Will Rising Food Prices Kill the Recovery?

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Fish will cost you more in India (photo: Danish Siddiqui/REUTERS)

If food costs more, will you buy any less? Surprisingly enough, that simple question may be the key to whether 2011 sees a strong rebound in economic growth, or is, instead, a bust.

The issue is that raw food prices are indeed way up. Corn is at a two and a half year high. And some think it could rise by another 30% this year. Sugar was up 77% in the last six months of 2010. Beef prices are up as well. On the face of it, climbing food prices seem like a bad thing. It can cause inflation and cause people to buy less of everything else. Rising food prices have already lead to violent riots in Tunisia and Algeria. But a number of economists, including Goldman Sachs’ Andrew Tilton and IHS Global Insight’s Nariman Behravesh, say this time around, food prices won’t necessarily be a recovery killer. Here’s why:First of all, food prices might not be as much of a driver of economic growth as many people think. In a recent research paper World Food Prices and Monetary Policy published by the National Bureau of Economic Research, Luis Catao, of the International Monetary Fund, and Rutgers University economist Roberto Chang argue that rising food prices do not always lead to slower growth. In a number of scenarios, economic growth will actually increase after a rise in food prices.

How could that be? The real determinate of whether an economy will grow or shrink has more to do with policy makers response to rising food prices. A gradual increase interest rates by a central bankers will eliminate any adverse effects of climbing food prices, and may actually boost growth.

The problem, for that scenario, is that around the world most policy makers have generally followed a policy of keeping rates as low as possible. Low rates tend to cause your local currency to fall, and that can boost exports. But that might soon be changing. Rising inflation in India and elsewhere may soon force a number of countries to raise interest rates. Indeed, China has already begun raising its lending rates. Of course, in the US, Bernanke & Co. seem to have no plans to raise rates anytime soon.

Second, food prices don’t necessarily slow consumption, which gets back up to our original question. That’s because of substitution. Yes, we all have to eat. But we don’t have to eat as much or as well. In fact, economists assume that if food becomes relatively more expensive you will end up spending less on it. So if the price of a night out at a fancy restaurant goes up, we might forgo that pleasure for spending more nights in and buy a HDTV, the prices of which for the time being continue to fall. We’re still spending money, on what really doesn’t matter to the economy, to an extent.

What’s more, Behravesh says food prices in the US and other developed countries make up a relatively small portion of consumption, about 10%. So food prices would have to rise dramatically to really affect our budgets. That’s not as true in developing countries. The average citizen in China and India spends half their budget on food. In really poor countries, like Bangladesh, food can make up as much as 75% of a household’s expenditures. But the later group of countries still makes up a small portion of world economy activity. So while rising food prices could be a huge problem in poor countries, causing horrible food riots, it’s not clear the slowdown in consumption in those parts of the world would hurt global growth.

Tilton, for his part, points out that there is lag between rising raw food prices, like corn, which is what we have seen, and what happens to actual food prices, like corn chips. The actual food that you buy in the supermarket on average has yet to go up very much, just 1.5% in the past year. Tilton agrees this is about to change, but it will take seven months to a year before we see a change. Hopefully, by that time the economic recovery will be well on its way, and fatter paychecks will allow us to continue to get actually fatter without pause.