Weathering through the storm: Agrobusiness and the ups & downs of the market
Brazilian media often portray the country’s agricultural sector as the powerhouse of its economy, more often than not helping the chronically volatile economy weather through hard times. Why is it so?
The relevance of the Brazilian agricultural sector depends on at which data you look. Two renowned institutios are tasked with measuring the output of the sector: the Instituto Brasileiro de Geografia e Estatística (IBGE) and the Centro de Estudos Avançados em Economia Aplicada (ESALQ/USP). The latter is an educational institution on agriculture linked to the University of São Paulo (USP), while the former is a government agency tasked with providing federal and local policymakers with statistical data upon which to couch decision-making processes.
When it comes to reading the numbers on the agricultural sector (“ag-sec”) polled and provided by both agencies, you’ll come to slightly different conclusions. On this article I am particularly interested in exploring two premises: (1) whether or not the Brazilian agricultural sector really less elastic (that is, less responsive) to fluctuations in Gross Domestic Product and (2) how relevent a role the a Ag-sec plays in the Brazilian economy. To do that I am going to resort to the data on the “Ag-sec” provided by both IBGE and ESALQ/UPS.
In order to check how good the Ag-sec really is at weathering through the ups and downs of an emerging economy like Brazil’s, I stacked up Brazil’s total output (its GDP or Gross Domestic Product) against the GDP of the Ag-sec. To confront how relevant the Ag-sec is in relation to the Brazilian economy I looked at its total contribution to Brazil’s GDP, both in a percentage and nominal (in Billions of Brazilian Reais) bases.
How responsive to macroeconomic fluctuations is the agribusiness?
Elasticity is an eye-opening concept in economics. Determening to what extent a change in prices impact the demand for a certain good or service tells you “how elastic” or “how inelastic” that good or service is. For instance, if X% increase in prices leads to little or no change in the demand for a certain good or service, we say its response to price changes is inelastic (because it responded little to the change in price). Conversely, if X% increase in prices leads to a significant change in demand for a given good or service, then we’ll say that we’re dealing with an elastic product, because it responded more to the initial price change.
Elasticity has various forms and it’s a concept more frequently applied to microeconomics. Nonetheless, its core messsage — how responsive Y is to changes in X— remains a key analysis tool in macroeconomics as well. The graph I plotted below depicts a few key macroeconomic variables for Brazil: the agriculture GDP (in red), the transport sector GDP (in orange), the construction sector (in dark blue) and, finally, the Brazil’s Gross Domestic Product (GDP), in black. The period under analysis spans from 2010 up to 2019. What do the curves tell us?
The 2010–2019 years witnessed at least three stages of the Business Cycle, namely: when Brazil’s GDP — depicted as the thick black curve on the graph above — was at its peak (at 7.5% growth), in 2010; when it plummeted to its trough (at negative 6.7% accumulated) in 2015-16; and the slow-paced upward road to recovery we’ve been trailing since 2017, a year that brought in the first positive GDP growth at 1.3%.
A quick reminder: GDP sums up all the goods and services produced in a region (like a country or a city) within a defined period of time (usually a year). As such, one might expect it to work as a sort of “magnet”, either pulling the sectors that comprises it upwards (when GDP is expanding) or pulling those sectors down (when GDP is contracting or slowing down). That said, what one would expect from the graph I plotted above is a somewhat similar behaviour amongst the three sectors (Agriculture, Transport and Construction) in relation / as a response to GDP’s ups and downs.
What effectively can be observed, however, are varying levels of responsiveness towards GDP ups and downs. That can be roughly and moderately measured through a simple correlation math. As it varies from -1 to +1, correlation is a very handy tool! it allows the observer to quickly spot variables that are either directly related to another variable (a positive correlation) or inversely related to it (a negative correlation). On the graph I plotted I basically calculated the correlation between each sector in relation to Brazil’s GDP. As expected, the one sector that put out the lowest correlation (25%) was the agricultural one. Differently put: agribusiness is less responsive / more inelastic to fluctuations in GDP.
Why is that? Let us dwell a bit more on elasticity. Once it has been determined how elastic or how inelastic any given good or service is, another conclusion follows: the type of good or service. A good or service can be classified as inferior, normal, superior, essential, complementary or substitutes. It is not my intention to comment on all, but one of them: essential goods. They’re those that people cannot do without. Generally speaking, food is an example. And food, as well as a number of other raw resources, is what the agricultural sector produces.
When things go south, the average household may easily cut back on its entertainment expenses and on evertyhing that is not essential. Basic necessity goods and services are things on which households do not greatly cut back. On a larger scale, the agrobusiness sector (which includes all chains of production, not just what is produced in a farm) does respond to market peaks and valleys in the macroeconomy, but to a lesser degree. Both the transport and construction sectors, on the other hand, have statistically shown significantly higher levels of correlation: 83% and 89%, respectively.
In Brazil that is a understandable thing. As a continental country (the 5th largest in landmass), Brazil’s main defficiency is that its logistics is heavily dependent on road transportation (over 60%). On the left chart you can see the five most dominant types of transportation in Brazil. The road-based one far exceeds the other modes at 61,1%, followed by railway (21%), waterway (14%) and airway amongst others. It follows then that when overall activity level nosedives (GDP falls), fewer goods and services are demanded, which, in time, leads to a contraction in supply and which ultimately means fewer goods beens being transported countrywide. The map belows depicts, in read, the federal roads criss-crossing the country.
A note. As I write this article (14/March/2020), covid-19 spreads worlwide at alarming speed, having already reached Brazil and other major economies. A little over three months into the virus, which has been deemed a pandemic by the World Health Organisation, it is unquestionable that the balance has been tipped nearer to a global recession. That’s because as major economies come to a complete halt, all sorts of chains of production cease, which means fewer goods and services been demanded and supplied. The end-result is certainly a slowdown in activity levels. That said, and taking into consideration the measures currently being adopted by the Brazilian government (shutting down some services and banning large gatherings), Brazil’s already timid recovery is likely to take a heavier toll, and so should sectors that hold a higher correlation to GDP’s ups and downs, like tranport and construction.
On my previous article, published in early february, before covid-19 had drastically advanced, I argued why I do not believe Brazil’s GDP would grow 2.40% in 2020, as anounced by the government, or even anything close to 2%, as some other agencies liked to believe. I ran an econometric model with multiple variables which predicted a growth in GDP of 1.20%. You can read the article here.
The construction sector, in its turn, tends to be significantly responsive to the ups and downs in GDP levels because it’s a labour intensive sector. Large scale infrastructure projects have their ripple effects throughout numerous smaller sectors, from cement production, to transport, to heavy machinary, to food and so on. During dire economic times, unfortunately, multi-million Dollar investments are the first ones to be postponed or halted altogether, with the same far-reaching reveberations (negative, this time) throughout the economy.
How much does the agribusiness represent for Brazil?
As argued above, Brazil’s agricultural sector is often hailed as the country’s powerhouse because it is less affected by fluctuations in overall activity levels (GDP). Naturally, I cannot summarise things to a single variable. The world is too complex to be boiled down to a handful of variables, let alone a single one. Commodity prices in international stock exchanges is a variable that unquestionably dictates how bad or how well commodity-producing countries do. Exchange rates are another variable. I am going to comment on those in an upcoming article.
As to the question at hand (how much does the agribusiness represent for Brazil), the graph I plotted below makes things clear. For the data span available (sourced from ESALQ/USP), from 1996 up to 2019, the sector contribution to GDP has averaged 24,5%, having been as high as 31,9% in 1996 and as low as 19,1% in 2014.
From 2005 onwards the sector has performed below the average, but has been so from a mathematical perspective only. In other words, the fact that the Ag-sec contribution to GDP has dropped from an all-time high in 1996 of nearly 32% to a little over 21% in 2019 means little when you look at it nominally (in money terms). That’s what I did on the graph below: nominal Ag-GPD vs Brazilian GDP. The data also is sourced from ESALQ/USP and the values have a base year of 2010 to allow for inflation.
Historically, Brazil has always been an agricultural country. Modern jargon has us calling it a commodity-producing country. When you consider that food (which is one thing produced by th Ag-sec) is an essential good, that is: people cannot do without, and when you consider that the world population increases by the millions every year, it is fair to conclude that those countries that are the most productive producers of basic necessity goods are at a confortable position. That is partly true. As long as we all need to eat, there’ll always be demand for food. Things get a little more complicated when you factor in the effect of exchange rates which, depending on its level in relation to a given country’s currency, can either render the Ag-sec more attractive or an inviation for outright loss. As mentioned above, I am going to comment on other variables that impact the Ag-sec on an upcoming article, and when I learn more about it!