Neither capital flights and “sudden stops”, nor even – at least so far – disastrous export collapses: if one is to single out a major recent macroeconomic phenomenon brought by globalization to Latin America, I suggest “agflation” – as The Economist has called the process of sustained rise in world agriculture prices since last year and its consequences in terms of higher inflation rates throughout the global economy. As usual, one can point out both an upside and a downside in the story as far as the economies in the region are concerned.
Agflation has been primarily caused by a combination of structural factors, particularly the mismatch between the new pattern of global growth and the dearth of agriculture-related investments in most developing economies along the last decades. But it has also been aggravated by the way in which the use of bio-fuels has increased in large economies. One may find national economic policy choices as the ultimate causes of both issues and at the roots of agflation. On top of economic efficiency losses derived from those factors, one may add the possibility that bio-fuels – a potentially cleaner and safer partial alternative to fossil fuels as energy source – may end up victimized as a collateral damage.
1. Global Agflation
Agricultural commodities prices have definitely joined the bandwagon of the commodity super-cycle that has been in course for almost six years now (see Chart 1, from UniCredit Global Research, “Agricultural commodity price boom to continue”, 02/22/2008, available through our main page). Agriculture prices exhibited strong gains of 6.7% in January, as supply shortages and strong demand kept on pushing grains prices upward (Goldman Sachs, Commodities: Commodity Watch, 2/8/2008). While energy and base metals were the rising stars in the first years of the super-cycle, precious metals and, more recently, agricultural sectors, have afterward occupied the stage.
It is worth noticing that wheat, corn, and soybeans have been the leading commodities in this agricultural price boom. However, as of this year, rice, coffee, sugar, cocoa, meat, poultry, dairy products and else have all reached price records held for more than a decade.
Food inflation has outpaced energy prices since last year and, on a global scale, food price hikes have been a common factor shifting inflation rates upward almost everywhere (Chart 2). In China, soaring food prices have been a major factor responsible for the 7.1% rise in consumer prices last month, the fastest increase in 11 years. In both U.S. and Europe, food has joined energy in sustaining a positive differential between, on the one hand, headline inflation indexes and, on the other, core inflation indexes that exclude food and energy prices, making some analysts start questioning whether such exclusion has been still appropriate (see e.g. Avery Shenfeld, from CIBC Markets, whence we got the upper part of Chart 3).
Chart 2 – Food beats energy and consumers
The fact is that, despite the presence of local, idiosyncratic factors also affecting food prices, agflation seems to be a widespread phenomenon. And there is more potentially to come in the pipeline, judging from the 12-month lag between agricultural commodity prices and global food inflation that JPMorgan has detected (see lower part of Chart 3).
Latin America has not escaped and food has crept in as a main source of pressure on inflation in most countries of the region. Given the backdrop of robust growth for the fifth year in a row and shrinking output gaps, the spike of food prices worldwide has easily transmitted itself in increases in the food component of consumer price indexes in the region. Local, idiosyncratic factors – such as different monetary policies, consumption baskets, and supply responses – have aggravated or dampened those agflationary shocks but overall the latter have attracted increasing attention (as approached here by several fellow bloggers).
Agflation has meant both good and bad news in the region. As I argued in my previous blog (02/08/2008), the “China effect” and others through commodities on Latin America will depend on the combination of commodity-specific paths and country-specific overall commodity dependence. The macroeconomics of countries like Argentina, Brazil, Colombia, Ecuador, and Chile tend to benefit from terms-of-trade improvements accompanying agflation, both through balance-of-payments and national income effects. Net food importers in the region, in turn, will rejoice less from the agflation party.
The flipside (or downside) of those macroeconomic redistributive impacts is also an asymmetry in redistributive and poverty effects both within each country in the region and worldwide. Food corresponds to 10-15% of average consumption in the richest economies, whereas it corresponds to levels above 30% in most of the others. Poor urban dwellers, as well as poor countries devoid of agricultural bases, are being hurt most.
An obvious question to be made is whether agricultural price hikes have come to endure as much as it has been the case of other commodities. After all, supply responses are more easily elicited by prices in agriculture than it is the case of oil and metals. Costs of investing in new agricultural capacity are in general substantially lower than those in developing new sources of non-agricultural commodities. On the other hand, demand for agricultural goods will be less sensitive to the current economic slowdown in the global economy and, against the backdrop of current low levels of stocks and structural features of the global economy nowadays (see below), it is no surprise that most forecasts have been bullish about agricultural prices for at least the next three years.
Chart 3 – Agflation and misleading core inflation indexes
2. Structural Changes and National Policy Choices Are at the Roots of Agflation
Drivers of agricultural price hikes can be found at both demand and supply sides. And those drivers have been reinforced by the type of national economic policies that have prevailed in most of the systemically relevant countries in the global economy.
The world food equation is being rewritten, as aptly examined by Joachim von Braun in a report from IFPRI last December. Higher income levels in many developing economies have led not only to more food consumption but also to changes toward more protein-intensive diets, including in China and India, with that diet evolution implying indirect expansionary effects on agricultural basic commodities. Chinese consumers are nowadays eating 50kg of meat per year on average, whereas the figure was 20kg in 1985, and cattle, pigs and alike are also consumers of feedstock themselves. Shifting rural-urban populations have also altered spending and consumer patterns reinforcing those trends, as manifested in an increasing world demand for high-value agricultural production.
On the supply side, the response has not been fast-growing enough, despite neck-breaking records in the production of wheat, soybeans and other staples. That relative sluggishness reflects the dearth of agriculture-related infrastructure (irrigation, transports, energy) and technological (seeds adaptation, equipments) investments along the last decades in many agricultural areas with growth potential in the developing world. Renitent subsidies and protectionism in advanced economies helped sustain low levels of agriculture prices and under-investments in many of those areas. Not surprisingly those other areas in the developing world where, notwithstanding those barriers, such investments have taken place are the ones who have concentrated benefits from the rewritten global food equation.
One must also add the heretofore-inexistent effect by which rising oil prices, derived also from the new global pattern of growth, have spilled over to agriculture, namely the increased use of homemade bio-fuels in the U.S. and Europe. The stretch on their already stretched agricultural capacity has been such that crowding-out effects and rising land costs have outweighed the traditionally price-depressive effects of their subsidies to local agriculture production. The problem of global misallocation of capital and resources in agriculture that has lingered on throughout decades has been accentuated by protectionism and nationally based responses to oil prices.
To compound the misallocation, there is the fact that those national responses have had to resort to local crops that are far from the efficiency frontier in terms of bio-fuels as a source of energy, such as corn-based ethanol in the U.S. – joined by China in this drive – and rapeseed-based bio-diesel in Europe. By efficiency, one must read net energy balance as well as local and global environmental effects (see here, e.g., this blogger’s upbeat assessment of sugar cane-based ethanol vis-à-vis those alternatives).
A narrow understanding of “energy security” has underlined its identification with “self-sufficiency” or “independence” in bio-fuels production and use, making the latter liable to be captured by traditional agricultural protectionist interest groups. A broader definition of energy security as “a condition in which a nation and all, or most of its citizens and businesses have access to sufficient energy resources at reasonable prices for the foreseeable future free from serious risk of major disruption of service” [Barton, B. et al., “Energy security: managing risk in a dynamic legal and regulatory environment”, NY: Oxford University Press, 2004, p. 5], contrariwise, would lead to policies different from “autarky”. Energy security in the context of the recent decades of global economic integration has necessarily to encompass: (i) management of complex and far-flung infrastructures (integrity of networks in relation to fuel supplies, capital expenditure, short term reliability, and the ability to withstand intentional and unintentional damage); (ii) market competition and the use of prices for discouraging waste, absorbing shocks, and improving technologies; and (iii) related to the previous two aspects, international trade and investments in energy. On top of thwarting efforts toward higher “energy security”, by unnecessarily aggravating locally and globally a supposed conflict between “energy security” and “food security”, the autarkic approach to bio-fuels is preventing a larger global expansion of more environment-friendly and less-costly alternatives.
P.S.: I wrote this post from my talking points prepared for a panel on “Sustainable Bio-fuels: Science and Policy”, last Thursday, during the World Bank 2008 SDN Week. I thank Jamal Saghir as well as all participants for their constructive comments. Usual caveats apply.
5 Responses to “Global Agflation, Energy Security and Bio-fuels”
This is an important post that gives a lot of backbone to some of the recent shifts i’ve seen in the way Latam is being viewed by investors of all sizes. In the last few weeks, there has been a lot of talk passing my desk of how latam’s position as breadbasket of the world is evolving. At a more basic level, I read a comment (and if i could remember the source i would give it, but certainly cannot claim credit for myself) that grain exports to China were “basically a proxy for water imports”. There is a profound truth in that short statement which indicates the recent bout of ‘agflation’ is not some passing fashion.Please excuse the overuse of the first person in this comment.
Frederic Pierce, When the Rivers Run Dry! . He was that smart bloke to first notice that exporting grain from the Midwest to China actually implied exporting water pumped up from the Ogallala aquifer to China. Ragarding Latin America, that continent has 25% percent of the world water reservers with only 7% or so of the world population. So yes, I agro Latam will become the bread basket of the world. Very bullish for Brasil and Argentina in the long run…p.s. speculation on world grain markets should be banned world wide! The Jim Rogers’ of our world are actually driving lots of third world people to starvation right now. And the guy just keeps screaming, buy this soft com buy that soft com! It’s pretty damned sick. People may die of starvation because of him. This is also the reason I’m only investing in companies such as Black Earth Farming, Trigon Agri, Cresud etc because these companies actually put land into production. A better world starts at home, stay away from future markets…
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