IdahoStatesman.com, ID
12-27-07
Lotterman: Why meat, milk, grain prices are rising
In economics, predicting which direction prices will move in response to changing
market conditions is relatively easy. Forecasting how much they will change or
estimating what proportion of a price change stems from each of several relevant
factors is more difficult.
Consumer food prices are rising in response to higher producer prices for grains,
meat and milk. But what is causing these increases? Some point to increasing
use of corn and, to a much lesser extent, soybeans, to produce biofuels.
Others focus on growing demand from China and other Asian countries, where
economic growth is stoking demand for better diets and industrialization is
shrinking available cropland.
A "weakening" dollar is yet another factor. When the dollar becomes cheaper in
terms of other countries' currencies, so do U.S. exports. While new growth in
U.S. farm exports is most conspicuous in Asia, Europe also remains a major
customer, particularly for soybeans.
A euro buys 21 percent more in value of any U.S. export than it did in December
2005. It may buy even more in 2008. As U.S. soybeans shipped to Rotterdam get
cheaper, Europe buys more of them. That increases prices all the way back to
the U.S. farm level.
Determining which direction prices move in response to changing conditions may
be obvious to economists, but curiously opaque to others.
In the 1950s, government programs raised farm prices by buying up large
quantities of wheat, corn, cotton and other farm products. The problem was that
the government ended up storing enormous amounts of these commodities.
There were few ways to dispose of such surpluses without nullifying the
program's goals.
A bright agricultural economist named Willard Cochrane determined that it would
be cheaper and more efficient to simply pay farmers to not produce anything on
some fraction of their land rather than waste valuable resources to produce grain
that had no use.
Existing government surplus purchase programs increased demand for farm
products. Cochrane's plan reduced supply. Both actions would tend to raise farm
prices.
In 1960, Cochrane convinced presidential candidate John Kennedy that his idea
was better than the unpopular policies of the outgoing Eisenhower
administration, which were associated with Kennedy's opponent, then-Vice
President Richard Nixon.
Kennedy announced this new plan in a speech at a plowing contest in South
Dakota. Reporters peppered JFK with questions. What would this do to food
prices? one asked.
Kennedy turned to Cochrane, who bluntly replied, "Well hell, it will raise them of
course!"
That was as obvious to economists as the sun rising in the east, but anathema to
political handlers, just as it would be today. Two of Kennedy's campaign workers
quickly hauled Cochrane from the room and sharply instructed him that he had to
keep his mouth shut from then on.
No reporter asked the obvious follow-up question, "How much will this program
raise prices?" As it turned out, the answer was "not a lot." The plan was
implemented and, holding all other things equal, food prices were somewhat
higher than they would have been otherwise. But at the same time, improved
seeds, fertilizer and other technology were boosting farm productivity so much
that real food prices drifted steadily downward through the 1960s and have
mostly continued to do so ever since.
All three factors described above - biofuel production, economic growth in Asia
and a cheap U.S. dollar - act to increase U.S. producer prices, and hence U.S.
food prices. That is as clear as for Cochrane's acreage-limitation program. But
the amount by which each separate factor raises prices is not obvious.
Ethanol opponents, including some consumer groups and beef industry
associations, argue that biofuels are driving up food prices sharply. Ethanol
proponents argue the opposite. Recent studies at Iowa State University point
to food price increases of just a couple of percent as a result of the increased
ethanol use mandated by the latest energy bill. But other ag economists at the
same school and elsewhere see larger price hikes resulting.
One important factor is the length of the adjustment period. A given increase in
demand has greater effects in the short run than over a longer period. So the
current spike in farm and food prices need not be permanent.
But the change in demand is not over. Under current policies and the energy bill
President Bush signed just this week, ethanol production will continue to ramp up
for years. The debate on how that will be felt at the checkout lane will last even
longer.