THE FOOD SYSTEM
Agriculture From the Perspective of Economic Theory
The modern food system has developed using some basic economic concepts, with some caveats.
One force creating the modern food system is economic theory. It has driven both progress towards greater output and acts as a barrier to change today. From 1400 onwards, European kingdoms were engaged in frequent wars. This was expensive, and governments became concerned that they could not support their armies. If wealth was simply gold and silver (the prevailing view), then Spanish conquest of the Incas meant they had the most gold and silver. England and France needed fresh ideas about gaining enough wealth to compete.
Economics is often presented as a deterministic type of engineering, but it is really an observational social science involving the generalization and abstraction of observed human behavior—operating under the assumption that people are logical. It provides an explanation for why some things happen the way they do and offers general guidance to people making decisions. It is like a story that makes sense, but does not always match real life. The modern food system owes a lot to economic thinking, so it pays to understand it a bit about its influence.
Challenge 1 — What is wealth?
The breakthrough idea was that wealth was the result of human, natural, and invested capital—productive capacity. Fundamental to productive capacity in the pre-industrial era was agricultural productivity. As Debabrata Mandal points out, the difference between farming and agriculture is that agriculture is about financial impact. The Physiocrats and Adam Smith saw agriculture as the foundation of wealth. Agricultural surplus could be traded for other goods, so being the most productive agricultural country would also make you the wealthiest.
In the 1800s, European and American farming became agriculture. This is less romantic than the “noble farmer” but this system produces so much food today that more than 80% of the population of middle- and upper-income countries live in cities and are freed to work in manufacturing and services (or not at all).
Challenge 2 — How are prices set?
It was easy to observe that prices fell when the supply of a good was high. Wheat was cheap right after harvest and expensive right before it. Prices of spices fell when a ship from the Far East arrived in port. High supply meant low prices, and the reverse was true too. This observation was formalized
this as a “law” of supply-and-demand.
When there is greater demand for a fixed supply, the price should rise, and the limited supply will go to those who most value it (and can afford it). Conversely, when supply exceeds demand, the price will drop until additional buyers are attracted to soak up the supply (or the excess is destroyed). The cost of production has no direct impact on price, though high prospective cost tends to limit production to those who think they are efficient enough to earn a profit. A high prospective price attracts more people to produce, but a low prospective price retards people from producing.
This model of supply-and-demand assumes a “free market” — one where buyers and sellers are free to enter/leave the market and accept/reject price offers. Nobody is compelled to buy or sell; “free” markets are an abstraction and most agricultural markets are not entirely free. It also assumes that there are many buyers and many sellers, so that no buyer/seller “controls” the market.
So, it turns out that the balance of supply and demand sets prices, and prospective prices serve as a feedback loop to influence potential supply and demand.
Challenge 3 — Why do some countries gain more wealth than others?
If supply-and-demand set prices, then why did some countries seem to gain more than others. Adam Smith thought absolute advantage explained why some countries were getting richer faster. For example, The United States has a big absolute advantage today over Germany in wheat production because it has so much more land to cultivate (Table 3.1). However, growing conditions in Germany give them a comparative advantage, so they have higher yields. Consequently, despite a 5-fold disadvantage in area, Germany’s almost 2.5-fold yield advantage means they produce nearly half as much wheat as the US. Measured as yield, German wheat farmers are more efficient (and possibly profitable) than US wheat farmers.
David Ricardo and others asserted that comparative advantage was more important than absolute advantage. Importantly, comparative advantage gives each party the chance to specialize where they have the advantage and gain even more from that advantage. Specialization leads to more advantage (cumulative advantage —the rich get richer). In this example, both countries benefit by specializing where they have an advantage. It’s wheat for Germany, but corn and soybeans for the United States.
Challenge 4 — People favor a near-term benefit over a bigger long-term benefit
Writing in 1834, John Rae observed that people place a lower value on future consumption than current consumption. Later economists developed the concept further into what is known today as temporal discounting. Given a choice between consuming now or in the future, people assume that the future consumption will be valued less. The change in perceived value over time is called the discount rate, and the rate seems to change hyperbolically. Value drops very quickly, then more slowly. In an analogous way, current costs are felt more acutely than future costs.
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Near-term versus long-term value-conflicts appear frequently in the food system. Uncertainty about the future makes assessment of future value even harder, so decisions skew even more towards the short term. This is a real challenge in farming. The investment that a farmer makes in a crop or animal is separated in time from when they will be paid. For example, there is a gap of:
- 3–5 years from planting to first fruit on apple, peach, and orange trees.
- 2–2.5 years from calving for cattle to reach slaughter weight.
- 11 months from collection of strawberry runners for overwintering to harvest of strawberries the following year.
- 7–9 months from impregnation to slaughter of pigs
- 8 months from planting winter wheat to harvest.
- 6–7 months from planting corn to harvest
It creates a huge problem for farmers to be asked to adopt a practice that will extend the quality of the soil in 15–50 years but decrease their output or increase their costs today.
Time and uncertainty are issues throughout the food system. Agricultural processors must make huge investments to build efficient processing plants and depend on affordable inputs and reliable demand for many years to recover their investment. If farmers decide to switch crops, big losses in processing follow. Similarly, food manufacturers must determine what consumers will want in the future years to focus their investment. An uncomfortable fact is that at least 90% of new products introduced to grocery stores fail to recover their cost of development. Well-established categories of food can fall out of fashion. By the middle 2010s, ready-to-eat breakfast cereal, sandwich bread, carbonated soft drinks, and beer had been in decline in the US for many years.
Consumers display time discounting in their choices. Given a choice between eating a delicious doughnut today and living an additional 6 days in forty years—they eat the doughnut. This is an essential problem in almost everything health related. You can eat a healthy diet today by avoiding tastier, more convenient foods, but the reward arrives in the future—maybe the distant future (and you may never see the benefit due to premature death).
Challenge 5 — People don’t always act logically?
A fundamental assumption in the development of classical economics is that people act rationally.
People are often, but not always, rational or perfectly self-interested. Behavioral economics developed to combine an understanding of human psychology with classical economics. Humans use a wide variety of mental shortcuts (heuristics, biases) that are generally, but not always effective. Two examples are loss aversion and the endowment effect. Loss aversion is our tendency to be more sensitive to losses than gains; we are conservative decision makers (Figure 3.1). Given an uncertain outcome, we require twice the gain as potential loss. More broadly, to make any change the potential rewards must significantly exceed the potential loss.
And when we already have something, we feel even more conservative. To demonstrate just how odd the endowment effect is, students were given a mug with the price tag still on it ($5) and immediately offered a chance to sell the mug for $5 or to trade for pens worth $5. The students declined the straight exchange and required (on average) $10 to sell the mug. This is not rational because immediately trading for the cash creates more ways to benefit from $5. The briefest of attachment seems able to create a sense of ownership and induce reluctance to change. More generally, we are aware of what we have and resist having it taken away. Whether changing farming practices or dietary habits, we are invested in our current practices and must be strongly motivated to change. It is one reason that it is hard to change the system and that change is often slow.
Challenge 6 — Demand (and supply) isn't so easy to specify
There is a tension inside the idea of supply and demand. What is the “it” that is being bought/sold? A commodity is a material that is uniform and interchangeable. If wheat is a commodity, then all wheat is the same and can be used interchangeably. But all wheat is not the same. Some wheat is better for pasta, some is better for bread, and some is better for cakes, cookies, and the like. But nobody cares about wheat—they care about what can be done with wheat. Bread, pasta, and cakes are what we care about (and it may be more complicated than that).
But what if the wheat is being used to feed animals. Now wheat is not a set of potential flavors and textures but a set of nutrients (amino acids, carbohydrates, etc.). Now it competes with other combinations of nutrients found in corn, sorghum, and soybean meal. If the price of wheat goes up, more corn goes into feeds that usually include wheat. But high wheat prices don’t bring more corn into bread-making because corn can’t do what wheat does in bread. Everywhere in the food system, there is a constant effort to find the least expensive way to deliver an outcome. Trade-offs are an important tool in navigating a volatile supply-demand environment.
Adam Smith and his early colleagues wrote about “political economy,” which explored society, governmental action, and the public welfare. Our existing economic (and food) system is the product of collective human behavior, incentives, and disincentives played out over more than 200 years. Like many systems, it creates a mix of good and bad outcomes. The forces that eliminated the threat of starvation also increased the rate of soil degradation and environmental pollution. The forces that led to inexpensive, highly palatable food may also lead to a rise in chronic disease.
I am not an economist, but in my career economic concepts were used to advocate actions (and more frequently) inaction. If you are as unschooled in economics as I am, these might be interesting to you too.
- How Economics Explains the World (2024) Andrew Leigh
- Edible Economics (2023) Ha-joon Chang
- Economics in Two Lessons (2019) John Quiggin
- In Search of the Real Adam Smith
- Was Adam Smith Really a Right-Winger?
- Zombie Economics (2010) John Quiggin
- Thinking Fast and Slow (2011) Daniel Kahneman
- Predictably Irrational (2008) Dan Ariely
- Misbehaving: The Making of Behavioral Economics (2015) Richard Thaler
