The Current Industrialization of Agriculture

1. The Current Industrialization of Agriculture David Zilberman Department of Agricultural and Resource Economics University of California, Berkeley

2. Elements of Transition For 100 + years U.S. farmers produced commodities to mass markets- butthis is changing- • Transition from commodities to differentiated products • Transition from sales to markets to contracting and vertical integration. • Adjustments to environmental concerns &regulations • Some processes continue • Industrialization of production.especially in livestock. • Increase in farm size and decline in #of farms • Increased importance of purchased inputs • Globalization-pursuit of international markets&alliances

3. The Forces Shaping the Ag Economy • High rates of technological change-resulting frompublic research (mostly biological),private innovation (mechanical).spillovers from other sectors ( power) • yield per capita globally increased by 12% since 1950 • Corn yield per acre in the U.S.

4. The Forces Shaping the Ag Economy-II • Easily saturated (inelastic)Demand- 5-8% increase in supply leads to about 10% price reduction- • More output results in less income for farmers • Random shocks (climate, diseases, economic situation) • Increased relative costs of labor vs other inputs (during 20th century labor costs rose 5 times the CPI, while energy prices grow slower that the CPI, labor prices rose much faster than capital). • Consumerism and environmentalism

5. The Chronic low Profitability Problem • Random factors leads to price fluctuations. • Technological changes + inelastic demand lead to over supply, low prices and farm income problems. • Corn prices in 2000 Dollars

6. Real value of U.S. corn(measured in thousands of 2000 dollars) is declining over time

7. Policy responses to the farm income problem • Subsidization- policies that support income by raising prices, payment for land diversion etc. • As the price of wheat drop from around $3.8/Bushel in mid 90th to $2.1 in early 2000, Farm policy shifted from “Freedom to Farm” to the 2002 subsidies intensive farm bill • Protectionism-limits on certain food export(Sugar) • Subsidies are exercised by U.S, Europe and Japan • They harm developing countries($300 Billions/year worth of protection) • lead to over production and environmental damages.

8. Private strategies to enhance farm income-I • Product differentiation -generate products to meet specific consumers needs and desires, including • Time saving -Precut meats, packaged salads • Enhanced taste -Tree ripen fruits, exotic varieties • Health benefits -foods fortified with nutrients • Preference for Specific production processes-Organic, range free, Kosher, etc - • Supporting local farmers • Differentiation is essential elements of strategies introducing organic food, biotech foods and convenience foods.

9. Producers care about the manner of food production and processing. • California Study of willingness to pay for pesticides free food finds • 30% are not willing to pay extra • 25% are willing to pay 5% extra • 15% are willing to pay 10% extra • 15% are willing to pay 15% extra • 5% are willing to pay more than 30% extra • Environmentalist and people with high incomes are willing to pay more, smokers are willing to pay less • There is a gap between actual and stated willingness to pay (talk is cheap). • Yet,there is a significant niche market for “green ‘ products. • Sale of organic is growing by about 15-20% annually.

10. Contracting, integration and product differentiation • Differentiated products are innovations that require investment in product design and marketing • They require investment in consumer education-about the product and broader issues (nutrition,environment) • Investors are concerned with having sure supplies of the new ag products- and reduce supply uncertainty by vertical integration (produce the product themselves) or contracts. • Differentiation is likely to increase contracting and integration and reduce production by farmers to final markets

11. More about ag contracts • Contacting-where an integrator (provide some inputs to farmers, orders output and then sells it)-is useful mechanism to • Introduce new innovations quickly • Assure product quality • Meet detailed marketing obligation. • In most modern industries subcontractors play a major role in generating supply,that start occuring in agriculture. • More than 50% of California.fruits and vegetables are sold through contracts arrangements • The young Broiler industry grew fast because of contracts (no one wanted to grow birds without a contract from a buyer),and contracting in swine increases 50% of production. • There is increase in contracting for uniquely specified products(organic pork, rare flowers or herbs)-here the internet helps. • All new segments use contracting-from organics to biotech

12. Contracting promise and problems • Contracting plays similar role to franchising- it allows the fast spread of a new practice, and take advantage of economics of scale in purchase of inputs, research and marketing • For most parts rates of return of integrators is higher than those of farmers-but • We do not observe the integrators that did not make it • Integrators reap most of the return for risk and entrepreneurship • Farmers may complain about contractual arrangement, but the queues to get a contract are long • Contract arrangements are ignored in environmental regulations-integrators, who dictate much of the farms activities are not liable for its pollution- and they should.

13. Private strategies to enhance farm income-II • Expand availability of products • off season -Price of fruit at the beginning and end of the season may be three times the price of the same quality fruit in the midst of the season. Production is expanded (through direct investment or contracts) to locations that allow expanding the season • Throughout the year-adoption of Kiwi by consumers wasenhanced by its year around availability. • To new locations - New shipping and information technologies, and varieties with longer shelf lives allow physical expansion of markets and better response to opportunities • .

14. Private strategies to enhance farm income-III • Provide recreation and environmental services,e.g. • Dude ranches,Inns • wild life habitat (rice field feed migrating birds in California) • hunting rights • Diversion and cleanup of water to wetlands or wild life reserves • Reduce - intermediation- farmers receive less than 50% of consumer price-most go to intermediaries. Farmer price increases by • Selling in farmer markets • Direct sales to buyers cooperatives or clubs • Direct sales to consumers using the internet

15. The evolution of the structure of agriculture • Relative increase in labor prices and reduction of food prices were the major causes for • migration out of farming • increase capital intensification and size of farms. • When net annual income of field crops is $25-50/acre, you need between 800 to 1600 acres to earn 40.000 annually. • The main action in food production is outside the farm On farm activities,have been reduced over time- • human labor has been substituted with energy • Increases in farm productivity are due Lab activities • Marketing,processing and distribution are costly and complex • No wonder ag’s income is much smaller than that of agribusiness

16. Ag structure :present and future • There are 2 million farms in the U.S.with size of 500 acres. • The major players 300000 farms gross more than $100.000 and 50000 Grossing more than 500.000/year&control. • Most of the big farms are family owned. • Annual Farm revenues of about $200 billion generates income of $20-40 billion. • Agribusinesses (which sells inputs and market outputs) are grossing 8-10 times as agriculture. They are efficient, and labor and knowledge intensive. They expect to grow. • Yet,transfer of 5% of agribusiness income to the farm will almost double farm revenues.