Pricey food and New Zealand: Net and distributional issues

I have been crawling closer to writing about food prices for a while.  Originally I was going to only write about distributional issues, but now I’m going to write a little more.

A report released by NZIER yesterday afternoon suggested that New Zealand would be worse off, as a whole, if the relative price of commodities stayed high.  In truth, this result seems like an unlikely counterfactual to me in the current situation (even in the long-term) but the difference would likely stem from some of our implicit assumptions regarding the drivers of higher food prices – and as a result the net income effect and the change in domestic capacity.

However, it is not just people within New Zealand that are concerned, both Matt Yglesias, VoxEU, and the Economist are bemoaning high food prices.  To get an idea of the issues lets split ourselves into three sections:  1) short-term impact of current high food prices, 2) distributional impact of these prices in the short term (this is just for NZ, as it is an important point),  3) long-term impact of high food prices – and what it means if the relative price does stay higher.

The short-term leap

A mix of recovering world demand and poor growing conditions in many areas of the world has driven a jump in food prices.  Here we have two factors – demand and supply – working together to push prices up.

Now, if we look at New Zealand we have had a touch of a drought here – volumes will be a stoke lower then they would have been under our best conditions.  But, this is nothing like the situation we had at the start of 2008.

As a result, we are still on track to export much more food than we import.

The rest of the world suddenly values these things we are willing to sell a lot more then they did before.  Partially this is the result of a growing middle class through Asia and rising demand for “protein” (read meat and dairy products).  Also, this is partially the result of other places struggling to produce given adverse weather conditions.  Both these factors increase demand for New Zealand products – and as a result up bumps the price of what we sell overseas.

In fact, people are willing to give us more flat screen TV’s, more vacuum cleaners, and more copies of Time magazine for the same number of commodities – this suggests that in “net” terms there will be more income in our economy.

But there are distributional issues

Of course, an economy isn’t the be all and end all.  Inside an economy we have food importers and food exporters.  I know for a fact that, given my dinner last night, I am a food importer.  As a result, relatively higher food prices will likely sting me.

However, broadening the outlook, I know I provide services to groups who may be net food exporters – as a result, the underlying willingness to pay for my service may be higher, increasing my income.

Furthermore, a higher terms of trade pushes up the value of the New Zealand dollar – conveniently passing on some of the gains to us food importing types within the country.

In net terms, food exporters will benefit, while the impact for us food importers is more ambiguous – in fact, in the very short term many NZer’s will suffer from higher food prices.

The long-term:  Food scarcity

So food prices stay relatively higher than the price of other goods in the long-term.  In the long-term there is no real talk about demand, our focus is supply/capacity and/or scarcity relative to other goods and services.

If prices are staying relatively higher it is because the relative value people place on food compared to other goods is higher than it was.  To understand how this impacts upon New Zealand we have to ask what is driving this, is it:

  1. Because the globe is becoming relatively better at producing non-food goods and services than food goods and services (productivity increase in non-food areas)
  2. Because societies ability to produce food per person is lower than it was (rising scarcity of food)

In the first case global incomes are rising and the relative value of food is rising – win-win for New Zealand.  In this case our relative and absolute incomes are better off as a result of the long-term shock that drives relative food prices up!

In the second case things are not as clear.

Say that the population is steady, but the ability to make food fell in ALL countries (think of a jump in input costs, such as fuel and fertilizer – or a generic decline in global growing conditions).  In this case, we can’t make as much and neither can anyone else – this scenario isn’t pretty.  The negative “supply” shock on NZ would hurt, but if we remain a net exporter the fact that relative scarcity has risen overseas would help us out.  As a small open economy, we could sell our residual at these higher prices helping to dull the pain.

If the negative shock fell outside of NZ, suddenly things aren’t as bad.  We have the capacity to produce food, other people want said food.  We are still the residual claimant in the market and so we sell off all the food we produce at these higher prices – which implies of course that we are getting more DVD’s for the same amount of milk powder.  Much of the rest of the world is worse off, global income is lower, but given that “relative prices” of our exports are higher and our domestic capacity is completely unaffected we are better off in these terms.

However, we are only better off in absolute terms if the drop in income overseas doesn’t lead to an even greater drop in the relative price (and return) from the non-food things we sell – given our exposure to tourism this isn’t necessarily a given.

One thing we can conclude in this case is that we will do relatively better off in the face of “food scarcity”, but given that the global pie is smaller this doesn’t mean that we will be better off relative to the case where this elevated level of scarcity exists.

Conclusion

Given that I view capacity as the binding constraint on commodity exports, and given that I view part of the reason for higher long-term prices as productivity driven (and also part as the result of external scarcity), I see the increase in food prices as a net benefit for NZ.

Of course, there are distributional concerns that should be kept in mind.

And finally, I don’t believe the forecasts from the OECD et al that (relative) commodity prices will stay this high for a decade – I don’t believe the food scarcity argument at present.

  • Miguel Sanchez

    “the difference would likely stem from some of our implicit assumptions regarding the drivers of higher food prices”

    That’s a hell of an understatement. The difference stems from the fact that they took what has clearly been a DEMAND shock, modelled it as a SUPPLY shock, and came to some ‘forecasts’ that – surprise surprise – are the complete opposite of what has actually happened.

    This is the same organisation that just last month put out a report showing that high dairy prices are a huge net benefit to New Zealand. Oh, but that can’t be credible because they were PAID to come to that conclusion.

  • @Miguel Sanchez

    My impression is that they are saying that the relative price of food is higher in the long-run – and that this is the result of a global negative supply shock. The counterfactual in their case is when the relative price of food does not rise – so that there is no resource scarcity increase. An appropriate shock to cause this could be a permanent lift in input costs (fertilizer and fuel), or permanently poorer growing conditions.

    The counterfactual isn’t realistic – but the question I think they are answering is “if we are facing resource limits what is the welfare loss compared to the case when we don’t face these limits”.

    Now, I don’t believe this situation – but it is the situation they appear to have modeled to explain “long-run higher prices”. Furthermore, I don’t think the exact driver of this was made particularly clear in the release – it was a bit of a stretch to say it was high prices hurting NZ, when the prices are only a symptom of the underlying resource scarcity that was being modeled.

    As a result, in this post I tried to break down the different issues and drivers using simple supply and demand – hoping to make it clear “why” their result came to be, and ultimately “why” my outlook, without any access to a CGE model, may differ.

    I find the mention of a 25% fall in milk and dairy volume exports in the counterfactual strange – as in the long-run this must be due to domestic capacity falling (small open economy). That really drills home to me the fact that they MUST be looking at a long-run supply shock explanation.

  • @Miguel Sanchez
    I worked on the dairy piece produced by NZIER and it was modelled as a positive export demand shock. I don’t think the outcome of that modelling would surprise any economist so I’m not sure why you’re insinuating that NZIER ‘fixed’ the results. You, Matt and I all have paying clients in our professional work and I’m sure we’d all claim that the client doesn’t influence the results.

  • Miguel Sanchez

    “I find the mention of a 25% fall in milk and dairy volume exports in the counterfactual strange”

    Yes, you’d think that might have rung some alarm bells…

    rauparaha: fret not, that last comment was sarcasm. But since you worked on that report, maybe you can explain what kind of quality control this organisation has that allows it to make two such deeply contradictory statements at the same time.

  • @Miguel Sanchez
    Unfortunately, I was not involved in the food price modelling so I can’t shed any light on the differences between the two reports, sorry. I’m sure the authors of that piece would be happy to answer any such queries, though. I haven’t looked but the authors’ names and email addresses are probably on it.

  • @Miguel Sanchez

    As suggested in my previous comment – the reports were discussing two different counterfactuals essentially.

    Note that in the recent release New Zealand performed “relatively” well – but there was an absolute loss relative to the “less scarcity/higher aggregate supply” scenario.

    My impression is that one study was on a demand shock, the other was on a supply shock – so we would expect different results.

    “maybe you can explain what kind of quality control this organisation has that allows it to make two such deeply contradictory statements at the same time”

    Lets try to not let this get too personal, NZIER is a reputable institution that is known to provide robust analysis of economic issues – name calling is a bit unnecessary. Debate on what assumptions seem reasonable is encouraged (I admitted to personally disagreeing on some things), but could we please avoid unnecessary attacking if possible.

  • Miguel Sanchez

    “NZIER is a reputable institution that is known to provide robust analysis of economic issues”

    All the more reason to be asking questions. Look, it’s all very well to model what would happen IF there was a long-lived global supply shock; I don’t think the outcome of that modelling would surprise any economist. But then to title it “High food prices WILL harm the New Zealand economy” (my emphasis), and to insinuate the whole way through that this is a forecast, not just a thought experiment, is a tad shady.

  • @Miguel Sanchez

    “All the more reason to be asking questions”

    Agree 100%, just want to make sure they are questions rather than attacks on the independence of said work is all 😉

    “Look, it’s all very well to model what would happen IF there was a long-lived global supply shock; I don’t think the outcome of that modelling would surprise any economist”

    Agreed.

    “But then to title it “High food prices WILL harm the New Zealand economy” (my emphasis), and to insinuate the whole way through that this is a forecast, not just a thought experiment, is a tad shady.”

    Agreed in terms of the emphasis of the paper. I also felt that the emphasis of the piece was slightly off, and the counterfactual being tested wasn’t clear/could be highly misinterpreted. That was the fact that got me to write the post, to try and clear up the “why”.

    You are right that it isn’t really the higher relative prices hurting the economy, it is the resource scarcity/negative relative supply shock (I use relative as the counterfactual could well assume growing capacity to meet current demand conditions, while the main piece assumes no such growth in supply) that causes said damage. And I suspect that point should have been made clearer – even for a lay audience.

  • Kimble

    Well put Matt. One thing I have always appreciated about this site is the absence of ridiculous name calling.

    Miguel, stop being like Hitler.

  • @Kimble

    BAHAHAHAHAHA, I do love ridiculous sarcasm – I wish there was a specific text format for sarcastic comments. That would be a money spinner … or not.

  • Miguel Sanchez

    I would gladly have you pay me to clarify when I’m being sarcastic.

  • @Miguel Sanchez

    I don’t think I’d pay money – that is where turning this into a money spinner could get difficult.

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