China’s food prices – why have they trended up and what lies ahead?

(Available in Chinese)

Food prices have received a lot of attention recently. Understandably, much of the attention is on recent developments and short term prospects. But in this blog post I try to look back at some longer term trends, in order to look further ahead.

Since the early 2000s, food related prices have trended up (Figure 1). The deflator of agricultural value added has risen 8% per year on average since 2000, after falling during the second half of the 1990s. Producer Price Index (PPI) food prices (factory gate) have risen much less because prices of other inputs into the food processing industry have gone up less and rapid productivity growth in food processing has dampened the transmission of higher raw food prices.

Food prices at the retail level have also risen rapidly. Many food products are not processed. Thus, much of the higher vegetable prices and, in 2007-08, higher pork prices, show up undampened in the Consumer Price Index (CPI) data. Consumer food prices are also driven up by wage and other cost pressures in the logistics and retail sector. 

Supply factors are key in explaining China’s food price increases. In agriculture productivity can typically not increase as easily as in manufacturing. Spectacular growth of China’s manufacturing production (pdf), driven by strong investment and productivity growth, has kept down manufacturing prices. Expanding agricultural production rapidly is constrained by the availability of land—a key production factor—and yields per hectare cannot be raised as easily as manufacturing productivity since these yields are already quite high (there is plenty of room for raising labor productivity in agriculture, but that largely entails people moving out of agriculture). Thus, higher prices of energy and other costs increases in the 2000s drove up food prices substantially.

Higher food prices are often linked to strong demand for food in developing countries. Hegling and Roache from the International Monetary Fund (IMF) recently noted that “perhaps the most important explanation for the trend increase in food prices is that consumers in emerging and developing economies are becoming richer and changing their diet as a result…This increases the demand for scarce resources—for example, more land might be devoted to cattle grazing instead of crop planting, more crops are used for animal feed.”

However, China’s food price hike in the 2000s is not obviously caused by such demand factors. Changes in diet and resulting pressure on scarce resources were much more rapid in 1990-2000, when food prices were subdued, than in 2000-2009. Between 1990 and 2000, non grain usage of land rose by 8.9% of total acreage—largely on account of vegetables and orchards—and the amount of land used for grain declined by 3.4% of the total (Table 1). Between 2000 and 2009, non grain usage rose only by 1.3% of total acreage and the amount of land used for grain edged up by 0.4% of the total. Also, per capita daily calorie intake rose steadily from 1960 until 2000 but then it reached a ceiling at broadly the level of high income Asian neighbors such as Japan and South Korea.

China’s food prices are also influenced by global markets and at the global stage supply factors have also been key, as has been bio fuel. Several of China’s food prices follow international ones, with wheat and rice prices as the big exceptions. Since 2004, international food prices have outpaced manufacturing prices substantially. However, since the early 1960s, global food prices did not increase much and, relative to manufacturing prices, they declined strongly until the early 1990s (Figure 2).

Why did food prices rise so much since 2004 after having declined for decades? Nikos Alexandratos (pdf), formerly of the Food and Agriculture Organization, identifies three key factors (World Bank research reaches broadly similar conclusions):

• Triggered by the surging price of oil, bio-fuel related demand for cereals took off, diverting a rapidly growing share of cereals away from food consumption. Higher oil prices also increased the production costs of agriculture, notably via higher fertilizer prices.
• Global grain stocks had shrunk during 1997-2003, when consumption continued to grow while  low prices kept global grain production stagnant. Thus, by around 2004, global stocks were low.
• Supply shocks from weather induced crop failures in key producing countries, both in 2006-07 and in 2010.

Again, the role of food demand is not obvious. Global cereal demand (includes rice, wheat, and course, grains) growth rose from 1.6% per year in 1992-2001 to 1.9% per year in 2002-08. However, excluding US bio-fuel related corn demand, global cereal demand growth actually declined to 1.4% per year in 2002-2008 (Figure 3). Adding bio-fuel related cereal demand in other countries would single out bio-fuel related demand even more clearly. 
 
What lies ahead in the medium term? It is hard to say with confidence what will happen to commodity prices. However, several of the features that have emerged are likely to remain.

• Domestically, the supply side effects described above are likely to continue to operate.
• On the demand side, changes in China’s food consumption are likely to continue, as consumers shift to higher quality foods and increased variety. The scope for such shifts has bounds, though, since the overall composition of diets in China is already quite similar to that in Japan and Korea.
• At the retail level, the non tradable component of food is large. Thus, with continued rapid overall economic growth, wage increases and Balassa Samuelson effects, the price of food at the retail level is likely to continue to outpace prices of manufactured goods strongly.
• Internationally, the impact of energy prices on food prices is likely to remain strong. And the impact of global prices on many of China’s food prices is also likely to remain strong, even though the volatility of international grain prices in recent years has probably made China’s policymakers more keen to hold on to the controls on grain prices. 
• Most experts continue to think that food prices will eventually stop increasing as additional capacity comes on line. However, even in a benign medium term scenario price volatility along the way could well remain high, possibly accentuated by climate change, as it perhaps is already.