Mike A. Singer

English

Research Papers in Economics

ESSAYS ON ISSUES THE FEDERAL RESERVE BANK DECEMBER 1997
OF CHICAGO NUMBER 124
Chicago Fed Letter
U.S. agriculture: Challenges
for the twenty-first century
The U.S. agricultural sector faces
both opportunities and challenges in
the countdown to the next century.
Opportunities include expanded farm
export potential that stems from for-
eign population and income growth,
as well as more liberal trade policies.
Reflecting this, the annual growth in
the value of U.S. farm exports in this
decade is much improved over the
uneven performance of the 1980s.
In addition, advances in biotechnol-
ogy are improving productivity, re-
ducing costs, and providing raw
farm products more neatly tailored
to the needs and desires of both pro-
cessors and consumers. Many im-
provements in technology are also
helping to protect the environment
and enhance food safety. In addition,
improved information flows and co-
ordination between those who pro-
duce, process, and market agricultural
and food products are creating new
opportunities for agri-firms to add
value by responding to the tastes and
preferences of both foreign and do-
mestic consumers.
Yet the optimism generated by these
developments is tempered by other
considerations. Export opportunities
are threatened by global competition
and an increase in the use of nontariff
barriers such as sanitary/phytosanitary
measures1 and product labeling regu-
lations. Moreover, environmental
and food safety issues are increasingly
at the forefront of concerns expressed
by consumers and policymakers. Finally,
all this is occurring against the back-
drop of a new policy environment
and continuing structural change in
agriculture. This Chicago Fed Letter
reviews the outlook for world food
demand and highlights three areas
of concern that warrant continued
scrutiny: international trade, struc-
tural change, and the environment.
Outlook for world food demand:
Level and composition
Population and income are the most
important drivers of food demand.
Population growth increases the level
of food demand, while income gains
often contribute to changes in both
the level and composition of demand.
Over the past 25 years, world popula-
tion has risen more than two billion,
an increase of over 50%. (In compar-
ison, the U.S. growth rate was about
half that.)  Though the rate of growth
is expected to slow, world population
is projected to increase by another
two billion over the next 25 years.
Developing nations will continue to
account for a disproportionate share
of population growth.
Developing nations hold the greatest
potential for relative income gains,
as demonstrated by several South
American and Asian economies in
recent years. But it should be remem-
bered that economic gains typically
do not match the steadiness of popu-
lation growth. For example, the growth
of the Mexican economy was inter-
rupted by the peso crisis earlier this
decade, and a handful of Asian nations
are currently experiencing problems
associated with policies that promote
rapid economic growth. Moreover,
estimates from the United Nations
suggest that approximately 800 mil-
lion people in the world today suffer
from undernutrition related to inad-
equate income. To the extent that
this group shares in the distribution
of future income gains, this suggests
a potentially significant expansion in
effective food demand.
The historical pattern of consumption
in countries such as the U.S. indicates
that rising incomes in developing
nations will not only lead to higher
food demand, but will also nudge the
composition of demand in specific
directions. Higher incomes tend to
push food consumption away from
cereals toward meats, fruits, and vege-
tables, as well as an array of processed
foods. Therefore, gains in foreign
population and income, combined
with the potential of bringing more
underprivileged people into world
markets, indicate that meeting the
tastes, preferences, and nutritional
needs of consumers in other nations
is of growing importance to partici-
pants in the U.S. food industry.
Trade barriers: A critical issue
The importance of foreign market
access to U.S. agriculture cannot be
overstated; exports account for over
one-fifth of farm cash receipts.2 For
some individual commodities, such
as soybeans and wheat, the export
share of production is much higher.
Furthermore, the greatest agricultural
export gains in recent years have
been in higher-value and processed
products such as meat and poultry,
snack foods, and breakfast cereals.
This trend, in particular, has also
expanded the stake of nonfarm busi-
nesses and workers in food exports.
But despite the positive outlook for
world food demand and the ongoing
implementation of treaties liberalizing
trade, access to foreign markets is still a
troublesome issue. It is currently char-
acterized by a new emphasis on quali-
tative trade barriers, such as product
labeling requirements and the opera-
tion of state trading enterprises.
The European Union (EU) recently
introduced special labeling require-
ments for food products that contain
material from genetically modified
organisms (GMOs). These require-
ments were scheduled to go into effecton November 1, 1997. In particular,
they affect two crops widely grown in
the Midwest: corn and soybeans that
have been genetically engineered to
improve insect and weed management
and reduce pesticide use. Three mem-
ber countries of the EU placed an
outright ban on the use of the genet-
ically modified corn and soybeans.
The U.S. vigorously opposes the label-
ing requirement because it would raise
costs involved in monitoring and com-
pliance, could eventually lead to seg-
regating products based on GMO
content (further raising costs), and
could unnecessarily alarm consumers.
The outcome of this debate is also
important for the precedent it sets
in resolving such disagreements and
the tone it sets for upcoming trade
negotiations.
A second controversial issue concerns
the activities of state trading enter-
prises, such as the Canadian and Aus-
tralian Wheat Boards and the Dairy
Boards in New Zealand and Canada.
These organizations possess exclusive
rights and privileges in the export of
certain farm commodities or food
products. The primary concern about
these organizations is the lack of trans-
parency in their pricing activities.
Their actions are shrouded in secre-
cy, making it difficult to determine
whether sales are made on the basis
of competitive advantage or practices
such as subsidized pricing. Questions
were recently raised regarding whether
Canada is “dumping” durum wheat
in the U.S. at a price below the cost
of production. Durum wheat imports
into the U.S. have risen, but the increase
has coincided with a decline in domes-
tic production, making it even more
difficult to arrive at any conclusion
regarding improper pricing practices.
Structural change
The structure of agriculture is defined
by a group of characteristics, includ-
ing the number of farms, farm size,
type of commodities produced, and
legal organization. For the most part,
the trends in these areas have been
relatively stable for many years. For
example, the shift to fewer and larger
farm operations has been going on
since the mid-1930s. This, along with
the increasing concentration of sales
among larger operations, is probably
attributable to the use of technology
to enhance farm labor productivity,
as well as the farm family’s desire
(as with any business owner) to ex-
pand the business to maintain or in-
crease household income. However,
the decline in the number of farm
operations in recent years has been
concentrated among the mid-size
group, leaving the distribution of
farm numbers more heavily weighted
toward both small and large farms.
Those in the middle of the size distri-
bution are increasingly faced with a
choice between two alternatives: ex-
pand the operation to maintain family
income or shrink to a size that is
compatible with holding a full-time
job off the farm.
One of the most divisive structural
issues today is the degree of vertical
coordination within agriculture. Ver-
tical coordination or integration may
consist of using marketing or produc-
tion contracts or full-scale integrated
ownership. Under a production con-
tract, the farmer/grower produces a
specified quantity and quality for the
contractor, who maintains ownership
throughout the production cycle.
Consequently, the contractor makes
most of the production decisions and
purchases most of the inputs. More
prevalent are marketing contracts,
which typically include a negotiated
price or a price formula. In addition,
under a marketing contract, the con-
tractor does not own the commodity
until delivery and has little influence
over production decisions. In com-
parison, an “integrator” may own the
farm operation and related businesses
in the value chain, such as input supply
firms or processing facilities.
In general, the current trend is toward
greater vertical coordination in agri-
culture but the degree differs mark-
edly among commodities. For example,
processors of poultry, milk, and sugar
beets obtain more than half their raw
agricultural inputs through contracts.3
Manufacturers of canned and frozen
fruits, as well as macaroni and spa-
ghetti, also obtain large proportions
of their supplies from the farm pro-
duction sector through contracts.
In contrast, processors of corn, soy-
beans, and hogs (the primary farm
products in the Midwest) have histor-
ically obtained most of their raw mate-
rials through cash markets.
In particular, the hog industry repre-
sents an ongoing case study of the
impact of structural change and increas-
ing vertical integration. The number
of hogs grown under some form of
contract represents a small but expand-
ing share of total production. In addi-
tion, the number of farms with hogs
has been declining for many years and
the size of the average hog operation
has grown. More recently, there has
been an increase in the number of
extremely large operations, aptly
called “mega farms.” As one might
expect, there are both positive and
negative implications associated with
these larger units. On the plus side,
they are believed to operate more
efficiently and at lower unit costs.
With improved, standardized genet-
ics and management practices, they
can provide a more consistent and
uniform product that better meets
the needs and preferences of con-
sumers. These advantages also make
U.S. pork more competitive in world
markets. On the downside, critics
point to well-publicized odor and
waste management problems. Some
believe that more traditional pork
producers, long the backbone of the
industry, can no longer compete with
the mega hog farms. Those that remain
will feel more pressure to give up some
independence and enter into strategic
alliances. Moreover, the controversy
regarding the regulation of livestock
confinement units has escalated, with
some counties enacting strict zoning
and waste management regulations
that effectively bar mega hog farms
from constructing large units, but
also limit expansion by local farmers.
Focus on the environment
American farmers are major users of
natural resources and face growing
demands on the environmental
front. They are expected to help
maintain and improve the quality ofMichael H. Moskow, President; William C. Hunter,
Senior Vice President and Director of Research;
Douglas Evanoff, Assistant Vice President, financial
studies; Charles Evans, Assistant Vice President,
macroeconomic policy research; Daniel Sullivan,
Assistant Vice President, microeconomic policy research;
William Testa, Assistant Vice President, regional
programs; Rosemarie A. Wilcox, Administrative
Officer; Helen O’D. Koshy, Editor.
Chicago Fed Letter is published monthly by the
Research Department of the Federal Reserve
Bank of Chicago.  The views expressed are
the authors’ and are not necessarily those of
the Federal Reserve Bank of Chicago or the
Federal Reserve System. Articles may be
reprinted if the source is credited and the
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ground and surface water supplies
and are the primary guardians of soil
quality and productivity. Furthermore,
they are increasingly being asked to
provide reserves for wildlife and wet-
lands, remove environmentally sensi-
tive land from production, and adopt
sustainable farming practices. The
challenge for agriculture is to expand
output to meet the growing world
needs for food and fiber and main-
tain and/or improve farm income,
while at the same time limiting the
acreage base and using more costly
management and production practices
to accommodate society’s increasing
environmental sensitivity. Much of
the progress made to date stems from
the development and adoption of
new technologies, as well as policies
designed to encourage conservation.
Considerable gains have been made
in reducing soil erosion. Major influ-
ences have been the adoption of con-
servation tillage practices and the
implementation of the Conservation
Reserve Program (CRP). The shift
from conventional tillage to conser-
vation/reduced tillage practices means
leaving greater amounts of plant resi-
due (such as corn stalks) on the sur-
face. This reduces erosion and may
also trim certain costs, such as those
for fuel and equipment (but may re-
quire increased use of chemicals to
control weeds and other pests). Com-
plementing this, the CRP uses finan-
cial incentives to encourage farmers
to convert marginal cropland to con-
servation use and was responsible for
removing millions of acres of poten-
tially erodible land from production.
However, agriculture faces renewed
challenges in water quality. Measured
water quality is improving, thanks to
reduced pollution from industrial
and municipal point sources. But
recently, attention has turned toward
pollution from nonpoint sources, set-
ting the stage for greater scrutiny of
agricultural production practices.
The most recent Water Quality Inven-
tory from the Environmental Protection
Agency cites agriculture as a leading
source of “impairment” to surface
and ground water supplies from non-
point sources. This impairment can
take the form of sediment buildup
from erosion or the introduction of
fertilizers, pesticides, or livestock
wastes into surface or ground water
supplies through runoff or leaching.
The economic costs associated with
these problems take the form of in-
creased expenditures for dredging,
water treatment, and personal
health. Impairment can also result
in damage to aquatic life and recre-
ational areas.
A market-oriented explanation for
pollution suggests it occurs because
property rights to the environment
are not adequately defined. For ex-
ample, there is no market price as-
sociated with using environmental
resources as a receptor for eroded
soil or excess chemicals. Consequently,
these costs are not factored into ag-
ricultural production decisions. But
standard regulatory remedies can
be inflexible and unnecessarily raise
production costs. Rather than respond
with such a command-and-control
regulatory approach, the U.S. Depart-
ment of Agriculture adopted an in-
centive-based, voluntary approach
to improving environmental and
water quality. The CRP has had a
positive impact on water quality by
removing potentially erodible land
from production. More recently, the
Environmental Quality Incentives
Program was formed, which focuses
on providing education, technical
assistance, and financial assistance
to enhance water quality. Since soil
and water quality problems vary
from area to area as soil types and
land use vary, an important aspect
of these programs is the ability to
target regions and farming practices
that can provide the greatest benefit
for a given cost.
Summary
As we move into the twenty-first cen-
tury, U.S. agriculture faces growing
world demand for its products. How-
ever, its ability to meet that demand
is by no means assured. As trade bar-
riers such as quotas and tariffs are
reduced, attempts are being made to
erect new barriers based on issues
of food safety. Resolution of these
issues will depend upon the perfor-
mance of the World Trade Organiza-
tion as arbiter of trade disputes as well
as upon future international negotia-
tions. In addition, both consumers
and farmers have an important stake
in monitoring structural change and
environmental regulation, since devel-
opments in these areas will affect our
ability to produce adequate food to
meet foreign and domestic needs, im-
prove the environment, and provide an
adequate income to farmers.
—Mike A. Singer
Agricultural economist
1Technical barriers used for protecting
human, animal, and plant health.
2Eugene Moos, “Exports equal farm pros-
perity,” Agricultural Outlook, April 1996,
pp. 10–11.
3Stuart Frank and Dennis Henderson,
“Transaction costs as determinants of
vertical coordination in the U.S. food
industries,” American Journal of Agricultural
Economics, Vol. 74, No. 4, November 1992,
pp. 941–950.P
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Motor vehicle production (millions, seasonally adj. annual rate)
Cars
Light trucks
Motor vehicle production
(millions, seasonally adj. annual rate)
Oct. Month ago Year ago
Cars 6.0 6.1 5.5
5.4 6.2 6.3 Light trucks
1994 1996 1997
Manufacturing output indexes
(1992=100)
Sep. Month ago Year ago
CFMMI 123.8 123.7 118.0
117.4 123.6 124.2 IP
Purchasing managers’ surveys:
net % reporting production growth
Sep. Month ago Year ago
MW 70.4 60.5 63.7
53.9 62.4 57.4 U.S.
1995
Tracking Midwest manufacturing activity
Sources: The Chicago Fed Midwest Manufacturing
Index (CFMMI) is a composite index of 16 industries,
based on monthly hours worked and kilowatt hours.
IP represents the Federal Reserve Board’s Indus-
trial Production Index for the U.S. manufacturing
sector. Autos and light trucks are measured in an-
nualized units, using seasonal adjustments devel-
oped by the Board. The purchasing managers’
survey data for the Midwest are weighted averages
of the seasonally adjusted production components
from the Chicago, Detroit, and Milwaukee Purchas-
ing Managers’ Association surveys, with assistance
from Bishop Associates, Comerica, and the Uni-
versity of Wisconsin–Milwaukee.
The CFMMI increased 0.1% from August to September, following a 0.9%
increase in August. By comparison, the Federal Reserve Board’s IP index for
manufacturing increased by 0.4% in September and 0.8% in August. The steel
sector had the strongest performance in the Midwest index, increasing by
1.2% in September, following a 1.0% increase in August.
The Midwest purchasing managers’ composite index for production increased to
70.4% in September from 60.5% in August. The national purchasing managers’
composite index decreased from 62.4% in August to 57.4% in September. Eco-
nomic activity in the manufacturing sector grew at a slower rate in September
than in August. Motor vehicle production for October decreased from 6.1 million
units to 6.0 for cars and increased from 6.2 million units to 6.3 for light trucks.

U.S. agriculture: challenges for the twenty-first century

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U.S. agriculture: challenges for the twenty-first century

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