NextBillion - An Initiative of the William Davidson Institute at the University of Michigan

Most of NextBillion’s visitors have heard about the current jump in food prices. These higher prices have already triggered responses locally in the form of riots in countries such as Haiti, Egypt and Bangladesh. The OECD and FAO have recently issued a report predicting that food prices have moved permanently to higher levels compared with past prices (the Financial Times offered an advance of the study’s highlights some time ago). Although the reasons for this trend are beyond the scope of this post I suggest readers who are interested read this article.

In this post, I would like to explore the likely effects of higher food prices on the budgets of Base of the Pyramid consumers. An argument widely heard these days is that such food rises at least might improve the plight of poor farmers in developing countries, however, a recent study (which due to lack of data available includes only 16 countries) from the World Bank claims otherwise.Price increases have a negative effect on urban areas since they are net buyers. In most rural areas, the effects are negative too. The overall impact in rural households is negative since possible benefits depend not on what they produce, but on the net sale of these goods. Often rural households have to acquire other goods for which the price has risen too, so the increased income is more than offset by the other price rises.

Most poor people are net consumers of food, and not net producers.
The only exceptions might be rural Peruvians thanks to high maize prices and rural Vietnamese thanks to high rice prices (although the Vietnamese government has set restrictions on rice exports to keep national prices under control).

At any rate, in every country taken into account by the authors of the study, the poverty rate increases and people who were already poor are made even poorer by high food prices.

According to the Next 4 Billion, the $5 trillion market that the BoP as a whole represents, around 58% of their budget is spent on food. How would the price rises affect their budgets? Firstly, let us assume that people will not cut back on their food shopping and that they will keep buying the same amounts of food regardless the price. BoP consumers are rarely able to avoid expenditures on food regardless? of price changes; that is, they tend to be demand inelastic.

Secondly, for the sake of simplicity, let us assume that every region has one or more staple food, which it will consume most. I will use the rise of the price of these staples as a “guesstimation” of food inflation in this area.

Considering that the prices of wheat, rice and maize have increased (from 2005 to 2007) 70%, 25% and 80% respectively, the BoP food market size would increase around 35% due to price rises. The percentage of BoP budgets spent in food might go from 58% to between 75% and 80% in average.

This figure should be considered by all means as an upper-band approximation, because market buyers will migrate to cheaper alternatives (like the potato) or cut off the luxuries within their diet (such as fresh fruit). National governments will tend to offer help to poor citizens (the first movers are the Inter American Development Bank and the World Bank), and food suppliers will adjust the production of food upwards to profit from the rise in prices (FAO predicts a bumper crop for 2008-2009).

At any rate, the increase in food prices will affect the expense allocation in BoP households. It is difficult to guess how BoP consumers will adjust to this shock. It is likely that depending on the region and particular circumstance of every community spending on housing, energy or transport will be cut in different degrees.

For all our BoP readers working in the field: Have you perceived this shock? If so, how are people adjusting to higher prices? What kind of expenditures are they cutting? How would you suggest these communities to adapt at the local level to this shock?