Biofuels and Food Prices

Ernesto Zedillo provides an insightful discussion on the causes of higher food prices, which includes:

It is clear, however, that the most damaging distortions in agricultural markets originate in rich countries. There’s little doubt that the present spiral in grain prices is closely linked to U.S. and EU policies enacted to boost production of biofuels. The American and European governments subsidize the production of biofuels, limit their import and mandate their use. The exact extent to which these policies have impacted food prices is still a matter of contention, but not even the most enthusiastic proponents of ethanol can deny that by inducing a greater allocation of agricultural resources toward biofuel production, the amount of grain available for food has been reduced. According to the World Bank, while global production of corn increased by 51 million tons from 2004 to 2007, biofuel use of corn in the U.S. alone increased by 50 million tons, thus leaving no margin to satisfy the increase of 33 million tons in global consumption for other uses during the same period. This explains why some respectable experts, such as the former chief economist for the U.S. Department of Agriculture and a top World Bank agricultural economist, have imputed a large proportion of the rise in food prices to the growing use of food crops for fuel.

Hat tip to Greg Mankiw who is suggesting that Barack Obama should reconsider his support for corn based biofuel production.

Update: Movie Guy points us to Zeal Speculation and Investment for another discussion of food prices:

Over the last several decades a whole slew of factors have provided catalysts for the rise of the grains. With one of the largest being the lack of material growth in the agricultural industry. And considering the long-time behavior of grains prices, it is understandable why there has been little incentive to grow this industry. When the price of any good or service grinds sideways for decades on end while the rest of the world is inflating away, this tends to harbor dismal growth prospects. And this is typically not an encouraging environment for capital investment. In fact if the fruits of the land are not as appealing as an offer from a commercial developer, a prudent business operator will take the money and run. While technology improvements over the years have indeed enabled better crop yields, according to the US Department of Agriculture the US planted area for the major crops has dropped by nearly 15% since 1980 … The simple fact is the world’s population continues to grow, and so does the demand for staple foods. So with the primary end product of grains being food, supply needs to keep up with growing demand. And it is not! Supplies have been growing, but not sufficiently enough to meet demand growth. And to put a twist into this supply/demand imbalance, segmented economic prosperity is also changing the dynamics of the grains trade. Economic growth in the world’s developing nations has and will cause extra strains on the grains. As more and more people add protein and other valuable nutrients to their diets, grains demand will continue to gain strength … As will be apparent in the long-term charts the grains have been range-bound in sideways trend channels for the better part of the last four decades. Every so often there were strong rallies that elevated prices, but they quickly fell back within trend. But what we are seeing in the last couple years are major breakouts from these trends.

Nominal prices stay relatively constant and then they doubled over the past few years – what’s wrong with this story? Go further down and look at the last three graphs showing the relative prices of corn, wheat, and soybeans from 1970 to today. Relative prices spiked in the early 1970’s and then fell quite dramatically over time. As the charts show, real prices really are not that high compared to where they were in 1970. Oh well, it was a neat story until we adjusted for inflation!