Structural Determinants of Agricultural Prices

Real agricultural price trends are powerfully influenced by structural factors, and these factors in turn place limits on the extent to which policies can influence the sector's prices. The balance of supply and demand is the most obvious of these factors. For products oriented toward the domestic market, a poor harvest almost invariably leads to a increase in real agricultural prices. Abstracting from such short-run fluctuations, which tend to even out over time, the longer-run price trend is influenced by trends in supply growth relative to real demand growth. The responsiveness of food demand to income growth (income elasticity of food demand), for all households and food products taken together, tends to be consistent across countries at values in the range of 0.6 to 0.7. This implies that, in a highly simplified economy with no foreign trade in food products, aggregate real income growth in the economy of 5 % would generate demand for growth in food production of 3% to 3.5%. Faster growth in food production would tend to depress real agricultural prices and slower growth would tend to push them up.4

This relationship is altered when imports can compensate for shortfalls in production and exports can provide an outlet for excess supply,

3. Different definitions of price indexes and their interpretations are reviewed more fully in the author's Policy Analysis for Food and Agricultural Development: Basic Data Series and Their Uses, Training Materials for Agricultural Planning No. 14, Food and Agriculture Organization of the United Nations, Rome, 1988.

4. This illustration is also simplified in other ways. Among other considerations, the demand for food will grow as a function of increases in per capita incomes and population, expressed as separate variables, and the relevant concept of income for this kind of projection is not GDP but rather something closer to national income.

although not all staple foods are readily importable or exportable. Exports allow agriculture to grow significantly faster than the limits imposed by growth of domestic demand alone. When trade possibilities exist, international transport and handling costs will establish a gap between the fob export price and the cif import price of any commodity in a given country - a range within which domestic supply and demand and policy measures may influence prices.

The existence of international trading options subjects domestic prices to another structural factor: the influence of trends in world market prices. In most periods in this century, owing to consistent agricultural productivity growth on a world scale, international agricultural prices have not kept up with prices of industrial goods. They have declined in real terms. Binswanger et al. found that real international agricultural prices declined by 0.5 to 0.7% per year from 1900 to 1984.5 Independently of domestic policies, these trends have tended to depress real agricultural prices within each country. In addition to this factor, agricultural subsidies in developed economies have lowered the prices of their agricultural exports to poorer countries, thereby affecting world market prices considerably, as discussed in Chapter 3.

In summary, three important structural factors influence the trends in domestic real agricultural prices in all economies: the trends in domestic supply and demand, the secular, or long-run, trends in international prices, and the presence of subsidized exports in world markets. Notwithstanding the influence of these factors, domestic economic policy also has an influence on real agricultural prices, through both macroeconomic and sectoral instruments. The most important macroeconomic policy influences on real prices at the sectoral level are tariff and trade policy, exchange rate policy and fiscal policy. Each is discussed below in turn.

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