Food prices are soaring. Not since the early 1970s have we seen wheat prices jump so dramatically. Rice prices have also spiked upwards. For the rich developed countries the rise in food prices is, so far, not much more than a minor inconvenience. For other nations, though, the recent gains in food prices threaten severe economic and social distress. Rice, after all, is the staple food for half of the world's population.
The oddity of this story is that food prices, alongside energy and other commodity prices, are incredibly high at a time when the developed world seems to be succumbing to recession. In the past, weak growth in the US and Europe would have secured much lower commodity prices. That, though, no longer seems to be the case.
Why, then, are food prices so high? Supply, demand and policy factors are all important.
On the supply side, agricultural productivity has made only modest progress over the last couple of decades. The green revolution of the 1960s and 1970s led to the introduction of higher-yielding crop varieties which, in turn, allowed large numbers to escape the trap of rural poverty. But the pace of improvement was not maintained. Newer technologies were created but did not find favour. The rich West, in particular, chose to shun genetically modified crops.
Competition for land usage, meanwhile, has become more intense. Emerging economies have become increasingly urbanised and, in the process of doing so, have in many cases seen a reduction in land devoted to agricultural use. Soaring energy prices have seen a switch away from food production to the cultivation of biofuels, again limiting food supplies.
On the demand side, emerging economies have grown extremely quickly. Rising per capita incomes have led to significant dietary shifts. Wheat and rice are out, meat and dairy are in. The production of meat and dairy products, however, is an inefficient way of feeding people as it uses more grain resources.
Taken together, these various supply and demand factors have left inventories of wheat and rice at remarkably low levels. Throw in a couple of policy errors and it is not so surprising that food prices suddenly go through the roof.
The first policy error comes from the world's central banks. Too many of them chose to ignore higher food prices. They assumed that higher food prices were, from one year to the next, simply a case of bad luck. Surely, they reasoned, what goes up must, eventually, come down. Unfortunately, this view confuses cyclical and secular influences. The recent bout of food price gains, though, is not just a case of bad luck. We are seeing, instead, a pernicious and persistent increase in food prices, supported by a range of supply and demand factors.
This is particularly a problem for the world's emerging economies. Their per capita incomes are, of course, relatively low. The weight of food within their consumer spending baskets is, as a result, correspondingly high. Confusing cyclical and secular influences are, in these circumstances, a sure-fire way of debauching the currency. Seen this way, higher food prices themselves are not causing higher inflation. Rather, overly loose monetary conditions are causing higher food prices.
The second error - under-standable at the national level but disastrous at the global level - is the recent reaction of the world's food producers. Food-producing nations have become increasingly alarmed about the impact of rising global food prices on their local populations. In response they have chosen to limit exports in the hope that more of their production can be devoted to local needs.
This is, at first sight, a noble sentiment. It is also, though, likely to lead to still higher world food prices. By lowering the domestic price relative to the global price, the incentive for domestic producers to increase supplies is reduced, thereby exacerbating the global food shortfall.
Even worse, the economic success of many emerging markets serves to camouflage widening domestic social strains. Indeed, in many emerging economies there is now a yawning chasm between the newly affluent and the remaining poor. For the affluent, higher food prices might simply mean the purchase of one fewer DVD this week. For the poor, higher food prices may prove to be a matter of life and death. In these circumstances, social strains are likely to get worse.
What can be done? An obvious short-term strategy is to tax the affluent and the food producers to support those on low incomes. For many emerging markets, however, the tax system is, at best, rudimentary and, hence, not fit for the purpose.
Another option would be for the West - which chooses to subsidise its own farmers, thereby depriving farmers in other parts of the world of their fair share of the agricultural spoils - to offer more in the way of aid and less in the way of domestic subsidies.
Ultimately, though, there is no substitute for higher food production. That is what higher food prices are telling us. If, though, governments prevent producers from receiving the right price, the producers will not produce any more, leaving food prices excessively high. For the emerging world, this has the potential to turn into an economic shock on a par with the oil price increases which hit the western world in the 1970s.
• This report was compiled by the marketing department of HSBC Bank Malta plc on the basis of economic research and financial information produced by HSBC International Bank.
The oddity of this story is that food prices, alongside energy and other commodity prices, are incredibly high at a time when the developed world seems to be succumbing to recession. In the past, weak growth in the US and Europe would have secured much lower commodity prices. That, though, no longer seems to be the case.
Why, then, are food prices so high? Supply, demand and policy factors are all important.
On the supply side, agricultural productivity has made only modest progress over the last couple of decades. The green revolution of the 1960s and 1970s led to the introduction of higher-yielding crop varieties which, in turn, allowed large numbers to escape the trap of rural poverty. But the pace of improvement was not maintained. Newer technologies were created but did not find favour. The rich West, in particular, chose to shun genetically modified crops.
Competition for land usage, meanwhile, has become more intense. Emerging economies have become increasingly urbanised and, in the process of doing so, have in many cases seen a reduction in land devoted to agricultural use. Soaring energy prices have seen a switch away from food production to the cultivation of biofuels, again limiting food supplies.
On the demand side, emerging economies have grown extremely quickly. Rising per capita incomes have led to significant dietary shifts. Wheat and rice are out, meat and dairy are in. The production of meat and dairy products, however, is an inefficient way of feeding people as it uses more grain resources.
Taken together, these various supply and demand factors have left inventories of wheat and rice at remarkably low levels. Throw in a couple of policy errors and it is not so surprising that food prices suddenly go through the roof.
The first policy error comes from the world's central banks. Too many of them chose to ignore higher food prices. They assumed that higher food prices were, from one year to the next, simply a case of bad luck. Surely, they reasoned, what goes up must, eventually, come down. Unfortunately, this view confuses cyclical and secular influences. The recent bout of food price gains, though, is not just a case of bad luck. We are seeing, instead, a pernicious and persistent increase in food prices, supported by a range of supply and demand factors.
This is particularly a problem for the world's emerging economies. Their per capita incomes are, of course, relatively low. The weight of food within their consumer spending baskets is, as a result, correspondingly high. Confusing cyclical and secular influences are, in these circumstances, a sure-fire way of debauching the currency. Seen this way, higher food prices themselves are not causing higher inflation. Rather, overly loose monetary conditions are causing higher food prices.
The second error - under-standable at the national level but disastrous at the global level - is the recent reaction of the world's food producers. Food-producing nations have become increasingly alarmed about the impact of rising global food prices on their local populations. In response they have chosen to limit exports in the hope that more of their production can be devoted to local needs.
This is, at first sight, a noble sentiment. It is also, though, likely to lead to still higher world food prices. By lowering the domestic price relative to the global price, the incentive for domestic producers to increase supplies is reduced, thereby exacerbating the global food shortfall.
Even worse, the economic success of many emerging markets serves to camouflage widening domestic social strains. Indeed, in many emerging economies there is now a yawning chasm between the newly affluent and the remaining poor. For the affluent, higher food prices might simply mean the purchase of one fewer DVD this week. For the poor, higher food prices may prove to be a matter of life and death. In these circumstances, social strains are likely to get worse.
What can be done? An obvious short-term strategy is to tax the affluent and the food producers to support those on low incomes. For many emerging markets, however, the tax system is, at best, rudimentary and, hence, not fit for the purpose.
Another option would be for the West - which chooses to subsidise its own farmers, thereby depriving farmers in other parts of the world of their fair share of the agricultural spoils - to offer more in the way of aid and less in the way of domestic subsidies.
Ultimately, though, there is no substitute for higher food production. That is what higher food prices are telling us. If, though, governments prevent producers from receiving the right price, the producers will not produce any more, leaving food prices excessively high. For the emerging world, this has the potential to turn into an economic shock on a par with the oil price increases which hit the western world in the 1970s.
• This report was compiled by the marketing department of HSBC Bank Malta plc on the basis of economic research and financial information produced by HSBC International Bank.