Steve McCorriston, Professor of Agricultural Economics, explains the factors behind food inflation and argues that, unlike previous crises, the cost of living is unlikely to return to previous levels.
6 October 2022As everyone is aware, we are facing a cost of living crisis in the UK.
Energy bills and food inflation are rocketing. Food inflation was 12.4% in September 2022, and with imported goods counting for 40% of food consumption, the UK’s vulnerability to events on world markets is clear.
Each commodity crisis has unique features. With the current crisis, prices in supermarkets may not return to lower levels anytime soon.
The immediate crisis demands responses from government and business leaders, but also raises a crucial question: how we can protect the UK’s food security long-term?
A range of factors usually combine to lead to spikes in commodity markets.
This was seen in the major commodity crisis of 1972-74 when commodity prices came as a significant shock to the world economy. This had its roots in a number of factors such as the breakdown of the post-war Bretton Woods system, the floating of the US dollar, the exercise of cartel power by OPEC, as well as the Arab-Israeli conflict.
A ‘perfect storm’ of factors also underpinned events in the late 2000s. Low global stocks of key commodities, bad weather, export bans and oil price rises meant that a large proportion of US agricultural land was used for energy not food.
The primary cause of the rise in world market prices is the Russia-Ukraine conflict.
Both countries are major players in commodity markets. They are significant exporters of natural gas, phosphates and many agricultural commodities such as cereals and oilseeds.
Fossil fuel prices matter for food prices as they influence costs at all stages of food production and distribution. Oil matters for transportation; natural gas prices raise, for example, the price of refrigeration; fertilizer prices increase costs for farmers.
World prices were already rising prior to the recent conflict, largely reflecting the impact on commodity markets as economies started to recover following the global pandemic.
Furthermore, other countries concerned with their own food security have imposed export bans, leading to raised prices.
The most obvious factor that would relieve pressure on world prices of energy and food would be some resolution to the Russia-Ukraine conflict.
But even if this happened, it’s likely that there would still be upward pressure on prices and inflation in the UK. There are several factors that suggest that the current crisis could have a prolonged impact even if the war came to an end.
Production capacity will take time to recover given the damage to infrastructure and issues such as the clearing of mines in fields and ports. These issues would also not necessarily coincide with the planting season.
Many commodities are traded under contract and food prices would not necessarily fall as quickly as world commodity prices even if they did fall. Research has shown that shocks take several months to work their way through the food chain so that the impact of the shocks becomes somewhat embedded in the system, even if we did observe falling prices on world markets.
While all countries are affected, the UK has been impacted by extreme weather both at home and globally, which also impacts the price of raw commodities.
Sterling is weak at present and almost at parity with the US dollar. The exchange rate is a significant driver of retail food prices and the low level of sterling will continue to add upward pressure on food prices on supermarket shelves.
The government has taken some steps to ameliorate the impact on households, such as reducing tax and dealing with energy bills, but this will only go part-way to alleviating the impact on households.
The way in which the Bank of England addresses high inflation and aims towards hitting its inflation target of 2% will also increase pressure on households.
High inflation is also reducing the real value of employees’ wages and therefore increasing demands for wage increases to offset rising prices. These issues are being reflected in strikes, with more threatened across many sectors in the coming months.
While rising food prices affect all households (particularly if there is pressure on household budgets as a whole), poorer households that spend a larger proportion of their household budgets on food will be particularly impacted.
Different businesses will be impacted in different ways. Some may be able to sit it out; others may find it difficult to survive. The government may offer some help directed at businesses. There will also be pressure on wages as workers will want to maintain the real value of their take-home pay.
The UK’s short-term vulnerability highlights the need to have a far-reaching discussion about food security in the longer term.
There will be even greater pressures on global food supplies as the world population expands. Climate change will likely reduce yields and increase the frequency of extreme weather events. Moreover, in efforts to reduce emissions (agriculture contributes significantly to climate damage), the UK government may aim for a carbon-neutral agricultural sector.
The good news is that research is providing important insights that will play a part in formulating an appropriate response to this question.
I, and a team of colleagues at the University of Exeter, have developed an econometric framework that allows the Department for the Environment, Food and Rural Affairs (Defra) to analyse the domestic and global determinants of UK food prices.
The framework is set up to address a wide range of questions: for example, what would happen to UK food prices if sterling rose by 10%? What would we expect to happen to the prices consumers pay for food in supermarkets if world agricultural prices returned to the levels experienced before Covid?
This has become the major tool for Defra to deal with food and world commodity price issues that has been used to advise senior ministers and the Secretary of State. This framework has also been used to advise and inform other government departments across Whitehall, including HM Treasury.
Over the next few months, we will also be focusing on how different households respond to these shocks. What is it that households cut back on when they cut back? Do they buy less healthy food? Do they alter their shopping patterns and what supermarket chains do they visit? Does this vary across household types and does it vary regionally: is the response by households in the South East of England different from Scotland?
Our work is also investigating how climate events pass through the food system to consumers. We have found that it is often businesses in supply chains that take the hit from such events. We label this issue as the role of the ‘missing middle’, as it highlights the role of firms that constitute the food chain.
Professor Steve McCorriston
is Professor of Agricultural Economics at the University of Exeter Business School.
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