Why Food Price Shocks?

Bread for the World Institute’s 2009 Hunger Report, Global Development: Charting a New Course, discussed the main factors that led to the steep rise in food prices in 2008. These factors have not gone away; food prices are a key theme in this report as well. Overall, grain prices have come down from their 2008 peaks—but not to pre-crisis levels.¹ In the summer of 2010, wheat prices suddenly doubled in less than two months—a striking reminder of just how volatile food markets are and how hunger, malnutrition, and food insecurity are inextricably connected with the rest of the global economy.

High fuel prices were a major reason for the 2008 food price surges. Between January 2002 and July 2008, the price of crude oil shot up by 590 percent.² It crested in July 2008 at $147 a barrel; in December 2008, as the world was sinking deeper into economic recession, the price of crude plunged by more than 300 percent. Fuel prices were not in fact an important reason for 2010’s spike in wheat prices. So this is the exception—a factor that has changed since 2008. But the question is, how will the oil market respond once demand is restored to—or exceeds—pre-recession levels? Fuel prices will not be de-linked from food prices forever.

Food prices are in fact tightly connected to fuel prices because of modern agriculture’s dependence on petroleum. The global food system uses up staggering amounts of petroleum every day—it’s used for everything from inputs like fertilizer and pesticides to the transportation of products to market. Thus, food prices were pushed ever higher as the cost of petroleum soared. In theory, high food prices should be a boon to farmers, and in fact large commercial farmers in the United States took advantage of their economies of scale to glean generous profits. Not so for impoverished smallholder farmers in developing countries, who failed to produce more food and sell it for a profit while prices were at their highest because they couldn’t afford the higher costs of the petroleum-based inputs; they also lacked access to the credit that would have allowed them to cover those costs until they could sell their crops.

A woman in Chontala, Guatemala, works in her maize field. Smallholder farmers are affected first and most severely by increases in food prices.

Another reason for high prices is the decisions made by some grain-exporting countries. To prevent or minimize food shortages at home, several of these governments restricted the export of grain in 2008. This left food-importing nations like Ethiopia and most other sub-Saharan African countries in dire straits, because there are surprisingly few countries that export surplus grain. (See Figure i.3). With fewer suppliers, prices rose: from 2006 to 2007, the total food import bill for developing countries climbed from $191 billion to $254 billion, with more hard times on the way in 2008.³

Another problem on the “supply” side made matters worse. Because of a prolonged drought, global cereal supplies were at one of the lowest levels in years. The U.N. Food and Agriculture Organization (FAO) estimates agricultural production will need to double by 2050 to keep up with population increases⁴—yet climate change is already stressing production levels. There has been an increase in droughts as a result of climate change; these were already regular occurrences in the global south. In Australia, drought reduced the rice crop by 98 percent between 2001 and 2007.⁵

Climate change also helps explain why countries with surplus grain can be reluctant to export it. In 2010, wheat prices rose because Russia, the third-largest producer,⁶ imposed an export ban to protect itself against shortages in domestic markets after a drought and a spate of summer forest fires reduced production levels. Internationally, wheat production remained above average and global supplies were never in danger of running too low to meet demand.

Like any commodity that is traded, the ups and downs in the wheat market were a boon to speculators, who used the Russian export ban to bid prices artificially high. The complete absence of effective policies to prevent speculators from wreaking havoc in global commodity markets may in fact pose the greatest challenge to global food security.

Speculation was a factor contributing to the surge in food prices in 2008 as well, with the spike in commodity prices in 2008 coinciding with the collapse of the housing bubble in several developed countries. Commodity markets provided a ready outlet for speculators who had previously been involved in the housing market. The Commodity Futures Modernization Act of 2000 deregulated commodity trading in the United States and exempted it from oversight. “Soon after this,” reports the United Nations Conference on Trade and Development, “several unregulated commodity exchanges opened. These allowed any and all investors—including hedge funds, pension funds, and investment banks—to trade commodity futures contracts without any position limits, disclosure requirements, or regulatory oversight.”⁷ The commodities bubble did not last as long as the housing bubble, but it was long enough for the greed of a small number of speculators to cause hundreds of millions of people to go hungry.

In 2008, analysts believed that increasing demand for meats and dairy products from consumers in fast-growing economies like China and India was a factor in the rising food costs. The higher incomes in these countries enabled people to buy foods that were formerly luxury goods—foods that require more grain to produce because the grain is fed to livestock rather than directly to people. This is the “zero-sum game” applied to food security: A growing middle class gets to eat better, while poor people get hungrier because nothing is left for them. On closer analysis, however, this argument proved to be less true than first thought. For example, both China and India are net exporters of cereals. From 2000 to 2007, “growth in global grain consumption (excluding biofuels) was only 1.7 per cent per annum,” writes World Bank economist Don Mitchell, “while yields grew by 1.3 per cent and area grew by 0.4 per cent, which would have kept global demand and supply roughly in balance.”⁸ So far, at least, producing more meat and dairy products is not using up grain that could have gone to poor people.

On the other hand, a cause of the 2008 food price spikes that turned out to be more important than first thought was the diversion of cereal grains and oil seeds into biofuels. “Biofuels” refers to ethanol and biodiesel. Globally, ethanol production increased from 4.75 billion gallons in 2000 to 12.15 billion in 2007, while biodiesel production reached 2 billion gallons, an eightfold increase over those same seven years.⁹ Most biofuels produced in the United States are made from corn. U.S. ethanol production rose from 1 billion gallons in 2002 to 5 billion in 2006. The 2007 Energy Independence and Security Act mandated raising ethanol production to 36 million gallons by 2022, and President Obama has proposed raising ethanol production targets in the United States to 60 billion gallons by 2030.¹⁰

The International Food Policy Research Institute (IFPRI) predicts that in the coming decades, biofuel production will be responsible for 30 percent of the increases in global food prices.¹¹ Analysts at the U.N. Food and Agriculture Organization (FAO) explain: “Because the world energy market is so much larger than the world grain market, grain prices may be determined by oil prices in the energy market as opposed to being determined by grain supply.”¹² Global food security will be affected by whether “next-generation” biofuels—produced from inputs other than food staples, such as grass or algae—are developed sooner rather than later. There’s no word yet on when these fuels will move from the research phase to commercial development. Once they become available, they will likely also face a political hurdle as those who now receive generous subsidies to produce biofuels, predominantly large-scale corn producers in the United States, lobby to hold onto their share of the market.

Clearly, 2008 was a discouraging year because of the unprecedented rise in hunger. The silver lining is that we gained a better understanding of this complex problem and where governments and advocates must stand firm in focusing the world’s attention. That January, The Lancet—one of the most respected medical journals in the world—published a five-part series on the irreversible effects of early childhood malnutrition. It is no exaggeration to say the articles led to a seismic shift in thinking among some development experts about the priorities of international development assistance.

Because The Lancet series coincided with the food price shocks, nutrition has gained a lot of ground on the development agenda, moving up from its traditional position as a backwater in aid programs. Governments and experts now recognize the potential of better nutrition to spur economic and social development—and the impact of poor nutrition on any development effort. This report, Bread for the World Institute’s Our Common Interest: Ending Hunger and Malnutrition, owes much to The Lancet series and subsequent efforts to raise the profile of nutrition among policymakers and development workers.