Gresham's Law of Pork Safety

In January, the dim sums blog reported on the campaign announced by nine Chinese departments to conduct a national audit of pork slaughterhouses to clean up the industry. According to authorities, the program is progressing nicely. But the process of cleaning up the industry is more complicated than it seems. China's pork industry shows a strong tendency for "unsafe" food to crowd "safe" food out of the market.

At a meeting in June, Vice Minister of Commerce Jiang Zengwei gave an update on the audit program. He said 4141 slaughterhouses had passed their audits, 994 are undergoing rectifications, 71 lost their qualification as a "designated slaughterhouse," and 93 had been closed. There were another 563 that had not yet been checked. The audits are checking on sources of water, equipment for processing and cutting pork, disposal of carcasses and waste, and making sure that animal inspection certificates are in order.

Shanxi Province reports statistics on their crackdown that portray a much more grim situation than the statistics disclosed by the commerce ministry. Shanxi officials said only 67 of the province's 367 slaughterhouses passed their audit. Shanxi officials gave 210 slaughterhouses notices that they needed to make improvements. Shanxi said they closed 70 slaughterhouses--that would account for most of the 93 that were reported closed in the whole country by the commerce ministry. Shanxi also shut down 39 illegally-operated slaughterhouses. In Guizhou, citizens have been given a special cell phone number to report illegal slaughterhouses. Some cities are creating "black lists" of illegal slaughterhouses.

This is not the first crackdown on slaughterhouses. In June 2010 the Ministry of Commerce announced a similar remediation program that was supposed to be completed by the end of 2010, but it seemed to quietly slip into oblivion. The schedule for this year's program seems to have slipped a bit too. When it was announced in December, local authorities were supposed to finish their audits by July 31 (this month), but the Commerce Minister now says they have until the end of September. Provincial authorities are supposed to conduct sample audits (presumably to catch possible lax inspection by local authorities) by the end of November. Why is it so hard to straighten out slaughterhouses? An article about Shenzhen City's plan to replace its 16 old slaughterhouses with four new modern ones reveals the fundamental problem.

In 2005, Shenzhen authorities announced a plan to build four modern slaughterhouses to improve food safety in the city. However, this year--7 years later--only one of the four slaughterhouses is open. The No. 1 slaughterhouse opened in 2010. Ceremonies to lay cornerstones for two others were held in 2007 but are not open. Shenzhen authorities recently announced that these two slaughterhouses will be open by the end of 2012 and the fourth will open in 2013.

A reporter consulted the manager of Shenzhen's No. 1 slaughterhouse to find out why the slaughterhouse plan is going so slowly. The manager told the reporter that the slaughterhouse is actually operating at only 10 percent of its capacity (see March 2012 dimsums post on this topic). The manager said the large modern slaughterhouse has fixed costs that are several times higher than those of Shenzhen's 16 old slaughterhouses. The slaughterhouse cost 300 million yuan ($45 million), can process 600 hogs per hour (as well as 20 cattle or 50 dogs, by the way), has cold storage for 5000 metric tons of meat, automated equipment imported from Holland, and water treatment equipment.

With its high interest and depreciation expenses, the No. 1 slaughterhouse sells pork at 48 yuan/kg, higher than the 40 yuan/kg that prevails in the market, and it still loses money. The company's sales are primarily to high-end supermarkets, restaurants, hotels and cafeterias. The larger retail markets are dominated by meat from the old slaughterhouses.

The old slaughterhouses lack the modern equipment of the new facilities. More importantly, the old slaughterhouses operate as agents--they receive a commission for each hog slaughtered. The wholesalers who bring the hogs for slaughter procure them from widely-scattered farmers and then sell them on to retail vendors. There is no way to trace the source of the animals. City authorities want to move away from this agency model to integrated procurement, slaughter and marketing of hogs/pork with company brands.

The No. 1 slaughterhouse manager said the government must "have determination" to close down the old slaughterhouses. He says that his company would have lower unit costs if they produced a volume near their capacity.

It seems that the investors in the three unbuilt modern slaughterhouses have ownership interests in the old slaughterhouses. A representative from the company investing in the No. 3 slaughterhouse spoke at a meeting on Shenzhen's slaughterhouse plan, expressing hope that "the government will not make us lose money."

The four planned new slaughterhouses would have a capacity of 20,000 hogs per day, enough to meet the daily consumption in Shenzhen. No. 1 slaughterhouse manager says that these new facilities would have higher costs and charge higher prices than the prices that currently prevail in the market. But he says it wouldn't be that much higher.

The article gives the example of Hong Kong. It says the city used to have 6 or 7 slaughterhouses but now has only two. Its pork prices are only slightly higher than in Shenzhen.

Thus, China's food safety issue is one of prices and market structure. Safe food is more costly. It entails high (fixed) costs and the final product is not necessarily discernible from "unsafe" products of small producers with low costs. Low-cost producers will emerge to undercut the "safe" producers, so "unsafe" food crowds out "safe" food, a sort of "Gresham's Law" of food safety.