November 1998 SCSB# 390
Chapter 2 Policy, Trade, and Competition: Forces Shaping the U.S. Peanut Industry Changping Chen and Stanley M. Fletcher AbstractDomestic policy reform, increasing imports of foreign peanuts, and potential foreign competition are the leading forces reshaping the U.S. peanut industry. This study analyzed both short- and long-term impacts of these forces on the peanut industry. Results indicate that the changes in domestic peanut program accompanied with increasing imports of foreign peanuts as a result of the General Agreement on Tariffs and Trade (GATT) and the North American Free Trade Agreement (NAFTA) would reduce American peanut growers' farm income substantially, eliminate government costs for peanuts, and transfer peanut farmers' income to consumers, importers, and foreign producers. Findings also indicate that American peanuts were less competitive in the world market compared to its major export rival–China. The changes in domestic and international markets present the U.S. peanut industry with serious challenges at this special policy transition period. The long, acrimonious debate on the U.S. peanut program was concluded when the President signed the Federal Agricultural Improvement and Reform (FAIR) Act of 1996. The Act symbolizes that the U.S. peanut industry is entering an era characterized as eliminating government program costs and shifting U.S. peanuts to an increasing competitive arena. Under the new seven-year peanut program, Congress reduced the quota support price to $610/ton from $678/ton and eliminated minimum quota floor, price escalator, and undermarketings. Based on the Act and anticipated domestic market demand, the U.S. Department of Agriculture reduced the annual basic quota poundage from 1.35 million tons in 1995 to 1.1 million tons for 1996 crop year. Accompanying domestic policy reform, GATT and NAFTA with its transition mechanism, continue to open the U.S. domestic market to foreign peanuts and peanut products. U.S. peanut exports have not expanded as expected since the initiation of NAFTA and the new GATT and is not expected to increase in the next couple of years (Man-Producten Rotterdam B.).1 However, minimum import access levels for edible peanuts and peanut products under the trade agreements were about 96,298 short tons in farmer stock peanut equivalent in 1995 and will reach to about 135,669 short tons by year 2000 (Fletcher et al.). Increasing imports of foreign peanuts squeezes domestic edible peanuts out of the domestic food market due to their lower prices and induces further quota reduction by the government. Domestic policy reform, international trade, and increasing competition from foreign countries are changing the American peanut industry. Many are convinced that these forces will alter peanut growers' livelihoods since peanut production with a support price has been an economic backbone in many peanut-producing areas for more than five decades. Based on the 1992 Agricultural Census, seven states produced about 98 percent of U.S. peanuts. Of the seven states about 36 percent of the peanut-producing counties had 35 percent or more of their total crop income from peanuts. Twenty-four percent of the counties had 50 percent or more of their crop income from peanuts. From a state perspective, crop income from peanuts in the peanut-producing counties amounted to about 48 percent in Virginia, 50 percent in Oklahoma, and 70 percent in Alabama. Because of the highly concentrated peanut production, changes in policy and increasing imports could create difficulty for local rural communities to absorb the economic shock in a short time frame. While the bulk of literature (Borges; Earley; Fleming and White; Nieuwoudt et al.; Sanford and Evans; Song et al.; U.S. General Accounting Office) has examined various parts of the peanut program, no study has examined how this peanut program reform, in concert with trade and foreign competition, affects the U.S. peanut industry. An understanding of these factors that shape the U.S. peanut industry will be of particular interest to policy makers, peanut leaders, and peanut producers. The objective of this analysis is to examine the economic impact of domestic peanut policy reform and increasing peanut imports on the U.S. peanut industry. Specific objectives include the evaluation of the economic impact of domestic peanut program reform and increasing imports due to GATT and NAFTA on peanut producers, consumers, and government expenditures; and the analysis of the potential foreign competition faced by the U.S. peanut industry. Analytical FrameworkThe reform of the peanut program was driven by political pressure of increasing treasury costs to the government in the recent years (Borges) and the overall political climate towards supply management programs resulting in significant differences in the domestic and world prices. Increasing foreign competition as a result of GATT and NAFTA was also a catalyst for changes in the peanut program. The U.S. peanut program can be viewed as an income transfer from consumers to peanut producers while the other commodity programs are an income transfer from tax payers to commodity producers. Under a supply management concept there are theoretically no program costs to the government if domestic demand for edible peanuts equals the supply of edible peanuts, ceteris paribus. A surplus of edibles can be caused by policy makers' inability to project domestic edible demand since they do not have perfect information and knowledge about the market (Rucker and Thurman). The "error" in demand projection for edibles may also be attributed to policy consideration by policy makers for abundant high quality peanuts in the domestic food market. Another explanation for the "error" was that the previous peanut program had a minimum floor that quota could be set. In the last couple years, domestic demand fell below the minimum floor. Thus, any losses to the Commodity Credit Corporation (CCC) pool resulting from the "error" were historically paid by the CCC. Domestic demand for peanuts consists of demand for edible peanuts and demand for additional peanuts. The demand for edible peanuts in the domestic food market includes demand for quota peanuts and demand for imported edible peanuts. Without NAFTA and the new GATT, imported peanuts were not an issue because the United States utilized Section 22 to prevent foreign peanuts from coming into the U.S. domestic market. Under the new GATT, Section 22 was replaced with tariff rate quotas. Minimum import access level of peanuts to the U.S. domestic market was granted to member countries of the trade agreements including Argentina, Mexico, and Canada. In Figure 2.1, aggregate demand for edible peanuts under the previous program is hypothetically represented by D0D0. Domestic demand for American produced quota peanuts can be represented by D0*D0* assuming imported peanuts and peanut products constant at Q0 - Q1.2 The amount of peanuts imported is not determined by the domestic market forces but by the trade agreements. With a support price of Ps0, the estimated demand for quota under the previous program was set at Q1 by the government. Because of increased imports due to GATT and NAFTA, American peanut growers would lose quota by Q0 - Q1, ceteris paribus.
Peanut production for export or crushing is not subject to supply management control. The aggregate farm-level demand for additionals is denoted by PaDt, which is a combined demand of export and crushed peanuts. Additional peanuts include crushed and exported edibles through CCC and contracted additionals through commercial channels. The combined demand for additionals is assumed to be perfectly price elastic since additionals and unused edibles for food must be crushed or exported. Furthermore, world demand for U.S. peanuts and peanut products is a small component of the total world oilseed complex (Helmberger). Therefore, total aggregate farm-level demand for all edible and additional peanuts under the previous peanut program can be represented by a kinked demand curve, D0NDt (Figure 2.1). Aggregate demand for American produced peanuts at the farm-level under the previous program can also be captured by a kinked demand curve, D0*RDt. The original demand schedule for edibles, D0D0, however, shifted to D1D1 due to a shift in consumers' preference, for example, away from foods viewed as high in fat. This is evident by the continued decline in peanut food use in the domestic market since the 1989/90 peak. After accounting for imports, the domestic demand for American produced peanuts would be D1*D1*. If there was no change in the quota peanut support price, domestic demand could be Q4 for American produced edible peanuts. The 1996 peanut program reduced the support price for quota peanuts from Ps0 to Ps1, which would lead to an increase of demand for American produced edible peanuts by Q3 - Q4. The U.S. Department of Agriculture reduced the quota by Q1 - Q2, so that the demand and supply for edible peanuts under the FAIR Act would presumably be equal. Because of GATT and NAFTA, imported peanuts would increase by the difference between Q2 - Q3 and Q0 - Q1. While imported peanuts do not create a financial burden for the government, they are substitutes for domestic produced edible peanuts. Because of the lower price for imported peanuts, peanut product manufacturers will utilize them. The potential increase in the surplus of domestic edible peanuts forces the government to reduce quota peanuts in order to maintain a supply and demand balance with no government cost. Due to GATT and NAFTA, the U.S. government cannot reduce the imports which are the minimum access levels as designated in the agreements. Thus, the aggregate demand for all peanuts under the new peanut program can be represented by the kinked curve D1SDt, while the aggregate demand for American produced peanuts under the new peanut program is captured by D1*TDt*. Changes in support price, quota, and imports affect the peanut industry, especially quota peanut growers' welfare. A reduction of support price from Ps0 to Ps1 would decrease farm income for quota peanut producers by Ps0AG Ps1, ceteris paribus (Figure 2.1). A reduction of quota poundage from Q1 to Q2 would reduce farm income (i.e., gross income) for quota producers by JBQ1Q2, holding other things constant. If quota peanut growers produce more additionals to compensate for the reduction of their quota peanuts, income reduced due to quota reduction would be JBCK (Figure 2.1) because they could still sell the amount of additionals at Pa. The imports (Q2 - Q3) would decrease farm income for quota producers by GEQ2Q3, ceteris paribus (Figure 2.1). Given this framework, the changes in the welfare relative to domestic program reform and increasing peanut imports become apparent. The reduction in farm income for quota growers are gains for consumers and taxpayers since the program benefits under the previous program were from both consumers and government expenditures. Changes in the peanut program should result in an income transfer back to consumers by the area of Ps0HGPs1 (Figure 2.1).3 Of the farm income reduction due to lowering quota, JBCK is the savings for government expenditures and AJKF is the benefit captured by peanut importers. Area KFQ2Q3 is the benefit transferred to foreign peanut producers. The fixed seven-year peanut program under the FAIR Act provides us with an advantage to analyze these impacts. Since the minimum import access levels for foreign peanuts under GATT and NAFTA are fixed, impacts of the FAIR Act and trade on the American peanut industry to a large extent depend on the domestic demand for edible peanuts, ceteris paribus. Long-term impacts of domestic policy reform and increasing imports due to GATT and NAFTA were analyzed based on three different scenarios about changes in the domestic demand for peanuts. Methods and ProceduresWhile the support price is given under the new program and USDA has announced the basic quota for 1996, total quota must be estimated because of the provision of temporary quota for seed in the new program. A demand function for American produced edibles also needs to be estimated in order to analyze the program effect on income transfer between producers and consumers. The prices of additional peanuts and imported peanuts are obtained to estimate the program effects on government expenditures and benefit transfer. Total quota for the 1996 crop under the new program consists of basic quota and temporary quota for seed. Given that the 1996 basic quota has been determined by the U.S. Department of Agriculture, the amount of additionals for the 1996 crop year is derived using the relationship of quota to additional peanut marketings in the previous three years. Since peanuts are distinguished by type, peanut production is further decomposed into Runner, Virginia, Valencia, and Spanish according to the production distribution for each of these types of peanuts in the previous three years.4 The decomposition of peanuts by type is applicable since production distribution, yield per acre, and seed rate vary with type of peanut produced in each region.5 Planted acreage equals production divided by average yield per acre for the previous three years.6 Temporary quota for seed equals planted acreage multiplied by the seed rate for each type of peanut, respectively. Planted acreage for temporary quota equals temporary quota divided by average yield per acre for the previous years. Total quota is a sum of basic quota and temporary quota for seed. Aggregate demand for domestic produced edible peanuts at the farm gate was specified as a function of price for edible peanuts, personal disposable income, and the price of substitute for peanuts. Since there is little variation in government loan rate, free on board (FOB) price of shipping sales is used as the price for domestic edible peanuts (U.S. Department of Agriculture, 1965-1994). FOB price of cleaned and shelled peanuts was converted to the price of farmer stock peanuts using the formula established by International Trade Commission.7 Cleaned and shelled peanuts were also converted to farmer stock peanuts. The aggregate demand function for American produced edible peanuts was specified as:
where Q is quantity of demand for domestic edible peanuts (farmer stock peanuts, 1000 lbs.); P is real FOB price for edible peanuts (cents/lb) (base year: 1982-84=100); I denotes real disposable income for the United States (million dollars); S is real price of almond, a peanut substitute (cents/lb); and is random error for the equation. The equation was estimated by OLS and is summarized in Table 2.1. The Cochrane-Orcutt procedure was used to correct for autocorrelated errors (Shazam). All parameter estimates are as theoretically hypothesized. An increase in the edible peanut price decreases the demand for edible peanuts, ceteris paribus. An increase in personal disposable income increases the demand for edible peanuts. An increase in almond price increases the demand for edible peanuts. The price elasticity of domestic demand, at the mean, for edible peanuts is -0.14, which implies that a 10 percent decrease in edible peanut price results in about 1.4 percent increase in edible peanut demand, ceteris paribus. With the estimated demand curve D1*D1*, the demand for quota edibles under the previous program (i.e., Q4 in Figure 2.1) was estimated by substituting the support price, Ps0 in real term, into the demand function, holding disposable income and almond price at their means. The potential income transferred back to peanut consumers from quota growers was approximated by (Ps0 - Ps1)(Q4) + ½(Ps0 - Ps1)(Q3 - Q4) (Figure 2.1). To estimate the program effect on government expenditures, the price of additional peanuts was also derived. Market price of additional peanuts, Pa, is the weighted average price of export and crushed peanuts in the CCC pool and contracted additionals through the commercial channel. Based on the information for the 1992-1994 period, the derived weighted average price for additional peanuts was $349.80 per ton. Government expenditures saved due to quota and price support reductions are equal to (Ps0 - Pa)(Q1 - Q2) (Figure 2.1). If quota producers use additionals to compensate for the decrease in quota, gross farm income reduction due to quota reduction equal the area JBCK in Figure 2.1. To simplify the analysis, the price of imported foreign peanuts is assumed to equal the price of exported peanuts. The benefits associated with imported peanuts captured by peanut importers in this new crop year would be (Q2 - Q3)(Ps1 - Pa). Peanut importers' benefits were reduced by AJEG due to the decrease in quota support price. KFQ2Q3 is the benefit transferred to foreign peanut producers from American peanut growers. Long-term impacts of the FAIR Act and the increasing peanut imports due to GATT and NAFTA were approximated. Since the new peanut program is a no-net-cost program, there would be no impact on government expenditures since 1996 because the CCC would use pool profits and, if necessary, grower assessments to cover the costs relative to quota crushed. With additional peanut production held constant, the long-term impact of domestic peanut policy reform and trade on the American peanut industry is derived from changes in the quota level and imported peanuts and peanut products for edible peanuts. The minimum import access levels under GATT and NAFTA are assumed to be fully imported given the price difference between domestic produced quota peanuts and imported foreign peanuts. Over the next four years, three hypothetical situations are assumed for the domestic edible peanut demand: constant, increase by 2 percent, and decrease by 2 percent. Economic Impact of Domestic Policy and TradeThe U.S. Department of Agriculture estimated that the 1996 domestic demand for U.S. produced edible peanuts was 1.1 million tons. That is, basic quota for this new crop year is about 81.48 percent of the 1995 basic quota. Given this basic quota level, approximately 994 million pounds of additional peanuts would be produced in this new crop year (Table 2.2). Taking into consideration the differences in seed rates, yield, and production distribution for the different types of peanuts, U.S. peanut growers would plant 1,462 thousand acres and produce about 2,388 million lbs. of quota peanuts. Of this total quota, about 195 million lbs. of peanuts (i.e., 8 percent) are temporary quota for seed. This reduction in quota and the elimination of undermarketings due to the new program would result in about 573 million pounds or a 19 percent decline in total quota in 1996 relative to 1995 total quota level. Planted acreage would drop by about 77 thousand acres or by 5 percent between 1995 and 1996 (Table 2.2). Reductions in quota and support price levels accompanying other modified and/or eliminated provisions affect quota peanut growers, government expenditures, and peanut consumers. The quota reduction along with the 10 percent decrease in support price would create a decline of $276 million in gross income for quota growers, which is about 27 percent lower in 1996 than 1995 (Table 2.2). Of the decline in farm income, about $81 million is attributable to the support price cut and $194 million is due to quota reduction. If quota peanut growers produce extra additional peanuts to compensate the quota cut, quota growers would expect to have about $175 million less in gross income in 1996 than 1995 under the new peanut program. The reduction in farm income associated with the peanut program is a savings for the federal government and an income transfer to peanut consumers. Changes in the program would completely eliminate the financial burden for taxpayers which could have been about $94 million in this new crop year, holding other things constant. Under the new program, about $80 million of farm income would be transferred back to peanut consumers from quota peanut growers through the reduction in the quota support price.8 Since imported peanuts and peanut products directly replace domestic edible peanuts and peanut products, about 208 million pounds of domestic edible peanuts (farmer stock peanuts) would be squeezed out of the domestic food market in 1996 (Table 2.2). This means that increased imports for foreign peanuts and peanut products would result in gross farm income reduction by about $64 million. Of the income reduction due to GATT and NAFTA, about $27 million is transferred to peanut product manufacturers and $36 million is transferred to foreign peanut producers assuming the price of peanuts imported equal the price of peanuts exported, ceteris paribus. Long-term impact of the FAIR Act and increasing imports of foreign peanuts and peanut products associated with GATT and NAFTA over the next four years are summarized in Table 2.3. If there was no change in domestic demand for American produced peanuts (Scenario 1), American peanut producers would have about $19 million less in farm income for the next four years compared to the base year, 1996, other things constant. If there was a 2 percent increase in domestic demand for American produced edible peanuts (Scenario 2), American peanut growers would gain about $55 million in farm income over its base even though imports of foreign peanuts increase. If domestic demand for American produced edible peanuts declines by 2 percent (Scenario 3), there would be about $61 million of farm income reduction for American peanut producers, ceteris paribus. Competitive Position of U.S. PeanutsWhile increasing imports of foreign peanuts into the United States due to GATT and NAFTA affects the U.S. peanut industry, potential competition from American major export rivals in the world market presents the industry with additional challenges. In the world peanut market, the United States, China, and Argentina have been three major peanut exporters since the early 1980s. China has emerged as a leading exporter with a larger market share than the United States's since 1993 (U.S. Department of Agriculture, 1990-95). As GATT and NAFTA expose the American domestic market to increasing foreign competition, a concern exists about whether U.S. peanuts will be able to compete with other foreign peanuts in the world market if the peanut program is eliminated. This section examines the third force–competition that shapes American peanut industry. The analysis focuses on U.S. and China only because data are not currently available for Argentina. Competitiveness is a matter of long-term survival (Thurow). A competitive position of a commodity is determined by many factors, but costs and survival profits in producing the commodity are important indicators of the competitiveness of the commodity (Ahearn et al.; Capalbo et al.; Gupta and Gladwin; Let Stum and Camaret). Based on cost surveys published by the U.S. Department of Agriculture (1988-94), China Agricultural Yearbook (Zhongguo Nongye Nianjian), and China Rural Statistic Yearbook (China State Statistical Bureau), economic costs of producing peanuts were substantially different between the United States and China. Economic costs in producing peanuts (farmer stock peanut basis) averaged about 24.98 cents/lb. (quota rent excluded) for the United States, but only 8.77 cents/lb. for China (Table 2.4). Cost of production was nearly three times higher for the U.S. peanuts than for Chinese peanuts. The difference in economic cost was significant at the 1 percent level of probability between the two countries. The large economic cost for American peanuts was attributable to land value and expenses for using and maintaining farming equipment. A significant difference in economic cost between the two countries still remains if cotton land rent was used as a proxy for peanut land rent. Even if land rent was excluded in the U.S. economic cost, economic cost of production for the United States was still about twice the cost for Chinese peanut production. Furthermore, peanut production in the United States was capital intensive due to using and maintaining modern farm equipment. Chinese peanut production was more labor intensive due to the abundant and cheap labor source. Land rent accounted for about 14 percent of the total production cost for the United States, but Chinese peanut growers do not pay land rent in peanut production because land is free due to the centrally planned economic system. Based on the world peanut price in Rotterdam (converted to farmer stock peanut price) and estimated economic costs, net returns averaged about 15.14 cents/lb for Chinese peanuts at the farm gate during the 1988-93 period, while about a 0.15 cents/lb loss was observed for U.S. peanut production (Table 2.4). If land value were excluded (which is not possible in the United States), net returns still averaged only 3.36 cents/lb for the United States, which was about 12 cents/lb below the net returns for Chinese peanut producers. One might question how the United States could maintain a 27 percent world market share or export about 20 percent of its total production given the high costs and low net returns. A possible explanation is that few peanut growers depreciate farm equipment or account for the fixed cost expenses in their additional peanut budgets. That is, only cash costs are probably considered for export peanuts. Summary and ConclusionsThe debate on the U.S. peanut program was concluded with the signing of the FAIR Act. Free trade and/or increasing trade brought by GATT and NAFTA is being undertaken. Domestic policy and increasing competition as a result of these trade agreements have been challenging the U.S. peanut industry. This study analyzed the forces that are affecting the American peanut industry. Results reveal that domestic policy reform and increasing peanut imports significantly affected peanut growers' farm income, government expenditures, and consumers. Increasing imports of foreign peanuts would transfer American peanut producers' income to peanut importers, manufacturers, and foreign peanut growers. Potential competition from the rest of the world, particularly from China, under the free and/or reduced trade barrier agreements challenges the U.S. peanut industry. Findings in this study suggest that domestic policy, trade, and competition have been shaping the U.S. peanut industry. These forces from domestic and international markets are moving the American peanut industry toward a new arena characterized as more open, with less policy intervention, and with a more competitive market environment. The industry may be better off in the long run because less policy distortion and free trade will improve production and marketing efficiencies. However, these forces will create economic difficulties for the U.S. peanut industry in the next several years. The drastic decline in farm income for peanut growers raises concerns about peanut growers' survival in those highly concentrated peanut production regions and those who rely on peanuts. Given the fact that imports of foreign peanuts and peanut products continue to increase and that there is a sluggish domestic demand for American produced peanuts, a further decline of American edible peanut production could be expected. Decreased peanut production would inevitably affect the peanut shelling and manufacturing sectors. These forces may further alter current crop production patterns in the areas where peanut production is highly concentrated. It is a challenge for policy makers and those who rely on peanuts to help the U.S. peanut industry to go through the transition period. NotesReferencesDocument prepared by: Leigh H. Stribling, lstribli@acesag.auburn.edu Alabama Agricultural Experiment Station Auburn University |
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