4 - Declining real prices of grains: Causes and implications
In the media people occasionally talk about the real underlying rate of inflation or real interest rates. Hardly ever heard is the term the real price of grain. Is there a real price of grain? If so, what does it mean and does it change?
A real price is typically the actual price (also called nominal price) adjusted for general inflation. So if the actual price of wheat is USD190 per tonne and remains so for a couple of years, yet the annual average rate of general price inflation is 2% per year, then after two years the real price of wheat (i.e. adjusted for inflation) is USD182.6 per tonne. This real price is determined by this formula:
So, in this example the actual price of wheat was constant but its real price declined due to the impact of general price inflation.
When we look back through history what has happened to the real price of wheat? As this chart shows, the real price of wheat, at least in Australia, has declined at around 2.1% per annum. So, in real terms, farmers have been getting 2.1% less each year, on average, for each tonne of wheat they sell. Why? And why aren’t lots of farmers going broke if they keep on getting lower real prices?
Causes of the decline in real prices of grain
There are a few reasons for the decline in real prices of grain. Firstly agricultural scientists, plant breeders and engineers are constantly finding ways of producing more grain from existing or fewer resources. Grain yields are trending upwards, so farmers have more grain to harvest and sell off each field. Also, the real prices of some inputs required for grain production are, like real wheat prices, displaying a declining trend. Then, beyond the farm-gate, improvements in road, rail, storage and port infrastructure help lower the real cost of moving grain onto ships and thereby help lower the real price of grain.
If the real price of grain is falling, does it follow that the profitability of grain production is also falling and that many farmers face bankruptcy? Over the last few decades it cannot be said that insolvency has plagued grain production in Australia. Rather, grain production has been shown to often be a worthwhile investment in Australia. If you consider a simplistic profit equation for a field of grain, it is
Scientists and engineers are helping increase grain yields, whilst improving the efficiency of inputs, and consequently real prices of grain and some key inputs are declining. The net effect of these changes is usually for real profit to be constant or to decline slightly. Noting that modern technologies allow farmers to manage many more crop fields than was possible for their grandparents, it follows that, even if the real profit from each field is declining, summing the profits across all the fields causes the modern farmer to be wealthier than their grandparents. In short, even though the real grain price may be declining, and even if real profit from each field may be slightly declining, farm businesses are able to maintain or improve their overall farm profitability by owning, renting or leasing more fields.
Implications of the decline in real prices of grain
There are implications beyond the farm of the decline in the real price of grain. A decline in the real price of a grain means that consumers can either afford to purchase more of that grain, as its real cost is less, or consumers can maintain the same quantity of grain purchases and use more of their income to spend on other items. Many grains like wheat are known as a food staples so their direct consumption, especially in higher income countries like Australia, tends to not greatly increase if (in real terms) the grain becomes cheaper.
However, when the grain is a feed ingredient in animal production (e.g. chicken meat) then these products can be produced more cheaply and become more affordable to consumers. As a result, consumers increase their consumption of these meat products that partially rely on feed grains. Hence, a decline in the real price of a grain, where that grain can also serve as an animal feed, makes other products that rely on that feed to be more affordable and so their consumption increases.
The end result of the declining real price of grains is that consumers tend to be able to have more diverse diets, consuming more meat and dairy products, and eating more elaborately transformed grain products such as cakes, pastries, artisan breads and grain-based snack foods, such as those shown below.
The greater range of goods that consumers can afford provides more commercial opportunities beyond the farm in the food and retail sectors. As value-adding opportunities increase beyond the farm it is important to align farm production, wherever possible, to share in these opportunities. Participating in these value-adding opportunities can occur in a variety of ways including:
(i) Equity partnerships in post-farm gate activity.
(ii) Closed loop marketing arrangements.
(iii) Special quality segregations.
(iv) Developing varieties with uniquely valued traits.
(v) Using production processes that generate price premiums.
(vi) Educating end-users about the valuable traits of a particular grain, class or variety of grain.
The Australian Export Grains Innovation Centre (AEGIC) exists to increase value in the Australian grains industry. At AEGIC, we are very aware of how the real price of grain affects growers’ incomes and generates commercial opportunities beyond the farm. AEGIC is constantly engaged in finding ways to improve the profits of grain growers and lift revenues in the wider grains industry beyond the farm gate.