The Coming Boom in Agriculture

Check out this recent article in Forbes.com.  A coming boom in agriculture?  I think so. The old way of looking at food supply and demand is giving way to a new emphasis on the changing diets of hundreds of millions of people. Those changes will substantially increase demand for grains, putting upward pressure on prices.

The old approach to agriculture economics emphasized the stability of demand. Consumers don’t change their food consumption much as their incomes change, nor as the price of food products change. Over the course of the recent recession, for instance, spending on food in the United States dropped by three percent, compared to 22 percent decline for car sales, 14 percent for furniture, etc. Within the food category, the drop in spending was primarily a shift from high value foods to economy foods rather than a decline in total calories consumed.

Food supply, on the other hand, is wildly variable in the traditional analysis. Weather and pests cause booms and busts in agricultural production, along with a long-run trend toward greater productivity by farmers. All the action was in food supply, not food demand.

Things are different today. Bugs and weather still affect production, but the biggest story is the growth of demand for meat by formerly-poor people around the world. Let’s begin with the grain demand of different diets. An ounce of meat takes about ten times as much grain as an ounce of grain eaten directly. Those animals have to be fed, after all. The exact ratio depends on the type of grain, the type of meat, the location of production, but the number is fairly huge in its impact.

If I have a good year, with lots of companies calling me for help with their business plans, I don’t consume more calories. I might spend more on filet mignon and less on hamburger. But I’m not the guy who’s moving the market. Go to India, China, Indonesia. There are many millions of people moving from poverty into the middle class, or what is the middle class in their context. With higher incomes they are spending more on food. In some cases they are adding calories, but in many cases they are shifting from grains and vegetables to add chicken, pork and beef to their diets.

Let’s say that a family on a path from poverty to middle class has increased it’s  income by five percent (inflation-adjusted). They would typically increase food spending by about four percent. A large portion of that four percent gain would go for more meat. And meat has that 10-to-1 ratio of grain demands. Our newly middle class family may be spending only four percent more on food, but it could have triggered a 40 percent increase in demand for grains.

We all know that the world is getting richer, but the numbers are pretty dramatic. One estimate shows the middle class around the world increased by 700 million people from 2000 through 2006. That’s huge. The global recession obviously reversed the trend temporarily, but further global growth will push middle class numbers up by another billion or so people.  That’s a lot more meat to be consumed and an incredibly larger demand for grain.

Unless you believe that the emerging countries are going to turn around and head back to the stone age, you have to believe that demand for grain will rise disproportionately. But what about supply?

Agricultural supply improvement has been the dominant trend for centuries. The green revolution in the 1950s and ‘60s is a big part of the story, but the dismantling of communal farming is also hugely important. When Deng Xiaoping allowed Chinese communal farmers to divvy up their land into family plots, incomes quadrupled in less than a generation. That more than anything else set up China for rapid economic development. How much farther can productivity increase? In the Western world, productivity will increase as seeds and fertilizers and farming methods improve. That’s a slow process when the farm is already at the cutting edge of productivity. It’s much easier to boost output when your current methods are antiquated. So the real question is how much yields can grow in the emerging countries.

Already China’s output per hectare (the metric unit of area measurement) is higher than the United States’s output. That may be partly due to climate and soil, but cheap labor plays a major role. When labor is cheap, each weed can be pulled by hand.  As labor gets more expensive, farming methods will become a little less productive on a per-hectare basis (though far more productive on a per-person basis). Rising labor costs are already challenging manufacturers in China. Challenges for farmers will be next.

In short, I doubt that global agricultural production will keep pace with the demand that will occur at current price levels. So prices will rise.  Not every single year, but on average over the next couple of decades, look for higher and higher grain prices.

Livestock, in contrast to crop farming, is a business about margins. Selling prices will rise, as will the cost of buying grain to feed the animals. On average, livestock will be an OK business, but it will not benefit as dramatically as grain production.

Does anyone else see this coming?  Certainly they do, though perhaps not in full detail. The Kansas City Federal Reserve Bank says that farmland values in their area have risen by 25 percent in the past year. Other areas of the country are showing similar gains.

At a recent meeting with Midwestern farmers I was continually asked if farm land was a bubble, like tech stocks or other forms of real estate had been. Maybe this past year’s increase had elements of a bubble. I think a great deal of buying was by mature farmers who had enjoyed several good years. They were investing their profits in the asset they knew best—farm land. A true bubble would include more buying by non-farmers, including institutional investors and city-based speculators. Over the long run, there’s no doubt in my mind that grain prices will be rising, justifying further increases in the value of highly productive farmland.