The New Economics Of Food

As global demand outpaces supply, both haves and have-nots are in for a shock

On a cool April morning, Illinois farmer Vic Riddle steps down from his tractor, trudges into his house, and settles behind his computer to surf the commodity-market news. His calloused fingers punching up rows of export data, he notices Asia is gobbling up U.S. grain again. "We knew the demand was going to be coming," he says, a smile creasing his face. "But not this much, this soon."

Some 7,000 miles away in Shanghai, the family of Zhou Honglin sits down for a hearty dinner. Just five years ago, they would eat mostly rice and vegetables. But these days, the college professor, his accountant wife, and teenage daughter enjoy a spread of meat, fish, and eggs. They often indulge in commercially made pork dumplings and visit restaurants twice a month or so--luxuries they couldn't afford until recently. "Like most people in the city, we are eating better now," says Zhou.

Families such as the Zhous aren't feasting alone. As disposable incomes rise sharply across the developing world, millions of people are eating better. A fast-growing middle class from Seoul to Sao Paulo is buying more beef, poultry, and pork. In Brazil, chicken consumption is up 20% in just the last year. McDonald's Corp. has brought hamburgers to 93 countries, and Texas-style steakhouses draw enthusiastic throngs through much of Asia. Per capita global consumption of beef, pork, and poultry has surged 11% in the past decade. In China alone, the hog herd will soar to 510 million by 2000, from 307 million a decade ago. And the new taste for meat is placing heavy pressure on the grain supply, since hogs yield one pound of pork for each four pounds of grain they consume. Consequently, feed-grain use is surging to record highs in developing nations, up 8% over the last year alone.

CYCLES OF PANIC. At the same time, a combination of poor harvests in many parts of the world, plus changes in farm policy in Europe and the U.S., have depleted food reserves. One big problem: the devastation of the U.S. winter wheat crop. Globally, available supplies of corn, wheat, and other grains have fallen from 77 days of consumption in 1993 to an estimated 48 days, their lowest levels in at least 35 years.

The recent upsurge in grain prices is just one sign of a far-reaching change in the global economics of food. With worldwide demand racing ahead of supply, there will be upward pressure on food prices for years. Prices for farm commodities will become far more volatile, triggering periodic fears of greater inflation in the financial markets. Rising food prices will herald a massive transfer of wealth from food consumers to food producers across the globe. And the U.S., the world's largest food-exporting country, should narrow its balance-of-payment deficit. "I see prices going back up over the next decade," says U.S. Agriculture Secretary Daniel R. Glickman. "That's a profound change."

Over the last two decades, consumers have grown used to stable or even falling prices for farm goods, particularly raw commodities. Adjusted for inflation, the price of farm products plunged 40% between 1975 and 1995 (chart, page 80). But this trend may be reversing as grain prices hit record levels this spring. Wheat sold for as much as $7.17 per bushel, up from about $3.50 a year earlier. Corn and soybean prices went sky-high, too.

Since their peak in late April, prices have fallen somewhat as U.S. farmers hope for an end to the recent spate of poor harvests. Nevertheless, the demand from developing countries is rock solid. "It took these prices to make us realize it's demand, not just a bad crop, that's driving the markets," says veteran trader Jacob J. Morowitz of the Chicago Board of Trade.

In the U.S., the new balance between food supply and demand means that food prices will rise faster than overall inflation, hitting especially hard at low-income families. At the same time, food-importing nations in Africa, Asia, and the Mideast will find their food bills soaring, drawing funds away from needed investments. "If you don't feed your country, it's civil war. There's no price too high to avoid that," NatWest Securities Corp. analyst David C. Nelson points out.

With smaller stockpiles, price shocks will become more frequent. On May 1, for example, word that Mexico and Taiwan were buying helped send corn prices soaring 5%, only to drop 2% the next day in the absence of additional news. "You're going to see more volatility," predicts John D. Bowlin, president of Kraft Foods Inc., the second biggest foodmaker in the world. "We could have price movements that are very eye-catching," agrees Andrew M. Novakovic, who heads Cornell University's department of agricultural economics and marketing.

LESS OF A CUSHION. With less food in storage, the agricultural sector is taking on some of the risks common to companies employing "just-in-time" inventory practices. "We are trying to run a larger and larger operation with smaller and smaller inventories," explains Harvard University professor Ray A. Goldberg. "That's fine, if we have no emergencies. But when we do have an emergency, as we currently do, the `just-in-time' magnifies the problem."

The potential for quickly boosting grain production is limited. On a global scale, there is little unused land that could readily be farmed. Improved farming technology will eventually boost yields, but the "green revolution" is taking hold less rapidly than expected, and it presents risks few had anticipated. Even if farmers plant fencepost-to-fencepost, they won't restore anytime soon the surpluses that cushioned crop problems in the past.

For U.S. consumers, rising farm prices will show up quickly in the price of bread. Interstate Bakeries Corp., the nation's biggest breadmaker, already has raised its prices this year and could hike them again if wheat shortages get worse. "This is scary," says Ray Randy Sutton, general counsel for the Kansas City (Mo.) company. Dairy and meat products will eventually feel the pressure, too. The high cost of feed could force meat producers to slaughter their animals, driving beef, pork, and poultry prices down. But by next year, meat prices will be soaring as the supply cutbacks are felt.

The retail price of other foods may be slower to respond, since processing, packaging, and distribution make up over 75% of the cost of the food Americans buy. Some food executives also insist that competition on grocery shelves will make it difficult to raise prices to consumers. Still, it's likely that, over time, companies will pass along their higher raw-material costs.

INFLATION ALERT. The impact of rising global food demand is being felt in other ways. Higher grain prices have forced Archer Daniels Midland Co. and other manufacturers to reduce production of ethanol, a gasoline additive brewed from corn, until raw materials become affordable again. Even pet-food manufacturers are finding costs rising unexpectedly: Tyson Foods Inc. chicken feet, ground up for dogs and cats until recently, have found a new audience in China, where the gristly morsels known as "paws" are snack food. This year, the Arkansas-based company expects to ship 100 million pounds of paws.

In the short run, rising prices for food could add a couple of tenths of a percentage point to overall consumer inflation. That may not seem like much, but it hurts low-income U.S. households, which spend up to 17% of their income on food. Indeed, the stability of food prices in recent years has been one of the few bright spots for low-wage workers, who have struggled with stagnant incomes. "With food prices rising, it is going to be disastrous" for the working poor, says Larry W. Jones, president and founder of Feed the Children, an Oklahoma-based nonprofit group that distributed more than 42 million pounds of food last year.

Impoverished nations are also squeezed out as richer countries race for food. Even as diets improve in much of the developing world, some 800 million remain malnourished--and higher food prices could make that worse. The U.S. Agency for International Development (AID) expects to distribute less than half as much wheat this year, for instance, because prices have climbed so sharply. "The potential for real human tragedy is great," warns Leonard Rogers, an AID official.

Still, it isn't time to resurrect Thomas R. Malthus, the 19th century doomsday economist who believed population would expand until checked by famine or other calamity. Inspired by higher prices, U.S. and European farmers will increase their plantings. Brazil, Argentina, Canada, Australia, and South Africa will boost production as well. And today's increasingly open markets will respond more quickly to demand, moving supplies where they're needed, says Chicago Board of Trade Chairman Patrick H. Arbor. "We will see big production, hand in hand with strong demand and strong prices."

But while today's high prices will encourage farmers around the world to plant every available acre, there's not a lot of idle land. The elimination of Agriculture Dept. set-aside programs, which brings 14 million acres of U.S. land back into production, adds less than 1% to global grain acreage. Nations such as Argentina and Australia will surely switch land from pasture to grain. But most land not now in production is less suitable for growing grain. Experts estimate that the amount of global cropland used for corn, wheat, and other grains could increase only about 3%, at most.

One potential source of increased grain production is the Former Soviet Union, but agriculture there is a mess: Grain yield has fallen about 20% since 1990. A lack of capital is hurting the farm sector, where the use of fertilizer, for example, has dropped by one-third. With the current economic turmoil, no one expects agriculture to make a comeback for years.

China suffers from a different problem. With economic growth strong, urban sprawl and industrial development is pushing out farmland. Over the last decade, China has lost more than 2% of its arable land. Take the case of Wong Liwah, a 36-year-old peasant north of Guangzhou who recently saw her 14.5-acre rice and vegetable plot paved over for a factory. Wong has no regrets: She has been given a new apartment and promised a job in the factory that will pay double her farm earnings. "Farming is not easy work," says Wong. "We are much better off than we were before."

Wong's story is repeated through much of the world. Even remote areas take a "build it, and they will come" approach to development, rushing to plant industrial parks on farmland. Population pressure compounds the problem, as apartment buildings soar in response to a critical housing shortage. And if high prices prompt farmers to plant fragile land, the environmental damage could compromise production in the future, warns Agriculture Secretary Glickman. "I don't want to see another Dust Bowl created on my watch," he says.

As for increasing production through technology, yields may not rise as fast as some suppose. After two decades of constant improvement, farm productivity growth has tapered off since the late 1980s. Stagnant farm prices made it less profitable to invest in research. Now that prices are soaring, there's an incentive to develop new technology--but it will take time.

Even current technology may be tough to implement in developing countries. Consider J.R. Simplot Co.'s efforts to supply McDonald's with french fries in Asia. Simplot has spent eight years struggling to grow a big Idaho-style potato in northern China. Challenges include tiny farms, inappropriate for mechanized equipment, run by farmers who distrust basic Western farm technologies such as soil testing. Over time, the Chinese and their U.S. advisers have developed a rapport, and output is up. But Simplot's Chinese Idahos are far from ideal.

Other impediments to boosting yields in the developing world include inadequate storage and transportation facilities. Building bigger port, rail, and highway systems to move food takes capital. And the latest farm technology won't arrive until intellectual-property concerns can be satisfied. Pioneer Hi-Bred International Inc., a Des Moines-based supplier of hybrid seed, won't risk sending their valuable products to markets where their genetics can easily be stolen.

MIXED BAG. The new economics of food will help boost the U.S. economy, which could enjoy a $30 billion agricultural trade surplus this year. That surplus will zoom as farm prices increase. The big winners: Vic Riddle and his fellow farmers in the U.S. heartland. Fertilizer, pesticide, seed, and farm equipment companies also stand to gain from strong global demand. It's a mixed bag for agribusiness companies such as Archer Daniels and Tyson--high commodity prices hurt their processing margins, but they'll compensate in the long run through exports and international expansion. U.S. livestock producers, especially Ma-and-Pa operators, stand to lose as feed costs gyrate.

At the same time, farmers are dealing with the consequences of recent changes in farm policy, including the 1996 Farm Bill (box). Over the past decade, the U.S. government has eased out of the business of stockpiling grain, so there is no longer any reserve to cushion year-to-year production and price swings. The new legislation discontinues most of the regulations that constrained American farmers. "Now, we can plant what we think the market will need," says Susan J. Adams, who farms 1,100 acres near Atlanta, Ill.

U.S. farmers have a good chance to regain export markets they dominated through the 1960s and '70s. The resource-rich heartland, with one-quarter of the world's productive capacity, enjoys a wide comparative advantage in producing grain and soybeans. U.S. farmers also will benefit from the Uruguay round of the General Agreement on Tariffs & Trade talks, which reduced export subsidies and made trade barriers more manageable. As Illinois farmer Riddle says: "I feel like I'm in the right business right now." Farm real estate prices are up 21% since 1991.

As farm prices rise, other nations are pressed to become more self-sufficient, presenting an opportunity for Western agribusiness companies. Asia, especially, needs technology and knowhow. On Apr. 20, China disclosed plans to attract as much as $7 billion in foreign agriculture investment over the next five years. After pussyfooting around China for years, griping about excessive red tape and technology theft, many agribusiness companies sense a boom ahead: "I've never seen anything so wide open for growth this century," declares ADM Chairman Dwayne O. Andreas.

The stock market has taken notice, bidding up companies that stand to gain from the new economics of food. Pioneer's stock price has jumped 50% over the past year as higher commodity prices encourage farmers to use more of its expensive hybrid seed. Pesticide and herbicide makers such as Monsanto Co. see similar global benefits. Fertilizer is also a big winner: Dumping on a balanced blend of nitrogen, potash, and phosphate is the simplest way to improve yields. The business "really is being driven by demand in the world," says Wendell F. Bueche, CEO of IMC Global Inc., which has seen its stock price soar in recent months.

With the food economy driven increasingly by global demand, the U.S. may find more and more that the way to the world's heart is through its stomach. The growing Western role in feeding China, for instance, could develop into a new basis for trust in Sino-U.S. relations. As nations are drawn into the global food trade, interdependence tends to moderate their political behavior and deepen ties. If the world's food production is to keep pace with rising demand, its citizens will need to eat from one another's plates.

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