Wednesday, September 26, 2012

Escalating Agricultural Prices in China

There is an upward spiral of prices in China that is hard to stop due to the intertwining of different commodity prices, government policy and institutional constraints.

A short article originating from a local grain bureau in Hubei Province calls for a big boost in the wheat support price of 12 to 15 percent. The article is apparently written to influence the decision on the wheat support price, which is typically announced in late September, ahead of fall wheat planting. Setting prices has always been difficult for Chinese officials and often has had unintended consequences. But the process is even more complex now.
The writer of the article observes that the time for farmers to decide on their plantings of winter wheat is not far off and worries that farmers don’t have much motivation to plant wheat since profits have been low for several years. Rising wages and input costs make wheat production less attractive. The writer says that a survey of 200 farmers in Henan Province found that average returns to wheat from 2010 to 2012 were just 14 percent of what a farmer can earn in a month working off-farm.  Returns rose slightly in 2012, but farmers found that nearly half of the extra income from higher prices was consumed by higher input costs. He asserts that wheat prices need to be increased to keep wheat profitable in the face of rising production costs--the cost of inputs and the opportunity cost of labor (off-farm wages).

The prices of other commodities affect wheat. The writer points out that returns from planting rice are three times higher than the returns from wheat. A higher wheat price is necessary to induce farmers to plant wheat instead of rice.

The writer then argues that wheat prices are too low on the demand side because feed manufacturers are using large amounts of wheat for animal feed. The reason for this is that Chinese corn prices are higher than wheat prices. The writer attributes this to a tight international corn market due to “natural disasters” and biofuels (in the United States) which increase the cost of importing corn. With corn prices higher than wheat, the perverse result is that wheat produced to provide “food security” for Chinese people is used to feed animals.
Chinese agriculture used to be a compartmentalized sector of vast numbers of peasants confined to villages with small plots of land where they had no choice but to plant grains using their own seeds, manure, family labor, water buffalo and oxen. As agriculture has “modernized” and globalized over the past 10 years, the prices of petroleum and other industrial inputs began to influence the production costs of farmers.  Jobs in factories and construction sites and good roads make it easy to quit farming. Urban lifestyles mean more consumption of meat and processed food which means more demand for corn and not so much for wheat. Meanwhile, expanding the size of farms--the usual adjustment mechanism for reducing per-unit costs and raising farm income—is constrained by land policies. China’s price policy for farm commodities is to set floor prices that guarantee farmers no downside risk.

The result is a tendency for all prices to go up, never down. And the intertwining of prices means that one price increase leads to another. Thus, ever-escalating prices.

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