The President spoke this afternoon about high food prices and food aid. If you’d like more detail, here’s our “fact sheet.” And if you really want to dive down deep, here is a transcript of a press briefing done by three senior administration officials after the announcement: OMB Deputy Director Steve McMillin, CEA Chairman Ed Lazear, and Deputy National Security Advisor for International Economic Affairs Dan Price.

I’d like to zoom out a bit and discuss how food prices interact with policy.

Let’s consider the following questions:

  • How much are food prices increasing?
  • Why are food prices increasing?
  • What kind of effect is this having in the U.S., and what are we doing about it?
  • What about overseas effects?
  • What did the President announce today?
  • Is the ethanol mandate contributing to the increase in food prices?

How much are food prices increasing?

Much of the increase in food prices worldwide is due to increases in grain prices. Since March of last year:

  • wheat prices are up 146%
  • soybean prices are up 71%
  • corn prices are up 41%
  • and rice prices are up 29%.

Why are food prices increasing?

  • Increased demand in “emerging markets” (like China) accounts for about 18% of the rise in food prices. As people in poor countries get richer, they consume more meat. Since it takes a lot of grain to produce a little meat, as the proportion of meat in diets increases, the demand for grains increases.
  • Rising energy costs have increased the cost of growing food, accounting for up to another 18% of the increase.
  • Bad weather has harmed wheat harvests, especially in Australia, China, and Eastern Europe.
  • Dollar depreciation accounts for a portion of the increase in U.S. food prices.
  • Increased biofuel production has increased the demand for corn, but accounts for only 3% of the overall increase in global food prices.

What kind of effect is this having in the U.S., and what are we doing about it?

Food price inflation in the U.S. is up 4.5% over the year that ended in March, only slightly faster than the overall inflation rate of 4.0% (CPI). Certain staples are up by greater percentages: milk is up 23% over the same period, bread is up 16%, and eggs are up 35%.

Obviously, this inflation hurts, and family budgets get squeezed. On average, Americans spend about 14% of their total expenditures on food. But grain price increases don’t affect American food prices as much as they do food prices in developing countries, because grain prices are a relatively small portion of total food expenditures in the U.S. About half of all food dollars in the U.S. are spent dining out, and Americans eat more heavily processed food. Service costs (waiters, chefs) and food processing costs account for a large proportion of U.S. food spending.

There are two big federal programs that spend money on food. The U.S. government spends about $40 B a year on food stamps, helping about 28 million people this year. The food stamp program automatically adjusts to food price increases. In addition, the President’s budget proposes some changes to expand the food and vegetables component of food stamps, and to keep savings and combat pay from reducing eligibility for food stamps.

The Women, Infants, and Children (WIC) program will spend about $6 B this year on about 8.6 million people. This year we have increased funding for WIC by more than 18%. And in mid-April we transferred about $150 M from a reserve to account for higher costs in WIC.

What about overseas effects?

Let’s look at Mozambique as an example of a developing country, and compare it to the U.S.

  • Americans spend on average 14% of their total expenditures on food. In Mozambique, it’s 68% for those making under $1 a day.
  • Food prices have increased 4.5% over the past year in the U.S., and 15.4% over the past year in Mozambique.
  • The effect of one year of current food price inflation therefore means that an American has, on average, 0.5% less income to spend on other things. But in Mozambique, one year of current food price inflation squeezes out 10% of their income.

This is why international food experts talk about a food crisis – poor countries are acutely affected by grain price increases.

What did the President announce today?

To address this problem, two weeks ago my administration announced that about $200 million in emergency food aid would be made available through a program at the Agriculture Department called the Emerson Trust. But that’s just the beginning of our efforts. I think more needs to be done, and so today I am calling on Congress to provide an additional $770 million to support food aid and development programs. Together, this amounts to nearly $1 billion in new funds to bolster global food security. And with other food security assistance programs already in place, we’re now projecting to spend nearly — that we will spend nearly $5 billion in 2008 and 2009 to fight global hunger.

This funding will keep our existing emergency food aid programs robust. We have been the leader for providing food to those who are going without in the past, and we will continue to be the leader around the world. It will also allow us to fund agricultural development programs that help farmers in developing countries increase their productivity. And of course this will help reduce the number of people who need emergency food aid in the first place.

In addition, the President reiterated his call on Congress to support his proposal to allow U.S. dollars to be spent in poor countries to buy food from local farmers. This makes U.S. taxpayer dollars go farther to help more people, and it helps develop local agricultural infrastructure. (Teach a man to fish…)

Countries are moving in two different directions in response to higher food prices. Some are moving in the right direction: eliminating tariffs, permitting genetically modified foods, and increasing food assistance for their poor citizens. Others are moving in the wrong direction, restricting exports and imposing price controls on specific goods. These wrongheaded policies ultimately hurt the people who need the food, by restricting efficient trade and causing supply shortages.

Is the ethanol mandate contributing to the increase in food prices?

Right now it is not, because the price of oil is high, and other policies are supporting demand for ethanol. I’ll explain.

  • Increased global demand for biofuels is increasing the price of food, but only a little. Our experts think about 3% of the global food price increase is a result of increased demand for biofuels.
  • Two of three U.S. ethanol policies are contributing to that increase (the subsidy and the import tariff).
  • But the mandate is not now big enough to affect ethanol demand, because oil prices, the ethanol subsidy, and the import tariff together produce more ethanol than the mandate requires.
  • Given other ethanol policies and current market conditions, the ethanol mandate therefore is not affecting the price of corn or other food.

We have three domestic policies that affect ethanol supply and demand: the 51 cent /gallon tax credit (subsidy) for ethanol blended into fuel, the 54 cent /gallon ethanol import tariff, and the renewable fuel standard (RFS) mandate.

Our experts tell us that, given today’s high oil prices, the current RFS mandate is not “binding.” In other words, given the existence of the subsidy and the tariff, fuel blenders would be choosing to buy the same amount of ethanol as they are right now, even if the mandate did not exist. As evidence, the mandate in law is for 9B gallons of ethanol to be blended into fuel this year. But fuel blenders are blending about 9.15 B, more than this year’s mandate. When oil is in the $110-$120 range, and ethanol is subsidized 51 cents/gallon, you don’t need the government to tell you to buy ethanol, you do it because it’s cheaper than blending gasoline. If the subsidy weren’t in place, it would be a different story: the mandate probably would be binding and would be distorting fuel blending decisions. And the mandate could bind in the future, if the price of oil drops substantially, or in future years as the mandate increases. It could then affect the price of corn and other grains. But the President’s action last year, which was to propose an increased mandate, is not increasing the amount of ethanol used this year, and therefore is not now increasing fuel or food prices.

Our experts believe that increased use of corn to produce biofuels in the United States accounts for about 19% of the increase in the global price of corn. That’s 19% of the 41% increase in the price of corn over the last year, meaning that corn prices are about 8% higher in the U.S. as a result of increased domestic demand for ethanol. Corn is obviously only one of many grains, and grains are a subset of food, and food spending also includes food processing costs and the service costs of a waiter and cook if you go out to eat. When our experts combine all these factors, they conclude that increased worldwide use of biofuels has increased food prices by about 3%.

While increased demand for biofuels are responsible for some of the corn price increase, this does not mean that the increased RFS mandate is responsible for the 8% increase. Regular gasoline can contain up to 10% ethanol, and fuel blenders have to make a decision about how much ethanol to substitute for gasoline into a gallon of fuel (between zero and ten percent ethanol). There are two reasons why a blender might substitute more ethanol in place of gasoline:

  1. the RFS mandate in the law requires him to use more ethanol;
  2. or ethanol is less expensive than gasoline.

Let’s look at $116 oil (this morning’s opening price). That’s $116 for a barrel of West Texas Intermediate Crude (WTI), which is the really good stuff. Refiners use a mix of good and not so good stuff, so that on average the price they pay for oil run through their refinery is about $6 a barrel less than the WTI price. A barrel of oil contains 42 gallons, so crude oil costs 110 / 42 = $2.62/gallon. Add in refining, distribution, and marketing costs of roughly 50 cents/gallon to turn oil in to gasoline (it varies a lot), to get about $3.12 per gallon of gasoline, before taxes.

Now let’s turn to ethanol. Corn is currently trading for around $6/bushel. Estimates vary, but the break-even price for corn, which is the price per bushel a blender would be willing to pay to produce a gallon of ethanol and just break even, is currently above this price. This means that a fuel blender has an incentive to substitute ethanol for gasoline, no matter what the government tells him to do. It’s rational for this fuel blender to go all the way up to 10% ethanol in the fuel he sells, the maximum that U.S. vehicles can tolerate without modification.

So yes, increased ethanol usage has made corn about 8% more expensive over the past year. But it has not affected wheat prices, which have recorded the biggest grain price increase. And the higher U.S. ethanol prices right now are driven not by the higher renewable fuels government mandate, but instead by market forces that are looking for alternatives to $100+ oil. In contrast, the ethanol subsidy (51 cents per gallon) and the ethanol import tariff (54 cents per gallon) are subsidizing ethanol production relative to food production. Note that these two policies have been in effect since long before the President took office.

Conclusions

  • World grain prices are up. Way up. Especially for wheat.
  • U.S. food prices are up, but by a lot less, because raw inputs account for much less of our total spending on food.
  • More meat-eating in developing countries, higher energy costs, bad weather, the $, and increased demand for biofuels all contribute to higher food prices.
  • Poor countries are more severely affected by grain price increases than rich countries like the U.S.
  • The President’s recent and new proposals total almost $1 B of new money to bolster food security. When combine with pre-existing plans, the U.S. will spend about $5 B this year and next to fight world hunger.
  • Other nations can make the situation worse by raising protectionist barriers or imposing price controls. Either can cause a supply shortage.
  • Increased demand for biofuels is contributing to the higher price of corn and soybeans, and that is in part attributable to subsidies in U.S. law. But the expanded ethanol mandate (“Renewable Fuel Standard”) has little to no effect on the current ethanol price, because the high world oil price creates a market incentive for fuel blenders to choose ethanol over gasoline.