New Growth Industry: Organic Food

August 17, 2016
Editor(s): Heath Gilham
Writer(s): Quoc Anh Nguyen, Daniel Pederick, Kevin Kingsley, Max Yang

Due to a boom in popularity, demand for Australian organic products has outweighed supply by almost 40% in certain segments, most significantly the US, China, and Europe. The most substantial difference has been in China. Due to notoriously poor food standards and contamination of products in these areas (particularly China), citizens’ distrust may have resulted in foreigners demanding the healthier Australian organic products as opposed to the local unhealthy products.

Therefore, a grey market has emerged in these areas, as the demand was likely unanticipated by producers as it was caused by reasons that could not have been easily predicted. Disenchantment with domestic products in foreign countries was an unforeseen circumstance.

The boom extends far beyond baby formula, as other organic products such as honey and even fertiliser have seen similar upsurges in stock prices due to the increased demand. Whilst at the present time Australia’s primary exports are commodities such as iron ore however, it is predicted that this organic food boom will be potent enough to eventually match or even exceed this magnitude. This indicates the potentially prosperous future for economic growth in this area, despite this newfound increase in demand for these products ostensibly only originating in a handful of countries.

Massive demand

Australia’s main sources of exports consist of minerals such as coal and iron to all parts of the world. In comparison the export of organic food is relatively small with Australia sending to only a handful of countries aside from China. With China being one of the world’s largest producers of many items, it might be a surprise that the country is highly dependent on other countries to obtain basic necessities such as milk and meat. The recent demand in Australia was ignited due to numerous scandals where Chinese residents fell ill after consuming their organic food. According to reports, these ‘instances range from babies poisoned by tainted milk powder to dead pigs found floating in a river.’ The most prominent case was during 2008, when 300,000 Chinese babies fell ill after drinking melamine-tainted milk. This infamous milk formula scandal, caused an enormous demand for Australian milk powder, resulting in AUD $25 tins being sold as high as AUD $100.

The massive increase in demand is most prominent for Bellamy’s (and also A2) baby formula in China. In 2014 Bellamy’s listed on the ASX with a share price of $1.00, and has since skyrocketed to a price of $10.65 by market closing on May 6th, 2016. However, this was actually representative of a sizeable drop from the peak of $15.50 in December 2015, emphasising the magnitude of this boom. This is supported by the graph below, where it is evident the share price rose by up to 900% from initial listing.

Another factor that has caused a stir on the demand for more organic food is the change in eating preferences. Until recently, China’s favoured meat was pork with beef being called “millionaire’s meat” as it was very rare. This is reflected in the Bloomberg graphic, which depicts the increase in beef exports to China. Farmers in Australia are currently capitalising on this surge, with exporting levels reaching over AUD $900M in value. With this increase in exports, more money will flow into the Australian economy and will therefore result in more wealth for Australian suppliers, such as farmers.

Effects locally

Due to the demands of the ever emerging middle class in China, the food boom has benefited Australia’s $53 billion farming sector. Last year, 58% of all products made by the nation’s 135 thousand farmers were exported, with a 16% increase in food exports to China over the past 10 years. This was driven not only by the demand in quality organic products but also the free trade agreement, lowering transaction costs for local producers. In fact, the RBA predicts food exports to exceed iron ore production by 2030, with the Chinese middle class predicted to increase to a staggering 800 million people. Despite the increase in foreign demand, local prices have not risen significantly creating a significant consumer surplus. Currently, supermarkets and retailers are implementing quotas on sales while waiting for producers to expand their operations. This results in significant deadweight loss as the local prices are under the market clearing price for organic goods.

The benefits to the economy extend beyond the export figures on the national accounts with significant trading of organic foods on the grey market. These market makers are known as ‘Daigou’ or personal shoppers and resell organic food stocks brought in Australian to Chinese consumers at a significantly inflated price. Estimates suggest that 3000 market makers operate in Sydney alone, capitalising on fact that local prices have not increased relative to international demand. Despite its ethical implications, these personal shoppers significantly increase economic activity by selling at the highest possible prices, decreasing consumer surplus and deadweight loss. The flow on effect internally is that production has significantly increased in Australia in order to cope with the additional demand.

Future Outlook

Overall, the boom’s effect on Australia in the long run should be positive. This is true for the organic food industry in particular, but also for agribusiness in general. In contrast to the mining boom, this organic food boom should not make Australia overly dependent on China as economic growth in Asia has created middle class populations in almost every country who face similar problems in sourcing safe food sources.

A third of respondents to a recent Pew Research Center poll believed that persistent food safety issue in China is a big problem. The Chinese government has been spurred into creating new laws to ban toxic substances in food production and regulate labelling, but many are sceptical about how well they will be enforced. Furthermore, the demand for clean food – mainly from the Chinese middle class – is large and growing. It is projected to rise from 68% of urban consumers in 2012 to 75% in 2022. China’s economy may slow down, but its middle class are not getting poorer any time soon. Besides, food makes up the majority of a family’s budget, and the degree of risk in local food means it is worth it for those middle class consumers to import overseas products.

The broader agribusiness industry will also stand to benefit. Food safety will not be the only source of demand for Australian agricultural products. As developing countries get richer, their population can spend more on pricey imported luxuries. They also tend to shift towards a more “Western” diet. This means more opportunities for Australian exports of meats, wine and dairy products.

The implementation of the Trans-Pacific Partnership – which Australia is a member of – should open up more opportunities for Australian agricultural exports to the 13 member nations as tariffs are cut. As a country with abundant land resources and an established agricultural sector, Australia is well-placed to reap the benefits.

In conclusion, it is evident that much of the demand for these products has emerged in China. This is a result of the poor food safety regulations and a general distrust of their products, and is a source of demand that is likely to remain for the foreseeable future. However, this boom is not as dependent on China as was the mining boom, as a general change in eating preferences along with the implementation of policies such as the Trans-Pacific Partnership ensures that demand for these products will also be strong in countries such as the US and also Europe. As trade barriers are broken down, exports in certain countries will become more lucrative. In these countries it is likely that there is a general change in tastes and preferences, favouring healthier organic products. Prices may also increase slowly to combat the currently sizeable consumer surplus. Combined, these factors indicate that it is highly likely that this sector will be a strong source of economic growth in Australia over the upcoming decade, one that may also be prosperous and successful for farmers and local organic producers.

Given the opportunity to match the massive overseas demand, producers may produce more efficiently and on greater scales, allowing the organic produce industry to only grow from here. This boom is presently so potent that it is predicted to provide profitable business for Australian organic food providers for up to 15 years, ultimately indicating that this is no passing fad.

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The CAINZ Digest is published by CAINZ, a student society affiliated with the Faculty of Business at the University of Melbourne. Opinions published are not necessarily those of the publishers, printers or editors. CAINZ and the University of Melbourne do not accept any responsibility for the accuracy of information contained in the publication.

Meet our authors:

Heath Gilham
Editor
Quoc Anh Nguyen
Writer
Daniel Pederick
Writer
Kevin Kingsley
Writer
Max Yang
Writer