Prices and the Global Economy
What are the prospects for agriculture in the short and long term?
The Global Financial Crisis
A flood of credit in 2000-2006 led to an artificial and unsustainable economic boom around the world. Without government intervention, credit would subsequently have been withdrawn from the system, reversing the process and causing a recession. However, as the withdrawal of credit began to happen in 2007, governments stepped in, slowing the reduction in credit and delaying the negative impact on demand. In theory, such intervention might act in a purely countercyclical way, smoothing out demand and avoiding severe recession. However, this is very unlikely: government interventions nearly always result in misdirection of resources, so we can expect a significant slowdown in economic growth relative to the 2002-2007 period for the next five years or so.
But it could be much worse. As the Greek crisis shows, we are seeing signs that overstretched governments might default on their debts, which would exacerbate the problem. It is even possible that there could be another recession relatively soon, which would have a significant downward effect on demand.
As the number of people on the planet increases, demand for agricultural products rises, since each extra person wants food and clothing. In the course of the next decade or so, population growth is likely to continue but at a slower pace. The reason is that an increasing proportion of countries are experiencing what is known as the ‘demographic transition’: as people become wealthier and infant mortality is reduced, people choose to have fewer children. So, population growth will continue to drive increased demand for agricultural produce but demand will increase more slowly.
Economic growth is directly associated with increases in per capita income and increases in wealth. As incomes rise and people become wealthier, so the types of agricultural products they demand change. Typically, people with higher incomes and wealth demand more meat and fish, which require more inputs per unit of output (see Charting Growth in Food Demand), so economic growth tends to result in an increase in total demand for agricultural produce.
Disease, Pests and Weeds
As every farmer knows, disease, pests and weeds have the potential to wreak havoc on crops. Fortunately, there are now many modern agricultural technologies that enable farmers to protect their crops from these threats. Nevertheless, a significant proportion of the world’s harvest each year is lost as a result of disease, competition from weeds, and predation by insects. However, as new technologies – such as gene-spliced cultivars – are developed, these losses are falling, improving supply.
Climate, soil and other environmental factors
The type of crops that are suitable to grow in any particular place will depend on the local climate, the type of soil, and other local environmental factors such as the slope of the land, proximity to water sources, and so on. Over centuries, crops have been developed that are more or less suitable to the particular environmental circumstances in any particular place.
More recently, technologies have been developed that enable farmers to grow crops in places that would not previously have been considered suitable. These technologies range from irrigation systems to new cultivars. Of particular note are cultivars developed using biotechnology, including gene-splicing, that are able to withstand more extreme environments, including very hot, dry and salty climates, as well as climates that are very wet and/or cold.
As these technological developments progress, constraints on agricultural production will be reduced and supply should increase.
In most parts of the world, climate is not static: temperatures, rainfall and rain patterns vary significantly from year to year. For the most part, these variations are unpredictable, although we are beginning to understand better the impact of various relatively short-term cycles, such as El Nino/Southern Oscillation and the Arctic Oscillation. And as our understanding of such cycles improves, so it should be possible for farmers to make better decisions about which crops to grow, when. Over time, this will result in reduced losses from unpredictable adverse weather events, improving supply.
Weak property rights
In many parts of the world, ownership of land is insecure for one reason or another: for example, there may be no widely accepted system for titling land or the titling system may be excessively bureaucratic or the government may have imposed restrictions on the ownership of land. The result of such insecurity is to undermine incentives to invest in improvements to land; farmers are less likely to invest their time and energy into improving land only to lose the land and see others reap the benefit of their effort.
In addition – and in many cases more importantly – insecure ownership makes it more difficult to offer land as a security against loans, so lenders face greater risks should farmers be unable to repay monies borrowed. To compensate for this increased risk of default, lenders charge more for loans they make to people with insecure tenure. This in turn increases the cost and difficulty of developing the land and building alternative businesses. The result is farming practices that require less capital. These tend to be less efficient, lower yielding, and also in many cases more destructive to the land (causing more erosion, for example).
Thus the combination of reduced incentives to invest in improvements and the use of less capital-intensive technologies reduces the supply of crops.
Inadequate rights to water plus water subsidies
In most places, ownership rights in water are poorly defined, difficult to enforce and/or cannot be readily transferred. As a result, farmers have fewer incentives to invest in conservation and sustainable management of water than if their rights were clearly defined, readily enforceable and transferable. Farmers thus tend to over-abstract water and under-invest in supply improvements (308 Kb pdf).
To make matters worse, governments across the world subsidise agricultural water. While farmers may see short-term benefits from such subsidies, the long-term consequences are very worrying: under-pricing of water leads to excessive use and undermines the incentives to invest in water conservation measures (582Kb ppt) . Perhaps more importantly, it also undermines the incentive on the part of water owners to invest in new ways to store and process water.
Weak property rights in land and water, combined with government subsidies to water use are contributing to a serious threat of future water scarcity, threatening future supply of agricultural produce.
Weak property rights also contribute to slower economic growth in affected places. This has two countervailing effects on demand. First, it inhibits economic growth and thereby reduces the rate of increase in demand for meat and fish. Second, by delaying the demographic transition, it slows the decrease in population growth – i.e. leads to more people being born – which has a positive impact on demand for food.
Restrictions on the use of existing and new agricultural technologies
In response to pressure from environmental and consumer activists, governments across the world have introduced restrictions on the use of modern agricultural technologies ranging from pesticides to GMOs. While in some cases restrictions may have a valid scientific justification, in many cases the action taken is disproportionate to the risk. Such restrictions often have perverse consequences, resulting in farmers utilising more inherently risky technologies: for example, restricting herbicide use means some farmers weed manually, increasing the risk of damage to joints (back, knees) and may increase the likelihood of snake bites and other injuries. Also, by forcing farmers to spend more time and money defending their crops from pests, such restrictions reduce profitability and make it more difficult for farmers to expand and diversify.
In the short term, the high levels of demand experienced up till 2008 are likely to fall slightly as the world economy continues to adjust to the bad investments made during the credit boom. But this will depend somewhat on government policies towards biofuels: the higher the effective subsidies to such fuels, the greater the diversion of crop production towards fuel and the greater the overall demand for agricultural produce.
Continued investment in new technologies should enable supply to increase – as long as governments do not impose excessive restrictions on the use of such technologies. So, in the next several years agricultural prices are likely to remain below the peaks experienced in 2007-2008, but are unlikely to fall dramatically.
In the medium term, the rate of growth of demand for food is likely to rise again as a growing population and economic growth result in increased demand for meat and other foods. However, this increase may be offset by reduced production of biofuels (assuming that opposition to such fuels will eventually force changes in government policy) and/or the development of third generation biofuels such as synthetic algae which would not compete for resources in the same way as crops such as corn and sugar.
At the same time, it is likely that at some point the massive benefits of new agricultural technologies, especially but not limited to cultivars developed through biotechnology, will lead governments to permit their use more generally. This will result in a substantial increase in supply. The question is whether the increase in access to these new crops occurs soon enough to prevent another escalation in the prices of crops.