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Tuesday, October 13, 2009

Becker on future food prices

Gary Becker is optimistic on future world food prices. His argument is a classic one in economics and it provides good guidance how we should think about similar questions.

Will World Food Prices Resume their Sharp Increase?


The worldwide recession has slowed the growth in the demand for cereals and other foods as many countries have experienced stagnation or contraction in their GDPs. Now that the recession appears to be over, world GDP will start growing again. Many are forecasting that this growth in world output, especially the growth in developing nations, will put sharp upward pressure on food prices and that of oil, natural gas, and other commodities. Even the Malthusian specter has been raised again that the growth in world population will exceed the capacity of the world to produce the food demanded to improve living standards in the developing world.

The sharp increases in food and other commodity prices during the period from 2002 to 2008 when world GDP was growing rapidly tends to support these fears. The World Bank's index of world food prices increased by 140 percent from 2002 to the beginning of 2008, and by 75 percent after September 2006. The price of oil went up more than fourfold from the beginning of 2002 to its peak at over $145 a barrel during mid 2008. At that time there were many predictions of oil going to $200 a barrel rather quickly, and also of food prices continuing to rise rapidly. The world recession clearly made these predictions obsolete, at least until world GDP begins to grow again.

Rapid growth in world GDP will put strong upward pressure on some commodity prices. However, the supply responses of exhaustible resources, like oil and natural gas, should be distinguished from the supply response of food production. The supply of fossil fuels is obviously ultimately limited by the amounts in the ground. Outputs of oil, coal, and other fossil fuels can be increased by new discoveries, such as the recent discovery of oil off of Brazil, by extracting more of these fuels out of existing fields, and by squeezing oil and other fuels out of shale and other rock formations. Yet, all these ways combined have rather limited effects on total output. This is why, along with OPEC's restrictions on oil output, long run supply responses of oil, gas, and coal to changes in their prices are usually estimated to be quite modest. The long run elasticities of supply in response to rises in the prices of fuels are about +0.4 to +0.5.

The short run response of world food production to increases in food prices may not be large either, although farmers can shift rather quickly among the production of corn, soybeans, wheat, and other crops. In the long run, however, world production of food is quite sensitive to the world price of food. Given time to adjust, farmers can substantially increase the production from given amounts of land devoted to farming by greater use of fertilizers and capital equipment. Higher prices encourage investments in discovering mew methods of improving farm productivity, such as corn and other hybrids, the green revolution, and genetically modified foods. Productivity advances in agricultural output were very rapid at many times during the past century, often outstripping advances in manufacturing and other sectors.

The amount of land devoted to farming in most countries declined drastically during the past century as urban sprawl, highways, and other land uses took over much of the land formerly used to farm. In the United States, farmers comprising less than 2% of the labor force and using well under half the available land, produce enough farm goods not only to contribute most of the food that feeds the huge American population, but these farmers also export corn, soybeans, wheat, and other farm goods all over the world. With high enough food prices, financial incentives will encourage farmers to take some land back from suburban, ethanol production, and other non-food uses.

World prices of food generally declined during the 20th century when world population and world GDP per capita grew enormously. The reason for these diverse trends is that productivity in the production of food expanded at a more rapid rate than did the demand for food. The advances in production were due to the use of new and more effective fertilizers, better farm machines, and many applications of scientific knowledge to improving the productivity of agriculture. Developed countries spent considerable resources on subsidies to farmers to help keep their prices up, not down. Even though it may not be possible to predict the exact nature of future agricultural innovations, one can reasonably expect similar growth in world farm output during the next several decades, especially if food prices rise by a significant amount.

Rapid growth in future world GDP is likely to greatly raise the prices of oil and other fossil fuels, unless concerns about global warming induce major steps to reduce the demand for these fuels. Rapid growth in world output is also likely to sharply raise the demand for cereals, meat, and other foods in developing countries. However, I have tried to show why food is different from fossil fuels and minerals, like copper, in that the supply of food is not limited by natural bounds on overall quantity. Rather, the efforts and ingenuity of farmers and researchers are able to greatly increase world food supply to meet even very large increases in the world demand for food.