The debate is far from being settled, and this is good news as all the forecasts so far are biased by the imperfections of the models they are based on. Since the mid-2000’s, there has been an underlying increase in the price of agricultural commodities, with two major peaks, one in 2007-2008, and another in 2010-2011. Over the last decade, structural variables in conjunction with hazards tied to the environment and the market – made worse by the increased financialization initiated in the 80s -- have led to price increases and higher price volatility. The question is: what are the determining factors behind the sharp rise in the price of agricultural commodities? Is this a long term trend or is a price turnaround still possible?
Thierry Pouch attempts to answer these questions in this new study (excerpts included below1
), namely by presenting the two main trends opposing economists and international institutions, in a very uncertain and unstable economic context.
There is also a lack of consensus over the interpretation of future trends in agricultural markets. New alternative interpretations are emerging worldwide, namely in Europe and the United States, advancing the possibility of a price turnaround for agricultural commodities.
The Momagri think tank has already shown that current forecasting models are not adapted to the reality of agricultural markets. And facts are there to prove it: over the years, virtually all forecasts have turned out to be wrong. Wouldn’t it be time to take the intrinsic imperfection of agricultural markets into consideration, and be inspired by projection models that are adapted to the virtually chaotic nature of agricultural markets, for instance the Momagri model? Given the current context and its hazardous implications, this would be a wiser option than simply relying on markets to auto-regulate themselves, while hoping that the natural balance of power on the markets will act as the ultimate antidote to the crisis and high price volatility?
momagri Editorial Board
The price of agricultural commodities and other raw materials has been rising since the mid-2000’s, and forecasting models all show that prices will continue this upward trend. Different factors explain this trend which comes after a period of decrease. However, certain forecasting exercises contradict this convergent theory. The evolution of global economy could well prove that those who are right, are the economists who have predicted that the increase in the price of agricultural commodities will not last as long as expected, and that markets ought to be preparing for a major downturn.
Since the mid-2000’s, global prices for raw materials have been rising. Both renewable and non-renewable raw materials have come under the fire of economic news, owing to their rising prices and their cost for importing countries. With the exception of the year 2009, price increases have been continuous for agricultural commodities. The determining factors behind this sharp rise in staple commodities, and mainly agricultural commodities, and their consequences for end users, have been investigated by a wide field of economic literature.
Beyond these issues, the recurrent question is: will price increases – sparked in 2005 –continue on this trend, and if so, are we in a position to explain the theory according to which the market for agricultural commodities is about to undergo a downturn? Two opposing trends have emerged on this subject.
The first, which brings together a large number of economists and international institutions such as the OECD and the FAO, defends the idea that price increases for agricultural commodities has marked a break with past years, and that this trend will continue owing to structural factors.
This trend may be reasonably considered as defending the most ‘optimistic’ scenario, in the sense that the current orientation of the markets promotes the development of agriculture through higher prices, with an expected domino effect on the rest of the economy (farming equipment, jobs, seeds…).
On the other hand, the second more marginal trend, defends a more ‘pessimistic’ scenario, according to which a number of conditions exist which are likely to trigger a long term downturn and drag down prices. A situation that would be detrimental to producers and productive investments. Examining and understanding these opposing views is both necessary and useful, in a context where there is a deep uncertainty about global economic growth, and where international relations are shifting.
The formation of the upward trend consensus
Since the mid-2000’s, the world economy has witnessed a significant rise in the prices of raw materials. On a time scale, the price of petrol was the first to rise, followed by other raw materials used for industrial applications (copper, zinc, nickel…).
This price increase comes after a long period of decrease. According to certain experts, the current trend invalidates the eminent theory, advanced in the 50’s by the Argentinian economist Raul Prebisch (1901-1986), and which predicts a gradual long term drop in the price of raw materials, which would hinder the development of producing countries owing to poorer terms of trade.
And indeed the commodity price index, as established by Grilli and Yang, clearly shows that prices have been following a downward trend since the turn of the 20th century. Therefore in order to understand the emerging upward trend, it is essential to consider the factors underlying it, which in a way have also contributed to forming the general consensus. In a nutshell:
Structural variables have impacted both global demand and offer over the past decade. The slump in agricultural production since the 90's, the increasing use of crops (such as maize) as a source of energy, the surging economy of emerging countries, their higher standard of living, the greater urbanization of their populations, and their nutritional transition to a diet that is richer in meat and dairy products, which requires the development of animal production and therefore a greater production of grain and oilseed crops (mainly soy) for feed.
Over the last decade, demand has gradually outstripped supply and has led to a rise in prices for agricultural commodities.
The economic context also added to the tension and further increased the price of agricultural commodities. For instance, climatic conditions (droughts in Australia, Ukraine and Russia…), investments operated by financial firms (banks, insurances, sovereign funds, hedge funds…looking to diversify their assets after the housing bubble burst in the US), as well as the shifting Dollar exchange rate, since most transactions are settled in USD. As for the influence exerted by financial players on the formation of prices for agricultural commodities, this comes as a result of the financialization of economic markets - which began in the 80's - and has created a problem in terms of global market regulation.
This configuration of agricultural markets is the configuration used by economists to interpret future trends - which diverge in the degree of influence attributed to individual variables - and issue forecasts. Most of these forecasts predict that prices will continue their upward trend up until 2022, causing experts and observers to question the capacity of global agriculture to feed a world population of 9 to 10 billion people at affordable prices by 2050, thereby placing agriculture at the heart of what is to become a global challenge in the near and long term future.
The OECD and the FAO have clear cut positions on this point. The perspectives for global agriculture issued by these two international organizations are unambiguous, and clearly advance that prices will remain high for the ten years to come, although price volatility will sometimes interfere with this trend. According to the OECD and the FAO, China’s meat demand is expected to grow 7%/year up until 2022, which will in turn increase grain and oilseed production for feed. Other estimates corroborate this trend, for instance those issued by the FAPRI, the USDA and the World Bank.
This abundance of analytical data and forecasts has somewhat blocked out any opposing theories, as well as any doubts concerning the long term character of price increases. The slump in prices for agricultural commodities in 2009, failed to act as a clear message that might have led experts to review their position.
After fears of a profound and long lasting recession, a growth spurt has been triggered by emerging countries, mainly China, leading to a second peak on the markets for agricultural commodities in 2010, and confirming the long term character of price increases.
A scenario that is nonetheless fragile
Economic forecasts are often wrong, mainly because of the biased methods used for calculations. Moreover, agricultural markets are, by definition, volatile. These weaknesses have nonetheless failed to challenge the shared conviction of a long lasting increase in prices for raw materials, and mainly agricultural commodities. Structural factors are now leading certain economists to question the consensus that has formed over the past years, on the long term character of these price increases. The idea behind this, is that we are on the brink of a downward trend which should last just as long, and which will bring prices down to the levels observed in the mid-80’s, and in 2005.
Experts defending this theory recently made their voices heard during the symposium organized by the Kansas City Federal Reserve Bank, on 16 July 2013.
During this symposium, Patrick Westhoff, an economist of the University of Missouri, who is specialized in agricultural economics, challenged the dominant theory according to which prices will remain high for the years to come. This is not the first time Patrick Westhoff has defended this position. In 2010, he had already advanced the idea of a market turnaround in a book that made a lot of noise at the time it was published. His analysis is based on the same variables used by other economists, only he reaches a very different conclusion.
A number of converging factors exist that all tend towards the scenario of a long term price downturn. Is the boom of the last years wearing off? In this case, who would challenge the tenants of the alternative theory, and if so wouldn’t we be back in a period similar to that of 1985-2005? Or does this simply confirm the forecasts issued by the FAO and the OECD which predict chronic price volatility in a general context of price increases. The main point of this exercise, carried out by Patrick Westhoff, lies in the fact that it is always constructive and stimulating to take opposing views into consideration when making economic forecasts. For instance, Patrick Westhoff takes macroeconomic variables into account, including monetary variables, proving in this way that the agri-food sector is not a separate entity, as often assumed. Lastly but most importantly, this more ‘pessimistic' trend helps take the measure of the complexity of the global food system.
What Patrick Westhoff deplores above all, is that only a handful of variables are taken into account by those experts predicting that the underlying increase in the price of agricultural commodities is now a structural element of global economy. If this is true, and these variables impact prices by causing them to rise, this means the reverse could also be true, and these variables could in the same way drag prices down. Could the upward trend of prices for agricultural commodities – a trend which began in 2007 - be about to reverse?
1 Follow this link to read the entire article http://www.chambres-agriculture.fr/fileadmin/user_upload/thematiques/Economie/Focus_1308_01.pdf