Home Economics: Will Rising Food Prices Ruin the Recovery?

Soaring grain prices threaten to add new troubles to a global economy already in trouble

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A rotting ear of corn sits on a struggling plant in a drought-stricken farm field in Bondurant, Iowa, on Aug. 7, 2012

Here we go again. On two occasions since 2007, the world economy has endured rapid and extreme increases in food prices that have inflicted great pain, especially on the poor. Now, with drought in the Midwestern U.S. burning through one of the most important food-producing regions in the world, get ready for a dizzying feeling of déjà vu. Corn and soybean prices recently reached record highs. Wheat has also spiked. Jim Kim, President of the World Bank, is already warning that rising food prices can cause families to eat cheaper, less healthy food or pull kids out of school, steps that “can have catastrophic lifelong effects on the social, physical, and mental well-being of millions of young people.”

(MORE: How the Drought of 2012 Will Make Your Food More Expensive)

That is bad news for the global economy. We are already facing all sorts of hurdles in our so far futile efforts to climb out of the Great Recession. Joblessness in the U.S. and Europe remains high. The euro-zone debt crisis continues to boil. The world’s emerging markets are slowing down. Rising food prices will just add to the gloom, since they can kill growth in two important ways. First, there is a consumption effect. When families are forced to allocate a larger share of their weekly income to milk, bread and other basics, they are unable to spend as much on clothes, toys and other stuff, dampening overall consumer spending. This could be a big issue in the advanced economies, where unemployment is already straining the finances of the average household. Second, there is a policy effect. Rising food prices often cause higher inflation, which could force central banks to react by hiking interest rates to control the upward pressure on prices, slowing down growth in the process. This could prove a big problem in the developing world. With economies in China, India, Brazil and elsewhere cooling off, central banks have been encouraged to cut rates to stimulate growth. Higher inflation, though, could stymie that effort by forcing central bankers to keep rates high to control inflation even if growth continues to sag. Since emerging markets are playing a larger role in overall global growth, a continued slowdown in China, India and other big developing nations could dampen the entire global outlook.

How likely is that? So far, economists are taking the position that higher food prices won’t stop central bankers in China and elsewhere from easing money to spur more growth. Here’s Capital Economics on this, from a late July report on China:

The recent surge in global agricultural commodity prices — if sustained — will add to the downside risks to China’s economy but it is unlikely to be a decisive factor. Overall inflationary pressures are weak and the authorities will not be deflected from loosening policy further … The People’s Bank [China’s central bank] has raised interest rates and reserve requirements in the past when food price inflation has surged, but only when the Chinese and global economies were strong. This emphatically is not the case today. If the Chinese authorities want to alleviate food price inflation they are now more likely to do so via subsidies and stock releases, rather than tighter monetary policy.

(MORE: Thanks to Heat Wave, Grocery Prices Are Likely to Spike by the Fall)

Some economists feel similarly about the entire global economy. They are so far staying calm about the impact the recent surge of food prices could have on global growth. Economists at Bank of America Merrill Lynch, in a recent report, argued that slower growth and other factors could limit how elevated food prices would translate into increased inflation, and thus limit their impact on overall economic growth.

Despite the significant jump in crop futures prices, we see a host of factors helping to delay and/or mitigate the impact on inflation … On the policy front, our EM [emerging markets] team expects local central banks to remain focused on growth … But even if higher food prices constrain central banks on the margin, the impact on global growth should be limited.

Economists, however, always like to leave themselves an escape route to change their outlook down the road, and they are doing so again. The impact of high food prices on global growth will depend on how high those prices go. That will depend on factors that are impossible to predict — the weather, for example. A bit more rain in the U.S. Midwest might salvage some of the corn crop and bring prices down, for example. Or continued drought in the U.S. combined with problems elsewhere in the world (for example, a feeble Indian monsoon) could conspire to deal a harder blow to the global economy. Personally, I’m more negative than the Merrill gang about the effect of rising food prices. I think consumer sentiment, especially in the advanced economies, is so fragile right now that bigger bills at the supermarket, even only slightly bigger bills, could convince many families of the need to retrench.

(MORE: Food Fight! Stores, Producers, Consumers Battle over High Food Prices)

Generally, though, this third food-price scare in five years shows yet again how badly we need to invest in global agriculture. The problems we’re facing today are an outgrowth of long-term trends — greater wealth in the developing world, a lack of investment in rural infrastructure, falling yield growth — that are altering the supply-demand equation in world food markets, making them more susceptible to bad harvests, natural disasters and other unexpected shocks. So be prepared to get that sickening, familiar feeling again and again.

PHOTOS: A Global Food Crisis