AGRICULTURAL OUTLOOK                                        February 21, 2001
March 2001, ERS-AO-279
               Approved by the World Agricultural Outlook Board
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CONTENTS
IN THIS ISSUE
BRIEFS

Specialty Crops: Cutbacks in Potato Acreage Likely in 2001 Livestock, Diary, &
Poultry: Hog Producers' Returns To Moderate In 2001
Resources & Environment: Conservation Tillage Firmly Planted in U.S. Agriculture

WORLD AGRICULTURE & TRADE
Institutional Reform in Russia

FOOD & MARKETING
Changing Dynamics in Produce Marketing Marketing Fees Reflect Supplier-
Supermarket Relationship

SPECIAL ARTICLE
Crop Production Capacity in Europe

IN THIS ISSUE

Cutbacks in Potato Acreage Likely in 2001

Record-high U.S. potato stocks and a corresponding drop in grower prices are
prompting growers to plant fewer acres this year. To what extent growers will
cut back remains in question as they evaluate market potential for alternative
crops such as dry beans, wheat, sugar beets, and soybeans. A record harvest last
fall (471 million cwt of potatoes) accounts for the current abundance of spuds
and lower grower prices, which for OctoberDecember 2000 averaged 15 to 20
percent below year-earlier prices. Charles Plummer (202) 694-5256;
cplummer@ers.usda.gov

Hog Producers' Returns to Moderate in 2001

Pork production in 2001 is forecast up 2 percent from 2000, based on market hog
inventory, pig crops, and farrowing intentions reported in December. As a
result, hog prices in 2001 are expected to average in the low $40's per cwt,
compared with nearly $45 in 2000 and the mid-$30's in 1998 and 1999. With low
feed prices expected to continue, producer returns should remain above breakeven
(returns equal to cash costs) for most of the year. Leland Southard (202) 694-
5187; southard@ers.usda.gov


Conservation Tillage Firmly Planted in U.S. Agriculture

Farmers across the nation used conservation tillage (no-till, ridge-till, and
mulch-till) on more than 109 million acres of farmland in 2000, amounting to
over 36 percent of U.S. planted cropland area and up from 26 percent in 1990.
Use of no-till expanded threefold during the decade to reach more than 52
million acres, due partly to implementation of conservation compliance plans
required to remain eligible for farm program benefits. Conservation tillage
together with other crop residue management practices helps reduce soil erosion,
slow nutrient and pesticide runoff, and cut farmers' fuel costs.
Carmen Sandretto (202) 694-5622; carmens@ers.usda.gov

Institutional Reform in Russia

Russia is a key customer for U.S. agricultural exports, especially meats. But
the institutions inherited from the Soviet
Union make it a relatively high-cost and risky country in which to do business.
Western exporters operating in Russia face substantial costs in transporting
meat between ports and provincial regions, in obtaining information about
agricultural markets, and in enforcing contracts. Unreformed institutions not
only function poorly in a market environment but have withstood most attempts to
alter them. A recent Economic Research Service study shows that most of the
Russian livestock market, for example, is isolated from world markets--in great
part a result of the high costs of doing business within the country. Stefan
Osborne (202) 694-5154; sosborne@ers.usda.gov

Changing Dynamics in Produce Marketing

A large share of today's fresh produce is sold directly by shippers to
retailers, bypassing intermediaries and terminal wholesale markets. Price may be
just one component of a more complex shipper/retailer sales arrangement that 
could include offinvoice fees to retailers such as promotional fees or rebates, 
as well as services such as automatic inventory replenishment. In addition, 
while the fresh produce industry has traditionally marketed primarily through 
daily sales arrangements, the volume requirements of very large produce buyers 
and the demand for reliable, year-round availability and quality of produce is
making longer term arrangements--i.e., contracts--more desirable for both
shippers and retailers. Linda Calvin (202) 694-5244; lcalvin@ers.usda.gov

Marketing Fees Reflect Supplier-Supermarket Relationship

In supplier-supermarket arrangements for marketing a variety of products, the
use of marketing fees to retailers--e.g., rebates, shelf-placement fees, and
advertising allowances--is becoming more common. Specialized fee agreements
between suppliers and food retailers may be fixed payments or may vary with the
quantity exchanged in the transaction or with volume of sales of a particular
product. Most controversial is the "slotting"  fee, a lump sum paid by suppliers
to retailers for introducing new products to supermarket shelves. From the
anticompetitive perspective, marketing fees are the result of changing balances
in supplier vs. retailer market power, but the procompetitive view argues that
fees help to enhance market efficiency. Carolyn Dimitri (202) 6945252;
cdimitri@ers.usda.gov

Crop Production Capacity in Europe

From Spain to Ukraine, agricultural production is pursued under a vast array of
agronomic and political conditions. In Western Europe, policies in recent
decades have maintained high farm prices and provided income payments to 
farmers, often leading to surplus production. The region has been a large 
grain exporter for over two decades. In the countries of the former
Soviet Union (FSU) and in Eastern Europe where countries had been under Soviet
influence, withdrawal of consumer and producer subsidies following political
independence in the early 1990's resulted in lower crop yields and production.
In the decade ahead, Europe as a whole will continue to be a net exporter of
grain, although the magnitude of exports will depend partly on the ability of
the FSU, particularly Russia and Ukraine, to develop institutions and policies
to accommodate the new market conditions, encourage investment in the
agricultural sector, and increase production capacity. David R. Kelch (202)
694-5151; dkelch@ers.usda.gov

BRIEFS
Specialty Crops: Cutbacks in Potato Acreage Likely in 2001

Record-high U.S. potato stocks and a corresponding
drop in grower prices are prompting growers to plant fewer acres this year. To
what extent growers will cut back remains in question, as they evaluate market
potential for alternative crops such as dry beans, wheat, sugar beets, and
soybeans. While some potato industry groups and representatives are urging
growers to cut acreage by as much as 10-15 percent, growers will shift
significant acreage away from potatoes only if alternative crops show a clear
economic advantage. Based on expected relative returns as of early February,
growers may decrease potato acreage by as little as 2 to 5 percent.

A record harvest last fall (471 million cwt of potatoes) accounts for the
current abundance of spuds. A combination of increased acres harvested (up 3
percent from fall 1999) and record yields (up 7 percent) pushed U.S. potato
production for the year to nearly 516 million cwt (up 8 percent from 1999 and 3
percent above the 1996 record). Adding pressure to oversupply is a record
Canadian potato crop of 101 million cwt.

From October through December, grower prices averaged about 15 to 20 percent
below those of the same period a year ago. While prices contracted with french
fry manufacturers prior to the growing season limited the decline for processing
potatoes to less than 10 percent, fresh potato prices fell an average of 31
percent. Average retail prices for fresh potatoes were down 9 percent in October-
December from a year earlier, responding to grower prices in the typical
pattern. (Retail prices typically do not change as much as grower prices from
year to year because some key components of retail prices, such as marketing and
transport cost, are independent of grower costs.)

Retail prices for processed potato products such as french fries have not
reflected the significant decrease in grower prices. Although the cost of raw
potatoes to processors fell, average retail prices for frozen french fries for
the October-December period actually increased by 2 percent over the same 
period in 1999. A significant increase in the cost of energy to run processing 
facilities in the winter of 2000/01 accounts for the rise. In fact, spiraling 
energy costs led at least two potato dehydrating facilities to suspend 
operations temporarily.

Despite rising energy costs, most frozen potato processors have used the
abundant supply of low-cost raw potatoes to boost inventories of frozen potato
products. Their stocks on January 1 were 1.2 million lbs, up 1 percent from last
year. Potatoes used for processing this season through January 1 hit a record
high 95 million cwt, up 5 percent from last year and 2 percent above the 1996
record.

Despite heavy use by processors, stocks of fresh potatoes from last fall's crop
remained at record-high levels on January 1, an abundance that has growers
worried. If energy costs remain high, processing use may slow, and last year's
supply could carry over into this fall's harvest. At that point, another large
fall crop would probably push grower prices even lower next year.

Hoping to nip that possibility in the bud, the Potato Growers of Idaho created
the Potato Management Company (PMC), a marketing cooperative that intends to
remove some of the fall 2000 potatoes from the supply chain to raise grower
prices. The company is buying potatoes from member growers for a nominal fee and
disposing of them (primarily by dumping on fields and donating to charity).
Participation in the plan is voluntary and is not limited to Idaho growers. 
The hope is that market prices for the remaining potatoes rise enough to more
than offset the revenue lost from the dumped potatoes. PMC's success in pushing
up prices for growers depends entirely on how many potatoes it is able to remove 
from the market. Participating growers will pay a membership fee to PMC to 
administer the program.

Outside the U.S., rising demand for U.S. potatoes and potato products is
expected to continue. In the first 2 months of the 2000/01 marketing year
(October and November), fresh potato exports were up 9 percent from a year
earlier, and exports of frozen french fries were up 14 percent. Reduced potato
output in Europe last fall should mean the U.S. can maintain a competitive edge
in foreign markets for frozen french fries this year, particularly in Asia and
the Pacific Rim. A drop in U.S. interest rates could weaken the dollar relative
to many foreign currencies, which would boost these exports even further.

Despite strong foreign demand, the production and price outlook for potatoes in
2001 remains uncertain. A 3-percent cut in potato acreage, combined with average
acreage abandonment and trend yields, would bring total production for the year
to about 476 million cwt, near the 5-year average and down 8 percent from 2000.
But another exceptional growing season like last year's could easily push
production well over 500 million cwt again.

USDA's first official estimate of planted acreage for
spring potatoes will be released in April, and the summer and fall acreage
estimates will be released in July.
Charles Plummer (202) 694-5256
cplummer@ers.usda.gov

SPECIALTY CROPS BOX
Imports of Canadian Fries Continue to Rise

Demand for frozen french fries has increased steadily over the past three
decades. U.S. per capita consumption of frozen potato products (primarily french
fries) has increased by 30 percent since 1990 (by over 70 percent since 1980 and
113 percent since 1970).

While the U.S. potato processing industry has expanded tremendously during this
time, the Canadian industry has also experienced rapid growth, particularly in
the past decade. Canadian fries are destined mainly for U.S. fast-food
restaurants, with fry imports from Canada increasing an average of 26 percent
per year since 1989. Canadian-produced fries currently account for about 13
percent of all fries consumed in the U.S., up from about 2 percent in 1989. In
2000, total fry imports from Canada are forecast at 1 billion pounds, 17 percent
higher than 1999.

The Canadian/U.S. exchange rate has been a significant factor in the rapid
increase in Canadian production capacity and exports to the U.S. over the past
decade. The value of the Canadian dollar has fallen 20 percent relative to the
U.S. dollar since 1989, enhancing the price competitiveness of Canadian
products. And although the value of the Canadian dollar is expected to increase
somewhat over the next several years, Canadian processing capacity is still
expanding and will likely result in increasing exports of fries to the U.S.

BRIEFS
Livestock, Diary, & Poultry: Hog Producers' Returns to Moderate In 2001

Higher farrowing intentions signal increased pork production in 2001, resulting
in lower hog prices that will reduce producers' returns. But with low feed
prices expected to continue, returns should remain above breakeven (returns
equal cash costs) for most of the year.

In 2000, hog prices averaged in the mid-$40's per cwt, compared with the mid-
$30's in 1998 and 1999. Higher hog prices, along with relatively low feed
prices, drastically improved producers' returns, which were above breakeven in
early 2000 for the first time since late 1997. Responding to the improved
returns, in the fourth quarter producers reversed the decline in the number of
sows farrowing that had persisted for seven quarters. The number of sows
farrowing during September-November rose 1 percent compared with the same period
a year earlier, and producers in December indicated intentions to increase the
number by 2 percent during December-May.

Farrowing intentions in December-February are up 4 percent from actual
farrowings a year earlier and slightly higher than reported in September. March-
May farrowing intentions are up just 1 percent from actual farrowings a year
earlier--lower than expected by many analysts. The cautious increase could be
attributed to concerns about a possible squeeze on slaughter capacity in late
2001 when most of the March-May pig crop comes to slaughter, or may reflect that
the capacity of existing farrowing facilities has been reached. The lead-time to
build new facilities today has been lengthened compared with several years ago
due to the need to raise large amounts of capital for the larger farrowing
facilities and environmental regulations (which increase the time needed to
obtain operation permits).

Based on the market hog inventory, pig crops, and farrowing intentions reported
in December, commercial pork production in 2001 is forecast at 19.25 billion
pounds, up 2 percent from 2000. If this level of production is realized, it
would be just 28 million pounds short of the record set in 1999.

Pork production in first-quarter 2001 will likely be down less than 1 percent
from a year ago. The JuneAugust 2000 pig crop implies a first-quarter 2001
slaughter of about 24.7 million head, down from 25 million a year earlier. Given
the heavy dressed weights in January and the upward trend in weights, the
average dressed weight is expected to rise about 2 pounds.

Most of the September-November pig crop will be slaughtered in second-quarter
2001. Dressed weights are expected to decline from the first quarter but still
be about a pound above a year ago. The larger pig crop and dressed weights are
expected to boost pork production in the second quarter about 2 percent above a
year ago.

With pigs per litter expected to be up slightly, the DecemberFebruary pig crop,
which will be slaughtered mostly in the third quarter, is expected to be up 4-5
percent. The average dressed weight for the quarter jumped 4 pounds in 2000 and
is expected to climb another pound this year. Third-quarter pork production is
expected to total about 4.8 billion pounds, up 5 percent from last year.

December farrowing intentions for March-May imply a pig crop of about 26 million
head. If these intentions are realized, fourthquarter slaughter would also total
26 million head, and production would total nearly 5.1 billion pounds, up just 1
percent from a year earlier.

Although the economy is slowing, per capita consumption of pork is expected to
change little yearover-year. In the first half of the year, the slowing economy
and sharply higher energy costs this heating season, which will tighten
household budgets, may temper the strong demand experienced last year. In
addition, the outlook is for increased year-over-year pork supplies beginning in
the second quarter. As a result, prices are expected to average about the same
in the first quarter as a year earlier (low $40's per
cwt) and in the mid-$40's in the second and third quarters. In 2000, hog prices
averaged $50 in the second quarter and $46 in the third quarter.

In fourth-quarter 2001, seasonal influences, along with rising pork and poultry
production, are expected to pressure hog prices into the mid-$30's per cwt. Beef
production, however, is expected to be down sharply, which will reduce the
overall level of competition at the meat counter. Weekly federally inspected hog
slaughter is expected to exceed 2 million head per week except for holiday
weeks. When slaughter rates exceed 2 million head per week for an extended
period, slaughter capacity is strained and hog prices are bid down.

Overall, hog prices in 2001 are expected to average in the low $40's per cwt,
compared with nearly $45 in 2000. However, given the expected continuing low
feed prices, producers' returns should support a year-overyear increase in the
number of sows farrowing this year. This suggests a further rise in pork
production in 2002.

Retail pork prices (as measured by the Bureau of Labor Statistics price index)
are expected to average about the same in 2001 as in 2000. In 2000, prices rose
a sharp 7 percent. The farm-to-retail price spread is expected to widen as farm
value declines. In 2000, the farm-to-retail spread narrowed 2 cents per pound
after 2 years of stable spreads.

U.S. pork exports are expected to rise 2 percent in 2001, after a 1-percent rise
in 2000. Pork exports continue to face stiff competition in the slow-growing
world meat markets. Pork imports rose 17 percent in 1999 and in 2000, due
largely to increased imports from Canada. In 2001, pork imports are expected to
slow dramatically as U.S. production rises and pork prices decline. Leland
Southard (202) 694-5187 southard@ers.usda.gov

BRIEFS
Resources & Environment: Conservation Tillage Firmly Planted in U.S. Agriculture

Farmers across the nation used conservation tillage (no-till, ridge-till, and
mulch-till) on more than 109 million acres of farmland in 2000, over 36 percent
of U.S. planted cropland area and up from 26 percent in 1990. Expansion of no-
till accounts for most of the growth in conservation tillage in the last decade.
In 2000, no-till was used on over 52 million acres of 297 million
cropland acres planted --17.5 percent--a threefold increase in notill acreage
since 1990.

Some of the rise in no-till use since 1990 occurred as farmers implemented
conservation compliance plans required to remain eligible for farm program
benefits under the 1985 Food Security Act and subsequent farm legislation. As
use of conservation tillage increased, acreage in no-till rose while use of
ridgetill and mulch-till remained fairly stable through 1998.

With implementation of new and improved data collection procedures in 2000,
acreage identified as mulch-till dropped substantially from 1998 (data were not
collected in 1999). Whereas some of the expansion in no-till usage since 1998
likely came from farmers switching from mulch-till, the decline in reduced
tillage acreage is most likely a result of the new procedures that determined
residue levels were below the 15percent threshold, moving that acreage to the
conventional/intensive-till category.

Conservation tillage is one component of conservation through crop residue
management (CRM). CRM includes preserving residue from the previous crop and
reducing the number of times equipment passes over a field. A cover of crop
residue helps cut soil losses from wind and water erosion. Crop residue
management practices, when applied appropriately, can improve soil quality,
decrease emissions that contribute to global warming, enhance water and air
quality, and provide higher economic returns to farmers.

CRM helps improve soil quality by reducing soil erosion, building soil organic
matter, improving soil tilth (to aid root penetration), increasing soil moisture
(through reduced water runoff, enhanced water infiltration, and suppressed
evaporation), and minimizing soil compaction. These benefits can protect soil
productivity to maintain or increase future crop yields.

Elimination or reduction of tillage activity through CRM slows the breakdown of
soil organic matter into carbon dioxide, reducing emissions of one of the gases
associated with global warming. Recent research indicates that continuous no-
till has the potential to increase organic matter in the top 2 inches of soil by
about 0.1 percent each year, on average, and to sequester up to 10 tons of
atmospheric carbon per acre over 25-30 years. In addition, CRM requires fewer
trips across the field and generally less horsepower for field operations, which
in turn reduces fossil fuel emissions.

A major water quality benefit of CRM is to help keep nutrients and pesticides on
the field where they can be used by crops, and reduce their movement into
surface water (nearby lakes and streams) or groundwater. Crop residues left on
the soil surface improve air quality by reducing wind erosion and the generation
of dust that contributes to air pollution.

Economic benefits to farmers from CRM derive primarily from higher returns due
to an overall reduction in input costs of $20 $40 per acre. Yield response to CRM
is usually positive or neutral. Crop yields vary with site-specific soil
characteristics, local climate, cropping patterns, and level of management
skills. In general, decreasing the intensity of tillage and/or reducing the
number of field operations results in lower machinery, fuel, and labor costs, as
well as time requirements for the farm operator.

Cost savings of conservation or reduced tillage may be offset somewhat by
increases in chemical costs for
controlling weeds and insects and in starter fertilizer costs to attain optimal
yields. But reducing labor and time requirements through use of conservation or
reduced tillage may also cut the "opportunity costs" of time spent on farming--
e.g., freeing time to add income by farming more acres, expanding other farm
operations, or working at an offfarm job.

Expanded use of no-till, which can leave as much as
80 percent of
the soil surface covered with crop residues, has been significant on all major
crops over the last decade, but no-till continues to be more widely used for row
crops such as corn and soybeans than for small grains or sorghum. Fields planted
to row crops tend to be more susceptible to erosion because these crops provide
less vegetative cover, especially early in
the growing season.

Use of no-till is especially important for doublecropping because it facilitates
planting the second crop quickly and limits potential moisture losses in the
seedbed, allowing greater flexibility in cropping sequence or rotation. No-till
was used on more than 60 percent of acreage double-cropped to soybeans in 2000.

Most of the increase in no-till acreage since 1998 occurred in Illinois,
Indiana, Iowa, and Ohio, where no-till soybean acreage was up by a total of 1.8
million acres. Ohio and Indiana used notill on 60 percent of planted soybean
acreage. Illinois, Indiana, and Iowa increased no-till corn acres by 1.4 million
in the past 2 years.

In 2000, the Midwest region planted almost 27 million cropland acres using no-
till--25 percent of total cropland acres. Kansas increased no-till acres by
almost 830,000 acres between 1998 and 2000, but still trailed Nebraska in
overall use of no-till among Northern Plains states. Tennessee and Kentucky both
planted 55 percent of their corn acres with no-till in 2000, and Tennessee used
no-till in planting 45 percent of its cotton acres. Improvements in weed control
options, including genetically engineered (biotech) cotton, contributed to the
no-till increase in the Southeast region.

Given the conservation and potential economic advantages of conservation tillage
systems and efforts to promote conservation, why aren't conservation systems
used more widely on U.S. cropland? First, adoption is the final step in a
complex process, so the one-fifth of cropland acres already in reduced tillage
may be in a transitional stage to conservation tillage. Second, for some soil,
climatic, or cropping situations, use of conservation tillage systems has not
yet been demonstrated to consistently produce the healthy plant population
required for favorable economic results. Third, the additional management skill
requirements and potential economic risk involved in changing systems are
further deterrents to adoption of conservation tillage practices. Additional
limiting factors include attitudes and perceptions against new
practices and, in some cases, institutional constraints such as lenders or
landlords that are reluctant to encourage adoption of new technology because it
has the potential to increase variability of yields and net returns.
Agricultural researchers and farm equipment manufacturers have improved
conservation tillage equipment designs over the last decade to produce a range
of CRM equipment suitable for use under a variety of field conditions. The
outlook for CRM adoption for the 2001 growing season will likely be positively
influenced by a combination of low commodity prices and higher input costs,
especially for diesel fuel, that encourage farmers to seek potential cost-
savings from CRM without sacrificing yield.
Carmen Sandretto (202) 694-5622
carmens@ers.usda.gov

RESOURCES & ENVIRONMENT BOX
Crop Residue Management for Systematic
Conservation

Crop residue management (CRM) systems use fewer
and/or less intensive tillage operations,
including the elimination of
plowing (inversion of the surface layer of soil). CRM systems are often combined
with cover crops and other conservation practices to provide sufficient residue
cover to protect soil from wind and water erosion. Tillage systems associated
with CRM practices are:
    reduced tillage (15-30 percent residue), and conservation tillage (more than
    30 percent
residue), which includes mulch-till (soil is disturbed prior to planting),
ridgetill (residue left on the surface between tilled ridges), and notill (no
tillage performed).
CRM is generally a cost-effective method of erosion control that requires fewer
resources than intensive structural measures such as terraces, and can be
implemented in a timely manner to meet conservation requirements and
environmental goals.
RESOURCES & ENVIRONMENT BOX
USDA's Crop Residue Management Survey

The Crop Residue Management Survey, conducted by USDA's Natural Resources
Conservation Service (NRCS), collects information on crops planted, residue
level for various tillage systems, and other field data from each agricultural
county in the U.S. To derive 2000 tillage/residue estimates, NRCS and other
conservation partners adopted new data collection procedures to provide more
accurate information and to include more crops in the assessment of tillage
system usage by crop. Findings of the 2000 Crop Residue Management Survey are
reported by the Conservation Technology Information Center (CTIC) in West
Lafayette, Indiana (see www.ctic.purdue.edu).


WORLD AGRICULTURE & TRADE
Institutional Reform in Russia

Russia is a key customer for U.S. agricultural exports. But due to the
inadequacies of institutions
inherited from the Soviet Union, it is a relatively high-cost and risky country
in which to do business. Nearly a decade of attempts to produce genuine
institutional change has rendered small results. The financial crisis of 1998
amply demonstrated Russia's inability to institute meaningful reforms in budget
planning, tax collection, and myriad other areas. Perhaps most significant for
Western exporters, Russia's barriers to trade have impeded the growth of trade.

Trade barriers can be deliberate policy measures, such as tariffs and quotas, or
they can be unusually high transaction costs that stem from institutional
shortcomings. Most Western economies have been able to eliminate institutional
inadequacies over time, so transaction costs are relatively unimportant.

In contrast, Russia and the other countries of the former Soviet Union have
inherited institutions from the Soviet era that not only function poorly in a
market environment but have withstood most attempts to alter them. These
unreformed institutions have engendered considerable trade transaction costs,
which in turn have cut off large portions of the country from the benefits of
domestic and international trade.

Major Costs of Doing
Business in Russia

Impediments to trade in Russia are of particular concern for U.S. meat
exporters. Since the breakup of the Soviet Union, Russia has become an
increasingly important market for U.S. meat and poultry exports. As trade grew,
from 1995 to 1998, exports to Russia averaged 43 percent of the value of all
U.S. poultry exports and
12 percent of the value of U.S. frozen pork exports. The U.S. supplied Russia
with more than half of the poultry consumed there. In 1998, the financial crisis
in Russia severely disrupted this robust trade relationship. Meat exports to
Russia collapsed after a combination of low oil prices and meager tax revenues
led the country to default on its own debt issues.

In the ensuing years, the U.S. has continued to be a major supplier of Russia's
livestock needs, and U.S. poultry exports have recovered to more than half of
their pre-crisis levels. But the high costs and risks of conducting business in
Russia continue to present challenges to U.S. exporters. U.S. pork exports to
Russia have remained stagnant, but this is due more to subsidized competition
from the European Union rather than to Russia's institutional barriers to trade.

A recent Economic Research Service (ERS) study shows that most of the Russian
livestock market is isolated from world markets--in great part as a result of
the large costs of doing business within the country (see box). In particular,
transporting meat and other goods between ports and provincial regions,
obtaining information about agricultural market opportunities, and enforcing
existing contracts involve substantial costs for Western exporters operating in
Russia.

Under communism, Russia's transportation
infrastructure favored delivery of imported goods to urban centers; it provided
only rudimentary links between most rural areas and cities. As Russia has had
little money to update the system, it is still less expensive to import
agricultural goods from the West than from the country's provincial regions. As
a result, Western importers enjoy an advantage in Russia's urban markets,
particularly in Moscow and St. Petersburg. What they cannot do, however, is
expand their export base into other parts of Russia, where trade opportunities
remain largely untapped.

While the lack of modern transportation infrastructure provides some advantages
to Western livestock producers who export to major Russian cities, the lack of
freely available market information puts them at a disadvantage. Again, the
problem has its roots in Russia's communist past. Because Soviet central
planners determined output targets and prices administratively, there was no
need for farmers to gather market information--nor for a national-level
institution that would gather and disseminate information to them. To this day,
Russia has no counterparts to the public and private institutions in the U.S.
that provide farmers with price information and analysis on a daily basis
throughout the country, such as USDA's Market News or the Chicago Mercantile
Exchange.

U.S. farmers can choose from a vast array of available information to make
production decisions for the future and to find profitable sales opportunities
in different regions of the U.S. Lack of publicly avail able information in
Russia means that domestic and foreign sellers of agricultural products must
each invest considerable time and effort researching marketing opportunities.
This wasteful duplication of effort would not be necessary if a national
information gathering system existed. The lack of information puts foreign
sellers at a disadvantage, because domestic sellers have access to at least
local information. Not surprisingly, research done by ERS and other
organizations indicates that prices in domestic Russian markets currently move
independently of one another, so that farmers in different regions are not
sharing information or taking full advantage of marketing opportunities.

In addition to coping with the dilemma of scant market information, Western
exporters in Russia face two major difficulties in enforcing contracts. First,
local government officials often interfere with transactions by intervening at
crucial and unanticipated junctures. In countries governed by the rule of law
(the idea that laws will be enforced consistently), exporters can predict when
governments will intervene in a transaction simply by keeping abreast of
legislative developments. In Russia, however, legislation is often
contradictory, and local officials' on-the-spot decisionmaking authority can in
practice supersede it.

Second, injured parties find it difficult to obtain legal relief when a contract
is breached, because Russia's commercial legal system does not resolve contract
disputes in a timely and predictable manner.
The Soviet judicial system was geared toward forcing state-owned firms to comply
with rules, not toward hearing complaints about private contract disputes. In
the early 1990's, Russia created an entirely new judicial system to adjudicate
contract disputes between privately-owned companies, called the "arbitration
court" system. The new system does not rely on precedent--that is, rulings made
in previous cases--to reach decisions. The legislative environment in Russia is
too fluid and the case history too short for precedent to provide useful
guidance to judges in lower courts. Instead, higher arbitration courts in Russia
review all decisions of the lower courts to ensure that proper procedures were
followed. Decisions are sometimes overturned even when no appeals have been
filed-which means that all arbitration cases are in effect automatically
appealed, drawing out the legal process.

Further, it is not clear whether the political interests of local authorities
influence judges' decisions. To the extent that judges' decisions are subject to
political manipulation, the outcome of the legal process is unpredictable. The
inability of injured parties to find timely and predictable resolutions to
contract disputes introduces an unwelcome element of uncertainty into all large-
scale commercial transactions.

Prospects for
Institutional Reform

Clearly, successful institutional reform could reduce the cost of doing business
in Russia and so expand domestic and foreign trade in meat and other goods. But
if, for example, Russia's livestock markets were fully integrated with world
markets, would Russia increase or decrease its imports of meat? As indicated
earlier, imported Western livestock products currently dominate the urban
markets of Moscow and St. Petersburg because of the relatively high cost of
transporting goods from the provinces to urban areas. If institutional reforms
were to lower the overall cost of trading in Russia, U.S. exports in their
traditional Russian markets would face increased competition from the country's
provinces--even as lower trading costs would allow U.S. exports to penetrate
more deeply into provincial markets.

The primary issue is whether Russia enjoys a comparative advantage in livestock
production--that is, whether the "opportunity cost" of producing livestock in
Russia is lower than in other countries. (The opportunity cost of producing a
good is the sacrifice of producing alternative goods.) If the opportunity costs
of livestock production were lower for Russia than for its trading partners,
then Russia would benefit from exporting meat.

ERS research has shown that Russia does not have a comparative advantage in the
production of meat or even grain (in contrast to
fuel, metals, and many industrial goods, such as fertilizer). For example,
Russia's domestic livestock production is costly relative to domestic petroleum
production, while the opposite is true of the U.S.
Therefore, Russia could pursue its comparative advantage and gain from trade by
importing livestock products from the West and exporting oil products.

While institutional reform in Russia would bring numerous benefits to domestic
and foreign traders alike, prospects for meaningful change are not encouraging
at present. The reforms suggested to Russia by Western experts in 1992,
particularly reform of the judicial system, are largely incomplete.

Performance of the arbitration courts will improve if the legislative
environment becomes more stable. A stable legislative environment means the
upper courts will have time to clarify gray areas of the law, which will make
arbitration court decisions more timely and predictable. Tax law is one of the
main sources of legislative uncertainty, because the President and the Duma (the
Russian legislative body) are often at odds and issue conflicting legislation.
Approval of the tax code that the Duma is currently considering would help
stabilize tax legislation.

Prospects for developing a national market-information system are poor. While
the creation of an institution that distributes market information would have a
stabilizing effect on commodity markets--a key policy goal--the Russian Ministry
of Agriculture is not seriously considering it. According to the Ministry's
recently published 10-year strategy for agricultural policy, commodity market
stabilization is best achieved through government intervention in the market.

However, there is potential for the formation of major private commodity
exchanges, including the eventual expansion of some existing regional commodity
markets in Russia to cover the entire nation. A number of web sites already
bring together Russian grain buyers and sellers and have the potential to grow
into online commodity markets.

Rebuilding the transportation infrastructure will be the most expensive of all
the reforms, and the Russian government currently has more pressing priorities
for its scarce funds. Not surprisingly, the press contains little on any plans
for renewing Russia's transportation infrastructure.

For the above reasons, little progress is expected in these potential areas of
reform in the near future. U.S. exporters of meat and other products will likely
face significant difficulties expanding their share of the Russian market, at
least in the near term.
Stefan Osborne (202) 694-5154
sosborne@ers.usda.gov

WORLD AGRICULTURE & TRADE BOX
Linkages of Russian Pork and Beef Markets to the World

How well has Russian agriculture integrated into world markets? ERS researchers
examined the extent to which changes in world prices for pork and beef were
eventually transmitted to, and reflected in, Russian consumer prices for those
goods. Poultry prices in Russia were unavailable for analysis because the
Russian statistical agency GOSKOMSTAT has never collected them.

For purposes of the study, "price transmission" refers to the percentage by
which the Russian domestic price of beef or pork changed in response to a
percent change in beef or pork import
prices from Russian customs statistics. A "price transmission" of 100 percent
means that domestic prices rose by the same percentage as import prices. A
"price transmission" of 0 percent means that domestic prices did not respond at
all to changes in import prices. A number between zero and 100 indicates
domestic and international prices are partially linked.

ERS staff measured average price transmissions for pork and beef in Russia's 30
largest cities. The cities fell into four categories based on their geographic
accessibility: cities with seaports (6), cities on the Volga (7), cities on the
TransSiberian railroad (6), and landlocked cities with no significant trade
access (11).

According to ERS' findings, no cities except Moscow and St. Petersburg had price
transmissions statistically greater than zero. This result confirmed that even
in large cities such as Ekaterinburg and Nizhnij Novgorod, agricultural markets
are not significantly integrated into world markets. The behavior of the markets
in Moscow and St. Petersburg is markedly different and is consistent with
previous research showing that Moscow and St. Petersburg rely on imported food
much more than the rest of the country.

Many Western observers sent to Russia often do not travel outside of Moscow and
St. Petersburg. This can lead to confusion when the observers extrapolate the
experience of the two capitals to the entire country. For example, there is a
misconception that, before the economic crisis that hit in August 1998, Russia
imported more than half of the food it consumed. While that is true for the two
capitals, it is not true for Russia as a whole.

For more details on U.S. meat and poultry exports to Russia, see the February
issue of Livestock, Dairy and Poultry Situation and Outlook at
http://www.ers.usda.gov/publications/so/view.asp?f=liv estock/ldpmbb/


FOOD & MARKETING
Changing Dynamics in Produce Marketing

The business relationship between produce shippers and retailers has recently
gained national attention as retail consolidation increased. A large share of
today's fresh produce is sold directly by shippers (often grower/shippers) to
retailers, bypassing intermediaries and terminal wholesale markets. In the
direct shipper-retailer transaction, price may be just one component of a more
complicated sales arrangement.
The shipperretailer arrangement might also specify offinvoice fees to retailers
in the form of promotional
fees, rebates, or other discounts. And it might involve provision of various
services such as use of plastic returnable cartons, automatic inventory
replenishment programs, or third-party food safety certification.

Hearings conducted by the Federal Trade Commission and the U.S. Senate Committee
on Small Business during the past year provided a forum for industry leaders,
government officials, and academics to present their perspectives on how the
recent wave of supermarket mergers (AO August 2000) and growth of new trade
practices have affected various industries, including the produce industry.
While shippers expressed concern that recent retail consolidation has led to
greater market power for some retailers and the growing incidence of retailer-
requested fees and services, retailers argued that the new trade practices
reflect their costs of doing business and the demands of consumers.

USDA's Economic Research Service (ERS) has examined the forces behind the
changing dynamics of produce marketing and the evolving shipper-retailer
relationship. Because public data on transactions between shippers and retailers
are scarce, ERS conducted interviews of shippers, retailers, and wholesalers for
information on marketing of grapes, oranges, grapefruit, tomatoes, lettuce, and
bagged salads. While the small number of interviews demands caution in
interpreting the findings, the research provides an important first step in
understanding recent changes in produce marketing.

Factors in
Shipper-Retailer Relationships

Some of the factors that underlie recent changes in the shipperretailer
relationship are shifts in consumer demand, technological innovation, and
consolidation in retailing and produce shipping. Americans are annually
consuming 49 pounds more fresh fruits and vegetables per capita in 1999 than in
1986, an 18-percent increase. They are also eating more food away from home,
increasing the foodservice share of produce shipments (e.g., to restaurants and
schools). In 1999, food away from home accounted for 48 percent of total
spending on food, up from 44 per cent in 1992 and 40 percent in 1982. Many
retailers, faced with a declining share of consumer food spending, are
introducing
more ready-to-eat meals, commonly referred to as retail Home-MealReplacement or
Meal Solutions.

As produce consumption has increased, so has demand for variety and convenience.
The typical grocery store carried 345 produce items in 1998 compared with 173 in
1987. New produce items
include exotic imports as well as variations on standard products. For example,
in addition to traditional mature green and vine-ripe tomatoes, consumers may
choose from a wide array of new tomato products: extended-shelf-life, grape,
yellow and red baby pear tomatoes, as well as cluster, greenhouse, organic, and
heirloom varieties. Variety is also evident in the year-round availability of
items once
considered seasonal as U.S. consumers indicate their willingness to pay higher
prices for imported outofseason fresh products.

As Americans spend less time preparing meals they eat at home, the convenience
of fresh-cut produce has become more important. Fresh-cut produce is lightly
processed (cut and/or packaged) perishable fresh produce such as broccoli
florets, in comparison to unprocessed bulk produce commodities such as potatoes.
Bagged salads (washed, cut, and ready-toeat) are now a major sector of the
produce industry. New developments in packaging technologies have spurred the
growth of a wide array of fresh-cut
products, which are usually either branded or privatelabel products and need
dedicated shelf space yearround.

New technology is transforming the shipper-retailer relationship as well.
Information technologies have dramatically changed the amount and timeliness of
information available. The advent of standardized price look-up (PLU) codes on
unpackaged fruit and vegetable products (universal product codes on packaged
grocery items were introduced earlier) makes retail sales data readily
available, allowing for implementation of category (product) management programs
in the produce department. With more
accurate tracking of sales and profit margins, shippers and retailers can work
together to improve category profitability by designing effective sales, product
mix, and pricing strategies, potentially benefiting preferred suppliers as well
as the retailer.

Investment in the human resources and technology necessary to analyze category
information, however, may be difficult for smaller shippers to finance. As a
result, shipper trade associations or mandated marketing programs, such as the
California Tomato Commission, are developing category management programs with
selected retailers, enabling shippers of all sizes to share in the benefits.

Retail consolidation at the national level has sharply increased the sales
shares of the largest 4, 8, and 20 U.S. retailers to 27 percent, 38 percent, and
52 percent, respectively. While food retailers have been consolidating, so have
other produce buyers such as wholesalers that sell to retail buyers. Retailers
often cite the potential for lowering procurement, marketing, and distribution
costs as motivating factors in mergers and acquisitions.

Along with consolidation, changes in retailers' buying practices can affect
shippers. For example, some large retail firms reduce distribution costs by
establishing automatic inventory replenishment programs with their suppliers.
Using retailers' sales data, shippers are made responsible for providing the
correct amount of produce to each distribution center served, on a just-in-time
basis, potentially reducing the size and cost of retail distribution centers.

Along with retailers, shippers are also consolidating. Large retailers require
shippers large enough to meet their needs. Given the product diversity and 
seasonality of some crops, retailers have increasingly sought to reduce costs 
by dealing with suppliers that can provide broader product lines year-round 
or over extended seasons. This trend pressures U.S. shippers to coordinate with 
each other and with shippers in other countries to meet retailers' more complex 
needs. However,providing a broader product line on a year-round basis can be 
risky and costly, given the high capital requirements involved in production
and distribution of many fresh produce items.

Large supplier firms may be able to secure funds for these activities more
easily than small firms, which favors consolidation and greater vertical and
horizontal coordination in the produce shipping industry. They may also develop
some countervailing negotiating strength in their relationships with retailers.

Consolidation and concentration in produce shipping is increasing but shows
considerable variation among sectors. For example, not one of 149 California
fresh grape shippers is estimated to have accounted for more than 6 percent of
total industry sales in 1999. In contrast, the largest 4 of 23 California tomato
shippers in 1999 accounted for an estimated 43 percent of sales. Although 54
bagged-salad firms nationwide sold to mainstream supermarkets in 1999, the top
two accounted for 76 percent of total freshcut salad sales. Hence, for a few
fresh produce items, consolidation at the shipper level has surpassed retail
consolidation, even though the sales volume of these firms may still be small
relative to sales of the large retail chains.

Sales & Marketing
Arrangements

Direct grocery retail sales (shipper to retailer) is the most important
marketing channel for domestic sales of grapes, oranges, grapefruit, lettuce,
and bagged salads, but not for sales of tomatoes. Marketing of tomatoes differs
from the other produce in the study because they continue to ripen after they
leave the shipper. Shippers generally sell tomatoes to repackers near final 
consumers, who then generate a uniform pack and sell to retailers, mass 
merchandisers, foodservice, or other intermediaries. The interview data 
indicate that the 1999 share of direct sales to retailers and
mass merchandisers ranges from 6 percent for Florida tomatoes to 64 percent for
lettuce/bagged salads.

Traditionally, the fresh produce industry has marketed primarily through daily
sales arrangements-i.e., individual sales at the daily market price with no
volume commitments over time. Variations in demand and supply (quantity and
quality), both in season and out, generate price volatility for perishable
products. Given constantly changing conditions, the flexibility of daily sales
arrangements made sense. The challenge of managing price risk discouraged longer
term arrangements, with sellers and buyers
unwilling to go much beyond advance pricing.

In the fresh produce industry, advance pricing means establishing price ceilings
a few weeks in advance for produce featured in advertisements. Advance pricing
arrangements are not forward retail purchases, which entail a commitment to
purchase. If the market price declines below the negotiated price ceiling,
shippers generally have to lower prices to the current f.o.b. price because
retailers usually have the option to buy elsewhere. Shippers commonly consider
advance prices to be an unequal arrangement, reducing their ability to capture
gains from potential market highs.

Based on ERS interviews, daily sales remain the leading, but declining, sales
and marketing arrangement across all products in the study except bagged salads.
In 1999, daily sales accounted for an average 58 percent of total sales of
grapes, oranges, grapefruit, and tomatoes, down from 72 percent in 1994. Daily
sales of lettuce accounted for 66 percent of total sales in 1999, with
comparable 1994 data unavailable. Use of advance pricing arrangements for
promotions has been growing, and it appears that the number of weeks for which
maximum prices are fixed in advance has grown as well. Advance pricing increased
from 19 to 24 percent of the total value of sales during 1994-99.

The volume requirements of very large produce buyers have created growing
interest in more sophisticated coordination mechanisms than daily sales or
advance pricing. For example, fresh produce sales of each of the top five U.S.
retailers and mass merchandisers are in the multi-billion-dollar range, so
relying on daily sales runs the risk of being unable to procure the volumes,
sizes, varieties, quality, and consistency levels necessary. Furthermore,
branded, fresh-cut products, such as bagged salads, require consistent,
reliable, year-round availability and quality, making longer term arrangements--
i.e., contracts--more desirable for both shippers and retailers.

The movement toward contracts appears to be led by mass merchandisers rather
than by conventional retailers, although foodservice users are also becoming
more involved. Shippers reported three main factors influencing their decision
to enter into retail contracts: to ensure the market or sale, to maintain future
relationships with buyers, and to achieve stable prices. While some shippers
indicated they actively seek contract business with their customers, most
engaged in contracting in response to buyer requests.

Between 1994 and 1999, use of short-term contracts (less than 1 year) for
grapes, oranges, grapefruit, and tomatoes increased from 7 percent of total
sales to 11 percent, while use of annual
or multiyear contracts increased from 2 percent of total sales to 7 percent.
Lettuce sales moving via long-term contracts were even higher at 14 percent in
1999.

Contracts--usually annual or multiyear--have become standard for the bagged
salad industry. These written contracts specify price, quantity, advertisement
periods, fees, and services.

Fees & Services
Tax Shippers

Almost all of the interviewed shipping firms reported that fee and service
requests from buyers had increased. The exceptions were some tomato shippers,
who indicated that buyers' requests were unchanged. The shares of fees as a
percent of sales for shippers' top five retail and mass merchandiser accounts
varied across product category. California and Florida tomato shippers had few
retail and mass merchandiser sales and no fees at all in their top five
accounts. Orange and grapefruit fees as a share of sales averaged 1.13 percent
and 1.77 percent. Bagged salad firms reported that fees as a share of all sales
(not just the top five retail and mass merchandiser accounts) ranged from 1 to 8
percent of shipper sales.

Of those paying fees, grape shippers had the lowest share of fees paid per sales
on an account basis, 0.66 percent. The fragmented nature of the California grape
industry may provide shippers with some protection from retailer requests for
fees. Given an implicit need for retailers to spread purchases among more grape
suppliers than among suppliers of commodities with more consolidated supply
structures, retailers may be less inclined to charge certain fees.

While overall the ratio of fees to produce sales might appear low, it is
important to remember that market prices are sometimes at or below total costs
of providing the product, and may cover only variable costs. Consequently, these
fees could be sufficient to eliminate profits or increase losses in periods of
low prices, particularly for commodity shippers who act as price takers (i.e.,
they cannot raise prices without losing customers) and cannot pass along costs
to customers.

The most frequently paid type of fee is the volume discount, a trade practice
that has been used for years, but recently with greater incidence and magnitude.
(For more on marketing fees, see following article.) Shippers generally viewed
this fee as negative or neutral in its impact on their business. Nevertheless,
volume incentives have the potential to promote more stable relationships
between suppliers and retailers; as a retailer buys more units from a supplier,
costs per unit decline, providing an incentive for the retailer to buy larger
quantities (over the season) from a particular supplier. Shippers may also gain
efficiencies in marketing by increasing the size of individual accounts.

Fresh produce shippers are particularly concerned about pay-tostay and slotting
fees. Slotting fees are fixed, upfront fees to retailers to guarantee shelf
space for new products. Pay-to-stay fees are similar to slotting fees but apply
to existing products. In the following discussion, pay-to-stay and slotting 
fees are considered together and referred to as slotting fees.

The recent emergence of slotting fees for certain kinds of freshcut produce--
e.g., bagged salads and baby carrots--has led to shipper concern that they will
soon become standard for other produce commodities as well. However, a key
finding of this studyis that this does not appear to be the case, at least so far. 
Thirteen commodity produce shippers reported receiving requests for slotting fees, 
but none of them paid the fees in 1999, although a few lost accounts for not 
complying. Despite the current high profile of slotting fees in the produce 
trade press, retailers agreed with shippers that such fees are not prevalent 
beyond the fresh-cut category.

Slotting fees are common for bagged salads and other fresh-cut branded products.
While most lettuce/bagged salad shippers indicated that shippers initiated
slotting fees in the mid-1990's in an effort to win new retail accounts and gain
market share, a few reported that retailers initiated slotting fees. Now,
slotting fees are both offered by shippers and requested by retailers. Retailers
reported that slotting fees are associated primarily with branded categories
such as bagged salads, baby carrots, and dried fruits and nuts. Retailers agreed
that competition among bagged-salad suppliers for market share is intense and
that payment of upfront fees is a way for shippers to obtain or expand shelf
space.

None of the bagged salad shippers would reveal the exact size of slotting fees
requested of or paid by their firms, but several discussed in general the use of
slotting fees in the sector. For instance, shippers reported that annual
slotting fees could range from $10,000 to $20,000 for small retail accounts to
$500,000 for a division of a multiregional chain, and up to $2 million to
acquire the entire business of a large multiregional chain.

Shippers of bagged salads pay slotting fees to retailers who guarantee to carry
their product. In interviews, these shippers did not elaborate on any other
commitments they might receive in exchange for fees paid. No firm mentioned
slotting fees as a guarantee of a specified number of linear feet in
refrigerated displays. A few mentioned using thirdparty or retailer scanner data
to track sales in stores, but it is not clear if shippers have any recourse
should volume of sales not meet expectations. In a few cases, when one retail
chain acquired another, previous slotting fee agreements were not honored.

Not all retailers request slotting fees or accept them, even for branded, fresh-
cut products. Instead, some retailers focus on gaining the efficiencies of
handling relatively high-volume products by negotiating long-term agreements
with suppliers and then requiring these preferred suppliers to provide services
such as automatic inventory replenishment, use of returnable containers, or
other special packaging.

Services requested by retailers, or offered by produce shippers, are also on the
rise. New services such as third-party food safety certification are quickly
becoming the norm as shippers respond to changing consumer preferences.

Several services, such as electronic data interchange and category management
programs, derive from new scanner technology that provides both shipper and
retailer with more timely market intelligence, which could reduce costs and
increase profits. Some of these new technologies impose high fixed costs and so
may pose a competitive disadvantage to smaller shippers, and some fees and
services may raise shippers' costs without providing benefits of equal value.
Linda Calvin (202) 694-5244, Roberta Cook (University of California, Davis),
Mark Denbaly, Carolyn Dimitri, Lewrene Glaser, Charles Handy, Mark Jekanowski
(formerly with USDA/ERS, now with Sparks Companies, Inc.), Phil Kaufman, Barry
Krissoff, Gary Thompson (University of Arizona), and Suzanne Thornsbury
(University of Florida) lcalvin@ers.usda.gov
This article does not necessarily reflect views of Sparks Companies, Inc.

FOOD & MARKETING BOX
Emergence of Slotting Fees in the Bagged Salad Industry

The changed relationship between shippers and retailers is due only partly to
retail consolidation. Growth of the bagged-salad industry and the emergence of
slotting fees in this industry illustrate the complex economic forces at work.

In the early 1990's, three separate trends converged to produce the new bagged
salad industry: the continuing interest of consumers in more convenient product
forms, the evolution of breathable films that preserve fresh-cut produce, and
the desire of shippers to add value to and differentiate their products. Unlike
bulk fresh produce commodities such as lettuce or tomatoes, bagged salads are
produced and marketed much like other manufactured grocery products, available
every week of the year and requiring dedicated year-round shelf space.

According to Information Resources, Inc. (IRI), bagged-salad sales grew rapidly
in the early and mid1990's and new firms entered the industry. In 1994 and 1995,
year-to-year sales rose 49 and 32 percent. Sales growth continued into the late
1990's, although the rate of growth slowed to between 5 and 12 percent, and
competition among shippers intensified. Slotting fees (upfront fees paid by
suppliers to retailers to guarantee shelf space for new products) were adopted
in the mid-1990's within this highly competitive environment as part of a market
share battle between competitors eager to protect their investment in costly
salad processing plants.

Retailers typically sell two or three brands of bagged salads, including
retailers' private-label products. Many shippers strive not only to capture 
the business of retailers, but also to place specific products in stores. 
IRI data show that the number of lettuce-based bagged salad items in mainstream 
supermarkets increased from 202 in 1993 to 464 in 1999. As the new industry 
launched many new bagged salad products, retailers were also coping with a 
large increase in products in the rest of the produce department.

Retailers had used slotting fees in other areas of the grocery store since about
1984, even before the recent increase in retail consolidation. As bagged salads
developed characteristics of manufactured food products, it would not have been
surprising for retailers to request slotting fees for bagged salads. However,
most shippers reported that it was baggedsalad shippers who first offered
slotting fees as a means to garner market share from their competitors.

IRI data indicate that the number of bagged-salad shippers selling to mainstream
supermarkets has declined from a high of 63 in 1995 to 54 in 1999. The share of
bagged salads sold under private label, where no slotting fees are used, has
increased from 2 percent in 1993 to 10 percent in 1999.

Now fees are sometimes offered by shippers and sometimes requested by retailers.
Since retailers had already requested slotting fees for other products before
the recent retail consolidation, these fees for stocking bagged salads may not
necessarily be a function of retailers' market power alone, but rather a
combination of product characteristics, interfirm rivalry in a capital-intensive
sector, and the relative negotiating strength of buyers and sellers. This
article is based on information from U.S. Fresh Fruit and Vegetable Marketing:
Emerging Trade Practices, Trends, and Issues, AER 795, January 2001. It is
available online at www.ers.usda.gov, click on "publications," then type aer795
in "search for publications."


FOOD & MARKETING
Marketing Fees Reflect Supplier-Supermarket Relationship

Since the time of the first national supermarket chain (A&P) in the 1920's,
supermarket retailers and their suppliers (distributors or manufacturers) have
conducted business creatively. For instance, the longstanding tradition of
manufacturers presenting retailers with samples of new products can be traced to
the early 1920's. During the last two decades, provisions incorporated into
supplier-retailer arrangements have moved well beyond free samples to include
provisions for adjustments such as rebates, shelf-placement fees, and
advertising allowances.

Such adjustments--referred to as marketing fees--can affect consumer prices,
profitability of the firms, and structure of the industry. Most of the
adjustments can be categorized as lump-sum payments from suppliers to retailers
or per-unit allowances granted to retailers by suppliers.

The use of fees is controversial, particularly because growth in their usage
appears to coincide with a wave of supermarket mergers. Some comments that
reflect differences of opinion about the growing use of fees and the potential
results include:
mergers have given retailers market power over suppliers,
and fees are the result of this market power; fees undercut competition 
and reduce consumer welfare by reducing output, increasing prices, or 
slowing product innovation; growth of new product offerings exerts enormous
pressure on a limited amount of shelf space, and fees serve to allocate shelf 
space; and fees reflect the increasing costs of retailing.
                                        
This article presents an economic rationale for marketing fees and explores
possible impacts on consumers. It describes three types of fees commonly used in
supplier-retailer transactions, examines the effects of pricing strategies or
fees on competition, and assesses the potential economic impacts of fees.

Fees Serve
Many Purposes

Specialized fee agreements between suppliers and retailers have been developed
to accomplish a wide variety of purposes. Some fees are fixed payments, while
others vary with the quantity exchanged in the transaction or with some aspect
of retailer performance--e.g., volume of sales of a particular product. The most
controversial fee is the "slotting" fee, a lump sum paid by suppliers to
retailers for introducing new products to supermarket shelves. Although slotting
fees were first introduced to supermarket retailing in 1984, tracking their
history is nearly impossible since fees are negotiated privately and terms of
transactions between retailers and suppliers are confidential.

The limited information that is available on slotting fees comes
from the trade press, which presents conflicting reports on how frequently
slotting fees are used. One source, market researcher ACNielsen, suggests that
about $930 million--or 4.2 percent--of the $22.2 billion spent on trade
promotions for products in 1987 was paid as slotting allowances. In contrast,
another source, Freeman and Meyers, estimates that slotting fees in 1987 totaled
$6-$9 billion.

"Pay-to-stay" fees are similar to slotting fees in that they are lump-sum
payments made to retailers, but suppliers use pay-tostay fees to keep existing
products on the shelf. Other examples of fees are "hello" or "street" money,
paid to grant a supplier an audience with a retailer to pitch a new product;
advertising or promotional allowances--either lumpsum or per-unit payments-to
advertise the suppliers' products; and supplier-paid volume discounts or rebates
that may increase with the volume sold.

Fees can have both short- and longrun impacts on the grocery industry. Shortrun
effects stem from changes in prices and product variety. In the long run, fees
potentially affect entry of new firms into the industry and the pace of new
product innovation.

Increasing use of fees may enhance consumer welfare in the short term if prices
fall or product variety increases, and in the long term if the fees do not
restrict entry of new firms into the industry and if innovation is not stifled.
However, consumer welfare may decline if the reverse holds. The outcome for
consumer welfare depends largely on the balance of negotiating power between
retailers and suppliers.

Economic Impact Of Fees

Slotting fees, pay-to-stay fees, and per-unit rebate with volume incentives
differ in purpose and impacts on firms and consumers. These fees may also be
associated with different types of products.

Slotting fees. To analyze the effects of slotting fees, researchers typically
assume that supermarkets have a limited supply of shelf space with many new
products vying for display. They want to sell only successful products, but
consumers' acceptance of any new product is uncertain, making the risk of new
product failure unknown. Product innovators, through extensive market research
and product testing, generally have information about consumer acceptance of the
new product, but retailers are assumed to be less informed about product
desirability and potential consumer acceptance.

A positive aspect of slotting fees is that they may sort out products most
likely to gain consumer acceptance from those that are less likely to succeed in
the marketplace. Manufacturers may offer to pay retailers a slotting fee for a
new product to indicate their confidence that consumers will buy it. Retailers
for their part may solicit slotting fees from manufacturers based on their
assumption that only manufacturers of products deemed likely to sell would be
willing to invest in a product by paying slotting fees. Slotting fees also help
to spread the risk of new product failure across many new products, diminishing
the potential impact of loss from any one product.

Slotting fees have potential impact on both supplierretailer and retailer-
consumer relationships. Turning first to the supplierretailer relationship, the
procompetitive perspective is that slotting fees appear to make it possible for
new products to enter the market, thus benefiting consumers through increased 
variety or quality of products. In contrast, the anticompetitive perspective 
is that slotting fees are the result of retailers wielding their power to 
extract lump-sum payments from suppliers.

Regardless of whether slotting fees are pro- or anticompetitive, the fees may
affect wholesale (supplier-to-retailer) prices or supplier solvency.
If the supplying industry is competitive, prices that retailers pay to suppliers
tend to balance revenues with suppliers' costs. When competitive suppliers begin
paying a fixed slotting fee, costs and thus wholesale prices could rise, so
that, in effect, retailers may pay higher prices to compensate suppliers for
paying the fixed fee. On the other hand, if suppliers operate in a market that
is not competitive, it will be possible for supplying firms to remain profitable
without increasing the wholesale price paid by the retailer. In either case, the
higher costs prompted by the slotting fee may cause some suppliers to exit the
industry.

The net effect of fees on consumers (the retailerconsumer relationship) is
complex and difficult to assess because of variations in structure and behavior
along the food marketing chain. Wholesale prices partially determine consumer
prices, which depend on retailers' costs of purchasing, transporting,
warehousing, and selling grocery items. Another factor in consumer prices is
degree of competition among local supermarkets. Consumer prices would rise if
retailers could pass the higher wholesale price along to consumers.
Alternatively, competition among local supermarkets might prevent retailers from
raising consumer prices.

The actual effect of slotting fees on consumer prices is uncertain. A study
conducted at the University of Chicago indirectly explored slotting fees using
publicly available aggregate data on industry sales, number of products, and
price indexes. The study suggests that use of slotting fees can lead to a fall
in consumer prices and a rise in product variety. A Marketing Science Institute
survey, however, indicates that both manufacturers and retailers believe that
consumer prices increased as a result of slotting fees. Research efforts have
been hampered by the unavailability of proprietary information-i.e., detailed
transaction-level data that include quantities sold, prices, and fees paid.

Pay-to-stay fees. Like slotting fees, pay-to-stay fees may cause consumer prices
to rise or fall. Unlike slotting fees, pay-tostay fees are not used to transmit
information on consumer acceptance from supplier to retailer, since the product
is already known in the marketplace from retail sales data. Procompetitive
arguments for pay-to-stay fees point out that they help to allocate costs of
shelf space between supplier and retailer, and that they serve to place products
in prime locations such as at eyelevel space on the shelf. An anticompetitive
argument states that such fees exclude competitors from the market either by
making entry more difficult or by cutting profitability. For example, a
manufacturer might be paying the retailer a pay-to-stay fee to in effect "not
carry" a new substitute product, another brand of a substitute product, or a
private label product. The supplier might also offer to pay the fee in order to
raise rivals' costs, with the intent of reducing the competition it faces and
thus increasing market share and profits. If manufacturers of existing products
succeed and wield their market power to outbid suppliers of new products,
consumer variety will ultimately be reduced.

The argument in favor of cost-sharing through pay-tostay fees
stems from the notion that as retailing costs are increasing, some costs are
more easily borne by retailers and others by suppliers. An efficient allocation
would spread the costs to the party that could most easily bear them, and is
most likely when the parties have equal bargaining power. If one party has a
strategic advantage, however, the other might ultimately bear more than its
appropriate share of costs.

Volume incentives and rebates. One frequently used fee is the volume incentive,
a per-unit rebate directly linked to quantity sold. For example, a sales
agreement might specify that a supplier will pay a rebate of 10 cents per carton
for the first 1,000 cartons that the retailer buys, 20 cents for the next 1,000,
and so on. From the procompetitive perspective, volume incentives serve to build
longterm relationships between suppliers and retailers. Retailers' costs per
unit decline as more units are purchased from the supplier, providing an
incentive for the retailer to buy larger quantities from a particular supplier.
Consumers benefit, however, if the decline in retailers' per-unit costs
(wholesale prices) are passed on through reduced retail prices. At the same
time, the larger volume may reduce the supplier's per-unit marketing costs, thus
increasing their profitability.

An anticompetitive viewpoint is that the retailer may be demanding an
unjustified per-unit discount from suppliers, potentially reducing suppliers'
revenue below costs, and, in the long run, leading to an unsustainable situation
that supports fewer suppliers. Another point of the anticompetitive argument is
that even when per-unit discounts do not eliminate profits, discounts may reduce
supplier profits and may drive some firms out of business.

Fees & Competition

Regardless of whether fees are considered the result of market power or of
movement toward enhanced efficiency--i.e., whether they are anti- or
procompetitive--the growing use of fees, especially in light of the record
number of retail mergers over the past few years, has captured policymakers'
attention. As early as the mid-1990's, the Bureau of Alcohol, Tobacco, and
Firearms prohibited the use of certain fees for marketing alcoholic beverages.
In 2000, the Senate Committee on Small Business held a hearing on fees, the
Congressional Budget Office scrutinized fees, and the Federal Trade Commission
held a workshop examining fees. Also last year, USDA's Economic Research Service
(ERS) conducted an in-depth study of fees in fresh produce marketing (see
preceding article).

Ultimately it is the Federal Trade Commission (FTC) or the Department of Justice
that determines whether a pricing strategy is anticompetitive or violates
antitrust legislation. According to FTC regulations,
"a practice is illegal if it restricts competition in some significant way and
has no overriding business justification. Practices that meet both
characteristics are likely to harm consumers--by increasing prices, reducing
availability of goods or services, lowering quality or service, or significantly
stifling innovation." In some cases, a pricing strategy that appears at the
outset to damage competition might be allowable if any detriment to consumers is
outweighed by an efficiency gain, such as a better product or reduced costs.

Fees are becoming more common provisions in supplierretailer transactions for
many products and can have positive as well as negative effects on firms and
consumers. Fees may raise supplier costs and wholesale prices, and lead to
higher retail prices or reduced product variety. But fees may also increase 
competition among firms, and bring lower retail prices, a proliferation of 
new products, greater product variety, or higher quality products. The net 
effect of fees on consumers depends largely on the balance of benefits and 
costs in each specific case. Carolyn Dimitri (202) 694-5252
cdimitri@ers.usda.gov


SPECIAL ARTICLE
Crop Production Capacity in Europe

From Spain to Ukraine, agricultural production is pursued under a vast array of
agronomic and political conditions. In Western Europe, policies in recent
decades have maintained high farm prices and provided income payments to
farmers, leading to surplus production. High food prices in Western Europe,
maintained through high import barriers, dampened domestic demand, although high
incomes allowed adequate diets. The region has been a large grain exporter for
over two decades but mainly through subsidies. Agricultural policies have
ensured a higher return to farmers than would prevail under market conditions,
and Eastern European countries planning on joining the European Union (EU) could
be in the same position in a few years.

In the former Soviet Union (FSU) and in Eastern Europe, where countries had been
under Soviet influence, expanding area and yields prior to the 1990's led to
greater production. Food subsidies encouraged high consumption in Eastern Europe
and in the former Soviet Union, which prevented the regions from being major
exporters.

Europe as a whole will continue to be a net exporter of grain in the next
decade, although the magnitude of exports will depend on the ability of the FSU,
particularly Russia and Ukraine, to implement reforms that would increase
production capacity.

Europe
In the Aggregate

Area harvested has generally declined across all three regions of Europe.
Western Europe cropland use dropped by 10 percent from 1961 to 2000 because of
urban growth and land set-aside measures. Eastern European crop area fell by 17
percent during the same period, due mostly to movement out of marginal land
during the reforms of the early 1990's when crop subsidies were discontinued. In
the FSU, large amounts of land were taken out of production during the last
decade (about 15 million hectares or a drop of nearly 19 percent) because of low
prices for crops and the removal of input subsidies.

Despite a declining area, Western European grain production has been climbing
steadily throughout the last 40 years, from 92 million to 217 million metric
tons in 2000, as yields increased from 2.14 to 5.63 tons per hectare. U.S.
yields moved from 2.51 to 5.93 tons per hectare for the same time period. (Data
are from the Food and Agriculture Organization.) The yield increase has been
largely a combination of the application of technology and the high prices and
income support provided by the Common Agricultural Policy (CAP) of the European
Union.

Eastern European production nearly doubled from1961 to 1989 because of rising
yields. But production has fallen considerably in the last decade as yields
declined. The recent fall in yields in Eastern Europe--from 3.74 tons per
hectare in 1991 to 2.8 tons per hectare in 2000--resulted from policy changes
that accompanied political turmoil in the early 1990's. These policy changes
were comprised largely of the withdrawal of subsidies both for inputs such as
fertilizer, pesticides, and subsidized loans to farms.

In the FSU, average yields fell from 1.96 tons per hectare in 1992 to 1.58 tons
per hectare in 2000, for similar reasons. With less area in grain and with
falling yields, production in the FSU dropped 35 percent from 1992 to 2000.

The critical issue for crop production in Europe is whether grain yields in
Eastern Europe and in the FSU will return to previous levels and eventually
begin to approach yields in Western Europe.

Agricultural Gains Reflect
Policy in Western Europe

Before World War II, most countries in Western Europe were net grain importers,
and during WWII and immediately thereafter the populations of many of these
countries suffered malnutrition. In an attempt to prevent future wars, to
advance their economies, and to guard against future food crises, six countries
formed the European Economic Community in 1957 (predecessor to the European
Union) and in 1967 implemented the Common Agricultural Policy (CAP), which has
been the principal engine of agricultural growth in Western Europe ever since.
The CAP now applies to 15 countries (the current EU members) and will likely
expand to over 20 EU members in the next few years with additions from Eastern
Europe and the Baltics. The agricultural policy goals of the original member
countries (Belgium, Luxembourg, France, Italy, The Netherlands, and West
Germany) were, among other things, to equalize farm and nonfarm income, provide
abundant food at reasonable prices, and increase food self-sufficiency. Policies
used to accomplish these goals included guaranteed farm prices set at relatively
high levels, prohibitively high tariffs, and export subsidies as an outlet for
any possible excess production (and conversely, export taxes when world prices
rise above EU prices.)

The policy goals have generally been accomplished--the EU has one of the highest
grain yields in the world, with a large grain surplus exported. Self-sufficiency
in total grains increased from 86 percent in 1968/69 to 118 percent in 1990/91.
Per capita farm income in the EU has also stayed relatively close to nonfarm per
capita income because of the CAP. However, the EU also has the world's largest
agricultural budget.

The success of the CAP (albeit at high cost to consumers and taxpayers) and of
the EU is evidenced by successive enlargements:
1973 (Denmark, United Kingdom, and Ireland), 1981 (Greece), 1986 (Spain and
Portugal), and 1995 (Austria, Finland, and Sweden.) Numerous other European
countries have applied for membership and are likely to become members soon,
including countries in Eastern Europe (Hungary, the Czech Republic, Poland, and
Slovenia). These countries have already begun to align their policies with the
CAP. Countries in the Baltic region have also applied for EU membership and will
likely join in the next decade--Estonia is already in final negotiations with
the EU over details of membership, and Latvia and Lithuania are likely to follow
soon.

Agricultural production has exceeded expectations of the original founders of
the CAP and led to large surpluses of grain, butter, wine, and beef. Successive
reforms of the CAP in 1992 and 1998 that led to lower policy prices have not
slowed the growth in production, as yields and total production continue to rise
despite less intensive fertilizer use and declines in area harvested. Large
stocks of grains and their associated costs continue to plague EU agricultural
policy.

Other countries in Western Europe, such as Switzerland and Norway, have
agricultural policy regimes similar to the CAP, and their standards and
legislation are equivalent to the EU's legislation for trading purposes. Thus,
yields are high throughout Western Europe as technology continues to push up
yields, increasing total production in spite of a small decline in area
harvested. With consumption levels relatively stable and yields increasing,
pressure on the European Union budget due to the CAP will mount as storage 
costs and/or export subsidies climb. However, trade agreement constraints on 
export quantities under the World Trade Organization limit subsidized exports.

Western European countries have rapidly adopted new technology since the end of
WWII and have reaped the benefits of early adoption. Farmers in the EU have been
able to increase yields in the face of lower prices and less fertilizer use.
Improved seeds, cultivation techniques, and pest control methods (not higher
pesticide usage) have been largely responsible for higher yields, although other
factors such as added irrigation capacity and better machinery have also helped.
Continued research and development in these areas will likely push yields
further upward in spite of lower policy prices.

Nitrogen pollution is a particular concern, and EU legislation setting limits 
on groundwater levels of nitrate contamination has been in effect for a few 
years, although the legislation affects mostly livestock operations rather 
than crop producers. Western Europe is densely populated, and pollution from 
the agricultural sector will continue to affect crop production indirectly 
through impacts on livestock production.

Transition Underway
In Eastern Europe . . .

Developments in agriculture in Eastern Europe differ dramatically from the West.
Withdrawal of consumer and producer subsidies led to a rather chaotic economic
situation in most countries when they gained political independence in the early
1990's, resulting in lower crop yields and lower food consumption. Yields fell
because inputs such as fertilizer and machinery became too expensive relative to
farm income, leading to a sharp decline in their use. Even water use for
irrigation was adversely affected by withdrawal of subsidies. Similar
developments occurred in the FSU, except that large areas of poor land in the
FSU were idled, in contrast with Eastern Europe where less marginal farmland was
farmed.

Input subsidies were largely eliminated in Eastern Europe after the collapse of
communism in the early 1990's, and fertilizer and pesticide prices rose rapidly.
While this led to lower input use, residual fertilizer in the soil prevented
yields from dropping initially. In general, farmers had been applying too much
fertilizer, but yields declined when nutrient reserves were eventually
exhausted.

Technological innovations were implemented less efficiently in the East than in
the West, leading to lower yields for the same amount of inputs. Plant breeding
research was fairly advanced, but applications of the information and methods in
the field were hindered by lack of an effective extension service. Also, farmers
could not obtain the credit required to make innovations. Tractor usage also
declined as fuel prices rose rapidly, reflecting world market conditions and
internal marketing problems. Uncertainty about land ownership was also a
deterrent to investing in agriculture and hastened the decline in production in
the 1990's. Settling land ownership issues will be necessary to attract
investment in agriculture and return production in the region to its previous
level.

Eastern European countries that are in line to join the EU within the next few
years are likely to see their agriculture rebound if farmers are granted
compensation payments that EU farmers receive for cuts in support prices (AO
January- February 2001). Such payments were begun in 1993 under the 1992 CAP
reform. The compensation payments increased with the cuts in policy prices of
the 1998 CAP reform under Agenda 2000, which ostensibly prepares the EU for
enlargement to the East.

The effect on yields of joining the EU will be key to future crop production
levels in Eastern European countries. With membership, adoption of technology is
likely to be rapid because of access to Western European output and input
markets and an increase in foreign direct investment. Higher support prices, in
combination with direct payments, will allow farmers in the East to update
capital equipment. Enhanced productivity and more efficient marketing channels
will benefit producers after enlargement. Yields should rapidly approach pre-
1990 levels and eventually approach Western European levels.

It appears that 8 of 15 countries in Eastern Europe and the Baltics may become
EU members within the next decade. Although the Baltics are included in the FSU,
their agricultural sectors are more similar to those in Eastern Europe. Farmers
in these countries may also receive higher prices (dependent on currency rates
and CAP reforms) for their crops than they currently receive, and this should
increase yields. Countries that will take longer to become EU members will most
likely adopt EU policies over time, increasing their yields and total crop
production. The countries in Eastern Europe joining the EU will most likely be
net exporters of grain within the next decade.

. . . and in Russia &
Neighboring Countries

The FSU region of Europe is likely to be a significant source of volatility in
future world production and trade. Russia and the Ukraine are the most important
agricultural producers in the region.

The decade-long transition occurring in Russia and many of its close FSU
neighbors (e.g., Belarus, Ukraine, and the Moldova Republic) is more wrenching
than in Eastern Europe and has resulted in dramatically lower yields, lower
input usage, smaller area harvested, and a severe decline in food consumption.
The move from large state farms with centralized control to a more chaotic 
mixture of state farms and some private farms attempting to operate in a 
market environment has been difficult. 

Production and consumption declined largely because of the withdrawal of
subsidies to state farms and to consumers. In addition, crop production is
inefficient because of a lack of critical institutions to enforce the rule of
law regarding land use and ownership.

Price and trade liberalization began in Russia and Ukraine in 1992. From 1990 to
1998, crop production fell substantially--35 percent in Russia and 39 percent in
Ukraine. The fall in output, especially grain, is due to the effects of reform
on demand and supply of crops and livestock in the two countries.

Consumption and production of livestock products in Russia and Ukraine were
heavily subsidized during the 1970's and 1980's. The removal of these subsidies
after 1992 led to a substantial drop in livestock inventories and, consequently,
the demand for feed grain. In addition, the free fall in consumer income
following the reforms led to a drop in demand for relatively expensive meat
products and a rise in demand for their cheaper substitutes, bread and potatoes.
A modest increase in demand for food grain has been overwhelmed by the decline
in demand for feed accompanying the collapse of the livestock sector.

Before 1992, the supply of crops and livestock in the FSU was boosted
artificially by three kinds of subsidies: 1) direct budget subsidies, 2) border
price support, and 3) indirect input price subsidies. Direct budget subsidies
are payments to farms out of the budget but have played a relatively small role
in FSU agricultural support. Border price support (e.g., tariffs) kept domestic
producer prices above world trade prices. Indirect input price subsidies were
the most important in stimulating supply and kept the price of agricultural
inputs low relative to agricultural outputs. The input price supports were not
the result of financial subsidies from the government's budget. Rather, the
planned economy structured the administrative price system so that farmers'
revenue from output was higher than expenditures on inputs.

The end of subsidies led to a steep decrease in the price of outputs and an
increase in the prices of tradable inputs (i.e., products that can be sold for
foreign exchange) such as herbicides, fuel, and especially fertilizer. The
result was a dramatic decline in the use of tradable inputs. From 1990 to 1997,
average fertilizer use per hectare fell from 88 kilograms to 16 kilograms.
Consequently, yields--which had been catching up with yields in the U.S. and
Europe in the late 1980's--fell sharply in the 1990's. Wheat yields in 1997 in
the FSU were the same as those that prevailed in 1975.

Removal of the three subsidies mentioned above led to a price system that
reflects the technology of production and market preferences. Much of the fall
in crop production is, therefore, a natural market response to unsubsidized
prices.

Nevertheless, some increase in crop production in the FSU could occur in two
possible ways: 1) governments may choose to implement supports to boost
agricultural production, and 2) production may improve under institutional
reforms (see sidebar).

It is unlikely that agricultural policy will change sufficiently in the near
future to have a major impact on agricultural production. Russia's Ministry
of Agriculture, for example, recently acknowledged that it lacks the 
financial resources to implement significant support policies
for agriculture. While it is possible that the government may choose to increase
agricultural production through subsidies, it could do so only for a limited
time.

Even if the government fails to stimulate agricultural production through direct
support, it is still possible that production will recover somewhat if reforms
are successfully completed. However, even if reform is successful, production
will not return immediately to pre-reform levels, since most of the drop in
output is an irreversible response to the removal of Soviet-era subsidies.

Prospects for Agriculture

The tumultuous decade of the 1990's has continued to have a large impact on the
agricultural sectors in Eastern Europe and the FSU. These countries continue to
struggle with creating the necessary institutions and policies to develop
economies that provide appropriate market signals between consumers and
producers. To date, the agricultural sectors in the FSU have been set back by
the chaotic conditions created by a lack of institutions to deal effectively
with the new market conditions. It appears that the FSU will be a net importer
for at least the next few years, and Eastern Europe could become a net exporter
of grain within the next decade.

Western European agriculture continues to be dominated by the Common
Agricultural Policy of the 15 member states of the European Union. Many of the
nations of Eastern Europe have been adopting the mechanisms of the CAP and will
likely attain higher levels of productivity, enhancing their likelihood of
becoming net exporters of agricultural products. Western Europe should continue
to be a major player in the export markets of most major commodities. Aging
populations throughout Europe, and a low population growth rate due to low birth
rates, have contributed to slow growth in domestic food demand that is likely to
continue into the foreseeable future.

Growth patterns in crop yields and composition of agricultural production in
these three regions are likely to change over the next decade because of 1)
enlargement of the European Union to include most of Eastern Europe and 2) the
direction of agricultural policy and agriculture in the FSU. In the aggregate,
though, Europe will remain a net grain exporter to the world. David R. Kelch
(202) 694-5151 and Stefan Osborne (202) 694-5154 dkelch@ers.usda.gov
sosborne@ers.usda.gov

Bill Liefert , Susan Leetmaa, and Nancy Cochrane also contributed to this
article.

SPECIAL ARTICLE BOX

Western Europe--the European Union-15 (Austria, Belgium, Denmark, Finland,
France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal,
Spain, Sweden, and the United Kingdom) plus Switzerland and Norway.

Eastern Europe--Albania, Boznia-Herzogovina, Bulgaria, Croatia, "Czech
Republic," "Hungary," Macedonia, "Poland," Romania, "Slovakia," "Slovenia," and
Yugoslavia.

Former Soviet Union (FSU)--Republic of Russia, Ukraine, Belarus, Uzbekistan,
Kazakstan, Georgia, Azerbaijan, Moldova, Kyrgyzstan, Tajikistan, Armenia,
Turkmenistan, and the Baltics.

Baltics--"Estonia," "Latvia," and "Lithuania."
Quotes indicate those countries most likely to become EU members in the next
decade.
SPECIAL ARTICLE BOX
Reducing Costs of Producing in the FSU

Agricultural production costs in the FSU are relatively high. Crop production in
the FSU would likely increase if production costs were lowered, making
agricultural products more competitive with imports. Costs could be reduced by
addressing farm-level reform and institutional reform.

The bulk of farm-level reform attempted so far in Russia consists of the
privatization campaign of the early 1990's. The large former state and
collective farms were officially reorganized, but they remained intact and
essentially unreformed. Actual privately-owned farming operations (as opposed to
household plots associated with the large farms) accounted for only 6 percent of
total sown area and 3 percent of crop production in 1997. While the legal status
of the former state farms has changed, many of their economic incentives have
survived. Insolvent farms cannot go bankrupt; when farms cannot repay government
loans, the loans are either forgiven or rolled over indefinitely. With no
significant market for agricultural land, there is no mechanism for transferring
land to more skilled managers.

The goal of meaningful farm-level reform would be to create economic incentives
to facilitate the movement of land, labor, and capital from farms with high
costs to those with low costs. Bankrupting insolvent agricultural enterprises is
one way to divorce resources from high-cost farms. Another way to redistribute
land to low-cost producers is to develop a mortgage market. The most cost-
efficient farmers, who stand to earn the most from agricultural land, would be
those willing to bid the most for farmland. The current 10-year policy strategy
of the Russian Ministry of Agriculture cites the necessity of bankrupting
chronically insolvent farms and the development of a land market.

The second approach to lowering costs in FSU agriculture is to implement
institutional reforms that would complement farm-level reform. In order to
develop a mortgage market, for example, legislation has to be passed to permit
it, and an institutional framework is needed to regulate and enforce mortgage
contracts. The Russian Ministry of Agriculture policy strategy does not state
specifically whether land will be used for collateral in mortgage transactions.
Currently the Russian Federation prohibits the use of land for collateral. In
Ukraine, a land reform bill passed in 1995, but the parliament imposed a 6-year
moratorium on agricultural land transactions.

Development of a rural finance and banking system would also help lower costs.
Such a system would allow profitable farms to expand their holdings by
purchasing resources released by bankrupt farms, and to invest in new
technology.

The countries of the FSU have not made much progress in farmlevel and
institutional reform, largely because it has not been attempted. The largest
obstacle to farm-level reform is the political will for land reform. The
conservative agricultural establishment in Russia and Ukraine has consistently
opposed the private ownership of land, and in general opposes making land a
commercial commodity.

END_OF_FILE






