The Main Demand and Supply Factors

What have been the main demand and supply factors that have determined the general increase in global food prices over the last four years?

To start with, the prices of major food commodities such as grains and vegetable oils have increased dramatically in recent four years, and to record highs of over 60 percent in the last two years (1: 1). While slower growth in production and rapid growth in demand have been the main reasons for this trend, other factors such as increased global demand for biofuels feedstocks, adverse weather conditions, declining value of the US dollar, rising energy prices, increasing agricultural costs of production, increasing foreign exchange holdings by major food-importing countries, recent policies adopted by some exporting and importing countries to mitigate domestic food price inflation have contributed to the scenario (1: 1). All these factors can be categorised into long term and short term contributing trends.

Long-term Trends

The long-term trends can be broadly described as decreased growth rate of production, global rise in standards of living and decreased grain stocks.

• Growth Rate of Production: Since long time, growth in production has been mainly due to increased average aggregate yield than increase in cultivated area (1: 5). This growth rate averaged 2 percent per year between 1970 and 1990, and later declined to 1.1 percent from 1990 to 2007 (1: 5). Moreover, stable food prices during 1970-90 led to reduced focus on research and development activities by governments to increase productivity (1: 5). Though private parties have been focussing in this regard, their interests have mainly revolved around improving market shares, thereby leading to concentrate on cost-reducing than yield enhancing technological developments (1: 5).
• Global Rise in Standards of Living: During the last decade, economic growth in developing countries has led to increased per capita income of and per capita consumption by respective citizens (1: 7). To be precise, rapid economic growth in China and India, which contain nearly 40 percent of the world’s population, has led to increased demand for agricultural products (1: 7). Also, growing population has further complicated the situation (1: 7).
• Decreased Grain Stocks: Stable food prices in the last two decades, the cost of holding stocks and the short term cost benefits of just-in-time management have led governments and private companies to reduce their grain stocks over the period, though consumption has increased dramatically (1: 13). Consequently, the consumption of grains and oil seeds has increased production since 2000, and led to a plummet in stocks-to-use ratio from 30 percent to a record 15 percent (1: 13). This scenario has made importing countries to be more conscious about acquiring food commodities, leading to dramatic increase in demand (1: 13).

Short-term Trends

The global economic growth has also created an increasing need for energy and a rise in crude oil prices that have led to enhanced focus on biofuels (1: 13&15). This scenario has two consequences in the form of shifting traditional croplands in to biofuel production lands and increased utilization of certain crops for to generate biofuels (1: 13-19). To be precise, corn use in ethanol production in the United States has increased from 1 billion bushels in 2002/03 to 3.1 bushels in 2007/08 amounting up to 25 percent of the total US corn disappearance (1: 15).

Apart from these, the depreciation of US dollar has resulted in increased imports from US by other countries leading to increased demand than production (1: 13&14). Also, the denomination of crude oil in terms of the US dollar has led to increased imports by countries with rapid economic growth resulting in crude oils shortage and a rise in focus on biofuels (1: 13&14).

Moreover, the rapid increase in the costs of fertilizers, fuel and pesticides in 2004 has led to increase in the cost of production of food commodities, thereby increasing their price in the market (1: 20). During 2006-07 period, adverse weather conditions, such as dry spring and harvest time floods in the Northern Europe and a two year drought in Russia and Ukraine, have led to severe decline in agricultural production (1: 21). Such resultant decline in global yields has occurred only three other times in 37 years (1: 21).

Finally, policies, such as eliminating export subsidies, adopted by many exporting countries to restrict exports and protect domestic supply has further led to increased shortage of food commodities and rise in prices (1: 23&24).

With reference to one significant agricultural commodity of your choice, examine in more detail the specific forces which have determined its price in recent years.

International trade in rice has increased from 4 to 7 percent of global rice production in the last twenty years; its trade per year is still much below the trade shares for other grains and oilseeds (2: 1). Moreover, “the global rice market is heavily segmented, with little substitution among types and qualities by producers or consumers” (2: 1).

Coming to the global rice prices, decreased rice stocks and ever increasing demand from various quarters of the globe in recent years have led to dramatic rise in price levels of rice that have not been seen since the 1970s food crisis (3: 1). The high prices have made even the largest exporters of rice, such as Thailand and Vietnam, to limit exports in 2008 below previous year’s levels in order to guarantee domestic rice supplies and contain local prices (3: 1). Likewise, countries like India and China are taking export minimizing measures such as setting $1000 per ton minimum export price and taxing grain exports during March-May 2008 (3: 1; 4: 22).

There are several reasons behind rapidly increasing rice prices. Industrialization and urbanization has led to the reduction in available land for rice crops and water irrigation (3: 1). Moreover, change is dietary habits due to rapid economic growth in recent years is resulting in decreased focus on rice production. To be precise, developing urban middle class in Asia, particularly in India and China, is consuming more meat and dairy, resulting in diversion of production from food grains to animal feed (3: 1). Apart from this, rice is increasingly becoming an important staple in Africa, thereby leading to further increase in global demand for rice (3: 1). For example, Nigeria now imports more than 2 million tons of rice annually (3: 1).

Adverse weather conditions in rice exporting countries such as flooding and a major cyclone in Bangladesh, flooding in Indonesia, drought in the Philippines and Australia, and severe cold weather in Vietnam and China have severely affected global rice production (3: 1). Moreover, pest-related problems such as insect and disease outbreaks in Vietnam have led to further reduction in rice production (3: 1). The severity of the condition can be assessed by the fact that the Philippine government in 2008 had to ask fast-food restaurants to offer half portions of rice to prevent wastage (3: 1).

Furthermore, higher oil prices are not only increasing the cost of rice production but also encouraging many farmers to shift towards biofuel crops, thereby reducing the crop lands for food commodities including rice (3: 1).

As stated earlier, rice exporting countries are minimizing their export levels of rice so as to guarantee adequate domestic supply. This is leading to increased upward pressure for the supply of rice at the international stage, as international trade in rice is already very thin (3: 1).

The following figure depicting stocks to use ratio of rice for China, India and the world further explains about the increase in rice prices (4: 22).

Due to rise in stocks and decreased prices in the 1990s, harvested area was reduced by 6 percent between 1999 and 2003 (4: 22). Stocks were further reduced by below trend yields during 2002-06 period (4: 22). Consequently, stocks-to-use reached lowest levels in 2004-05 for both the world and India, whereas Chinese stocks reached their minimums in 2006-07 (4: 22). Accordingly, it may seem that rice prices would have reached highest in 2004/05 than in 2007/08. However, the apparent increase in rice prices in 2007/08 is due to existing short supply of many basic food commodities and the export restrictions by rice exporting countries due to escalating internal food inflation (4: 22).

To conclude, increasing differences between supply and demand due to various above mentioned factors and the simultaneous short supply of many basic commodities have greatly influenced rice prices.

What are the effects of rising food prices on individual consumers and nations? Briefly suggest what governments can do to limit the impact of soaring food prices on their economies.

The effects of high prices can be observed in view of the effects on developing countries and developed countries.

Developing Countries

As the poorest families in developing countries spend nearly 80 percent of their income on food commodities, they are affected greatly with rising food prices (5: 1). Accordingly, it is of no surprise that developing countries with large proportions of poor and middle class people such as Bangladesh, Egypt and Philippines face major trouble with increasing food prices (5: 1). Interestingly, large agricultural producers such as China and India are also affected by this trend (5: 1). Furthermore, poor people living in urban areas of Asia and Africa are severely affected due to increased food prices without substantial increase in their incomes (5: 1). This may lead to decreased nutritious consumption by poor people leading to problems of malnutrition (5: 1).

Also, high prices lead to civil conflicts and instability in many countries. For instance, increased prices of soybeans in Indonesia led to street protests in early 2008 (5: 1). Similarly, Egypt witnessed civil protests in early 2008 due to increased prices of bread that is made from wheat and flour (5: 1). Apart from this, high price rises also lead to inflation all over the world. For example, China had record high inflation of 8.7 percent in early 2008, as the food prices rose by 20 percent (5: 1). Likewise, a high inflation of 12.4 percent was observed in mid 2008 due to dramatic increase in food prices (5: 1).

High increases in food prices lead to increased pressure on economy, as countries need to raise their food subsidies in line with the prices, failing which respective citizens will need to bear those prices (5: 1).

Developed Countries

Though high prices lead to increased inflation and burden on consumers, the effects are not so crucial up to some extent, as consumer spending on food commodities is relatively a small proportion of the overall spending and the their cost makes only a small portion of the final price paid by the consumer (5: 1). Also, high prices of certain commodities such as wheat have been advantageous for certain agricultural exporters such as US, Canada and France (5: 1). Moreover, cost specific subsidy programs have helped these countries in preventing great problems like elsewhere (5: 1). However, very rapid increase in prices may affect even the strong economies, due to increased burden on damage prevention mechanisms.

Mitigation

Coming to mitigation processes, countries may adopt various mechanisms in dealing with such high prices based on impacts on respective populations, and financial and administrative resources (5: 1). They generally adopt a combination of certain responses that are shown below.

• Direct controls on costs (5: 1).
• Subsidies for consumers (5: 1).
• Reduced tariffs on imports (5: 1).
• Restrictions on food exports (5: 1).
• Enhanced support for local farmers (5: 1).

For instance, India has reduced import tariffs on food commodities such as cereals and edible oils since 2006 (5: 1).

Though most of these responses help in reducing the effects of high prices on populations of respective countries, measures like export restrictions may have negative effects on global food security (5: 1). For reduced exports lead to severe shortage in global food supplies.

What are the main features of an oligopolistic market? With the aid of examples, show how collusion between firms in such markets may be detrimental to consumers and explain briefly what governments can do to control the worst abuses of such a situation?

The type of market in which limited number of suppliers and sellers rule is called ‘oligopoly’ (6: 1). This kind of market is represented by heavy market concentration, occupied by the leading companies of respective countries (6: 1). Basically, the market reflects high risk of collusions, as companies need to act strategically to analyse the reactions of competitors in the market (6: 1). Also, collusions may be explicit where companies in the same industry formally agree to control the market or implicit where the agreement is informal (7: 304).

Main Features of an Oligopolistic Market

• The market contains limited number of companies that sell differentiated or homogeneous products (8: 1).
• Interdependence of firms engaged in similar competition is the main feature of this market (6: 1). It makes businessmen to assess the outcomes of competitions with respect to changes in production of goods and their sales (6: 1).
• The market generally restricts the entry of new firms to gain unusual profits (6: 1).

There are two kinds of competition in the oligopolistic market-price and non-price. Price competition focuses on achieving increased market share for products through discount offers on prices, whereas non-price competition deals with other activities for increasing market for products (6: 1). Most importantly, price leadership is dominant in oligopoly, by which firms with less market shares have to follow the prices of products fixed by the firm with maximum shares (6: 1).

Oligopoly can be explained by two theories-Kinked-Demand Theory and Cartel Theory of Oligopoly.

• Kinked-Demand Theory: The theory is applicable to markets in which companies sell differentiated products (8: 2). As per the theory, companies deal with elastic and inelastic market demand curves during high and low prices, respectively (8: 2).
• Cartel Theory of Oligopoly: It explains that companies form groups, such as the OPEC (the organisation of petroleum-exporting countries, and work together to decide on output and product prices (8: 3). Similar to monopoly, the groups tend towards less production and high price to increase profit margins (8: 3).

Consequences of Oligopoly

• As mentioned above, companies tend to form groups to reduce production and increase product prices (6: 1).
• Grouping may help in stabilizing unstable markets (6: 1).

Effects of Collusions on Consumers

Collusions among firms may have an indirect effect on consumers, as these firms can influence government actions in terms of contracts, reductions in taxes, loans, regulations and enforcements, thereby maximizing profits at the cost of tax payers (9: 1).

Apart from this, the formation of such groups can have considerable consequences for consumers pertaining to product selectivity and prices.

Examples of Firms in Oligopolistic Markets and their Effects on Consumers

The interdependence of these firms on one another to capture substantial portions of markets and raise profit margins results in adverse effects for consumers.

1. Price of Prescription Drugs: There are allegations by FDC (Federal Trade Commission of the US that regulates medical drug trades) against many prescription drug manufacturers in the US that they are collaborating with generic drug manufactures to keep high profit margins by selling drugs for higher prices to consumers (10: 5). To be precise, Hoechst Company, manufacturer of a chest-pain drug called Carbizem CD, was accused of an agreement to pay $40 million per year to Andryx Company for convincing it not to make a generic drug which is relatively cheaper (10: 5). Likewise, the cost of Ativan, a tranquilizer rose from $11 to $85 in 30 days in 1999, as its manufacturer Mylan Laboratories allegedly prevented the supply of an important ingredient of the drug to prevent the production of generic drugs (10: 5).
2. During 2002-2006 period, the US government had investigated on allegations related to the fixing of DRAM (a semiconductor used if computer memory) prices (11: 1). By default, there is no much scope for improvement in features or service of this product (11: 1). This had led the four major players in this cartel, which controlled 70 percent of the market, to restrict small players and maintain high prices for the consumers (11: 1).
3. In 1992, American Airlines and Braniff decided together to increase their prices equally by twenty percent so as to avoid competition between them and increase profits. This would ultimately lead to high prices for consumers (12: 234&235).
4. In 1999, OPEC decided to cut down its production of oil by 2 million barrels per day, which would make up to 3 percent of the global supply, with an intention to keep oil prices over $10 per barrel (10: 2). Similarly, the reduction of production by 3 million barrel per day led to price of crude oil to rise from $13 to $17 (10: 1).

Thus, collusions limit the choices for consumers and may impose high prices on them.

Governments’ Role in Controlling the Worst Effects of Oligopoly

The adverse effects of oligopolistic businesses need to be controlled through proper government initiatives by bringing relevant policies such as the monopoly regulation and fair trade act of 1980 by Korea to control the detrimental effects of monopolistic or oligopolistic markets and prevent new companies from exerting such power (13: 26).

There have been various initiatives by governments of the developed nations in this regard. To be precise, UK’s competitive policy has three aspects, namely directly controlling monopolies, directly controlling oligopolies and creating competitive conditions (14: 291). As per the policy, the government tends to intervene in the affairs of oligopolies to influence prices and entry behaviours of respective companies in line with public interests (14: 293). Moreover, government tends to increase competition by preventing firms from unnecessary collusions or mergers (14: 294).

Some scholars feel that policies against monopoly and oligopoly should be initiated at national level than local level, as regional policies may be exploited through coalitions among local interests (15: 301).

Coming to Gilbraith’s opinion, a famous economist, pure curbing of powerful companies may not be truly beneficial, as these companies have huge resources to do research and development activities to bring new technological advancements (qtd. In 16: 1). Accordingly, he proposed that small companies need to be supported through financial incentives so as to make them capable for competition instead of controlling the growth of large firms (qtd. In 16: 1).

Thus, governments need to adopt a two way approach to control oligopolies by preventing unwanted collusions and encouraging small firms.

Why do many large firms decide to operate beyond their home country, i.e. become multinational? With the aid of a case study of a particular company of your choice show how and why that company expanded abroad.

Primary Reasons

The tendency towards growing beyond home country is generally a result of various objectives, compulsions and opportunities of a company. The objectives of companies are to gain profits and increase market share (17: 96). When the feasibility of accomplishing these objectives is less in home country or there are more opportunities abroad, companies tend to go multinational (17: 96).

There may be various restraints in the domestic market such as high competition from local and international companies, high production costs, paucity in adequate skilled workforce and technologies (17: 96). On other side, ‘pull’ factors such as relatively low production costs, availability of raw materials, advanced technologies, skilled manpower, huge customer base, and tax incentives attract companies to host countries (17: 96).

Coming to professional services sector, the main reasons for their internationalization is similar to manufacture sector as described above except for few variations. Though trade agreements and scope for increased market equally influence both the sectors, developments in information technology (IT) has given major boost to services sector, software in particular, as IT is spreading globally irrespective of businesses, thereby increasing the scope for professional services (18: 15).

Requirements

However, to become multinational, companies need to possess certain characteristics such as excellent core competencies in terms of operational abilities, managerial and administrative skills, and the ability to maintain amicable relations with foreign companies and/or countries (17: 96). It seems like that without such capabilities, companies may not be in a position to make full use of opportunities in the host country while effectively dealing with contingencies.

Host Country’s Policies and Company’s Stage of Internationalization

Depending on the company’s strengths and the host country’s policy, abroad operations may range from simple foreign investments, partnerships with native companies to direct control of abroad operations (17: 96). It also depends on a company’s stage of internationalization in deciding whether its abroad operations are limited only to imports, exports, franchise and licensing, or extend towards joint ventures and total ownerships (17: 96). Moreover, the extent of internationalization largely depends on the host country’s policies, as some countries have free foreign trade policies and others may have reservations in allowing foreign entities in terms of kinds and extents of investments, and constraints on profits to make them spend those profits in the host country (17: 96).

Types of Companies with Respect to International Activities

Companies can be classified into four categories based on their abroad activities, namely focused, differentiated, vertically integrated and hybrid companies (19: 1). Focused companies mainly stick to exports, whereas differentiated companies are subsidiaries of multinational companies with multidomestic strategies (19: 1). Likewise, vertically integrated companies work with more focus on exports along with foreign divesting investments (FDIs), and hybrid companies adopt different international strategy depending on opportunities with the main strategy being ‘regional division of labour’ (19: 1).

Potential Problems

However, companies may need to deal with various problems while extending activities abroad. They include, but not limited to, problems in managing far away braches, communication, going with common objectives, pressures from regional groups, and problems with increased media focus (20: 21).

Company Analysis

In line with the globalization processes of many companies, Ford, the well known American automobile company, also has spread its operations internationally. When the major initial steps towards globalization were taken 1993 under the chairmanship of Alex Trotman, the main objective of the company was to evolve as single global engineering and manufacturing company (21: 164). Successive chairman and top managers who have involved with Ford globalization has vast experience in global operations have made Ford to effectively focus on global development (21: 164).

Moreover, Ford has extended its operations to regions like Eastern Europe and China, with subsequent increase in sales in respective countries (22: 1). Also, in view of capitalizing brand loyalty, Ford has spread its activities to Canada (22: 1).

However, Ford’s increased focus on globalization in recent years has quite different reasons. The company with it costly infrastructure, heavy union contracts and arguably short-term focus on products such as SUVs (sports utility vehicles) has to face huge competition in the US market from its rivals with cheaper prices from China, Japan and South Korea (22: 1).

Also, most of the consumers seem to be inclined towards reliable, low cost and fuel efficient cars that are available from rival companies, leading to considerable decrease in Ford sales (22: 1). This has made Ford to take certain measures such as making the right cars in right places (21: 1). Accordingly, it has designed its new Fiesta car in India with local engineers along with workforce from the UK, Australia and Germany (21: 1). This car, with high price and quality, is meant to compete with Hyundai, which captured some of its US market share in 2005, in the South Asian market (22: 1).

As a whole, Ford has been operating in 38 countries, with 111 plants and nearly 226,000 employees (21: 165). As early as 1997, it earned nearly $65.8 billion in global sales (21: 165). By 2000, Ford has unified its worldwide operations to create five international design and manufacturing centres to decrease procurement costs and maximize its potential as a global leader in automobile sector (21: 165). Finally, opting for non-US designs for US markets and assigning respective nationals as top executives of regional centres have made Ford relatively more global than its counterparts like General Motors, Toyota or BMW (21: 165).

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