Whenever governments act to raise or lower prices for a product, their action affects both buyers and sellers. This is true whether it involves the U.S. or Minnesota trying to raise corn prices or the Brazilian government trying to lower the price of cooking gas. That may seem obvious to those who choose to read an economics column, but it apparently escapes much of the general public.
Willard Cochrane, a retired ag-econ professor from the University of Minnesota, tells a wonderful anecdote illustrating this issue. Cochrane served as agricultural adviser to presidential candidate John Kennedy in 1960. Low farm prices were a problem throughout the 1950s. During the Eisenhower administration, the government had bought up large quantities of wheat, corn and cotton to raise prices, but the storage cost was onerous and the public criticized the program.
Cochrane persuaded Kennedy to advance the idea of simply paying farmers to not grow anything on some fraction of their land. If one wanted to raise farm prices, this was a cheaper and less wasteful way of doing it than simply building up government-owned surpluses. Kennedy laid out this ag plan at a major speech to farmers in the Midwest.
In the question-and-answer period after the speech, a reporter asked Kennedy, “What will this plan do to food prices?” Kennedy referred the question to Cochrane who never was one to suffer fools gently. “Well, hell,” the good professor responded, “it will raise them, of course!” It was as obvious as the fact that the sun rises in the east or that manure flows downhill. But Kennedy’s campaign managers took pains to ensure that too-honest Prof. Cochrane did not have further contact with the media.
A few weeks ago, I criticized U.S. Sen. Norm Coleman’s proposal to establish a “strategic biofuels reserve.” (See Politics fuel proposals for ethanol reserve.)
Coleman responded by arguing that existing ethanol programs add “between 30 and 50 cents per bushel to the price of corn, making little difference in the price consumers pay for breakfast cereal.”
Whether ethanol programs really raise corn prices that much is questionable, but that is not the subject of this column. Rather, is it possible to raise the price of a food input by the 15 percent to 35 percent implied, without raising the price of food products?
Cochrane scorned that idea in 1960. Has anything happened in the intervening 43 years to change the “laws of economics?” The specific example of cornflake prices being unaffected by higher corn prices is possible. The actual cost of grain is a very small component in producing most breakfast cereals. Advertising, transportation and even the box in which the corn flakes are sold all cost more than the actual corn used. At recent Minnesota farm prices, the corn in a 24-ounce box of cornflakes is about 6 cents. If prices would drop by 50 cents per bushel without ethanol, the cost would drop by about a cent and a half.
It is entirely possible that cereal manufacturers might absorb a 1 or 2 cent increase in raw-material cost for a product that sells for more than $3, especially if that increase were offset by lower transport or packaging costs. Coleman may be right on this specific example without disproving Cochran’s general assertion.
But, as congressmen from farm states all know, only an infinitesimal proportion of corn production goes into corn cereals. Much more goes into corn oil and corn sweetener and much, much more into beef, chicken or dairy foods. Humans still eat most U.S. corn production in the form of animal products.
Could any government program significantly raise the price farmers get for corn without raising the cost of margarine, baked goods and beverages containing corn sweetener, steaks, milk, cheese or ice cream?
Here, history and economic analysis clearly show the answer is no.
Higher feed prices eventually get passed on to consumers as higher food prices. That simply is how market economies work. It is not a matter of justice or fairness, but simply the unavoidable outcome of human behavior.
Such market workings introduce a paradoxical element in government efforts to increase corn prices via implicit subsidies for high-fructose corn sweetener and ethanol. These nontraditional uses for corn increase corn utilization and, all other things being equal, raise corn prices.
The financial viability of ethanol and sweetener plants, however, depends on the price of corn staying relatively low over the long run. The high corn prices we experienced in 1995 were the biggest financial blow that many corn-processing plants in the Upper Midwest ever had.
As higher corn use — for corn sweetener, ethanol, or the nonsubsidized corn-based plastics developed by Dow, Cargill and others — succeeds in raising prices, profits thin for plants that produce these products.
© 2003 Edward Lotterman
Chanarambie Consulting, Inc.