AGRICULTURAL OUTLOOK
January/February 2002
AGO-288

CONTENTS

IN THIS ISSUE 

AG ECONOMY
Slow World Growth & U.S. Recession Leave Mixed Picture for Farm & Rural 
Economy

BRIEFS
U.S. Sheep Industry Continues to Consolidate

COMMODITY SPOTLIGHT
Tobacco Industry Continues Long-Term Downsizing

WORLD AG & TRADE
How U.S. Farm Policy Meshes with World Trade Commitments
Pressures for Change in Eastern Europe's Livestock Sectors 

FOOD & MARKETING
Traceability for Food Marketing & Safety: What's the Next Step?

SPECIAL ARTICLE
Public Sector Plant Breeding in a Privatizing World


IN THIS ISSUE

How U.S. Farm Policy Meshes With World Trade Commitments

The U.S. and other countries made commitments in 1994 under the Uruguay 
Round Agreement on Agriculture (URAA) to reduce the total amount of trade-
distorting domestic subsidies provided to producers, to reduce export 
subsidies, and to increase import access to domestic markets. Thus far, the 
U.S. has been able to comply with its URAA commitments and still provide 
significant income support to producers. But surges in direct payments to 
producers after 1997 in response to low market prices have caused domestic 
subsidy levels to approach the U.S. ceiling commitment. U.S. support is 
expected to remain below its ceiling under current farm programs, but 
increases in support under new programs, if not carefully crafted to utilize 
exemptions, could present a problem for compliance with the URAA 
commitments. 
Frederick J. Nelson (202) 694-5326;  fjnelson@ers.usda.gov

Public-Sector Plant Breeding In a Privatizing World

Since 1970, the balance between public and private plant breeding activity 
in industrialized countries has shifted from the public to the private 
sector. Traditionally, the private sector has relied on public-sector 
research results. Today this is no longer the case. Presently the public 
sector instead may utilize private-sector research results in some areas of 
biotechnology. Funding mechanisms, as well as institutional cooperation and 
competition in plant breeding, are often quite complex. This has led to 
considerable discussion of the appropriate roles for public- and private-
sector activity. However, it is clear that public-sector plant breeding will 
yield the largest social returns if it continues to focus on research 
directed at carefully identified problem areas, with clear public goods 
components. Paul W. Heisey (202) 693-5526; Pheisey@ers.usda.gov 

Slow World Growth & U.S. Recession Leave Mixed Picture for Farm & Rural 
Economy

By November 2001 it was official. The U.S. economy was in recessionand had 
been since March. The recession ended a decade-long expansion, the most 
durable on record. World economic growth--both in 2001 and 2002--is expected 
to be sluggish, posting the lowest back-to-back growth rates since the world 
debt crisis of 1981-82. David Torgerson (202) 694-5334; dtorg@ers.usda.gov 
 
Traceability for Food Marketing & Safety: What's the Next Step?  

Traceability systems are recordkeeping systems that are primarily used to 
help keep foods with different attributes separate from one another. When 
information about a particular attribute of a food product is systematically 
recorded from creation through marketing, traceability for that attribute is 
established. Food suppliers and government have several motives for 
documenting the flow of food and food products through production and 
distribution channels--and a number of reasons for differentiating types of 
foods by characteristics and source. However, the area where traceability 
seems to be getting the most attention lately--government-mandated tracking 
of genetically engineered crops and food--is not among the practical or 
efficient uses of traceability. Recently, the European Union (EU) proposed 
government-mandated traceability for genetically engineered crops and foods 
to help distinguish them from their conventional counterparts. Elise Golan 
(202) 694-5424; egolan@ers.usda.gov 

Pressures for Change in Eastern Europe's Livestock Sectors

Twelve years after the fall of Communism in Central and Eastern Europe 
(CEE), the meat and dairy processing sectors of the CEE countries are 
undergoing a rapid process of concentration and modernization. The process 
is most evident in Poland and Hungary, but similar trends can be observed in 
all the CEE countries. This restructuring has been accelerated by the 
pending CEE accession to the European Union (EU), both because of pressure 
to meet EU sanitary standards and because of assistance provided by the EU 
to the food processing industry. Nancy Cochrane (202) 694-5143; 
cochrane@ers.usda.gov

Tobacco Industry Continues Long-Term Downsizing

A recent dramatic shift from auctioning to contract selling in the tobacco 
market is changing the character of the industry. By contracting directly 
with leaf producers, cigarette manufacturers have more influence over which 
qualities of leaf are available. In addition, already-existing restrictions 
on smoking areas and advertising and the growing consciousness of the health 
risks of smoking are having a long-term effect on the industry. Thomas 
Capehart (202) 694-5311; thomasc@ers.usda.gov

U.S. Sheep Industry Continues to Consolidate

The U.S. sheep industry continues a long decline marked by shrinkage in 
inventories, prices, and revenues. The industry also bears the brunt of 
heightened concerns about sheep-borne animal diseases, as well as 
recent removal of a tariff-rate quota (TRQ) on imported lamb meat from 
Australia and New Zealand. And while 5 years have passed since the 3-
year phaseout of the National Wool Act, the industry still feels the 
loss of the Act's price support programs. However, there are several 
positive currents: domestic lamb and mutton consumption has held fairly 
steady for the past decade, while production in major lamb exporting 
countries is on the decline. Keithly Jones (202) 694-5172; 
kjones@ers.usda.gov


AG ECONOMY
Slow World Growth & U.S. Recession Leave Mixed Picture for Farm & Rural 
Economy

By November 2001 it was official. The U.S. economy was in recession--and had 
been since March. The recession ended a decade-long expansion, the most 
durable on record.  World economic growth--both in 2001 and 2002--is 
expected to be sluggish, posting the lowest back-to-back growth rates since 
the world debt crisis of 1981-82.  

With a larger percentage of jobs lost in nonmetro counties relative to metro 
counties, the U.S. and global economic slump appears to have had a 
disproportionately negative impact on the rural economy.  In the coming 
year, though, the combined world and domestic recessions will have mixed 
effects on farm operations. On the one hand, the world recession and strong 
dollar will dampen growth of agricultural exports, putting downward pressure 
on farm prices.  At the same time, flat wages, lower interest rates, 
declining fertilizer prices, and negligible input price inflation will cut 
2002 farm expenses relative to 2001.  For farm households, the overall 
impact will be mixed, with net farm income up but off-farm income down due 
to the soft economy.

The National Bureau of Economic Research (NBER) declared on November 26, 
2001 that the U.S. economy was officially in recession.  According to the 
NBER, an academic non-profit organization, "A recession is a significant 
decline in activity spread across the economy, lasting more than a few 
months, visible in industrial production, employment, real income, and 
wholesale-retail trade [indicators]."   The NBER noted that before the 
attacks of September 11 the decline in the economy might have been too mild 
to qualify as a recession, but the attacks may have been a key factor 
pushing the economy into a recession.

The four monthly indicators used by NBER to determine the starting month of 
a recession--industrial production, wholesale-retail trade, personal income, 
and employment--did not point unambiguously to a specific beginning date for 
the recession.  Based on industrial production (an indicator of 
manufacturing activity) and wholesale-retail trade alone, for example, the 
recession would have started as early as the Fall of 2000. Partly as a 
result of the 2001 tax rebate, though, real personal income actually 
continues to grow as of late 2001. But overall weakness in the service 
sector in early 2001 and employment data--often considered the single best 
indicator of overall economic activity--led the NBER to conclude that the 
recession started in March of 2001. 

The U.S. recession occurred despite an accommodative monetary policy by the 
Federal Reserve Board beginning in December 2000, but lower short-term 
interest rates could not overcome a slump in investment spending on business 
plant and equipment as financial intermediaries continued to tighten credit 
conditions.  Nor did reduced short-term rates buoy sluggish retail sales.  
Normally, a sharp drop in short-term interest rates generates a noticeable 
drop in long-term interest rates, which can help stimulate investment.  But 
as of early November 2001, a 4 percentage-point drop in the Federal funds 
rate--the overnight rate at which banks lend each other money--generated 
only a 0.66 percentage-point drop in long-term AAA corporate bond rates.

During an economic expansion, imbalances inevitably develop that set the 
stage for the next recession. With the benefit of hindsight it is possible 
to locate the excesses, but predicting when a recession will start and how 
long it will last is next to impossible. In any event, few economists 
believed that the U.S. economy could maintain the annual growth rates of 4 
percent or above that occurred during 1996-2000.  

In retrospect, excesses were most evident in the technology sector. Fueled 
by expansion of business Internet use, home computing, and dramatic growth 
in the use of mobile cell phones, the new technology revolution did enhance 
productivity growth, but household and business demand for high-tech 
equipment eventually reached the saturation point.  The technology bubble 
was the first to burst after technology company earnings growth peaked in 
early 2000.

The collapse of the technology sector inaugurated the first of three stages 
(broad economic developments) that eventually led to a full-fledged U.S. 
recession.  In the first stage, collapse of the technology sector quickly 
reverberated through the financial markets, wholesale trade, and 
manufacturing sectors.  In stage two, increasing energy prices combined with 
tighter credit and falling U.S. exports to cause a drop in manufacturing 
profits, output, and jobs.  The third stage was the spread of the recession 
in the manufacturing sector to the larger services sector, making the 
downturn economywide.

Financial Markets Hit by Falling Technology 
Sector Profits & Employment (Stage 1)

In early March 2000, the technology-laden NASDAQ stock index had soared 
above 5,000, about double the level of just a year earlier.  By the end of 
2000, however, the NASDAQ gains had evaporated, and the index dipped below 
2,500. 

The NASDAQ had been bid up as the technology companies that dominate the 
index saw earnings and sales growth boom following double-digit growth rates 
in equipment and software investment during the late 1990s.  The investment 
was driven largely by nontechnology companies exploiting the cost-saving 
potential of the Internet and the personal computer, and by the expansion of 
the world telecommunications network.  

Despite the NASDAQ plunge, overall demand for computer-based office 
equipment in 2000 was strong, and output during the year actually grew.  But 
price cuts were required to keep sales volume up, so earnings declined, and 
by the fourth quarter, employment in the technology sector also shrank.  So, 
in contrast to the earnings growth they enjoyed through the late 1990s, many 
Internet backbone companies began to suffer deteriorating balance sheets and 
employee layoffs.  New technology companies with growth prospects predicated 
on rapidly increasing computer or telecommunications sales, or on other 
unrealistic assumptions, went bankrupt, causing further layoffs. The prices 
of those high-technology stocks that dominate the NASDAQ index then fell as 
the technology bubble burst, with the new lower stock prices reflecting more 
reasonable potential long-term sales and earnings prospects. 

The financial markets were not reacting negatively just to exigencies 
experienced by dot com and new technology companies. Electronic equipment 
manufacturers, for example, had an unexpected drop in operating income of 
over $3 billion in the last quarter of 2000, despite increasing sales 
volume, and employment in that sector dropped in 4 of the last 5 months of 
2000. Starting in late 2000, declining profit margins and the beginning of 
widespread technology company layoffs contributed to a tightening of credit 
conditions as loan standards were raised and the spread between corporate 
bonds and U.S. Treasury bonds widened.

By usual standards, the enormous drop in household wealth caused by stock 
market losses could well have been large enough to trigger a recession as 
early as mid-2000, especially given other weaknesses then present in the 
economy (as in the housing, and car and truck markets).  The wealthiest 10 
percent of the U.S. population ignored their large paper losses in the stock 
market, however, and instead used the trillion-dollar gain in the real 
estate market to finance new consumer spending in excess of household 
income. In addition, while technology and related manufacturing jobs were 
lost, other sectors of the U.S. economy continued to create jobs.

Manufacturing Output Recession 
Begins in Late 2000 (Stage 2)

A second catalyst to the recession was the runup of energy prices between 
1999 and the end of 2000.  Continued overall strength in the U.S. and Asian 
economies along with substantial drops in oil production among OPEC and 
foreign non-OPEC oil producers combined to cause a more than doubling of 
wholesale energy prices.  The price of wellhead natural gas more than 
quadruped between early 1999 and the end of 2000, reflecting both continuing 
strength in U.S. industrial demand during much of this period, and the 
increasing use of natural gas in electricity generation.  In some parts of 
the country, gasoline prices rose more than 70 percent. Rising crude oil 
prices and higher demand caused a shortage of refinery capacity in the 
Midwest, which caused higher than average gasoline price increases in that 
region. Sharp energy price increases hammered consumer and business budgets 
and, coupled with tighter credit conditions, slowed the adoption of new 
technologies for home and business use. This further lowered technology 
companies' profit margins, but the greatest impact was on more prosaic 
goods--output of textiles and domestically manufactured cars and trucks 
dropped far more sharply than new technology goods. 

Manufacturing employment drops in most years, driven by rapid productivity 
growth in auto and other mature industries. But the magnitude of the decline 
in manufacturing employment and the drop in industrial output in late 2000 
indicated a clear-cut manufacturing recession was underway. The drop in 
industrial production in October 2000 marked the start of a lasting slowdown 
in manufacturing.  In late 2000 and early 2001, the largest consecutive-
quarter employment drop since the 1990-91 recession confirmed that 
manufacturing was in bad shape. 

The bellwether "real manufacturing and trade sales" indicator declined in 3 
of the last 4 months of 2000, presaging a full-blown recession despite 
continued growth of retail sales.  The drop in wholesale and manufacturing 
sales was especially pronounced.  Manufacturing sales declined more than $10 
billion in the last quarter of 2000, driven largely by plummeting sales of 
machinery.

Although the technology-stock bull market collapsed through 2000 and 
technology-company earnings dropped, the boom in total equipment investment 
continued into early 2001.  This boom largely drew on imports and inventory 
depletion, however, and domestic production of electronic goods and 
equipment started to decline in January 2001.  

As general credit conditions tightened and it became increasingly difficult 
for medium and small businesses to obtain credit, demand for computer-based 
equipment and other business products finally fell.  This exacerbated the 
drop in the high technology-sector profits as the volume of technology 
product sales dropped despite lower prices. Worldwide demand for 
manufactured goods stagnated, resulting in lower corporate earnings for 
technology-using companies as well as technology-making companies, 
particularly since wage and energy costs had accelerated.  These factors in 
turn caused further weakness in the technology sector, pushing down the 
NASDAQ and the Dow stock indexes, and generating a second and third wave of 
technology layoffs. 

Manufacturing Recession Spreads 
To Rest of Economy (Stage 3)

By the end of the first quarter of 2001, the service sector could not 
generate enough new jobs to offset the increasing loss of U.S. manufacturing 
jobs.  The disappearance of a total of 165,000 jobs in March 2001 signaled 
the beginning of the U.S. recession.  As the third wave of technology and 
nontechnology manufacturing layoffs began and wholesale trade workers were 
added to the layoff lists, the drop in employment accelerated.  By late 
November, numbers for September 2001 showed continuing drops in industrial 
production, overall private nonfarm employment, and wholesale-retail trade.  
With no sign of an upturn, there was little doubt that the slowdown that 
started in March indeed qualified as a recession.  Although real consumer 
spending on manufactured goods was actually up in this 6-month period, it 
did not induce any new U.S. manufacturing output, as inventories were tapped 
and imports rose.  But real consumer spending on services was flat from 
March to September, quite consistent with a broad-based shrinkage in the 
domestic economy.   

World Growth Slows 
As Locomotives Falter 

World economic growth prospects depend to a large degree on the economic 
growth of the leading economies, the so-called locomotives.  During the 
1996-2000 period as a whole, the U.S. did help pull the world economy along, 
growing faster than the global average.  In fact, except for Canada, the 
U.S. had the fastest growth rate of all of the leading industrial "G-7" 
countries (U.S., Japan, Germany, France, the United Kingdom, Italy, and 
Canada) for each year of 1996-2000. However, as of the last half of 2001, 
the U.S. and Japan were both in recession; Germany contracted in the third 
quarter.  

Weakness of the world's three largest economies made world recession in 2001 
almost inevitable. With estimated world GDP growth just above 1 percent in 
2001, growth is considerably less than the 2.5 percent considered necessary 
by the International Monetary Fund (IMF) to keep the world out of recession. 
World growth below that rate causes key standard-of-living indicators, such 
as individual country unemployment rates, to deteriorate.

Contributing to the global slowdown was a general weakness in leading East 
Asian economies. Just as East Asia was helped out of the 1998 crisis by low 
oil prices, the region received a negative hit from the recent run-up in oil 
prices, in addition to a sharp drop in demand for parts by U.S. computer and 
telecommunications manufacturers.  Besides Japan, Taiwan and several other 
major customers of U.S. farm and manufactured goods exports were in 
recession by early 2001.  U.S. technology and manufacturing companies, 
facing weak bottom lines, were forced into major layoffs in Asian and 
European operations as well as in the U.S.  The result was lower demand for 
U.S. goods exports and a deepening of the worldwide manufacturing recession.

Concentration of the manufacturing recession in the technology sector 
contributed to a sharp slowdown in the economies of Asia, particularly in 
East Asia.  Japan's recession, coupled with the decline in U.S. computer 
equipment demand, resulted in a slowdown of Asian economic growth in 2001 
almost as sharp as in the Asian financial crisis during 1997-98.  U.S. 
exports to Asia in goods, such as machine tools, dropped, and by early 2001 
total U.S. machine production fell to less than half the level of early 
2000. 

A strong dollar exacerbated the recession in U.S. goods production.  The 
dollar had been expected to fall in value against the yen and the euro, but 
it appreciated instead in 2001. Japan, which had been expected to pick up in 
2001, went into a full recession, causing the yen to fall in value relative 
to the dollar.  Similarly, when European Union growth fell below 
expectations, the euro declined in value. This was largely because financial 
investment prospects appeared better in the U.S. The net result was a 5-
percent appreciation of the dollar in late 2001, a trend likely to only 
aggravate the already huge $500 billion U.S. trade deficit.  For the farm 
sector overall, slow economic growth and a strong dollar kept commodity 
prices relatively low. Some markets, such as the textile market, simply 
collapsed with sharp drops in the world price of cotton.

U.S. & World Growth 
Prospects for 2002 

A reflection of the potential depth of the domestic recession was the fall 
in U.S. industrial production by late 2001.  The industrial production 
index, a broad gauge index of output from U.S. factories, mines, and gas and 
electric utilities, fell for 14 months in a row (as of October 2001) for the 
first time since World War II.  The domestic industrial decline was 
concentrated in the high-technology sector as business computer equipment 
production dropped over 10 percent between November 2000 and October 2001.  

In the coming months, the strength of personal income growth, low energy 
prices, the lagged effects of loose Fed monetary policy, and the combined 
impact of a fiscal stimulus package and the 2001 tax cut are expected to 
bring the country out of recession.  This is expected to occur by Spring 
2002, with trend growth restored by late 2002.  The current Blue Chip 
consensus forecast of 1 percent U.S. GDP growth for 2002 reflects that 
outlook. 

The prospects for world economic growth in 2002 are likely to be driven by 
the three largest economies. The U.S. is expected to be back to further 
growth in 2002, but not to reach full throttle until late 2002.  Japan, the 
world's second-largest economy, is expected, by many private economists, to 
remain in recession in 2002 as problems in the banking system limit credit 
expansion for new business ventures. Germany is expected to grow less than 1 
percent in 2002, and the entire 12-country Euro zone to grow less than 2 
percent.  With these potential economic locomotives growing so slowly, 
overall world GDP growth in 2002 is expected, by most analysts, to be 
between 1 and 1.5 percent, still a recession by global standards.  Asia is 
forecasted to have GDP growth of less than 2 percent for 2001 and 2002.  Not 
since 1981 and 1982, when the world debt crisis began, have Asian and world 
growth been so sluggish for 2 consecutive years.

Outlook is Mixed 
For Rural Economy

The average rural household personal income has likely suffered more from 
the recession than the average household. The manufacturing slump, which 
started in late 2000 (at least 4 months before the start of the general 
recession), hurt the rural and farm economies more quickly and sharply than 
the economy as a whole, reflecting their dependence on the manufacturing 
sector for off-farm income.  Further, with the world recession expected to 
last longer than the U.S. recession, and with the dollar expected to remain 
relatively strong, the manufacturing sector is likely to recover less 
rapidly than the overall U.S. economy.  The gap between nonmetro and metro 
unemployment rates has already widened and is expected to widen further as 
manufacturing takes longer to recover fully than other sectors. 

The one bright prospect for most (non-energy producing) rural areas is that 
energy prices are expected to remain relatively low until at least the 
middle of next year. This should partly offset the impact of reduced income 
from overtime pay, an important component of rural income. 

Farm exports are projected up for fiscal 2002 but most farm commodity prices 
are weak. However, weak commodity prices in 2002 are likely to be partially 
offset by lower energy and fertilizer prices early in 2002, and those with 
ample storage facilities can probably obtain diesel fuel at very low prices 
for next year's farm operations, noticeably reducing expenses.  With 
wholesale natural gas prices close to the 1999 low, nitrogen-based 
fertilizer prices are expected to continue to drop sharply compared with 
2000. Combined fuel and fertilizer expenses, while not expected to drop 
below the low levels of 1999, should be down sharply from 2001.

Further news on the positive side is that farm interest rates, especially in 
the first half of 2002, should be quite favorable for those with good 
credit, significantly cutting farm interest expenses compared with 2000 and 
2001.  Farmers largely dependent on off-farm income will likely have a 
harder time getting loans and will likely face reduced hours or earnings for 
part-time off-farm employment.  But the going rate for farm labor will 
likely be lower in 2002 than in 2001; as the general rural job market 
deteriorates, fewer fringe benefits will be necessary to attract farm 
workers.  

David Torgerson (202) 694-5334; 
dtorg@ers.usda.gov 


LIVESTOCK BRIEF
U.S. Sheep Industry Continues to Consolidate

The U.S. sheep industry continues a long decline marked by shrinkage in 
inventories, prices, and revenues.  The industry also bears the brunt of 
heightened concerns about sheep-borne animal diseases, as well as recent 
removal of a tariff-rate quota (TRQ) on imported lamb meat from Australia 
and New Zealand. And while 5 years have passed since the 3-year phaseout of 
the National Wool Act, the industry still feels the loss of the Act's price 
support programs.  

However, there are several positive currents: domestic lamb and mutton 
consumption has held fairly steady for the past decade, while production in 
major lamb exporting countries is on the decline.  In addition, U.S. sheep 
producers recently received Federal funding for new marketing, promotion, 
and animal health improvement programs.

It is clear that the glory years for the U.S. sheep industry have passed.  
From a 1942 peak of 56 million head, the number of sheep in the U.S. shrank 
to 6.9 million head on January 1, 2001, 2 percent below the 2000 level, and 
will likely contract a further 2 percent in 2002.  The number of sheep 
operations is also declining, though at a slower rate than the sheep 
inventory.  Sheep operations totaling 66,000 in 2000 are expected to 
continue declining in 2001 and 2002.

Production, like inventory, is on a downswing.  For the first half of 2001, 
output of lamb and mutton was nearly 7 percent below a year earlier, even 
with dressed weights averaging 2 to 4 pounds heavier and with strong 
slaughter lamb prices averaging in the low $80s per cwt. Expectations of 
continued price strength had encouraged producers to keep lambs on feed 
longer, resulting in overfinished, less desirable market animals at higher-
than-normal dressed weights.  The result was rapidly declining prices. Lamb 
prices are however expected to recover in early 2002 when the problem of 
overweight lambs abates and when seasonal demand begins accelerating in 
midwinter.


The seasonal price change defied the usual pattern for lamb prices, which 
generally rise in spring due to increased lamb consumption during religious 
celebrations.  This year, high prices convinced producers to feed lambs to 
heavier weights, expecting strong prices to continue into the third quarter 
when production typically declines. But first quarter production was only 
6.3 percent below a year earlier, due largely to an average gain of 5 pounds 
above the normal dressed weight.  Dressed weights remained fairly high for 
the second, third, and fourth quarters of 2001, keeping production slightly 
ahead of a year ago. Despite slight spurs to lamb consumption during the 
Muslim holy month of Ramadan and the U.S. holiday season, price gains were 
negligible. 

Imports Spike
In the 1990s

Lamb and mutton imports have trended upward since the mid-1980s, with very 
sharp increases since 1994. Australia and New Zealand are the primary U.S. 
suppliers of imported lamb, providing 98 percent of all of U.S. imports.  
Lamb supplied by these countries, which comes from smaller, grass-fed 
animals, has found favorable consumer acceptance in the U.S.

Following the rapid rise in lamb imports in the mid-1990s, in July 1999, the 
U.S. established a 3-year TRQ on lamb imports from New Zealand and 
Australia, fated to be struck down by a World Trade Organization (WTO) 
ruling in less than 2 years.  Despite implementation of the TRQ, imports 
from Australia and New Zealand did not slow; effects of the tariffs were 
largely offset by weak Australian and New Zealand currencies.  

The TRQ for the first year (July 22, 1999-July 21, 2000) was 70.2 million 
pounds product weight, with an ad valorem duty of 9 percent, and an over-
quota duty of 40 percent. During the first year of the TRQ approximately 76 
million pounds of lamb was imported from Australia and New Zealand. During 
the second year (July 22, 2000-July 21, 2001) the TRQ increased to 72.1 
million pounds product weight, and the duties declined to 6 percent and 32 
percent. Growth of lamb imports accelerated in the second year--by about 23 
percent. According to customs data, over-quota imports from Australia and 
New Zealand were 22.8 million pounds and 3.2 million pounds, respectively.

In 2000, imported lamb and mutton comprised nearly 37 percent of 
consumption, compared with 10 to 12 percent in the early 1990s.  Imports in 
2000 were 14.7 percent higher than in 1999 and 102 percent higher than 5 
years earlier. 

Currency exchange rates made the U.S. market profitable for Australia and 
New Zealand, particularly in 1998 when the U.S. dollar appreciated against 
the Australian and New Zealand currencies by more than 18 percent and 24 
percent.  For example, in January 1998, U.S. lamb prices of $74 per cwt 
meant an equivalent return to Australian lamb exporters of $114 per cwt in 
Australian currency.  By December 1998, U.S. lamb prices had declined to $71 
per cwt, but the return to Australian exporters in Australian currency was 
up 4.3 percent from January.  Again in 1999 and 2000, further appreciation 
of the U.S. dollar allowed Australia and New Zealand to effectively manage 
the TRQ, even at over-quota tariffs of 40 percent in 1999 and 32 percent in 
2000.

In May 2001, a WTO panel, acting on complaints filed by New Zealand and 
Australia, ruled against the U.S. tariffs.  The appellate body recommended 
that the U.S. bring its tariff restriction on lamb meat imports into 
conformity with its obligations under the WTO agreement on safeguards and 
the General Agreement on Tariffs and Trade (GATT) of 1994.  The U.S. 
complied with the WTO ruling and removed the tariffs on November 15, 2001.

Imports of lamb and mutton are expected to total 150 million pounds in 2001, 
up 16 percent over 2000.  In the first 9 months of 2001, imports totaled 
nearly 110 million pounds, up 15 percent from the same period last year, 
nearly equivalent to imports for the entire year in 1998.  Imports of lamb 
and mutton will continue to increase at least well into 2002.

The U.S. sheep industry is still strongly affected by elimination of the 
National Wool Act program in 1993.  Elimination of the wool and mohair 
programs resulted in loss of a guaranteed portion of income for sheep 
producers.  Public Law 103-130, signed into law November 1, 1993, mandated a 
3-year phaseout of the National Wool Act programs, including direct price 
support payments to producers.  

In the 4 years prior to termination (1990-93), direct payments to wool 
producers based on quantity produced averaged $122 million per year.  Market 
value of the wool produced in those years averaged $53 million per year, 
equivalent to just 43 percent of the direct payments.  In the 5-year period 
following elimination of the program, wool inventory declined 22 percent.  
Wool production and prices have since remained flat.  Because of the strong 
U.S. dollar, wool imports have increased while U.S. exports of fine wool 
have declined.  In addition, the drop in sheep numbers will continue to 
cause decline in the domestic wool industry into the near future.

The sheep industry continues to benefit from several cooperative initiatives 
between the private and public sectors.  In December 1999, USDA and the 
sheep industry embarked on a number of improvement efforts, including the 3-
year, $100 million Lamb Industry Assistance Package, instituted in January 
2000 to help the industry become more competitive in the global economy.  
The package includes four major elements: direct payments to producers; 
animal health; marketing and promotion; and government purchase of lamb 
meat.  The package was designed to increase the competitiveness of domestic 
lamb.  

On November 15, 2001, when the U.S. acted to comply with the WTO ruling by 
removing tariffs on Australian and New Zealand lamb, USDA's Lamb Meat 
Adjustment Program was extended through July 31, 2003, and $37.7 million in 
federal aid was added to boost the domestic sheep industry.  Of that amount, 
$26 million will be allocated to purchase or retain ewe lambs, while the 
remainder is restricted to direct payments to producers for slaughter and 
feeder lambs.

Sheep numbers are declining not only in the U.S., but also in the world's 
primary lamb exporting countries, Australia and New Zealand.  At the same 
time, demand for specialized prime lamb cuts geared to different export 
markets is on the increase.  With declining production, Australia and New 
Zealand will be hard-pressed to increase exports and at the same time 
fulfill domestic requirements.  Given the biology of the sheep, it will take 
Australia and New Zealand at least 2 years to recover to the point where 
production can comfortably meet expected domestic and export demands. For 
the U.S. sheep industry, the production lag in Australia and New Zealand 
presents temporary relief from competition--an opportunity to rebuild its 
stock and recover some of its lost market share.  

Keithly Jones (202) 694-5172; 
Kjones@ers.usda.gov


COMMODITY SPOTLIGHT
Tobacco Industry Continues Long-Term Downsizing 

A recent dramatic shift from auctioning to contract selling in the tobacco 
market is changing the character of the industry. In addition, already-
existing restrictions on smoking areas and advertising and the growing 
consciousness of the health risks of smoking are having a long-term effect 
on the industry.  

Among tobacco producing nations, the U.S. ranks third in output behind China 
and Brazil.  A major exporter of tobacco leaf, the U.S. ranks second behind 
Brazil, after many years of being the largest exporter.  Paradoxically, the 
U.S. also imports more tobacco leaf than any other country.   To achieve 
economical blends with desired smoking characteristics, U.S. manufacturers 
import lower quality leaf from overseas to blend with domestic leaf. The 
U.S. is the second-largest manufacturer of cigarettes after China, and the 
largest exporter.  About a third of cigarettes produced in the U.S. are 
exported.  

Of the 16 states that grow tobacco, North Carolina and Kentucky account for 
67 percent of total U.S. volume.  Annual marketings of tobacco leaf are 
about 1 billion pounds.   Although tobacco acreage is small compared with 
many other crops, it is a high-value crop, ranking ninth in value of 
production, just behind potatoes.

Flue-cured tobacco accounts for 65 percent of tobacco produced in the U.S.; 
burley makes up the remainder.  Flue-cured tobacco is so named because it is 
cured in an airtight barn or container with a flue or chimney exposing the 
leaf to heat. Burley tobacco is cured by hanging the entire plant in an 
open-sided barn exposing the leaf to the atmosphere.  Nearly all, 93 
percent, of tobacco output is used for cigarettes.  The remaining 7 percent 
is used for cigars, snuff, chewing tobacco, and loose smoking tobacco. 

Contracting Is Revolutionizing 
Tobacco Marketing

Auction markets have dominated tobacco marketing since the 1800's.  Many 
towns and cities in the Southeast depend not only on tobacco production for 
their livelihood but also on the marketing of tobacco.  

As the dominant crop in both small and large southeastern towns, tobacco 
auctions represent more than just a means of marketing tobacco. The opening 
of the auction markets has been a traditional day of celebration that 
brought together the entire community. It was an occasion for parades and 
gatherings, and promoted a sense of community in a way other agricultural 
commodities did not.

The Tobacco Inspection Act of 1935 mandated inspection and market news 
services at auction markets designated by the Secretary of Agriculture.  
Since the inception of the tobacco program in 1938, nonrecourse loans known 
as price supports have been available for many types of tobacco.  To receive 
price support, however, leaf must be sold in USDA-approved auction 
warehouses and inspected by USDA graders. 

Tobacco has been sold at auctions because, unlike many commodities, tobacco 
leaf is not a homogeneous product that can be graded by taking a moisture 
sample or observing color.  The qualities that make tobacco leaf desirable 
are less tangible.  The feel of the leaf is important, but so are its smell 
and color.  Elasticity of the leaf is considered, among many other 
characteristics.  Individual buyers require markedly different leaf 
characteristics, depending on the final use.

Until recently, tobacco was sold in small lots called sheets.  A sheet of 
tobacco is a square piece of burlap with up to 250 pounds of leaf wrapped in 
it.  The four corners of the sheet can be tied together so the tobacco can 
be easily moved and transported.  Untied, the tobacco can be easily 
inspected by graders and buyers.  

In the past decade, bales have become more popular as a means of marketing 
tobacco.  A bale consists of about 700 pounds of compressed tobacco.  Bales 
permit more efficient movement of tobacco through the marketing chain.  

Contracting Supplants
Auctions in 2001

Cigarette manufacturers have been proposing contract marketing as an 
alternative to auction markets for a number of years. Manufacturers assert 
that auction markets are not providing the combination of grades and 
characteristics they need to manufacture cigarettes. By contracting directly 
with leaf producers, manufacturers will have more influence over what 
qualities of leaf are available. These factors are more critical today 
because lower quotas mean less tobacco is produced, shrinking the pool from 
which manufacturers can pick and choose in their search for needed grades. 
Most contracts are marketing contracts, not production contracts, and 
stipulate a delivery point and other details of the transaction. Some 
current contracts give the grower the right to reject the price offered 
under the contract and sell the leaf at auction.
 
During the 2000 marketing season (July 2000-June 2001), flue-cured leaf sold 
under contract accounted for about 50 million pounds out of a total 564 
million pounds sold.  Burley producers sold 87 million out of 311 million 
pounds through contracts outside of  auction warehouse channels.  

The magnitude of contract sales in 2001 has turned tobacco markets upside 
down.  Flue-cured growers sold 440 million pounds through contracts out of a 
total 545 million pounds, or 81 percent of total sales.  Burley growers 
began selling leaf in early November, and after 3 weeks of sales, 73 out of 
111 million pounds were sold under contract.  

The dramatic shift to contract marketing has had a significant impact on 
tobacco warehouses.  In North Carolina alone, 69 of the 129 warehouses 
closed before the season began. It is estimated that 28 out of 78 warehouses 
may close in Kentucky.

Some warehouses have become collection centers for companies buying under 
contracts. Warehouses were already suffering from 3 years of large quota 
cuts that reduced the quantity of leaf they marketed and caused some less 
competitive warehouses to close.  An additional 60- to 80-percent reduction 
in the amount of leaf available at auction will leave so little tobacco that 
it may not be economically viable for most warehouses to remain in business.

Contracting also calls the future shape of the tobacco program into 
question. For many years some types of tobacco in the program have been sold 
mainly through contracts.  When selling under contract, growers relinquish 
their right to price support but are still bound by the marketing quota for 
their type of tobacco. 

Many growers feel that without auction markets, the tobacco program will 
become obsolete. And, if auctions cease to exist, many producers fear that 
contract buyers may lower leaf prices and growers would then face lower 
incomes.  However, contracting appeals to many growers because they are paid 
immediately. The contract price currently exceeds expected auction prices, 
and all of a grower's leaf is sold to one buyer in one transaction.  Growers 
selling under contract avoid paying warehouse commissions and fees.  

Cigarette Output & Consumption
Continue Steady Decline

The cigarette industry has stabilized after higher prices and tax increases 
during the past few years. Declining tobacco leaf production has also led to 
lower cigarette production. Cigarette output in 2000 reached 594.7 billion 
pieces, below 1999 but higher than expected.  Domestic taxable removals (the 
volume of cigarettes for which manufacturers paid tax and subsequently 
shipped) totaled 423.3 billion pieces compared with 429.8 billion in 1999.  
Exports for the year were 148.3 billion pieces, 3.1 billion fewer than 1999.

In 2000, cigarette consumption slipped 5 billion pieces (250 million packs) 
to 430 billion pieces (21.5 billion packs of 20 cigarettes), continuing the 
long-term slide since peaking in 1981.  Higher prices and taxes have been a 
major cause of declining cigarette consumption.  Manufacturers raised 
wholesale cigarette prices twice in 2001, so continued declines are 
expected.  Cigarette consumption in 2001 is forecast at 425 billion pieces, 
or 21.3 billion packs. 

During the past decade, numerous states have increased cigarette taxes.  
Taxes range from 2.5 cents per pack in Virginia to $1.41 in Oregon. In 2001, 
Maine raised its cigarette tax from 74 cents to $1 per pack and Rhode Island 
raised its tax from 71 cents to $1.  Wisconsin's cigarette tax increased 
from 59 cents per pack to 77 cents.  As a result of a voter referendum, 
Washington's cigarette tax will increase as of January 1, 2002, from 82 
cents per pack to $1.42, making it the highest in the nation. As of July 
2001, 20 states have tax rates of at least 50 cents per pack, and six states 
have rates $1 or greater.  Virginia and Kentucky remain the lowest cigarette 
taxing states at 2.5 and 3 cents per pack.

Cigarette exports peaked in 1996 at 244 billion pieces.  Since then, 
declining consumption in some importing countries and movement of U.S. 
production offshore have reduced U.S. cigarette shipments to about 150 
billion in 1999, 2000, and 2001.  Japan, Saudi Arabia, Cyprus, and the 
European Union are major buyers of U.S. cigarettes.  

The impact of the Master Settlement Agreement (MSA) between cigarette 
manufacturers and state attorneys general continues to be another agent of 
change. The MSA, signed November 1998, further limited advertisements by 
manufacturers and mandated payments to states for the costs of treating 
smoking-related illnesses and reducing underage smoking.

After the MSA, cigarette manufacturers raised prices to cover the costs of 
the settlement and passed them on to consumers.  In November 1998 when the 
agreement was signed, manufacturers raised cigarette prices 45 cents per 
pack, the largest increase ever. 

In spite of the price increases and the restrictions resulting from the MSA, 
the proportion of Americans who smoke remains fairly steady, at about 25 
percent.  But smokers are smoking less.  Annual per capita consumption has 
dropped from 2,834 cigarettes per adult over age 18 in 1991 to 2,014 in 2000 
(includes smokers and nonsmokers).  Restrictions on where people can smoke, 
higher prices, advertising restrictions, and greater awareness of health 
risks are having a long-term effect on the tobacco industry. 

Thomas Capehart (202) 694-5311; 
thomasc@ers.usda.gov

COMMODITY SPOTLIGHT SIDEBAR
USDA Tobacco Program

The USDA tobacco program consists of marketing quotas and price supports.  
Growers of each type of tobacco vote every 3 years whether or not that type 
of tobacco will be part of the program.  The outcome is applied to all 
growers of that type of tobacco.  Flue-cured and burley producers have 
approved the program every year except one since 1938.  

Marketing quotas under the program determine the quantity of tobacco a 
producer is allowed to sell each season.  The Agricultural Adjustment Act of 
1938 (as amended over the years) provides that total flue-cured and burley 
basic quotas equal the sum of 1) the buying intentions of domestic cigarette 
manufacturers, 2) the 3-year average of unmanufactured tobacco exports, and 
3) adjustments of loan association inventories needed to reach the specified 
reserve stock level.  The Secretary of Agriculture may adjust this three-
part total either up or down by a maximum of 3 percent.  

The effective quota determines the quantity of tobacco a producer may sell.  
The effective quota for each type of tobacco is the basic quota adjusted by 
the individual marketings from previous seasons for each quota holder.  
Overmarketings and undermarketings carried over in each season can be as 
much as 3 percent of that year's effective quota. 

Price supports are the other component of the tobacco program.  They enhance 
the income-stabilizing capacity of quotas by providing a minimum or floor 
price for each grade of leaf. Knowing what floor price to expect well ahead 
of the tobacco season helps producers make informed planting decisions.  

Since 1987, the annual fluecured and burley price support has been the 
level for the preceding year, adjusted by changes in the 5year moving 
average of prices (twothirds weight) and in the cost of production index 
(onethird weight). Costs include variable costs, but exclude costs of land, 
quota, risk, overhead, management, marketing contributions or assessments, 
and other costs not directly related to tobacco production. The Secretary 
can set the price support between 65 and 100 percent of the calculated 
adjusted change from the previous year. 

Support prices are guaranteed through nonrecourse loans that are available 
on each farmer's marketed crop. Each grade of flue-cured and burley tobacco 
is assigned a support price.  In 2001, the flue-cured support price averaged 
$1.66 for each pound of tobacco.  The support price for burley was $1.83 per 
pound. Loan rates range from $1.24 to $1.92 per pound, depending on grade, 
for flue-cured and $1.14 to $1.85 per pound for burley.  Price supports for 
other supported types of tobacco range from $1.25 to $1.74 per pound.  Price 
supports for each grade are announced before the auction season begins.  

At the auction sale barn, each individual lot of tobacco is auctioned and 
goes to the highest bidder, unless bids do not exceed the government's loan 
price.  If the bid is below the loan price, the farmer may accept the 
support price (loan rate) from a designated cooperative. The tobacco is 
consigned to the cooperative (known as a price stabilization cooperative), 
which redries, packs, and stores the tobacco as collateral for USDA's 
Commodity Credit Corporation (CCC). The cooperative later sells the tobacco 
and the proceeds are used to repay the CCC loan plus interest.   

Since 1982, nonetcost assessments cover projected losses to the CCC in 
operating the tobacco pricesupport program. U.S. flue-cured and burley 
growers have paid nonetcost fees since 1982, while purchasers have paid 
fees on U.S.grown tobacco since 1986. Beginning in 1994, nonetcost 
assessments have been levied on importers of fluecured and burley tobacco.  

Both flue-cured and burley reserve stock levels are currently lower than 
they might have been because of legislation forgiving CCC loans on 1999 crop 
tobacco.  Because the loans are forgiven, this tobacco (88 million pounds of 
flue-cured and 230 million pounds of burley) is not considered part of the 
reserve stock component of the quota calculation and has been effectively 
removed from the supply of leaf available for use by the tobacco industry.  
It is likely this tobacco will be destroyed.  Legislation forbids selling 
the tobacco domestically, and international trade agreements will make it 
difficult to export.  Repaying the CCC $637 million for the 1999 loan stocks 
means the government will have large expenditures for the tobacco program 
that would normally be covered by the no-net-cost assessments.  However, 
without the forgiveness of the loans, quotas would have fallen further since 
the reserve stocks would have been high and the consequent negative 
adjustment to the quota formula would have been large. Additionally, the 
cost of carrying the 1999 tobacco would have been ultimately borne by the 
growers in the no-net-cost assessment, lowering grower income.  


WORLD AGRICULTURE & TRADE
How U.S. Farm Policy Meshes With World Trade Commitments

Farm income support and trade programs will probably continue to be subject 
to restrictions established under international trade agreements.  The U.S. 
and other countries made commitments in 1994 under the Uruguay Round 
Agreement on Agriculture (URAA) to reduce the total amount of trade-
distorting domestic subsidies provided to producers, to reduce export 
subsidies, and to increase import access to domestic markets.  The 
implementation period for the commitments was 1995 to 2000, and existing 
commitments will continue at 2000 levels until a new agricultural trade 
agreement is reached under the new multilateral trade negotiations initiated 
in Doha, Qatar, November 15, 2001.

The U.S. has so far met commitments under the URAA, but surges in direct 
payments to producers after 1997 in response to low market prices have 
raised concerns that domestic subsidy levels in the near future might exceed 
the ceiling on domestic support established under the URAA.  U.S. support is 
expected to remain below its ceiling under current farm programs, but 
increases in support under new programs could cause a compliance problem 
with the URAA commitments.  A compliance problem could hamper efforts in the 
new multilateral trade talks to accomplish U.S. goals for liberalizing 
international trade and getting other countries to reduce domestic support 
to their agriculture sectors and increase market access.

Concerns about exceeding the ceiling on domestic support are particularly 
relevant because alternative income support programs are being considered in 
Congress for possible inclusion in the next multi-year farm bill.  Support 
can be provided if programs are designed to be consistent with certain 
exemption provisions in the URAA. 

How Compliance
Is Determined

Domestic subsidies under the URAA are measured using a specially defined 
indicator, the "aggregate measurement of support" (AMS).  In 1994, twenty-
eight countries established ceiling levels for their AMS and agreed to 
reduce them by 20 percent by the year 2000.  Countries must document in 
official notifications to the World Trade Organization (WTO), the governing 
body for the URAA, their calculated AMS for each year, 1995 to 2000.  The 
U.S. has, so far, officially notified for marketing years 1995 to 1998.  
Information for 1999 and 2000 is under internal review for later 
notification.

Domestic support to agriculture is classified into three basic categories 
for purposes of AMS calculations and WTO notifications:

Green-box support is the least trade distorting.  As such it is exempt from 
support reduction commitments and thus not included in the AMS.  This 
category includes certain types of support received directly by producers in 
the form of government payments or input subsidies, as well as certain 
government outlays not received directly by producers, but that provide 
benefits to the agricultural sector in general.  Three types of green box 
support of particular interest to lawmakers drafting new farm legislation 
are decoupled income support (i.e., support not tied to current production 
level or current market prices), income insurance and safety-net payments, 
and environmental payments.

Blue-box support has supply-control features that partially offset trade-
distorting effects, and is also exempt from inclusion in the AMS.  The U.S. 
currently makes no direct payments to farmers that fit into this category.  
U.S. deficiency payments were linked to compliance with acreage reduction 
programs prior to 1996, so they were in the blue box in 1995.  Deficiency 
payments were eliminated after 1995 under the 1996 Farm Act.

Amber-box support is the most trade distorting type.  It includes all direct 
support to agriculture that is not eligible for the green or blue boxes.  
All amber box subsidies must be included in the AMS calculation, except 
those qualifying for what is known as the de minimis exemption.  This 
exemption permits product-specific support to be excluded from the AMS if 
the product's total support does not exceed 5 percent of its value of 
production (10 percent for developing countries).  Also, nonproduct-specific 
support, e.g., input subsidies and direct payments not related to current 
production of specific commodities, can be excluded from the AMS if the 
total value is less than 5 percent of the total value of all agricultural 
commodities produced (10 percent in the case of developing countries).  
Examples of the largest amber box support included in the U.S. AMS in 1998 
were market price support benefits for dairy and sugar, and benefits related 
to marketing assistance loans, especially loan deficiency payments.  

Total domestic support to agriculture can be defined to include all the 
benefit measures included in the above three boxes, before any exemptions 
and regardless of the de minimis status.  However, the remainder of this 
article focuses only on the support measures received directly by producers, 
called "total direct support to agricultural producers," or simply "total 
direct support."  This total includes all of the amber-box and blue-box 
support measures plus green-box outlays that involved payments made directly 
to producers.  This total therefore excludes green-box outlays notified to 
the WTO as domestic food aid and outlays for general government services 
such as research, inspection, and marketing.  These latter items must be 
notified to the WTO but do not involve direct payments to producers.

Total direct support to U.S. agricultural producers before subtracting the 
exempt blue, green, and de minimis payments was less than the AMS ceiling in 
1995-97.  Direct payments increased enough after 1997 to cause total direct 
support to exceed the AMS ceiling each year, making the exemptions essential 
to meeting URAA commitments.  

The U.S. AMS in 1998 was $10.4 billion, just 50 percent of the $20.7 billion 
ceiling.  Preliminary estimates for 1999 and 2000 indicate that the average 
AMS during these years was nearly 60 percent higher than in 1998.  This 
means the AMS for these years would now be much closer to the ceiling, 
perhaps as much as 80 percent of the ceiling.  This increase in the AMS 
reflects primarily the larger loan deficiency payments and marketing loan 
gains received by producers as a result of low market prices relative to 
commodity loan rates.  There were also increases in the AMS due to payments 
related to emergency programs for various commodities.  The implication for 
lawmakers is that some future programs may need to be carefully crafted to 
assure they fall into an exempt category in order to keep the AMS within the 
ceiling.

Criteria for Green 
Box Inclusion

For support programs to qualify for the green box category, and thus be 
exempt from the AMS, they must meet both general and policy-specific 
criteria.  Under the general criteria, support provided by the program:
*  shall be provided by a publicly-funded government program and not involve 
transfers from consumers,
*  shall not have the effect of providing price support to producers, and 
*  shall have no, or at most minimal, trade-distorting effects on production 
(this criterion is subject to considerable interpretation since "minimal" is 
not defined).  

Green-box provisions do not set any upper constraints on the total amount of 
green box support that can be given to agriculture.  The three largest 
direct payment categories in the U.S. green box in 1998 (in value terms) 
were decoupled income support (production flexibility contract payments), 
resource retirement payments (Conservation Reserve Program payments), and 
payments for natural disasters (crop and livestock disaster payments).  

Decoupled income support--Direct payments to producers are considered 
decoupled payments if they are not related to or based on market prices, the 
type or volume of production, or factors of production in any year after a 
defined and fixed base period.  The U.S. included production flexibility 
contract (PFC) payments as decoupled payments in the 1996-98 notifications 
to the WTO.  These payments were the largest single category value-wise, 
representing 23 percent of total direct payments to producers in 1998.

The PFC totals were largely predetermined by the 1996 Farm Act using acreage 
and program yields that would have been in effect for 1996 under previous 
legislation.  Current prices, resource use, and production decisions did not 
affect the amount of PFC payments received by a farmer under the 1996 Act 
unless PFC land was used for nonfarm purposes or for producing fruits and 
vegetables.  Consequently, one may argue, current production decisions and 
cropping patterns are not significantly distorted by current PFC payments.  
There may be longrun effects on production, however, since PFC payments 
increase the business income of farm families no matter what they produce, 
even if they completely idle their PFC land.

A key issue arising from recent farm bill proposals for income safety nets, 
or counter-cyclical payments, concerns the interpretation of the URAA 
condition stating that decoupled payments must not be based on or related to 
market prices in any year after the base period.  Since revenue and income 
are related to prices, payments would have to be carefully crafted to 
qualify as "decoupled" income support. 

Income insurance and income safety nets--Direct payments to producers can be 
considered income insurance or safety-net payments under the green box 
category if they meet four policy-specific criteria:
*  eligible producers must have experienced a loss that exceeds 30 percent 
of average gross income, or the equivalent in net income terms, during the 
preceding 3-5 year period; 
*  the amount of current payments must not exceed 70 percent of the current 
income loss; 
*  payments shall relate solely to income, and not relate to prices, 
production, or factor use; and 
*  payments from this provision combined with that for natural disaster 
relief shall not total more than 100 percent of the total loss for 
individual farmers.  

The U.S. green box does not currently include any programs based on the 
above safety-net criteria, but some farm bill proposals for income safety 
nets seem similar in concept to green-box income insurance.  Whether or not 
these proposals, if adopted, would actually qualify for any green-box 
category has yet to be determined.  The language of the URAA provisions for 
income insurance contains some ambiguities and significant benefit 
limitations.  In 1995-98, U.S. income and revenue insurance benefits were 
combined with multiperil crop insurance benefits and notified to the WTO as 
nonproduct-specific, amber box support. 

URAA income insurance provisions cover programs that make payments to 
producers based on their unique individual income experiences.  Income 
insurance or safety-net programs, such as those in some recent farm bill 
proposals that base payments on national-level indicators, would not qualify 
for the income insurance category of the green box.  If they were not 
carefully crafted to qualify for the green box as decoupled payments, they 
would probably have to be included in the amber box and could make it harder 
for the U.S. to remain within its AMS ceiling.

Environmental program payments--Direct payments to producers under 
environmental programs qualify as green-box payments if they require 
producers to meet clearly defined specific conditions related to production 
methods or inputs.  The amount of the payments shall be limited to the extra 
cost or loss of income from complying with such conditions.  U.S. funding 
for environmental programs in the green box category has been relatively 
small compared to total farm program spending, but recent farm bill 
proposals would increase such outlays.  The green box condition that limits 
the amount of payments to the cost of compliance might be an issue for 
policymakers to consider.  Payments to landowners under the U.S. 
Conservation Reserve Program (CRP) have been notified in the green box under 
the resource retirement rather than environmental programs category.

Resource retirement payments--Payments made conditional on retirement of 
land from marketable agricultural production for at least 3 years may be 
placed in the green box category called "structural adjustment assistance 
provided through resource retirement programs."  Such payments cannot be 
related to current prices, type or quantity of production, or to remaining 
resources.  To qualify as green box, a program also cannot require that the 
retired resources be used for any alternative production of marketable 
agricultural products.  In 1998, the CRP was listed as a resource retirement 
program in the U.S. green box.  The CRP, which would be expanded under farm 
bill proposals, was the fifth-largest component of total direct support to 
U.S. agricultural producers in 1998.

Other green box programs--The third largest green-box category that involved 
direct payments in 1998 was payments to farmers for relief from natural 
disasters--accounting for $1.4 billion in support provided in response to 
widespread weather-related crop damage.  A small amount of U.S. farm credit 
subsidy was notified in the category for "structural adjustment payments 
involving investment aids" (interest rate subsidies).  The U.S. reported 
nothing in the other direct payment categories of the green box--those for 
producer retirement or regional assistance payments.

Amber Box Support 
Exclusions

The U.S. included several programs in the amber box nonproduct-specific 
(NPS) category of support since they were multiproduct in scope, the 
implementation provisions were generic, or the payment amount was not based 
on current production of any specific commodity.  (The URAA does not define 
"nonproduct specific").  Since the total value of the NPS category of 
payments for the U.S. was $4.6 billion in 1998, or only 2.4 percent of total 
value of production (and thus below the 5 percent de minimis level for 
developed countries), the entire $4.6 billion was excluded from the U.S. 
AMS.  The largest two examples of NPS support in the U.S. in 1998 were the 
crop market loss payments and the net benefits from crop and revenue 
insurance.

Crop market loss assistance payments--Producers who received fiscal 1998 PFC 
payments also received additional payments allocated to producers in 
proportion to the amount of their PFC.  These additional payments, called 
crop market loss payments, were mandated by legislation enacted in October 
1998 partly in response to generally low agricultural market prices.  The 
payments were not tied to current production of any specific product, and 
the proportionality factor was the same (generic) for each PFC commodity.  
But since payments were based on or related to recent market-price 
conditions, they could not be classified as green box decoupled payments.  
Crop year 1998 payments amounted to $2.8 billion.  

Crop and Revenue Insurance Benefits--Insurance benefits were measured as the 
amount of insurance indemnities paid to producers, minus the producers' 
share of the insurance premiums.  Producers are offered generic, or common 
provisions for participation in various insurance programs operated by 
USDA's Risk Management Agency.  The Federal government subsidizes the 
insurance premium.  Taken as a whole, insurance program provisions do not 
comply with all the green box provisions for payment for relief from natural 
disasters, which includes qualifying crop insurance programs.  In 
particular, the requirement for the green box that recipients of crop and 
revenue insurance payments must have at least a 30-percent loss is not 
always met.  Crop-year net insurance payments amounted to $747 million in 
1998. 

Other NPS programs--Other NPS benefits notified to the WTO include input 
subsidies (for irrigation, grazing livestock, and state credit programs) and 
1998 multiyear disaster payments.  This disaster payment program did not 
fully comply with the 30-percent loss threshold criteria for disaster relief 
in the green box, so it was notified in the amber box as NPS, since the 
provisions are generic, or common provisions, similar to crop insurance.  
The input subsidies are clearly not limited to any specific products.

U.S. Farm Support 
at a Crossroads

As the U.S. enters the twenty-first century, many policymakers are 
struggling to reshape the nature of U.S. agricultural policy.  A significant 
public interest in market-oriented policy, environmental policy, and URAA 
commitments, are encouraging the development of "decoupled" income support 
programs, safety-net and risk-management tools, and environmentally-focused 
incentives.  Programs with payments tied to the current levels of 
production, prices, or resource use are limited under the URAA.  Thus far, 
the U.S. has been able to comply with the conditions established by its URAA 
commitments and still provide significant income support to producers.  U.S. 
support under current farm programs is expected to remain below its ceiling, 
but any increases in support under new programs, if not carefully crafted to 
utilize exemptions, could present a problem for compliance with the URAA 
commitments.

Frederick J. Nelson (202) 694-5326
fjnelson@ers.usda.gov

For more information:
Food and Agricultural Policy--Taking Stock for the New Century, September 
2001. http://www.usda.gov/news/pubs/farmpolicy01/fpindex.htm

"WTO: Uruguay Round Agreement on Agriculture--Domestic Support," Briefing 
Room on World Trade Organization, WTO (Updated September 18, 2001).  
http://www.ers.usda.gov/briefing/WTO/domsupport.htm

"U.S. Ag Policy--Well Below WTO Ceilings on Domestic Support," Agricultural 
Outlook (October 1997), pp. 26-32.
http://www.ers.usda.gov/publications/agoutlook/oct1997/ao245h.pdf

"U.S. WTO Domestic Support Reduction Commitments and Notifications," 
Briefing Room on Farm and Commodity Policy: Analysis of Programs and 
Policies, (Updated December 15, 2000)
http://www.ers.usda.gov/briefing/farmpolicy/usnotify.htm

"U.S. Farm Program Benefits: Links to Planting Decisions & Agricultural 
Markets," Agricultural Outlook (October 2000), pp. 10-14.
http://www.ers.usda.gov/publications/agoutlook/oct2000/ao275e.pdf



WORLD AG & TRADE
Pressures for Change in Eastern Europe's Livestock Sectors 

Twelve years after the fall of Communism in Central and Eastern Europe 
(CEE), the meat and dairy processing sectors of the CEE countries are 
undergoing a rapid process of concentration and modernization.  The process 
is most evident in Poland and Hungary, but similar trends can be observed in 
all the CEE countries.  This restructuring has been accelerated by the 
European Union (EU) accession process, both because of pressure to meet EU 
sanitary standards and because of generous assistance provided by the EU to 
the food processing industry.   

Drastic declines in livestock inventories and production during the early 
years of the transition have been well documented. There are still few signs 
of significant growth in livestock output in most of the CEE countries.  In 
general, cattle inventories and beef output are still declining, although at 
a slower rate.  Output of poultry meat has begun to grow in several 
countries, especially Poland, and pork output is also turning around.  Many 
of the other CEE countries have also seen some growth in poultry, while port 
has stabilized at lower levels.  The principal exception to these positive 
developments is Romania, where inventories of all species continue their 
decline.

Structural changes are underway that could eventually lead to significant 
shifts in production and trade patterns in CEE countries. A combination of 
pressures is leading to a steady increase in concentration in CEE meat 
sectors.  This trend is most apparent at the processing level, but there is 
evidence of farm consolidation as well.  The result could be a dramatic 
reshaping of these sectors in the next 5 to 10 years.

The main driving force behind the changes is the preparation for membership 
in the EU. Once the CEE countries become members, all CEE meat and dairy 
plants will have to meet strict EU standards or close down.  With the help 
of foreign investment and EU assistance, the larger CEE plants are gradually 
retooling to meet these standards.  Smaller plants are already being closed.  

Other factors have reinforced these changes. The loss of Russian markets 
following the 1998 ruble devaluation forced CEE countries to seek 
alternative markets in the West.  However, Western markets remain difficult 
to penetrate because of the generally low or uneven quality of CEE output.  
The BSE crisis in the EU has led to tighter standards for cattle imported 
into the EU and is forcing a restructuring of the cattle/beef sector 
throughout the CEE countries. 

Decline & 
Recovery 

The early years of transition saw steep declines in livestock inventories 
and production in all CEE countries.  Between 1989 and 1993, cattle 
inventories in Poland fell by 29 percent; hog inventories fell by 36 percent 
in Hungary and 31 percent in Romania.  Meat output declined similarly, and 
for a brief period the CEE countries, formerly net meat exporters, became 
net importers. In brief, the following factors contributed to the decline.
*  Elimination of subsidies caused prices of feed and other inputs to rise 
substantially.
*  Real income of the population was falling.
*  Liberalization of retail prices caused meat prices to rise, as consumer 
purchasing power fell.  The result was a drastic decline in demand for meat.
*  In many of the countries, state and collective farms were privatized or 
liquidated.  As part of the liquidation process, animals belonging to the 
state farms were given to former landowners.  These new private farmers were 
often unable to feed the animals and simply slaughtered them.
*  With the opening of international borders, domestic meat products could 
not compete with attractively packaged imports from the West.  

Since the early 1990s the situation has been changing.  By 1997, declines in 
pork and poultry sectors had virtually stopped; only cattle numbers were 
still declining. 

Output of poultry meat has stabilized nearly everywhere, and output is 
growing rapidly in Poland. Other countries, including Hungary, Bulgaria, and 
Romania are seeing some increases in poultry meat output. This growth is in 
part due to changing preferences of consumers, who increasingly substitute 
poultry for beef because of price and health concerns.  In 2001, consumer 
fears of BSE in cattle have accelerated this trend.  Stronger demand has led 
to higher domestic poultry prices, which in turn has stimulated output.

In addition, the poultry sector has attracted a great deal of investment 
recently at both the production and processing levels.  Investors have been 
attracted to the sector by increased demand, the short growing cycle of 
broilers, and the ease with which the technology can be transferred across 
borders within CEE.   

Hog inventories and pork output have also stabilized.  Output has increased 
in several of the countries in recent years, but, there is no clear trend of 
sustained growth.  Rather this sector is experiencing cyclical increases and 
downturns in response to fluctuating grain prices and changes in government 
policy.

Cattle numbers and beef output are still in decline throughout the region.  
Cattle are still mainly dairy animals, and beef comes from young bulls and 
culled dairy cattle.  The resulting meat is thus of a relatively low 
quality, and consumers prefer pork and poultry.  
 
In contrast, the dairy sectors in Poland, Hungary, and a few other countries 
are beginning to see some growth.  Some significant increases in milk yields 
have increased output even as cattle numbers continue to decline, and 
quality has also improved.  In Poland, for example, half the milk now 
produced meets the highest EU standard (known as "extra class").  These 
improvements are the result of significant investment and foreign technical 
assistance to the sector.

Preparing for 
EU Accession

Ten of the CEE countries are officially candidates for EU membership.  
Poland, Hungary, Czech Republic, Estonia, and Slovenia are in the so-called 
first wave that began negotiations in 1998.  Slovakia, Latvia, Lithuania, 
Bulgaria, and Romania constitute the second wave.  Some of the second wave 
has caught up and it is entirely possible that as many as eight CEE 
countries could join the EU by 2005.

Livestock production and processing sectors throughout the CEE continue to 
be divided between modern commercial operations, subsistence farms, and 
small one-room slaughterhouses.  The large enterprises have received 
considerable investment in recent years and will have little difficulty 
meeting EU standards.  Smaller units will find it much more difficult to 
meet the strict standards.

Regulations that meat plants will face include animal welfare rules, 
sanitary requirements at the plant, and environmental rules.
*  Animal welfare rules will restrict the animals time in transit, regulate 
the number of hens kept in a cage, prohibit tethering of cattle and pigs, 
and strictly regulate slaughtering procedures.
*  EU rules require a thorough system of identification and tagging of 
animals to assure the ability to trace the animal back to the farm of 
origin.
*  "Dirty" phases of processing (slaughter and evisceration) must take place 
in a separate room from "clean" phases (cutting and further processing.)  
Many small plants have only one room and cannot expand.
*  Live animals must enter the plant on a separate road from which finished 
meat exits.  Owners of the smallest plants do not own sufficient land to 
build new driveways.
*  Plants must have equipment for measuring back fat of hogs and must apply 
the European grading system (known as EUROP).
*  Environmental regulations require plants to have water purification 
systems.  EU environmental regulations will force some plants to close 
because their locations are too environmentally sensitive.

The CEE governments have all been phasing in some of the EU regulations over 
the past 5 years.  For example, slaughterhouses in Hungary and Poland are 
required to have equipment for measuring back fat.  Dairy plants are not 
allowed to buy milk that is below the second class as defined by EU 
standards.  

Hungary has made more progress than its neighbors.  But even there, only a 
third of the 600 meat plants meet all EU requirements.  The situation is 
more critical elsewhere.  In Poland, of 4,150 meat plants operating in 2001 
only 19 slaughterhouses and 23 processing plants were licensed for export to 
the EU--between 40 and 60 others are applying for EU export licenses. 
Bulgaria has only three EU-approved slaughterhouses for sheep and lamb, none 
for broiler chickens, and six for ducks and geese.

Polish Ministry officials estimate that the total investment needed to bring 
Poland's meat plants into compliance with EU regulations will be about $900 
million, or about $300 million per year.  Of this, EU preaccession funds are 
expected to provide only $35 million a year, including co-financing from the 
Polish side.  The Polish Agency for Reconstruction and Modernization is 
providing some subsidized credit, but the bulk of the required capital will 
have to come from the plants' own profits or from foreign investors.

Some CEE countries--Poland for example--have negotiated a 3-year transition 
period following accession, during which plants that do not meet EU 
requirements can continue to operate as long as they sell only on the 
domestic market.  Accession will almost certainly mean the eventual closure 
of hundreds of smaller plants.  

Fallout Remains From 
Russia's Financial Crisis

As early as 1993, many CEE countries resumed their positions as net meat 
exporters.  But their largest export market turned out to be Russia.  
Because of dependence on the Russian market, the Russian financial crisis of 
1998 had severe negative impacts on the CEE livestock sectors, particularly 
in Poland. Polish pork exports to Russia for 1998 were down by 26 percent 
from 1997, and producer prices for live hogs fell by 40 percent during 1998.  
Poultry prices dropped similarly, depressed by the sudden oversupply of pork 
on the domestic market.

Hungary's food exports to Russia fell by 20-25 percent in 1998, and meat 
exports to Russia ceased. Live hog prices in January 1999 were 36 percent 
below the levels of January 1998.  Romania's exports of livestock products 
were down by 20-25 percent in 1998. 

Three years later, Poland and Hungary have partially recovered from the 
negative impacts of Russia's financial crisis.  Polish pork and poultry 
prices in 2000 had returned to the pre-crisis level, and output of both 
meats rose in response.  Meat exports to Russia have also risen. 

CEE countries have not fully recovered the lost markets in Russia, mainly 
because Russian import demand remains well below pre-1998 levels. Poland has 
regained some of its pre-crisis market in Russia.  But Russian imports of 
Polish half carcasses and sausage were still only half the 1997 level.  
Hungary's pork exports to Russia were only 37 percent of the 1997 level.

The CEE countries have attempted to reorient their trade toward the EU. The 
"double zero trade agreements" the CEE countries signed with the EU in 2000 
have had some positive impact.  In particular CEE poultry exports to the EU 
have risen since the agreements were signed. But in many cases the tariff-
rate quotas granted by the EU have remained unfilled because of quality 
problems.  The EU has banned imports of fresh or frozen pork from Poland and 
Bulgaria because of swine fever outbreaks.  More generally, the EU allows 
meat imports only from plants that have been inspected by EU veterinarians 
and found to meet all EU sanitary standards; few CEE plants meet those 
standards. The EU permanent veterinary committee now recognizes Poland as 
free from swine fever, which may improve Poland's exports.

BSE Forces Restructuring 
Of Cattle Sectors

During the recent outbreak of BSE in Western Europe, most CEE countries did 
not experience a single case.  Two cases occurred in the Czech Republic, 
four in Slovakia, and one in Slovenia.  Even so, the presence of BSE in 
Western Europe had significant short-term impacts on CEE cattle sectors.  
The BSE crisis will also accelerate the restructuring of the CEE meat 
industry that was already underway.

In April 2001, the EU, reluctant to trust testing procedures in CEE 
countries, declared all CEE countries to be "at risk" of BSE.  This meant a 
temporary ban on all cattle imports from the CEE until governments could 
demonstrate they had valid testing procedures in place.  Most CEE countries 
have traditionally exported large numbers of live cattle to the EU, their 
largest customer.  The result of the ban was a virtual halt of live cattle 
exports.  

In an effort to resume cattle exports to the EU, nearly all the CEE 
countries have now imposed mandatory testing of all slaughtered cattle.  The 
EU requires that all cattle above 30 months of age be tested for BSE.  
Poland went one step further and now requires all cattle to be slaughtered 
over 24 months to be tested.  

The cost of testing reportedly ranges from $22 per animal in Poland to  $55 
per animal in Hungary.  The Hungarians estimate that their testing program 
will cost the cattle industry $10 million per year.  Polish authorities 
estimate the cost of their testing program for the remainder of 2001 to be 
68 million zlotys (US$17 million).  Both governments are allocating funds to 
at least partially offset these costs.  But in the long run, these measures 
will greatly increase the cost of beef production.

Production costs will also rise as a result of a ban on use of meat and bone 
meal in feed and the need to build specialized rendering plants for all 
cattle carcasses.  These new regulations will accelerate concentration in 
the processing sector, as smaller plants will find these costs prohibitive.

The Move to Greater 
Concentration

These changes are already creating a trend of increasing concentration, 
particularly in the processing sector.  For example, the current number of 
red meat plants in Poland--4,150--is down from nearly 7,000 in 1997. About 
350 produce 60 percent of meat output. Four large capital groups control an 
ever larger share of the industry.

Poland's poultry industry is even more concentrated than red meat production 
and is better prepared for EU accession.  There are about 25-30 large 
poultry plants that account for 60-70 percent of all birds slaughtered. As 
with red meats, four capital groups control most of this market, and there 
is a substantial share of foreign ownership in the poultry sector.  The 
Poultry Producers Council expects that all poultry plants will meet EU 
standards in 2 or 3 years.  Those that are unable to meet EU standards are 
already being closed down. 

Hungary's meat and dairy industries have been highly concentrated since the 
beginning of the economic transition.  In the dairy sector, the six largest 
plants control 70 percent of the milk market, and one Dutch-owned capital 
group accounts for 27 percent of the market.  Three poultry processing 
companies control over 90 percent of Hungary's poultry market. 

Experts in Poland and Hungary believe that the small number of larger plants 
meeting EU standards will be able to produce enough meat to satisfy domestic 
demand and allow for exports.  The principal concern is that many of the 
smaller plants are in rural areas where unemployment is already high.  CEE 
concerns about the social costs of this restructuring are also having a 
strong influence on the direction of negotiations.  For CEE countries, 
accession will be politically very difficult without some assurance of a 
stronger social safety net for workers displaced by this process.

The phenomena of concentration and modernization adds a new dimension to 
projections of the impacts of EU enlargement on livestock production and 
trade. Analysis by USDA's Economic Research Service suggests that a 
potential for significant increases in beef and pork output in CEE countries 
once they join the EU. CEE prices are currently well below EU prices, and as 
prices rise to EU levels, it will stimulate increased output.  At the same 
time, CEE producers will be subject to stringent regulations regarding 
product quality and animal welfare. But compliance will raise production 
costs, which may, in turn, dampen expected output increases.  

Compliance with these regulations will significantly increase production 
costs, and many smaller producers could be forced out of business. But 
restructuring of the industry already underway could raise the efficiency of 
the CEE meat and dairy industries to the point where they can compete in the 
enlarged EU despite higher costs.  

Nancy Cochrane (202) 694-5143 
cochrane@ers.usda.gov

Need more info?
For a more detailed exposition see Bjornlund et al., Livestock Sectors in 
the Economies of Eastern Europe and the Former Soviet Union: Transition from 
Plan to Market and the Road Ahead, Economic Research Service, USDA, AER-798, 
forthcoming.

See Cochrane, "Enlargement to the East," Europe--International Agriculture 
and Trade Report, USDA, ERS, WRS-99-2, October 1999 for a detailed 
explication of ERS model results.

WORLD AG & TRADE BOX
Double-Zero Trade Agreements

Between July and September 2000 the EU signed so-called "double-zero" trade 
agreements with all the CEE candidate countries.  These agreements establish 
three lists of goods: tariffs are abolished for goods on the first list; for 
goods on the second list, the agreement calls for zero tariffs within 
quotas; for the third list preferential tariffs are granted within quotas.  
For most CEE countries, pork and poultry are on the second list.  For these 
goods the two sides not only grant zero tariffs within the quotas, but also 
refrain from subsidizing exports.  

For more information see Agricultural Outlook, December 2000.


FOOD & MARKETING
Traceability for Food Marketing & Food Safety: What's the Next Step? 

When information about a particular attribute of a food product is 
systematically recorded from creation through marketing, traceability 
for that attribute is established. Recording and transmitting 
information about food products at specific points along the marketing 
chain can have a number of practical purposes including product quality 
control and supply-side management. However, the area where 
traceability seems to be getting the most attention lately--mandatory 
tracking of genetically engineered crops and food--is not among the 
practical or efficient uses of traceability.  

Information on any number of the attributes of a food product can be 
recorded and passed along the food marketing chain.  A coffee producer, 
for example, may maintain records on bean variety, location of 
cultivation, labor conditions on the farm, whether the bean was grown 
organically, or in the shade, and on the shipping firm.  Records such 
as these might later prove useful to the coffee producer in tracking 
quality or in replicating a top-selling shipment.  These records could 
be used to distinguish one type of coffee from another.  Recently, the 
European Union (EU) proposed government-mandated traceability for 
genetically engineered crops and foods to help distinguish them from 
their conventional counterparts.

Traceability systems are recordkeeping systems.  In practice, 
traceability systems are used primarily to help keep foods with 
different attributes separate from one another. There are two primary 
approaches for separating attributes:
*  A segregation system separates one crop or batch of food ingredients 
from others.  Though segregation implies that specific crops and 
products are kept apart, segregation systems do not typically entail a 
high level of precision and do not necessarily require traceability.  
In the U.S., though white corn is channeled through the bulk commodity 
infrastructure, it is segregated from other types of corn.  
*  An identity preservation (IP) system identifies the source and/or 
nature of the crop or batch of food ingredients.  IP systems are 
stricter than segregation systems and tend to require documentation, 
that is, traceability, to guarantee that certain traits or qualities 
are maintained throughout the food supply chain.  Tofu-quality soybeans 
are put into containers to preserve their identity.  

Food suppliers and government have several motives for documenting the 
flow of food and food products through production and distribution 
channels--and a number of reasons for differentiating types of foods by 
characteristics and source.  In some cases, the benefits of 
establishing detailed traceability may not warrant the costs.  For 
example, consumers may not be willing to pay for information on 
specific government-approved pesticides used on each apple in a bin of 
apples. In other cases, the benefits of IP and traceability may exceed 
the costs.  For example, if a large-scale canned fruit manufacturer 
could profitably produce both a line of organic applesauce and 
conventionally produced apple sauce, the firm would want to separate 
organic and conventionally produced apples and document the source of 
each. Traceability systems will vary widely depending on the 
motivations driving their development and the degree of assurance 
desired (increasing reliability usually increases costs).

Private Sector Motivations 
For Traceability

Food suppliers who operate in the private sector have three distinct 
motives for establishing traceability systems: to differentiate and 
market foods with subtle or undetectable quality attributes; to 
facilitate traceback for food safety and quality; and to improve 
supply-side management.  A firm may establish a traceability system to 
achieve any number of these objectives, and as a result, the private 
sector has a significant capacity for tracing.

Differentiate and market foods with subtle or undetectable quality 
attributes.  While the U.S. food market successfully mass-produces 
homogenous commodities such as grains and meats, it also offers goods 
and services tailored to the tastes and preferences of narrow segments 
of the consumer population.  The growth in micromarkets reflects an 
increased ability to satisfy variations in consumer food preferences as 
well as rivalry among food manufacturers.

Food producers differentiate products for micromarkets over a wide 
variety of quality attributes including taste, texture, nutritional 
content, cultivation techniques, and origin.  Consumers easily detect 
some quality innovations--green ketchup is hard to miss.  However, 
other differences involve credence attributes--characteristics that 
consumers cannot discern even after consumption of the product. The 
claim that a product contains no genetically engineered ingredients 
asserts a credence attribute: consumers cannot taste or otherwise sense 
a difference between food products containing genetically engineered 
ingredients and those made with non-genetically engineered ingredients.  

Credence attributes can be content attributes or process attributes.  
*  Content attributes affect the actual physical properties of a 
product, although they can be difficult for consumers to perceive.  For 
example, consumers are unable to determine the amount of isoflavones in 
a glass of soymilk or the amount of calcium in a glass of enriched 
orange juice by drinking the beverages.  
*  Process attributes do not affect final product content but refer to 
characteristics of the production process.  These reflect consumer 
concerns about the production process, including environmental 
stewardship, animal welfare, and labor conditions.  Process attributes 
include organic, free-range, dolphin-safe, shade-grown, earth-friendly, 
and fair trade.  In general, neither consumers nor specialized testing 
equipment can discern process attributes. No test conducted on the 
contents of a can of tuna, for example, could ascertain that the tuna 
had been caught using dolphin-safe technologies.

The task of producing credence attributes may prompt some firms to 
segregate or establish IP and traceability systems--in fact, where 
attribute testing is not possible, IP and traceability may be the only 
way to differentiate these attributes. Some firms may differentiate 
production by establishing separate product lines within the same plant 
or by sequencing production and thoroughly cleaning production 
facilities between differentiated product batches.  Other firms may 
dedicate a whole plant to the production of one specific product line.  
Firms that produce foods with process attributes by contracting with 
ingredient suppliers for commodities with particular attributes have, 
de facto, established traceability and IP systems.  For example, firms 
that market dolphin-safe tuna segregate (sometimes exclusively buying 
dolphin-safe tuna) and keep records of their transactions.  Likewise, 
because no test can now distinguish between highly-processed oils 
derived from genetically engineered commodities and those derived from 
conventional commodities, these products are usually differentiated 
through tracking.  The incentives to develop segregation or IP systems 
and to document transactions are the same for process and content 
attributes in cases where testing for content attributes would be 
costly, inaccurate, or difficult.  

Once a firm has produced a product differentiated by a credence 
attribute, it then faces the difficult task of establishing market 
credibility.  Consumers are often skeptical about the existence of 
credence attributes. In response, a firm can acquire credibility like 
it acquires other inputs--by making or buying it.  Some firms build 
credibility by establishing a reputation for delivering the attributes 
they advertise.  Other firms purchase the services of third party 
entities (neither the buyer nor the seller) to provide objective 
validation of quality attributes. Third parties offer four primary 
services to help verify quality claims: establish product quality 
standards and/or traceability standards; test products, and/or review 
traceability documentation to verify that traceability and/or technical 
standards have been met; provide certification that standards have been 
met; and report violations of standards.  

Third-party services can be provided by a wide variety of entities, 
including consumer groups, producer associations, private third-party 
entities, and international organizations. The following are examples 
of third parties.
*  The Good Housekeeping Institute, founded for the purpose of consumer 
education and product evaluation, sets product standards and provides 
consumer guarantees for a wide range of goods, including foods. 
*  The American National Standards Institute (ANSI), a nonprofit 
membership organization, facilitates development of voluntary private-
sector standards for a wide range of products.
*  Underwriters Laboratories (UL), a private nonprofit entity, provides 
standards and certification, primarily for electrical appliances. 
*  The Council of Better Business Bureaus works with the National 
Advertising Review Board to investigate questions of truth and accuracy 
in national commercial advertising.
*  ISO, a worldwide federation of national standards bodies, promotes 
the development of standardization and international standards for a 
wide range of products.  

Governments can also provide voluntary third-party verification 
services.  For example, to facilitate marketing, producers may 
voluntarily abide by government established and monitored commodity 
grading systems.

Facilitate traceback for food safety and quality.  Many firms use 
traceability systems to minimize potential damage from deficiencies in 
their food safety systems.  Food suppliers have a strong economic 
interest in quickly isolating the source of food safety or quality 
problems, before the food item reaches consumers; all firms want to 
avoid the association of their brands with safety hazards or 
compromised quality.  A traceability system can help producers reduce 
the time required to identify and remove contaminated foods from 
production lines and from the market.  
 
Most food producers put coded information on food packaging to 
facilitate product identification.  For example, most voluntary recalls 
listed on the USDA's Food Safety and Inspection Service website refer 
consumers to coded information on products' packaging.  Some firms use 
detailed coded information. For example, one milk processor uniquely 
codes each item to identify time of production, line of production, 
place of production, and sequence.  With such specific information, the 
processor can identify faulty product to the minute of production.  If 
a food safety or quality problem were encountered, the information 
could help contain the costs of damage control.  

The struggle to control BSE in cattle in the United Kingdom has 
warranted the development of various traceability systems to document 
the distribution of beef products.  One example is the traceback system 
adopted by an Irish supermarket which uses DNA testing capable of 
tracing meat to animal of origin rather than to farm or herd.  

Improve supply-side management.  For many firms, traceability systems 
have already proven their value in managing production flows and 
tracking retail activity.  In the U.S., the vast majority of packaged 
food products, as well as a growing number of bulk foods like bagged 
apples and oranges, bear codes that enable stores and manufacturers to 
collect data on retail trade patterns.  These codes, known as bar 
codes, are composed of a series of numbers detailing standard 
information on type of product and manufacturer (the UPC code), and a 
series of numbers assigned by the manufacturer to nonstandard 
production or distribution details.  While the original purpose of bar 
codes was to facilitate tracking of retail sales by item and to 
generate information on food consumption trends and patterns, their use 
is not restricted to that purpose.  The bar code technology is also 
used to manage inventory flow.  

Manufacturers have developed other high-tech tracing systems for 
managing input and output flows.  For example, ranchers have been using 
electronic identification eartags and corresponding data collection 
cards to track information on animals' lineage, vaccination records, 
and other health data.  The advantage of electronic tags is that 
producers and packers can use transponder readers to track individual 
animal characteristics.  This allows for efficiency gains by sorting 
individual cattle in feed yards, recording preconditioning and other 
health regimes, and conducting disease surveillance and monitoring.  
Additionally, the resulting chain of documentation enables producers to 
sell their cattle at a price that reflects quality.  

Motives for Government-Mandated 
Traceability 

A government may have three reasons for considering making some 
traceability systems mandatory: to facilitate and monitor traceback to 
enhance food safety; to address consumer information about food safety 
and quality; and to protect consumers from fraud and producers from 
unfair competition.

Monitor and enhance food safety.  To help protect the public's health, 
the Federal government, along with State and local public health 
departments, plays an active role in tracing foodborne illness 
outbreaks. Both USDA and FDA rely ultimately on documentation 
maintained by private firms.

In a traceback investigation, public health officials attempt to 
identify the source of a foodborne illness outbreak and then trace the 
flow of the contaminated food throughout the food supply system. When 
investigation units trace diseases to their origin and contaminated 
foods are removed from the food supply, illnesses can be prevented and 
lives saved.  In the cases of some types of foodborne illnesses, such 
as those caused by E. coli 0157:H7, no cure is known; identifying and 
removing the source of illness is the only means of preventing the 
spread of disease.  The faster the disease-causing bacteria can be 
detected, the faster disease investigators can respond to outbreaks and 
the more lives that can be saved.

Federal government and other public health officials have taken strides 
in building the infrastructure for tracking the incidence and sources 
of foodborne illness.  The Foodborne Diseases Active Surveillance 
Network (FoodNet) combines active surveillance for foodborne diseases 
with related epidemiologic studies to help public health officials 
better respond to new and emerging foodborne diseases.  FoodNet is a 
collaborative project of the Centers for Disease Control and Prevention 
(CDC), nine states, USDA, and the FDA.

Another network, PulseNet, based at CDC, connects public health 
laboratories in 26 states, Los Angeles County, New York City, the FDA 
and USDA to a system of standardized testing and information sharing.  
PulseNet helps reduce the time it takes disease investigators to find 
and respond to foodborne outbreaks.  

Both Foodnet and Pulsenet differ from passive surveillance systems that 
rely on reporting of foodborne diseases by clinical laboratories to 
state health departments, which in turn report to CDC.  Under passive 
information gathering, only a fraction of foodborne illnesses are 
routinely reported to CDC.  

Once investigators have identified a contaminated food source, the 
Federal government works with food manufacturers to isolate the cause 
of contamination and to remove the contaminated food from the market.  
Two Federal agencies may take action: USDA and the U.S. Food and Drug 
Administration (FDA).  USDA, which regulates the safety of meat and 
poultry, does not have authority to require that manufacturers recall 
contaminated foods; recalls handled by USDA are voluntary--although 
USDA can detain or seize adulterated or misbranded products.  USDA may 
also remove inspectors from federally inspected plants that are 
recalcitrant about addressing safety problems, effectively halting 
plant operations.  Recalls handled by FDA, which regulates all domestic 
and imported food except meat and poultry, are conducted voluntarily, 
sometimes by FDA request.

Both USDA and FDA rely ultimately on documentation maintained by 
private firms to trace the flow of inputs into the final food product 
and to track the distribution of final food products throughout the 
retail sector. A firm's traceback documentation is constructed from its 
traceability system: the documentation used to trace a food from farm 
(or point of production) to plate (or retail or eating establishment) 
is used to trace a food product back from plate to farm. The Federal 
government does not monitor private firms' traceback ability, and such 
systems are not mandatory.  Mandatory, government-monitored 
traceability of private industry production would be needed only if 
private firms fail to supply enough traceback capacity.

Private firms provide the optimal amount of traceback capability if 
markets function properly. If all benefits as well as the costs of 
traceability are borne by private firms, then the market supply of 
traceback will be optimal: the net benefits of traceability systems for 
food safety will be maximized.  However, when markets fail, as when the 
benefits firms actually reap are not equal to social benefits, the 
amount of traceback capacity may not be optimal. Where the market fails 
to give food suppliers incentives to maintain traceback or other food 
safety systems, and consumers are willing to pay for more safety, there 
could be a need for intervention to increase traceability.  

But, even assuming that the operations of the marketplace do not 
provide sufficient food safety, is a government-mandated traceability 
system the best or least-cost solution? Usually, performance standards-
-rather than process standards--ensure the most efficient compliance 
systems.  With performance safety standards, such as standards for 
pathogen contamination or recall speed, the individual firm can choose 
the most efficient process to achieve a particular standard. For some 
firms, plant closure and total product recall may be the most efficient 
method for isolating production problems and removing contaminated food 
from the market.  For other firms, detailed traceback, allowing the 
firm to pinpoint the production problem and minimize the extent of 
recall may be the most efficient solution.  Other firms may be able to 
maintain safety at less expense by adopting new technologies, such as 
irradiation, and dispensing with recordkeeping. 

Process standards such as mandatory traceability require that firms 
adhere to a common set of production or management systems, regardless 
of the size or technological characteristics of the firm. As a result, 
process standards tend to be less efficient than performance standards 
for achieving product standards, including safety standards.  Likewise, 
mandatory, government monitored traceability is likely to be a less 
efficient mechanism for building food safety than enforcement of food 
safety performance standards.  

Address consumer knowledge about food safety and quality. Where markets 
produce all the information that consumers are willing to pay for, 
mandatory traceability systems would be superfluous and introduce 
unwarranted costs.  However, sometimes consumers would like more 
information about the safety and quality standards maintained by food 
manufacturers.  It is possible that mandatory, publicized traceability 
systems could help reduce such asymmetry by providing consumers 
additional safety and quality information so that consumers could more 
readily choose food products to match their preferences. For example, 
various government agencies mandate that oyster producers document the 
time and place of oyster harvest.  However, a general mandatory 
traceability system may not be the most efficient way to enhance food 
safety  enforcement of food safety performance standards is generally 
a better option. 

Protect consumers from fraud and producers from unfair competition.  To 
protect consumers from fraud, and producers from unfair competition, 
the government may require that firms producing foods with credence 
attributes substantiate their claims through traceability systems.  If 
firms are not required to establish proof that credence attributes 
exist, some may try to pass off standard products as those having 
credence attributes, in order to gain price premiums. In these cases, 
the government may require that firms producing valuable credence 
attributes verify their claims.  For example, the government may 
require that firms producing organic foods verify the claim.  No such 
verification would be necessary, of course, for conventional foods 
because typically consumers are not willing to pay more for these 
foods.  

Similar But Distinct Concerns
For Private, Public Sectors 

In the private sector, the goals for traceability of food supplies are 
mainly to assure buyers of the existence of quality attributes, to 
facilitate traceback for food safety and quality, and to improve supply 
chain management.  

The main goal of the public sector for traceability is to ensure that 
recordkeeping is sufficient for traceback, with the objective of 
mitigating foodborne public health problems.  Additionally, when 
markets fail, the public sector may have an interest in providing 
consumers with access to information about safety or quality standards 
maintained by private firms, and in protecting consumers and producers 
from fraudulent claims.  

Proponents of the EU proposal for mandatory traceability of genetically 
engineered food and feed argue that such a system is necessary 
*  to ensure the government's ability to recall genetically engineered 
products in case of unforeseen food safety or environmental problems; 
*  enhance consumer choice; and
*  to control and verify labeling claims.  

However, it is doubtful that mandatory traceability will prove to be 
the most efficient mechanism for achieving any of these objectives.  

Performance standards, which allow firms to determine the most 
efficient mechanism for compliance, are usually more efficient than 
process standards for ensuring food safety or environmental quality.  
With government-mandated food safety performance standards, all food, 
including genetically engineered food, that did not meet the standards, 
could be subject to recall and/or seizure.  A strictly enforced 
performance standard would enhance firms' incentive to maintain 
efficient food safety systems. 

When there are process attributes that are valued by consumers--like 
non-genetically engineered foods--then food suppliers may have the 
incentive to market those attributes.  Consumer surveys have indicated 
that many EU consumers are opposed to the purchase of genetically 
engineered foods. Manufacturers and retailers can opt to market non-
genetically engineered foods.  Consumers' choice of products would then 
be enhanced without imposing government mandated traceability.  Many 
retailers and food establishments are doing this--both in the U. S. and 
in Europe.

Mandatory traceability for all foods is also unlikely to be the most 
efficient mechanism for verifying quality claims for the subset of 
foods with credence quality attributes valued by some consumers, such 
as non-biotech foods.  A government may indeed have an incentive to 
require that producers of non-genetically engineered foods verify that 
these foods are actually not genetically engineered, if the non-
genetically engineered attribute is of value to some consumers.  
However, no such verification would be necessary for the genetically 
engineered foods currently on the market, because this attribute is not 
of value to consumers (most biotech products currently on the market 
boast producer, not consumer attributes).  A mandatory traceability 
system for both genetically engineered and non-genetically engineered 
foods is unnecessary to protect consumers from fraud.  Such a system 
could raise costs without generating compensating benefits.  

Elise Golan (202) 694-5424
egolan@ers.usda.gov
Barry Krissoff (202) 694-5250
barryk@ers.usda.gov
Fred Kuchler (202) 694-5468
fkuchler@ers.usda.gov

FOOD & MARKETING SIDEBAR
European Union (EU) Proposes Mandatory Traceability Standard for 
Genetically Engineered Foods and Feeds 

The European Union's (EU) proposed regulations for mandatory 
traceability and labeling of genetically engineered foods and feeds, 
unveiled in July, could take effect by the end of 2003.  

The EU mandatory traceability proposal contains the following 
requirements.

*  EU handlers of genetically engineered foods or feeds must document 
from whom they received those items and to retain and transmit 
genetically engineered-related information. Handlers would be required 
to keep records for 5 years.   
*  EU farmers must indicate that the commodity was grown using genetic 
engineering methods and further delineate each type of biotech 
transformation event that may be present in each delivery.  For 
imported commodities, this information must be provided by the 
importer. For imported processed products, the importer must indicate 
which ingredients are genetically engineered.
*  Each genetically engineered transformation event must have a 
specific unique identifier. 
*  Retail level foods must be labeled as containing genetically 
engineered ingredients on an ingredient-by-ingredient basis.

A traceability system may add to the costs to growing, handling, storage, 
transport, processing, and administering the sale of genetically engineered 
food products. Estimating the magnitude of the costs of identity preserving, 
tracing, and labeling is complex and subject to varying assumptions. Some 
key determinants of the costs include the stringency of the tolerance level, 
the ease of cross-pollination at the farm level, and the volume of the 
product transported, stored, and processed.

 
SPECIAL ARTICLE
Public-Sector Plant Breeding in a Privatizing World 

Public and private plant breeding sectors have developed and coexisted for 
more than a century  in many industrialized countries, but since 1970 the 
balance between these sectors has shifted.  The last third of the 20th 
century witnessed an acceleration in the type and level of biology 
applicable to plant breeding, as well as enhanced intellectual property 
protection for plant varieties. Meanwhile, the forces of globalization and 
the pressures on public budgets have shifted the balance of plant breeding 
activity from the public to the private sector.
Throughout the world, a variety of economic forces determine the amount of 
investment in scientific plant breeding and the relative shares of public 
and private sector efforts. Private investment in plant breeding is most 
affected by:
*  the cost of research innovation; 
*  structural market conditions;
*  organization of the seed industry;
*  the ability of firms to capture the returns to research; and
*  the constraint that seed must be sold at a price that will enable the 
farmer to make a profit.

While public investment in plant breeding is also strongly affected by the 
cost of innovation, several unique considerations serve to further justify 
public plant breeding.
*  Private firms may not consistently produce a freely available supply of 
scientific knowledge at a socially optimal level. 
*  Private and social returns from plant breeding may diverge in cases where 
firms are unable to profit from the benefits of their research. For example, 
plant breeding in the past for self-pollinating crops such as wheat was 
often done by the public sector because private sector firms could not 
charge enough for seed to make plant breeding profitable.  This is largely 
because farmers could replant seed saved from the previous harvest.  
*  The desire to earn profits in the near term may lead private firms to 
operate on a shorter time horizon than would be necessary to attain the 
broadest basic research objectives. 
*  Other traits of plant varieties (environmental suitability, including 
disease resistance and nutritional characteristics) that may remain under-
researched by private breeding programs.

Today, despite the varying dominance of private plant breeding across crops 
and countries, mixed linkages between public and private systems are the 
rule rather than the exception.  In the U.S., for example, the public sector 
maintains the national plant germplasm system, but the private sector does 
more of the breeding of finished varieties.  Traditionally, the private 
sector relied on public-sector research results.  Until the 1970s, for 
example, public sector inbreds played an important role in U.S. private-
sector corn hybrids.  Today this is no longer the case. Presently, the 
public sector instead may utilize private-sector research results in some 
areas of biotechnology.  Funding mechanisms, as well as institutional 
cooperation and competition in plant breeding, are often quite complex. This 
has led to considerable discussion of the appropriate roles for public- and 
private-sector activity.
Although data on investment in plant breeding are hard to come by--even for 
the public sector--available information for several industrialized 
countries shows that, in absolute amounts, the U.S. probably invests more in 
plant breeding than any other country. In the mid- to late 1990s, annual 
plant breeding investment for U.S. field crops was an estimated $150-$340 
million in the public sector and $260-$410 million in the private sector.  
These estimates exclude many of the biotechnology investments related to 
plant breeding.  In contrast, in the early 1990s Australian public 
investment in plant breeding for field crops was valued at just over $30 
million.  However, if plant breeding investment is divided by the value of 
output, the U.S. dominance suggested by the absolute totals disappears. For 
most countries and crops, annual investment in plant breeding is less than 1 
percent of the gross value of production--the notable exception is Canadian 
canola.
In the late 1990s, fueled by huge private and public sector investment in 
canola breeding, plant breeding investment for major Canadian field crops 
was valued at over $130 million annually.  This canola investment may not be 
strictly comparable to estimates for other industrialized countries or crops 
because it includes more expenditures on biotechnology.
In the early 1990s, wheat breeding research expenditures per ton of wheat 
produced in the United Kingdom were considerably higher than the same 
estimates for the U.S. On the other hand, wheat breeding investment per ton 
of wheat is lower in Australia, Germany, and Canada than it is in the U.S.
Public vs. Private: 
A Case-By-Case Distinction

Crop-specific technical and market factors often determine the relative 
shares of public and private plant breeding investment. These factors, 
however, vary over time as well as from country to country.

Real inflation-adjusted investment in public-sector plant breeding in the 
U.S. rose until the 1980s but began to stagnate during the mid-1990s, 
followed by a decline. In contrast, from the mid-1960s to the mid-1990s, 
real private-sector investment in plant breeding grew at a remarkable 7 
percent annually. Comprising only one-sixth of the public-sector total in 
the 1960s, private-sector plant breeding surpassed public investment by the 
mid-1990s.
Trends in other industrialized countries are more difficult to trace, but in 
some European countries, such as France and Germany, private-sector plant 
breeding has long had a very strong presence. In the United Kingdom, the 
Plant Breeding Institute at Cambridge, notable for its development of wheat 
and barley varieties, was privatized in 1987, signaling a general trend. 
Given the large private-sector investment in canola breeding in Canada, the 
private-sector total there may now be higher than the public sector's, 
although public sector breeding is still dominant for the other major 
prairie crop, wheat. Australian plant breeding still appears to be conducted 
primarily in the public sector.

Because hybrid crop seed cannot be duplicated, private-sector investors have 
incentives to favor research that produces hybridized seed.  As might be 
expected, the area of the U.S. planted to field corn is dominated by hybrids 
developed in the private-sector. Private sector hybrids also dominate in the 
European Union and in Canada.  Public-sector inbreds--genestocks which are 
combined to form hybrids--played an important role in U.S. private-sector 
hybrids until the 1970s, when their direct influence began a sharp decline. 
Public sector breeding has long prevailed for improving self-pollinating 
crops, which farmers may replant from seed saved from a previous crop.  Yet 
even in the case of self-pollinating crops, plant breeding has shifted to 
the private sector over the past 20 years or more.  This has happened 
especially in the U.S. for soybeans and in Canada for canola. Already by 
1970, the majority of the U.S. area planted to cotton was planted to 
private-sector varieties, and today the share has increased to over 90 
percent.
Though the private sector's emergence has been abetted by increased 
intellectual property protection for plant varieties, each crop illustrates 
the influence of outside factors as well. These include: 
*  popularity of the corn-soybean rotation, which has led farmers accustomed 
to buying private-sector corn seed to begin buying private-sector soybean 
seed as well.  The shift from public to private sector soybean varieties 
began at least 20 years ago, well in advance of the introduction of 
herbicide-tolerant soybeans in the mid-1990s.
*  growing impracticability of farmer-saved seed in cotton; and 
*  payoffs of earlier research in canola sponsored by the edible-oil 
processing industry, which applied several types of intellectual property 
mechanisms to protect varieties grown in the field. 

Most Australian and Canadian wheat area is still planted to varieties that 
were developed in the public sector, although a rapidly growing percentage 
(around 10 percent in Australia and just under 40 percent in Canada) is sown 
to varieties which are subject to some sort of intellectual property 
protection. In contrast, European wheat acreage is increasingly dominated by 
private varieties, reflecting the different breeding histories and stronger 
plant variety protection of many European countries. 
The U.S. situation is intermediate. Over the past 20 years, an increasing 
proportion of the U.S. wheat area has come to be planted to private 
varieties. However, private varieties are far more prominent in the soft red 
winter wheat areas where wheat is grown primarily as a rotation crop, than 
in the major hard red winter, hard red spring, and white growing areas where 
public varieties still dominate in farmers' fields.  As in the case of 
soybeans, farmers using purchased seeds for a rotation crop such as corn are 
more likely to buy private-sector wheat seed.
Public-Sector Research Still
Finding Its Place 

Many prominent plant breeders, as well as a some research policy analysts, 
are in general agreement about the future role of public plant breeding. In 
many cases, there is clear economic justification for public-sector 
investment in activities related to plant breeding.  Considerably less 
consensus exists on determining an appropriate public stance on intellectual 
property issues. Given the growing role played by the private sector, public 
research may increasingly respond to voids left by private sector research, 
and may be increasingly directed toward the interests of the scientific 
community at large.  Such roles could include the following.

* Educating and training plant breeders.  By coordinating training efforts 
between the public and private sectors, the public sector might continue to 
foster the public goods component of human capital development. To the 
extent that plant breeding skills are not firm-specific, firms will not 
invest optimally in training, given the likelihood the scientist might jump 
to a rival firm. At the same time, private sector firms require a steady 
supply of plant breeders with skills that may extend to molecular biology, 
and even some knowledge of general business theory and intellectual 
property.

*  Refining and testing methodologies for variety selection.  This would 
include developing and testing molecular-based systems and developing new 
methods of selection for desirable traits such as pest resistance. Despite 
private sector enthusiasm for some elements of genomics and proteomics (the 
study of proteins encoded by an organism's genes), scientists still lack a 
complete understanding of gene action, interaction, promotion, and 
silencing, which could be used in crop improvement. All life sciences 
express the need for further advances and more training in computational 
biology--and knowledge has a public goods component. The public sector does 
appear to be increasing the proportion of resources directed to more 
fundamental research.

*  Increasing public commitment to germplasm preservation and development.  
Both research analysts and the private sector advocate this role. Germplasm-
related activities include collection and preservation of germplasm from 
crop species and their wild relatives, and incorporation of useful traits 
from this germplasm into material adapted agronomically to the target 
region. Social returns are very likely greater than private returns in the 
germplasm maintenance and pre-breeding areas, unlike the relative returns 
for variety development. This may be because of differences between social 
and private discount rates and risk preferences.  Furthermore, there are 
larger barriers to appropriating research returns in germplasm maintenance 
and pre-breeding than there are in producing finished varieties.

*  Attending to minor crops.  It is somewhat more difficult to argue, with 
economic reasoning, for public breeding applied to minor crops (i.e., those 
with small markets). While such specialty crops grow well only in a modest 
area and are saddled with a limited seed market, their production may still 
benefit consumers nationwide, and in some cases public breeding may be 
justified. Since many fruits and vegetables fall under the heading of minor 
crops, nutritional considerations may direct some public-sector resources to 
these crops.  As it becomes feasible for research on one plant to address 
plant breeding problems in another plant, at least some of the plant 
breeding needs of minor crops may be addressed by research on major crops.

*  Solving technological bottlenecks.  The public sector may "invent around" 
technological bottlenecks due to private ownership of intellectual property. 
However, public institutions may want to guard against overinvolvement in 
near-market, product-focused research, at the expense of fundamental 
research that does not have immediate market applicability. Besides, private 
firms may also have strong incentives to invent around technological 
bottlenecks.

*  Identifying problems and limitations of existing agricultural technology, 
including existing crop varieties. While the private sector can play a role 
in the identification of such limitations, the public sector is likely to 
take a more long-term view, and to represent a broader constituency.  For 
example, the public sector may place more emphasis on the environmental 
suitability of varieties.

Intellectual Property: Important 
But Imperfectly Understood 

As plant breeding research moves from conceptual development to later 
stages, its value may be affected by the intellectual property regime.  In 
the U.S., this regime consists of at least three legal components, as well 
as the interpretation that has developed around the legislation.
*  Plant patents for asexually reproducing species were instituted in 1930.  
*  Plant varietal protection certificates for sexually reproducing species 
that are genetically stable--that is plants that breed true to type--became 
available with the Plant Variety Protection Act of 1970, which was amended 
in 1994.  
*  The U.S. Supreme Court ruled in 1980 that standard utility patents--the 
major type of patent granted by the Patent and Trademark Office--could be 
granted to living material, and in 1985 utility patents were explicitly made 
applicable to plants. Today utility patents are sometimes granted not only 
for genetic engineering constructs, but also for entire plants, such as corn 
inbred lines, corn hybrids, and soybean varieties, even if these plants were 
developed without the use of "modern" biotechnology.  In December, 2001, the 
Supreme Court upheld the applicability of utility patenting to plants.

Intellectual property regimes affect private-sector efforts both in near-
market variety development and investment in more "basic" research such as 
genomics. More specific recommendations on problems or potential changes in 
the intellectual property system affecting the life sciences have come more 
often from lawyers than from economists or, for that matter, from plant 
breeders.
Economists clearly have a role to play in making theoretical and empirical 
headway in answering questions about industrial organization and 
intellectual property, addressing questions such as the following.
*  Will the dominant form of private sector activity in plant breeding come 
from firms that are considered "life sciences giants" or from those more 
specialized in agriculture?
*  Will large multinational firms supplying new plant varieties be like the 
pharmaceutical industry, looking for blockbuster products, or like the 
semiconductor/computer/software industries where a "cumulative innovation" 
model prevails?

Whatever the answers to these questions, society benefits when the public 
sector has "freedom to operate"--for example, when it maintains public 
access to research tools subject to intellectual property protection by the 
private sector, and when it engages in fruitful collaborative research. In 
its interaction with the private sector, public-sector plant breeding will 
benefit from continuous and careful performance review.  This review might 
consider the ways in which public sector research complements, rather than 
substitutes for, private-sector plant breeding.
 Across all the life sciences, precedent determined by internal policy in 
patent granting institutions such as the U.S. Patent and Trademark Office, 
as well as by court decisions, is likely to be at least as important as 
formal policy revisions by national legislatures.  As many of the policy 
changes in the area of intellectual property will be directed primarily to 
human health research, agricultural science policymakers are well advised to 
debate larger science policy issues.
Economists have not reached complete consensus on the economic models of the 
influence of institutions (such as the intellectual property regime) on both 
private-sector plant breeding investment and the public sector's freedom to 
operate and to collaborate with the private sector.  Nor have they fully 
determined the data and methods necessary to test these models.  Thus there 
is ample room for future economic research to contribute to policy debates 
over the roles of public- and private-sector plant breeding. Nonetheless, it 
is clear that public-sector plant breeding will yield the largest social 
returns if it continues to focus on research directed at carefully 
identified problem areas, with clear public goods components. 

Paul W. Heisey (202) 694-5526; 
Pheisey@ers.usda.gov
C.S. Srinivasan, University of Reading, UK 
c.s.srinivasan@reading.ac.uk
Colin Thirtle, Imperial College, University of London, UK  
c.thirtle@ic.ac.uk
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