Unit 1 Micro: Economics of Volatile Corn Prices

Corn is a soft commodity along with the likes of coffee, tea and rubber. Referred to as “yellow gold”, corn is used in products ranging from cereals, snack foods, salad dressings, soft drink sweeteners, chewing gum and peanut butter. Little wonder that shifts in the world price of corn can have a noticeable effect on the prices that we may for many popular foods and drinks.

The world’s appetite for corn is strong. In recent months there has been a surge in the global price of corn, indeed at the end of June 2011, corn prices were up 74 per cent on a year earlier. Super-high prices affect the price of feed for livestock farmers and eventually lead to more expensive foodstuffs for consumers, including millions of people in the world’s poorest countries exposed to persistent and life-shortening food poverty. Robert Zoellick, President of the World Bank has said that high and volatile food prices are “the single gravest threat” facing developing countries at the current time.

The main reason for the strong rise in corn prices has been fast-growing global demand set against restricted supply and falling international stockpiles.

The key to understanding the demand-side of the market for the corn is to focus on demand from three key industries - livestock, ethanol and food processing. World demand for corn has grown at rapid rates in recent years including farmers who use corn as feed in fattening livestock in developing countries. As per capita incomes rise, so does the demand for meat which has a high income elasticity of demand in poorer nations. Consider the example of China which, despite being the second largest producer of corn in the world, has moved from being a net exporter of grains to being a net importer as domestic demand for foodstuffs has soared. China is after the world’s corn and will be for years to come!

Another cause of rising demand has been purchases for corn-based ethanol in the United States and the European Union. Four years ago the United States Congress passed the Energy Independence and Security Act which acted as a green light for producers of alternative energy such as ethanol. The Act requires 15 billion gallons of ethanol be consumed in the United States per year by 2015, irrespective of what has happened to the global price of corn or crude oil. The result in the USA in 2011 is that over a quarter of scarce corn production must be given over to ethanol manufacturing.

Demand seems insensitive to market prices, i.e. there is a low price elasticity of demand. For 2012, despite high prices, world corn consumption is forecast by the US Department for Agriculture to climb to a record 872m tonnes, up 3 per cent from 2011 levels.

To some analysts there has been a permanent increase in global demand for corn not matched by a corresponding outward shift in supply potential in corn-producing nations. The result has been scrambling by buyers to purchase available stocks and an inevitable rise in prices.

The short-term situation has been exaggerated by a year-long ban on grain exports by Russia (only recently lifted) and by speculative buying in soft commodity markets, and there have also been supply problems outside of the USA - grain-producing regions in Russia, Ukraine, Kazakhstan, and South America were hit by drought in 2010.

One interesting aspect of the large rise in price focuses on the incentive effects this has on farmers. Standard economic theory predicts that high prices will eventually bring about an expansion of market supply helping to restore the supply-demand balance. This is known as the cob-web effect.

Consider the United States - a country that produces 40 percent of the world’s corn supplies and accounts for more than half of world corn exports. In the agricultural states of Iowa, Illinois, North Dakota, South Dakota, Minnesota and Montana, will farmers devote more acreage to planting more corn as high prices provide a strong profit-motive to expand production? There is some evidence that they will. In early July, the US Department for Agriculture (USDA) reported from a survey of over 80,000 farmers, evidence that America’s farmers planted 92.3 million acres of corn in 2011, the second-highest figure since 1944. Some farmers have switched away from soybean, the USDA estimated 2011 soybean acreage at 75.2m down from the 77.4m acres planted last year - this is the price mechanism in action.

Global corn prices have fallen back from their June 2011 highs partly because speculators have been selling their futures contracts in the wake of good news on corn harvests and signs that increased corn acreage in 2011 will boost corn stocks over the next year.

Lower prices will bring relief to livestock farmers whose feed costs will drop and they will reduce the input costs of food manufacturers. That said the problems created by high levels of price volatility in this key commodity market are unlikely to go away prompting several developing countries to consider moving themselves into the futures markets for corn to hedge against price uncertainty.