Economist Contends Effiency
Focus Has Dark Consequences

OMAHA, Neb. — It's time to decide what kind of food system the world wants in the future.

"We're all familiar with the massive consolidation that we've had in agriculture," says Robert Taylor of Auburn University. "Nationally, it's throughout the United States economy, and throughout the world economy."

That move to larger-sized businesses was driven by economic efficiency, he says.

"But we're to the point where it's no longer about economic efficiency," he continues. "The move to get larger and larger and to consolidate is driven largely by the attempt to get more raw, unadulterated economic power."

Taylor contends there is now a growing imbalance of economic power that impacts consumers, processors, meat packers, retailers and producers.

The retail price of beef, adjusted for inflation, has dropped dramatically since 1980.

"Consumers have benefited tremendously from that," Taylor says. "Part of that is due to increased economic efficiency. A little bit of it is due to lower real beef costs over time because real beef costs, adjusted for inflation, have also dropped dramatically."

Beef prices dropped for the 21-year period beginning in 1980. Retail value of pork has followed the same general pattern.

He says consumers have benefited not only from the price of beef and pork, but they have also benefited from improved quality. The consumer has also benefited from a drop in prices of broilers.

"In the early 1980s," Taylor says, "there were some efficiency gains from consolidation in meat packing and moving to larger and larger plants."

With efficiency gains in meat packing in a competitive market, Taylor explains, gross revenues are expected to come down.

"That's exactly what happened in the 1980s," he says. "With lower slaughter costs, adjusted for inflation, those high grow revenues are competed away."

In the early 1990s, however, the trend in gross revenues started going up.

"And it's continued to go up dramatically," Taylor adds.

There was a 50 percent increase in gross revenues for meat packers between 1994 and today.

"In my opinion," Taylor says, "that has come about because of buyer power. It's just raw power. It's the growing imbalance of economic power between cattle feeders and the meat packers. It's working to the advantage of the meat packers."

While not quite as dramatic, pork producers have faced the same thing.

At the retail level, gross revenue to food retailers concerning beef has not changed over the same period, but it did shoot up dramatically in 2001.

"That spike, in my opinion, can be explained by monopoly power," Taylor says.

Going back to the farm and wholesale prices, buyer power was exerted starting in the early to mid 1990s, he says.

The farm to retail price spread for beef declined during the early 1980s.

"I think that can be explained by efficiency gained in a competitive market," Taylor opines.

The spread, however, turned upward in the 1990s. Taylor says that indicates that a lot of the efficiency gains that would normally accrue to consumers have been lost in the last few years through the exertion of buyer power at the packer level and seller power at the retail level.

"It's an imbalance of economic power," he explains.

Interestingly, Taylor says, he doesn't see any efficiency gains in the pork industry. The poultry industry, too, has some problems.

"The poultry industry integrated in the early to mid 1950s," he says. "For a while, contract poultry production was reasonably profitable. Nobody got filthy rich, but they did okay."

In the last 10 years, however, contract poultry producers have been squeezed more and more by the poultry integrators.

"It's to the point now that I have a lot data on this from individual records and from cost of production budgets," Taylor says. Someone wanting to start in poultry production now might begin with a couple of hundred thousand dollars in the form of the family farm and equipment. With the latest technology, fully computerized, six houses of broilers would be a full-time job.

"Six houses would require an investment of about $750,000," Taylor says. "Banks are very willing to loan contract producers that kind of money, because up until now they haven't had many loan defaults."

Those that have defaulted were usually producers who spoke out in public and lost their contracts.

Essentially, Taylor says, a poultry producer puts up $200,000 and borrows $750,000 to go to work for themselves making minimum wage with no benefits and a zero rate of return on equity.

"All of that equity is at risk because the contract with a producer can be instantly broken," Taylor points out.

That can bankrupt a producer.

Poultry producers are facing a crisis as much as beef and pork producers.

"It's not just beef and pork," Taylor insists. "It's also contract poultry production."

Kansas State University figures from a study of returns on cattle feeding in Kansas, Taylor says, indicate a downward trend that hit zero in 1994.

"That is when the farm to wholesale spread started turning up," he notess.

From 1980 to 1990, the average return was $41.40.

From 1990 through the end of the decade, the average return was negative. Cattle feeders in Kansas lost an average of $14.60 per head.

"There are those who have contracts," Taylor says, "and some who have contracts that provide them preferential treatment."

If that preferential treatment is $30 a head, those with preferential treatment, facing the last 10 years in the Kansas market, would be making about $15 a head, while those without the preferential treatment would be losing $45 a head for the last 10 years.

"That's why we have a crisis," Taylor contends.

The corporate profit component of the domestic food marketing bill has been growing while farm income has been going down.

"I don't know if they were smart enough to figure this out ahead of time or if this is something that has simply evolved."

This is how they control cattle feeders, he says.

"First you come in and offer preferential contracts to the chosen few," he explains.

If preferential deals of $30 a head are offered for some, that increases aggregate supply. Those without preferential treatment don't increase supply for a given expected price.

"Because the preferential suppliers are getting more, they will increase supply," Taylor continues. "That lowers the cash market price."

The preferential deals, he says, may be enough for those with the preferential contracts to remain liquid, continue in business and make a decent return even with the lower cash prices that result from the aggregate supply response.

"With lower cash prices," Taylor adds, "the independents will be forced out."

After the independents are forced out, then the preferential contracts will go away. Those who had the preferential contracts, he says, will be left with just enough to stay solvent and just enough to stay in business.

"Their preferential deals will evaporate over time," Taylor predicts, "just as the economics of contract poultry production has deteriorated over time."

The end result, he contends, is that the independents are gone, markets are gone and chosen producers are controlled by the packer.

"The Department of Justice will generally not enforce predatory pricing laws because they maintain that it is difficult, if not impossible, to distinguish between rigorous competition and predatory pricing," Taylor says. "I disagree with them in a lot of cases, but that is their attitude."

Consequently, he says, there is basically no enforcement of predatory pricing laws.

"Anybody who tries to get into the business on the packing side can be forced out of business quickly," Taylor points out. "Knowing that, people just won't step up to the plate."

The other effect is that a person can get into cattle feeding only by invitation, he adds.

"This is happening increasingly throughout the ag economy in the United States with a dramatic move to contracting," Taylor says. "It's not just in beef and pork, but it's throughout agriculture."

Taylor predicts that it could come to the point where the only way a person could get into business is to be invited by a corporate executive.

"To me that's un-American," Taylor says. "It's certainly not the American dream to have to suck up to some corporate executive so you can get in business."

In addition, Taylor says, there will be some crashes. If so, he says, the packers may be able to pick up some production facilities at bankruptcy prices.

Another problem with market power is that retail prices are very slow to change, he says.

"Part of this is due to market power by the retailers," Taylor explains. "We now have a new title for the critters. We call them ‘category captains’, and they have tremendous power in the vertical supply chain. They can decide what goes on the shelf and who it's bought from."

Taylor says retailers also know that consumers don't like prices to change drastically.

Consequently, he says, there is a lot of stability in retail pricing.

If there is a burp in the demand or supply, the retail market won't clear it, Taylor notes.

"Let's say we have a sudden, unanticipated increase in supply, which would normally mean a lower price," Taylor postulates. "A lower price would clear it because more would be consumed."

With stable retail prices, however, it's not cleared.

"The retail markets aren't cleared, and this ends up magnifying the variability of prices for slaughtered cattle and hogs," Taylor says. "That effect is further magnified by thin markets."

If packers stabilize owned or contracted production, that makes the remaining market a shock absorber for the whole industry.

"Prices become more volatile," Taylor contends. "It also transfers risk to the producer."

Taylor says training for economists is getting narrower and narrower.

"Now, about all they study is economic efficiency," Taylor says, "but some of the older economists thought in much, much broader terms."

In a book published in 1921, the same year the Packers and Stockyards Act was passed, Frank Knight wrote that several factors are important to the welfare of society, Taylor says.

"One of those is clearly economic efficiency," he insists. "The second one is maintaining a balance of economic power."

In the drive for economic efficiency, Taylor claims, the balance of economic power has been neglected.

"Now, you see some of the consequences," he says.

Taylor says he would add to Knight's list the stewardship of resources in the environment and a sense of community.

"All of these are important," Taylor says. "In the last 10 or 20 years in particular, everything has been driven by efficiency. Washington policy-makers get the efficiency argument only."

Taylor believes livestock producers — indeed, all of society — will have step back and rethink the world's food system.

In 1964, a group of food economists said the world had come to a fork in the road. They said they could go down the family farm road, or they could go down the efficiency and consolidation road.

"It's obvious which we took," Taylor says, "but I think this has progressed to the point where we're very near the end of the road, and if we go much further, we'll simply fall off a cliff."

Taylor thinks it's time for the general public to think about the food system they want in the future.