
AGRICULTURAL OUTLOOK                                        March 31, 1999
April 1999, ERS-AO-260
               Approved by the World Agricultural Outlook Board
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This revised Agricultural Outlook includes text that was inadvertently
omitted from the first version and incorporates late changes to the article
on risk management. 



CONTENTS

IN THIS ISSUE

AGRICULTURAL ECONOMY
Outlook for the Farm Economy in 1999

COMMODITY SPOTLIGHT
 Broccoli: Super Food for All Seasons

WORLD AGRICULTURE & TRADE
Rice Tariffication in Japan: What Does It Mean for Trade?

FOOD & MARKETING
Food Price Outlook for 1999: An Update

FARM FINANCE
Boom & Bust: Will Agricultural History Repeat in the 1990's?

RISK MANAGEMENT:
Insurance & Hedging: Two Ingredients for a Risk Management Recipe

SPECIAL ARTICLE
Long-Term Agricultural Projections Reflect Weaker Trade


IN THIS ISSUE

Near-Term Weakness Expected in U.S. Farm Economy

The stage was set for agricultural prospects to worsen in 1999 when the
outlook for U.S. agriculture changed abruptly during 1998.  Rising world
commodity supplies and weakening international demand last year reduced farm
prices and the value of farm exports.  The U.S. government reacted with
legislation to increase assistance to farmers, which is helping to maintain
farm income and tempering financial hardship for many producers.  In 1999,
supplies of most agricultural commodities will remain large, and the outlook
for exports remains somewhat pessimistic in the near term.  With exports and
prices likely to be lower in 1999, farm financial stress will intensify,
particularly in the Corn Belt. 

Much of the U.S. agricultural sector will be adjusting to the combination of
weak demand and large global supplies in the next few years, according to
USDA's 10-year baseline projections.  Compared with the last few years,
agricultural commodity prices are down, the value of U.S. agricultural
exports is lower, and net farm income declines. The international factors
weakening the long-term U.S. agricultural outlook include fallout from the
financial crisis in Asia and economic contraction in Russia; projected lower
growth (relative to last year's baseline) in China's grain imports; and
expanding production potential among trade competitors.  In the second half
of the baseline, more favorable economic growth in developing regions
supports gains in U.S. agricultural exports, leading to rising nominal market
prices, gains in farm income, and increased financial stability in the U.S.
agricultural sector. 

Boom & Bust: Will Agricultural History Repeat?

Conditions in the farm sector in the 1990's in some respects resemble those
of the boom and bust cycle of the 1970's into the 1980's.  Reminiscent are
changes in the value of the dollar, the role of agricultural exports,
weather-related problems followed by a surge in production, and sustained
increases in farmland values and farm indebtedness.  But significant
differences exist. Although a number of factors could aggravate the current
downturn, the magnitude of the contraction could be mitigated by the current
domestic economic stability, less pronounced expansion, and more conservative
borrowing and lending. 

Managing Risk with Insurance & Pricing Strategies

Making good risk management choices requires: 1) understanding the farm's
risk environment, 2) knowing how the available risk management strategies
work and which risks they address, and 3) selecting the strategy or
combination of strategies that will provide the protection that best suits
the farm's and the operator's individual circumstances.  The farm's principal
risk lies in the uncertainty of the revenue generated by the production
process.  Insurance and forward pricing offer tools to manage risk.  The
majority of insurance policies sold are: standard yield-based crop insurance,
revenue insurance, and revenue insurance with market-value protection. 
Combining insurance with forward pricing--e.g., a cash forward sale, a
futures hedge, or a put option hedge--generally results in lower risk than
either alone. 

Rice Tariffication in Japan

Japan changes its rice import system on April 1, 1999 to allow imports
outside the existing minimum access quota, but annual increases in the quota
will be less than without the April 1 change.  Japan's minimum access quota
for rice imports, implemented in 1995 under GATT's Uruguay Round Agreement on
Agriculture (URAA), ended the effective ban on rice exports to Japan.  The
tariff on imports within the minimum access quota is zero, but the URAA
allows Japan to add a markup to these imports.  Imports above the minimum
access amount will be subject to a tariff, but there is virtually no chance
that any rice paying the over-quota tariff could compete with Japan's
domestic production.  U.S. rice exports to Japan will likely be lower than
they would have been without tariffication, hitting California producers
hardest. 

Broccoli: Super Food for All Seasons

Broccoli has again caught the interest of American consumers, after
stagnating sales in the early 1990's.  Broccoli is regularly identified as
the vegetable eaten most often for health reasons, and the introduction of
pre-cut and packaged value-added products provides more convenience for
consumers. Americans consumed 2 billion pounds of broccoli in 1998, about 8
pounds per capita, 34 percent higher than in 1990 and nearly 3 times the 1980
level.  The industry boasts farm revenue averaging $484 million (1996-98), up
24 percent from the previous 3 years, reflecting higher prices caused by
rising demand. The U.S. retail price for fresh-market broccoli in 1998
averaged $1.10 per pound, up 12 percent from a year earlier and up 27 percent
since 1995.  

Food Prices to Post Modest Gains in 1999

The Consumer Price Index for all food is expected to increase 2-3 percent in
1999, following a 2.2-percent increase in 1998, the smallest since 1993. Food
at home is projected to increase 2-2.5 percent, while food away from home
should increase 2.5 to 3 percent.  Overall, lower meat, egg, and coffee and
soft drink prices countered higher prices for dairy products, fresh fruits
and vegetables, and fats and oils.  Although 1999 looks like another year of
low food price inflation, uncertainties remain about the ultimate effect of
changes in meat exports, increasing consumer demand for high-butterfat
products, and high orange and banana prices.


AGRICULTURAL ECONOMY
Outlook for the Farm Economy in 1999

[NOTE: See the Special Article in this issue for a discussion of long-term
prospects for U.S. agriculture.]

The outlook for U.S. agriculture changed abruptly during 1998. At home,
inclement weather devastated California, Florida, and many regions in
between. Rising world commodity supplies and fallout from the Asian financial
crisis reduced farm prices and the value of farm exports. The U.S. government
reacted with legislation to increase assistance to farmers. Totaling nearly
$6 billion, these funds are helping maintain farm income and tempering
financial hardship for many producers. With exports and prices likely to be
lower in 1999, farm financial stress will intensify, particularly in the Corn
Belt.

Global events have been and will continue to be a major factor in the U.S.
agricultural economy. While strong world economic growth and lower trade
barriers in 1996 and 1997 helped push U.S. agricultural exports to a
record-high $60 billion in fiscal 1996, expanding world production and
weakening world demand have hurt U.S. exports since then. Grain, cotton,
beef, and poultry exports have all been seriously affected. In 1998, the U.S.
economy was strong, but the foundation of world demand deteriorated as Japan,
South Korea, Malaysia, Philippines, Thailand, Indonesia, Russia, Saudi
Arabia, and Brazil all saw recessions. In the boom period of 1996 and 1997,
the world economy grew 3.4 percent per year. In 1998, growth fell to 1.9
percent, and in 1999, a further slide to just 1.7 percent is expected.

Brazil's problems are a particular concern given the fall of the real during
January. For now, the currency has stabilized following the decision to allow
it to float (AO March 1999). But the underlying large government deficit
remains, and until this is addressed, Brazil faces high interest rates and
slow growth. Because Brazil is the largest economy in South America, its
performance will affect the entire continent. At this point, indications are
not optimistic for 1999.

Anemic world economic growth and lower prices are expected to lower U.S. farm
exports to $49 billion this year, down nearly $11 billion from the 1996 peak.
Exports to Asia account for over 80 percent of the decline in total export
value. The drop in exports has given rise to several questions: Could more
aggressive use of credit guarantees boost exports? Would elimination of trade
sanctions help solve the problem? Would full use of the Export Enhancement
Program restore lost trade? But the answer to these questions is no. Credit
guarantees are being pushed to the limit, trade sanctions are having only a
minor effect on U.S. exports, and the Export Enhancement Program, which is
available primarily for wheat, would drive down world wheat prices, making it
a waste of taxpayers' money given the ample competitive supplies on the world
market.

Many uncertainties could affect agricultural markets and the well-being of
market participants over the next 1 to 2 years. Weather is always a key and
could work to make prospects better or worse. Another major factor will be
the world economy. If the Asian economies fail to stabilize or if the
economic problems in Brazil spread, U.S. agricultural exports could drop
further. Right now, the engines of growth in the world economy are the U.S.
and the European Union (EU), and both are slowing. Should either of these two
regions fall into recession, there would be a global recession that would
further erode world food and fiber demand and U.S. farm exports.

Higher Farm Stress 
Expected in 1999

Given this somewhat pessimistic outlook regarding demand for farm products,
what are the implications for the overall health of the U.S. farm economy?
Starting with aggregate cash flow, declining prices caused farm market
receipts to fall by $10 billion down to $198 billion during 1998. Prices are
likely to hold at that reduced level this year, with crop receipts projected
to drop again and livestock receipts to rise with some improvement in cattle
prices.

Helping to offset the decline in cash receipts in 1998, and so far this year,
have been declines in interest rates, fuel prices, and feed costs. In fact,
total production expenses decreased 2 percent from 1997 to 1998, the first
significant drop in more than a decade. And expenses are likely to change
little in 1999.

Direct government payments to farmers reached nearly $13 billion in calendar
1998 and will probably total at least $11 billion in 1999, again providing
strong support. For the 1990's, government payments exceeded these levels
only once--in 1993.

All these figures reflect an industry still performing adequately financially
as it entered 1999, thanks to higher government payments and lower production
costs, which helped push total net cash farm income for agriculture in 1998
to the second highest ever. The farm balance sheet was fairly sound, as farm
equity steadily increased through the 1990's and as the overall debt-to-asset
ratio remained steady at about 15 percent, down from over 20 percent in the
mid-1980's.

But these aggregate figures mask a marked erosion in market income in many
regions and commodity sectors, and all signs now point to higher farm
financial stress in 1999. Net cash farm income is projected at $55.5 billion
in 1999, down $3.6 billion. While U.S. farm real estate values may rise
slightly, land values began declining in a number of Midwestern states during
the last half of 1998. The drop in income, coupled with declining asset
values for many producers, means many will have difficulty obtaining credit.
Those who do obtain credit will use it for variable cash expenses rather than
investment, and will find themselves squeezed as they try to repay debt out
of current income. Many producers who struggled with cash flow in 1998
resulting from low prices and adverse weather will likely see their problems
worsen in 1999.

Aggregate farm income estimates include a large, stable, and growing core of
commodities that include fruit, vegetables, nursery and greenhouse products,
and broilers. Farm sales of these commodities--which exceed the total value
of food grain, feed grain, and oilseed sales--will trend up again in 1999.
So, looking beneath aggregate U.S. farm income reveals that the greatest
financial strain in 1999 will be on field crops. For the 1998 wheat, corn,
soybean, upland cotton, and rice crops, net income will be 17 percent below
the previous 5-year average, and for 1999 crops, current projections show
income 27 percent below the previous 5-year average. 

While slow world economic growth and abundant world food and fiber supplies
converge in 1999 to reduce the economic performance of U.S. agriculture,
Americans will continue to benefit from ample high-quality food choices, with
food prices rising only 2 percent this year. 

Field Crop Prices 
To Remain Low . . .

Wheat, corn, and soybeans saw sharply lower prices in 1998/99, with carryover
stocks expected up. Farm prices for wheat in 1998/99 are expected to average
$2.70 per bushel, the lowest season-average price in 8 years. USDA estimates
carryover stocks on June 1 at nearly 1 billion bushels, the highest since
1988. Since wheat was the first major commodity to sink after the mid-1990's
runup, it will likely be the first to start reviving. The 1996 Farm Act
envisioned that planting flexibility would help reduce surpluses by causing a
cutback in planted acreage when prices were low. This year is the first big
test, and wheat is passing the test. For the 1999 crop year, the world wheat
situation will be tighter, with lower U.S. and EU production. U.S. wheat
prices should rise, but with weak global demand and trade, the increase may
be limited to a range of 10 percent.

For corn, total supplies in this marketing year are up sharply, and carryover
stocks on September 1 are likely to be at their highest level since 1993.
USDA's corn price forecast is the lowest in more than a decade. For the 1999
crop, trend yields would push U.S. supplies up again even with a little less
acreage. Total use should expand by about the same amount, leaving U.S. corn
carryover stocks near this season's high levels and setting the 1999/2000
price outlook for feed grains about unchanged from this year. 

For soybeans, U.S. supplies this season are record high, and U.S. producers
face strong competition from Brazil and Argentina. Carryover stocks on
September 1 are expected to exceed more that 400 million bushels, the highest
carryover in more than a decade. Soybean prices will probably average just
over $5 per bushel this season, the lowest since 1986/87.

The key crop outlook question is: Can market forces stabilize or reduce
stocks in 1999/2000? The answer: not likely. In fact, the 1996 Farm Act
provisions are causing the pain of grain surpluses to be spread to oilseed
markets. Producers are turning to soybeans because it appears to be the best
of the less-than-ideal alternatives for the moment, and a further increase in
carryover stocks and lower prices is likely for the 1999 crop year. Soybean
acreage is likely to rise at least 1 million acres, encouraged by the high
marketing assistance loan rate for soybeans relative to other crops, the
benefits of herbicide-resistant soybeans, low out-of-pocket planting costs,
and the crop's resilience in adverse weather. Given trend yields, prices
could average well below $5 a bushel, and marketing loan payments could be in
excess of $2.5 billion.

Cotton may be the commodity most vulnerable to the world economic slowdown.
Lower global demand for cotton textiles and apparel has resulted in the
second-lowest U.S. cotton exports in 20 years. The demise of the Step 2
cotton program has aggravated the export decline and will permit raw cotton
to be imported (AO September 1998). With a strong dollar and with Asian
textiles seeking a home, the U.S. has seen a 20-percent increase in imported
cotton textiles and apparel since the start of 1997. Of the total cotton
textiles and apparel Americans will buy this year, about 45 percent will be
imported. Weak demand has pared farm prices, despite the drought-reduced crop
in 1998. In 1999, a return to trend yields that raises U.S.
production--coupled with any weakness in world demand--could push U.S. ending
stocks higher, placing additional pressure on cotton prices.

. . . While Livestock & Poultry
Prices to Tick Up

The meat and poultry industry is in for another year of record-high
production in 1999. For cattle, market prices eroded further last year, and
averaged the lowest in the 1990's. Continuing liquidation and record-high
slaughter weights caused beef production to increase by 1 percent in 1998. A
3-percent decline in beef production is expected in 1999, but much of the
year-to-year decline will not occur until the second half. For all of 1999,
fed-cattle prices are expected to average $65.50 per cwt, compared with
$61.50 last year.

Hog production has received attention this year as prices for all of 1998
averaged slightly below $32 per cwt, the lowest since 1972 (AO March 1999).
What was responsible for the drop. Ten percent more production? Constrained
slaughter capacity? Imports? Megafarms? A rush to avoid environmental
constraints? Answer: all of the above probably had a role. But the most
important factor can be expressed by paraphrasing a colorful statement of
George Bernard Shaw about another farm animal. His summary opinion of New
Zealand: too many sheep.

Continued large supplies will keep a lid on hog prices during the first half
of 1999. But as slaughter begins to decline in the second half, prices should
rise above last year's level, particularly by the fourth quarter. For all of
1999, USDA forecasts a slight decline in production and hog prices averaging
$34 per cwt, 7 percent higher than last year.

As beef and pork production are cut back, broilers will gain increased
domestic market share. Loss of the Russian market hurt broiler exports, but
prices were still strong in 1998. With lower feed costs, broiler production
will probably be up nearly 6 percent in 1999, pushing total meat and poultry
supplies to record-high levels in 1999.

Milk production is seeing its first sustained production increases since
1995, and prices are coming down from the record-high $15.38 average in 1998.
For all of 1999, farm-level milk prices will likely average about $1 per cwt
below last year--about halfway between the 1997 and 1998 levels. Lower feed
costs and high earnings of the past year are expected to help producers
through the price decline.

Agriculture is a cyclical industry, and economic performance of the sector
will improve. Over the next 2-4 years, economic recession in a number of
countries should give way to economic recovery, lower prices will reduce
agricultural production, weather will curb output in some areas, and demand
for U.S. agricultural products will rise, bringing stronger farm prices and
incomes. Unlike the rapid change in agricultural fortunes in 1998, the
recovery could occur at a very gradual pace.

Keith Collins
Chief Economist, USDA

BOX - AGRICULTURAL ECONOMY

The projections and discussions in this article are drawn from a presentation
at USDA's 1999 Agricultural Outlook Forum held in Arlington, VA, on February
22-23, 1999. Near-term numbers reflect official USDA data as of February 22,
1999. Long-term numbers were prepared in October-December 1998 and are
published in USDA's Agricultural Baseline Projections to 2008, released in
February 1999. USDA's complete 1999 baseline estimates are accessible via the
Internet at http://www.econ.ag.gov/briefing/baseline/.

SIDEBAR - Low Prices for Field Crops: How Did We Get Here?

The recent Asian financial crisis and subsequent economic problems in many
other countries are contributing to weak commodity prices, but the roots go
back further. In 1995, record-high prices provided strong incentives to grain
producers to expand production, which they did, both in the U.S. and abroad.
In 1996, global production of wheat increased 44 million tons to a record 583
million, reflecting higher acreage and good yields. Output rose another 27
million tons in 1997. Similarly, global coarse grain output soared in 1996,
jumping more than 100 million tons to a record 907 million. Although
production slipped slightly in 1997, it was still the second largest on
record.

Oilseeds experienced a similar supply response triggered by high prices,
although lagging by a year. Led by gains in soybeans, global oilseed
production in 1997 increased 24 million tons to a record 286 million. Again,
there was a striking increase in area, and favorable weather boosted yields.
This was followed by a smaller production increase in 1998. 

Against this backdrop, world trade in coarse grains declined in 1997/98, and
is increasing only modestly in 1998/99. The volume of world wheat trade held
up in 1997/98 but is forecast down sharply in 1998/99 to the lowest since the
mid-1980's. 

Even before world imports began to falter, U.S. grain exports started to
weaken as the U.S. lost market share in 1996/97 in the face of strong
competition from other suppliers.  While U.S. exports and market share for
corn have increased in 1998/99, they remain relatively low by historical
standards. For wheat, the volume of U.S. exports and market share has
improved only marginally.

Oilseed trade has been stronger, which helps explain why soybean prices have
showed less weakness relative to the grains despite large supplies. Record
high in 1997/98, world trade in the major oilseeds has remained strong in
1998/99 despite a decline in soybean trade volume. Global trade in the major
protein meals, including soybean meal, has risen for the last several years,
and will be record large again in 1998/99.  

Likewise, vegetable oil trade, including soybean oil, is expected to be
record high in 1998/99, although its growth rate has slowed. U.S. exports of
soybeans and products have been comparatively strong, even with some loss of
market share to South America. However, in 1998/99 U.S. exports are
contracting, a large factor behind recent price weakness. 

Peter A. Riley (202) 694-5308 
pariley@econ.ag.gov 


AGRICULTURAL ECONOMY
Farm Income Outlook by Resource Region

The brunt of cash-flow problems for farm businesses in 1999 is expected to
fall most heavily on three regions of the U.S.--the Heartland, Mississippi
Portal, and Northern Crescent. 

Given continued low prices for corn and soybeans, average net cash income in
the Heartland is expected to be 18 percent lower than in 1998 and 35 percent
below the 1997 average of $50,600. More than one in four farm businesses
(40,800) may not earn enough income to cover expenses in 1999, compared with
15 percent in 1997 (the latest data available). 

These anticipated cash flow problems will only compound financial
difficulties for vulnerable farms (negative income and high debt levels),
which account for 6 percent of the region's total (9,500). These farm
businesses will need to address the shortfall in earnings quickly by
liquidating inventories or tapping other working capital, selling off
machinery and equipment, or offsetting farm losses with savings or off-farm
income. Those without sufficient equity will need to restructure loan terms. 

The farm businesses in the Mississippi Portal are also expected to experience
cash flow difficulties in 1999. Lower receipts for cotton and soybeans and
reduced government payments are expected to lower average net cash income to
$73,000, down 13 percent from 1998. About 18 percent of the region's farm
businesses (3,600) are not expected to cover cash expenses compared with 16
percent in 1997. The share of vulnerable farms could reach 7 percent by the
end of 1999, up from 6 percent in 1997.

The Northern Crescent is unique in being one of the few regions where, on
average, 1998 net cash income is likely to be above the year before, thanks
in large measure to higher milk prices. In 1999, a combination of falling
milk prices and relatively low grain prices will result in an 11-percent
decline in net cash income. But average net cash income for this region in
1999 is forecast not much below 1997's average of $50,300. The share of farm
businesses in a vulnerable overall financial position should remain around 6
percent (3,200).

The Heartland, Mississippi Portal, and Northern Crescent--the regions with
the highest year-over-year declines in average net cash income--are not the
most susceptible to financial difficulties arising from cash shortfalls.
Sharp declines in net cash income would be much more problematic if they were
to occur in the Northern Great Plains (down 3 percent) or Prairie Gateway
(down 6 percent). Each of these regions began 1999 with 8 percent of farms
(3,500 in Northern Great Plains and 5,000 in Prairie Gateway) in a vulnerable
financial position and another 13 percent of farm businesses (4,300 in
Northern Great Plains and 7,500 in Prairie Gateway) with debt representing
more than 40 percent of assets. 

Average income in these regions is not expected to decline as dramatically as
in other regions, because of somewhat more favorable cattle prices, the
potential for lower production costs, and higher government payments that
should offset the effect of lower crop receipts on farm income. Even so,
weather and disease problems have had a cumulative effect on financial
performance of individual farm businesses in these regions that is not
reflected in average net cash income. Results for the Prairie Gateway
indicate that 30 percent of farm businesses (20,700) did not earn enough
income to cover cash expenses in 1997, which was the highest percentage among
regions.

The regional outlook for net cash income during the next 5 years using
national figures from USDA's agricultural baseline projections suggests that
cash flow problems are likely to persist in the Heartland and Northern Great
Plains, with each region establishing new lows in net cash income each year
through 2001. Average net cash income begins to inch up after 2001 in the
Heartland but remains relatively flat in Northern Great Plains. As a result
of persistent lower incomes in these regions, farm debt will remain fairly
high relative to what can be repaid from current income. Farmers in both
regions are projected to continue using available credit lines fully. 

The Mississippi Portal projections also show net cash income declines during
the next 5 years. But unlike other regions where income is falling, the level
never drops below the most recent low ($56,700 in 1995).  In the Northern
Crescent, average net cash income declines through 2000 but rebounds to the
1997 level by 2003.

The farm financial outlook is more promising over the next 5 years in the
Fruitful Rim, given the favorable outlook for vegetables, fruit, and nursery
and greenhouse products and their relative importance to farm income in the
region. The Eastern Uplands is also expected to have rising average net cash
income, based on continued growth in poultry receipts and modest gains in
cattle receipts. In the Southern Seaboard, average net cash income is
expected to remain near 1998 levels. 

Mitchell Morehart (202) 694-5581, James Johnson (202) 694-5570, and James
Ryan (202) 694-5586
morehart@econ.ag.gov
jimjohn@econ.ag.gov

BOX - AGRICULTURAL ECONOMY

This material was presented at USDA's 1999 Agricultural Outlook Forum,
February 22-23, 1999, and is based on a new regional classification of farms
developed by USDA's Economic Research Service that reflects land
characteristics and commodity mix. This classification divides farms into
more homogeneous groups compared with traditional regional groupings that
follow political boundaries. For more information on the classification by
resource region and a discussion of farm income changes by type of farm, the
speech may be downloaded from
http://www.usda.gov/agency/oce/waob/outlook99/speeches/014/morehart.doc

SIDEBAR - About the Model

The regional scenarios analysis was conducted using a farm business financial
partial budgeting model. The model is static--any potential structural or
production response is not treated--and reflects historic production patterns
and farm structure within each region. The model incorporates elements of
income and expenses to project cash flow, assets, and debt. Results from the
Economic Research Service's Short-term Forecast Model, the USDA Baseline
Model, and FAPSIM model, were used as input into the farm business model to
derive forecasts for specific categories of income and expenses (such as corn
receipts and feed costs). The farm business model uses individual farm data
for farm businesses (defined as those with gross sales of more than $50,000),
obtained from USDA's Agricultural Resource Management Study (ARMS). Model
results were summarized across resource regions to determine the relative
impacts of the financial outlook. Since farm business performance varies
within a region, these results are not used to predict performance of
individual farms within a region.


COMMODITY SPOTLIGHT
Broccoli: Super Food for All Seasons

U.S. presidents may not all have cared for broccoli, but it appears that many
Americans have come to enjoy it. After stagnating sales in the early 1990's,
broccoli has again caught the interest of American consumers. The industry
boasts farm revenue averaging $484 million (1996-98), up 24 percent from the
previous 3 years. The sharp gain in revenue reflects higher prices caused by
rising demand for broccoli and its value-added products. 

In the 1980's, broccoli enjoyed a surge in popularity fueled largely by
increased health consciousness of consumers. Today, the resurgence of
broccoli demand appears to be based on both health-related issues and matters
of convenience. The introduction of pre-cut and packaged value-added products
provides more convenience for consumers, and highly publicized medical
research linking compounds in broccoli with strong anti-cancer activity in
the body has added a powerful incentive to consumption.

According to the recently released 1997 Census of Agriculture, U.S. broccoli
acreage is concentrated on relatively few farms--6 percent of the growers
harvest 80 percent of the crop. About 63 percent of U.S. broccoli area is on
farms that harvest 500 or more acres of broccoli--up from the 53 percent
reported in the preceding census in 1992. The concentration of acreage on
large farms since 1992 likely reflects the rise of the value-added sector in
broccoli, where grower/processors require large volumes to operate
fresh-processing plants year round. The 1997 census found increasing
concentration as well among farms raising lettuce and carrots, which are also
experiencing rapid growth in the value-added arena. 

California Leads in U.S. 
Broccoli Production

Broccoli is grown in nearly every state, including Alaska and Hawaii.
California harvests 82 percent of the acreage, although it is home to just 22
percent of the farms growing broccoli. California's share of broccoli acreage
was up only slightly from 1992. Arizona is the second-largest producer with 8
percent of the acreage (up from 5 percent in 1992) and less than 2 percent of
the farms. Oregon, Maine, and Washington round out the top five producing
states, with another 6-7 percent of U.S. acreage. Several states noted in the
1992 census as important producers reported dramatically reduced broccoli
acreage in 1997, including Texas and North Carolina (down 80 and 73 percent).
Low shipping-point prices early in the decade likely discouraged higher
production at that time.  

Although broccoli is produced in several areas of California, the state's
acreage is concentrated in Monterey, Santa Barbara, and Imperial Counties
(48, 24, and 6 percent). In Monterey's fertile Salinas Valley, broccoli
acreage increased 10 percent between 1992 and 1997, and at $225 million
broccoli is second only to lettuce in the valley's agricultural production
value. Monterey County provides a substantial amount of value-added produce
items such as bagged salads and pre-cut broccoli florets. 

In Santa Barbara's Santa Maria Valley, broccoli acreage jumped 72 percent
between 1992 and 1997, vaulting ahead of strawberries as the county's leading
agricultural commodity. Some of this increase is likely due to the
introduction of value-added fresh broccoli products by several area firms.
Both the Salinas and the Santa Maria Valleys also have firms producing frozen
broccoli products. 

The Imperial Valley and Arizona's nearby Yuma Valley have also seen acreage
increases since 1992. These two desert areas harvest broccoli from late fall
to early spring, while the coastal Salinas and Santa Maria Valleys produce
virtually year-round. However, the peak production period in the desert
valleys, December and January, when they account for the largest share of
U.S. broccoli shipments, coincides with the lowest output period of the
coastal valleys. 

The 1997 Census of Agriculture reported nearly 3,900 acres of broccoli in
Oregon. The state's Willamette Valley accounts for two-thirds of the broccoli
acreage and serves both fresh and processed markets--two large vegetable
freezing firms are located in the valley. 

No current acreage or production data are available for Maine's broccoli
industry, although the state's broccoli acreage is likely up from the 3,219
acres reported in the 1992 census. Potatoes still account for the largest
share of Maine's agricultural industry. Most broccoli is produced by a few
former potato growers in Aroostook County in far northern Maine, where most
of the state's potatoes are also produced. From late July through early
November, Maine ships broccoli to eastern metropolitan areas such as Boston,
New York, and Philadelphia. Maine growers can compete with California
shippers on the east coast because of their transportation cost advantage.

Fresh & Processing Markets
Influenced by Trade

Most broccoli produced domestically is sold fresh or frozen, with
fresh-market production accounting for 94 percent of the U.S. crop.
Fresh-market broccoli also includes value-added fresh-cut and prepared
products such as bagged florets and broccoli coleslaw. Although broccoli is
generally not canned, limited quantities of dried and dehydrated broccoli are
used in soups. 

Domestic production of broccoli for freezing has declined during the 1990's,
and relatively few U.S. firms now pack frozen broccoli. Domestic freezers get
the majority of their raw product under contract with growers who plant
specifically for requirements set by the processors--such as varieties and
volume schedules. However, broccoli is generally considered a dual-use
vegetable, meaning varieties suitable for the fresh market can sometimes be
utilized for processed products. Thus, processors may also purchase
additional volume on the open market from fresh-market growers, usually when
fresh-market prices are low.

Trade plays an important role in U.S. broccoli markets, although the role
differs for fresh and frozen products. About 18 percent of U.S. fresh-market
broccoli supplies are exported, and 5 percent of fresh-market broccoli
consumption in the U.S. is from imports. Canada, Japan, and Hong Kong import
the largest shares of U.S. product, taking 56, 35, and 5 percent of U.S.
fresh
broccoli exports. All of the fresh broccoli imported by Canada and Mexico and
90 percent of the market in Japan are supplied by U.S. product. U.S. imports
of fresh-market broccoli come primarily from Mexico. The bulk arrives during
fall and winter, with smaller quantities coming during spring and summer.  

U.S. fresh-market exports and imports have both been trending upward in the
past two decades. Export volume during the 1990's has risen 73 percent, while
imports have more than tripled, with all the growth in imports occurring
since 1994. The most opportune time for Mexican exports to the U.S. is
January through May, when Mexican production is greatest, but this market
window is limited by a high tariff--25 percent in 1994--being phased out
slowly over 15 years. Given the well-supplied U.S. market, NAFTA offered
little additional economic incentive for Mexican broccoli exporters following
implementation of the agreement on January 1, 1994. However, the steep peso
devaluation that began in December 1994 altered this balance and likely
provided much of the impetus for the increased fresh-market broccoli exports
to the U.S. seen since 1995.

Although there are no government data for frozen broccoli exports, U.S.
shipments are likely small (less than 5 million pounds) and move primarily
into Europe, Japan, and Canada. In 1989, Statistics Canada reported just
86,000 pounds, valued at $41,000, of U.S. frozen broccoli imports. 

U.S. frozen broccoli imports have been rising for the past two decades.
Imports come primarily from Mexico--85 percent of the total--with Guatemala
providing most of the remainder. Mexican frozen broccoli imports to the U.S.
face a 15-percent base tariff under NAFTA, being phased out over 10 years,
while Guatemalan imports enter duty free under the Caribbean Basin
Initiative. Imports of frozen broccoli, primarily from Mexico, rose
eight-fold from 1980 to 1987, from supplying 9 percent to nearly half of U.S.
demand. Today, imports account for a hefty 80 percent of the frozen broccoli
consumed in this nation. 

Why does the U.S. rely on imports in the frozen broccoli market? Processing
costs are the key. Trimming broccoli by hand is said to yield the highest
quality product, but labor is the largest cost associated with producing
frozen broccoli florets. Lower labor rates have drawn broccoli marketers to
Mexico, as they have many other industries attempting to cut costs over the
past 2 decades. Based on this cost incentive, American firms have created an
export-oriented frozen broccoli industry in central Mexico, reflected in the
rapid rise in frozen broccoli imports.

Market Price Trends Up . . .

Prices for fresh broccoli (unadjusted for inflation) averaged a record-high
$30.80 per cwt (f.o.b. shipping point) during the 1998 season, up 51 percent
from 1989. In the frozen market, the majority of broccoli is grown under
contract. As a result, processing prices tend to be more stable than those in
the fresh market and have changed little over the past 15 years. Average
prices paid by processors at the processing plant door for raw broccoli were
$19.40 per cwt in 1998, up just 6 percent from $18.25 per cwt in 1989. 

With renewed demand in the 1990's, f.o.b. prices for fresh-market broccoli
have recently resumed the steady upward trend exhibited during the 1970's and
early 1980's. During the mid- to late-1980's, broccoli prices trended
downward, reflecting excess production caused by growers' overreaction to
increasing demand. Production expanded briefly into several southern and
eastern states during the 1980's but is now largely centered in the western
states. As prices declined, many of these new broccoli growers found the crop
unprofitable and consequently moved from broccoli to other crops. 

Despite the upward trend in the 1990's, monthly fresh-market broccoli prices
have continued to fluctuate widely around mean prices, as they did in the
1980's. Seasonal price patterns tend to be weak, since broccoli is produced
year round in the U.S. and imports of fresh-market broccoli are limited. A
weak, 2-year cyclical pattern appeared in the first half of the 1990's, but
that pattern has not been evident over the last 3 years. The widest bands of
price irregularity occur during March and November when temporary supply
disruptions occur, primarily because of the shift from one seasonal growing
region to another in California.   

In 1998, the U.S. retail price for fresh-market broccoli averaged $1.10 per
pound, up 12 percent from a year earlier. Largely reflecting renewed demand,
the retail price for fresh-market broccoli has risen 27 percent since 1995.
The marketing price spread--the difference between farm and retail price--for
fresh-market broccoli is very similar to that of carrots, celery, and
lettuce. On average, grower/shippers in these industries received 25-30
percent of the retail value for bulk commodity, with the remaining 70 percent
going to marketing costs such as transportation, retail labor, and other
selling costs.

. . . Along with Per Capita Use 

Americans consumed 2 billion pounds of broccoli in 1998. On a per capita
basis, this works out to about 8 pounds, which is 34 percent higher than in
1990 and nearly 3 times the 1980 level. From the early 1970's, the trend in
per capita broccoli use gradually moved upward until reaching a peak in 1989.
This peak occurred during a time of strong economic prosperity in the nation.
The economic slowdown of the early 1990's, however, witnessed a sudden drop
in fresh-market broccoli use. Consumption of other vegetables and fruits,
including iceberg lettuce, cauliflower, cantaloupe, and several others, 
showed similar use patterns during that period. Use of frozen broccoli,
however, remained relatively stable during the late 1980's and early 1990's.

After reaching a low-point for this decade in 1991, fresh-market broccoli use
picked up strongly and now sits at an all-time high of 5.6 pounds per
person--81 percent higher than in 1991 and more than 3 times the 1980-82
average. Frozen broccoli use, on a fresh-equivalent basis, reached a
record-high 2.6 pounds per capita in 1996 but has since returned to the 2.2
pounds per capita level of the early 1990's. This decline likely reflects
weather and pest-related production problems in Mexico during the past 2
years, rather than a change in consumer behavior.

What caused the resurgence in fresh-market demand? The keys are likely the
introduction of several value-added broccoli products plus a heightened
awareness of the association of broccoli with good health. 

The health aura which broccoli has enjoyed for many years has strengthened
over time as medical and nutritional research continue to explore the
linkages between diet and health. Annual private surveys of produce consumers
routinely inquire about specific perceptions of fresh vegetables, and
broccoli is regularly identified as the vegetable eaten most often for health
reasons, including cancer prevention. In addition, consumers often specify
high fiber content as the reason to purchase broccoli. Broccoli, carrots, and
sweet potatoes are routinely identified by consumers as the three vegetables
with the greatest nutritional benefits. 

USDA's nutrition information confirms that consumer perceptions of broccoli's
nutritional value are correct. Broccoli's fiber content is one of the highest
among vegetables, and 100 grams of broccoli contains 75 percent more vitamin
C than an equal amount of oranges. 

One medium stalk (148 kg) provides 200 percent of the daily recommended
intake of vitamin C, 16 percent of recommended of dietary fiber, and 10
percent of recommended vitamin A in the form of beta-carotene. Broccoli also
contains folate, potassium, and several other minerals, providing 6 percent
of daily calcium and 4 percent of daily iron needs. Reports on the link
between broccoli and the compound sulphoraphane, a potent anti-cancer
chemical, have been in the news since researchers at Johns Hopkins University
began releasing study results in 1992. 

Private surveys of produce consumers in the early 1990's found that almost a
fifth of consumers considered broccoli to be among the most time-consuming
produce items to cut, trim, and prepare. The emergence of value-added
broccoli products in the early 1990's responds directly to these consumer
concerns. Valued-added products such as bagged pre-cut florets, diced
broccoli pieces, and stir-fry mixes have undoubtedly played a role in the
resurgence of broccoli demand by making it more accessible and attractive to
time-pressed consumers. Innovative products like broccoli coleslaw (with
shredded broccoli, red cabbage, and carrots) and baby broccoli hybrids may
also be helping to expand total broccoli use. In a 1999 survey, 84 percent of
broccoli consumers said they had purchased pre-cut broccoli florets in the
past year. 

The increase in broccoli consumption is good news for both growers and
consumers. Broccoli demand is expected to continue to trend higher, which 
will help grower prices and incomes. In addition, as new value-added products
are introduced and the potential health benefits of broccoli become better
understood through medical and nutritional research, consumers will also reap
the benefits.

Gary Lucier (202) 694-5253
glucier@econ.ag.gov 

SIDEBAR - Cole Facts

When two Italian brothers planted a trial crop of broccoli near San Jose,
California in 1923, they were sowing the seeds of the commercial broccoli
industry in the U.S. Broccoli is believed to have originated in Mediterranean
Europe, and wild broccoli can be found today along Europe's Mediterranean and
Atlantic coasts. The seeds initially planted in California over 60 years ago
came from Messina, Italy.

The type of broccoli most familiar to U.S. consumers is sprouting (or
Italian) broccoli rather than heading broccoli, which is similar to
cauliflower. Broccoli, along with cauliflower, cabbage, brussels sprouts,
kohlrabi, kale, and turnip, belongs to the Cruciferae (mustard) family. The
name "broccoli" derives from the Italian brocco, meaning arm branch. Members
of the broccoli family are also sometimes referred to as "cole crops." The
word cole is thought to be a derivative of the Latin for stem or stalk of a
plant. The ancient Greeks referred to the cole crops as Kaulion, meaning
stem, and in some European countries broccoli is called calabrese. 

Broccoli, a biennial crop cultivated as an annual, is classified as a
cool-season crop and produces the highest quality where mean monthly
temperatures average 60 to 65 oF. In the past, most fresh and processing
varieties were direct seeded, with a small amount of the crop transplanted in
order to be ready for early market windows. Now, in part to assure better
stands (and yields), an increasing amount--currently about one-fourth of the
crop--is produced from greenhouse-grown transplants. 

Fresh-market broccoli is largely packed in the field, generally in 23-pound
cartons holding 14-18 bunches, which are cooled before transport to market,
and then sold in bulk or pre-packaged. Traditional retail bulk displays of
broccoli crowns--bunched stems banded together--and loose stems are most
prevalent. However, rising consumer interest in value-added products such as
spears (florets with attached stalk) and pre-cut and bagged florets have
helped expand consumer interest. Broccoli for most of these value-added
products is harvested and trucked to a packing plant for final cutting,
trimming, and packaging.  

Fresh broccoli has long been a mainstay of well-stocked salad bars. Many
consumers also enjoy broccoli in raw form as an appetizer with a vegetable
dip. However, broccoli is more commonly used as a side dish or entree
component (e.g., stir-fried with meat). Popular variations include steamed
broccoli covered with melted cheese and chicken-broccoli stir-fry. 

Broccoli for processing is hand harvested, dumped into large bulk containers,
and trucked to a processing plant, where it is washed, cut, and trimmed.
Frozen broccoli is marketed primarily as spears, cuts (1-inch pieces), and
chopped product (pieces smaller than 1 inch). These are often frozen by the
traditional "wet-pack" method, in which broccoli is first blanched and then
frozen in sealed containers.

Another popular method of freezing is called individually quick frozen (IQF).
IQF is a process in which broccoli is cut and blanched, the pieces frozen
separately as they travel along a conveyer line, and the frozen pieces packed
into plastic polybags found in supermarket freezer cases. Alternatively,
processors may initially pack IQF products in bulk storage containers for
later custom packing. Frozen food processors also pack broccoli in products
such as vegetable blends (with cauliflower and carrots, for example),
boil-in-bag pouches with cheese sauces, and meal entrees. 


WORLD AGRICULTURE & TRADE
Rice   in Japan: What Does It Mean for Trade?

[NOTE: Agricultural Outlook went to press in March, shortly before Japan's
tarrification policy was scheduled to be implemented.]

Rice has long been the staple food of Japan, a country of just over 125
million people with a land area slightly smaller than California. Because of
the high costs of producing rice in Japan, rice prices there are among the
highest in the world. The wholesale price of domestically grown Japanese rice
averages about 306 yen/kg, compared with about 60 yen/kg for California rice
arriving at a Japanese warehouse (excluding government markup or tariff) .
Rice-exporting countries see marketing potential in Japan, and have sought to
persuade it to change the policies that insulate and isolate it from world
rice markets. But Japan has effectively kept most imported rice out of the
domestic market, arguing that food security requires protecting domestic
production.

On April 1, 1999, Japan changes its rice import system to allow imports
outside the existing minimum access quota. But subsequent annual increases in
the quota will be less than without the April 1 change. The tariff to be
applied to imports outside the quota is equivalent to $3,080 per ton at
current exchange rates, representing a tariff rate of about 450 percent on
last year's U.S. rice exports to Japan. The new tariff is about 20 percent
higher than the maximum government "markup" currently allowed for rice
imports within the quota.

Total world trade in rice has recently grown to more than 20 million tons per
year. Japan imports over 600,000 tons of rice, mostly the high-priced
varieties, and therefore accounts for a disproportionate share of the value
of world rice trade. However, if Japan were to ease its import policy, the
level of rice imports could be higher than under the current managed- trade
regime.

Japan's Minimum Access

Until 1995, Japan had maintained an effective ban on rice imports, which
rested on the exclusive right of part of its agriculture ministry, the Food
Agency, to conduct trade in rice. Under this state trading regime, Japan
imported rice only if domestic production failed to satisfy consumption
needs. When it joined the General Agreement on Tariffs and Trade (GATT) in
1955, Japan claimed the right to regulate trade in rice and some other
commodities under GATT's "Balance of Payments" (BOP) clause that granted
concessions to countries with trade deficits. But in 1963, Japan "disinvoked"
the BOP rationale for trade barriers as the trade balance went from deficit
to surplus in the wake of Japan's successful export of manufactured goods.
However, Japan maintained some "residual" trade barriers, such as those for
rice and beef, which were to be lifted at an unspecified future time.

In the 1980's, the U.S. rice industry twice petitioned the U.S. government to
persuade Japan to relax its barriers against rice imports, and U.S. officials
frequently raised the issue with Japan. However, Japan refused to alter its
stance, and in most years imported no rice other than a relatively small
quota
that was opened in 1972, principally for the use of Okinawa's sake brewers,
when the Okinawa island group passed from U.S. to Japanese control.

The Uruguay Round (UR) of GATT negotiations focused particularly on barriers
to agricultural trade, and in general were able to "tariffy" nontariff
barriers--i.e., to substitute tariffs on imports for fixed quantitative
limits to trade. However, negotiating countries agreed to exceptions under
conditions spelled out in Annex 5 to the UR Agreement on Agriculture (URAA).
Annex 5 provides that a developed country (such as Japan) will allow "minimum
access" for imports in the first year of URAA commitment equal to 4 percent
of average annual consumption in the UR base period, 1986-88. This rises in
annual increments of 0.8 percent of the base period consumption until it
reaches 8 percent in the final year.

Japan's first year of URAA commitment was Japanese fiscal year (JFY) 1995
(April 1, 1995-March 31, 1996), and the final year is 2000, with quantities
of required imports rising from 379,000 tons of milled rice to 758,000 tons
in 2000. Japan imported rice according to this commitment through JFY 1998,
with imports reaching 606,000 tons (milled basis), or 6.4 percent of the base
period consumption. However, Annex 5 of the URAA also allows a developed
country to "tariffy" its import barriers (convert an import ban or quota to
an import duty) at the beginning of any year. In accordance with Annex 5,
Japan announced that it would lower annual market access increases in 1999
and 2000 from 0.8 percent of base period consumption to 0.4 percent on April
1, 1999. While Annex 5 requires that Japan continue to meet its existing
minimum access amount (606,000 tons in 1998), the smaller increases in
minimum access will put the import quota in 1999 at 644,000 tons instead of
682,000, and in 2000, the quota will be 682,000 tons instead of 758,000.
Until another agreement is made, Japan's annual minimum access after 2000
will remain at 682,000 tons.

The tariff for imports within the minimum access quota is zero, but the URAA
allows Japan to add a markup to within-quota imported rice of up to 292
yen/kg when it enters Japan. The markup remains a part of Japan's new import
rules. For imports above the minimum access amount, Japan has specified a
tariff of 351.17 yen/kg in 1999 and 341 yen/kg in 2000.

In addition to the tariff on over-quota imports, the Japanese government
reportedly also wants to implement a special safeguard mechanism. One version
of this proposal, which has not yet been officially announced, states that if
over-quota imports exceed 30,000 tons, or if imported rice prices fall below
90 percent of the average for 1986-88, an additional tariff of 117.6 yen
could be imposed, bringing the total tariff in 1999 to 468.77 yen/kg.
Presumably, the special safeguard would be removed at the end of the fiscal
year in which it was imposed. 

Tariff Puts Foreign
Rice Out of Reach

Japan's tariffication measures will slow the rate of increase in minimum
access in 1999 and thereafter, reducing the previously expected level of
imports in 2000 by 76,000 tons. Since the U.S. has accounted for a large
share of Japan's imports to date (nearly 50 percent), U.S. rice exports will
likely be lower than they would have been without tariffication. Hardest hit
will be California, since the overwhelming majority of U.S. rice exports to
Japan under the minimum access arrangement has originated in California.
Other major suppliers to Japan have been China, Australia, and Thailand.

Could relatively high-quality rice conceivably be imported over the quota and
still compete with Japanese production? The effect of the tariff (equivalent
to about $3,080 per ton at an exchange rate of 114 yen/$) depends on the
price of imported rice relative to domestic. Using January to November 1998
prices (c.i.f., milled rice--includes cost, insurance, and freight) for
Regular Minimum Access imports, the tariff of 351.17 yen/kg will raise the
per-kg price of Chinese rice to 425 yen/kg (up 474 percent), Australian rice
to 435 yen/kg (up 420 percent), and U.S. rice to 429 yen/kg (up 449 percent).
In contrast, Japan's highest-priced rice type, Uonuma Koshihikari, sells at
wholesale for 519 yen/kg, and standard quality rice sells at 332 yen/kg.
Sales results from a special part of the quota reserved for the "simultaneous
buy-sell system" (SBS) indicate that there is virtually no chance that any
rice paying the over-quota tariff could compete. 

The SBS has been used with some success in other commodity markets, such as
the Japanese and Korean markets for beef. In an SBS, private-sector buyers
and sellers can negotiate directly to determine the quantity, quality,
timing, etc. of a sale. In the Japanese rice SBS, buyers and sellers propose
a quantity and price of rice to be exchanged. The Food Agency then examines
all bids, choosing those that have the widest margin between the proposed
selling and buying prices. The Agency keeps the margin.

The margin is the markup, which under the URAA cannot exceed 292 yen/kg. The
closer the margin gets to 292 yen/kg, the more likely the Food Agency will
accept the bid, so buyers' and sellers' bids reflect pressure to maximize the
difference. However, at some price buyers will lose money if they cannot
dispose of the imported rice within Japan and recover at least the SBS
purchase price. Results of recent SBS sales give some idea of the maximum
price at which imported rice types can be sold in the Japanese market.

The outcome of the last SBS sale--a total of 30,000 tons on December 9,
1998--indicates that a tariff of 351 yen/kg is likely to preclude any
over-quota purchases. The markup for whole-grain rice sales (milled and
brown) ranged from 167 to 179 yen/kg, and for broken rice was about 50
yen/kg. Sale results indicate that the highest marketable addition to
imported rice prices--whether markup or other additions such as a tariff--is
currently around 179 yen/kg, and current market conditions would clearly not
support over-quota sales with an added 351-yen/kg tariff.  Nor would a
reduction to 341 yen in 2000 be enough to stimulate over-quota trade. 

Import Prices 
Remain High

Behind the Japanese government's decision to impose a high tariff on rice is
the high price of domestically produced rice in Japan, upwards of 400 yen/kg
at retail. Japanese producers' prices are about two-thirds of retail rice
prices, with the remainder going to wholesale and retail marketing costs.
During the 1990's, the Japanese government has taken steps to allow more
competition in retailing and wholesaling of rice. However, producer prices,
although somewhat lower than in the past, remain extremely high because of
the government's trade and agricultural policies.

Pressure to keep prices high reflects fears that lower prices would put
small-scale, high-cost farmers out of business, and that larger scale,
low-cost farmers would lose the extra income that comes from high prices.
Despite the URAA, the Japanese have effectively kept most imported rice out
of the domestic market in order to prevent greater supply from depressing
prices. In addition, the government has bought large stocks of Japanese rice
and expanded a program to pay producers to divert riceland to other uses, in
order to keep producer prices strong.

Since Japan sets its tariff in yen, the effect of the tariff on import demand
varies with the exchange rate. The rise of the yen from 360 to the
dollar--the fixed rate prevailing in the 1970's--to rates as low as 80 yen
per dollar in 1995 made Japanese rice much more expensive compared with
imported rice. In 1998, the yen ranged from 147 per dollar to 108 per dollar. 

Given a tariff level at 351 yen/kg, Japanese buyers are unlikely to import
any rice other than premium outside the minimum access amount. With a very
strong yen, premium U.S. rice may be competitive with top-quality Japanese
varieties. But regardless of the exchange rate, prices for standard quality
U.S. imports--including the 351-yen/kg tariff--would not be competitive with
domestic rice in Japan. Japan will, however, meet its commitments for minimum
access quantities. The minimum access quota is divided into two components:
the SBS share and the general quota. A minimum SBS share is mandated by the
URAA, and the remainder, the general quota, is purchased by the Food Agency,
which puts most of it into stocks. 

The government currently aims to replace rice stocks each year. Very little
Food Agency imported rice is consumed as table rice in Japan; industrial use,
feed use, and food aid exports have been the primary uses of imported rice.
Since the Food Agency paid an average of 68,000 yen per ton for the imports
($599/ton at 114 yen/$--the average exchange rate for the first 2 weeks of
February 1999) and sold most of the rice at a lower price or donated it, the
government lost money on this rice. In addition, the cost of storing rice for
a year is substantial, especially for brown rice, which is stored in
refrigerated warehouses. 

The amounts of rice imported under the SBS, which allows rice exporters
greater contact with Japanese buyers, far exceed the minimum share mandated
in the URAA, increasing from 3 percent of total Japanese rice imports in JFY
1995 to 19 percent in JFY 1998. Since the Food Agency keeps the price margin
or markup, it makes money on the SBS rice, instead of losing it in general
quota purchases, and further expansion of the SBS might be expected. However,
as the quantity of imports actually competing with Japanese domestic rice
increases and greater rice supply acts to depress prices within Japan, the
Food Agency may be pressured to limit expansion of the SBS.

Rice varieties imported through the SBS have been very diverse, reflecting
strong differentiation of rice markets within Japan and worldwide. For
example, in the December 1998 SBS sale, c.i.f. (selling) rice prices in
successful bids ranged from 45 yen/kg to 180 yen/kg. Some imports appear
destined for table use, such as the Chinese short grain milled rice which
dominated in 1998, while other imports were industrial use or glutinous rice
(a market which California has dominated). Little of the rice recently
imported under the SBS has been medium grain, the predominant rice produced
in California and Australia, which makes up the largest share, by type, of
purchases made by the Food Agency in the general quota.

Japan's government continues to argue that stringent protection at the border
is required to ensure that rice production area does not fall drastically,
for both food security and environmental reasons. In Japan, rice paddies are
considered a defense against flooding as well as a water filtration system.
In addition, rice cultivation has cultural and aesthetic dimensions.

Japan's trade partners counter that food security is better achieved through
free trade and that environmental and other possible benefits of rice farming
should be realized through other means than high rice prices and barriers to
trade. The coming multilateral negotiations for a new World Trade
Organization agreement are likely to address these arguments as well as the
size of Japan's proposed tariff on rice. 

John Dyck (202) 694-5221, Nathan Childs (202) 694-5292, Karen Ackerman (202)
694-5264, David Skully (202) 694-5236, and Sarah Hanson (FAS, USDA, Tokyo).
Hugh Maginnis (FAS) and Linda Kotschwar (FAS) also contributed to this
article. jdyck@econ.ag.gov
nchilds@econ.ag.gov
ackerman@econ.ag.gov
dskully@econ.ag.gov

SIDEBAR - Rice Preferences Vary

Because rice consumption is so differentiated in Japan, it presents a
potential market for several different kinds of rice imports. While there is
some demand for long grain indica rice in ethnic restaurants, the main table
rice is shorter grain japonica rice. The table rice market is further
differentiated by preferences for certain varieties of short grain rice, and
these varieties are sometimes promoted as products from a certain area, such
as a prefecture or town. Smaller markets exist for glutinous (very sticky)
japonica rice and for rice for industrial uses, such as sake (rice wine)
brewing and rice crackers, etc. Organically produced rice is popular and
commands a price premium. Japanese rice is sold as a single variety or
marketed as a blend. Most imported rice is blended with other rice and
Japanese consumers do not know its origin.

SIDEBAR - Japan: California Rice Growers' Best Customer

Japan produces and consumes primarily japonica rice, a variety usually
purchased by higher income countries. Japonica accounts for about 15 percent
of world production and 11-12 percent of world trade in most years, while
indica rice accounts for more than three-fourths of world production and
trade. Japonica rice is slightly more rounded (or plump) and stickier than
indica, and typically sells at a premium to indica in international markets.

Japan is the world's largest importer of japonica rice, which accounts for
the bulk of Japan's rice imports. Without Japan's purchases, world japonica
trading prices would be much lower than today, as was the situation during
most of the 1980's after South Korea--the largest importer at that
time--withdrew from the market. The bulk of world japonica exports are from
Australia, the U.S., and China, with smaller quantities supplied by Egypt,
the European Union, and Taiwan (food aid only). Besides Japan, other major
japonica importers are Turkey, Jordan, and South Korea. 

California produces mostly japonica, and Japan is now the largest export
market for California rice. In U.S. market year 1997/98 (August-July), Japan
accounted for about half of California's rice exports and almost one-fifth of
the state's crop. Without the Japanese market, California would have severe
excess supply, lower prices, and would likely decrease production.


FOOD & MARKETING
Food Price Outlook for 1999: An Update

The Consumer Price Index (CPI) for all food is expected to increase 2 to 3
percent in 1999, following a 2.2-percent increase in 1998. Food at home is
projected to rise 2 to 2.5 percent, while food away from home should increase
2.5 to 3 percent. The 1998 all-food increase  was the smallest since 1993 and
follows the USDA baseline projection of an average growth rate of 2.3 percent
from 1998 to 2008. 

Although 1999 looks like another year of low food price inflation,
uncertainties remain that will influence whether the increase for all food is
closer to 2 or to 3 percent. Will the sluggish export market for beef and
higher-valued cuts of pork and poultry continue throughout 1999? Can the
expected 2-percent increase in milk production meet consumer demands for
butterfat products in 1999? And will higher expected retail prices for
oranges and bananas continue longer than the first 6 months of 1999? 

The food categories involved in these uncertainties--beef, pork, and poultry;
dairy and related products; fats and oils (including butter); and fresh
fruits--together account for 39 percent of the food-at-home CPI. Thus the
answers to these questions will be determining factors in the final figure
for 1999.

Retail food price changes are underpinned by general economic factors that
influence both food prices and the relationship between farm and marketing
costs. Increasing economies of size in the farm sector continue to reduce the
cost of producing food at the farm level. At the same time, the farm value
share of the retail cost of food continues to decline as consumers pay for
additional processing and services to reduce the time required for food
preparation. The share of the consumer food dollar going to purchase food
away from home has increased steadily, averaging 45 percent for the past 2
years, while the farm-value share of the retail price for food items is
expected to average only 23-24 cents on the dollar for 1998 and 1999. 

As post-farm gate processing and services take up an increasing proportion of
the food dollar, the retail price of food increasingly reflects the general
inflation rate in the wider economy. In recent years, food price increases
have been small, in line with the low general inflation rate, which was only
1.9 percent in 1998 and is forecast to be around 2-3 percent in 1999. 

Food price changes are a key variable in determining what proportion of
income consumers spend for food and what is left for purchases of other goods
and services. In 1997, 10.7 percent of household disposable personal income
went to pay for food, with 6.6 percent for food at home and 4.1 percent for
food away from home, down from 10.8 percent in 1996. The downward trend in
the proportion of household disposable personal income used for food should
continue into 1998 and 1999. Preliminary figures (inflation-adjusted) on food
sales for 1998 show food at home spending went down 0.1 percent, and spending
on food away from home went down 1.5 percent, while per capita disposable
income rose 3.1 percent. With continued competition among grocery stores,
restaurants, and fast-food establishments, the same pattern is expected
through 1999.

The food at home CPI increase of 2.2 percent in 1998 was kept moderate by
lower grain prices and adequate feed supplies, large supplies of competing
meats, adequate supplies of coffee, increased sugar production, and strong
competition in the soft drink and prepared food industries. The 1998 CPI
increase of 2.6 percent for food away from home was smaller than in 1997.
Continued strong competition among restaurants and fast-food establishments
kept pressure on prices, while lower costs for raw materials, especially
food, kept costs down.

Overall food price increases in 1998 were influenced largely by three
circumstances. Large consumer demand coupled with stagnant milk production
contributed to higher retail prices for dairy products, especially high
butterfat items. Reduced fresh fruit and vegetable supplies resulting from
damages inflicted by El Nino weather patterns and Hurricane Mitch led to
substantial retail price increases for those foods. And modest increases in
the indexes for sugar and sweets, cereals and bakery products, and other
foods were the result of adequate supplies and a small increase in the
general price level, which contributes to manufacturing, processing, and
marketing costs.

Overall food price decreases in 1998 may be accounted for by large, competing
supplies of meats that led to retail price decreases for beef and pork; lower
feed prices that led to larger egg production and a consequent drop in retail
prices; and adequate coffee supplies and competition among soft drink
producers for market share that lowered the prices for these items in the
nonalcoholic b everages index.

Beef and veal. After falling 0.2 percent in 1998, the CPI for beef and veal
is expected to increase 1-2 percent in 1999. Commercial beef production is
expected to decline 2-3 percent in 1999, with further reductions expected in
2000. However, continued record-large supplies of competing meats at prices
lower than beef prices will limit large retail price increases. As supplies
decline, retail beef prices will begin rising modestly in spring 1999.

Economic slowdowns in Asia and Russia resulted in a declining U.S. beef trade
balance in 1998, with less of the top-graded U.S. beef going into the export
market. The strong U.S. economy led to an almost 11-percent rise in beef
imports in 1998, while exports grew less than 1 percent. Trade is expected to
be more balanced in 1999. World beef supplies are expected to decline and
slow U.S. imports to 3-4 percent, while U.S. beef exports are expected to
rise 7-9 percent, largely as a result of food aid programs to Russia.

Pork. With expectations of plentiful supplies of pork and competing meats
throughout 1999, pork retail prices are expected to fall another 3-4 percent,
after sliding 4.7 percent in 1998. Pork production increased 10 percent in
1998, leading to the largest per capita consumption rate increase since 1994,
with an increase of almost 8 pounds from 1997 per capita consumption of 48.7
pounds. With fractionally lower production and expected export increases of
10 percent, U.S. per capita pork consumption in 1999 will decline slightly
from 1998 levels. U.S. pork exports in 1999 are expected to be over 1.3
billion pounds, up from more than 1.2 billion in 1998.

When hog prices were historically low in late 1998, concerns were raised
about why retail prices did not drop as sharply as producer prices (AO March
1999). Different demand situations can explain why retail pork prices do not
parallel hog prices. 

First, contractual agreements between hog producers and slaughter plants are
increasingly the norm, with only about 10 percent of slaughter hogs sold in
the open spot, or cash, markets. When the available slaughter hog supply
exceeds plant capacity (as it did in fourth-quarter 1998), slaughter plants
lower their bid for the available supply of noncontracted hogs, which sharply
reduces spot market prices. Conversely, when slaughter facilities are a
relatively low rates of utilization (as in third-quarter 1997), packers bid
spot market hog prices up sharply.

Second, pork retail prices are generally slow to react to farm price changes
and do not fluctuate as much as producer or wholesale prices. Historically,
declines in the farm value of pork take more than a year to be passed on to
consumers, while increases take about 4 months. Retail values do not rise at
the same rate nor to the same degree as farm values. For example, the net
farm value for pork increased 24 percent in 1990, but the pork CPI increased
by only 14.7 percent in 1990 and 3.3 percent in 1991. Similarly, retail
prices tend to fall less than farm values. In 1991, the net farm value for
pork fell 10 percent, followed by an additional decrease of 14 percent in
1992, but the pork CPI rose 3.3 percent in 1991 and declined by only 4.7
percent in 1992. More recently, in 1996, when the net farm value for pork
increased 27 percent, the pork CPI index increase was only 9.9 percent in
1996 and 5.2 percent in 1997.  

Retailers strive to offer a variety of meat and poultry products to
consumers, knowing that increased sales in one meat species comes at the
expense of another. During the December holidays, retailers found they were
able to move pork without significant retail price reductions, as pork
supplies met rising retail consumer demand at the price range set by
retailers.  

Other meats. Other meats are highly processed food items (hot dogs, bologna,
sausages). The CPI for this category increased 0.9 percent in 1998, and 1999
prices are expected to increase up to 1 percent. Price changes for items in
this category are influenced both by the cost of meat inputs and by the
general inflation rate, since they reflect additional manufacturing costs. 

Poultry. Broiler meat production for 1999 could increase to 29.4 million
pounds, about 5 percent above 1998. However, 1999 turkey production is
forecast at 5.25 million pounds, fractionally below 1998. Turkey producers
are recovering from 2 years of negative returns, which has held down
production increases. 

Export prospects for U.S. poultry have become less certain due to the
continuing financial crisis in many Asian countries and loss of the Russian
market. Broiler meat exports are forecast to remain weak through much of
1999, with first-half exports expected to be 20-25 percent lower than 1998.
As these circumstances  continue into 1999, increases in production likely
will lead to lower retail prices for much of the year, despite reduced
supplies of competing red meat. The poultry CPI is expected to change only
slightly again in 1999, between -1 and 1 percent, following an increase of
0.3 percent in 1998.

Fish and seafood. The CPI for fish and seafood was up 2.6 percent in 1998,
with an expected increase of 2-3 percent in 1999. More than 50 percent of the
fish and seafood consumed in the U.S. in 1998 came from imports. Imports for
1998 were up, especially for salmon, shrimp, tilapia, mussels, clams, and
oysters. The strength of the U.S. dollar favors a continued rise in imports,
especially from Asian countries.

U.S. farm-raised production supplied 20-25 percent of U.S. fish and seafood
consumption in 1998. The U.S. has one of the world's largest year-round
farm-raised fishing industries. Domestic production of catfish reached record
highs in 1998, about 560 million pounds, and catfish growers are expected to
continue expanding in 1999. U.S. per capita seafood consumption has remained
flat in the 1990's--between 14.8 and 15.2 pounds of edible meat per year.
Increases in total domestic seafood consumption have come from population
growth. However, a strong U.S. economy is expected to boost away-from-home
food demand, which is especially important for seafood, as a large percentage
of seafood is consumed at restaurants.

Eggs. After a period of volatile egg prices in 1996, the CPI for eggs fell
1.5 percent in 1997 and 3.3 percent in 1998, and is expected to fall 1-3
percent in 1999. With table-egg production expected to be about 2 percent
higher in 1999, consumption is expected to increase to the highest level
since 1988. Higher production levels and slower growth in exports led to
lower retail prices in 1997 and 1998, and is expected to do the same in 1999. 

Dairy products. Robust demand and stagnant milk production produced record
high retail prices for milk and most dairy products throughout most of 1998.
Increased demand and lower feed costs have provided a strong incentive to
boost milk production in 1999, leading to expected increased production of 2
percent. As a result of a lag in retail price adjustments to production
increases, the milk CPI is forecast up 4-5 percent in 1999, following a 3.6
percent increase in 1998. Strong consumer demand for dairy items, especially
gourmet ice cream, cheese, and butterfat products, is expected to continue
into 1999.

Fats and oils. The fats and oils CPI increased 3.7 percent in 1998 and is
expected to rise another 3-4 percent in 1999. The large increases, following
a modest 0.9 percent increase in 1997, are largely an artifact of the 1998
move of butter from the dairy products index to the fats and oils index by
the Bureau of Labor Statistics, since higher retail prices for butter, which
now accounts for 31 percent of the fats and oils index, led the increase. The
remaining items contained in the fats and oils index are highly processed
food items, and their price changes are influenced by the general inflation
rate, as well as by U.S. and world supplies of vegetable oils. 

Fresh fruits. Reduced production of most summer stone fruits and fall pears
in 1998 helped to boost retail fresh fruit prices for the year. However, the
1998 U.S. apple crop, which was up 9 percent from a year ago, helped mitigate
retail price increases for other fruits. In 1998, U.S. production of grapes,
pears, peaches, apricots, sweet cherries, strawberries (in the 6 highest
producing states), and blueberries all declined. Production of tart cherries
and cranberries was up slightly. 

The 1997/98 U.S. citrus crop increased 5 percent over the previous year,
mostly because of a record orange crop, up 9 percent over the previous year.
Wet, cool conditions in California and spring drought conditions in Florida
reduced U.S. orange production forecasts for 1998/99 to 21 percent below
1997/98 production, and a freeze in California's San Joaquin Valley in
December 1998 caused USDA to lower 1998/99 orange production forecasts even
more, bringing the level to 27 percent less than the previous year's 13.9
million tons. California's production estimate alone was down 49 percent. 

Because California produces about 80 percent of U.S. fresh-market oranges,
retail prices for oranges are expected to increase 40-50 percent for the
first 6 months of 1999. Imports from other countries, along with diversion of
part of Florida's orange production (usually used for juice) to the fresh
market, should mitigate  the effects.

Most of the tropical fruit supplies in the U.S., including the most popular
varieties--bananas, mangoes, pineapples, and papayas--are imported. After
seasonally lower banana prices in 1998, higher retail prices are forecast for
most of 1999. Hurricane Mitch, which hit the banana-growing areas of Honduras
and Guatemala in November 1998, caused major damage to the crop. The impact
of storm damage in Central America on retail prices should occur as early as
February or March 1999, with prices peaking in April. Retail banana prices
are forecast to increase up to 15 percent in the first 6 months of 1999, and
an additional 8 percent during the last half of the year.

Fresh oranges and bananas account for 20 and 18.5 percent of the fresh fruits
CPI. Higher prices for these two products raise the expected CPI for 1999
beyond the increased level that would be expected simply from steady U.S.
consumer demand for fresh fruits. Following a 4.3-percent increase in 1998,
the fresh fruits CPI is expected to increase 7-8 percent in 1999. 

Fresh vegetables. El Nino-driven cold, wet weather in Florida, California,
and Mexico reduced fresh-market vegetable supplies and disrupted planting and
harvest windows, resulting in increased retail prices throughout the first
half of 1998. In addition, although downgraded to a tropical storm by the
time it reached the U.S., Mitch caused wind and water damage to some central
Florida vegetables in early November, putting additional upward pressure on
prices. As a result, the fresh vegetable CPI rose 10.9 percent in 1998.

Two percent fewer acres of fresh-market vegetables and melons were harvested
in fall 1998. Acreage of cool-season crops--lettuce, carrots, and
broccoli--declined 1 percent, while that of warm-season crops--tomatoes, bell
peppers, snap beans--dropped 3 percent. Mitch damaged several of the
fall-season vegetable crops in Florida and flooded cantaloupe fields in Costa
Rica and Honduras, reducing supplies and causing higher consumer prices into
early 1999. Strong winds caused some bloom loss for tomatoes and peppers;
snap beans and radishes were drowned, requiring replanting of some fields;
yield potential for Florida's fall vegetables was diminished; and product
quality of vegetables like tomatoes and eggplant that did survive was
reduced.

During the 1999 winter season (January-March), harvested acreage of 13
selected vegetables is forecast to rise 3 percent to 193,500 acres, and
imports from Mexico will add to large domestic supplies. For calendar year
1999, fresh-market vegetable acreage is expected to increase about 1 percent.
Potato production, which increased 2 percent in 1998, is expected to increase
another 1 percent in 1999. As a result, the fresh vegetable CPI is forecast
to fall 1-3 percent in 1999, if weather and growing conditions in the major
fresh vegetable growing areas return to normal.

Processed fruits and vegetables. Production of the four leading vegetables
for processing (tomatoes, sweet corn, snap beans, and green peas) was down 2
percent in 1998, after a 3-percent decline in planted acreage a year earlier.
Per-acre yields were below a year earlier for tomatoes, green peas, and sweet
corn (down 7, 3, and 2 percent), but were higher for snap beans (up 3
percent). Wholesale prices of canned vegetables and juices for 1998, however,
averaged only 1 percent above the previous year, placing little pressure on
retail prices. The ready availability of canned and frozen vegetables, frozen
concentrate orange juice, and other fruit supplies kept the CPI increase for
processed fruits and vegetables to 1.7 percent in 1998, but the reduced
acreage and lower yields are expected to lead to an increase of 2-4 percent
in 1999. 

Sugar and sweets. Domestic sugar production was up to 8 million tons in
1997/98 and is projected up another 3 percent in 1998/99 to 8.3 million tons.
Higher sugarbeet prices and lower prices for competing crops led to acreage
increases in both years. Along with higher sugar output, lower retail prices
for selected sugar-related food items in 1998 kept the increase in the sugar
and sweets CPI to only 1.6 percent. It is projected to continue to increase
1-3 percent in 1999.

Cereal and bakery products.  These products account for a large
portion--almost 16 percent--of the at-home food CPI. Lower grain prices in
1997 and 1998 held the increase to 2 percent in 1998. Most of the costs to
produce cereal and bread products--more than 90 percent in most cases--are
for processing and marketing, leaving the farm ingredients as a minor cost
consideration. Competition for market share among the three leading breakfast
cereal manufacturers led to the cereal component of this index falling 9.7
percent from 1995 to 1996, and 1.4 percent from 1996 to 1997. In 1998, cereal
prices were up slightly--1.3 percent. Continued strong demand for cereal and
bakery products, balanced by continued competition among producers, should
keep the CPI increase for cereals and bakery products to about 2-3 percent in
1999.

Nonalcoholic beverages. Coffee and carbonated beverages are the two major
components of this category, accounting for 15 and 38 percent of the
nonalcoholic beverages CPI. After increasing 3.7 percent in 1997, due
primarily to higher coffee prices, the index fell 0.3 percent in 1998. Lower
coffee prices and strong competition in the soft drink industry between the
two largest firms continued throughout most of 1998. After increasing almost
13 percent in 1997, coffee prices fell almost 3 percent in 1998; carbonated
beverages were down 1.4 percent in 1997 and 1 percent in 1998.

Brazil's 1998/99 coffee harvest reached a near-record 36 million bags, a
third of the world's total and 50 percent above the 1997/98 marketing year.
The current large Brazilian crop is forcing other countries to cut prices,
which should continue to lower prices in the U.S. (AO March 1999). Brazil is
the largest producer of arabica coffee beans, which are preferred for gourmet
coffee blends. U.S. imports of coffee are up to 80 percent arabica beans.

Brazil's recent near-record production should lead to larger U.S. stocks and
continued lower consumer prices. The continuing decline of coffee prices,
combined with continued competition in the soft drink industry, should keep
the CPI for nonalcoholic beverages to a moderate 2-3 percent increase. 

Other prepared foods. Other miscellaneous prepared foods--including frozen
dinners, pizzas, and precooked frozen meats--are highly processed and largely
track changes in the all-items CPI. Competition among these products and from
the away-from-home market should continue to dampen retail price increases
for items in this category. In 1998, the CPI for other prepared foods
increased 2.7 percent, and the 1999 increase is expected to be in the same
range at 2-3 percent. Annette L. Clauson, (202) 694-5373
clauson@econ.ag.gov

For further information on food prices, visit the ERS website at
http://www.econ.ag.gov/briefing/FoodMark/

SIDEBAR - Minimum Wage Increases  The Impact on Food Prices 

Ongoing debate about the merits of increasing the minimum wage has generated
empirical research on the potential effects of an increased minimum wage on
employment, but little work has been done on the impact of minimum wage
increases on prices in general or on food prices in particular. Because the
food industry has larger-than-average concentrations of workers in low-wage
occupations, increases in the minimum wage might be expected to have fairly
large impacts on food prices. USDA's Economic Research Service (ERS) recently
conducted research to estimate what the price effects of a minimum wage
increase in the food industry might be, taking into account the size of the
increase, effects on benefits in addition to wages, and effects on pay in
other low-wage categories.

ERS estimates derive from an economic model (Leontief Input/Output model)
that assumes all increased wage costs can be passed through to the consumer.
Firms are not always able to pass through wage increases this way--purchasers
may be able to substitute other products if firms increase prices too much,
for example. But by assuming full pass-through, the model results can be
considered as upper bounds. 

The model takes into account the industry employment structure, share of
workers in the minimum wage bracket, share of wages and salaries in the total
cost of production, and the percentage increase in the minimum wage. A change
in one input component--the minimum wage in this case--trickles through the
system, affecting costs and, in turn, prices. ERS researchers estimate new
food prices under several likely scenarios that vary the base of the minimum
wage increase (50-cent increase over the 1992 minimum of $4.25 or 50-cent
increase over the 1997 minimum of $5.15), spillover effects (increases of 1-3
percent in near-minimum-wage categories to maintain graduated wage scales),
and the effect on total compensation (wages and other benefits).

ERS estimates these price effects separately for the two industry categories
defined by the U.S. Bureau of Labor Statistics (BLS) that would generally be
considered the food and restaurant sectors. The food and kindred products
industry category includes establishments that manufacture or process food
and beverages for human consumption. The eating and drinking places industry
category includes retail establishments selling prepared food and drink for
consumption on the premises, including fast-food restaurants. Results
indicate a smaller effect in the food and kindred products industry, with
consumer price increases ranging from 0.3 to 0.5 percent, than in the eating
and drinking places industry, which shows consumer price increases of 0.9 to
1.3 percent. But for both categories, the effects are small in absolute
terms.

What accounts for these small increases? The proportion of total cost of
production affected by any wage increase in the food industry would be
relatively small; labor's share of the cost of production was only 13.5
percent for the food and kindred products industry and 34 percent for the
eating and drinking establishments. Moreover, the share of food industry
workers in the minimum wage category is also small--less than 10 percent in
most subsectors of the food and kindred products industry and around 23
percent in the eating and drinking places industry. So the proportion of
labor costs affected by a minimum wage increase--even including spillover
effects on other low-wage workers--is relatively small. Finally, the wage and
salary share of labor costs, the portion affected directly by a minimum wage
increase, is only part of total labor costs--75-80 percent in most
cases--further limiting the price effects of even full pass-through of
increased wage costs.

Chinkook Lee (202) 694-5354
chinlee@econ.ag.gov

FARM FINANCE
Boom & Bust: Will Agricultural History Repeat in the 1990's?

The recent deterioration in commodity prices following several years of
healthy gains in farmland values and rising debt levels has led to
speculation that agriculture could be entering a contraction similar to that
of the 1980's. Over the past 2 years, prices for many key agricultural
commodities (especially grains, oilseeds, and hogs) have fallen dramatically.
In addition, preliminary 1998 real net farm income is lower than for 4 of the
preceding 5 years, and the 1999 forecast indicates further deterioration.
Because lenders may balk at extending loans to agricultural borrowers who
cannot demonstrate solid repayment ability, some have characterized the
anticipated downturn as a "credit crisis." But whether reduced incomes create
financial hardship depends on initial farm financial strength, how far income
falls and how long it remains low, and the decisions that farmers and lenders
make as events unfold.

The 1970's Boom Became
The 1980's Bust 

The Boom. Commodity prices surged from 1973 through 1975 and remained high
through 1979. During this period, farm income, rate of return on assets from
current income, and rate of return from real capital gains were unusually
large. Farmers responded strongly to perceived profit opportunities from
increased production by bringing more land under cultivation and by investing
in productivity-increasing technologies.

One factor that contributed to the initial surge in farm income was the
increase in effective demand abroad for U.S. agricultural products. This
increase stemmed partly from devaluation of the dollar following a major
change in foreign exchange valuation--in 1972 the U.S. abandoned the fixed
exchange rate regime that had been in place since the end of World War
II--and partly from adverse weather conditions in competing production
regions overseas. For example, exports to the Soviet Union increased when the
Soviets began to purchase feed to offset domestic production shortfalls,
instead of cutting livestock herds.

Government policies during the 1970's amplified the supply response. Along
with many other governments concerned about foreign exchange or food security
issues, the U.S. expanded support for agricultural production. Federal
commodity programs encouraged higher production and indirectly encouraged
increased farm borrowing. By setting price floors, commodity programs reduced
risk associated with falling prices, making farm income a more reliable
source for debt repayment. Price floors were raised during the boom period,
when the increase involved no immediate increase in Federal budget
expenditures, further supporting farm income and farm borrowing.

Increased farm income, rising inflation, readily available credit, and low to
negative real interest rates led to sustained increases in farmland values
and in outlays for farm machinery and equipment. Because financial assets
lose value with inflation while real assets gain value, rising inflation
encourages investors to shift their holdings from financial to real assets.
Such a shift exacerbates the loss for financial assets but strengthens the
gain for real assets, including farmland.

Real interest rates--nominal interest rates less the rate of inflation--were
low or negative during much of the 1970's. Low real interest rates encourage
debt financing, since debt can be repaid in the future with cheaper, inflated
dollars. From the beginning of the boom in 1972 through the peak in land
values in 1981, farm debt grew 15 percent faster than assets. Although the
increase in asset values was widely dispersed, the increase in debt was
concentrated among farmers who were financing new purchases of land or
equipment. With strong equity, rising incomes, and increasing collateral
values during the boom years, most farmers had little trouble getting loans.
Given the strong farm financial picture, lenders at that time fully expected
to recover both the balance due and all foreclosure costs in the event of
default.

The Bust. By the end of 1970's, concern was mounting about declining farm
liquidity and about indications of farmers' vulnerability to cash flow or
interest rate shocks. For example, interest and principal payments had grown
from less than one-sixth (16 percent) of gross cash income in the early
1970's to almost one-fourth (24 percent) of gross cash income by 1980.
Nevertheless, farmers, lenders, and economists were slow to realize the
extent of needed adjustments. Instead, many who anticipated a contraction
argued that it would be short and would involve shifting income from asset
accumulation to debt service, but that asset values would remain sound.

By the early 1980's, many of the factors that spurred the boom were
reversing. Commodity prices fell, input prices and interest rates rose,
export demand turned down, and farm income declined. Many farmers who had
bought land or made other long-term investments--especially those who used
debt financing--now had difficulty meeting their other financial obligations
or even making a living. 

Nominal interest rates rose sharply in 1980, peaked in 1981, and remained
high for several years, the result of inflation-fighting policy decisions by
the Federal Reserve Board. High interest rates made dollar-denominated
investments attractive and caused the foreign exchange value of the dollar to
appreciate, making U.S. goods relatively expensive for purchasers abroad. The
monetary tightening successfully curbed the double-digit inflation of the
late seventies--inflation as measured by the Consumer Price Index peaked at
12.5 percent in 1980 and fell below 2 percent by 1986. But the high value of
the dollar along with high price floors for program commodities hurt U.S.
agriculture's international competitiveness and pressured farm incomes. 

The fall in real farm income and the increase in real interest rates altered
the economic environment that had made debt-financed investment in farmland
and other nonfinancial assets attractive, delivering a double whammy to
heavily indebted farmers. Because the value of capital assets is directly
related to the cash flows they generate and inversely related to interest
rates, falling incomes and rising rates pressured farm asset values, which
fell dramatically from 1981 through 1986.

Lender Stress Follows
Farm Loan Defaults

Like the agricultural crisis, the crisis among lenders--banks, thrifts, and
the Farm Credit System (FCS)--had its roots in the 1970's. Increased
instability in banking, as in agriculture, arose from the change in the
exchange rate regime, rising inflation, volatile nominal interest rates, and
anti-inflationary Federal Reserve Board monetary policies. And as in
agriculture, there were few obvious signs of trouble for lenders in 1980,
when small banks (those with less than $100 million in assets) and FCS
institutions, were enjoying good rates of return on assets and returns on
equity, low loan charge-offs, and improving equity-to-asset ratios

According to the Federal Deposit Insurance Corporation (FDIC), most of the
bank failures in the 1980's--a period of more bank failures than any decade
since the 1930's--were precipitated by four regional and sectoral recessions,
including the one in agriculture. Banks were vulnerable to these recessions
because they tended to serve relatively narrow geographic markets, but not
all regional recessions were accompanied by bank failures. Generally,
failures were associated with recessions in sectors that had experienced a
fairly sustained expansion and had grown faster than the national economy. 
Agriculture was such a sector.  In contrast, recessions that were preceded by
slow growth (such as in the rust belt) did not lead to many failures.

Recessions that caused problems for lenders were similar in that each
followed a period of rapid expansion, speculation that contributed to the
runup in asset values, and wide swings in demand for real estate that
contributed to the severity of downturns. But the behavior of agricultural
lenders and their regulators arguably accentuated the sector's boom and
aggravated the decline. Credit helped fuel the boom, and when the down cycle
hit, some borrowers inevitably defaulted, weakening lenders. 

Lenders who found themselves in trouble had generally not been in a seriously
weak condition in the years preceding the recessions. But lenders who failed
had often assumed greater risks than the survivors, measuring risk as the
ratios of total loans and nonresidential real estate loans to total assets.
Still, only a small fraction of lenders with high risk exposures failed. 
Mitigating factors included strong equity and reserve positions, more
favorable risk/return tradeoffs, superior lending and risk management skills,
and proactive changes in risk policies before losses became severe. Lenders
that relaxed credit standards, entered markets where management lacked
expertise, made large loans to single borrowers, or experienced loan growth
that strained their internal control systems or back-office operations were
most likely to fail. These factors were as much associated with distress
among FCS lenders as with distress among commercial banks.

The greater a lender's exposure to agriculture, the more problems arose from
defaulting farm loans. Life insurance companies and large banks were least
affected because of the relatively small share of their assets related to
agriculture.  Even many rural banks were adequately diversified to survive
the downturn. Of 5,000 agricultural banks existing in 1981, 328 failed in the
next 10 years, but return on equity for agricultural banks never fell below 5
percent, on average, and capital-to-asset ratios were higher on average than
at other banks, even improving over the decade. FCS lenders faced greater
challenges because their loan portfolios were not diversified either by
geography or by industry, and because of organizational and operating
inefficiencies. 

The 1990's: Deja Vu?

Some of the experiences of the past few years are astonishingly similar to
events of the agricultural cycle of the 1970's and 1980's. Some of the events
and conditions supporting recent gains in farm income and asset values
parallel those that occurred in the boom years of the 1970's, starting with
the recent up-cycle which followed a pattern of rising agricultural exports
during a period of tight stocks that resulted from production controls and
unusually bad weather in many growing areas worldwide. This combination, then
as now, led to high prices and optimism about future income from farming
which along with falling interest rates, supported farmland price increases. 

Recent increases in farm indebtedness add to the sense of deja vu. The
beginning of the current down-cycle also shows parallels--policies that
imposed supply controls on agricultural production have been relaxed, foreign
demand has diminished in the face of financial crises that started in Asia,
the dollar has appreciated relative to other currencies, and carryover stocks
of grains and oilseeds are increasing. 

Despite the similarities, many factors are substantially different. In
contrast to the early 1980's, the farm sector and its lenders are far less
vulnerable to economic instability, because they use leverage more
conservatively now than in the 1970's. Today's stable domestic economic
environment, strong overall economic growth, and low unemployment in most
parts of the country--unlike the stagflation and recession of the late 1970's
and early 1980's--make income from off-farm employment a reliable alternative
source of debt repayment capacity for farm families in many parts of the
country. 

Monetary tightening by the Federal Reserve Board and vulnerability of farmers
and lenders to interest rate changes were defining characteristics of the
1980's crises. Although indicators of farm sector financial strength have
weakened, increases in nominal interest rates--likely to be small compared
with those of the 1980's because inflation is relatively low--are not the
threat they were in the early 1980's. Currently, interest and principal
payments consume only 14 percent of farmers' gross cash income, compared with
22 percent in 1979 and 28 percent in 1983. Even though low commodity prices
and farm incomes create concerns about loan repayment ability, low nominal
interest rates have continued to support asset values, including farmland,
rather than pressuring them.  

Both the duration and amplitude of the recent up-cycle are compressed
compared with the 1970's. Nominal net farm income rose 30 percent in 1972 and
77 percent in 1973 after a long period of stability. Over the next 5 years,
real net farm income averaged 16 percent higher than during the 5-year period
before the 1972 increase. In 1996, nominal net farm income rose 48 percent
from 1995, but 24 percent over the average of the previous 5 years, and
current projections for 1998/99 indicate this increase has not been sustained
for even a few years.

Growth of real debt, while supported by a similar combination of factors,
does not reach the magnitude of the 1970's. Much less of the recent increase
in farm assets has been debt financed, indicating that the increase in
farmland values has led to less borrowing against equity. From 1990 to 1998,
nominal farm assets increased 34 percent, while nominal farm debt rose 23
percent. In contrast, debt increased 4 percent faster than assets from 1972
to 1979 and 15 percent faster from 1972 through 1981.

Unlike experts in the 1970's and early 1980's, farm financial advisers in the
1990's have been more temperate regarding expanding production and increasing
debt loads. Farm economists as well as financial regulators have advised
farmers to proceed more conservatively. They have consistently warned, for
example, that cash from production flexibility contract payments authorized
by the 1996 Farm Act would drive up land prices initially, but that land
values could fall as these front-loaded payments tapered off, and could
result in loss of equity and borrowing capacity.


Overall, farm lenders are less vulnerable to downturns in the sector than
they were in the 1980's. Many lenders have higher capital ratios, better
quality capital, and better internal controls than during the 1970's and
1980's.  Consolidation and financial innovations (securitization, third party
guarantees, options, and swaps) have enabled many lenders to reduce their
risk exposure to local economic conditions and interest rates movements.
Regulatory changes, including risk-based capital standards, risk-based
insurance premiums, and prompt corrective action increase the costs to
lenders of allowing deterioration of credit quality in their loan portfolios.
Lenders are also subject to closer scrutiny now from Federal regulators.

Conditions in the farm sector in the 1990's in some respects resemble those
that contributed to the boom and bust cycle of the prior two decades.
Reminiscent are changes in the value of the dollar, the role of agricultural
exports, weather-related problems followed by a surge in production, and
sustained increases in farmland values and farm indebtedness.

But significant differences exist: the role of interest rates and inflation,
more conservative attitudes toward borrowing for both farmers and lenders in
recent years, and the more limited duration and amplitude of the recent
up-cycle.

Downturn Could Intensify

While many of the conditions that led to the dramatic fall in commodity
prices during 1998 are similar to those that produced agriculture's
contraction in the 1980's, the differences that exist point to a sector
better able to withstand adversity and less likely to be as dramatically
tested. Greater domestic economic stability, a less pronounced expansion, and
more conservative borrowing and lending should help reduce the magnitude of
any contraction. 

Still, a number of factors could aggravate the current downturn. For example,
some lucrative and traditional off-farm employment opportunities may
disappear, especially in energy producing states. Changes in government
policies could strengthen the dollar, affecting exports, or bring on greater
agricultural production, possibly pressuring prices. Favorable weather here
or abroad could also increase price pressure on major commodities. Continued
demand shocks in food importing countries, or weakening of currencies of
other agricultural exporters like Canada, Australia, and Brazil, could
further erode agricultural exports. Changes in agricultural lending or their
regulation could affect lenders' willingness to lend to creditworthy farmers
during a contraction.

The duration of the current contraction will be a key factor in determining
successful strategies for farmers and lenders. Farmers may survive a
short-lived contraction by liquidating inventories or delaying capital
replacement in order to shift income or accelerate cash flows. However, if
incomes do not improve, these techniques tend to increase liquidity problems
and dissipate equity. A more drawn-out contraction, therefore, calls for more
aggressive debt reduction and possibly asset liquidation.

Robert N. Collender (202) 694-5343
rnc@econ.ag.gov 

BOX - FARM FINANCE

This article is adapted from a presentation at USDA's 1999 Agricultural
Outlook Forum, held in Arlington, Virginia, February 22-23. 


RISK MANAGEMENT
Insurance & Hedging: Two Ingredients for a Risk Management Recipe

[NOTE:  This article is the second in a series on risk management.] 

The past few years have seen a proliferation of market-based mechanisms
available to agricultural producers for managing yield, price, and revenue
risks. Making the right choices is becoming more complicated. Yet the
fundamentals for making good risk management choices remain the same: 1)
understanding the farm's risk environment, 2) knowing how the available risk
management strategies work and which risks they address, and 3) selecting the
strategy or combination of strategies that will provide the protection that
best suits the farm's and the operator's individual circumstances.

USDA's Economic Research Service (ERS), using data from the Department's Risk
Management Agency (RMA) and National Agricultural Statistics Service (NASS),
has identified general conditions underlying farm-level risk management
behavior in the U.S., how conditions relate to the performance of different
risk management strategies, and why certain risk management strategies work
better than others at reducing farm-specific risk across a range of different
risk environments. This research has focused on three field crops with the
highest acres planted--corn, soybeans, and wheat--but it provides a useful
guide for risk management for other major field crops as well.

Defining a Farm's 
Risk Environment

Within a single crop year, once crop decisions have been made and resources
have been allocated to production agriculture, the farm's principal risk lies
in the uncertainty of the revenue generated by the production process. Farm
revenue uncertainty, particularly the component related to field crop
production, is principally a function of yield and price uncertainty, as well
as the correlation between price and yield.

Weather is the principal cause of yield uncertainty. Within any given
agro-climatic setting--characterized by weather pattern, soil type and
fertility, growing season, day length--variability of yield is attributable
mainly to factors such as temperature, cloud cover, and timeliness and amount
of precipitation. 

Price uncertainty for farmers combines two elements. Price-level uncertainty
is the consequence of imperfect information about future domestic and
international supply and demand conditions. Basis uncertainty--uncertainty
about the difference between a commodity's local cash price and its nearest
futures contract price--derives from uncertainty about future commodity
movements and hauling costs. The tendency for price and yield to change in
opposite directions provides a "natural hedge" which tends to stabilize farm
revenues over time, particularly in major producing areas (AO March 1999).

Farmers' attitudes towards risk can vary greatly and are a key determinant in
selecting risk management strategies. A farmer with a strong aversion to risk
will be willing to pay more for a given level of risk reduction than a farmer
with a weaker aversion to risk. An operator's overall level of wealth can
also have a strong bearing on risk decision making. In general, at higher
levels of wealth an individual is more willing to undertake a given level of
risk--a phenomenon called decreasing absolute risk aversion--but there are
exceptions to this rule. The preferred or optimal risk management strategy
may also vary because of other management objectives, such as profit
maximization or enterprise growth. In addition, lenders may strongly suggest
or even require use of risk management tools to protect their stake in the
farm's production outcome. 

The Mechanics of Crop 
& Revenue Insurance

The array of crop and revenue insurance policies and coverage levels
available to U.S. farmers has been rapidly expanding over the past few years.
In spite of the growing complexity of agricultural insurance programs, the
majority of policies actually sold can still be fairly well represented by
two generic types of agricultural insurance: standard yield-based crop
insurance and revenue insurance.

The largest share of farm coverage continues to be traditional yield-based
crop insurance, although revenue insurance coverage is rapidly gaining.
Traditional yield-based crop insurance--referred to as multiple peril crop
insurance (MPCI)--includes both the minimum catastrophic coverage (CAT) which
insures against severe losses and whose premiums are fully subsidized by the
Federal government, and higher levels of coverage--called "Buy-Up"
coverage--with partially subsidized premiums. Revenue insurance policies
include Income Protection, Revenue Assurance, and Crop Revenue Coverage. All
three revenue insurance programs receive partial subsidization of premiums by
the Federal government.

Two time periods are relevant in calculating insurance program prices. The
first is planting time, when a Projected Price is used to set insurance
premium rates and price elections, and to value coverage levels. The second
is harvest time, when the harvest-time futures price is used to value the
farm's production whether sold or stored.

For yield-based insurance purposes, RMA establishes a Projected Price about 3
months before the insurance signup period for each commodity. This
yield-based-insurance version of the Projected Price is not derived solely
from a futures market price average, but is a forecast of the season-average
price that incorporates additional market information. 

For revenue insurance valuation, the Projected Price is the average of the
daily settlement prices of the harvest-time futures contract during the month
preceding program signup. For the price at harvest time, the average closing
price of the harvest-time futures contract during the month prior to the
contract's expiration is used. For example, the Projected Price for a corn
revenue insurance contract is the February average closing price of the
Chicago Board of Trade's (CBOT's) December corn contract. And the
harvest-time futures price for the December corn contract would be the
average daily settlement price during November.

Yield-based crop insurance (MPCI) pays the operator an indemnity if the
actual yield falls below a yield guarantee, but MPCI does not offer price
protection. Under MPCI, the producer pays a processing fee for minimum CAT
coverage and a premium for "buy up" coverage to obtain partial protection
against yield loss only. The yield guarantee is determined by multiplying the
producer's average historical yield--referred to as the actual production
history (APH)--by the coverage level. Coverage levels range from 50 to 75
percent (expanded to 85 percent in some areas for 1999) of the APH yield, and
from 60 to 100 percent of the Projected Price.

Example of crop insurance:
Suppose a corn producer has an APH yield of 150 bushels per acre, the
Projected Price is $2.50 per bushel, and the producer selects 75-percent APH
coverage with 100-percent price coverage--referred to as the elected price.
The producer's yield guarantee is 112.5 bushels per acre (75 percent of 150
bushels). An actual yield below 112.5 bushels will result in an indemnity
payment to the producer equal to the elected price of $2.50 times the
difference between the yield guarantee and the actual yield, even if the
harvest-time price rises above the Projected Price. However, if the actual
yield does not fall below the yield guarantee, even if the harvest-time price
falls below the Projected Price, the operator gets no indemnity.  Thus MPCI
partially insures against production risk, but does not insure against price
risk. 

Revenue insurance--e.g., Income Protection and the standard Revenue Assurance
programs--protects farmers against reductions in gross income when a crop's
prices or yields decline from early-season expectations. The revenue
guarantee equals the product of the farmer's APH yield, the Projected Price,
and the coverage level selected by the producer. A producer receives an
indemnity when the actual yield, multiplied by the harvest-time futures
price, falls below the revenue guarantee. Since revenue insurance coverage is
generally available at a maximum of 75 percent (85 percent in some designated
counties), it provides only partial protection against both price and yield
risk, and is less effective at reducing risk when the natural hedge is
strong. Revenue insurance with replacement coverage protection is available
to farmers via the Crop Revenue Coverage program or the Revenue Assurance
program when purchased with an increased price guarantee option. The added
replacement coverage protection (RCP) feature offers a revenue guarantee that
depends on the higher of the price elected at signup or the harvest-time
futures price. Thus, the producer's revenue guarantee may increase over the
season, allowing the producer to purchase "replacement" bushels if yields are
low and prices increase during the season. Replacement coverage complements
forward contracting or hedging by partially ensuring that the farmer can buy
back futures contracts or deliver on cash contracts when yields are low and
harvest-time prices are high. Producers are still subject to basis risk, and
only partial coverage (up to 85 percent in designated counties) can be
obtained.

In general, the revenue guarantee of revenue insurance with RCP equals the
product of the producer's APH yield, the coverage level selected, and the
higher of the early-season Projected Price or the harvest-time futures price.
Indemnity payments are triggered when the harvest-time revenue, based on the
harvest-time futures price, falls below the revenue guarantee. Thus, revenue
insurance with RCP also provides only partial protection against yield and
price risk, and is less effective when the natural hedge is strong, because
high prices offset low yields and revenue is more likely to stay at least
somewhat above the guarantee. 

The premium for revenue insurance with replacement coverage is more expensive
than for revenue insurance without RCP, partly because the replacement cost
protection provides greater price protection. Also, premium differentials
increase when producers are permitted to subdivide their acreage into
"units," such as by section and irrigated/nonirrigated status (as under CRC),
rather than basing the premium on a producer's total acreage in a county (as
under Income Protection).

Under 75-percent coverage, the standard revenue insurance guarantee for a
corn producer with an APH yield of 150 bushels and a projected harvest-time
price of $2.50 is $281.25 per acre. A revenue insurance policy with RCP
(under 75-percent coverage) has $281.25 as an initial minimum revenue
guarantee, but this guarantee may increase if market prices rise during the
growing season. If a low or normal yield and low harvest-time price cause the
market value of the crop to fall below the revenue guarantee, revenue
insurance policies with or without RCP will pay the same indemnity. However,
if the low yield is accompanied by a high harvest-time price, revenue
insurance with RCP will pay an indemnity, while policies without RCP will pay
a lower or no indemnity.

What Is Forward Pricing?

Forward pricing involves setting the price, or a limit on price, for a
product to be delivered in the future. Forward pricing strategies include
contracts such as cash forward, futures, options, delayed pricing, basis,
minimum price, and maximum price (for feed purchases). Three general types of
forward pricing strategies--a cash forward sale, a futures hedge, and a put
option hedge--are described here for comparison with the risk-reducing power
of crop and revenue insurance programs. 

A cash forward sale is a contract between a seller (e.g., a farmer) and a
buyer (e.g., an elevator) requiring the seller to deliver a specified
quantity of a commodity to the buyer at some time in the future for a
specified price or in accordance with a specified pricing formula. Most crop
growers sell forward at a fixed or "flat" price based on an observed futures
price quote. Some farmers use basis contracts that specify a "set" price
difference relative to the futures price to be applied at delivery time. Some
use "hedge-to-arrive" contracts that fix the futures price component and
leave basis to be determined at delivery time. Cash forward contracts
eliminate both price-level and basis risk by locking in a local cash market
price for the quantity under contract, but any production in excess of the
hedged amount is still subject to routine market price risk.

Example of a cash forward sale: Suppose that a corn producer has planted 100
acres of corn with an APH yield of 150 bushels per acre. At planting time,
the projected harvest-time price is $2.50 per bushel, the local cash price is
$2.38, and the basis is $0.12. The producer agrees to forward contract the
farm's entire expected corn production of 15,000 bushels at a price of $2.38,
for an expected revenue of $35,700. If the price at harvest-time is $1.80,
the operator still gets $35,700 for the crop, $8,700 above the cash market. 
However, if the producer harvests only 85 bushels per acre, even though the
futures price rises to $3.50 (local cash price $3.38 with constant basis),
the net revenue under this contract will fall to $13, 730 ($35,700 less
$21,970) because the operator has to purchase the shortfall (6,500 bushels
@$3.38) in the cash market.

Hedging is designed to reduce price-level risk prior to an anticipated cash
sale or purchase. A futures hedge involves the sale (short hedge) or purchase
(long hedge) of futures contracts--standardized contracts traded on a
commodity exchange--as a temporary substitute for an intended sale or
purchase on the cash market. The futures contract is later bought (sold) to
eliminate the futures position as the actual commodity is sold (bought). Crop
growers are generally short hedgers against crops they intend to sell later
in the season. 

For example, every corn futures contract traded on the Chicago Board of Trade
(CBOT) calls for delivery of 5,000 bushels of No. 2 yellow corn during one of
five designated delivery months each year. Hedging requires relatively little
investment, because only a small portion of the futures contract's face value
is required as a margin good-faith deposit to guarantee performance of the
contract. Hedging also provides flexibility, since the hedger can eliminate a
position in the futures market by simply contracting for an equal number of
offsetting contracts. Still, the primary advantage of a futures hedge is the
elimination of the price-level risk of an existing cash position by locking
in a price.

A producer can hedge by selling futures contracts--short hedge--covering part
or all of anticipated output. For example, a corn grower could sell 10,000
bushels of December corn futures in May to hedge an expected 20,000-bushel
corn crop. Such a hedge normally is lifted by buying an equal number of
futures contracts as the cash commodity is sold. Since parallel movements in
cash and futures prices during the period of the hedge tend to offset each
other, any losses (gains) in the cash market are made up by gains (losses) in
the futures market.

Any contract, cash or futures, that tends to fix the price prevents the
seller from gaining from subsequent price increases as well as losing from
subsequent price declines. Moreover, forward pricing contracts contain an
element of nonperformance or production risk--if the quantity actually
produced turns out to be less than the contracted quantity and the price at
delivery lies above the contracted price, the producer must make up the
shortfall at a loss. Thus, risk is minimized by forward pricing only part of
a crop until yield is assured. 

Finally, hedging replaces price risk with basis risk--uncertainty about the
price difference between the futures contract and the cash market--and if the
basis is wider than was expected when the futures position changes against
the short position. Unexpected additional payments could result in a strain
on the farm's cash flow and/or credit reserves, particularly if eventual
losses in the futures market cannot be offset by actual cash sales into the
higher price cash market due to a production shortfall.

Hedging in futures offers farmers many of the benefits of forward
contracting, but requires establishing an account with a certified broker,
placing orders with the broker, and being prepared to meet margin calls
during periods of adverse price movements. Consequently, most farmers prefer
to access futures markets indirectly by forward contracting with their local
elevator. Example of direct use of the futures market (transferring
price-level risk but not basis risk or yield risk): Suppose a corn producer
planted 100 acres of corn with an expected yield of 150 bushels per acre. At
planting time, a December corn futures contract is trading at $2.50 per
bushel, the local cash price is $2.38, and the basis is $0.12. The producer
sells two December corn futures contracts on the CBOT (equivalent to 10,000
bushels of corn) at a price of $2.50 per bushel. At harvest-time, if actual
yield equals expected yield and the basis remains constant but prices fall,
say futures to $2/bushel and local price to $1.88/bushel, the operator's
total revenue, ignoring transaction costs, would still be $23,800--$5,000
profit from futures trading (sell 10,000 @ $2.50 and buy 10,000 @ $2) plus
$28,200 (15,000 @ $1.88) from sale to the local elevator. If the basis widens
because the local price falls faster than the futures price, the gains from
hedging would remain the same, but total revenue would be lower. However, if
yield falls, say to 85 bu/acre, even if harvest-time prices rise, say futures
to $3.50 and local to $3.38 so basis is constant, the $10,000 loss from
hedging (sell 10,000 @ $2.50 and buy 10,000 @$3.50) would more than offset
the higher local price (8,500 @ $3.38 = $28,730), bringing net revenue down
to $18,730, again ignoring transaction costs.

A put option is the right, but not the obligation, to sell a specified number
of futures contracts at a designated price (called the strike price), at any
time until expiration of the option. Hedging with a put option is very
similar to buying price insurance in that the buyer/farmer pays a premium to
the seller/grantor of this option to protect against a fall in price. The put
option eliminates downside price-level risk by giving the buyer the right to
enter into a short position in the futures market at the strike price if the
option is exercised, even if futures prices fall below the strike price. The
farmer who hedges by buying a put option knows the premium in advance and is
not subject to margin calls as is the futures hedger. And the put option
holder stands to gain if the futures price rises by more than the cost of the
premium--if prices rise, the farmer can simply choose not to exercise the put
option and instead sell in the higher priced cash market.

As with a futures hedge, a put option hedge is subject to both production
risk and basis risk, since ultimately, any futures position entered into upon
the exercise of a put option will likely be liquidated and the grain sold
into cash markets. But unlike a futures contract hedge, the premium is
forfeited upon payment even if the put option is never exercised.

Example of a put option: Consider again the example of the corn producer with
100 acres planted to corn and an expected yield of 150 bushels per acre. At
planting time a December corn futures contract is trading at $2.50 per
bushel, the local cash price is $2.38, and the basis is the difference or
$0.12. The producer buys two put options based on the CBOT December corn
futures contract (equivalent to 10,000 bushels of corn) with a strike price
of $2.50 per bushel for a premium of $0.16 per bushel or $1,600. 


At harvest-time the December corn contract price is down to $2 per bushel,
and the local price is $1.88 (basis is constant). If the harvested yield is
the 150 bushel/acre expected yield and the producer wants to finalize
marketing decisions on November 1, by exercising the put option at $2.50 and
immediately offsetting the short position in the futures market by buying two
December corn contracts at $2, the producer realizes a gain of $0.50/bushel,
or $5,000. Selling the harvested corn locally for $1.88/bushel, total revenue
(ignoring broker's fees and transaction costs) is $31,600 (15,000 bushels @
$1.88 plus $5,000 minus the $1,600 premium). 

Optimal Hedge Ratio Varies 
Across Pricing Strategies

To price forward, a farmer must choose not only the type of contract--cash,
futures, or options--but also the share of the expected crop to hedge. For
the farmer, the optimal proportion (in a risk-reducing sense) of the expected
crop that should be forward priced--called the optimal hedge ratio--depends
on the extent of basis and production risk faced by the producer. 

While forward pricing in either the cash, futures, or options markets
eliminates price-level risk, it fails to eliminate production risk, and cash
forward contracting alone eliminates basis risk.  Basis risk generally is
small relative to price-level risk, but can be important, particularly at
locations distant from the futures delivery points.

The production risk associated with a forward pricing contract depends on a
farm's yield variability. As yield variability increases, optimal hedge
ratios decrease and the risk-reducing effectiveness of a hedge declines. In
the presence of high yield variability, the probability of having
insufficient crop to deliver on a forward contract is high and the associated
risk lowers the effectiveness of forward contracting.

Yield variability can be only partially offset by crop or revenue insurance,
since coverage levels are generally limited to 75 percent, so the optimal
hedge ratio will vary with both the availability and type of insurance
coverage. Further, since yield protection permits a higher optimal hedge
ratio, and because crop and revenue insurance do not fully eliminate
production risk, combinations of forward pricing and insurance generally
result in lower risk than either alone. 

Combination of Strategies 
Depends on Risk Environment

ERS used historical data to construct representative corn, soybean, and wheat
enterprises for a variety of risk environments--i.e., across ranges of yield
variability and price-yield correlations--to analyze the risk reducing
effectiveness of different crop and revenue insurance programs and forward
pricing strategies in different risk environments. The level of risk aversion
and wealth for a given enterprise is held constant across risk management
strategies, and all enterprises are assumed to minimize risk per acre of the
crop produced. 

The estimated certainty equivalent income--the income an individual is
willing to receive with certainty in lieu of undertaking a risky
prospect--associated with a straight cash sale at harvest (no insurance, no
forward contracting) is the baseline scenario against which all other risk
management strategies are evaluated. Certainty equivalent gains/losses--the
estimated value of gains/losses in risk reduction--are then calculated to
reflect the differences in revenue risk reduction and costs (e.g., premiums)
over the different strategies.

Federal subsidies are not included, in order to compare the pure risk
reduction effectiveness of crop and revenue insurance programs and forward
pricing strategies, independent of government influence. The incorporation of
Federal insurance premium subsidies per acre would be a direct addition to
certainty equivalent income for the relevant risk strategies. Using this
framework, some general relationships emerge between revenue variability and
risk management. 

For a farm with high yield variability and a weak natural hedge, crop yield
or revenue insurance alone provides substantial revenue risk reduction.
Forward pricing combined with crop insurance further reduces risk, although
the gains are small relative to the risk-reduction gains of crop yield and
revenue insurance alone. Forward pricing alone--without crop yield or revenue
insurance--provides relatively little risk reduction, because price
variability contributes less to revenue variability than does yield
variability. Without crop yield or revenue insurance, the revenue risk
stemming from yield variability greatly reduces the effectiveness of forward
pricing. However, as the natural hedge strengthens, the risk reduction
provided by crop yield and revenue insurance weakens, even when yields remain
highly variable, and forward pricing remains fairly ineffective as a risk
transfer tool.

When yields are relatively less variable, crop yield insurance alone affords
some risk reduction, but provides much greater risk reduction when combined
with forward pricing, particularly forward cash contracting. Since price
variability predominates when yield variability is low, cash forward
contracting, which eliminates both price-level and basis risk, is a very
attractive option to a producer whose primary concern is minimizing risk.

With low yield variability and a strong natural hedge, forward pricing
strategies are more effective than either crop or revenue insurance. Under a
strong natural hedge, low yields are generally associated with high prices,
thus moderating overall revenue variability, even without insurance or
forward pricing. Still, crop revenue insurance, when combined with forward
pricing, can provide additional marginal risk reduction. 

When low yield variability coexists with a weak natural hedge, forward
pricing alone easily outperforms crop yield and revenue insurance in reducing
risk, because price variability plays the dominant role in determining
revenue variability, and because of the weaker relationship between the
on-farm yield and the aggregate market price. Still, additional marginal
gains in risk reduction can be obtained by combining crop revenue insurance
with forward pricing.




In summary, ERS findings indicate that:

Price variability faced by growers of a given crop is approximately the same
across the country, and basis risks are relatively small, so differences in
revenue variability between farms are caused primarily by differences in
yield variability and price-yield correlation. 

Yield variability is generally proportionally higher than price variability
at the farm level. As yield variability increases, optimal hedge ratios
decrease and the risk-reducing effectiveness of hedging declines. Partially
offsetting yield variability with crop or revenue insurance raises the
optimal hedge ratio.

Price-yield correlations are generally negative in major growing areas,
particularly for corn. Since a farmer's revenue risk diminishes as
price-yield correlation becomes more negative, crop or revenue insurance
purchased with low coverage levels may be superfluous in the face of a strong
natural hedge. Also, optimal hedge ratios decrease as farm price-yield
correlation becomes more negative.

Price correlation between farms is generally higher than yield correlation. 

The risk-reducing effectiveness of hedging increases as correlation between
farm and futures price increases. In other words, the more closely the
futures market price mirrors the farm price, the better it works for hedging
risk. 

Combining forward pricing with insurance generally results in lower risk than
either alone. With high yield variability, the difference among the forward
pricing strategies is slight, but with low yield variability--where price
variability contributes a larger share to revenue variability--the difference
may be significant. When used in combination with a given type of insurance,
cash forward contracting provides the greatest risk reduction for a
risk-minimizing producer.

Randy Schnepf (202) 694-5293, Richard Heifner (202) 694-5297, and Robert
Dismukes (202) 694-5294
rschnepf@econ.ag.gov
rheifner@econ.ag.gov 
dismukes@econ.ag.gov


SPECIAL ARTICLE
Long-Term Agricultural Projections Reflect Weaker Trade

A number of international factors have combined to weaken the U.S.
agricultural outlook in USDA's 10-year baseline projections, either by
reducing global demand or increasing foreign supplies. These include fallout
from the economic crisis in Asia and economic contraction in Russia, which
reduced global agricultural demand; projected lower growth (relative to last
year's baseline) in China's grain imports; and expanding production potential
among trade competitors.


In the initial years of the baseline, much of the U.S. agricultural sector is
adjusting to the combination of weak demand and large global supplies.
Agricultural commodity prices are down, the value of U.S. agricultural
exports is lower, and net farm income declines. 

In the longer run, conditions in the sector improve. Despite strong export
competition and only moderate grain import demand in China, more favorable
economic growth in developing regions supports gains in trade and in U.S.
agricultural exports in the second half of the baseline. This leads to rising
nominal market prices, gains in farm income, and increased stability in the
financial condition of the U.S. agricultural sector. 

Demand Dampened In Asia & Russia

Weakened economic growth and depreciated currencies in East and Southeast
Asia and in Russia contribute to a 3-4 year period of weak global
agricultural demand and trade. Assumptions for these and other developing
economies are important for global agricultural demand because incomes in
those countries are at levels where consumers begin to diversify their diets
and where consumption and imports of foods and feeds are particularly
responsive to income changes. For Asia, 1-3 years of negative growth in
crisis countries are followed by a return to moderately positive economic
growth. Structural reform, particularly in financial and banking sectors,
leads to more stable economic growth in the last 5 years of the baseline,
although longer-term growth for crisis-affected Asian countries is generally
lower than in previous USDA baselines. 

For Russia, incomes are assumed to decline through 2000, with positive
economic growth resuming in 2002, followed by moderately higher growth in
later years. Declining incomes combined with the effects of currency
devaluation result in sharp reductions in Russian meat imports in the first
half of the baseline.

Relatively moderate gains are projected for grain import demand in China.
Agricultural policies assumed for China now include a greater emphasis on
grain self-sufficiency. Increased governmental intervention in grain
production and trade is anticipated, with price support for rice, wheat, and
corn encouraging output and reducing imports of these crops. Revised
livestock data for China indicate that animal inventories, meat production,
and meat consumption are 20 to 30 percent lower than previously thought.
These revisions suggest slower growth in the livestock sector over the next
10 years compared with the previous baseline. Grain feed use in China is now
estimated to be lower, and is projected to grow more slowly, than implied by
earlier data. Somewhat weaker economic growth is also assumed for China, and
a long-term trend of currency devaluation against the U.S. dollar is assumed
to resume in 2001 after holding relatively steady in the last half of the
1990's. These macroeconomic conditions contribute to smaller gains in net
agricultural import demand in China over the next 10 years. 

Near term import demand prospects will also be affected by recent economic
developments in Latin America, where the financial and trade impacts of the
Asia crisis have led to weaker currencies and slower growth. Setbacks in
Latin America are assumed to be relatively minor in the baseline, but larger
and more prolonged shocks are possible, which would have more significant
effects on global markets.

Export Competition Strengthens

U.S. exports and world prices also will be pressured by increased exportable
supplies from both traditional and nontraditional competitors. Early in the
baseline, global supplies of many agricultural commodities are large. In
addition, expanding production potential in a number of foreign countries
results in strong export competition throughout the 10-year baseline.
Increased yield growth for corn, wheat, and soybeans in Argentina and
conversion of undeveloped land for soybeans in Brazil, for example,
strengthen competition in global markets. New seed technologies, increased
fertilizer use, and an improved agricultural investment climate facilitate
these production gains in South America. 

Developing and transition economies, where currencies have been sharply
devalued, are also likely to provide increased competition for U.S. farm
exports. In Russia, for example, increased competitiveness because of
devaluation of the ruble, combined with persistent weak domestic demand,
could boost Russian grain exports. And in Korea  the devaluation of the won
is expected to improve incentives for the local livestock industry to expand,
increasing production and lowering meat imports. 

The projections also indicate the potential for increased European Union (EU)
competition in the global wheat market in the medium term. Even with current
EU policies, modest increases in world wheat prices combined with declining
internal EU market prices are expected to allow the EU to export wheat
without subsidy by about 2002. EU exports of wheat will then be able to
exceed the subsidized export limit set in the Uruguay Round Agreement on
Agriculture (URAA). 

Agricultural Trade Stronger
In the Longer Term

Prospects for global trade and U.S. exports improve in the longer term. Based
on the outlook for an Asian recovery in 3 to 4 years, projected trade
expansion is driven by generally favorable economic growth in developing
countries and by freer trade associated with ongoing unilateral policy
reforms and existing multilateral reforms. Income growth in developing
countries will continue to be the key reason for growth in demand for
agricultural goods, both through increases in direct food use and through
derived demand for livestock feeds to meet rising meat demand.

Relatively strong longer term growth is projected in the volume of global
trade in bulk agricultural commodities, with broad-based expansion across
developing regions, including China, South and Southeast Asia, Latin America,
North Africa, and the Middle East. Trade in grains is expected to lead the
stronger projected growth of bulk commodity trade during 2000-08. Projected
growth in coarse grain trade is particularly strong, predicated on rising
incomes, diet diversification, and increased demand for livestock products
and feeds in developing regions. Wheat and vegetable oil trade will also
continue to expand in response to rising incomes in developing countries.
Trade in soybeans and meal will benefit from expansion of developing
countries' feed-livestock sectors. Raw cotton demand and trade beyond 2000
are projected to be stronger than in the 1990's, but slower than in the
1980's when cotton was increasingly substituted for synthetic fibers. 

Global meat demand and trade will be depressed in the near term by the
slowdown in import demand in East Asia and Russia. Growth in meat trade,
however, is projected to resume after 2000, as demand recovers in these key
markets. Tariff reductions under the URAA also will support growth in meat
trade in East Asia, including Japan and Korea. 

With recovering global demand, agricultural commodity prices are projected to
strengthen over the longer term. However, real prices are projected to
decline, consistent with the long-term trend, as productivity gains continue
to outpace demand growth.

The total value of U.S. agricultural exports is projected to decline in
fiscal 1999 and 2000, but to increase to almost $73 billion by 2008, up from
a forecast $49 billion in 1999. Weak global demand and prices hold down the
value of U.S. bulk and high-value product (HVP) exports early in the
baseline. After 2000, however, both bulk and HVP exports are projected to
strengthen. 

U.S. Crop Markets Adjust

In the initial years of the baseline, many field crop markets are adjusting
to the combination of weak demand and large global supplies, before moving
back toward longer term trends with more robust growth. 

Planted acreage for the eight major U.S. field crops (corn, sorghum, barley,
oats, wheat, rice, upland cotton, and soybeans) increases nearly 10 million
acres by 2008 from 1998 levels, surpassing the recent high level of plantings
for these crops in 1996. At first, however, aggregate area planted to these
crops declines somewhat, reflecting low prices for many crops due to weak
demand and large global supplies; plantings turn upward again in 2002.
Planting flexibility under current legislation facilitates acreage movements
by allowing producers to respond to market prices and returns, augmented by
marketing loan benefits in low price years. Marketing loan benefits influence
the cropping mix somewhat in the early years of the baseline when many prices
are near or below market assistance loan rates (see AO October 1998 for more
on marketing loans). Projected soybean prices are lower than soybean loan
rates during the next few years, for example, so marketing loan gains and
loan deficiency payments will add to market receipts, encouraging producers
to plant more acreage to soybeans than they otherwise would. 


Projected acreage gains in the longer term reflect land drawn into production
based on strengthening farm prices. Yield gains for many crops are sufficient
to mitigate some of the pressure on total land use. 

Projected gains in demand for U.S. soybeans, barley, and rice are driven
primarily by domestic markets. U.S. exports of soybeans and products face
strengthening competition from Brazil and Argentina. Increases in total U.S.
corn use are also larger in the domestic market than in trade, although corn
exports grow at a higher rate. Strong competition in global corn trade from
Argentina as well as moderate world import demand growth (particularly for
China, which is projected to be a net corn exporter until 2005/06) combine to
mute U.S. corn export gains.  Increases in disappearance of U.S. wheat,
sorghum, and cotton are driven by exports. U.S. wheat exports rise steadily
during the baseline but face greater competition from the EU starting in
2002/03 as stronger world wheat prices and lower internal EU prices permit
the EU to export wheat without subsidies. U.S. cotton exports benefit in the
last half of the baseline from an assumed resumption of Step 2 program
payments in 2002/03 (See AO September 1998 for information on Step 2).

U.S. domestic demand for most crops is projected to grow slightly faster than
population through 2008. Growth in domestic use of rice reflects a greater
emphasis on dietary concerns and an increasing share of domestic population
with Asian and Latin American origins. Gains in corn sweetener use and corn
used for ethanol production also exceed population growth rates. Increases in
domestic soybean crush reflect continued strong growth in poultry production,
generating demand for soybean meal. Domestic wheat use, however, is nearly
flat, as declining feed use offsets food use gains. Greater U.S. exports of
cotton yarn, fabric, and semi-finished products will promote growth in
domestic mill use of cotton, although increases in textile imports, mostly
apparel, and competition from man-made fibers, limit domestic cotton use
gains. 

Low Feed Prices Fuel 
Livestock Sector Expansion

Changes in the U.S. meat complex in the near term reflect sharply lower grain
and soybean meal prices from the elevated levels of the 1995/96 crop year, as
well as weakened demand for meat exports to the Pacific Rim and Russia. In
the longer run, feed prices below those of the mid-1990's, low inflation,
domestic demand strength, and a rebound in export sales are expected to
contribute to producer returns that encourage higher pork and poultry output,
although only moderate cyclical expansion is projected for beef. Record total
meat supplies are projected through the baseline, with a larger proportion of
poultry.

The cattle herd builds only slightly from a cyclical low near 97 million head
in 2000. The inventory remains below 100 million head in a brief and moderate
expansion through 2003, before turning downward again. Shifts toward a
breeding herd of larger-framed cattle and heavier slaughter weights partially
offset the need for further expansion of cattle inventories. The beef
production mix continues to shift toward a larger proportion of fed beef,
with almost all steers and heifers being feedlot fed. 

Beef production also moves increasingly toward a high-graded product being
directed toward the hotel-restaurant and export markets. The U.S. remains the
primary source of high-quality, fed beef for export. However, emergence of
the U.S. as a long-term net beef exporter will be delayed until near the end
of the baseline, after the cow herd is reestablished and weak demand in the
Pacific Rim recovers.

The pork sector will continue to evolve into a more vertically coordinated
industry with a mix of production and marketing contracts. Larger, more
efficient pork producers will market a greater percentage of the hogs over
the next 10 years. With a more vertically coordinated industry structure, the
hog cycle is dampened. A slow expansion in pork production begins in 2002 and
continues for the remainder of the baseline. The U.S. becomes an increasingly
important net pork exporter, in part reflecting environmental constraints for
a number of competitors (e.g., Denmark and Taiwan, AO March 1998). However,
projected gains in U.S. pork exports are somewhat muted by reduced market
growth prospects in the Pacific Rim and Russia.

Continued technological advances and improved production management practices
are expected in the broiler and turkey industries, although gains are not
anticipated to hold down production costs as significantly as in the past 10
years. Competition in global poultry markets holds U.S. poultry exports to
moderate gains. Following slower growth in sales to Asia and a sharp
reduction in exports to Russia in 1998 and 1999, a slow recovery is projected
for poultry exports to both markets. 

High milk-feed price ratios and dairy productivity gains push milk output per
cow higher, and milk production grows despite slowly declining cow numbers.
Lower real milk prices continue to push weaker operations out of dairying.
Milk production will expand in the West as well as on large-scale dairy
operations in the North. Expansion in commercial use of dairy products will
be led by sales of cheese and dairy ingredients for processed foods, while
fluid milk sales are stagnant.

Decreases in real retail prices of meats combined with increases in real
disposable income allow U.S. consumers to purchase more meat with a smaller
proportion of disposable income. Poultry gains a larger proportion of total
meat expenditures as well as total meat consumption, reflecting lower
production costs and prices relative to other meats. On a retail-weight
basis, poultry consumption is projected to exceed red meat consumption at the
end of the baseline. 

Retail prices for all food are projected to rise less than the general
inflation rate, continuing a long-term trend. Meals eaten away from home
account for a growing share of food expenditures, reaching almost half of
total food spending by 2008.

Farm Financial Conditions 
Improve Beyond 2000

Reflecting initial weakness in the sector (see Agricultural Economy in this
issue), net farm income declines in the first few years of the baseline,
falling to about $44 billion in 2000, slightly below the 1990-97 average.
Farm income declines in the near term, as the large global supplies and weak
demand compress farm commodity receipts. Lower production expenses in the
initial years, particularly for farm-origin inputs, energy-related costs, and
interest expenses, offset some of the reduction in cash receipts.
Additionally, increased government payments bolster farm incomes for 1998 and
1999 (AO January-February 1999).

Net farm income improves beyond 2000, due largely to strengthening demand,
moving gradually upward to exceed $50 billion for the last few years of the
baseline. Nonetheless, gains in farm income are less than inflation, so real
farm income declines. The agricultural sector increasingly relies on the
marketplace for its income as direct government payments fall and represent
only about 2 percent of gross cash income by 2008. Crop and livestock
receipts are up in nominal terms as both production and prices rise. 

Production expenses increase in the baseline, with expenses for
nonfarm-origin inputs rising faster than expenses for farm-origin inputs.
Cash operating margins tighten somewhat, with cash expenses increasing to
about 79 percent of gross cash income by 2008, up from around 74 percent in
recent years. 

Higher nominal farm income and relatively low interest rates assist in asset
accumulation and debt management, leading to an improved balance sheet for
the farm sector. Farm asset values increase through the baseline, led by
gains in agricultural land values. Farm debt rises less rapidly than assets
and is not beyond the ability of farmers to service. As a result,
debt-to-asset ratios continue the downward trend of the last 10-15 years from
the high levels of over 20 percent in the mid-1980's, declining to near 13
percent by the end of the baseline. With asset values increasing more than
debt, farm equity rises significantly. Increasing nominal farm income in the
baseline, combined with rising farm equity, suggests relative stability in
the aggregate financial condition of the farm sector. 

Paul Westcott (202) 694-5335 and Rip Landes (202) 694-5275
westcott@econ.ag.gov
mlandes@econ.ag.gov

BOX - SPECIAL ARTICLE

The projections and discussion in this article draw on USDA Agricultural
Baseline Projections to 2008 released at USDA's 1999 Agricultural Outlook
Forum in February. Longrun baseline projections (through 2008) assume no
shocks and are based on specific assumptions regarding macroeconomic
conditions, policy, weather, and international developments. The baseline is
one representative scenario for the agricultural sector for the next 10 years
and provides a point of departure for discussion of alternative farm sector
outcomes that could result under different assumptions. 

USDA Baseline Information 
Available on the Internet

For the full report and briefing materials, including an expanded set of
charts, visit the Economic Research Service briefing room for USDA's
agricultural baseline projections at

http://www.econ.ag.gov/briefing/baseline/.

For a hard copy of the report, call 1 (800) 999-6779 and ask for USDA
Agricultural Baseline Projections to 2008 (WAOB-99-1). $21 per copy.


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