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Supply response to high prices is a lasting one

The steep ramp-up of grain and oilseed prices over a couple of years only to drop by one-half in a matter of three or four months has been extremely confusing to lots of folks.

The fact that the 50 per cent drop took place so quickly was a surprise – it usually takes a couple or so production periods – but otherwise such a drastic price drop is as predictable as night following day.

Why is that?

In economics lingo, it is called supply response. In everyday language it goes like this, “high prices cure high prices.”

For crops, prices triple and quadruple bring additional area into production, encourage investment in yield-enhancing technology, and drive customers to seek alternate suppliers.

Acreage increased

In fact, it takes price increases of such a magnitude to get much of an aggregate response in the acreage used for major U. S. crops. Total acreage does not change much with “normal” variations in prices, either up or down. In the case of a drastic drop in prices, acreage does not decline quickly – in contrast to the rush of incoming acreage when prices explode.

Following the price rise that began in the fall of 2006, we saw U. S. farmers switch crops and make use of every possible acre they could reasonably farm. As Conservation Reserve Program contracts came up for renewal, many farmers with acres suitable for cropping did not renew.

For the eight major crops in the U. S. (corn, soybeans, wheat, rice, barley, oats, sorghum, and cotton), harvested acreage increased from 217 million acres in 2006 to 231 million acres in 2008, the highest level since 1998.

Similarly, Brazilian acreage for the same eight crops also increased from 103 million acres in 2006 to 107 million acres in 2008. Farmers around the world respond just like U. S. farmers.

Crop failures

The price increase was partly due to unusually large wheat crop failures in several areas of the world. With the return of more normal circumstances, world wheat harvested area rose from 526 million acres in 2006 to 554 million acres in 2008. Yield increased from 41.6 bushels per acre in 2006 to 45.3 bushels per acre in 2008.

With high prices, we were not surprised to hear seed companies talk about yield breakthroughs and numbers that seem like some pipe dream.

Just as acreage quickly comes into production when prices skyrocket but drains away slowly when prices tumble, yield-enhancing technology, once introduced, is here to stay. In fact, at low prices individual farmers feel they need high yields to keep gross income from falling through the floor.

It also is not uncommon, when prices surge upward, for countries to step up efforts to secure future international access to agricultural production as a means of ensuring their long-term food security.

This is usually done by diversifying sources of international supplies and may include providing loans or grants to other countries to improve their agricultures, as was the case in the 1970s when Japan provided funds to help develop Brazil’s capability to produce soybeans.

Foreign leases

This time around we are seeing an additional approach being introduced that may push the outer envelope of using other countries’ agricultures to further a country’s food security goals.

South Korea’s Daewoo Logistics is seeking to ink a deal to enter into a 99-year lease on 2.5 million acres in Madagascar to produce corn and other crops for Korean consumption. They expect to produce 232 million bushels of corn on that land in 15 years. By way of comparison it should be noted that in 2005, Korea imported 231 million bushels of corn from the U. S.

China has its eyes on 2.5 million acres in the Philippines and an unreported amount of acres in the Zambezi River valley in Mozambique. It is reported that the Chinese hope to boost annual rice production from 100,000 tonnes to 500,000 tonnes in the next five years. Rice is not a staple in Mozambique so it is expected that most of the rice will be shipped to China.

China and Korea are not alone. We have seen reports that oil-rich countries in the Middle East are also seeking lands to provide a stable supply of food for their domestic consumption.

Supply chain link

Recent unconfirmed media reports suggest that these countries are seeking as much as 20 million acres on which to grow crops that can be shipped back home for domestic consumption.

This agricultural production becomes a link in a supply chain and almost functions like domestic production. It never really enters into world trade.

Visiting countries could agree to provide investment in infrastructure and agricultural research and extension and increased access to reasonably priced agricultural inputs. It is possible that the home countries could end up with more agricultural production on the remaining land than could be reasonably expected from all the land and no visitors.

We expect there will be push-back from several quarters, especially if the home countries have farmers already occupying the land. The list of possible complications does not end there.

Nonetheless, it seems clear that several countries will likely lease land in other countries to augment their domestic agricultural production needs.

There are a couple of lessons here:

Sentenced to low prices

The first is that extraordinary increases in crop prices are not good for anyone; it sets up a world supply response that sentences farmers everywhere to years of low prices.

The second lesson is that nothing scares many of the world’s developing countries more than the prospect of not having sufficient quantities of reasonably priced food.

To us, the “leasing of foreign land alternative” is an indication of how far “rich” developing countries will go to achieve food security goals and their ability to find substitute means to get around imposed international trading rules.

That is why, based on past events, we tell farmers that it is in their long-run best interest to hope for prices that fluctuate within a “normal” and reasonable – but fairly wide – band that covers production costs on average.

While winning the lottery has a nice ring to it, farmers should not want prices to triple and quadruple over a short period of time.

– Daryll E. Ray holds the Blasingame chair of excellence in Agricultural Policy, Institute

of Agriculture, University of Tennessee, and is the director

of UT’s Agricultural Policy Analysis Center (APAC). Ray’s

column is written with the research and assistance of

Harwood D. Schaffer, Research Associate with APAC.

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