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USDA Report - Corn Prices and Rising Food Costs
By Ephraim Leibtag
Summary
Higher corn prices increase animal
feed and ingredient costs for farmers and food manufacturers, but
pass through to retail prices at a rate less than 10 percent of
the corn price change
Given that foods using corn as an ingredient make
up less than a third of retail food spending, overall retail food
prices would rise less than 1 percentage point per year above the
normal rate of food price inflation when corn prices increase by
50 percent.
Even this increase may be partially tempered by
changes to corn use in food production.
Background
Record U.S. trade driven by economic growth in developing countries
and favorable exchange rates, combined with tight global grain supplies,
resulted in record or near-record prices for corn, soybeans, and
other food and feed grains in 2007. For corn, these factors, along
with increased demand for ethanol, helped push prices from under
$2 per bushel in 2005 to $3.40 per bushel in 2007. By the end of
the 2006/07 crop year, over 2 billion bushels of corn (19 percent
of the harvested crop) were used to produce ethanol, a 30-percent
increase from the previous year. Higher corn prices motivated farmers
to increase corn acreage at the expense of other crops, such as
soybeans and cotton, raising their prices as well.
What effect do these higher commodity costs have
on retail food prices? In general, retail food prices are much less
volatile than farm-level prices and tend to rise by a fraction of
the change in farm prices. The magnitude of response depends on
both the retailing costs beyond the raw food ingredients and the
nature of competition in retail food markets. Ethanol’s impact
on retail food prices depends on how long the increased demand for
corn drives up farm corn prices and the extent to which higher corn
prices are passed through to retail. ERS research has traced the
effect of higher corn prices on U.S. retail food prices by analyzing
data on price trends and price response of corn-dependent foods
to cost changes.
Retail Competition Moderates Food Price
Inflation
Retail food prices adjust as the cost of inputs into retail food
production change and the competitive environment in a given market
evolves. Strong competition among three to five retail store chains
in most U.S. markets has had a moderating effect on food price inflation.
Overall, retail food prices have been relatively stable over the
past 20 years, with prices increasing an average of 3.0 percent
per year from 1987 through 2007, just below the overall rate of
inflation. The main exception occurred when sharply higher farm
prices increased retail prices 5.8 percent in 1989 and 1990. Since
then, food price inflation has averaged just 2.5 percent per year.
Retail prices
are a function of both consumer demand and the interaction between
food manufacturers, distributors, and retailers, with each group
having some pricing power in the supply chain. Ultimately, though,
the retailer has a more complicated pricing decision since it is
selling a wider variety of products to a more diverse consumer clientele
than most manufacturers or distributors. The challenge for the food
retailer is to determine how best to distribute the costs of providing
both food and services to consumers across a wide range of products.
This pricing challenge removes some of the direct connection between
the costs of a given product and the retail price charged.
When there are
cost shocks in the food production system due to changes in the
commodity or farm product market, most retailers respond by passing
on a fraction of their higher costs to consumers. Among factors
affecting this pass-through rate is the level of processing and
value-added services that take place between the farmgate and the
grocery store aisle. Products that require more processing and packaging
are usually less directly linked to changes in farm prices, while
the price of less processed foods more closely follows the changes
in farm prices. For example, changes in farm prices for eggs, fresh
fruit, and fresh vegetables show up in more volatile retail prices
for these less processed foods. The price volatility of pork and
beef is also above the average for all foods. The other food categories
average between 2.3 and 3.4 percent in price change per year.
Higher
Farm Corn Prices, Slightly Higher Food Prices
Field corn is the predominant corn type grown in the U.S., and it
is primarily used for animal feed. Currently, less than 10 percent
of the U.S. field corn crop is used for direct domestic human consumption
in corn-based foods such as corn meal, corn starch, and corn flakes,
while the remainder is used for animal feed, exports, ethanol production,
seed, and industrial uses. Sweet corn, both white and yellow, is
usually consumed as immature whole-kernel corn by humans and also
as an ingredient in other corn-based foods, but makes up only about
1 percent of total U.S. corn production.
Since U.S. ethanol
production uses field corn, the most direct impact of increased
ethanol production should be on field corn prices and on the price
of food products based on field corn. However, even for those products
heavily based on field corn, the effect of rising corn prices is
dampened by other market factors. For example, an 18-ounce box of
corn flakes contains about 12.9 ounces of milled field corn. When
field corn is priced at $2.28 per bushel (the 20-year average),
the actual value of corn represented in the box of corn flakes is
about 3.3 cents (1 bushel = 56 pounds). (The remainder is packaging,
processing, advertising, transportation, and other costs.) At $3.40
per bushel, the average price in 2007, the value is about 4.9 cents.
The 49-percent increase in corn prices would be expected to raise
the price of a box of corn flakes by about 1.6 cents, or 0.5 percent,
assuming no other cost increases.
In 1985, Coca-Cola
shifted from sugar to corn syrup in most of its U.S.-produced soda,
and many other beverage makers followed suit. Currently, about 4.1
percent of U.S.-produced corn is made into high-fructose corn syrup.
A 2-liter bottle of soda contains about 15 ounces of corn in the
form of high-fructose corn syrup. At $3.40 per bushel, the actual
value of corn represented is 5.7 cents, compared with 3.8 cents
when corn is priced at $2.28 per bushel. Assuming no other cost
increases, the higher corn price in 2007 would be expected to raise
soda prices by 1.9 cents per 2-liter bottle, or 1 percent. These
are notable changes in terms of price measurement and inflation,
but relatively minor changes in the average household food budget.
Impacts
Extend to Meats Through Higher Feed Costs
Given that livestock feed rations traditionally contain a large
amount of corn, a bigger impact would be expected in meat and poultry
prices due to higher feed costs than in other food products. Currently,
about 55 percent of corn produced in the U.S. is used as animal
feed for livestock and poultry. However, estimating the actual corn
used as feed to produce retail meat is a complicated calculation.
Livestock producers have many options when deciding how much corn
to include in a feed ration. For example, at one extreme, grass-fed
cattle consume no corn, while other cattle may have a diet consisting
primarily of corn. For hog and poultry producers, ration variations
may be less extreme, but can still vary quite a bit. To estimate
the impact of higher corn prices on retail meat prices, it is necessary
to make a series of assumptions about feeding practices and grain
conversion rates from animal to final retail meat products. To avoid
downplaying potential impacts, this analysis uses upper-bound conversion
estimates of 7 pounds of corn to produce 1 pound of beef, 6.5 pounds
of corn to produce 1 pound of pork, and 2.6 pounds of corn to produce
1 pound of chicken.
Using these
ratios and data from the Bureau of Labor Statistics, a simple pass-through
model provides estimates of the expected increase in meat prices
given the higher corn prices. The logic of this model is illustrated
by an example using chicken prices. Over the past 20 years, the
average price of a bushel of corn in the U.S. has been $2.28, implying
that a pound of chicken at the retail level uses 8 cents worth of
corn, or about 4 percent of the $2.05 average retail price for chicken
breasts. Using the average price of corn for 2007 ($3.40 per bushel)
and assuming producers do not change their animal-feeding practices,
retail chicken prices would rise 5.2 cents, or 2.5 percent. Using
the same corn data, retail beef prices would go up 14 cents per
pound, or 8.7 percent, while pork prices would rise 13 cents per
pound, or 4.1 percent.
These estimates
for meat, poultry, and corn-related foods, however, assume that
the magnitude of the corn price change does not affect the rate
at which cost increases are passed through to retail prices. It
could be the case that corn price fluctuations have little impact
on retail food prices until corn prices rise high enough for a long
enough time to elicit a large price adjustment by food producers
and notably higher retail food prices.
On the other
hand, these estimates may be overstating the effect of corn price
increases on retail food prices since they do not account for potential
substitution by producers from more expensive to less costly inputs.
Such substitution would dampen the effect of higher corn prices
on retail meat prices. Even assuming the upper-bound effects outlined
above, the impact of rising corn commodity prices on overall food
prices is limited. Given that less than a third of retail food contains
corn as a major ingredient, these rising prices for corn-related
products would raise overall U.S. retail food prices less than 1
percentage point per year above the normal rate of inflation.
While higher
commodity costs may have a relatively modest impact on U.S. retail
food prices, there may be a greater effect on retail food prices
in low-income developing countries. As a relatively low-priced food,
grains have historically accounted for a larger share of the diet
in less developed countries. Even with incomes rising, consumers
in such countries consume a less processed diet than is typical
in the U.S. and other industrialized countries, so food prices are
more closely tied to swings in both domestic and global commodity
prices.
Markets
Adjust and Prices Stabilize
Continuing elevated prices for corn will depend on the extent to
which corn remains the most efficient feedstock for ethanol production
and ethanol remains a viable source of alternative energy. Both
of these conditions may change over time as other crops and biomass
are used to produce ethanol and other alternative energy sources
develop.
Even if these
conditions do not change in the near term, market adjustments may
dampen longrun impacts. In 1996, when field corn prices reached
an all-time high of $3.55 per bushel due to drought-related tighter
supplies in the U.S. and strong demand for corn from China and other
parts of Asia, the effect on food prices was short lived. At that
time, retail prices rose for some foods, including pork and poultry,
but these effects did not extend beyond the middle of 1997. For
the most part, food markets adjusted to the higher corn prices and
corn producers increased supply, bringing down price.
Food producers,
manufacturers, and retailers may also adjust to the changing market
conditions by adopting more efficient production methods and improved
technologies to counter higher costs. For example, soft drink manufacturers
may consider substituting sugar for corn syrup as a sweetener if
corn prices remain high, while livestock and poultry producers may
develop alternative feed rations that minimize corn needed for animal
feed. Adjustments by producers, manufacturers, and retailers, along
with continued strong retail competition, imply that U.S. retail
food prices will remain relatively stable.
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