Agribusiness Concentration Implications for Farmers and Consumers
A parable from the 1960s tells of a car owner searching under a streetlight for his lost car keys. Someone asked the car owner if that's where he lost the keys, and he replied "No, I lost them elsewhere." When asked why he was not searching where he lost the keys he said "Because there is no light there."
Populists are searching for their "car keys" under the "light" of market structure-the size, number, and concentration of firms in an industry. The keys however, are to be found in the murkier, empirically more obscure, areas of market conduct (predatory and exclusionary behavior of firms) and market performance (innovation, investment in research, efficiency, profit rate, meeting customer needs at low cost).
This brief paper searches market conduct and performance for the impact of agribusiness industry concentration. I begin with an anecdote from a trip to the grocery store last Saturday -- an experience much like that of any other Saturday. The soft drink industry structure is notable for its domination by two firms -- Coke and Pepsi. Meanwhile, the bottled water industry structure is characterized by many firms, none dominant. The important observation, however, is that market performance rather than market structure matters -- Coke and Pepsi were selling for 1.5 cents per ounce compared to bottled water at 7 cents per ounce.
The issue is not whether the agribusiness sector contains imperfect competition (it does) or some economic inefficiency (it does). Rather, the question is: Does market structure, conduct, and performance of the agribusiness sector below standards of workable competition contribute significantly to the economic problems of the family farm and consumers? In the following sections, I make a case that the answer to the question posed is no.
Rhetoric versus Reality
The issue of concentration inspires a wide gap between rhetoric and reality. Tony Smith, a philosophy professor at Iowa State University, in his paper at a 1986 conference Is There a Moral Obligation to Save the Family Farm stated that "a competitive sector sandwiched between two oligopolistic sectors will inevitably experience disadvantaged terms of trade." His statement is flawed. To be sure, economic theory predicts that if (1) input supply, (2) farm, and (3) marketing sectors begin as perfect competition and subsequently (1) and (3) become monopolistic, then the farm sector (2) will experience low prices, incomes, and rates of return relative to the input supply and product marketing sectors. However, if resources of the farm sector are mobile, then farm labor, management, and equity capital after making adjustments to incentives will earn rates of return comparable to those of other sectors.
Farm resources are mobile. To be sure, commodity terms of trade (defined as the ratio of prices received by farmers for crops and livestock to prices paid by farmers for production inputs) averaged only 39 percent of the 1910-14 average (a longstanding "parity" base period) in 1999. But due to productivity gains from improved farm inputs and management, the output from each unit of farm production resources in 1999 was 3.93 times that in 1910-14. It follows that farm real prices defined as the price received for the output of each unit of farm aggregate input averaged 53 percent higher (0.39 x 3.93=1.53) in 1999 than in 1910-14! That, along with increasing farm size and off-farm income, is the reason why farm households increased their income per farm household from farm and off-farm sources to an all time record of $60,912 in 1999, 37 times the 1933 level (adjusted for inflation) and 15 percent above average household income of the nation. At the same time labor was freed from farming to produce other benefits of an affluent society.
Resources on commercial farms with competent operators average as high as those resources would earn in other occupations, but returns are not high every year. However, compelling empirical evidence reveals that farm resources are indeed highly mobile in the long run of 5 or more years after price shocks (Tweeten 1989, ch. 4). Farm resources are not highly mobile in the short-run of up to five years. Hence farmers experience annual and cyclical periods of low income and rates of return. That annual and cyclical instability results from weather; monetary, fiscal, and trade policy at home and abroad; and from imperfect outlook expectations rather than from imperfect competition in the private agribusiness sector (Tweeten 1989, ch. 5). Stephen Koontz, an economist who has devoted his careen to the study of industry structure, concludes that "Concentration [in agribusiness] is not the cause of low prices and profitability in agriculture" (p. 1).
Why is Consolidation Occurring?
William Hefferman expresses concern for farmers over concentration of market power in clusters of agribusiness firms, and predicts that
...as the food chain clusters form, with major management decisions made by a small core of firm executives, there is little room left in the global food system for independent farmers … If the number of [US?] farmers is reduced to about 25,000 in the next decade, there will be many farm families who will be involuntarily removed from their land (pp. 12, 13).
Hefferman's presumption of only 25,000 farms remaining in a decade is premature. The number of farms fell from 1,925,700 in census year 1992 to 1,911,859 in 1997 the latest census year, or at a rate of only 0.14 percent per year (US Department of Agriculture, p.10). At this rate, 3,096 years instead of Hefferman's predicted 10 years will be required to reach 25,000 farms. The loss of farms, in fact, has gone down as agribusiness consolidation has gone up.
Farms are consolidating for the same reasons that agribusiness and indeed all industries are consolidating. These reasons include availability of large, expensive, indivisible technological capital that reduces costs per unit of output. Costs per unit are reduced, however, only if that "lumpy" capital is spread over many units of output.
Firms are consolidating also to gain advantages of task specialization. That is, costs are lower and efficiency higher by having specialists in the respective fields of management, information systems, marketing, finance, and blue-collar activities. An all purpose family member in a family firm performing each of these tasks will not do so very efficiently. Financing expensive research and development, advertising in national media, coping with risks, meeting government regulations (e.g. food safety and quality, environment), and obtaining access to national venture capital markets are also reasons to lower unit cost by expanding size through firm growth or consolidation.
Sometimes, firms utilize production and marketing contracts rather than consolidation to achieve economies of size. Koontz (p. 5) states that "I would argue that little contract production has emerged because of power. It has emerged to produce a product more consistent with low-cost processing systems and consumers wants."
In short, farms consolidate to achieve economies of farm size arising from technology rather than from pressures of (or response to) agribusiness concentration. Even in the highly unlikely case that a less concentrated agribusiness sector would raise farm commodity prices, family farms would not necessarily fare better. Benefits of higher prices would be bid into land prices and higher land prices would make entry impossible for some potential farm operators. Higher commodity prices would bring more machinery, displacing farms through consolidation.
To illustrate further, consider that Japan, with four times the farm commodity support rate of the US, lost farms at a 2.2 percent annual rate from 1984 to 1995 compared to a 1.1 percent loss rate of US farms. Major countries of the European Union lost farms at 1.8 percent per year in the same period, despite a commodity support rate twice the US level. High support prices could no offset the forces of technology. It follows that the largest "threat" to family farm numbers is not the perfidy but the productivity of the agribusiness sector in developing a new generation of inputs that function much in the way of tractors, combines, milking machines, hybrids, and pesticides to raise the output of each farmer.
The Organization for Competitive Markets (p. l ) states that:
Concentration has caused misallocation of resources throughout the food system. Because of undue market power, big lumbering agribusinesses use their market clout to redirect resources away from decentralized, nimble, independent production agriculture and rural communities to evermore overflowing corporate coffers.
The foundation for this hold statement is a mystery. In fact, the empirical evidence runs counter to the statement.
Firm enlargement and concentration have two general impacts. One is to gain economies of size and scope. The fruits of such economies in the agribusiness sector can go to consumers, farmers, or to the economizing firms.
The second major impact of increasing firm size and concentration is to confer market power. That market power potentially can be used by agribusiness firms to pay farmers less for products (or charge more for inputs) or to charge consumers more for food and fiber. Agribusiness consolidation will decrease marketing margins if the impact of size economies prevails and will increase marketing margins if the impact of market power prevails. Whether the economies of size dimension benefiting society or the market power dimension hurting society predominates cannot be answered on theoretical grounds. Fortunately, a large number of empirical studies have addressed the issue in recent years.
The most comprehensive and recent studies of the livestock and poultry industries indicate some good and bad news for society. The good news is that cost-reducing advantages of concentration far overshadow the market power effects so that marketing margins are reduced by concentration (see Azzam 1997, 1998, and Schroeter and Azzam for pork and beef; Persaud for poultry, beef, and pork). Using annual data for 1970-92, Azzam (1997) found that the cost-efficiency effects of concentration are twice the market power effects in the US beef packing industry. The bad news for farmers is that benefits of lower marketing margins are passed to consumers rather than to farmers. Agribusiness firms pay what it takes for farmers to deliver crops and livestock; in the long-run of five years or more that price averages the full cost of production including a reasonable profit on competently managed commercial farms.
Wohlgenant and Haidacher's results were consistent with a competitive food marketing sector for beef and veal, pork, poultry, eggs, dairy, fresh vegetables, and processed fruits and vegetables. Using Wohlgenant's data and econometric specification, Holloway tested for perfect competition in poultry, egg, dairy, fresh vegetable, and processed fruit and vegetable markets. The results also were consistent with perfect competition for all the commodity groups tested. Holloway's test was (strictly speaking) not applicable to the beef and pork sectors because a critical assumption was not met. Nevertheless, Holloway maintains that any departures from competition in these sectors have been relatively insignificant. Matthews et al. found that farm prices in the beef sector rise and that farm-to-wholesale spreads fall with greater beef-packing concentration. There was no evidence of exploitative behavior in the marketing sector.
Other rigorous analytical studies of the agribusiness marketing sector corroborate these results. The Grain Inspection, Packers and Stockyards Administration (GIPSA) of the United States Department of Agriculture used weekly cost and revenue plant-level data from the 43 largest steer and heifer slaughter plants to examine the effects of concentration on prices paid for cattle. "The analysis did not support any conclusions about the exercise of market power by beef packers" (GIPSA). The weekly plant level data collected by GIPSA and the scholarship exemplified by the study were in themselves strong contributions to the literature, as was the finding that cattle prices in local areas are affected very little by differences in concentration in those regions. The findings of strong regional price linkages and rapid price adjustments imply that slaughter hogs and cattle are bought and sold in a single geographic market. Thus, the results of studies examining the margin-concentration relationship using national four-firm concentration (or Herfindahl Index) data would carry over to regional markets as well.
Quail et al. (1986, p. 55) earlier estimated that slaughter cattle prices would have been 24 to 47 cents higher per cwt. in four US regions if the regions would have had lower beef-packer firm concentration ratios and hence more competition. Critics strenuously objected to these findings, however. Ward and Bullock rejected the conceptual and statistical models used by Quail et al. Ward accused the authors of underestimating economies of size-less concentration could have increased packer costs and reduced beef prices even more. Bullock noted that transportation costs and whether regions are surplus or deficit in beef production relative to consumption were not adequately accounted for by Quail et al. These factors according to Bullock might better explain price differences attributed to concentration and could support the conclusion that the beef packing industry is competitive.
The conduct and performance of farm input supply industries have been studied less than food processing and marketing industries. A review of firm input industrial organization studies raises no red flags, however, and many of the industries that supply American farmers are world-renowned for innovation and competitiveness (see Tweeten 1988; 1989, ch. 8).
Farm input supply and product marketing firms in many instances are oligopolies (few sellers) or oligopsonies (few buyers). Although it is not possible to conclude a priori that oligopoly will be more or less efficient or pay more or less for farm output than would an atomized (numerous firms) market structure, a good case can be made that oligopoly begets extensive product differentiation and advertising. Outlays are large for food advertising and may be one reason why the principal malnutrition problem in the US today is chronically eating too much rather than too little. Although too much eating is socially undesirable, it benefits farmers as producers. I have estimated that a more perfectly functioning market providing optimal nutrition would reduce domestic demand for food by 12 percent. An atomized food industry with less product differentiation, advertising, and controlled to serve the public interest likely would reduce the demand and price for farm output on average.
If agribusiness firms are wielding market power to accrue excessive profits, then cooperatives should prosper along with private agribusiness firms. Overall aggregate profits of agribusiness firms that process and market farm products average less than 5 cents out of each dollar spent by consumers for food in supermarkets. Stock market investors are highly perceptive, and they price food processing and marketing firms as slow-growth, low-profit businesses (Koontz, p.3).
The presence of producer cooperatives reduces chances for exploitation of farmers. Producer-owned cooperatives constitute approximately one-third of farm markets and are prominent in nearly all major categories of farm outputs and inputs. They have not prospered in competition with private firms. Cooperatives have consolidated at a rapid pace in recent years to compete and survive. A number of cooperatives have integrated vertically to operate in nearly all phases of farm input supply, contracting, product processing, and product marketing. Some cooperatives have consolidated or in other ways grown to a size providing countervailing power against large private firms. In fact, the size and predatory conduct of some large cooperatives has drawn the attention of antitrust agencies in recent decades.
Farming has been far more influenced by favorable performance of agribusiness bringing increased productivity than by unfavorable performance bringing high farm input prices or tow commodity prices. Productivity gains have brought massive benefits to society as a whole and hence to farmers in the long run because farm income pet capita has trended toward national income per capita.
To be sure, farmers experience annual and cyclical economic setbacks. The economic instability that is the heart of commercial farm problems is not the product of a concentrated agribusiness sector or of productivity gains, however. Weather, government policy, and business and commodity cycles are the villains.
The major source of decline in number and increase in size of family farms has been technology, especially farm machinery. Such technology is not the result of monopoly structure or sub par performance of agribusiness. Scale-influencing technologies would have caused losses in commercial farm numbers even if farm prices would have been much higher.
One cannot help but be struck by the stark contrast between vilification of agribusiness industries by populists and the absence of evidence justifying such vilification through numerous in-depth economic studies of agribusiness. There is no evidence that farm problems of annual and cyclical income instability and squeezing out of commercial family farms would be any different today if the agribusiness sector were perfectly competitive. Evidence indicates that an increasingly concentrated structure of agribusiness has maintained high performance measured by innovation, falling real marketing margins, and economic efficiency. Nonetheless, continuing study is warranted of the structure, conduct, and performance of the farm and agribusiness sectors. Antitrust policies are in place and have been and will be used to stop anticompetitive behavior and consolidation. More emphasis needs to be placed on market conduct, however, including conduct of the government (e.g., Northeast Dairy Compact) and cooperatives as well as of privates firms.
American agribusiness is the envy of the world and can take pride in helping this nation to supply the highest quality and quantity of food to US consumers at the lowest real cost in the world. Before federal antitrust agencies tamper exuberantly with such a system, it is important to remember the Hippocratic Oath "to do nothing to make the patient worse."
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