet in the statistics. For example, Sarasin launched its AgriSar fund in March.
There are also numerous more mainstream funds that have built up exposure to agriculture. Among the many are Insight's multi-manager funds, Investec's new Enhanced Natural Resources fund and Newton Income.
There are many ways for such funds to get exposure to agriculture. Perhaps the most straightforward is to invest in equities that are linked to the agricultural sector. But those funds with the appropriate powers can also invest in the agricultural futures market. There are also indices, such as those run by Goldman Sachs and Merrill Lynch, which track agricultural commodities.
This article benefited greatly from discussions with Professor Chris Barrett of Cornell university, Joe Kaplinsky, Professor Michael Lipton of Sussex university, Professor Robert Paarlberg of Wellesley college and John Thompson of Investec Asset Management. None of them necessarily shares any of the views expressed in the piece.
