MARCH-APRIL 1997

EDITOR'S NOTE The following is a reprint of an article written by Dennis T. Avery and published in the Hudson Institute's Winter 1997 edition of the Global Food Quarterly. Mr. Avery, who previously served as senior agricultural analyst for the U.S. Department of State, is a recognized expert on international agriculture.

Has the World Shifted Back to "Farm Surplus"?

Has the World Shifted Back to “Farm Surplus” ? The illusion of world farm surplus is back in the headlines. Crop prices for 1997 are back to the levels of two years ago. It is clear now that the high world market prices for wheat, corn and soybeans in 1995/96 were a temporary spike — and the spike is now over. It seems hard to sell additional supplies of meat and dairy products in the world market.

However, the reason for the slumping prices is not that the world is back in a farm surplus situation or a lack of consumer demand for meat and milk. The reason is that the world still has all of its old farm trade barriers. Export farmers can’t get at the newly-affluent consumers in countries like China, India and Indonesia.

Bigger World Crops

World crop output in 1996/97 was high. Wheat production increased by 8% and coarse grains by 11%, while oilseed production held its own.

In wheat, the major exporters harvested 21% more production, with even the major importers getting a 5% increase. In coarse grains, exporters harvested 9% more, and importers 5% more. Trade was down slightly for wheat, coarse grains and rice (about 3% each). There isn’t a lot of carryover stock, because the U.S. Department of Agriculture and the government of the European Union (EU) no longer hold the world’s grain and oilseed carryover. The EU had 31 million tons of wheat and coarse grains as carryover into 1996/97 crop year, down from 45 million tons in 1991/92.

The U.S. had 47 million tons of carryover stocks, down sharply from some past years when the U.S. sometimes had more than 200 million tons of stocks.

The world’s importing governments and grain-using industries are just learning how to protect themselves against short crops in the absence of the USDA, with storage bins, delivery contracts, and hedges in the futures market.

The world’s grain and oilseed markets are more nervous than in years when governments held big stocks — but they are not willing to bid higher prices given the big crops that “normal” weather will produce.

Will the 1997/98 crops be large as well? Very possibly. One of the biggest changes in world agricultural outlook is the formerly setaside cropland in America freed up by the 1996 farm act. So far, it hasn’t been a very big change. American farmers are expected to plant 257.5 million acres to major crops in 1997; that is 12 million more acres than they planted two years ago, but only 5.5 million acres more than they planted in 1994. Still, U.S. farming won’t be cut back due to setaside acres, as it has been to some degree in prior years.

Does Surplus Reign

The world has had a surplus of farming resources for 120 years, ever since the steam engine opened up 1.5 billion acres of crop and pastureland in western North America, Argentina and Australia the 1870s. Steam trains and steam ships cut the cost of shipping grain from Chicago to Liverpool by half. The steam engine was followed by hybrid seeds, the gasoline tractor (releasing acres from forage for draft animals), artificial insemination, the modern broiler chicken and a whole host of developments to wring more food out of fewer acres. Technology advances continue.

France and England had record wheat crops last fall, with yields 10% above the previous record. Yields in France’s northern region ran as high as 11 tons per hectare.

In East Germany, the West German government has invested a total of $12 billion to rebuild the old Communist agriculture. The result is that yields per hectare and per cow are nearly up to the West European standard, and quality is comparable.

Swedish farmers are putting out full-color brochures bragging about their “ecological production.” They’re saying that low-yield semi-organic farming is the modern ideal.

South America's Bumper Crops

More significant changes are occurring in South America, where record crops of grains and oilseeds have just been harvested and the outlook is more of the same. South American soybeans have just produced record harvests in Argentina (13.5 million tons), Brazil (26.5 million), Paraguay (2.5 million) and Bolivia (1 million).

Argentina’s corn crop is also a new record at 14.5 million tons. Argentina is planting an extra 2 million hectares that have apparently come out of cattle pasture, and the whole of Argentine agriculture is apparently using more fertilizer and pesticides. The more intensive farming systems will probably continue. Argentina’s beef cattle will have to compete more intensively with crops, and with the dairy industry which is expanding to serve Brazil and Chile under their MERCOSUR free trade agreement.

Brazil is still trying to overcome the woeful lack of transportation facilities. The effort to dredge a channel south along the Parana River is stalled by environmental problems. (Could you get permits now to dredge the Everglades?) The “soybean king” who was trying to build his own railroad to the interior has gone bankrupt.

The latest approach will take less capital — trucking the soybeans 600-700 miles north from the Cerrados Plateau to a new barge port on the as-yet-uncharted and unimproved channel of the Madiera River for a thousand-mile voyage to the Amazon River port of Oriximina. There they will be transferred to Panamax vessels — still 1500 miles upriver from the Atlantic!

Brazil is also expanding its hog and poultry industries in the Cerrados, hoping it will cost less to transport the livestock products than the feed.

In 1997, we can expect farmers in America, Australia, Canada, Argentina, Hungary and 15 other countries to be contending for every possible export market. Every export farmer in the world remembers last year’s prices and has hopes.

The only reason for suspecting that the farming outlook might improve is progress on the demand side. What’s changing now is rapid income growth for billions of people who have never earned enough to eat well before.

For 100 years, the world’s only significant economic progress occurred in the First World countries — and their consumers were already well fed when the progress started. What’s different in the 1990s is rapid economic growth in Third World countries where billions of people are finally getting above subsistence diets.

Let’s update our information on some of the top growth markets:

Indonesian Exports Jump 65 Percent

Indonesia has 211 million people, headed for more than 300 million. (However, its fertility rate has already dropped from 5.3 births per woman in 1970 to 2.7 — and population stability is 2.1 births per woman; expect population stability about 2035.)

Meanwhile, per capita incomes have soared from about $75 per person to more than $1,000, and life expectancy has increased from 40 years to 63 years.

The Indonesian economy has been expanding by about 7% annually for the past five years. U.S. exports have quadrupled since 1987, and rose 20% just in the year 1995. Top U.S. exports have included machinery, farm products, aviation equipment and household consumer goods.

Indonesia’s farm imports from America jumped 65% (to $845 million) in 1995 alone.

Indonesia’s major exports to the U.S. include clothing, shoes and natural rubber.

The country’s wheat milling industry is expanding at 8-10% per year. Even though Indonesia does not produce any wheat, wheat will rapidly take up most of the growth in Indonesia’s food grain consumption. The country’s rice consumption is very high, and as incomes rise Indonesians will be drawn to the lower cost, higher protein and convenience of wheat foods.

Fast food restaurants such as McDonalds, Kentucky Fried Chicken and Dunkin Donuts abound in the cities, and are beginning to spread to smaller communities.

Meat consumption is expanding rapidly. The poultry industry expanded its broiler flock by 25% in 1995 alone, from 450 million birds to 600 million. The country is Moslem, so its only hog production is for export to Singapore. However, its beef cattle imports have increased from 123,000 head in 1994 to a projected 350,000 for 1997.

The animal feed industry is expanding at 10-12% annually, with much of the feed imported. Indonesia removed a 35% surcharge on soybean meal in 1992. Then deregulated its soybean meal industry — setting of a surge of imports for poultry feed. Corn imports are already nearly 1 million tons per year (out of 3.8 million tons of feed corn consumption).

The demand for fresh fruit imports is rising so fast that President Suharto has complained about its impact on the trade balance.

Milk consumption is just getting started, with consumption rising by 35% per year and production rising by only 6 %. More than half of the dairy products are already imported (so far from New Zealand and Australia).

Indonesia has already begun clearing more than a million acre of tropical forest (including a large fresh-water wetland) for expanded production of rice, oil palm, corn and soybeans. More forest land is scheduled to be cleared for cattle production.

China's Phenomenal Progress

China has now had ten straight years of economic growth at more than 10% per year. Its industrial output is rising at more than 20% per year. Such rapid growth was previously unheard-of for so large and primitive a country. Per capita incomes have risen from about $600 in 1980 to more than $1,600 — and some economists estimate that real incomes in the coastal regions may now be above $4,000 per capita.

The death of Deng Xiaoping will probably not present a serious interruption to China’s economic progress. The Western consensus is that China’s average citizens now have a clear vision of affluence — and have already enjoyed enough of it in their own pockets that Deng’s semi-capitalist policies cannot effectively be reversed. (Expect someone in China’s Communist structure to try — and fail.)

China’s population growth rate is down to about 1% annually, and the number of people is expected to stabilize about 2010. Meanwhile, per capita incomes have soared, especially in the half of the country closest to the coast. (Water is still China’s best transport facility, though its railroads are trying to catch up.)

Most of the urban households have low-cost apartments and busses and bicycles for transport, so their disposable income gains are focused on food, clothing and appliances. Most have refrigerators — and virtually all have color televisons.

China’s increase in meat production (and consumption) has been phenomenal. Annual meat consumption has jumped by 20 million tons since 1993! Since most of that is pork, figure a 5-1 feed conversion ratio — and that’s an increase in Chinese feed demand of somewhere around 100 million tons annually!

Chinese experts say they want to increase their manufactured feed industry from 30 million tons per year to at least 100 million tons by the year 2000, and possibly 120 million. Corn use in feeds is projected to rise from 20 million tons to 70 million!

While China is trying to generate that much additional feed, its consumers are also demanding more wheat, more tobacco, more sugar, more beer, more fruits and vegetables, and lots more cotton. (The textile industries are the biggest employers, with much of the output earning foreign exchange.)

China is resisting the idea of farm imports. The government buys some wheat, and in recent years has permitted vegetable oil imports to reach 3 million tons per year. However, the Minister of Agriculture continues to say, “China will produce its own food,” and the government buys only when it chooses.

China’s huge hog expansion hit a snag in 1996 because of the high feed prices. About 10% of the herd was liquidated. The extra slaughter depressed meat prices — but Chinese producers expect to have rebuilt their herds and be ready for further expansion by the end of this year.

Note also the rapid expansion in poultry. Per capita poultry meat consumption has quadrupled since 1989, with recent expansion at roughly 20% per year. The poultry flock is still only about 4.1 billion birds, however, for a population of 1.2 billion. Egg consumption in the rural areas (where the majority of the people still live) is only one egg per person per week.

Kentucky Fried Chicken has more than 100 outlets in China now. At least 75% of Hong Kong’s “poultry consumption” is smuggled into China; this totals at least 600,000 tons per year. Legal imports are only about 50,000 tons.

The potential for poultry trade with China is amazing, given that Chinese consumers prefer all the parts that Americans don’t: dark meat, wings, gizzards, feet, heads and necks. Chinese think turkey breast meat is too dry, but like turkey wings and gizzards.

Ice cream is becoming popular, even though most of the delivery trucks aren’t refrigerated! Most customers buy the ice cream as snacks on the street, since only 3% have freezers at home. (Two-thirds have refrigerators, however.) The ice cream is mainly made from milk powder, since China’s own milk production is still tiny and the refrigeration marketing chain is still weak. Several Western firms are building joint-venture dairy businesses, and they are growing rapidly.

Vegetable marketing has been revolutionized. Under Chairman Mao, it consisted mainly of dumping truckloads of cabbage in the town square, so each family could take its allotment home for winter storage on its apartment balcony. Today, consumers get a much broader range of vegetables: fresh produce is availabel much more of the year.

China is already a vegetable exporter, selling such items as frozen peas and bamboo shoots, along with such specialties as canned and dried mushrooms, canned bamboo shoots, asparagus and edible ferns.

Fruit production in China has quadrupled in the last decade, and conusmption is up radically from the austere days of Chairman Mao. Farmes are planting more land to furits, becasue they earn more than rice or cotton. Apple productio is up to enarly 17 million tons after a 20% increase in 1995.

Quality is still not up to Western standards: "storage" means putting the furit in an underground cellar or under strw on the farm, so qulaity drops quickly, and the marketing season is only 3-4 months. This has created a major niche market for imported furit in the cities. (Again, much of Hong Kong's "consumption" is smuggled across the border.)

India Rejects "Hindu" Rate of Growth

Until the 1990s, India seemed not to care about economic growth. It was wedded to a huge, creaking socialist economic system that produced more red tape than material well-being. It had nearly 1 billion people supplied by an economy the size of Belgium’s. Its per capita income was one of the ten lowest in the world at $270, and its economic growth rate was lower (1.7%) than its population growth rate (2.1%).

The World Bank says that India has 40% of the world’s desperately poor, that more than 60% of the country’s population is malnourished, and that less than half can read. Until the 1990s, India’s leadership would simply note that Indians were not very concerned about such material things.

Today, however, India is no longer willing to accept the “Hindu rate of economic growth.” Community TV sets are beaming satellite pictures of the 21st century to virtually all of India’s villages. Public awareness of the booming economic growth in China, Thailand, Taiwan, and South Korea has finally pushed India’s politicians into a growth mode of their own. In India’s last election, every one of the political parties declared itself committed to double-digit industrial growth rates!

Indian economic growth has climbed to about 7% per year, led by industrial growth of more than 11% in 1996. However, India has not yet demonstrated that it can sustain high economic growth rates as China has done.

For one thing, India is still not nearly as export-oriented as China. One-third of India’s exports are textiles, and the country has abundant raw cotton, low labor costs and a long history of textile design and manufacture. Until recently, however, Indian policy was designed to protect the existing elderly mills, producing poor-quality goods that could only be sold in Communist countries. Only recently have international marketers like Liz Claiborne and Quelle (a big German catalog firm) taken offices there.

Still, the country has already achieved a 500 percent increase in foreign investment (now $10 billion per year). The government has targeted infrastructure like ports, roads, rails, oil and gas, telecommunications and power as key investment areas. A big power project with America’s Enron Corp. has been put back on track, but only after a highly-political and highly-publicized cancellation. To encourage private infrastructure investment, a five-year tax holiday on infrastructure has now been extended to irrigation, water works, sanitation and sewage systems.

The trade policy has been cautiously liberalized — producing some remarkable examples of the size and power of India’s market. Imports of timber and paper products were liberalized in 1992, and last year India imported more than $1 billion worth of logs, timber, paper pulp and other forest products.

India likes to claim it has 250 million middle-class consumers. That doesn’t mean it has that many people enjoying personal automobiles, refrigerators and two-week vacations. But in terms of food consumption, that number may be valid.

Certainly McDonalds has been impressed enough to start opening restaurants in a country where cattle are sacred and beef consumption is taboo. McDonalds is featuring a “muttonburger with special sauce” along with vegetarian sandwiches and French fries. McDonalds will sell millions and millions of these meals because India’s consumers have the same hunger for high-quality protein as the rest of the world — and because McDonalds is selling cooking oil and convenience more than anything else.

India is not a vegetarian society that seeks to save the world’s resources. For openers, India’s milk consumption has always been high, and since 1980 it has more than doubled — to 65 million tons per year. Milk consumption is rising 4-5 percent annually. Half is consumed as fluid milk, and the refrigerated marketing chain has been greatly strengthened in recent years. Still, most of the milk comes from tiny farms with one or two cows apiece, eating mostly crop residues. Around the cities, bigger dairies have cross-bred Holsteins and Jerseys thanks to artificial insemination.

You can certainly say that it is kinder to milk an animal rather than slaughter it, but the impacts of a milk cow and a beef steer on the planet’s scarce land resources are exactly the same. Beef and dairy animals both need feed, and it takes land to produce the feed.

India, in fact, already has a severe shortage of feed for its 400 million ruminant animals. One-third of the dairy fodder already comes as leaves and branches stolen from the country’s forests. Another one-third is crop residue, which should be going back onto the country’s croplands to preserve soil tilth and help prevent erosion. In many of the urban areas, cattle and buffalo are left to fend for themselves on garbage, grass clippings, and grazing the public parks and highway traffic islands.

India has approximately 45 million sheep, and 120 million goats. There is a strong preference — and price premium — for goat meat over mutton. Both sheep and goats are kept by the lowest-income rural residents, grazing their poorest land; they do such serious damage to the trees that 40% of the “forests” reportedly produce no usable wood.

Dairy and poultry look like the big expansion elements for the future, but a great deal of red meat will also be consumed.

Two-thirds of India’s Hindus indicate that they will buy meat when they can afford it. They will not eat beef, but Hindus will eat mutton, goat — and especially poultry meat and eggs.

Poultry production has taken off in the past 15 years, with efficient integrated producers. Poultry meat output is up from 180,000 tons in 1980 to 525,000 tons in 1995. Egg production has doubled, reaching 28 billion eggs in 1995. Poultry production is growing at 10-15 percent per year. India says production will reach 1 million tons meat and 40 billion eggs by 2000. Even those consumption levels are very low by international standards.

The poultry industry has access to plenty of protein meal. (India still exports it.) But there are seasonal shortages of grain, especially corn. The high price tag on vegetable oil has prevented use of fat in feeds. Poultrymen have tried to buy the poor-quality wheat in government stocks, but so far have not been allowed to do so.

There is a struggle over control of the dairy industry. The powerful dairy cooperatives are trying to keep private dairy plants from getting more milk for processing into ice cream, cheese and other dairy products. The coops say it would create a shortage of fluid milk, and drive up consumer prices. But India’s dairy product prices are already far higher than world market levels, because of the unmet demand. What about just producing more milk? Eventually, India will. (Imports of powdered milk are legal — surprisingly — but nobody has imported it because of the political sensitivity.)

India’s food grain production is fully adequate and setting records year after year. In fact, India has recently been exporting wheat and rice (3.5 million tons last year). That’s on top of holding the world’s largest food security reserve (26 million tons last year ) against the possibility of their next monsoon failure. (It’s been ten years since their last big drought; they normally have a monsoon fail one year in five, so they’re overdue.) India has even had room to double their cotton production in the last decade.

Nevertheless, the dairy, livestock and poultry industries will face severe feed shortages.

The Indian government is even more hostile to farm imports than China. Only vegetable oil and pulses (peas and bean) have been imported on a regular basis. (U.S. dried green peas are packaged locally and labeled as a U.S.-grown premium product.)

India tried urgently to produce all of its own vegetable oil too. But even cooking oil prices at three times the world market level weren’t enough to stimulate adequate vegetable oil production.

The concept of food security is even more sensitive in India than in China, because of the frequent monsoon failures. The Indian rural vote is also highly volatile. Thus, would-be exporters will need to present “feed imports” as a different concept than “food imports” when the time comes.

The Real Problem: Trade Barriers

The global picture is remarkably clear and consistent: We have huge numbers of newly-affluent consumers in what used to be poor countries, trying fervently to improve their diets. They especially want more wheat, meat, milk, eggs, fruits, vegetables and cotton.

We also have large number of export farmers who would like to supply that growing demand, mostly from land that is already in agriculture, but being farmed below its potential.

As a bonus, we have flocks of scientists with good ideas on how to get more production from the existing acres, safely and sustainably, with technologies like modern pesticides, soil-saving conservation tillage and closely-regulated biotechnology.

But at the same time: Indonesia is deliberately destroying tropical forest for low-yield production of cattle and chickenfeed.

China’s government, not Chinese consumers, is making that country’s buying decisions. It is choosing not to import much, even though it penalizes its citizens with high food costs and misdirected capital investments.

India is almost flatly rejecting farm imports and ignores how that penalizes consumers and how it overstresses India’s croplands and forests.

The American farm problem isn’t Canadian durum wheat exports, or Mexican feeder calves coming across our border, or a few tons of fragrant rice imports. The problem is closed farm trade barriers in Asia.

The WTO is the key to wealth for every country in the world.

Fortunately, the solution is at hand: The World Trade Organization. The WTO is the key to wealth for every country in the world. Trade is and will be that important to all countries in the long run — but it is especially important right now for emerging countries still trying to build wealth and income sources through exports. Countries like China and India cannot afford to stay out of the WTO, because their opportunities to export would be severely constrained.

Membership in the WTO already requires countries to dismantle most of their nonfarm trade barriers. If the WTO required dismantling farm trade barriers as well, these countries would still join — and be even better off. The WTO rules would defend the emerging-country governments from their own farmers’ demands for protection. This would be extremely valuable in protecting their urban work forces against too-high food prices, and defend the governments themselves against politically-popular rural investments that were unlikely to pay dividends.

Affluent countries that are already spending heavily on farm subsidies would also be better off. They could get lower food prices and much lower tax costs.

Western Europe’s farm subsidies are costing its consumers and taxpayers more than $150 billion per year, and the subsidies are not even keeping small farmers on their farms or protecting the traditional landscapes of the countryside. The farm subsidies, through the tax they impose on new job creation, are also a major factor in Europe’s double digit youth unemployment figures.

The countries which are well-positioned for farm exports would obviously be better off. Their rural communities would be helped especially. The income benefits to farmers have already been recognized in last year’s surge in farm land prices — after just one teasing year of strong grain exports to China. (Argentine land values jumped 30%.)

WTO farm trade liberalization would also usher in a “golden age” for the rural communities in the farm exporting countries.

In America, the new nonfarm employment opportunities in farm supply, farm processing and farmer services would come as a wonderful surprise — after Federal cropland setaside programs which reduced rural nonfarm jobs by an estimated one-third.

The list of export farming nations that would benefit will include the United States, Canada, Argentina, Brazil, Bolivia, Chile, Peru, Australia, New Zealand, Hungary, Poland, Romania, Turkey, Vietnam, South Africa, France, Denmark and the Netherlands.

Many of these will benefit as both exporters and importers, with comparative advantage increasing profits in both directions.

U.S. Agriculture Must Lead the Way

In one sense, the payments under the 1996 farm act are a blessing, a golden parachute. But if they distract American agriculture from what must be done to ensure farm prosperity once the payments end, then they will have worked against farmers’ interests.

And the payments will end. The Federal government will be engulfed in the looming wave of entitlement payments when the Congress takes up the question farm subsidies again about 2002.

Even before that, however, American farmers will have had the opportunity to set farm trade liberalization in motion. The WTO takes up farm trade in 1999. American farmers will have every incentive to push for the full liberalization that we had placed on the table but did not fight for in the Uruguay Round.

There is only one country big enough and interested enough to lead the WTO liberalization of farm trade. That country is the United States. If American farmers don’t care enough about free farm trade to spearhead the effort, they won’t get it any time soon.

European farmers, who fought against farm trade in the Uruguay Round, have since learned that the Common Agricultural Policy is shifting its focus to Eastern Europe and to small farmers who manicure the landscape. The Europeans cannot lead the reform, but they will accept it. The 15 or so major nations of the Cairns Group will support the reform, as they did in the Uruguay Round.

Unquestionably, the key to ending farm surpluses lies in the hands of American farmers.

Reprinted from: The Global Food Quarterly, Winter 1997, Number 19.

What Is The Farm Safety Net, And Will Congress Fund It?

by Michael McLeod

During the debate on the 1996 Farm Bill, there was extensive discussion about the adequacy of the “farm safety net.” The concern expressed by opponents of Freedom to Farm was that farmers would get a certain level of payments whether they needed them or not, but they would not have the advantage of larger payments if crop prices plummeted. In their words, the farmers would no longer have a viable safety net. As a result of this concern, Congressional farm leaders and Secretary Glickman have expressed increasing interest in establishing a better program of risk management – to enable farmers to better manage their own risks.

With the enactment of the “Freedom to Farm” bill, farmers no longer qualify for “deficiency payments” that are based on prices being below a targeted level. In return, farmers are guaranteed a fixed (but declining) payment through the year 2002, and they get almost total freedom to plant whatever crops they wish. The government is thereby removed from the process of trying to manage supply and dictate what farmers can plant.

How Much of Agriculture Had a Safety Net?

Despite all of the attention given the safety net or lack of one during the 1996 Farm Bill debate, the fact is that the majority of American agriculture has not had a strong safety net in the past.

While the program crops that receive direct federal assistance get most of the attention, a majority of all agriculture has not traditionally received price and income support. The commodities that have had federal price and income support (wheat, feed grains, cotton, rice, soybeans, peanuts, sugar and tobacco) accounted for approximately $61 billion in total value of crops grown in 1994. However, the total value of all crops grown in the United States for that year was $103 billion.

The total value of livestock and poultry in 1994 (cattle, hog, dairy, sheep, lambs, goats, chickens, turkeys and eggs) was $77 billion. Only the $20 billion of dairy products was protected by a price support program. Therefore, the commodities receiving federal price and income support totaled only $81 billion out of a total of $180 billion of all agricultural products.

It is important to note that although less than one-half of agriculture has received direct governmental assistance, the assistance has been critically important in those parts of the country that are the major producers of the affected commodities — such as cotton in the Southeast, corn in the Midwest, and wheat in the plains states. The majority of American agricultural production has been produced for the market with little Federal assistance. However, government price support has been crucial in the past, because agriculture has been an industry with very thin profit margins.

The Administration's Position

In response to a question in the November-December issue of The Agricultural Law Letter, Secretary Glickman indicated that USDA’s Risk Management Agency is developing a coordinated approach to increasing the safety net for farmers through several initiatives that center on expansion of the crop insurance program, risk management education and increased program integrity. According to the Secretary, their strategy is to:

1. clarify the authority to provide revenue insurance on a nationwide basis,
2. improve the process for submission and approval of new insurance products developed by the private sector,
3. provide more flexibility for new pilot programs and improvement of existing programs and incentives for more customer participation and satisfaction, and
4. launch an aggressive new risk management education program.

The Secretary indicated that the Administration’s budget will be designed to support these initiatives with adequate funding and any new legislation that may be required.

Unfortunately, the Administration’s budget that was submitted to Congress earlier this year falls far short of providing adequate funds for the multiple peril crop insurance program, let alone additional funding for a more comprehensive risk management program that includes revenue insurance.

The Administration budget seeks to partially make up a budget shortfall in funds to deliver the program by taking the money from the providers of the service, the federally-reinsured private crop insurance companies and their agency force, thousands of independent insurance agents. These companies and agents deliver the program by selling the policies to farmers and by providing the loss adjustment and other servicing functions. Also, the private companies assume the potential of underwriting loss on the policies in return for the potential to earn underwriting gain.

Although the budget document indicates that the Administration will submit legislation to reduce the reimbursement rate from the 28% of premiums required by the current law to 24.5%, no legislation has been submitted as this article is written. Also, the Administration has not yet submitted legislation which would increase the authority for revenue insurance products on a nationwide basis.

Marketing Assistance Loans

Marketing assistance loans are still available to farmers who signed up under production flexibility contracts in 1996. Basic nonrecourse commodity loans are retained but modified. Farmers may receive a loan from the federal government at a designated rate by pledging and storing a quantity of a commodity as collateral.

Loan rates for wheat and corn continue to be based on 85% of the preceding five-year olympic average (excluding the high and low price years) of farm prices. Wheat and corn loan rates may be reduced by up to 10% depending on the projected stocks to use ratio. Maximum loan rates for wheat and corn are established at the 1995 levels. Loan rates for sorghum, barley and oats are set at levels considered “fair and equitable” relative to the feed value of corn.

Loan rates for oilseeds also are based on 85% of the previous five-year olympic average of farm prices. Soybean loan rates are limited to $4.92-5.26 per bushel. Minor oilseeds are based on 85% of the five-year olympic average within a range of $0.087-0.093 per pound. The upland cotton loan rate continues to be the lesser of 85% of the previous five-year olympic average farm price or 90% of the Northern Europe-based average price but not less than $0.50 per pound or more than $0.5192 per pound (the 1995 level). Loan rates for rice are frozen at the 1995 level of $6.50 per hundredweight.

Marketing loan provisions are retained for feed grains, wheat, rice, upland cotton and oilseeds. Those provisions allow a farmer to repay a commodity loan at a rate less than the original loan rate when prices are below loan rates. Upland cotton and rice repayment rates are the lesser of the loan rate or the prevailing world market price.

Payment Limitations

It is important to note that the total amount of contract payments made to a person under one or more production flexibility contracts during any fiscal year may not exceed $40,000, a decrease from the $50,000 allowed under the previous farm law.

Marketing loan gains and loan deficiency payments are limited to $75,000 per person. The “three-entity rule” is retained. That means a person can receive contract payments, directly and indirectly, marketing loan gains and loan deficiency payments through no more than three entities up to a total of $80,000 per year. The limits are $40,000 on the first operation and $20,000 each on two additional entities. Limits on marketing loan gains continue at $75,000 on the first farm and $37,500 on each of two additional entities.

Price Support Loan Programs

Some farm programs have not relied on direct subsidies in order to supplement farm income. They have instead attempted to stabilize farm income by a system of price support loans. These are the peanut, sugar and tobacco programs.

Peanuts

For peanuts, the program is revised to make it a “no net cost program.” The quota support rate is frozen at $610 per ton, reduced from $678 in 1995. Loans for additional peanuts remain available. The marketing assessment is 1.15% of the loan rate for the 1996 crop and 1.2% for the 1997-2000 crops, shared by growers and purchasers.

The minimum national quota and provisions for the carryover of under-marketings are eliminated. “Quota” is redefined to exclude seed. Government entities and out-of-state nonfarmers cannot hold quotas. The sale, lease and transfer of quotas are now permitted across county lines within a state up to specified amounts of quota annually.

Sugar

Sugar price support loans and the associated tariff-rate quota for imports are retained. The raw cane sugar loan rate continues at 18 cents per pound. The refined beet sugar loan rate also is frozen at the 1995 level of 22.9 cents per pound. Loans are recourse when the level of the tariff-rate quota is at or less than 1.5 million short tons, raw value. If the quota is increased above that level, loans become nonrecourse. Cane processors must pay a penalty of $0.01 on each pound of sugar forfeited to the government; beet processors pay a $0.0107 per pound penalty. Marketing assessments paid on all processed sugar increase from 1.1% to 1.375% of the raw sugar loan rate for sugar cane processors and from 1.1794% to 1.47425% of the raw sugar loan rate for beet sugar refiners. The authority for domestic marketing allotments for sugar was repealed.

Tobacco

Programs to support and stabilize tobacco prices have been operated by the Federal Government since the early 1930s. Currently, the price of tobacco is supported through a combination of farm marketing quotas on an acreage-poundage (flue-cured) or poundage (burley) basis and minimum price support loans.

The program is operated at no-net-cost to the government and its taxpayers through the imposition of assessments on both quota holders/producers and tobacco buyers to cover the costs of administration and price support. Cooperative associations comprised of tobacco growers administer the program and levy the assessments on behalf of USDA.

There are approximately 124,000 growers of tobacco and an additional 236,000 quota holders involved in the tobacco price support program. While amended from time to time, the tobacco program, unlike all other price support programs, enjoys a permanent authorization that does not require periodic action by Congress.

Dairy is Supported by Government Purchases

In the case of dairy, the government has used a system of government purchases and marketing orders to maintain dairy prices at the desired level. Under the 1996 law, the minimum milk support price declines from $10.35 per hundredweight in 1996 to $9.90 in 1999, at a rate drop of 15 cents per hundred per year. The price support is eliminated after Dec. 31, 1999. Government purchases of butter, nonfat dry milk and cheese continue through 1999. Starting in 2000, a recourse loan program is implemented for butter, nonfat dry milk and cheese at loan rates equivalent to $9.90 per hundredweight for milk.

Crop Insurance Provides A Yield Safety Net

For all program crops except for peanuts, sugar and tobacco, the remaining basic safety net against price disaster is the marketing assistance loan program previously described, which essentially provides a guaranteed loan rate of 85% of the preceding five-year price. While this remaining safety net is more protection than most of American agriculture has traditionally received, it is a far cry from the level of government protection and “safety” to which many producers of program crops have grown accustomed.

Therefore, increased attention has recently been paid to the federally-reinsured crop insurance program, or multiple peril crop insurance program (MPCI), which provides yield protection. This program provides farmers with the opportunity to purchase government subsidized insurance of their proven yields. Coverage levels range from 50% to 75% of the farmer's yields.

The crop insurance program in its current form began with the enactment of reform legislation in 1980. After years of progress, in the early 1990s there remained an inability to get the majority of the nation’s farmers to purchase crop insurance and to not depend on government disaster bail-outs. However, with the enactment of the Crop Insurance Reform Act of 1994, this scenario changed dramatically. Congress repealed existing disaster bail-out authorities and expanded the crop insurance program to cover most of American crop production.

The law required that farmers sign up for at least the catastrophic level of production in order to qualify for farm program benefits. This new catastrophic coverage, known as CAT coverage, provided farmers a minimal level of protection for no premium charge.

The amount of protection is 50% of the producer’s historic yield insured at 60% of the Federal Crop Insurance Corporation indemnity price. This coverage was provided basically free, with the farmer paying only a $50 administrative fee for each crop insured on a county basis. Its purpose was to provide all farmers with at least a minimum level of yield protection and, therefore, eliminate the necessity for disaster bail-outs.

Subsequently, in the 1996 Farm Bill, the mandatory nature of CAT coverage was eliminated, yet producers opting not to carry the coverage are required to sign a waiver of any disaster benefits on insurable crops.

Most Crop Producers Are Covered

By all objective criteria, the federal crop insurance program has succeeded in delivering a significant level of yield protection to American agriculture. In 1996, farmers across the country held over 2.2 million multiple peril crop insurance policies of all types. These policies provided coverage on more than 203 million acres of crops — over twice as many as were insured before the 1994 reform of the program. For that protection, farmers themselves paid $830.4 million.

The majority of the acreage in these programs was "buy-up" or "additional" insurance, not the minimum catastrophic insurance. Under the buy-up or additional insurance (the traditional multiple peril crop insurance program), a farmer is able to insure up to 75% of his proven yield at the USDA’s established market price.

Revenue Insurance — The Next Step

Because of the concern of many members of Congress and the Secretary of Agriculture, there is increased emphasis on allowing farmers to purchase not only yield insurance, but also price or revenue insurance; hence the increased level of rhetoric on better risk management and the emphasis on new risk management programs.

USDA’s Risk Management Agency (RMA) is experimenting with three types of revenue insurance that extend coverage to include fluctuations in price. One type is the Income Protection (IP) program developed by RMA. This program has gained very limited acceptance. The Iowa Farm Bureau developed another type called Revenue Assurance (RA) and it is available to Iowa corn and soybean farmers in the 1997 crop year. However, the principal revenue insurance product is Crop Revenue Coverage (CRC). Developed by American Agrisurance, Inc. (located in Council Bluffs, Iowa), this product is reinsured by the FCIC, and it has enjoyed wide popularity among farmers. CRC was first offered last year for corn and soybeans in Iowa and Nebraska. This year it has been expanded to include cotton, grain sorghum and wheat and been made available in several additional states and counties.

CRC provides a revenue floor when prices decline and allows for recomputation of the revenue guarantee at harvest time to adjust for increasing price changes in the futures market. CRC provides for unit coverage similar to the underlying multiple peril crop insurance (MPCI) policy.

The new revenue insurance products, particularly CRC, are extremely popular with many farm groups and with their members of Congress. However, the Chairman of the Senate Agriculture Committee Senator Lugar (R-IND) has been very critical of the new programs and questioned whether the taxpayer should assume a role in helping farmers insure their price. He has correctly pointed out that farmers can purchase price protection in the futures and options markets.

Other members of Congress feel that the cost of a revenue assurance program would be a very wise investment in the view of the protection that it would provide for American agriculture.

The Government Safety Net Funding Challenge

Aside from Chairman Lugar’s concerns about revenue insurance, there is the basic question of whether Congress will provide the funding level necessary to make even the basic crop insurance work. A $200 million shortfall of funding for the program must be addressed in order for the program to be delivered next year.

As in the rest of government, there is tremendous pressure to reduce spending for federal agricultural programs. The current and fiscal year 1998 cost of the federal crop insurance program is approximately $1.7 billion. This is a considerable savings from the annual $4 billion that was routinely paid for a combination of wasteful government bail-outs, government-subsidized emergency loans and the federal crop insurance program over the last ten years.

Despite all of the lofty rhetoric about the need to provide farmers with a better safety net, it remains to be seen whether the political will to fund the safety net even exists.

During the debate on the agricultural appropriations bill last Spring, the House agriculture appropriations subcommittee was faced with having to reduce agricultural program spending. The available funds were so tight that the House Agriculture Appropriations Subcommittee felt compelled to reduce the money set aside for the 1997 transition payments to farmers under the new farm act. Despite the small reduction proposed, $98 million out of $5.385 billion, the proposal sent shockwaves through the farm community and sparked a flurry of political activity on Capitol Hill.

House Appropriations Committee Chairman Bob Livingston (R-LA) allocated another $73 million to the agricultural subcommittee and that (combined with reductions in the Export Enhancement Program spending) restored full funding for the transition payments.

That experience demonstrated just how fragile payments promised under contract to farmers can be when they are faced by a Congress with ever-increasing budget and appropriations pressures. Luckily, the reductions did not occur, but the possibility that they could occur was ominous for farmers and their Washington representatives.

The Past Is The Best Predictor Of The Future

The history of agriculture has made two lessons abundantly clear:

1. There will be major crop disasters. No one can predict either the incidence or severity of these disasters, but we know from experience that they will happen.
2. When agricultural prices are high, they will inevitably decline. The cyclical nature of agricultural commodity price levels is well documented throughout history.

The unanswered question is whether Congress is willing to provide enough of a yield and price safety net so that farmers who have been accustomed to receiving government assistance can protect themselves and survive such weather disasters and price drops. At this point, it is by no means clear whether there is the political will to do so.

Mr. McLeod is a partner in the firm and practices agricultural and agribusiness law. He is a former General Counsel and Staff Director for the Senate Agriculture Committee.

USDA Issues Dairy Order Reforms

by Wayne R. Watkinson

USDA issued a preliminary report in mid-April that details alternatives to the basic formula price (BFP) for milk. The BFP committee that tabled the options evaluated the alternatives “against the criteria of stability, predictability, simplicity, uniformity, transparency, sound economics and reduced regulation,” according to the report’s summary.

The BFP report followed the March release of three reports dealing with Class I price structures, milk classification and identical federal order provisions. All are part of the federal milk marketing order reform that is mandated by the 1996 farm bill. The full rulemaking procedure is expected to take most of the rest of this year to complete.

Processors, Producers React in Disappointment

Neither processor nor producer dairy industry officials like the approach USDA has taken with its reports on market order reforms, especially the latest one dealing with possible alternatives to the basic formula price. The main objection to USDA’s approach among industry officials is that no specific direction is provided. The scope of the full range of options was narrowed a bit, but USDA did not close the door on any of the options that have surfaced within the industry.

The International Dairy Foods Association issued a statement that summed up what many producer and processor representatives felt: “It is nearly impossible to evaluate USDA’s individual reports, including the most recent one on the BFP.” Each report, including three issued in March, has several options. So with five reports (three in March, a consolidated federal order map issued late last year and the BFP), “there probably are about 100 possible combinations,” said IDFA, making the association “hesitant” to comment on any of them.

Suggested Changes to the BFP

Options considered as alternatives to the BFP included economic formulas, California pricing, competitive pay price, product price and component formulas, cost of production, pooling differentials only, futures markets and informal rulemaking. The committee identified four options for “further discussion and debate.”

1. A four-class, multiple component pricing plan to price butterfat, protein and lactose used in cheese (class III) and butterfat and nonfat solids used in butter-powder (class IV);
2. A three-class, multiple component pricing plan to price protein used in cheese, butterfat used in butter and other nonfat solids used in powder (class III, one manufacturing class);
3. A product price formula computed from the butter, powder and cheese shares of U.S. production, using seasonal product yields and a California cost-based make allowance;
4. A competitive pay price series using a national weighted average price paid for grade A milk used in manufactured products, updated by a product price formula. The price series would contain an adjusted to attempt to remove the effect of current regulation and to reduce it to a level more comparable to the current BFP.

With the release of the BFP report, dairy industry organizations and other interested parties have about six weeks to meet the June 1 comment deadline. USDA made no attempt to evaluate the impacts of the March reports on producers, processors or anybody else.

In the Class I price structure report, USDA included Class I differentials in several areas of the country different than now structured. That could result in some lower prices to farmers. However, a problem remains in that the differentials have not yet been added to any basic price.

Increases in the BFP, for example, when added to lower differentials, may not change the current pricing structures much. But there may be impacts on manufacturing milk, fluid milk, for different products in different regions of the country, depending on the BFP reforms adopted.

Summary of Classification Report

In the classification report, USDA recommends that eggnog be reclassified from Class II to Class I; that any fluid beverage having less than 6.5% nonfat milk solids be reclassified from Class II to Class I, and that cream cheese be reclassified from Class III to Class II.

Currently, products packaged for fluid consumption, such as whole milk, skim milk, buttermilk and flavored milk drinks are classified as Class I products. Class II products include ice cream, yogurt, cottage cheese and cream. Class III and Class III-A products include cheese, butter and nonfat dry milk.

The technical report also recommends changing the classification of milk used in nonfat dry milk from Class III-A to Class III. If Class III-A pricing is not eliminated, four alternatives are recommended for consideration:

1. Place a floor under the Class III-A price;
2. Restrict Class III-A pricing to certain months or to certain markets;
3. Provide an “up charge” for nonfat dry milk used in higher valued products;
4. Provide for a combination of those three options.

Maintaining the classification of milk used to make nonfat dry milk in Class III-A also is an option but not discussed in the technical report. The report addresses Class III-A pricing because of industry concerns about the substitution of nonfat dry milk for fluid milk in Classes II and III uses when the Class III-A price is substantially below the Class III price.

Summary of Pricing Options

Most Class I pricing concepts that were suggested earlier to USDA would continue to employ a market-driven basic formula price with an added differential. Differentials are a composite of one or more elements: (1) a fixed component, (2) a location adjustment, (3) an adjustor relating to utilization or (4) the cost of balancing the market. The following options were developed by USDA as pricing options.

Option 1A (location-specific differential): $1.60 per cwt. fixed differential for three surplus regions (Upper Midwest, West and Southwest) within a nine-zone national price surface plus for the other six zones, an added component that reflects regional differences in the value of fluid and manufacturing milk.

Option 1B (modified location-specific differential option): $1 per cwt. fixed differential plus an added component that reflects the cost of moving bulk milk to deficit markets.

Option 2 (relative use differential): $1.60 per cwt. fixed differential plus a formula-based differential driven by the ration of Class I milk to all other uses of milk.

Option 3A (flat differential option): $1.60 per cwt. flat differential, uniformly applied across all orders to generate an identical minimum Class I price.

Option 3B (flat differential modified by Class I use): $2 per cwt. differential in markets where Class I utilization is less than 70% on an annual basis and a differential equal to $2+$0.075 (Class I use %-70%) in markets where the Class I utilization is equal to or exceeds 70%.

Option 4 (demand-based differential): $1 per cwt. fixed differential plus a transportation credit based on location of reserve milk supplies.

The report provides estimated differentials for the suggested 10 consolidated orders and for the current 32 federal milk marketing orders. USDA wants comments on the options proposed and has included a series of questions for public comment on the issue of Class I pricing.

Summary of Identical Provisions Report

Federal milk marketing orders include provisions that establish regulations for the operation of the orders. Over time, the orders have been individualized for specific situations associated with a given marketing area. However, USDA believes there are several provisions within the orders that are similar or that could be similar and still provide for efficient and orderly marketing of milk.

The technical report suggests a model for establishing the consolidated orders and provides suggestions on the order language that can be adopted uniformly throughout all orders. The report also reviewed, simplified, modified and eliminated differences in order provisions that (1) define various terms used in the orders; (2) establish regulatory standards for plants and handlers; (3) provide for uniform reporting dates of milk receipts and utilization; (4) provide for uniform dates for payment of milk, and (5) provide for computation of a uniform price. In addition, the report suggests how to reduce performance standards to make it easier for producers to associate with a market.

Definition of a Producer-Handler

USDA said one suggested change in the report may stimulate some debate: the definition of a producer-handler. The report suggests applying the most liberal standard to the producer-handler definition to prevent any producer-handler from becoming regulated as a result of milk order reform.

Producer-handlers have been exempt from full regulation because they assume the full risks associated with being a producer and a distributor of milk produced with only occasional and small volumes of milk purchased from other dairy farmers.

Mr. Watkinson is a partner in the firm and specializes in agricultural and agribusiness law.

International Trade Attorney Joins the Firm

McLeod, Watkinson & Miller is pleased to announce that Dale E. McNiel has become a partner in our firm.

McNiel is one of the world’s leading attorneys having an expertise on the provisions of international agreements regulating the trade of agricultural products. His extensive experience will greatly benefit our team of lawyers and government relations specialists. McNiel will be uniquely situated to bring this broad public sector experience to bear in helping to solve the problems of clients in the private sector.

“Our firm is fortunate indeed to have someone of Dale’s stature and experience,” said partner Michael R. McLeod. “His extensive experience in trade issues enhances our firm’s ability to serve our present clients more fully, and it will expand our practice into new and exciting areas.”

McNiel was recently a senior counsel in the office of the General Counsel at USDA. In this position, he helped develop U.S. positions and actively participated in the seven-year Uruguay Round of multilateral trade negotiations for the World Trade Organization (WTO) Agreement on Agriculture and for the chapter on Agriculture and Sanitary and Phytosanitary Measures of the North American Free Trade Agreement (NAFTA). McNiel also worked on a number of international dispute settlement cases brought under the provisions of the General Agreement on Tariffs and Trade (GATT), the WTO Agreement on Sanitary and Phytosanitary Measures, and the NAFTA, including a U.S. challenge to Canadian quotas on imports of ice cream and yogurt, a European Community challenge to the U.S. quotas on imports of sugar-containing products under a GATT waiver for actions under section 22 of the Agricultural Adjustment Act of 1933, as amended, the U.S. challenge to Canada”s tariff-rate quotas on imports of dairy, poultry, eggs, margarine and barley, a U.S. challenge to the European Community’s ban on imports of meat derived from animals treated with certain growth hormones, and two U.S. challenges to a wide variety of Korean import barriers (including shelf-life requirements, inspection practices, fumigation for cosmopolitan pests, incubation for medflies, sorting for spoilage, information requirements, and other practices). He also provided legal advice on a wide variety of other trade programs and laws. Prior to joining the General Counsel’s Office, McNiel worked in the Food Safety and Inspection Service where he drafted the guidelines for inspecting imported meat and poultry.

In addition to providing legal advice to the Secretary of Agriculture and other top officials at USDA, McNiel worked closely with trade officials at the Office of the U.S. Trade Representative, the U.S. Customs Service, the International Trade Commission, and the Departments of State and Commerce as well as Members of Congress and Congressional staff. He drafted regulations, legislation, several Presidential Proclamations, and pleadings and briefs for civil litigation. He participated in both civil and white collar criminal proceedings. He is the only USDA attorney ever to receive the distinguished service award, and he has received a host of superior service and merit awards.

“After 13 very rewarding years at USDA, I believe I bring to McLeod, Watkinson & Miller a broad understanding of international trade matters and of the legislative, administrative and judicial processes of the federal government,” said McNiel. “I hope to translate the experiences and success I have enjoyed in the public sector into similarly successful actions on behalf of our clients, and I look forward to a challenging and rewarding career with this firm.”

The Agricultural Law Letter is published to highlight recent changes and developments in the law and public policy. As with any publication of this type, it is essential that before any action is taken based upon this information, competent, individualized, and professional advice should be obtained. Copyright 1997 by McLeod, Watkinson & Miller. Reproduction in part or in whole is permitted with permission from McLeod, Watkinson & Miller. Contact Suzanne Bucciarelli at (202) 842-2345, or write to One Massachusetts Avenue, NW, Suite 800, Washington, D.C. 20001. Subscriptions to the newsletter are $25 per year.