Seed Industry Conundrum

China is desperate to raise agricultural productivity. Multinational companies are eager to do business in China and can offer technology and improved breeds. Yet many in China fear that allowing multinationals free rein in the country will wipe out weak domestic seed companies.

The Ministry of Agriculture recently released new draft regulations on licensing in the seed industry that are open for public comment until September 25. According to Farmer's Daily, the purpose of the new regulations is to raise the threshold for entering the seed industry, promoting development of stronger, integrated seed companies through mergers and acquisitions. The regulations raise capital requirements for companies engaged in rice and corn breeding six-fold and triples the capital requirements for seed-trading companies. Companies are required to have their own breeding personnel, fixed seed production areas, a complete after-sale service system and have their varieties validated.

China has over 8700 seed companies, and the top 10 companies control only 13% of the market. Two-thirds of Chinese seed companies have registered capital of 1-to-5 million yuan, but the new law raises capital requirements to 30 million yuan for seed production and trading. Over 90% of companies have no research and development capacity.

One way to jump start seed advances would be to allow multinational companies more freedom to operate in China. Currently, multinationals are permitted to hold no more than 49% of shares in a joint venture. There are reports that the Ministries of Commerce and Agriculture are exploring the possibility of allowing foreign companies to hold a majority stake.

An article in Daily Business News warns that the Chinese seed industry faces a new test from foreign companies. The chairman of the Longping High-tech Company told the reporter that the lifting of restrictions on foreign investment "is contrary to the spirit of the government's policy of promoting domestic seed companies."

There are already 70 foreign seed companies registered in China. The article reports that the first joint venture following the seed law was a venture between Pioneer and Shandong's Denghai in 2002. Pioneer had a 49% share. Longping is reportedly in negotiations for a venture with Limagrain in which Longping will have a 60% share, "and that cannot be changed." In 2006, Pioneer set up a joint venture with Dunhuang Seed. Monsanto and Syngenta are said to have "very large" market shares. A type of corn seed Syngenta Xianyu 335 is said to account for seven percent of corn plantings.

A grain industry analyst with China Grain Net is more optimistic in his assessment, suggesting that there could be positive benefits of opening the industry. He suggests that domestic companies can only become stronger if they are exposed to competition from multinationals.

Grain Risk Funds Boosted

Local governments in China have a surprising degree of autonomy in finances. But as some provinces get wealthy, the financial gap between localities is widening. In particular, agricultural provinces tend to have weaker finances. As the Henans and Heilongjiangs try to keep up with the Guangdongs and Shanghais, they rack up debts and are tempted to seize more farmland to build tax-generating projects.

In agricultural policy, the Chinese government is trying to even out the fiscal burden for maintaining a national priority: "food security." Various mechanisms are being tried out to shift more of the financial responsibility for grain subsidies and other policy measures onto the rich coastal provinces. One of the recent trends in China has been to transfer revenue from the central government to the financially weaker grain-producing provinces to help them fund subsidies (using tax revenue collected mainly from rich coastal provinces). Meanwhile, the richer coastal provinces are expected to foot most of the bill for subsidies to their farmers.

In 1994, a "grain risk fund" was set up in each province with funding shared by central and local governments. The money was to be used for procuring grain and edible oils to stabilize the market. When subsidies were introduced in 2004, the funds were used to fund direct subsidies to grain farmers. This year major grain-producing provinces are no longer required to contribute to their provincial funds. On August 25, Xinhua News Service reported that the central government has transferred 4.4 billion yuan (about $675 million) to the "grain risk funds" of major grain-producing provinces.

Nationally, the grain risk funds have been increased by 8 billion yuan. In addition to the 4.4 billion yuan of central government funds recently sent to major grain-producing provinces, local governments of other provinces have been ordered to contribute 3.6 billion yuan of their own money to increase their grain risk funds. Nationally, the fund now totals 38.2 billion yuan ($5.9 billion), of which 72% is in major grain-producing provinces.

The grain risk funds finance direct subsidies to grain farmers, grain and edible oil reserves, and policy interventions to stabilize grain markets. This does not represent a major increase in subsidies (although the funds will probably allow some of the poorer provinces to increase their subsidies or actually pay subsidies that previously existed only on paper). It represents a strategy of making rich provinces bear a larger share of the burden for maintaining "food security."

What's Up With Wheat? Cost!

A series of cost of production survey reports conducted by survey teams across China provide some on-the-ground insight about the inflation process in Chinese agriculture. This year's wheat crop was affected by last winter's drought to an uncertain degree that is hard to discern from these reports, but what is clear is that Chinese agricultural producers face rising costs across the board.

Chinese agriculture is rapidly industrializing, adopting chemical fertilizer, mechanization, and commercial seeds--raising productivity but also exposing Chinese agriculture to rising fuel and chemical prices. Rural land and farm labor--virtually free goods a decade ago--have now become scarce commodities with rising prices as urban development and demand for all kinds of agricultural commodities increases their opportunity costs.

It takes a year before complete national data from crop production cost surveys are published, but many local survey teams publish brief statistical reports on the Internet within a few months after the harvest. The reports are terse, based on small samples of farms, and from random regions, but they offer insights about what's happening on the ground.

The report for Henan Province, which accounts for one-third of China's wheat production, estimates the province's wheat output increased 1.3% in 2011. This year's report estimates the wheat yield at 390 kg per mu, up 2 kg from the yield in last year's report (which contained much more extensive data).

There are no other provincial reports on wheat costs of production and none from the major wheat-growing areas in Henan, Shandong, and Hebei. Most of the other reports are from a random collection of counties and they report widely varying yields. Reports from two areas in Hubei Province say that yields fell sharply, about 16% in Zaoyang. Two reports from Xinjiang give very different reports, one down, one up. Several other reports from Gansu, Anhui, and Jiangsu say yields either increased or decreased slightly.

A report from Wendeng, a district of Weihai on the Shandong peninsula, reveals some interesting details on this year's wheat production. The average yield was 390 kg/mu, down 3% from last year. The report also reveals that the farmers in its survey sample reduced their planting of wheat by 8% this year. There were two reasons. First, some farmers' land was taken over for a new industrial district created in two townships. Second, some farmers were not able to plant wheat due to drought conditions last fall which prevented them from irrigating the fields. Thus, the small decline in average yield does not take into account the land that wasn't planted in wheat at all (this land was planted in other crops in the spring).

What's clearly "up" in wheat production is the cost of production. The reports uniformly report rising production costs. Prices of fertilizer and fuel are up and labor costs are up since wages are rising rapidly. Several reports say land rents are up sharply as well.

The Henan report says wheat production costs rose a cumulative total of 132 yuan per mu over the past five years, an average of 7.9% per year. The increase was split almost equally over three components: material inputs (43 yuan), services (mainly mechanized ploughing and harvest, 43 yuan), and labor (46.5 yuan). The report worries that costs are rising at a faster rate than prices.

The Chinese government has been increasing subsidies on the premise that farmers need relief from rising production costs. In most places farmers get a fixed payment for each mu of land planted in grain, plus a general input subsidy that is linked to rises in fuel and fertilizer prices, and a payment per mu for improved breeds of seeds. Purchases of machinery are subsidized up to 30% but farm equipment is usually bought by entrepreneurs who plough, seed, and harvest fields for a fee of 40-to-60 yuan per mu. In Xinjiang, farmers get a subsidy of .4 yuan for every kilogram of wheat they sell to state-owned grain companies. In Baicheng farmers who lost their wheat crop got an insurance indemnity of 70 yuan per mu.

The subsidy strategy appears to be counterproductive. Some of the inputs explicitly subsidized--seeds and machinery--are increasing in cost. In Henan, the price of wheat seeds was up 20% this year. Machinery services costs were up 9% in and accounted for one-fourth of the increase in cost in Henan.

Rising land rents reflect the scarcity of land as well as increasing subsidies. In Henan, the average land rent went up 50% this year to nearly 200 yuan per mu. The report from Baicheng County, a remote area in Xinjiang near the Kazakstan border, says the land rent for wheat was up 8% this year to 121 yuan per mu (the land rent for the whole year is 200-to-300 yuan). Several reports cite subsidies and increased minimum wheat prices as factors increasing land rents.

When farmers receive subsidies to cushion them from costs, they increase their demand for factors of production that are limited in supply, thus driving up prices and production costs further. This prompts more subsidies and a vicious cycle of subsidies and cost increases.

Pork Vs. Environment

Waste from hog housing in Zhuzhou leaks into the river

Some municipalities in China are banning hog farms due to concerns over the water pollution they create. This micro-trend reflects the bigger conflict between boosting agricultural production and protecting the environment that China faces.

According to reports, Putian, a city in Fujian Province, has formulated a new land zoning plan that will require livestock and poultry farms in certain districts to move or shut down by November 30. The stated reasons are environmental improvement and a shift toward commercial-scale hog farms.

A commentary on the Putian plan posted on many agricultural news sites argues that the restrictions on hog farms are unjustified and harmful to hog farmers. The commentator points out that the restriction is in direct conflict with a 2007 directive from the State Council which clearly stated that local governments may not prohibit or restrict hog farms on the basis on "new countryside construction" or environmental protection. According to the commentary, other cities in Fujian are setting similar restrictions. Like most other articles on this topic, it also cites Dongguan in Guangdong, the most prominent example of a city that shut down hog farms.

The commentator argues that the government should shut down factories if it is really worried about reducing pollution, but officials continue to encourage factories. He says there may some merit in the goals of reducing pollution and transitioning to larger farms, but there needs to be a well-defined process. He complains of "abuse" of small farmers. The commentator says: "After all, small farmers quitting naturally and the government forcing them out are two different concepts."

Farmers in one township of Putian complained that they received small compensation of 100 yuan per square meter for shutting down and lost their subsidies.

The Zhuzhou Evening News reported on a visit to a district of this small city in Hunan along the river where there are many hog farms raising 50 or more head. The article appeared with an announcement about the city's new environmental restrictions on hog farms, so it may be intended to drum up public support for the environmental controls.

The reporter saw dozens of sheds housing hogs, and none of the farms have waste treatment equipment. The Huangtian village had 54 farmers raising hogs. These farmers had come from other places about five years ago as "entrepreneurs." The article doesn't go into details, but these might have been farmers resettled here after their land was requisitioned for urban development.

When he visited a hog farm the reporter was confronted by a strong smell. The farm was adjacent to houses for people. The boss of the farm said they originally came from Ningxiang and had rented land to operate the hog farm for five years.

The boss's wife said they typically just shoveled out the manure. Some of the manure is used for fertilizer, but it's mostly just piled up. When there's a big rain a lot of manure washes into the river.

The reporter understood that there are about 1000 such farms in the area.

An official from the Zhuzhou veterinary and livestock bureau explains that a 10,000-head hog farm produces waste equivalent to what 70,000-to-80,000 people would produce.

An official from the Zhuzhou environmental protection bureau says the city is issuing a new comprehensive plan that will prohibit or limit the number of livestock operations in the city's districts. All livestock farms will have to undergo an environmental assessment. The environmental protection bureau will accept opinions and inquiries on the new regulation on August 22.

This is a microcosm of China's attempt to juggle conflicting priorities:

Produce more food to keep prices down. More food production damages the environment. Require environmental controls...drives farms out of business and raises the operating costs of those that remain. Oops, higher food prices.

Expand cities and build new towns to urbanize, leaving farmers landless and unemployed. Resettle the displaced farmers and put them to work raising hogs, an activity that doesn't require much land. Oops, they pollute the water.

Next fix please...how long can we keep all these balls in the air?

Pork Imports Up--Temporarily?

A news report on a pork industry web site says that China's imports of fresh, chilled and frozen pork for January to June of 2011 reached 126,269 metric tons. Imports increased 43% from the same period in 2010.

More than half of the pork imports came from the United States. It attributes increases in pork exports by the U.S. and Denmark to increased demand from China, South Korea, and Japan.

The report notes that China and the United States have differences over use of "lean meat powders," but the report observes that no effect on pork trade is evident right now. The report speculates that opening the pork market to imports is an important measure to "fill the temporary shortage" in the market.

So, does that mean Chinese quarantine authorities will suddenly start finding banned additives in U.S. pork when the "temporary shortage" of pork dissipates next year? Keep in mind, during the year-earlier January-June 2010 period Chinese pork prices were depressed and Chinese authorities still hadn't lifted the H1N1-related restrictions on pork imports put in place in 2009.

The report also notes that smuggling of poultry is rampant due to high meat prices in China.

Early Rice Recovers?

The early-season rice crop has now been mostly harvested. There are varying reports on the status of the crop. The official party line is that the crop is good, and China has an eight-consecutive increase in "summer grain" production. Other reports note that losses to floods and droughts are serious.

One report cites data from the National Development and Reform Commission and China Grain Net that show a good harvest and production "back to normal." The China Grain Net balance sheet estimates that supply of early rice exceeds use by 1.2 million metric tons.

Another article says that the volume of rice is larger this year. However, due to rain the moisture content is high and there are lots of impurities. While costs are up and the supply-demand balance is tight, putting upward pressure on prices, quality problems will mean a generally low for much of the early rice.

The early rice crop is strategic because the government uses it to fill grain reserve bins (early rice has a high yield but most people don't like its taste and texture). A number of southern provinces are paying farmers a direct subsidy of 0.2 to 0.5 yuan per kg. if farmers sign a contract to deliver early rice to a state-owned enterprise. The purchase is executed at the market price or the minimum set by the government. This policy is intended to boost production of early rice and help government grain bins compete with private buyers to buy rice.

Some articles credit the subsidies with reviving early rice production. Last month, Wenzhou's local authorities announced that the minimum price for early rice would be no less than 2.2 yuan/kg. The minimum price was recently announced at 2.24 yuan, 9.8% higher than last year. Large farmers and cooperatives can get an extra bonus payment of .05 yuan/kg for contracting to sell to the government; individual farmers can only get .02 yuan/kg.

Perhaps more important than the subsidies, Wenzhou Grain Bureau officials held a "Five Delivers" campaign this spring in major rice-growing counties. They delivered information, policies, contracts, cash, and services. They signed contracts with 13,700 farms to deliver 78,100 mt, and expected to deliver funds of 5.63 million yuan. In some regions, farms can get a cash advance on the contract payment.

A China Grain Net report says companies are approaching the purchase of early rice with caution due to tight credit and big losses on rice last year. The article says Yihai Kerry and Beidahuang both lost a lot of money on rice in 2010. There is a rumor that Yihai Kerry will not buy early rice this year and Jiangxi's branch of COFCO will only buy high-quality rice, which means not much early rice.

Nevertheless, the government's eagerness to restock warehouses keeps demand robust and prices are rising. Farmers are said to be hesitant to sell their rice, waiting for prices to go up further. In Hunan, the price began rising in July and is about 2.34 yuan/kg, well above the minimum of 1.12 yuan/kg.

College-educated Farmer

One of the new strategies for transforming Chinese agriculture is to create a new cadre of educated farmers who will take the place of China's missing extension service by becoming early adopters of new techniques and transmitting them to their neighbors.

An article appearing on the Zhejiang Daily news site tells the story of 27-year-old Wang Binbin who took up a career as a rice farmer following his graduation from university. This appears to be a propaganda piece that provides a model of the new breed of farmers China would like to cultivate. His story includes many of the new trends in agriculture now being promoted by Chinese officialdom: college students "sent down" to the countryside, adoption of ecological pest control, large-scale farming, entrepreneurship, cooperatives, and mechanization.

Zhang graduated from Anhui University with a degree in Law in 2005 (In China a law degree seems to be primarily preparation for a career as a communist party official, quite unlike the western law school career path), and he took a job in the land management office in Yuanqiao Town. After the 2009 "Number 1 Document" was released and he saw the favorable policies for farmers, he realized that agriculture was a big field for entrepreneurship. He went back home to become a farmer.

Zhang formed a machinery cooperative with 7 farmers, borrowed 190,000 yuan to buy agricultural machinery so the entire farming process could be mechanized--planting, pest control, fertilizing, harvesting, and drying of crops. Each year Zhang rents 160 mu of land to grow rice, and his yield is double what his father got.

Seeing the labor-intensity of rice harvesting, he read up on mechanization and joined with a friend to design a new way of mechanizing the rice harvest. He got a national patent on his innovation. He improved the grain-drying equipment, reducing labor requirements from five people to one.

Last year there was a big rain 3 days before harvest, and he lost over 200,000 yuan when 350 mu of early rice was flooded. This year he will control misfortune and risk by increasing the scale of production and usuing new-style production methods.

This year Zhang contracted 1060 mu of land for one-season rice in Hubei's Xinzhou, producing nearly 420,000 kg.

Zhang has an "ecological mindset." He is testing out non-chemical pest control methods: netting and lights to keep bugs away on 30 mu. The "ecological" methods give him a lower yield of 200 kg, but the ecological rice brings what sounds like an absurdly high price of 160 yuan per kilogram. He plans to spread this technique to more of his land.

Among neighboring farmers, Zhang is seen as capable and enthusiastic. An old farmers couldn’t find people to harvest his rice when it matured. Zhang heard about it and brought his machinery to help him. In the last few days, Zhang delivered pesticide and seed worth 20,000 yuan to his neighbors. This year he delivered enough seedlings to neighbors to cover 300 mu, a pest control system used on 1000 mu and mechanized transplanting on 2000 mu.

Zhang sounds too good to be true. Maybe he is, but if he inspires a new breed of educated super-farmers he will have done his job.

Fruit Floods the Market

An article on low fruit prices in Tianjin illustrates the complexity of agricultural markets and the difficulty of measuring "inflation" in China. The article has been posted on dozens of industry web sites, many with a subtitle speculating that the "dive" in fruit prices might relieve upward pressure on the CPI.

The article reports on steep declines in prices for watermelons, peaches, grapes, litchees, and bananas in Tianjin markets. The prices of each of these fruits tend to decline during the summer when new harvests hit the market, but the price declines have been especially sharp this year for various reasons. The manager of Tianjin's Red Flag wholesale market says that, “Due to weather influences, this year most fruit is in excess supply, and this is creating downward pressure on prices.”

In June, ripening watermelons from Shandong, Anhui and other regions hit the market, pushing prices down 60% from their May levels. They came back up a little in July but are down again in August. A wholesale market manager estimates that current wholesale watermelon prices of 0.4 yuan per jin are about 25% less than a year ago.

Peach prices also plunged about 45% in July, but rainy weather blocked transportation later in the month, pushing prices back up. Prices are now about 2.5 yuan per jin. Late-ripening peaches in Beijing and Hebei are about to be harvested and could push prices down again.

Litchees are a fruit from subtropical regions, grown in the far south of China. Yet they are now widely available in Tianjin and other northern-China markets, a reminder of China's rapidly-maturing agricultural markets. This year large volumes of litchees were produced in Guangdong and Guangxi Provinces, and they are now in excess supply. Wholesale prices in Tianjin are down about 30% from last year.

Banana prices were pushed abnormally low because weather-related factors resulted in the spring and summer banana crops coming on the market at the same time, again creating a surplus. The current price is about 2 yuan per jin, down from 5-to-6 yuan in May.

Grapes came on the market at 15 yuan per jin in the spring, fell to 10 yuan in July, and now quite a few merchants are selling them at 7-to-8 yuan. Many of the grapes so far this season were raised in greenhouses. Large volumes of local grapes raised outdoors are expected to come on the market in mid-August, keeping downward pressure on prices.

The article notes that vegetable prices also decreased this week. Eggplant, for example, was down more than 10% from the previous week. Fish and shellfish prices appear to have begun to reverse their upward trend.

The article says the "dive" in fruit prices gives some people hope that the CPI for July might decline. However, some experts say the decline in fruit prices won't offset the big increase in pork prices. Also, some other commodities like cooking oil, milk powder, and mooncakes have rising prices.

This article could be propaganda spread to allay worries about inflation. However, it does highlight the difficulty of separating seasonal fluctuations and microeconomic price adjustments from inflationary trends. The U.S. produces "core" CPI numbers that remove volatile components--chiefly food. A similar "core" CPI number in China would give a very different picture of inflation, but that wouldn't make much sense in China since the population still spends 30%-to-40% of its income on food.

The contrasting trends in grain-cooking oil prices and fruit and vegetable prices reflects the messy transition towards China's comparative advantage. Prices of grains and oilseeds in China are generally at or above world prices and increasing. Prices of fruits and vegetables are still low but they fluctuate a lot from year to year and season to season. Last year at this time, rising vegetable prices were considered a major national concern, but this year prices are falling again. Chinese farmers and traders react quickly to price signals.

According to National Bureau of Statistics data published in May, production of fruits and vegetables increased about 5% in 2010, faster than just about any agricultural commodity. And that was last year, when fruit and vegetable prices were considered to be in short supply.

Explosive Income Growth

New data show that disposable incomes of China's urban residents rose 13.2% and rural incomes grew 20.4% in the first half of 2011. A China Grain Net commentary on the new statistics warns that these eye-popping growth rates are both good news and potentially bad news for an economy on a knife's edge.

The rapid growth reflects both economic growth trickling down to the lower rungs of China's economic ladder and upward pressure on commodity prices and housing prices. China's CPI was up 5.4%. After deducting inflation, the real growth in urban incomes was 7.6% but real rural income growth was still a blazing 13.7%.

In the first half of 2011, 18 provinces lifted their minimum wages. Urban employment increased by 6.5 million in the first half of 2011. Social insurance is also being ratcheted up.

Rural incomes rose due to rising income from off-farm employment and rising commodity prices. Income from employment rose 20.1%. Income from household business operations (chiefly farming) rose 21%, of which 17% was due to higher prices of commodities they sold.

The explosive growth in income is linked to inflationary pressures. Higher wages mean rising labor cost pressures that pass through to higher prices. An official with the State Information Center's Economic Monitoring Department observes that rising labor costs are an indisputable trend. He says wages are still low but they're rising steadily.

Wages of unskilled workers have a lot of room to rise. The highest monthly minimum wage is Shenzhen's 1320 yuan, equivalent to about US$200 per month. The highest hourly minimum wage is Beijing's 13 yuan, about $2 an hour. During the 12th five-year plan, the target is to raise minimum wages 13% per year.

(The minimum wage tends to ratchet wages upward, but actual wages for unskilled workers are higher, especially in coastal areas where factories are raising wages in order to keep workers. Thirteen provinces set "reference wages" that are about 15% higher than the minimum.)

Rising commodity prices cut two ways. Increased demand is pushing up farm prices, bringing more income to farmers. Perhaps the vast rural population is finally getting a long-awaited invitation to the China growth party. On the other hand, rising food prices--which account for most of the increase in CPI--hit low-wage workers hardest. The food component of China's CPI was up 11.7% year-on-year in May.

In fact, the rural population now buys most of its food (instead of eating food they grew themselves) so they also are somewhat vulnerable to rising food prices.

Another land-constrained sector is housing. China's real estate developers have been eager to erect luxury housing estates, but migrants are crowded into work-site dormitories and tents and ramshackle rental housing in villages on city outskirts. The housing CPI was up 6% in May.

Meanwhile, labor and commodity costs don't seem to be having a profound effect on consumer prices of manufactured goods. Other sectors' prices are rising faster than in past years but still much more slowly than food and housing. Clothing CPI was up 1.8%, medical and health products were up 3.2%, and consumer prices in other sectors were up by less than 1%.

The target for the 12th five-year plan is for GDP and personal income to rise at equal rates. This represents a goal of transitioning from export- and investment-led growth (GDP growth exceeds personal income growth) to consumption-led growth. This also entails spreading more income to low-wage workers.

The fundamental scarcity of land pushes up prices of food and housing, undermining the goal of lifting the real living standards of the billion or so people at the bottom of China's economic ladder. Double-digit income growth could be "explosive" in more ways than one.