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Food for thought on global supply dynamics

Comment
There is a need for more efficient supply chain logistics, technologies, and systems to help alleviate the economic and social ills associated with rising and volatile food prices in emerging markets and less-developed countries.

Over the last three decades U.S. and world food prices have trended upward while becoming increasingly volatile (see Figure 1). This trend highlights the need for more efficient supply chain logistics, technologies, and systems to help alleviate the economic and social ills associated with rising and volatile food prices in emerging markets and less-developed countries.

Why food prices are rising
Several key factors have been behind the rise in average global food prices since 2004. These include misguided macroeconomic, monetary, and other government policies. For example, policies that promote the use of biofuels (such as ethanol, which typically is made from corn) have created new links between food and energy supply.

Article Figures
[Figure 1] World food and oil prices
[Figure 1] World food and oil prices Enlarge this image
[Figure 2] BRIC consumer spending
[Figure 2] BRIC consumer spending Enlarge this image

It is generally believed when world oil prices reach the US $70 to $80 per-barrel range, biofuels production becomes more competitive and several types of grains are diverted to the production of biofuels. According to the U.S. Energy Information Agency and the U.S. Department of Agriculture, in 2011 the United States produced nearly 14 billion gallons of fuel ethanol from approximately 5 billion bushels of corn, or approximately 39 percent of national production. Similarly, in 2011 Brazil produced about 6.5 billion gallons of ethanol from approximately 325 million metric tons of sugar cane, or 50 percent of national production, according to IHS Agricultural Services estimates.

There is a downside to that shift: the diversion of a substantial amount of corn production toward fuel has led to shortfalls in the production of corn-based food staples. Moreover, because grain's byproducts are major ingredients of livestock feed and such food necessities as bread and flour, the large-scale use of grain for biofuels has contributed to malnutrition in some less-developed nations. On the upside, second-generation fuel sources like ethanol have made modest progress in contributing to global fuel supplies. But they have yet to become a significant factor, as evidenced by the fact that Brazilian and U.S. fuel ethanol production combined accounted for approximately 90 percent of global ethanol production in 2011.

In addition to government policies, other important elements contributing to rising food prices include a growing middle class in emerging markets, rising world urbanization rates, sensitivity to bad harvests and supply chain disruptions in agricultural markets, and higher costs for fuel and fertilizer.

Improved living standards in many parts of the world, including Brazil, Russia, India, and China (BRIC), are raising the demand for fuels and food (see Figure 2). Moreover, as people become wealthier, they consume more meat. Increased demand for meat, in turn, affects overall food costs.

For one thing, it boosts demand for livestock feed, which is mostly grain. According to some estimates, it takes approximately 10 calories of grain to produce one calorie of meat. For another, more deliveries of meat to consumer markets means greater demand for expensive fuel. Adding to the upward pressure on food prices is the combination of 1) rising food transportation costs due to higher petroleum and other energy prices, and 2) rising fertilizer prices caused by increasing demand for products that enable the higher grain yields required to meet the ever-increasing demand for meat.

The German statistician Ernst Engel (1821-1896) discovered that as income increases, the percentage of household income spent on food declines, even though the total amount spent on food actually rises. Thus, as countries transition to more-developed economies, households tend to dedicate a smaller share of their budgets to food and other necessities—even though the absolute level of food consumption increases.

Over the last decade, American consumers spent a smaller percentage of their household incomes on food than consumers in any other country. And although the North American and Western European middle classes are struggling with declining median household income (adjusted for inflation), their counterparts in many emerging markets have made consistent income gains over the last decade. India in particular has made tremendous strides on this front. In 2000, the average Indian family spent 41.7 percent of its outlays on food; 10 years later, this share had decreased to 27.7 percent. During the same period, Chinese consumers' spending on food as a percentage of total outlays dropped less dramatically, from 29.2 percent in 2000 to 22.3 percent in 2010. As predicted by Ernst Engel, the total dollar amount of food spending per capita has increased while the percentage of household outlays devoted to food has decreased.

Parallel with the growth of the middle class in many large countries, the global urbanization rate for the first time in history surpassed the 50-percent mark sometime between 2001 and 2004. As urbanization rates increase, the pressure on farm productivity and supply chain efficiency increases as well.

The food supply chain: A call to action
Global and domestic food supply chains are complex and heterogeneous within or among countries. In general, agriculture, fisheries, and aquaculture are the furthest upstream; manufacturing and packaging of processed food occupy an intermediate space, with trade (wholesalers and retailers) and services (such as restaurants) further downstream. There have been considerable gains in recent years in emerging countries related to their food-supply networks. Recent advances in Internet and mobile communications have greatly enabled market mechanisms to improve food supply chain dynamics and assist in the monitoring and mitigation of food-price volatility.

There are several areas that can help many emerging countries improve the delivery of food to end users, either domestically or globally, thus reducing food-price volatility while simultaneously increasing supply:

  • Supply chain expertise, such as efficient consumer response (ECR), that assists the entire food supply chain in monitoring consumers closely while providing food at a lower price;
  • Implementation of food safety, hygiene, and quality standards;
  • Government infrastructure projects that promote efficiencies in delivering food to domestic or global end markets;
  • "Cold" logistical and supply chain systems to improve the quality of perishables during transportation; and
  • Opening up domestic markets to Western products and multibrand retailers.

Accelerating global economic integration over the last 30 years continues to elevate per-capita incomes in the developing world. Consistent with economic theory, as incomes rise the share of expenditures dedicated to necessary goods, such as food, follows a path of continuous decline while the absolute levels of consumption continue to rise. In turn, increases in food consumption, in conjunction with global financial and macroeconomic policies, have been putting increasing pressure on the price of food staples, inputs to meat production, biofuels, and other energy components. Consequently, the importance of efficient supply chain mechanisms for delivering food within and across borders has become more important than ever. To ensure efficient distribution of food supplies, supply chain managers worldwide will be faced with unique challenges and opportunities to ensure that consumers receive an adequate supply of food to meet their needs, thus helping to sustain, nourish, and further grow the global economy.

Chris G. Christopher, Jr., Ph.D., CBE is executive director of the U.S. Macro and Global Economics practice at the research and analysis firm IHS Markit.

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