Food Prices: What Drives the Cost of What We Eat

Book: Commodities: Markets, Performance, and Strategies
Editors: H. Kent Baker, Greg Filbeck, Jeffrey H. Harris
Publisher: Oxford University Press, 2018
ISBN: 9780190656010

Food Is Different

Chapter 22, by Donald F. Larson, shifts the focus from trading strategies and portfolio construction to something more fundamental: the price of food. This is not just an investment chapter. It is about people, hunger, and how price swings in commodity markets affect the world’s most vulnerable.

The chapter opens with a stark observation: high food prices threaten the welfare of the world’s vulnerable, who spend a large share of their incomes on food. At the same time, falling food prices combined with high volatility hamper growth in poor countries that depend on commodity exports. And at the household level, uncertain food prices discourage on-farm investment and push poor families into survival strategies that keep them poor.

Food commodities are different from oil or copper in ways that matter for everyone, not just traders.

116 Years of Food Prices

The chapter traces food prices from 1900 to 2015 using a hybrid index based on World Bank data and earlier research by Grilli and Yang (1988). The data reveals several distinct episodes:

• Early 1900s: Prices climbed, then fell sharply after World War I
• 1940s: Twin peaks around World War II, followed by an extended decline
• 1974-1975: A sharp spike during the OPEC oil crisis
• 1980s-2000s: A long period of relatively low and stable food prices
• 2007-2008 and 2010: Twin price spikes that shook global food security

Here is what is remarkable: despite the world’s population growing from 1.6 billion in 1900 to 7.4 billion by 2016, food prices in 2016 were not dramatically different from 1900. Think about that. The world has 4.6 times more people, everyone eats more calories and more protein than in the past, and yet food prices have roughly kept pace.

How? Productivity gains. More on that below.

The Distribution of Food Prices

When you plot all monthly food prices from 1960 to 2016, the distribution is heavily skewed. Most prices cluster at the lower end, with a thin tail of peak prices (many from the 1970s). The median price in the index is 86.65. The peak was 271.88 in November 1974. The lowest was 44.79 in July 2000.

This is important because it matches what theory predicts about commodity prices. Prices tend to stay relatively low most of the time, with occasional sharp spikes when something goes wrong (bad harvests, trade disruptions, supply shocks). The spikes are brief but intense. Surpluses, on the other hand, can be stored and carried forward, which prevents prices from collapsing symmetrically.

Storage Theory: Why Prices Spike

The chapter does a good job explaining the theory behind food price behavior. The key concept is “competitive storage.”

Market participants form rational expectations about future prices when deciding how much grain, rice, or other food to store. Under normal conditions, inventories absorb small shocks. Prices stay relatively stable.

But when a large, unexpected negative shock hits, like a series of bad harvests or a trade embargo, current supplies get strained. Prices jump. And because inventories are low, the probability of higher prices in subsequent periods increases too. As supply eventually responds to higher prices, inventories rebuild and prices come back down.

Unexpected surpluses do not cause the same drama. You can just store the extra supply and carry it forward. This asymmetry explains why food price spikes are sharp and brief while low-price periods are long and stable.

The origins of storage theory go back to Working (1931) and Kaldor (1939). They explained “inverse carrying charges” (when the spread between spot and futures prices does not cover storage costs) and “backwardation” (when the spread turns negative). These episodes usually happen when inventories are low, and the concept of “convenience yield” explains the gap.

Do Speculators Cause Price Spikes?

This is the million-dollar question, and the chapter addresses it directly.

An alternative explanation for price spikes is excessive speculation. When financial institutions started pouring money into commodity index funds after 2000, many people blamed them for food price increases.

But most research finds little evidence that speculators disrupt agricultural markets in a lasting way:

• Etienne, Irwin, and Garcia (2014) examined daily pricing of futures contracts for 12 food commodities between 1970 and 2011. They found multiple episodes of explosive price movements, but classified only 2 percent of pricing behaviors as speculative bubbles. The bubbles were short-lived, mostly lasting less than 10 days. They found no evidence that bubbles have become more frequent.

• Gilbert (2010) found that index futures investment contributed to food price increases during the 2007-2008 spike, but concluded that misguided but rational expectations about Chinese demand actually drove the investments.

• Hamilton and Wu (2015) concluded that index fund traders did not affect recent food prices.

• Stoll and Whaley (2010), Sanders and Irwin (2011), and Bohl and Stephan (2013) found no links between speculation, index fund activity, and price volatility.

The overall conclusion: deepening of global commodity markets should actually be a stabilizing force, as information barriers drop and global inventories respond to market signals. But worries remain that the scale of financial assets in commodities has increased food prices’ exposure to financial market volatility.

The Productivity Miracle

The most hopeful part of the chapter is about productivity. Between the 1960s and 2010s:

• Global population more than doubled (from 3.3 billion to 7.1 billion)
• Agricultural land increased by only about 8.5 percent
• But cereal yields increased by more than 240 percent

In the 1960s, agricultural lands produced around 619 thousand calories per hectare per year and about 17 kilos of protein. By 2010, an average hectare produced 1,493 thousand calories and nearly 42 kilos of protein. That is a 240 percent increase in land productivity.

The Green Revolution was the main driver. Publicly funded agricultural research created new crop varieties that dramatically increased yields. This research has consistently paid high dividends. Without it, the math of feeding 7 billion people simply would not work.

Available calories and protein per capita increased substantially between the 1960s and 2010s. Diets have shifted toward more animal products, which require more land and water per calorie. Yet the system has kept up, at least so far.

The Terms of Trade Problem

Food prices are among the most volatile of all commodity groups. And they are more volatile than the prices of manufactured goods. This creates a terms-of-trade problem for developing countries that export food and import manufactures.

When food prices spike, it might sound good for exporting countries. But the volatility itself is damaging. Research shows that increased terms-of-trade volatility slows both economic growth rates and poverty reduction rates in developing countries.

At the household level, episodes of high and volatile food prices can overwhelm the coping capacity of poor households. For farmers, price volatility discourages investment in new technologies that could improve their productivity. So the very people who could help increase food production are held back by the uncertainty of food prices.

My Take

This chapter is sobering. It connects commodity market dynamics to real human welfare in a way that the trading and portfolio chapters do not.

The most important insight is that food price volatility is not just a trader’s problem. It is a development problem. Price spikes cause malnutrition, poverty, and political instability. Price uncertainty prevents farmers from investing in their own land.

The productivity story is encouraging, but it comes with a warning. Since 2010, food prices have averaged higher than in recent decades, raising concerns that long-sustained rates of productivity growth might be slowing. If productivity growth stalls while population and income growth continue, the math gets ugly.

In Part 2, we will look at what governments have tried to do about food price volatility, why most interventions have failed, and what alternatives exist.

This is Part 1 of a two-part series on Chapter 22. Continue to Part 2: Food Price Volatility: Why Prices Swing and What Can Be Done.

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