AGRICULTURAL OUTLOOK                                       August 21, 1998
September 1998, AO-254
               Approved by the World Agricultural Outlook Board
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CONTENTS:

IN BRIEF

AG ECONOMY

Record 1997 Net Cash Income Helps Farmers Face Market Downturn

BOX:  The Agricultural Resource Management Study: Serving the Information 
Needs of Agriculture

BRIEFS
Weaker Price Prospects Dampen Expansion of U.S. Durum Acreage
Dairy Markets Unsettled, Prices Erratic
U.S. Apple Production Up, Prices Down

COMMODITY SPOT
U.S. & World Cotton Markets Diverge in 1998/99 

Soybean Prices Plunge on Big World Harvests, Weaker Demand
     Box: Putting the Brakes on Consumption Of Added Fats and Oils

RESOURCES & ENVIRONMENT
Exploring Methods of Selecting Cropland for Conservation

SPECIAL ARTICLE
Regional Trade Agreements & U.S. Agriculture 


IN BRIEF

Record 1997 Net Cash Income Helps Farmers Face Market Downturn

U.S. agriculture is producing voluminous output in 1998, despite severe drought
in portions of the Plains and the South.  However, expanding field crop and
meat supplies coincide with export demand that is lackluster compared with
recent years.  As a result, U.S. farm prices and income will drop sharply
following generally strong farm financial performance in 1996 and 1997.  Many
farmers are financially stressed, particularly those in the Plains and the
South and those with little off-farm income.  But most farm businesses are
financially sound as the U.S. agricultural sector enters this market downturn,
according to USDA's Economic Research Service.  Net farm income has been well
above average in recent years and balance sheets are relatively strong.  In
addition, farm credit availability is strong, as are financial conditions of
most farm lenders. 

Current ERS analysis of the U.S. farm economy is based on the 1997 Agricultural
Resource Management Study (ARMS).  Data collected through the ARMS are the
primary source of information  about agricultural resource use, costs of
production, the environment, the structure and financial condition of farm
businesses, and the economic well-being of farm operator households.  The data
are specific to farming operations by size, region, commodity speciality, and
other structural parameters, including operator demographics. 

 U.S.-World Cotton Price Gap Has Stretched

 The U.S. and foreign cotton sectors face divergent circumstances in the 1998
season, and the marketing year (August-July) has begun with an unusually wide
gap between U.S. and world prices.  Adverse weather, the Asian crisis, and U.S.
and foreign government policies on cotton are among the factors affecting U.S.
production and exports in 1998/99.

The 1998/99 U.S. outlook continues the trend toward smaller acreage planted to
cotton, as net returns at planting time for some competing crops looked more
favorable than for cotton in many areas of the Cotton Belt. USDA's August Crop
Production report projects this season's total output at 14.3 million bales,
well below the 19-million-bale crops of the past 2 years.  With U.S. stocks
shrinking and with foreign stocks outside China expected to grow, the price
premium for U.S. over foreign cotton has jumped.  Government payments to
encourage domestic use and exports of U.S. cotton--under Step 2 of the cotton
marketing loan program--have soared, and funds are likely to be depleted ahead
of expectations. 

Soybean Prices To Plunge on Big World Harvests

Greater world supplies of soybeans and weaker demand have combined to produce a
dramatic market turnabout this year.  U.S. farmers enjoyed record sales of
soybeans in 1997/98, thanks to a bumper harvest and favorable prices.  In 1998,
U.S. soybean farmers will produce their second consecutive record harvest--at
2.83 billion bushels, this year's crop will be nearly 4 percent larger than
last year's.  But the 1998/99 outlook for marketing has greatly changed. 
Global soybean ending stocks are projected to be twice as high in 1998/99 as
their diminished level 2 years ago.  Soybean prices at the farm level are
forecast to slide from the 1997/98 average of $6.45 per bushel to $4.85-$5.85
this season, the lowest since 1986/87. 

Dairy Markets Unsettled, Prices Erratic

Strong economic growth continues to bolster demand for dairy products, although
the effects have been uneven.  Butter and cheese prices moved sharply higher
over the summer, while nonfat dry milk remained close to the Federal support
price.  Strong milkfat demand, moderate skim solids demand, and sluggish milk
production are expected to keep dairy markets unsettled and prices erratic
during the remainder of 1998.  Dairy prices are not likely to stabilize until
substantial production gains are posted.  Expansion in milk output may start
accelerating by late 1998 or early 1999--if the recent declines in concentrate
feed prices are combined with adequate supplies of dairy-quality forages. 

Regional Trade Agreements & U.S. Agriculture 
 
Regional trade agreements (RTA's) have become a fixture in the global trade
arena.  In the Western Hemisphere, about 40 regional trade pacts are currently
in force, with at least a dozen others under negotiation.  RTA's have generated
intense debate, with opponents arguing that these trade pacts will divert trade
from more efficient nonmember producing countries, while advocates contend that
RTA's can serve as building blocks for further multilateral trade
liberalization.  

USDA's analysis of the longrun impacts of four major RTA's (the North American
Free Trade Agreement, an expanded European Union, the Asia Pacific Economic
Cooperation forum, and the potential Free Trade Area of the Americas) indicates
that, on balance, they will generate more trade economywide than they divert.
In agriculture, RTA's have both trade-creating and trade-diverting effects, but
trade creation dominates in most RTA's.  While the U.S., as a global trader
with diverse partners, can gain potentially more from global free trade than
from RTA's, the commitments made within RTA's are expected to exceed those from
the Uruguay Round's multilateral agreements, and joint pursuit of RTA's and
multilateralism can benefit U.S. agriculture.



AG ECONOMY

Record 1997 Net Cash Income Helps Farmers Face Market Downturn

U.S. agriculture is producing voluminous output in 1998, despite severe drought
in portions of the Plains and the South. Before the effects of the drought in
Texas and Oklahoma set in, these States as well as Kansas set new wheat yield
records, and current weather patterns have been favorable in most primary corn
and soybean producing areas. Larger supplies and lower prices are expected for
wheat, soybeans, and corn. Meanwhile, record-large commercial production of
beef and pork has reduced livestock prices, with beef and hog prices in 1998
below last year and below the 1990-97 average. (AO June-July 1998)

The expanding field crop and meat supplies coincide with export demand that is
lackluster compared with recent years. Crop growing conditions have generally
been favorable elsewhere in the world, and larger foreign supplies are reducing
foreign import needs and heightening competition in export markets. In
addition, the Asian economic crisis is interrupting growth in global
agricultural demand, and a strengthening dollar is raising the cost of U.S.
goods to foreign buyers. 

With supplies building, U.S. farm prices and income will drop sharply following
generally strong farm financial performance in 1996 and 1997. U.S. net cash
income in 1998 will fall nearly $7.4 billion below last year's record $60.7
billion, returning to the levels of the early 1990's. (The 1998 forecast
excludes the effect of advancing farm program payments under recent
legislation.)

An analysis of short-term farm business performance by USDA's Economic Research
Service (ERS), based on the 1997 Agricultural Resource Management Study (ARMS),
provides the first comprehensive view of farm financial strength as the U.S.
agricultural sector enters this market downturn. Results show that most farm
businesses are financially sound and will likely withstand the current downturn
into 1999. In addition, farm credit availability is relatively strong, as are
financial conditions of most farm lenders. Nevertheless, many farmers are
financially stressed, particularly in the Plains and the South where they face
repeated crop losses or the combination of low output and reduced prices. 

Today's market events, while causing financial stress in some parts of the
U.S., are not altering the fundamental comparative advantage of U.S.
agriculture. Growth in global income and population and advancing agricultural
trade liberalization are the underlying drivers of U.S. farm export
opportunities, and in turn U.S. farm income. These trends are expected to
remain positive over the long term.

Farm Financial Health Status

Most farm business operations (those with at least $50,000 in gross farm sales)
entered 1998 in good financial shape. Even though prices for many commodities
retreated from 1996's unusually high levels, a turnaround in the cattle
industry and near-record crop harvests brought profits to many of the Nation's
farms and ranches in 1997. 

Nationally, two out of every three farm businesses (65.5 percent) were
considered to be in a favorable financial position (positive net farm income,
and debt/asset ratio less than 40 percent) as of January 1, 1998. This
represents a modest decline from a year earlier when 67.9 percent of farms
qualified, but remains one of highest percentages of the 1990's. These
profitable, low-leveraged operations entered 1998 with sufficient funds to take
advantage of investment and expansion opportunities. The share of vulnerable
farms (negative net farm income, and debt/asset ratio more than 40 percent) was
slightly higher entering 1998 than the previous year 5.6 percent compared with
4.1 percent but still below the 7.8 percent registered in 1995. 

Some areas of the country most notably the Appalachian, Southeast, and Delta
regions  rebounded strongly from a weak performance in 1996, demonstrating
increases in the share of financially favorable farm businesses.

Not all farmers registered a good year in 1997, particularly in the Northern
Plains where a combination of poor growing conditions (spring flooding) and
diminished yields (largely resulting from scab) left many producers with
substantial losses and considerable financial uncertainty as they faced 1998. 

Overall financial performance dropped in the Lake States, Northern Plains, Corn
Belt and Pacific regions. Each of these regions exhibited a significant decline
in the percentage of farm businesses classified in a favorable financial
position and an increase in the share considered vulnerable. The Corn Belt,
despite a decline in overall financial performance, remained one of the regions
with the highest percentage of financially favorable farm businesses. 

Generally speaking, farm businesses that specialized in the production of wheat
and corn retreated from 1996's financial success, while beef cattle farms and
ranches improved in overall financial performance in 1997.

Farm business before-tax earnings were relatively consistent with the
widespread profitability enjoyed in 1996. Net farm income, a comprehensive
measure of farm business profits, averaged $58,943 in 1997 an increase from
1996's $55,384 and one of the highest levels reached during the 1990's. Larger
gross incomes from higher livestock sales, steady government payments, and
increased earnings from farm-related sources such as custom feeding generated
an average income increase that offset average rises in production expenses. 

Not all farm types nor all regions of the country reported relatively stable to
increasing net farm income levels for 1997. Farms producing primarily corn, 
soybeans, cotton, a mix of cash grains, and hogs reported 1997 incomes that
were lower than in 1996. For corn and cotton farms, however, 1997 incomes
remained on par with those reported before 1996. For soybean and hog farms,
1997's net income, on average, remained above earlier years.

On average, reductions in farm business incomes were confined to three regions:
the Northern Plains, Mountain, and Corn Belt. The share of farm businesses with
negative net farm income notably increased in the Lake States, Corn Belt, and
Northern Plains regions. The highest percentages of farms losing money in 1997
were in the Southern Plains (27 percent) and Mountain (28 percent) regions.

Even though farm households took in less from farming in 1997, off-farm income
kept average household income at 1991-95 levels. (This includes all farm
households, including those with less than $50,000 in gross farm sales.) The
same is expected in 1998. Since 1991, average operator household income has
been relatively stable, mirroring the average for all U.S. households. 

Changes in farm-related income are more critical to some households than
others. To generate a cash income close to that of all U.S. households, farms
need to generate sales in the upper end of the small farm category
($100,000-$249,000). Many operators in this category overwhelmingly name
farming as their major occupation. Although small farm operators who named
farming as their major occupation generated almost twice as much farm income as
other small farms, their household income in 1997 was about the same as the
average U.S. household. Farmers currently undergoing the most financial stress
are those with little off-farm income (see page 8).

Balance Sheets Remain Strong 

Average net worth of farm businesses increased for the fourth consecutive year
in 1997. Increasing farm real estate values and modest increases in debt not
only spurred increases in net worth, but also helped to hold the average
debt/asset ratio at 1996's value of 17 percent. Since the late 1980's, most
farm businesses have been reluctant to take on burdensome debt loads. That
trend continued in 1997, with farm businesses strengthening their balance
sheets. More than 80 percent ended the year with a debt/asset ratio below 40
percent, indicating only a small risk of insolvency or of cash-flow problems
from debt commitment. 

Only about 4 percent of farm businesses faced risk of insolvency, defined as
having a debt/asset ratio above 70 percent. The number of highly leveraged
farms was consistent with levels observed during the previous 5 years and
remains well below the mid-1980's, when more than 10 percent of farms risked
insolvency.

The Lake States region was one of the few where the average debt/asset ratio
increased in 1997. Its 24-percent average debt/asset ratio was the highest
among production regions. A reduction in average debt helped the Southeast,
Delta, and Mountain regions reduce average debt/asset ratios in 1997. At the
end of 1997, however, the Delta, Lake States, and Southern Plains regions had
the highest concentration of highly leveraged farms at least one out of five
farm businesses had a debt/asset ratio above 40 percent.

Lower income in 1998 could weaken the ability of farm businesses to meet debt
repayment obligations. Debt repayment capacity utilization (DRCU) is computed
as the ratio of actual debt to maximum feasible debt and measures the extent of
a farm business's or operator's use of potential credit repayment ability
(i.e., a rise indicates that farmers tap a greater share of credit estimated to
be available to them). In 1997, farm business DRCU averaged below 40 percent
for the second consecutive year. At 36 percent, the DRCU was slightly lower
than a year earlier and comparable with 1992, the lowest of the 1990's.
However, the percentage of farms that borrowed well beyond their ability to
repay from current income increased to 20 percent.

In 1997, farm businesses in the Mountain and Southern Plains regions had
improved debt repayment ability based on higher current incomes and modest
changes in debt use. However, lower income and increased debt pushed debt
repayment capacity utilization to dangerously high levels (DRCU above 70
percent) in the Lake States and Northern Plains regions.

This broad measure of farm business performance is sensitive to short-term
changes in net income that are occurring in 1998. For example, a 20-percent
reduction in net income applied to the 1997 base data would increase the DRCU
to 60 percent, and the share of farm businesses with severe repayment problems
would climb to 35 percent. 

Regional and commodity changes in debt repayment ability reflect divergent
financial strategies taken by farmers in recent years. Some farm businesses
took advantage of the favorable financial conditions in 1996 to pay off or pay
down existing debt. Others used available funds and debt capital to expand and
invest in new machinery and equipment. Businesses that borrowed with the
expectation of continued strong prices may experience debt repayment problems
in 1998. 

The makeup of vulnerable operations (high debt and negative income) varies by
economic size and economic conditions during the year, but is concentrated
among the larger small farms (those with gross sales of $100,000 to $249,000).
These farms accounted for 6 percent of the vulnerable operations in 1997, up
from 4 percent the year before. This group includes a greater proportion of
cash grain farms.
Mitch Morehart (202) 694-5581;
morehart@econ.ag.gov
Also contributing: Janet Perry, Jim Ryan and Jim Johnson

Internet users will find more information (including a large number of charts
and tables) on the financial performance of U.S. farm businesses at
http://www.econ.ag.gov/briefing/fbe/sf/results97/brief97.html


Farm Credit Conditions 
Favorable at Mid-1998

Overall, farm credit availability remained strong in the first half of 1998.
Most U.S. farmers continue to enjoy competitive credit markets and lower
interest rates. However, if the prices of major commodities remain weak,
lenders will be more cautious when lending to farmers in the coming months,
particularly in regions most dependent on commodities experiencing lower prices
and poor production.

As 1998 progresses, credit conditions in sections of the Plains and Southern
States affected by poor production and lower prices can be expected to
deteriorate more rapidly. Indicators of farm financial stress, such as farm
loan delinquency rates, typically do not become evident until after serious
problems arise (that is, they are lagging indicators of financial stress).
Surveys of bankers indicate an uptick in farm loan repayment problems. A survey
of Farm Credit System (FCS) lenders in February revealed that some FCS
associations, particularly in the Northern Plains, expected higher levels of
financial stress this year compared with last year.

Demand for Farm Service Agency (FSA) lending is also as an indicator of farm
financial health. Although loan demand was up in sections of the Northern
Plains, total FSA loan volume obligations for the current fiscal year should be
similar to last year. An increase in demand for FSA programs from 1998 events
will occur in fiscal 1999 as farmers first exhaust their commercial credit
sources. 

Farmers have invested heavily in capital assets, such as new machinery, since
1994, adding over $20 billion in total outstanding farm debt. Some farmers will
undoubtedly have difficulty servicing this additional debt if farm incomes
weaken over an extended period. However, farm income is only a portion of total
farm household income and other (off-farm) income sources remain strong. Also,
most farmers' strong balance sheets will allow them to weather a temporary
economic downturn.

Recent increases in farm debt have been supported by strong farmland markets.
Farmland remains the sector's primary asset and farmers' primary source of
collateral. Strong farm incomes, coupled with government payments, a falling
cost of capital, and in some regions strong urban demand for farmland, have
increased farmland values. There are early indications that the rapid ascent in
farmland values may be stalling. If farmland values fall, lenders will become
much more circumspect when lending to farmers.

The financial condition of farm lenders remains strong at this time. Commercial
banks with significant agricultural loan portfolios and most FCS associations
are well capitalized and have reported strong profits in recent years.
Therefore, lenders should be able to weather a short-run deterioration in farm
credit quality. 
Steve Koenig (202) 694-5353 and
Charles Dodson (202) 694-5345;
skoenig@econ.ag.gov
cdodson@econ.ag.gov

Factors Affecting Long-Term Growth in Ag Exports & 
Farm Incomes

Cyclical production is a major factor contributing to the current commodity
market situation. Large global supplies of a number of agricultural commodities
are pressuring prices. For wheat, part of this buildup of supplies results from
an increase in global production over the last 2 years in response to high
prices in 1996 and 1997. As wheat prices have fallen recently, global
production can be expected to decline in 1999 in response.

The situation is also characterized by lower exports. The value of U.S.
agricultural exports during the first 9 months (October-June) of the 1998
fiscal trade year was down 4 percent from the same period last year; exports to
Asia were down 16 percent. These declines reflect in part the Asian economic
crisis. Asia, including Japan, typically accounts for almost half of U.S.
agricultural exports. U.S. farm exports to other regions, however, were up
nearly 7 percent. In particular, agricultural exports to Canada were up 9
percent compared with October-June trade levels of last year, and were up 18
percent to Mexico. Outside Asia, economic growth mostly remains strong.

The Asian economic crisis is only one factor in the decline in U.S.
agricultural exports this year. The U.S. is facing strong competition from
record or near-record crops in South America, following 2 years of high field
crop prices globally. In addition, the lower U.S. exports to Asia  reflect
factors other than weakened demand from the economic crisis. For example,
China, a significant importer of corn in 1994/95, was a net exporter in 1997/98
and will be in 1998/99, contributing to the reduction in U.S. exports.

In the longer term, growth in global income and population and advancing
agricultural trade liberalization are the underlying drivers of U.S. farm
export opportunities, and in turn, U.S. farm prices and income. Greater market
orientation in the domestic agriculture sector under the 1996 Farm Act puts
U.S. farmers in a favorable position to benefit from their comparative
advantage in agriculture and compete in the global marketplace.

Growth in global agricultural demand, U.S. agricultural trade, prices, and farm
incomes remains the most likely prospect for U.S. agriculture. However, several
uncertainties could limit such growth over the next several years. This weaker
scenario would stem not so much from the current situation, but from a number
of medium-term factors.

The Asian economic crisis is a key factor leading to slower global demand
prospects. The timepath of Asian economic recovery is uncertain and there is
some possibility of economic growth below long-term rates for an extended
period of time. A prolonged Asian adjustment period would weaken demand for
U.S. agricultural exports for a number of years.

An ERS reassessment of China's agricultural sector data suggests the
possibility of weaker future import demand for basic commodities in China.
Preliminary work indicates that China underestimated agricultural acreage and
overestimated livestock numbers and production. With more acres and less
livestock, China would require less foodstuffs and livestock feed than
forecasters have expected. 

The European Union (EU) will be looking at options to implement a new
agricultural policy  Agenda 2000. Lower levels of price support (closer to
world prices) and eliminating the acreage set-aside could be key elements of
the new policy. Preliminary research findings indicate that the EU could make
sizable unsubsidized exports of commodities at lower price- support levels.
This could create greater global competition in agricultural trade,
particularly for wheat.

WTO negotiations in 1999 are becoming increasingly important. Because one of
the keys to strong U.S. agriculture is growth in trade, further liberalizing of
global markets will allow U.S. farmers to better realize gains from their
comparative advantage in an environment of freer competition. Use of P.L. 480
(Food for Peace Program) and the Food Security Commodity Reserve, and more
targeted use of GSM credits and other export programs can strengthen exports in
the short term. However, the pace and scope of policy reforms resulting from
the 1999 WTO negotiations to further liberalize trade will be more important
for the long-term health of the U.S. agriculture sector.
Paul Westcott (202) 694-5335 and Carol Whitton (202) 694-5287
westcott@econ.ag.gov
cwhitton@econ.ag.gov  

AGRICULTURAL ECONOMY BOX:

The Agricultural Resource Management Study: Serving the Information Needs of
Agriculture

USDA's Agricultural Resource Management Study (ARMS) serves the need of farmers
and policymakers for increasingly broad information about conditions in
agriculture and about agriculture's contribution to environmental quality. The
ARMS gathers data to show a detailed picture of the economics of agricultural
production and is the only such information source available to address many
agricultural policy issues.

Data collected through the ARMS are the primary source of information to the
agricultural community about agricultural resource use, costs of production,
the environment, the structure and financial condition of farm businesses, and
the economic well-being of farm operator households. These data are important
to addressing the question of how agriculture can produce high-quality food and
fiber products and at the same time maintain the long term viability of the
natural resource base and farm businesses.

The ARMS, established in 1996, has improved the efficiency of data collection
by combining the former Cropping Practices Survey and the Farm Costs and
Returns Survey into a single, integrated effort. ARMS was designed with a
flexible structure that accommodates a variety of questionnaire versions
focusing on specific topics of interest. Special commodity cost of production
versions are rotated every 5 to 6 years to focus on resource use and production
cost for each targeted commodity. The flexible structure also allows for
collection of data on varying resource use and financial issues, such as
national irrigation use, animal waste management, or risk management strategies
like revenue insurance.

Each year, the study is conducted in three phases. The initial phase, which
takes place in June, July, and August, collects general farm data such as crops
grown, livestock produced, and sales of farm commodities. This phase generates
screening data which are used to identify farms for inclusion in the other,
issue-driven phases of the study. Using the screening data allows the second
phase of the study to be directed to farms producing the commodities targeted
for analysis in that year, reducing respondent burden and making the survey
more cost-efficient. This second phase, conducted in the fall, collects data
associated with agricultural production practices, application of technology,
and resource use. 

Phase III, conducted February through April, collects data about whole-farm
income, assets, debts, managerial attributes, and specific data on costs for
selected commodities. Respondents to the commodity cost-of-production
questionnaire of Phase II are also asked to complete a Phase III follow-on that
includes a shortened set of farm financial, resource use, and
cost-of-production questions. The combined set of Phase II and Phase III data
provides the link between agricultural resource use and farm financial
conditions, fulfilling a major purpose of the ARMS design.

The detailed information gathered by this targeted, three-phase process allows,
among other things, for accurate estimates of commodity costs. Most farm
operations produce more than one commodity, which leads to problems in
determining commodity costs. For example, tractors and implements are usually
used for many activities on a farm, and costs for their use on a single
commodity cannot easily be separated from whole-farm costs. Therefore, it is
necessary to collect data on each separate field operation in order to estimate
the share of costs accounted for by the commodity being surveyed.

Data collected from farmers in the ARMS are confidential. Those who work with
the individual farm data are forbidden by law from disclosing any individual
data and are subject to heavy penalties, including fines and prison, if they
allow disclosure. Data from an individual farm are never released to any
government official nor to anyone outside the government the data are
summarized in such a way that disclosure of data from individual farms is not
possible. 

How Are the Data Used?

Farmers may not realize that data they provide are the basis of general
statistics on agricultural production presented to them and to the public. They
may receive the information through farm magazines, newspapers, radio and
television spots, or through extension advisors or land grant university
publications, often with no identification of the data source. But it is
farmers' participation in the survey that ensures accurate and reliable
estimates of practices, technologies, and inputs used in agricultural
production. 

The national coverage of ARMS reflects the varied financial and resource
characteristics of producers across the U.S. Researchers use the data from the
ARMS to investigate farm sector structure and performance, including
measurement of farm production costs, farm income, and other indicators of farm
financial performance. The data allow researchers to evaluate the comparative
economic performance of farming operations by size, region, commodity
speciality, and other structural parameters, including operator demographics,
and to understand approaches that farmers and their households take to manage
risk. Policymakers target programs and respond to changing economic and
environmental conditions based on this information. 

Congress, USDA, farm organizations, commodity groups, and agribusinesses rely
on summaries of the data to better understand the problems and issues facing
producers. For example, producer associations and USDA's Farm Service Agency
use summaries of ARMS data on the costs of production, particularly when
developing proposals for programs designed to assist farmers. ARMS data are
used to produce annual estimates of the cost of producing wheat, feed grains,
cotton, peanuts, tobacco, sugar, and dairy commodities, which are then used to
assess the distribution of costs across and within commodity groups. The cost
data can be used to analyze differences between low- and high-cost producers
and to conduct studies of the cost efficiencies of different production
practices such as conservation tillage. 

ARMS data are indirectly used by the Bureau of Economic Analysis (BEA) of the
U.S. Department of Commerce in producing estimates of the Gross Domestic
Product (GDP) analysts at USDA's Economic Research Service use ARMS data to
prepare the farm sector data that are then transmitted to BEA for calculation
of the farm portion of the GDP. If the ARMS data were not available, the BEA
would need to conduct its own survey of farm operators in order to determine
the contribution of agriculture to the national income and product accounts.

Costs and returns estimates also shed light on changes in the relative
efficiency of crop and livestock production and the break-even prices needed to
cover costs. The estimates also make it possible to develop regional estimates
of costs and input use by size and type of farm. Commodity prices, and thus
cash receipts, change in response to weather and to national or international
events. To reflect the distribution and impact of these problems on farms and
farm households, it is important to be able to monitor the health of the
agricultural economy by region, as well as by size and type of operations.

The agricultural community is faced with many complex environmental issues, and
the data collected by the ARMS can guide policymakers as they consider how best
to approach these issues. For instance, ARMS data on fertilizer and pesticide
use are being used in water quality studies. Data on machinery use and crop
rotations are helping to identify tillage systems and crop residue levels that
reduce soil erosion and that contribute to carbon sequestration, which may help
mitigate global warming. ARMS data on pesticide use also can help determine the
economic impact on producers of restrictions on the use of pesticides.

ARMS data demonstrate the speed at which U.S. farm operators are adopting newer
technologies. The 1997 ARMS indicated, for example, that although precision
farming technology was introduced only within the past 3-4 years, yield
monitors were being used on more than one-sixth of the corn acreage surveyed
and about one-eighth of soybean acres. ARMS data also show that all three
accepted conservation tillage practices -reduced tillage, mulch tillage, and
no-till are commonly used in corn production only one-fourth of all corn is
still being grown with conventional tillage practices. 

Data from the 1996 ARMS suggest that real economic efficiencies occur for corn
producers using some form of conservation tillage conservation tillage systems
resulted in an 11-percent cost reduction compared with conventional tillage.
The advantage of conservation tillage varies by region and soil type, but with
the exception of the Lake States region on moderate productivity soil,
conservation tillage provided substantial cost savings. 

Annual collection of general farm and ranch data are used to develop estimates
of net farm income. Data from the ARMS provide the only national perspective on
farmers' and ranchers' net farm income and financial situation, a crucial
component of decisions made within USDA in response to changing economic
conditions and policies. For example, the change in agricultural policy enacted
in the Federal Agriculture Improvement and Reform Act of 1996 exposed farmers
to increased level of market risk. Farmers' attitudes toward risk and their
ability to sustain higher levels of risk in the open market can be explored
through the data obtained in ARMS.

Current concerns about the welfare of producers on small farms and the income
potential of these producers make collection of income and balance sheet data
essential. The ARMS provides the data necessary to develop annual estimates of
the farm operation's assets, debts, equity, capital gains, capital flows, and
the rates of return to agricultural resources, and to determine how these items
change from year to year. Areas of poor financial performance and pockets of
potential stress can then be identified and comparisons undertaken among types
of farms.

In response to the January 1998 report of the National Commission on Small
Farms, ERS developed a new typology of farms using data from the ARMS. The
Commission classified farms with gross sales of less than $250,000 as small
farms, a description that includes approximately 9 out of 10 farms. Such a
broad category includes farms that vary widely in their business and operator
household characteristics, and that differ in their policy needs. The new
typology identifies five subgroups of small family farms and two subgroups of
large family farms, with the remainder in nonfamily farms. The ARMS is the only
source of farm business and farm household data complete enough to produce the
typology at the national level.

The ARMS also provides the financial data necessary to determine how farm
household finances change from year to year. The ability to pay operating costs
and the interest and principal due on debts can change very rapidly in response
to drought, flood, or other circumstances. However, farm and ranch operators
and their households may not depend solely on the income from the farm and
ranch business. Off-farm work is critical to the financial well-being of many
farm households, and even the households of large commercial farms have
substantial off-farm income. The ARMS is the only national data source that
provides the information necessary to show a complete picture of the financial
conditions of farmers.
Bob Reinsel (202) 694-5506
rreinsel@econ.ag.gov
Also contributing: Jim Johnson, Janet Perry, Bob Hoppe, and Judy Sommer

Availability of ARMS Data

NASS publishes two reports from the ARMS, Agricultural Chemical Usage -Field
Crops and Farm Production Expenditures. Most NASS State offices carry
information from these two reports in their publications. ERS prepares State,
regional, and national reports on the operating and financial characteristics
of farms by type of farm, and by income and debt/asset categories, which are
also available to NASS State offices. ERS also publishes a number of reports
that depend on data from the ARMS, including the Annual Report to Congress on
the Status of Family Farms, Financial Performance of U.S. Farm Businesses, and
Farm Operating and Financial Characteristics.

Three internet sites carry summaries of the ARMS data online. Much of the farm
financial information produced by ERS may be found at http://www.econ.ag.gov/
Briefing/fbe/. Agricultural Resources and Environmental Indicators, an ERS 
handbook, may be found at http://www.econ.ag.gov/Briefing/arei/arei.htm. NASS 
reports can be found at http://mann77.mannlib.cornell.edu/reports/nassr/
other/pcu-bb/.

Researchers interested in access to datasets generated by the ARMS survey
should contact Dave Banker (dbanker@econ.ag.gov) for information on
availability.

BRIEFS

Weaker Price Prospects Dampen Expansion of U.S. Durum Acreage

U.S. durum producers signaled in early 1998 that they would sharply increase
area seeded to durum wheat, according to USDA's Prospective Plantings report
released on March 31. Tight world durum supplies in 1997/98 led to rising U.S.
and world prices for durum, while prices for other types of wheat declined.
This market rarity resulted in producers expecting to plant 4.08 million acres
of durum in 1998, up a prospective 25 percent from 1997 and the largest acreage
since 1982. In addition, Statistics Canada reported that Canadian producers
intended to expand acreage by 29 percent in 1998. 

However, prospects of larger world supplies and lower prices implied by larger
1998 durum crops eventually led U.S. producers to modify their 1998 cropping
plans. USDA's June 30 Acreage report confirmed that durum producers actually
seeded only 3.7 million acres to durum this spring, up from 3.25 million acres
in 1997. Harvested area is projected at 3.6 million acres, up 15 percent from
1997 and the highest since 1989.

The larger harvested area and generally favorable growing conditions in the
Northern Plains this summer are pointing to a substantially larger U.S. durum
crop in 1998. USDA's August 1 forecast indicates that farmers will harvest 126
million bushels in 1998, up 46 percent from last year's weather-reduced crop
and the largest since 1982. U.S. durum yields are projected at 35.2 bushels per
acre, up 27 percent from last year and the highest since 1992. The States of
North Dakota, Montana, South Dakota, and Minnesota will account for over 91
percent of the U.S. durum acreage harvested in 1998. With yields averaging
about 29 bushels per acre, these States will account for about three-fourths of
U.S. durum production. 

Durum is also grown under irrigation in California and Arizona, where farmers
expect to harvest about 319,000 acres (9 percent of the total in 1998). Yields
of almost 103 bushels per acre push their share of production to about
one-fourth of the U.S. total.

Prices for all classes of wheat have been declining during the summer of 1998
as the prospects for large supplies coincide with weak export demand. However,
durum prices do not necessarily fluctuate in unison with other classes of wheat
because there is very little substitution between durum and the other classes
of wheat e.g., hard red winter, soft red winter, and white wheats. Durum is
usually ground into semolina, a granular product used in pasta.

Because high-protein Dark Northern Spring wheat can be substituted for durum in
the production of certain pasta products, the price premium for durum is often
evaluated by comparing No. 1 Dark Northern Spring wheat (with 14-percent
protein) and Hard Amber Durum wheat at Minneapolis Grain Exchange, a major
trading center for both types of wheat. The premium has widened since the
mid-1990's, sharply so in 1997/98 as world supplies of durum tightened. In
1998/99, the premium is declining as supplies rebuild. Durum was in abundant
supply during the 1989-92 marketing years and the price differential was
generally small during those years. 

Larger U.S. supplies and weaker prices will encourage U.S. millers to expand
purchases of U.S. durum and reduce imports from Canada, the world's largest
durum producer. Although domestic use of durum are forecast to rise in 1998/99,
ending stocks are projected to increase 46 percent from last year. 

Export prospects are dampened by projected larger crops in Italy, France,
Canada, Syria, and North Africa. World durum production is projected at 30.8
million metric tons (1.14 billion bushels), up about 26 percent from 1997/98.
Canada's output is projected at 6.3 million tons, up 30 percent from 1997/98.
Production in the three major exporters (Canada, U.S., and the European Union)
is projected to total 18.4 million tons in 1998, up 5 million tons from 1997. 

The expanded exportable supplies in 1998/99 are expected to coincide with a
downturn in global import needs since many importers are experiencing
production increases this year. The weaker import demand will intensify
competition among the major exporters this year and reduce U.S. exports to a
projected 45 million bushels (grain and products), down 15 percent from last
year. Export sales have started slowly. As of August 13, accumulated export
shipments plus outstanding export sales for the 1998/99 marketing year totaled
only 13.1 million bushels, 43 percent below last year's pace. Despite the lower
export projection, the U.S. will maintain it status as the world's second
largest exporter behind Canada.
Mack N. Leath (202) 694-5302 
mleath@econ.ag.gov 

BRIEFS

Dairy Markets Unsettled, Prices Erratic

Strong economic growth continues to bolster demand for dairy products, although
the effects have been uneven. Strong milkfat demand, moderate skim solids
demand, and sluggish milk production are expected to keep dairy markets
unsettled and prices erratic during the remainder of 1998. Dairy prices are not
likely to stabilize until substantial production gains are posted. Expansion in
milk output may start accelerating by late 1998 or early 1999 if the recent
declines in concentrate feed prices are combined with adequate supplies of
dairy-quality forages. 

Sales of milkfat have increased despite very high prices since mid-1997. Use of
regular ice cream, fluid cream, and cream cheese have increased, while declines
in butter sales have been quite modest. In addition, direct use of milkfat in
processed foods appears brisk. Some of this strength probably still represents
the momentum of increased sales built up by the very low milkfat prices of
1992-95. There also seems to be some return to traditional products after
experimentation with lower-fat versions. Milkfat demand is projected to be
fairly strong during the rest of 1998, although the high summer butter prices
may start to trim growth in milkfat sales. 

Demand for skim solids has not matched demand for fat. Fluid milk sales have
run about 1 percent below a year earlier, without significant growth in even
the lowfat milks. Use of products such as cottage cheese has slipped. In
addition, use of nonfat dry milk and other forms of skim solids in processed
foods apparently has eased, in part because of their relatively high prices
during much of the 1990's. Skim solids sales may have been affected by eroding
sales of nonfat or very lowfat foods that had used milk solids to maintain
quality when the fat was removed. If not for the moderate growth in cheese
sales, sales of skim solids probably would be below a year earlier.

Rapidly rising prices spurred dairy product users and retailers to increase
their pipeline holdings during the second quarter of 1998. These pipeline
stocks will be worked down in the second half of the year. However, wholesale
price changes since early July indicate that pipeline stocks probably did not
reach excessive levels. Low warehouse stocks have bolstered prices warehouse
holdings of butter were down sharply on July 1, while cheese stocks were 5
percent lower than a year earlier.

Sluggish milk production and very strong milkfat demand shot wholesale butter
prices to record highs by the end of June, where they held through July.
Although pipeline holdings of milkfat may have been sizeable by early July,
total inventories (including commercial warehouse stocks) probably were a
little tight and sales evidently stayed brisk. The strength in butter prices
pulled cheese prices up sharply, as cheese demand was too strong to allow very
much milk to be drawn from cheese production into production of butter and
nonfat dry milk. Between early May and mid-July, cheese prices rose about a
third. Since then, cheese prices have been mixed. 

Butter and cheese prices are expected to decline in autumn, particularly if
milk production begins to expand in earnest. Although milkfat demand stays
seasonally strong in autumn, demand actually peaks in summer when milkfat
production is at its seasonal low. Late summer-early autumn supplies may be
more than adequate for sales at recent prices. However, butter and cheese
markets probably will stay relatively tight until late 1998. 

Nonfat dry milk prices have stayed near the Federal support purchase price.
Contributing to this situation have been demand weakness, large powder stocks,
and butter prices high enough to keep milk going into joint production of
butter and nonfat dry milk. Federal purchases of nonfat dry milk under the
price support program continued in summer, despite seasonal production declines
and the availability of new allocations under the Dairy Export Incentive
Program (DEIP). Contracts under DEIP were sizable in July, but ample
international supplies and demand weakness in Asia meant there was little
reason for buyers to build stocks. Support purchases should diminish in coming
months, as DEIP contracts absorb most of the seasonally smaller surplus.

The roller coaster in farm milk prices is likely to continue. The Basic Formula
Price (BFP) which represents the value of milk for manufacturing and is the
mover of most prices under the Federal milk marketing orders rose
counterseasonally in early 1998, reaching a February peak of $13.32 per cwt.
The delayed seasonal collapse of cheese prices dropped the BFP to $10.88 in
May, before surging butter and cheese prices brought it back up to $14.77 in
July. If wholesale prices ease as expected, the fourth-quarter average may
decline to levels similar to a year earlier.

The average price of all milk in the fourth quarter is projected to post a much
smaller increase from a year earlier than did the first three quarters. Even
so, the 1998 average will be more than $1 per cwt above 1997's $13.34 and
second only to the 1996 record. This year's higher milk prices and lower
concentrate feed prices should start to stimulate milk production. Increased
returns are expected to spur herd expansions by stronger producers, and
milk-feed price ratios have reached levels normally associated with
above-average growth in milk per cow. But acceleration in milk production is
likely to be gradual for a number of reasons.

Adequate supplies of good forage remain a major concern. A promising start to
the forage season was dimmed by rains that reduced the quality of first and
second cuttings of hay across northern regions. Unless late cuttings are
particularly good, lack of enough quality forage will continue to trim
expansion in milk production. Also, high summer milk prices were a sudden
reversal of a sharp decline in manufacturing values between February and May.
Producers will not see the full effects of these higher prices in their milk
checks until well into summer. Even then, producer response may be cautious
because of the recent price volatility.

Year-over-year declines in milk cow numbers are expected to ease to only about
 percent by late 1998, compared with drops of almost 1 percent in the first
half of the year. Enough herd expansions are projected to come into production
to largely offset the exodus of weaker farmers. For all of 1998, cow numbers
are projected to decrease less than 1 percent.

Despite a favorable milk-feed price ratio, summer milk per cow probably will
post a relatively small increase from a year earlier. Last year's summer output
was quite strong because of generally favorable weather, while 1998 has seen
problems with heat. Autumn gains could exceed 2 percent, a truer representation
of the underlying expansion in milk per cow. The 1998 total is projected to be
almost 2 percent above last year.

Autumn and winter milk output is projected to rise considerably more than 1
percent from a year earlier. Possibly more important, milk production is
expected to be on a firm expansion course for the first time in several years.
The major threat to this growth remains the possibility of continued problems
with forage quality. Annual 1998 production is projected to be nearly 1 percent
above the 156.6 billion pounds of 1997.
Jim Miller (202) 694-5184
jjmiller@econ.ag.gov  

BRIEFS

U.S. Apple Production Up, Prices Down

USDA has forecast the 1998 apple crop to be 11.3 billion pounds, up 9 percent
from a year ago. Larger expected crops in all apple-growing States in the
Western U.S., except California, will offset production declines in the Central
and Eastern regions and help increase availability of domestic apples during
the 1998/99 marketing season. 

Although increased production will likely put downward pressure on fresh-market
grower prices, generally good size fruit from this year's apple crop, as well
as a smaller pear crop which tends to compete with apples in the fall will help
keep fresh-apple prices strong for growers. In 1997/98, a 6-percent decline in
fresh-market production helped raise the season-average grower price for
fresh-market apples to 22.2 cents a pound, up 7 percent from the previous year.

Washington will produce more than half of all U.S. apples in 1998 and
traditionally is the largest producer for both the fresh and processed market.
Washington's 1998 apple harvest is forecast at 6.1 billion pounds, 22 percent
larger than last year and the largest so far. Apple orchards in the State
bloomed heavily following a smaller crop in 1997. Weather was also very
favorable for much of the Northwest, especially during the stages of
pollination, fruit set, and early-season growth. The potential crop size also
grew as production increased on maturing trees that began bearing earlier in
the 1990's.

Meanwhile, relatively cooler temperatures and above normal rainfall in
California have slowed development of its 1998 apple crop by about 2 weeks,
just as weather has delayed many California summer fruits. California's apple
crop is forecast at 915 million pounds, down 5 percent from a year ago but
still about average. 

Orchard blooms were generally good throughout Michigan, the largest
apple-producing State in the Central region, and weather was mostly favorable,
especially during pollination. However, production there is forecast at 1
billion pounds in 1998, down 5 percent. Smaller crops are expected in many of
the States in the Eastern region as well, including in New York and
Pennsylvania, the two largest producers in this region. While orchard blooms in
these States generally suggested average-to-large size crops, hail and wind
damage later in the season have reduced crop size potential. 

Over 50 percent of U.S. apple production is for the fresh market. Fresh-market
apple supplies for fall 1998 are expected to increase from a year ago,
especially given the expected record crop in Washington and still a relatively
large crop in California, where over 70 percent and over 30 percent of the
apple crops are for the fresh market. 

Increased fresh-market supplies mostly of good exportable quality, will help
promote U.S. fresh apple exports in 1998/99. However, the Asian financial
crisis has taken a toll the stronger U.S. dollar relative to other currencies,
particularly in Southeast and East Asia, will likely continue to dampen export
prospects in these markets. During August 1997-May 1998, exports to the largest
market in Asia for U.S. apples Taiwan fell nearly 10 percent over a year
earlier. Similarly, exports to other important Asian markets such as Indonesia,
Thailand, the Philippines, and Malaysia declined 50-58 percent. 

Some of the decline in exports to Asia was offset by gains in exports to
Canada, the second largest foreign market for U.S. apples. Exports to Canada
increased 7 percent from August 1997 to May 1998. In contrast, exports to
Mexico, another important market for U.S. apples, fell about 39 percent,
attributed mainly to its decision in September 1997 to impose an antidumping
duty of 101.1 percent on imports of U.S. Golden and Red Delicious varieties.
Export prospects to Mexico this season could return to more normal levels with
the March 1998 agreement between the U.S. apple industry and Mexican commerce
officials to suspend the antidumping investigation.

Supplies of processing apples from the Central and Eastern regions during the
1998/99 marketing year will be limited by overall reduced production in these
regions. However, large supplies from Washington and California, where about 44
percent of processing apples are produced, should help keep overall supplies at
normal levels. Large stocks of processing apples entering the new season will
also offset smaller Eastern supplies.
Agnes Perez (202) 694-5255
acperez@econ.ag.gov  


COMMODITY SPOTL
U.S. & World Cotton Markets Diverge in 1998/99 

The U.S. and the foreign cotton sectors face divergent circumstances in the
1998 season, and the marketing year (August-July) has begun with an unusually
wide gap between U.S. and world prices. Adverse weather, the Asian crisis, and
U.S. and foreign government policies on cotton are among the factors affecting
U.S. production and exports in 1998/99. 

With U.S. stocks shrinking and with foreign stocks outside of China expected to
grow, the price premium for U.S. over foreign cotton has jumped. Moreover,
government payments to encourage use and exports of U.S. cotton under Step 2 of
the cotton marketing loan program have soared, and funds are likely to be
depleted well before potential reauthorization in 2002.

U.S. Crop To Shrink In 1998/99 Season

For the U.S., the 1998/99 outlook continues the trend toward smaller acreage
planted to cotton. This trend is a result of the most recent U.S. farm
legislation, currently in its third year, which allows producers greater
flexibility to plant the crops they choose in response to market signals.
Producers have sought to limit their risk, given cotton's relatively high cost
of production. As planting time approached this spring, net returns for some
competing crops looked more favorable than for cotton in many areas of the
Cotton Belt, signaling a need to plant fewer acres to cotton.

USDA's Prospective Plantings report, released in March, had indicated farmers'
intentions to plant 13.2 million acres to cotton this season, 4 percent below
1997/98 and 22 percent below the recent high in 1995/96. However, cool, wet
weather in California and dry conditions in Texas during planting time slashed
cotton area further. In the June Acreage report, USDA indicated that cotton
area planted and to be planted totaled only 12.9 million acres this year, 6
percent below 1997.

The U.S. Cotton Belt stretches across the southern-tier States and is usually
divided into four major producing regions (West, Southwest, Delta, and
Southeast). Although each region's cotton acreage is below 1997, the degree of
decline varies. Based on USDA's August Crop Production report, declines ranging
from 3 to 18 percent are projected for the cotton producing regions.

The largest percentage decline projected for this season is in the West, where
a cool, wet spring delayed planting and kept some intended cotton acreage from
being planted at all. USDA's National Agricultural Statistics Service (NASS)
projected area at 1.2 million acres in August, a drop of more than 18 percent.
NASS estimated that the West would produce nearly 2.6 million bales in 1998/99,
suggesting an average yield for the region of 1,021 pounds per harvested acre,
both well below normal. 

The Southwest plants and harvests the largest share of cotton area. However,
drought conditions in Texas and Oklahoma have limited plantings this season,
and the continued lack of moisture is likely to force large acreage
abandonment. Planted area for the Southwest was projected in August at 5.5
million acres, only 5 percent below last season. However, the harvested area
projection is only 3.4 million acres. In addition, the production estimate of
3.3 million bales is well below the region's 5-year average of 5 million bales
and the lowest output since 1989.

In the Delta, the largest producing region by volume, cotton area has declined
continuously since enactment of the 1996 farm legislation, reflecting the
expansion of alternative crops in the region. NASS projected planted area at
3.1 million acres, about 9 percent below a year earlier. But with better
growing conditions than in the West or Southwest, the Delta is projected to
have above-average yields 747 pounds per harvested acre and is expected to
produce a crop of 4.8 million bales this season.

In the Southeast, where cotton area has remained relatively stable since 1996,
plantings are projected at 3 million acres. Despite some weather-related
problems of its own, the Southeast is projected to produce a crop of 3.6
million bales, equal to the 5-year average but implying a below average yield
of 585 pounds per harvested acre.

Based on the August Crop Production report, USDA currently projects this
season's total output at 14.3 million bales, well below the 19-million-bale
crops of the past 2 years. The national yield is forecast near the 5-year
average, at 640 pounds per harvested acre, while the U.S. harvested area is
projected at only 10.7 million acres.

With U.S. production significantly below the previous two seasons, beginning
stocks near last year's 4 million bales, and imports forecast at 100,000 bales,
cotton supplies for the 1998/99 season are currently projected at 18.3 million
bales, 20 percent below 1997/98. As a consequence of tighter U.S. supplies, in
addition to steeper competition from abroad, U.S. cotton exports are expected
to be constrained this season.

As of August 12, USDA forecasts domestic mill use at 10.8 million bales during
1998/99, compared with 11.35 million bales last season, as the recent slowdown
in cotton use is expected to continue in the near future. Factors which are
likely to limit mill use this season are slower growth in the U.S. economy and
the continued influences of the Asian crisis, which has provided relatively
cheap cotton textile and apparel imports into the U.S. Liberalization of
textile trade under the North American Free Trade Agreement has also
contributed to increased imports. 

Although U.S. cotton textile exports have risen this year, they have not kept
pace with imports. Meanwhile, U.S. exports of raw cotton are expected to take
the brunt of the decline in 1998/99 and are projected at only 4.9 million
bales, 35 percent below last season. The 2.6-million-bale decline in raw cotton
exports is attributable in part to the loss of U.S. production in areas that
typically provide cotton for the export market. Other factors are the financial
problems across Asia and an anticipated increase in foreign competition,
particularly from China.

Asian Consumers Reeling

The decade's most rapidly growing economies have sustained a severe setback as
a result of the Asian crisis, and world cotton demand has suffered. At the same
time, China appears poised to exchange its place as the world's largest
importer of the last few years for a position among the world's largest
exporters. These two developments have tended to depress world cotton prices
and have contributed to the large disparity between U.S. and world prices. 

Clothing is a semidurable good, and like true durable goods (e.g., cars and
appliances), its purchase can be deferred at a given time while consumers rely
on earlier purchases (unlike the purchase of food and many services). While
Korea's urban consumer expenditures fell 9 percent in the first quarter of
1998, purchases of durable goods fell 39 percent. Garment sales have reportedly
fallen less than car sales, but perhaps as much as household appliances. In
Southeast Asia, the contraction of GDP and consumer spending has been even more
severe, and substantially larger declines in clothing purchases are likely. 

Together, consumers in Southeast and East Asia could cut their purchases of
cotton-containing products by 1 to 1.5 million bales during calendar 1998, the
equivalent of about 1.4 percent of world consumption. Since income prospects in
the region have been reduced for the foreseeable future, cotton consumption is
not expected to rebound fully. This has exerted a negative influence on world
cotton prices. While developed economies other than Japan are expected to
continue expanding in 1998 and 1999, the increased demand will be more than
offset by Asia's loss.

China's shift from net importer to net exporter of cotton has also depressed
foreign prices. China vaulted to the position as the world's largest importer
in the mid-1990's as policymakers encouraged imports to rebuild stocks and help
tame soaring inflation. Now, China's economy may be undergoing deflation, and
the years of high imports and large cotton crops appear to have driven stocks
uncomfortably high. 

The precise levels of China's production, consumption, and stocks are subject
to wide debate in the cotton trade. But there is no question that China began
restricting imports at the beginning of 1998, and during April 1998 it
announced a large export tender. 

While a second export tender was in effect withdrawn, China has announced an
unprecedented cut in the government procurement price for 1998 crop cotton and
the withdrawal of a price floor for procurement in Xinjiang Province,
traditionally China's main exporting region. China's cotton procurement prices
have been above world levels in recent years, so that exports would likely have
required subsidies. This year's freeing of procurement prices in Xinjiang while
freeing prices to end-users throughout China may open the way to exporting
without exposing China to charges of "dumping" cotton. Since China is not a
member of the World Trade Organization (WTO), the validity of any dumping
charges would be resolved bilaterally rather than through the dispute
settlement mechanism of the WTO. 

China's imports seem largely restricted to coastal mills that are joint
ventures with foreign investors and that meet strict regulations mandating
re-export of products made with imported cotton. But it seems likely that
larger amounts of cotton will be available for export once adequate crop
prospects are secure. 

Exhaustion of Step 2 Funding
Could Further Erode Demand

The 1990 farm legislation provided a mechanism the Step 2 program for keeping
U.S. cotton competitive on the world export market as well as encouraging
domestic mills to use U.S. cotton instead of importing cheaper foreign cotton.
The Step 2 program is now an integral part of the upland cotton marketing loan
provisions of the U.S. cotton program. But Step 2 funding for compensating
domestic mills and exporters is close to depletion. 

Step 2 provides a payment to exporters and domestic mill users of U.S. upland
cotton when, after 4 consecutive weeks, the U.S. price on the world market is
more than 1.25 cents per pound above the weekly average of the five lowest
price quotations offered (A-Index). In addition, the adjusted world price (AWP)
must be no more than 30 percent above the per-unit government loan rate
available to cotton farmers (AO July 1997). On October 1, 1998, the 30-percent
threshold will be raised to 34 percent.

The 1996 farm legislation limited Step 2 expenditures to $701 million during
the period FY 1996 through 2002. As the end of FY 1998 approaches, well over
half of the budgeted amount for the 7-year period has already been spent, and
the balance is expected to be depleted in FY 1999. 

Early depletion of the Step 2 funds is the result of several concurrent
developments last season. With U.S. prices already above world prices by the
start of 1997/98, Step 2 payments averaging about 1.5 cents per pound were in
effect from August 1997 through January 1998. 

By the spring of 1998, the price gap widened as U.S. planting delays associated
with weather problems diminished crop prospects and increased U.S. prices.
Meanwhile, world prices declined as a result of the Asian crisis and of China's
large offering of cotton for export. Consequently, Step 2 rates increased,
averaging 5 cents during February-April 1998, and rising to 7 cents in May.
With the continued decline of the U.S. cotton crop, especially in Texas, and
with prospects for a large foreign crop underway, the Step 2 rates jumped
dramatically, averaging more than 11 cents per pound in June and July, with the
rate peaking at 13.5 cents for the week of July 3-9.

The Step 2 program cost nearly $400 million in 1997/98, and the program
functioned as intended by keeping U.S. cotton competitive. Estimates of
increased demand resulting from Step 2 last season ranged from 300,000 to
650,000 bales. The increased demand kept U.S. stocks from rising in 1997/98 and
U.S. average farm prices held near 65 cents per pound for the season. 

As the 1998/99 season begins, the gap between U.S. and world prices is still
wide, but prices are more closely aligned, and Step 2 rates have fallen to
about half the rates seen in June and July. Despite the lower rates, the funds
allocated for the Step 2 program are expected to be depleted sometime this
season. The timing of the program's termination will depend on the level of
future payment rates, the pace at which domestic mills use upland cotton, and
the pace at which exporters ship the cotton to foreign markets. 

Given the program's imminent demise, demand is expected to increase during the
first part of the season to capture these payments. But if additional funding
for the program does not materialize, domestic and foreign demand for U.S.
cotton is expected to weaken in the short term. 

Shortly after the Step 2 program is terminated, special import quotas would
likely be triggered under Step 3 if U.S. cotton prices remain above the rest of
the world. Step 3, which effectively raises quotas for imports at low tariff
rates, ensures the U.S. textile industry access to competitively priced cotton.
The program is authorized when, for 10 consecutive weeks, the U.S. price on the
world market remains more than 1.25 cents per pound above the average of the
five cheapest quotations offered (A-Index), after subtracting any Step 2 rate
from the previous week.

However, the opening of Step 3 quotas does not necessarily result in large
quantities of U.S. cotton imports. Ordinarily, the price of domestic cotton to
U.S. mills is lower than imported fiber because of relative costs of
transportation; in addition, U.S. cotton may command a premium due to quality,
reliability, and the efficiency of "just-in-time" delivery. Therefore, tariff
reduction by itself will not generate significant cotton imports. The magnitude
of the price gap between the U.S. and the foreign source (including
transportation costs) will be crucial, as well as the domestic availability of
specific qualities of cotton that might be imported. Many variables, both in
the U.S. and overseas, will be at work to determine the competitiveness of U.S.
cotton. 

Despite a potential setback in demand for U.S. cotton this season, the forecast
decline in U.S. production exceeds the drop in demand stocks at the end of
1998/99 are projected to decrease from the beginning level. The latest estimate
places U.S. ending stocks at 2.6 million bales, just under the 1995/96 level
and the lowest since 1990/91.

While it is still early in the 1998/99 season, the outlook for cotton prices
and U.S. competitiveness this year and the implications for 1999/2000 may well
be determined over the next several months. 
Leslie Meyer (202) 694-5307 and Stephen MacDonald (202) 694-5305
lmeyer@econ.ag.gov
stephenm@econ.ag.gov 
 
COMMODITY SPOT

Soybean Prices Plunge on Big World Harvests, Weaker Demand

Last year, U.S. farmers enjoyed record sales of soybeans, thanks to a bumper
harvest and favorable prices. In 1998, U.S. soybean farmers will produce their
second consecutive record harvest. At 2.83 billion bushels, this year's crop
will be nearly 4 percent larger than last year's. But the 1998/99 outlook for
marketing has greatly changed. Soybean prices at the farm level are forecast to
slide from the 1997/98 average of $6.45 per bushel to $4.85-$5.85 this season,
the lowest since 1986/87. Greater world supplies and weaker demand are
responsible for this dramatic market turnabout. Compared with the diminished
level 2 years ago, projected global soybean ending stocks in 1998/99 are
expected to be almost twice as high.

Farm policies promoting greater planting flexibility which made expected market
returns the major determinant of farmers' acreage have helped make 1998 the
sixth consecutive year of higher soybean plantings. Comparatively lower grain
and cotton prices pushed U.S. soybean plantings this spring to an all-time high
72.7 million acres. Steadily rising yields and lower production costs (partly
due to widespread adoption of conservation tillage practices and
herbicide-tolerant varieties) have also boosted soybean acreage.

Higher yields will also contribute to increased production. Most soybean
acreage was planted earlier than usual in 1998, and a longer growing season
tends to help yields. Early-season prospects were favorable, with ample soil
moisture this spring. Despite concerns over drought that sometimes follows El
Nio, adequate rain fell during the summer in the major producing States.
However, soybean fields in the South have been hurt by hot and dry weather. The
U.S. average soybean yield is expected to reach 39.5 bushels per acre, which
would rank second only to the 1994 yield of 41.4 bushels. 

U.S. farmers have not been the only recipients of such bounty. Responding to
the same net return incentives, South American producers expanded soybean
plantings more than ever before. In Brazil, continuing transportation
improvements have lowered marketing costs, opening more remote lands for
competitive soybean production. El Nio helped bring abundant rainfall to South
American fields in early 1998, resulting in bumper harvests for Brazil,
Argentina, and Paraguay (the world's second, third, and sixth largest soybean
producing countries). Argentina's 1998 output was nearly 50 percent larger than
the drought-damaged 1997 crop. In addition, a rain-delayed harvest and slower
marketings will push even more foreign supplies into direct competition with
U.S. exports in 1998/99 (September-August). Excellent worldwide harvests of
competing oilseeds, such as rapeseed and sunflowerseed, will also pressure
soybean prices.

Despite a superb start, 1997/98 U.S. soybean exports are expected to be down
slightly from the previous year (870 million bushels) because of substitution
with soybean oil and meal exports. In 1997/98, robust foreign demand is hiking
U.S. exports of soybean meal and soybean oil (up 33 percent and 45 percent).
Domestic soybean crushing consequently soared to satisfy increasing demand for
meal and oil. But given large South American stocks this fall, export
competition will be much fiercer for the U.S. than a year ago when it was
virtually the world's only source of soybeans. As of mid-August, U.S. export
sales of soybeans and soybean meal in 1998/99 (i.e., new crop to be delivered)
were only 38 and 61 percent, respectively, of the amount sold a year earlier.
U.S. soybean oil exports are forecast at 2.8 billion pounds in 1998/99, down 5
percent from the previous year.

Competitor exports will edge higher, although lower U.S. prices should moderate
the decline in U.S. exports of soybeans to 850 million bushels in 1998/99.
Projected U.S. exports of soybean meal are scaled back from 9.3 million short
tons in 1997/98 to 9 million tons. The considerably lower total value of these
exports will be felt at the farm level. U.S. soybean farm income in 1998/99 may
be cut more than $2.5 billion (about $35 per harvested acre) from the record
1997/98 earnings.

Asian Financial Crisis Batters 
World Soybean Consumption

The other side of this outlook relates to the altered circumstances for foreign
trade growth, especially in Asia. In 1996/97, Asian nations accounted for 44,
25, and 56 percent of U.S. exports of soybeans, soybean meal, and soybean oil.
But serious economic recessions throughout the Pacific region have undermined
the demand base in several major markets. 

Since mid-1997, a wave of foreign exchange devaluations affecting Thailand,
Indonesia, South Korea, Taiwan, Malaysia, and the Philippines has pushed their
currencies to historical lows against the U.S. dollar. As a consequence, prices
of agricultural imports in dollar terms have dramatically risen. Soybean meal
consumption in Taiwan has also suffered a setback after the 1997 outbreak of
foot-and-mouth disease in hogs, which halted that country's lucrative pork
export trade with Japan. Imports (in soybean meal equivalent) by these six
countries in 1998/99 is expected 17 percent lower than in 1996/97.

Short-term credit for U.S. agricultural commodities, offered through USDA's
GSM-102 program, has been key in stabilizing soybean and soybean meal imports
from the U.S. Despite the availability of GSM credit, the ongoing financial
crisis has caused several Asian countries to ration imports. Even Japan's
economy slipped into recession as the yen fell to the lowest level versus the
dollar in 8 years. Rising meat imports will also trim Japanese 1998/99 soybean
meal consumption, resulting in soybean imports 7 percent lower than the 1996/97
level.

One of the few bright spots for farmers in the current world soybean complex is
a strong vegetable oil market. Since 1996/97, the average U.S. soybean oil
price has risen from 22.5 cents per pound to the 1998/99 forecast of 25.5-27.5
cents. A shortfall in global palm oil production with world prices rising 40
percent since mid-1997 is largely responsible for this situation. Palm oil
ranks a close second to soybean oil in world vegetable oil production and is
consumed extensively in Asia, the Middle East, and Africa. 

Supplies of palm oil have been cut by a severe drought in the major Southeast
Asian producing nations. In addition, Indonesia has placed restrictions on palm
oil exports to control domestic consumer prices. With the dissipation of El
Nio, the rains have resumed. But the long biological cycle of palm trees means
that palm oil production may not increase greatly until well into next year.
Sluggish growth would continue to buoy prices for soybean oil, providing the
only price-supporting factor for soybeans in the short term.

China is the world's premier market for vegetable oils, importing large volumes
of both soybean and palm oil. China will import more oils in 1998 as
consumption continues to expand and domestic oilseeds production declines.
China has not yet suffered the currency problems of its Asian neighbors, but
Chinese economic growth is slowing as export competition for all goods from the
other countries intensifies. Excluding China, there will be few other markets
where soybean oil trade is expected to gain in the coming year. Pakistan and
India, each large importers of soybean oil, may scale back oil imports to
conserve foreign exchange. Both countries have devalued currencies and lost
sources of credit because of economic sanctions imposed after nuclear weapons
tests. 

With attractive vegetable oil prices, farmers in Europe, Canada, Australia, and
the U.S. expanded 1998 plantings of rapeseed and sunflowerseed, oilseeds with
high oil content. Excellent oilseed harvests in Europe will squeeze
international trade in soybeans and shift a greater proportion of imports in
the form of soybean meal. Record oilseeds output is anticipated in India, as
well. This would trim India's need for vegetable oil imports and widen its
surplus of soybean meal that it exports to Asian buyers.

Even at an intense crush rate, soybeans alone do not have oil content high
enough to quickly rebuild world oil supplies. But global demand for protein
meal has weakened relative to the burgeoning meal supplies created jointly for
the vegetable oil market. Income declines have induced many Asian consumers to
reduce their meat consumption (still considered a luxury item for many) and
consequently livestock use of protein meal. A cut in soybean meal demand has a
greater effect on the soybean price, as protein meal is the predominant product
from processing soybeans. U.S. soybean meal prices have fallen to their lowest
level since 1985, a bargain for livestock producers. Lower feed costs are
helping domestic poultry and hog production expand, and should raise U.S.
soybean meal disappearance to a record 29.4 million short tons.

Late this year, South American producers should cut back their soybean
plantings and yields are expected to revert to trend levels. And, provided
economic reforms are implemented, a modest recovery by several Asian importers
would encourage demand. Nevertheless, while it is difficult to know how
relative U.S. commodity prices will look next spring, the chances for an
increase in 1999 soybean acreage are slim. The large expected 1998/99 carryout
stocks will weigh heavily on soybean prices, encouraging farmers to look for
more profitable crop alternatives.
Mark Ash (202) 694-5289
mash@econ.ag.gov  

COMMODITY SPOT BOX: Putting the Brakes on Consumption Of Added Fats and Oils

Numerous reports and analyses by public health organizations conclude that
Americans eat too much fat and recommend that Americans limit their fat intake.
Americans appear to be following this advice. Recent analysis by USDA's
Economic Research Service (ERS) suggests that consumer concern about fat
intake, and food manufacturer response to this concern, is limiting use of
added food fat in edible products (i.e., fat used as an ingredient or in
cooking) and reducing per capita consumption. Historically, price and income
were the principal determinants of annual levels of consumption. 

Annual per capita consumption of fat added to food has generally increased over
time since data collection began in 1909. Consumption occasionally declined
year to year, but it dropped for an unprecedented fourth consecutive year in
1997, signaling a more substantive arrest. Preliminary data for 1998 show total
use of fats and oils in edible products trailing last year, which strongly
suggests that per capita consumption will fall again this year. 

Total use of fats and oils in the domestic manufacture of edible products
peaked in 1993 at 15.7 billion pounds (as per capita consumption peaked at 70.2
pounds). Total use fell for 3 consecutive years to 14.8 billion pounds in 1996,
while per capita consumption declined to 65.8 pounds. In 1997, total use of
fats and oils rose to 15.2 billion pounds, but per capita use declined again
due to population growth. 

While total fats and oils use declined during 1993-97, soybean oil's share of
the total rose from 78 percent (12.2 billion pounds) in 1993 to 82 percent
(12.4 billion) in 1997. Among product categories for 1997, soybean oil
comprised 83 percent of the total fats and oils used in salad and cooking oil
manufacture, 80 percent of total use in production of baking and frying fats,
and 95 percent of the total use in margarine production. 

Soybean oil's rising share of the market over this period has come at the
expense of virtually all other fats and oils reported. The shares of cottonseed
oil, corn oil, and edible tallow dropped the most. The change in share is
largely the result of competitive prices for soybean oil among vegetable oils
and a long-term shift away from the use of animal fats in foods. But since
soybean oil has been increasing its share of markets that are declining
(margarine and baking/frying fat applications), gains in total use of soybean
oil will likely be unsustainable.

In addition, the share of soybean oil in the domestic food market may be
approaching its limit. Additional gains will have to come in markets for which
soybean oil is not as well suited. For instance, soybean oil will likely have
difficulty replacing cottonseed oil in the domestic potato chip frying market,
where cottonseed oil is deemed a premium oil because of its flavor-enhancing
attributes and high cooking temperature. And rising imports of substitute oils
will likely hinder significant growth in use of soybean oil. Olive oil imports
(from Italy, for example) have been rising rapidly in recent years as consumer
demand has led to more use in the salad and cooking oil market. Imports of
canola oil (from Canada) have also made significant inroads to this market.   

A continuing decline in per capita consumption of added fats and oils (and
associated declines in total use of fats and oils in the domestic manufacture
of edible products) is likely to reduce the growth potential of soybean oil in
added fats and oils products. This potential slowing of domestic use is
accompanied by forecasts for record levels of domestic soybean crush and
soybean oil production. The greatest potential for growth is export markets,
barring a sharp turnaround in domestic use of U.S. soybean oil. (Manufacturers
have recently added modest amounts of fat to some products following a mild
consumer backlash to "low-fat" foods. Also, there is some potential gain from
the recent market introduction of the fat-based fat substitute, olestra.)
Should per capita declines in domestic consumption of fats and oils continue,
oilseed producers could see farm prices for their products drop.  

The principal source of data on consumption of added fats and oils in the U.S.
is the Department of Commerce's Bureau of Census report, M20K Fats and Oils,
Production, Consumption and Stocks. This report details the quantities of added
fats and oils used in the domestic manufacture of edible products, such as
salad and cooking oil, baking and frying fat, margarine, and other edible use.
ERS calculates per capita domestic disappearance of added fats and oils by
adjusting for trade and changes in stocks.
Scott Sanford (202) 694-5309
ssanford@econ.ag.gov
An article in an upcoming issue of Food Review will explain changes in U.S. fat
consumption in more detail. 


RESOURCES & ENVIRONMENT

Exploring Methods of Selecting Cropland for Conservation

In the operation of conservation and environmental programs, environmental
targeting is a practice that has been increasingly used to improve program
performance. Environmental targeting directs program resources to lands where
the greatest environmental benefit will be generated for a given expenditure.
The objective of environmental targeting is to make the most efficient use of
tax dollars allocated to a particular program. 

Over half of the $3.2 billion USDA spent on conservation and environmental
programs in 1996 was allocated to the Conservation Reserve Program (CRP), which
is the largest natural resource conservation program currently operating in the
U.S. Since 1991, the CRP has used an environmental targeting mechanism known as
the environmental benefits index (EBI) for ranking and selecting offers of
cropland to include in the program. 

The CRP offers annual rental payments and cost-share assistance to farmers in
exchange for the establishment of long-term resource-conserving covers usually
grass or trees on highly erodible and other environmentally sensitive cropland.
Conversion of these lands reduces erosion and improves wildlife habitat, water
quality, and air quality. Presently, approximately 30 million acres of cropland
are enrolled under 10- or 15-year CRP contracts. 

Enrolling millions of acres under the CRP has wide-ranging effects on
government expenditures, air quality, water quality, and wildlife habitat, and
can affect agricultural income and food costs. But benefits from the
CRP improvements in environmental quality and the resulting gains in human
welfare depend on the type and location of the land that is enrolled. Until
1990, contracts for most CRP acres were selected based on their potential to
reduce soil erosion. But with the environmental benefits index, the ranking of
CRP offers can be based on a broader set of environmental criteria (AO October
1997). 

The EBI scores candidate land parcels based on a wide array of environmental
attributes (such as the potential to enhance water quality) as well as program
cost factors. In developing the EBI, USDA and other Federal agencies translated
the legislative intent of the CRP into factors representing categories of
environmental attributes that were considered important, and a point-scoring
system was devised to reflect their relative importance. Each of the factors
relies on observable characteristics that can be associated with a parcel of
land when a farmer's offers is evaluated. At the close of a CRP signup period,
candidate parcels with the highest EBI score are given priority for acceptance
into the program. 

In the 15th signup (March 1997), the scoring system was as follows:

     o  three factors--wildlife habitat, water quality, and erodibility--were
        given equal weights of up to 100 points each; 
     o  another factor, the likelihood of retaining environmental benefits of
        certain practices (such as tree cover) after contracts expire, was given a
        weight of up to 50 points; and 
     o  two factors--air quality and conservation priority areas--were given
        weights of up to 25 points each.

A seventh criterion, contract cost, is also considered. While the weight may
change from signup to signup, it was weighted at 200 points in the 15th signup. 

The EBI is a dynamic process, and its factors and relative weights have been
periodically adjusted and improved based on evolving priorities and any
perceived deficiencies. The construction of the EBI presently relies on the
judgments of natural resource experts and program managers. USDA believes this
is the best approach currently available for developing a CRP ranking method
because comprehensive and consistent monetary benefit estimates needed for
targeting land on a parcel-by-parcel basis do not exist. If disaggregate
monetized benefit estimates could be developed to reflect social values for
environmental improvement, these estimates could be used to directly select CRP
acreage. Such estimates could also be used to compare alternative ranking and
selection methods, such as different EBI weighting approaches, informing the
process of CRP targeting while recognizing that cost efficiency may not be the
only goal in enrolling cropland. 

USDA's Economic Research Service is taking some promising steps toward
developing a method that could eventually assist in the selection of CRP
enrollment, using estimates of the monetary value of environmental benefits
associated with different land parcels. Using economic valuation techniques,
and data on recreation, ERS researchers have demonstrated that it is possible
to derive estimates of disaggregated recreational use values to measure and
reflect social preferences (essentially, the public's willingness to pay for a
particular environmental impact). Such monetized value estimates could be
considered for providing additional or alternative input for targeting of CRP
acreage, and might also assist targeting efforts in other USDA conservation and
environmental programs.

Selecting Land for Conservation

Conceptually, using economic valuation techniques to target land for enrollment
is simple. The potential benefits of land enrollment would be measured in
monetary terms. Given a complete set of benefits and retirement costs for each
land parcel, the parcels would be selected for enrollment on the basis of which
ones provide the greatest net benefits. Several alternative EBI scoring systems
could be constructed to generate hypothetical CRP distributions, and the
scoring system yielding the greatest benefits could be adopted.

Presently, the complete set of benefits needed for such an evaluation has not
been determined. For example, the CRP affects a number of "use values" (values
people derive from using the resource) for such elements as surface and ground
water quality, air quality, outdoor recreation, and the maintenance of public
works. In some cases, avoidance costs such as the cost of using bottled
drinking water due to impaired water quality, and the cost of dredging canals
and rivers as a result of erosion have been used to estimate some of the
benefits of environmental programs in the past

In other cases, such as recreation, the cost-avoidance approach is not
applicable. Determining the recreation benefits associated with improvements in
the environment involves nonmarket valuation models, which allow the dollar
value of these benefits to be estimated based on observed behavior e.g., money
spent by users of a lake for recreation. In any case, benefit estimates
associated with small, localized land areas are required in order to
effectively target lands for retirement. This requires models based on
individual human preferences.

A number of "non-use" values are also affected by the CRP, such as the value
people place on knowing that wildlife populations are increasing. These values
are more difficult to assess and involve the use of contingent valuation
methods in which people are asked to designate a monetary value for a
particular benefit. Presently, little is known about the magnitude of these
types of benefits or even whether they are sensitive to the location of CRP
lands.

As a way of demonstrating the potential for environmental targeting based on
monetized value estimates, ERS focused on measuring the values the public
places on the enhanced recreational benefits that result from the CRP.
Recreational activities are often associated with environmental amenities. For
example, improved water quality leads to increased enjoyment of water-based
recreation activities, and improved species habitat results in better hunting
and wildlife-viewing opportunities. Although there are many CRP benefits in
addition to outdoor recreation, recreational activities are highly valued.
Recreation also provides a useful demonstration of a valuation approach because
it involves market-based costs such as travel, so that preferences can be
interpreted in dollar-based terms.

New data and improved methodology have permitted a refinement in the estimation
of recreation use values. Although this is only a partial accounting of CRP
use-value benefits, the results can demonstrate how economic valuation
techniques would work in measuring the benefits of land retirement under the
CRP and in developing more refined targeting measures. 

Recent ERS analysis has focused on three specific recreational activities that
are considered to be heavily influenced by the CRP: water-based recreation,
wildlife viewing, and pheasant hunting (the pheasant population has apparently
seen significant expansion as a result of habitat benefits resulting from the
CRP). The economic models employed in the analysis are based on recreation use
behavior at the individual level, as well as on improved measures of landscape
diversity and economic and statistical estimation techniques. 

A link is assumed between the physical effects of the CRP and what
recreationists value. For example, measures of the distribution of land types
in an area (such as the percent of land in transitional wetlands) are used as
indicators of the overall abundance of wildlife viewing opportunities.

The recreation data were gathered from surveys asking the type, frequency, and
location of outdoor recreational activities, including the distances
respondents were willing to travel to participate in these activities. The
distances (presumably involving travel costs) in effect served as a proxy for
prices that respondents were willing to pay for recreational benefits of the
CRP. Use values for the specific recreational activities were derived from
these data. 

The models for each of the three recreation activities were estimated from a
baseline CRP land distribution observed in 1992, the year much of the survey
data were collected. The first step in the analysis was to determine the
benefits of the CRP at that time  the contributions added by CRP vegetative
cover to the use value of the three recreational activities. 

Once the benefits of a baseline distribution are established, alternative EBI
formulations can be constructed and assessed by comparing their benefits to the
baseline's. Assessing an EBI formulation involves generating a hypothetical CRP
distribution based on the criteria of the candidate EBI and then determining
the benefits associated with the hypothetical distribution. 

To generate a hypothetical CRP distribution, ERS used the EBI scoring criteria
from the 15th CRP enrollment (1997), as well as information from USDA's 1992
National Resource Inventory data. To make the results consistent with the
baseline distribution, total acres were restricted to 34.04 million, with no
more than 25 percent of the cropland in any county included in the hypothetical
distribution. The results represent estimates of the recreation benefits of a
distribution of land different from that of the actual 15th signup. A number of
assumptions about what tracts of land would be offered, and especially about
the cover types that would be adopted, leads to a different distribution of
land than actually occurred in the 15th signup. 

In the context of this exploratory analysis, which is limited to recreation
benefits and is used to illustrate value-based targeting, observation of both
the baseline distribution and the hypothetical redistribution would indicate
several things about the recreation benefits of the CRP. Across the three
recreation activities considered, wildlife viewing accounts for the largest
share of benefits, followed by pheasant hunting and water-based recreation.
Across regions, the more densely populated North Eastern region contains a
large share of the total benefits, followed by the Plains, the South Eastern,
and the Pacific/Mountain regions. (These regions do not coincide with USDA's
farm production regions.)

In this exploratory analysis, population density plays an important role in the
distribution of recreational benefits within these regions larger benefits are
usually found where CRP lands and population centers intersect, because the
values being measured are use values. In general, the closer a recreational
resource is to a populated area, the more it will be used, resulting in a
higher value. On the other hand, land near population centers typically costs
more to enroll than land in less populated areas, affecting the net benefits of
enrollment.

In the hypothetical redistribution, water-based recreation benefits and
wildlife-viewing benefits in all of the regions increase substantially over
those in the 1992 baseline distribution Even in regions that would lose CRP
overall, the recreation benefits associated with these two activities
increases. This suggests that the EBI of the actual 15th CRP signup more
efficiently allocates acreage in terms of the recreation benefits associated
with these activities compared with earlier CRP enrollments.

The redistribution shifts CRP acres somewhat from west to east. And since most
pheasant hunting occurs in areas that lose CRP under the hypothetical
distribution, the pheasant hunting benefits decline slightly from the baseline.
However, the model does not take differing types of cover into account, which
may affect these results.

If this analysis were being used in an actual application of value-based
targeting of CRP land, the results suggest greater value for wildlife than
water-based recreation in a future EBI, since the wildlife viewing benefits
appear to be greater than the water-based recreation benefits. In addition,
these results might indicate a somewhat greater role for human population
density in future CRP targeting, since this is an important factor in
recreation use values. 

These results are, of course, exploratory and are based solely on use values
associated with three recreational activities. Nevertheless, these findings on
recreation benefits illustrate how economic valuation techniques could
eventually contribute to the development of more refined scoring criteria.
Several alternative scoring systems could be constructed and could be used to
generate hypothetical CRP distributions, and the scoring system yielding the
largest benefits could be adopted for a particular signup.

Extensive work would be required before alternative EBI formulations could be
compared and before acreage could be enrolled based on monetized measures of
benefits. In addition to the three recreational benefits described in this
article, all other benefits affected by the location as well as by the
characteristics of CRP land would need to be determined. Among these benefits
are: 

     The remaining recreational use values significantly affected by the CRP.
This requires analyzing additional new data on recreation and improving the
understanding of ecological processes associated with the CRP, such as changes
in animal populations.
     The impact on public works and industrial operations as sediment loadings
are reduced. Updates to engineering and other physical models can address these
issues.
     The value of improved air quality. This would require better models of
wind erosion, and new estimates of the health and other impacts of airborne
sediments.
     A measure of public willingness to pay for the CRP's improvements in
ecosystems, including the preservation of endangered species, wetland
protection and enhancement, and landscape amenities associated with the CRP.
This requires the development and use of contingent valuation models which,
while suffering from a host of biases and criticisms and involving an extensive
commitment of resources, is the only method available to determine these
values.
     The effect of the CRP on the quality of ground and surface water used for
drinking. Studies examining the willingness to pay for cleaner drinking water
already exist. To use these estimates, data are needed, for example, on the
CRP's impact on groundwater pollutants, which involves the development of
national-level physical-biological models on the transport of pollutants from
the field to ground water.
Peter Feather (202) 694-5608, Daniel Hellerstein (202) 694-5613, and Leroy
Hansen (202) 694-5612 
pfeather@econ.ag.gov
danielh@econ.ag.gov
lhansen@econ.ag.gov  


SPECIAL ARTICLE

Regional Trade Agreements & U.S. Agriculture 

Regional trade agreements (RTA's) have become a fixture in the global trade
arena, and their role in world trade is increasing. Defined as agreements
between separate economies to reduce trade barriers between members, RTA's have
been established in every region of the world. Over the period 1947-1994, 109
regional trade agreements were reported to the General Agreement on Tariffs and
Trade (GATT), the multilateral body charged with oversight of global rules
governing trade. Since 1995, at least 16 new RTA's have been reported to the
World Trade Organization (WTO), the successor body to the GATT. 

Nearly all WTO members are party to at least one RTA. In the Western
Hemisphere, about 40 regional trade pacts are currently in force, and at least
a dozen others are under negotiation. Moreover, RTA's formed over the last
decade are more comprehensive in their treatment of agriculture compared with
earlier RTA's, many of which excluded agriculture.

Another relatively new development is the effort to negotiate trade pacts that
include existing RTA's as well as individual countries. While not technically
RTA's, which are reported to the WTO, these free trade networks are likely to
become a key force in reconciling and building on the proliferation of RTA's. 

An example of such a network is the Asia Pacific Economic Cooperation (APEC)
forum, a free trade initiative encompassing 21 economies, including the U.S.,
Japan, and China. Members of APEC include economies in the North American Free
Trade Agreement (NAFTA), the ASEAN Free Trade Area (AFTA) of Southeast Asia,
and the Australia-New Zealand Closer Economic Relations (CER). APEC is
committed to achieving free regional trade in all sectors, including
agriculture, by 2020. Among the challenges will be to reconcile the AFTA
agreement, which excludes bulk agricultural products (e.g., grains, oilseeds),
with NAFTA and CER, both of which free almost all internal agricultural trade. 

The U.S. is an active participant in regional trade pacts and networks. In
1989, the U.S. and Canada formed the U.S.-Canada Free Trade Agreement (FTA),
which specified a 10-year phase-out of bilateral tariffs on most products,
including most agricultural commodities. In 1994, the framework was extended to
include Mexico in NAFTA. Since 1989 the U.S. has participated in APEC and has
trade initiatives in the Caribbean Basin and with Israel. 

Most of the major RTA's formed in recent years have internally liberalized most
agricultural trade. In the Western Hemisphere, NAFTA and MERCOSUR (Common
Market of the South), have removed nearly all agricultural trade barriers to
their members, or, like APEC, have a specified time frame for their
elimination. Notable exceptions among commodities are sugar, dairy, poultry,
and eggs in the bilateral pacts within NAFTA, and sugar in MERCOSUR. The
European Union (EU) has gone furthest in economic integration among its
members fully liberalizing internal agricultural trade and adopting a common
farm support program, the Common Agricultural Policy (CAP). 

A potential major regional trade agreement is the proposed Free Trade Area of
the Americas (FTAA). The goal is to encompass most countries of the Western
Hemisphere and to fold the hemisphere's many trade agreements into one
comprehensive trade bloc.

Pros & Cons of RTA's

Regional trade agreements have generated intense debate. Advocates emphasize
their trade-creating effects. By providing for freer trade among members, RTA's
can improve resource allocation within a region. With regional free trade,
production shifts toward the most efficient producers of specific commodities
within the RTA, and consumers are better off because they can purchase goods at
lower prices. 

But opponents of RTA's argue that most agreements generate a degree of trade
discrimination by lowering barriers on internal trade while retaining barriers
to trade with nonmembers,. A likely result is that the RTA's will be
trade-diverting, increasing trade among member countries while diverting it
from more efficient, lower cost producers in the rest of the world. Even if an
RTA results in internal trade creation, such gains, some critics maintain, are
likely to be outweighed by their trade-diverting effects. 

A second issue raised by RTA's is their effect on the global trading system,
and especially on multilateral trade negotiations. The current proliferation of
RTA's has occurred simultaneously with successful global trade negotiations,
which were concluded in 1993 under the GATT, and have continued in a series of
"mini-rounds" addressing specific sectors, including telecommunications and
services. A WTO mini-round of trade liberalization talks on agriculture is
scheduled to begin in 1999. 

Advocates of RTA's argue that recent regional trade agreements are likely to
serve as building blocks for further multilateral trade liberalization in the
WTO. This is because many recent RTA's, including NAFTA and MERCOSUR, have
moved at a faster pace than the multilateral negotiations in liberalizing trade
rules, particularly for agriculture. These smaller, regional negotiating groups
may also be more effective than a large, global body in tackling difficult or
complex issues such as sanitary and phytosanitary trade restraints. 

Critics of RTA's contend that the agreements are more likely to act as
stumbling blocks to multilateral trade liberalization. According to this line
of reasoning, RTA's are more likely to create and entrench protectionist
interests that benefit from trade diversion, and such RTA's may become
"fortresses" with an interest in slowing or derailing multilateral trade
negotiations. Furthermore, the current proliferation of RTA's has resulted in a
bewildering "spaghetti bowl" of crisscrossing bilateral tariff rates and
complicated rules of origin governing the transshipment of nonmembers' products
through member countries. This leads to substantial administrative
inefficiencies, and perhaps to disguised import protection resulting from
complex provisions on domestic content of products. 

RTA's & U.S. Agriculture

How are RTA's likely to affect U.S. agricultural production, trade, and support
programs? 

First, U.S. agriculture can gain from U.S. participation in RTA's. By lowering
trade barriers among members, the major RTA's in which the U.S.
participates NAFTA, APEC, and potentially the FTAA are expected to benefit U.S.
agriculture. Increased agricultural trade and specialization among RTA partners
will increase the efficiency of U.S. farm producers and lower prices for
consumers, although this will lead to some adjustment and change in U.S.
agriculture as some sectors gain through increased foreign sales and some lose
domestic market share to imports. RTA membership is expected to improve U.S.
international terms of trade in agriculture, with an increase in U.S. farm
export prices relative to import prices as relatively high tariff barriers of
some U.S. trade partners are reduced or eliminated.

U.S. agriculture can lose when RTA's do not include the U.S. RTA's generally
divert trade by lowering imports from the rest of the world as trade with
partners increases. Expansion of the European Union (EU) is likely to divert
agricultural trade and reduce U.S. agricultural exports to the EU and to third
markets. But the farm subsidies under the current CAP program are probably
unsustainable with EU expansion, and potential EU farm program reforms to limit
subsidies would limit these negative impacts on the U.S. 

In the case of the FTAA, the U.S. has the option of joining; a U.S. decision to
remain outside the FTAA would divert trade from U.S. agriculture. However, many
expect RTA's to induce economic growth in the developing countries of the
Western Hemisphere, and if this trade-linked growth occurs as a result of the
FTAA, then the U.S. is expected to benefit, even as a nonmember. Economic
growth in the region would stimulate Latin American agricultural trade with the
U.S., although this trade effect would be larger if the U.S. were party to the
FTAA. 

Agriculture is the source of most U.S. gains from RTA's. Gains from trade
liberalization are roughly proportionate to the size of the trade barriers
being reduced or dismantled in a trade agreement. Because agriculture still
faces relatively high trade barriers in world markets, it stands to gain
relatively more than many other sectors from U.S. inclusion in trade
agreements.    Agriculture accounts for 75 percent of the total expected U.S.
benefits from APEC participation. With or without U.S. participation in the
hemisphere-wide FTAA, U.S. agricultural trade will increase more than for other
sectors. In the case of EU expansion, U.S. agriculture will be affected more
than other sectors, but the effects will be negative, while effects on U.S.
manufacturing will be positive as EU farm subsidies provide an incentive to
Central and Eastern Europe to shift resources toward agriculture. 

RTA's and domestic farm programs have mutual impacts. RTA's limit the ability
of member countries to maintain independent farm programs. Market arbitrage
within a free trade area will tend to unify prices, making members' efforts to
use farm support programs to maintain different price levels either ineffective
or costly. 

But the conversion of most U.S. farm support into decoupled contract payments,
with the market determining the prices farmers receive, is compatible with free
trade pacts. At the same time, the reduction in farm support and the increase
in farm-sector market orientation in many countries over the past decade have
diminished the inherent conflict between free trade and farm programs, making
RTA's more likely to include agriculture, and increasing the gains from RTA's.  

RTA's & Multilateralism: Peaceful Coexistence?

Are RTA's building blocks, stumbling blocks, or complements to multilateralism?

Economywide, trade-creating effects dominate in major RTA's, enhancing world
welfare. 

Concern over the size of the trade-diverting impacts of RTA's has been a
frequent argument against regionalism. USDA analysis of the longrun impacts of
four major RTA's (NAFTA, APEC, FTAA, and an expanded EU) indicate that their
economy-wide trade diversion effects are likely to be smaller than trade
creation effects. Because they are expected to be net trade-creating, these
RTA's will improve global welfare. These findings suggest that the RTA's will
fulfill the intent of the GATT/WTO rules that permit RTA's: their gains from
liberalizing internal trade at a pace faster than committed to in the Uruguay
Round will outweigh the negative impacts that result from their discrimination
against nonmembers. The WTO specifies that the purpose of a regional trade
agreement be to facilitate trade among the signatory countries  not to raise
barriers to trade with WTO members that are not parties to the regional
agreement. 

In agriculture, RTA's have both trade-creating and trade-diverting effects, but
trade creation dominates in most RTA's. To date, empirical evidence shows that
the U.S.-Canada FTA, MERCOSUR, and the Australia-New Zealand CER have led to
increased agricultural trade both with partners and with nonmembers, supporting
the view that RTA's can unleash growth in trade that benefits members and
nonmembers alike. When fully implemented, NAFTA, APEC, and the FTAA are
expected to be net trade creating for agriculture. 

Only the EU, with its generous agricultural subsidies, has so far resulted in
net agricultural trade diversion. Its expansion to include Central and East
European countries is also expected to be trade-diverting. While trade-creating
RTA's are likely to pursue more open markets at multilateral talks,
trade-diverting RTA's are less likely to do so.

Regionalism and multilateralism are likely to be mutually reinforcing. An
effective multilateral process has already proved to be an important influence
on the agricultural trade liberalization achieved in some regional agreements.
In the future, multilateral commitments to reduce protection and support in
agriculture could be pivotal in influencing the pace of regional agricultural
trade liberalization as well as the directions to be taken by APEC, FTAA and an
expanded EU on farm policy reforms. In turn, the freer agricultural trade
already achieved in the Western Hemisphere and committed to in APEC is likely
to strengthen efforts to achieve freer trade at the upcoming mini-round. 

Should the U.S. pursue regionalism, multilateralism, or both? 

Progress in the multilateral talks on reducing barriers to agricultural trade
could reinforce RTA commitments to liberalize agricultural trade. While some
newer RTA's have defined a time frame for liberalizing substantially all
agricultural trade (NAFTA, MERCOSUR), specific reduction commitments have not
been fully defined in APEC, and the treatment of agriculture in the FTAA is
still to be negotiated. Another shortcoming of some RTA's is selective trade
liberalization, singling out certain sectors for exclusion, which makes the
trade-diverting effects of RTA's more likely to dominate. 

A strong multilateral process can help minimize the negative aspects of RTA's.
USDA analyses find that most RTA's have trade-diverting impacts in agriculture,
although they are smaller than the trade-creating effects. Among the examples
of RTA protectionist practices are the EU's closed membership and the adoption
by members of common, trade-distorting internal policies; AFTA's exclusion of
bulk agricultural commodities; and the adoption by the Andean Pact and Central
America Common Market (CACM) of common external tariffs that "escalate" or
increase with the level of processing. 

A strong multilateral process that effectively disciplines the practices that
lead to trade diversion can help minimize the negative aspects of RTA's. Such a
process can also make it more likely that RTA's will evolve as trade-creating
agreements. 

The U.S., as a global trader with diverse trade partners, can gain potentially
more from global free trade than from RTA's. But so far, multilateral talks
have fallen far short of achieving free trade, and the gains to the U.S. from
the deeper commitments made by RTA's are expected to exceed those from the
Uruguay Round. The influence of RTA's on the multilateral process is still
uncertain, and they have the potential to harm nonmembers. But because RTA's
and multilateralism can provide significant, mutually reinforcing influences,
their joint pursuit can benefit U.S. agriculture.
Mary E. Burfisher (202) 694-5268
Elizabeth Jones (202) 694-5149
burfisher@econ.ag.gov
eajones@econ.ag.gov  

This article draws from Mary Burfisher and Elizabeth Jones, eds., "Regional
Trade Agreements and U.S. Agriculture," forthcoming AER, ERS/USDA.

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