Food Prices: A boon for producers,
a buffer for consumers

by Z. Ghanem and P. Cross*

Many food prices began to accelerate sharply on global commodity markets in 2007. Then early in 2008, prices took off for basic foodstuffs such as grains and rice, raising the spectre of shortages and triggering hoarding and unrest in many parts of the world. Higher food prices, on top of the rising cost of gasoline, pushed up headline inflation in most countries.

While consumers paid higher prices for some food products, Canada overall stands poised to profit from the current surge in farm prices. As with most commodities, Canada is a net exporter of food and agricultural products, notably grains and livestock. Our trade surplus for agricultural products already posted a record quarterly increase to reach its highest level ever in the first quarter, even before the first seed for this year’s crop was planted. Meanwhile, the cost of food imported by Canada (largely fruit and vegetables, fish, coffee and tea) has fallen, mostly due to the rising exchange rate of the dollar and lower prices on world markets for many foodstuffs other than grains.

This article looks at food prices in Canada, what Canadians buy with their food dollars, whether this food is produced domestically or imported, and what factors determine the prices of food. For the latter, we use the Input/Output (IO) tables to examine in detail how much of each food dollar goes to the farmer and food manufacturer (the primary beneficiaries of commodity price increases) versus other goods and services involved in transporting and selling food to consumers.

Since the focus of this paper is on food prices, as much as possible this paper organizes food products in the same seven major categories as the CPI: namely, meat; fish; dairy (including eggs); fruit; vegetables; bread and cereals; and other foods. For simplicity, sometimes we combine meat and fish as well as fruit and vegetables.

The cost of food in Canada little changed

Overall, consumer prices for food consumed at home in Canada have risen only 1.2% in the 12 months ending in April 2008. This stability was unique compared with most nations. Food prices jumped 7.1% in the EU and 5.9% in the US over the same period. Increases in China were larger at 22% for food, due to blue ear disease in its swine population. Countries in Asia with rice-based diets are experiencing the fastest increase in food costs, as the price of rice doubled early in 2008.¹

Figure 1

In 2007, Canadians spent $75 billion on food and beverages outside of restaurants (including taxes), according to the Income and Expenditure Accounts. The largest share (16.0%) was devoted to meat and fish products. Fruits and vegetables were close behind at 15.6%.² Bread and cereals and dairy products were next at 12% each. ‘Other’ food products account for 18%, including coffee, tea, sugar, fats and oils, many of which are imported.

Figure 2 shows the year-over-year change in consumer prices for these major components in April 2008. First, it is noteworthy that prices have been stable for meat and fish, while they fell for the ‘other’ category, the two largest components of food consumption. Dairy prices, the third largest area of spending, have risen 3.4%. Vegetable prices fell 13% while fruit prices dropped 4%, largely thanks to the stronger dollar (fruit and vegetable prices in the US, by contrast, rose 4.1%). Bread and cereal products (which include pasta and rice) have seen the only significant rise in prices, up 10%.

Figure 2

The recent trend in food prices -- overall stability, but large relative price shifts among its components -- is un­precedented in Canada. The standard deviation of year-over-year price changes for the seven major food groups was 5.51 points in the first four months 2008, the largest on record back to 1986. Moreover, the marked divergence of relative food prices early in 2008 follows on the heels of the smallest standard deviation among prices ever in 2007 (1.44 points).

So just over one-tenth of the food Canadians buy is experiencing notable upward pressure on prices; for most other food and beverages, prices are stable or falling. Not only does this dampen the overall cost of food, but sharp relative price movements also create ample opportunity for consumers to substitute less costly items for bread and cereals.

The importance of substitution by consumers away from higher-priced foods has been significant in the past. While many studies³ show a low elasticity of demand for food when prices change, even low elasticities are magnified when price movements are large. When prices doubled for beef from 1977 to 1979 or for coffee between 1975 and 1977, consumption of these commodities fell (nearly 20% in the case of coffee)⁴. Even relatively small price increases of about 25% for dairy products (1980 to 1982) and fish (1986 to 1988) sparked a drop in demand, while a 7% increase in cereal prices between 1988 and 1991 drove consumption down 4.6%. There is every reason to expect consumers to continue this pattern of switching from higher to lower priced foods in the current price environment.

Figure 3

Lower import prices dampen food costs

Table 1 shows more precisely the domestic and imported shares of the food Canadians buy, using the IO tables. Overall, in excess of 70% of the food on Canadian tables is produced domestically. This includes over 80% of meat and dairy products, partly because supply management practices limit import competition for poultry, dairy and eggs. Bread and cereal products also are largely supplied by Canadian farms and factories (rice is an obvious exception, other than wild rice).

Table 1 Consumer spending on select food components in 2007, excluding taxes

Conversely, imports account for over 40% of all fish and fruit and vegetables purchased in Canada. Imports supply nearly one-third of other food products, notably coffee, tea and some fats (such as olive oil).

Canada’s imports of agricultural products are dominated by fruits and vegetables, particularly in winter months when imports of fresh produce nearly double. Imports of fruit and vegetables totaled $7.3 billion in 2007. Not far behind at $5.4 billion were coffee, tea and sugar, all products that cannot be grown in Canada’s nordic climate. Imports of all these fruits, vegetables and other staples have been trending up in recent years, as lower prices boosted the volume of demand.

Figure 4

The cost of importing food into Canada has fallen 7% from its average in 2002 through the first quarter of 2008, according to International Trade data. The largest price drops among imports were for fresh vegetables (-12%), meat (-10%) and sugar (-15%). These declines were mitigated by coffee, tea and fruit (down only 5%). The cost of some imports even rose (notably corn, after ethanol-fueled demand exploded in 2007), despite the steady appreciation of the loonie since 2002.

Higher export receipts boost trade surplus for food

Despite the constraints of its climate, overall Canada ran a hearty surplus of $9.0 billion in its trade in agricultural and fish products in 2007⁵. This equaled its second highest showing ever, behind only a $10.7 billion surplus in 2001. In the first quarter of 2008, the surplus was on pace to break that all-time high, running at an annual rate of $11.2 billion as higher grain prices had an increasing impact. Canada has large surpluses for grains, meat and fish products, which outweigh deficits for foods which are difficult or impossible to grow here (such as many fruits, vegetables, coffee, tea and sugar, which collectively show a trade deficit of over $4 billion).

Figure 5

Canada’s exports of agricultural products hit a record high of $34.6 billion last year, after hovering around $31 billion since the commodity boom began in 2002. Last year’s increase was driven by grains, which set a record on the strength of a $1.5 billion hike for wheat and canola despite a poor crop on the prairies (the average yield per acre of wheat fell 12% last year). Despite the poor harvest, Canada remained the world’s second largest exporter of wheat, after the US. A 25% increase in crop sales drove farm cash receipts to a record $40.5 billion last year, and they continued to strengthen in the first quarter of 2008.

Since 2002, prices for Canada’s food exports have risen 3%. However, all of the increase was for grains, notably wheat which doubled between 2006 and the first quarter of 2008. Export prices for all other agricultural products have fallen across the board since 2002, notably for fish (-14%) and meat (-21%). The jump in feed costs due to higher grain prices put downward pressure on cattle prices.

The March 2008 seeding intentions survey revealed that prairie farmers plan a 25% expansion in acreage devoted to wheat. This 3.5 million acre increase (an area twice the size of PEI) is partly at the expense of oats and barley, which are mostly used to feed livestock. Intended plantings for canola also hit a high-water mark. One measure of the enthusiasm of prairie farmers to boost grain output is that the amount of land lying fallow in 2008 is at its lowest level since the First World War. The marked increase in seeding by farmers in Canada and around the world in 2008 helps explain why wheat prices recently have retreated from their February high, although they remain well above their 2007 average and twice their 2006 level.

Figure 6

Meanwhile, exports of meat and fish products languished at just under $11 billion. They have never recovered to their peak of $12.6 billion set in 2002, just before the discovery of isolated cases of mad cow disease (BSE) in Alberta led the US to close its border to live cattle shipments from Canada. Exports of live cattle to the US totaled 1.4 million head in 2007, versus the pre-BSE level of 1.7 million in 2002. Hog exports hit a record last year. Meanwhile, high imports of meat led to a slight drop in the overall trade surplus for meat and fish products.

The distribution of the food dollar

Using the IO tables, we can look at which industries contribute to the value-added of every dollar spent on each type of food product. The analysis starts by examining the broad allocation among the primary producers of food (farmers, fisheries and manufacturers), other goods (notably energy) and services.

Producers earned the largest share of final spending for fish, meat and dairy products. Fishermen (not manufacturers) dominate for fresh fish products, garnering 34% of each dollar consumers spent on seafood. Meat and dairy products have almost identical revenue structures: manufacturers receive nearly one-quarter of all revenues, while farmers get just under 15% (probably increased by supply management practices). By contrast, manufacturers and farmers garner only one-third or less of revenues from consumer spending on bread and fruit and vegetables. Most of this goes to manufacturers, as farmers received less than 3%.

Figure 7

Other goods consistently account for about 10% of value-added GDP for food products. This mostly reflects energy products needed to grow, harvest and transport food to consumers. Demand for energy is about equally split between fuels and electricity. Paper and plastic products are the next largest goods used, mostly in packaging. Chemicals (notably fertilizer) and wood are the next two most used manufactured goods made in Canada; the bulk of farm machinery is imported.

Services contributed between half and three-quarters of what consumers buy at the grocery store. The share of services was lowest for fresh fish, dairy products, meat, and soft drinks, at around 50%. Services account for about 60% or more of consumer spending on breads, fruits and vegetables.

Wholesale and retail trade dominate the value-added of services in food. This reflects the cost of warehousing, stocking the shelves, advertising to consumers, and of course profit margins.

Surprisingly, finance and real estate makes a larger contribution than transportation (7.3% versus 5.7%)in producing most food products. This reflects the importance of renting buildings as well as loans to finance day-to-day operations. Transportation is consistently between 5% and 6% of value-added for all food products. The gap between finance and transportation, however, may have narrowed after gasoline prices hit record highs early in 2008.

Business services are just behind transportation inputs for most food industries. These reflect a wide range of services, from engineering designs for the lay-out of stores to concepts for advertising campaigns to legal and computer services for day-to-day operations. Information services (notably telecommunications) are small compared with most other services, but their share of output is still larger than the farmer’s for fruit and vegetables and bread.

The implication of this break-down of value-added by food type is clear. The rapid rise in some food commodity prices (notably grains) affects only a small fraction of what consumers buy. For bread and cereals, the most affected by rising grain prices, the cost of commodities represents less than a tenth of what consumers pay for bread, even factoring in energy costs. This is the lowest share of any of the major food products.

These results are confirmed by simulations with the IO model⁶. This shows that a 10% increase in the price of grain commodities (defined as wheat, barley, corn and other grains and fodder⁷) leads to only a 0.26% rise in overall food prices for consumers. Surprisingly, the largest impact is on poultry (prices rise 1.6%) and eggs (1.0%), reflecting the importance of grain for feeding poultry. Beef and pork prices increase 0.6%. The next largest increases would be for breakfast cereal (0.6%) and bread (0.3%). The larger impact of grain prices on meat relative to bread and cereals partly reflects the higher share of services in producing the latter.

Meanwhile, commodity prices are a larger share of the other foods consumers buy, up to one-third in the case of fresh fish and 15% for meat and dairy products. But prices for these goods are not experiencing the shortages and price spikes currently seen for grains and rice. This will further insulate consumers from the surge in grain prices, and give them alternatives to buy at the grocery store to cushion the inevitable price increases for bread.

Conclusion

Canada is uniquely positioned to weather the storm of sharply-rising prices for grains and rice. While consumers face higher prices for some products, they have been insulated at the check-out counter from higher overall grocery bills by stable or falling prices for most other products. The absence of price increases for these other food products reflects factors such as the lower cost of food imports after the exchange rate appreciated and the relatively small role that commodities play in what consumers buy. For most food products, services contribute the bulk of the value-added for food that consumers buy. As well, sharp relative price shifts give consumers ample room to adapt by substituting lower-priced foods.

From a broader perspective, Canada overall stands to gain from the agricultural price shock. Already, Canada’s surplus in agricultural trade is on track for a record high in 2008. Moreover, farmers have stepped up their planting this year, especially of higher-priced crops. Besides directly increasing the value of agricultural output and the trade surplus, the boom down on the farm will indirectly benefit a wide range of suppliers, from machinery to transportation, financial and business services.

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Notes