11/12/2012 10:06 EST | Updated 01/12/2013 05:12 EST

Will Food Prices Cost the World Economy?

Volatile commodity prices have wreaked havoc with the world economy in the past decade. This summer saw yet another surge in food prices. It got many wondering whether this time around, the ill-timed increase would apply the brakes to an accelerating world economy. Are they right?

Key to the price surge was the summer drought in the United States, the worst in a half-century. Between June and August corn prices increased by 40 per cent while soybean prices jumped by 33 per cent, reflecting U.S. dominance in agricultural exports.

Wheat prices also lurched ahead by 44 per cent, highlighting adverse weather conditions in traditional breadbasket economies such as Russia, Ukraine, and Kazakhstan, which account for roughly a quarter of the world's wheat exports.

Adding to this price pressure are the demands of the fast-growing emerging market middle-class and ethanol production requirements. Moreover, the USDA forecast for a decline in global year-end stocks for wheat and coarse grain in 2012-13 is hardly comforting markets. The effects of this food price surge are wide-ranging, but also have quite varied impacts on different economies.

In general, developed markets will not be hamstrung by higher food prices. For Canada, the increase will actually boost agricultural exports, lifting the forecast for agri-food export growth to 12 per cent in 2012 and 11 per cent in 2013.

Meanwhile, negative consumer effects will be relatively small. Canadians spend 16 per cent of their overall budget on food, which translates into a modest CPI increase of just 0.3 percentage points for 2013. At the same time, we expect that softer energy prices will mitigate these gains, resulting in consumer inflation that remains well within target. For both the US and Europe, effects are similarly negligible and should not hinder the budding economic recovery.

In contrast, households in emerging markets will be strongly affected. In these markets the food bill can account for anywhere from 25 to 40 per cent of income, causing a price increase to crowd out other spending. It also forces many households to dip into savings, or even run up debts to keep things going.

Higher food prices are a key source of social unrest in emerging markets, as seen in the 2008 food crisis and the Arab Spring in 2011. While September data from the Food and Agriculture Organization indicate that prices seem to have stabilized, further shocks should not be ruled out, as short-term demand pressures persist. Economies that are net food importers or dependent on food subsidies can expect to face increasing near-term pressure.

On the flipside, food producers stand to gain -- first from the pure price effect, but ultimately through increased production. South America is already demonstrating high levels of planting, and is expecting an end-year bumper crop. Higher farm incomes also suggest increased investment in leading-edge agricultural machinery, in turn boosting productivity and yields. As such, Canadian agricultural machinery and equipment exports should rise 22 per cent this year and 12 percent in 2013. Higher production and normal weather conditions suggest a retreat of prices in 2014.

The bottom line? Just as it is gathering some badly-needed momentum, the world economy is weathering higher food prices. Fortunately, this won't hamper momentum in the growth-engine economies of the developed world, and will ultimately suppress prices through higher food output.