Thursday, February 28, 2013

Chicken Pharming With Chinese Characteristics

Following the scandal over excessive use of pharmaceuticals in chicken-raising there is a lot of introspection in China's chicken industry. One of the items up for consideration is the "company + base + farmer" industry chain model which has been the foundation for China's "agricultural industrializtion." The poultry industry is the leading proponent of this model in which a company relies on thousands of small-scale farmers in a "production base" to supply chickens. The company supplies farmers with chicks, feed, pharmaceuticals, and tells them what to do. The company promises to buy the full-grown chickens at a reasonable price. This model is said to be in accord with "Chinese characteristics" since it incorporates large numbers of small-scale farmers, increases their income and involves them in modern agricultural supply chains. A "win-win."

One article questioned the high risk associated with the "company + farmer" model. A manager associated with one of China's leading agribusiness companies quoted in the article said the melamine, clenbuterol, and chicken-drug incidents demonstrate that the model is not feasible.

Kentucky Fried Chicken has over 4000 outlets in China that need to be supplied with chicken. It contracts with other companies to supply the chicken. KFC has no way of controlling or supervising the production and slaughter of chickens. It has to trust the supplier company to supervise production of chickens by tens of thousands of farmers. Suppliers can display animal quarantine certificates but news media investigations have shown that these certificates can easily be bought. KFC has to rely on testing of the chicken delivered to it in order to verify that standards were maintained in the production and processing. With tens of thousands of producers, each using his/her own methods and dozens of substances to test for, it would be easy for batches of bad chicken to slip through the sample testing.

In earlier decades, China's "special feature" was vast numbers of poor farmers, but today the Chinese countryside's special feature is scarce land, labor, and feed and soaring costs. The article points out that cost pressures squeezed farmers' profit margins which put more pressure on them to cut corners. Chicken farmers get a fixed price based on a 6-to-7-percent premium over production costs. With costs of feed, labor and land rising rapidly, profit margins are squeezed. Cost-cutting can harm the health of chickens, which farmers can address by using more pharmaceuticals to keep them alive.

One of the constraints on chicken farming is lack of space. Chickens are more vulnerable to disease when they are in crowded conditions. According to a farmer raising chickens for a Shanxi company, their guidelines call for 5000 birds per house. With such a high concentration, chickens are more likely to get sick, so farmers use illegal drugs or ignore the requirement that they stop administering drugs 7 days before slaughter in order to prevent high mortality.

The alternative to the "company + farmer" model is for companies to raise the birds themselves and have complete control over the process. The head of Yum! Brands China operations indicated that the company is trying to bring big companies into China to raise chickens. However, companies would have to acquire large tracts of land to build their farms. This is difficult to arrange since it means occupying the land of one or more entire villages and probably displacing grain production. (Pig farms are often confined to hillsides or forest land.) If it can be accomplished, the cost of land is high and large fixed investment and compliance with all kinds of environmental and other regulations are required. The treatment of waste is much higher when birds are highly concentrated in one place. The company would have to pay laborers and find skilled managers willing to run a farm in a remote area. One of the reasons for using the "company + farmer" model is that farmers supply the land and labor, reducing costs substantially. Moreover, the presumed lower risk of a fully integrated model assumes that the managers of company-operated farms can be trusted to follow regulations and standards.

Most Chinese people ate very little meat until chicken and pork production started to take off in the 1990s. And there was a reason for that...producing livestock requires lots of land to produce feed and forage and spread the waste. The country temporarily got massive amounts of meat by putting pigs and birds in backyards but that era is over now. China still doesn't have enough land. Costs are soaring, food safety is a national nightmare and the chickens are coming home to roost.

Sunday, February 24, 2013

Imports, Subsidies: Up, Up and Away

Caijing magazine reports that Chinese officials are contemplating major "breakthroughs" in grain policies in 2013 to cope with a likely scenario of lower global grain prices vis-a-vis domestic Chinese prices.

China's strategy for encouraging grain production has been to boost subsidies and price supports to give farmers steady net returns. The increase in domestic grain prices didn't affect grain trade too much as long as global prices were also elevated--due to the U.S. drought during 2011 and 2012. However, this year many analysts are anticipating record harvests in several major countries which may drive world prices lower during the second half of 2013, if not earlier. With Chinese prices still on an upward trajectory and world prices falling, imports will be attractively priced for Chinese mills and other consumers of grains, leading to a possible "flood" of imports.

Grain imports already increased sharply during 2012. One top rural policy advisor observed last month that China's grain self-sufficiency rate (including cereals and soybeans) had already fallen to 90 percent in 2012. Another rural policy advisor to the State Council worried that grain imports could surge if farmers lose their enthusiasm for planting grain and world prices fall, potentially opening a complicated "Pandora's box" when corn and other grains begin entering the Chinese market.

The Caijing article notes that China's WTO commitments place a limit on subsidies at 8.5 percent of the value of output. China has already increased subsidies quite a bit, so officials have little room to maneuver. The Ministry of Finance announced that the government had spent 0.80 yuan on financial support for grain, including 0.28 yuan for direct subsidies to farmers for every kilogram of grain produced in China. [At an average grain price of 2.25 yuan/kg, that makes the direct subsidy 12 percent of the gross value of production.]

The idea behind these subsidies, say officials, is to offset rising production costs to encourage farmers to keep spending on inputs. However, the Caijing article says that the subsidies don't make much difference to farmers; they continue using old-fashioned farming techniques. The director of the Ministry of Agriculture's Research Center for Rural Economy ascribes the problem to the "decoupling" of the subsidy for improved seed from the purchase of improved seed [In most places the "seed" subsidy is now given as a cash payment based on area planted without regard to the type of seeds used.]

Since 2008 the government has also been raising minimum prices for rice and wheat by 6-to-10 percent annually. There are also price support ("temporary reserve") programs for corn, soybeans, and rapeseed.

The net return for rice is estimated to be 30-to-40 percent above expenses, wheat 20 percent, corn 10 percent, and rapeseed less than 2 percent. Despite higher subsidies and price supports the Ministry of Finance said that the net return to wheat production fell by 13 percent last year.

Officials are worried that grain production is on a knife-edge. Vice Minister Hui Liangyu wrote in the communist party journal that agriculture is facing "two highs and two constraints"--high costs, high risk, resource constraints and lack of young laborers.

Given their WTO commitments, officials have little space to raise price supports. The Caijing article notes that there is "an urgent need to adjust" policies for grain production and trade. The article reports that officials are speeding up their plans to make major adjustments to the policies. A National Development and Reform Commission official says there will be a major "breakthrough" this year in grain policy.

The Caijing article notes that the strategy of raising price supports every year builds in expectations of ever-higher prices. This encourages farmers to hold grain as long as possible, waiting for a better price. Users have to bid prices higher to pry grain loose from farmers, which encourages them to hold the grain even longer. This encourages the upward spiral in prices.

One of the problems is fiscal. Local governments shoulder a large share of the burden for financing agricultural support, but grain-producing regions have a thin tax base and are not inclined to spend on grain projects. One mechanism under consideration is an intergovernmental revenue system that will transfer funds from grain-consuming regions to producing regions. The funds received by the producing region will be based on the amount of grain sold outside of the region.

A countercyclical payment for soybeans is being considered. This would set a "target price" based on production costs plus a reasonable profit. Farmers would receive a subsidy equal to the difference between the target and the market price if the target exceeds the market price. However, this subsidy faces some difficulties. It hasn't been determined whether the subsidy payment would be based on acreage, volume of output or volume sold. Moreover, there are no good records to verify these quantities. They are considering using satellite imagery to verify acreage.

As if China doesn't have enough objectives for agricultural policies, the article suggests that agricultural pollution--now "very serious"--be considered in reformulating policies.

One expert quoted in the article advised officials to move with caution. Since subsidies can only increase, never decrease, they should be careful of where this is leading. They should not make major changes in one policy without considering the effect of other policies. He warns officials not to be over optimistic.

When China entered the WTO the big worry was how international competition would affect farmers. Officials cut taxes on farmers and gave them small subsidies and everything seemed to be working out OK as long as farmers were locked away in the countryside. Now that rural people are beginning to participate in the general economy by streaming into cities for work, rural land and labor has an opportunity cost that needs to be factored in to production decisions. Costs are soaring and outpacing subsidies. Authorities gave up most of their policy leverage to join WTO and now the chickens are finally coming home to roost.

Wednesday, February 20, 2013

Chinese Village--New Riches and Despair

Chinese new year is a time for culture clashes and introspection as China's urban elite visit their rapidly-changing rural home towns.

One Beijing blogger posted an essay, "Who Sold Out My Nostalgia," despairing over his village's exchange of work in the fields, trees and ponds for piles of cash, concrete buildings and empty leisure time.

The blogger arrived in his home town for the new year and found none of the animals, fields, trees and ponds he remembers from his childhood in the village over 20 years ago. The village is now little different from the endless concrete buildings, factory yards and broad streets that cover Beijing.
Construction project outside Beijing that covers five former villages.

"The villagers are still here, but the village is not," writes the blogger. His family and friends had their land occupied by high-rises and factories. They received big wads of cash -- as much as 1 million yuan -- in compensation for their demolished houses and now they live in big housing complexes just like city people.

The blogger despairs over the villagers' existential crisis. They have money to spend now, but no purpose.  The blogger sees friends and relatives engaged in a treadmill of gambling, womanizing, and fitful sleep. No goals, no future, "Just scum with no spiritual pillar playing games," writes the blogger. The main activity in the village is high-stakes games of mahjong and dominoes. People routinely lose 20,000 yuan in the popular domino games.
Ad for a "training center" for playing Beijing domino games

The symbols of wealth "contaminate" the blogger's nostalgia for the countryside. A parade of expensive cars -- the first expenditure villagers make after getting compensation for their demolished home -- come and go in the village. A lady standing in line at the bank ahead of the holiday comments to her friends about the large sums of money spent on the holiday these days. Each family feels obligated to serve 20 courses at new year meals--any less would be an embarrassment--but less than half of the food is eaten.

No one smokes cheap 10-yuan-per-pack cigarettes. All the young men smoke expensive Chunghwa or Jade Creek brands. Two relatives had an altercation when one offered the other a cigarette. The man turned down the cigarette, complaining that only migrant workers smoked that kind.

One young man was given a job as a security guard after his family's land was taken by an apartment building. His monthly salary is 1000 yuan but he spends 2000 yuan, presumably getting the extra money from his parents.
Comic from another news article mocking 
villagers' spending of compensation payments.

The blogger worries that giving farmers compensation for their land may give them fleeting riches, but leads them into an ugly trap. He compares the compensation payments to opium. They have no work, no entrepreneurial spirit. The demolition of their houses also demolished their honesty and industriousness, replacing it with alienation.

Once a farmer, always a farmer, writes the blogger. If farmers are not given technical skills, a job, a way to make a living after losing their land, their future is "frightening" and "an unpredictable disaster."

Tuesday, February 19, 2013

Subsidy: 49 Acres and a Grain Dryer

A new type of subsidy for "large farms" being tested in five trial provinces represents a new direction in China's approach to farm subsidies.

The "large farm" subsidy marks a departure from the rural entitlement subsidies introduced in 2004 to a subsidy aimed at transforming the nature of farming. This subsidy is paid to farmers who plant grain on at least 300 mu (49 acres) of land in Shandong, and 500 mu in Heilongjiang500 mu in Jiangxi (1000 mu for cooperatives planting rice) and 1000 mu in Liaoning Province. While these are still a relatively small farms by standards in other countries, it's far bigger than the average land holding in most Chinese villages of 4-to-6 mu. The provinces seem to be getting 100 million yuan each from the central government to fund the large farm subsidies this year, probably matched by local funds. Heilongjiang says it is spending 200 million yuan on the subsidy pilot.

The "large farm" subsidy focuses on helping farmers make investments in fixed assets--irrigation, grain-drying, and grain storage facilities and equipment. The subsidy comes in the form of an interest rate subsidy or cash award given after the investment or purchase of equipment is made. One article describing Shandong Province's program says the old subsidies have been critcized for their lack of incentives and failing to fulfill their original intent; the large farm subsidy is described as a good way to search for better subsidy methods.

A number of provinces have experimented with a different "large farm" subsidy that paid farms 10 yuan per mu of land, but this new pilot subsidy is different. Jiangxi Province says its 16-yuan-per-mu "large farm" subsidy is being replaced with the new one that subsidizes investments instead of subsidizing land.

The description of Shandong's large farm subsidy is confusing. It seems to imply that large farms get a payment of 230 yuan per mu of land and a maximum payment of 1 million yuan for farms of 4000 mu or more. A description of Shandong's program procedures is vague, but seems to say that the subsidy is for investments in irrigation, grain-drying, or grain-storage made during 2011-12. Descriptions of the program from Heilongjiang, Jiangxi, and Liaoning make it clear that the subsidy offsets the costs of investments. In Anyang, Liaoning Province, for example, the subsidy covers 30 percent of the cost of on-farm investments.

A Ministry of Agriculture official speaking at a Tsinghua University conference on rural affairs last month said that the large farm subsidy is intended to have a demonstration effect and encourage local officials to channel new increases in subsidies and financial programs toward supporting large grain farms and "family farms." The subsidy is paired with other campaigns to facilitate the consolidation of land into larger-scale operations.

A "land swap" initiative attacks the fragmentation of land-holdings that holds back land consolidation. Each family generally receives multiple plots of land in different locations. The idea of land swaps is to let villagers exchange plots of land to consolidate their land-holding to form larger parcels. The villager can then farm the land on a larger scale himself or sub-contract it to someone else. The MOA officials reports that land swaps totaled 16.1 million mu (2.6 million acres) as of last June, accounting for 6 percent of rural land transfers.

One of the big problems facing commercial-scale farmers is raising cash for investments or to finance working capital. The large farmer subsidy program incorporates agricultural loan guarantee companies to help with credit access.

Sunday, February 10, 2013

China Closed 26% of Slaughterhouses

Authorities in China closed 26 percent of hog slaughterhouses last year, according to a teleconference held by 9 different government departments on January 17, 2013. Each locality was required to check up on the qualifications of hog slaughter facilities from December 2011 through November 2012 and over 5000 were closed. This blog has been reporting on this campaign over the past year (see posts from January and July 2012)

According to the announcement, the number of slaughter facilities was reduced from 19,938 to 14,720, a 26.2-percent reduction. Most of the closed slaughter facilities were small ones, which were reduced in number from 14,019 to 10,135, a reduction of 27.7 percent. The number of "designated hog slaughter facilities" also was reduced from 5,919 to 4,585, a reduction of 22.5 percent.

The objective was to speed up the consolidation of the sector by eliminating slaughter facilities with outdated equipment, reducing excess capacity and address chronic food safety concerns in the pork sector. The conference discussing the campaign acknowledged that progress in assuring the quality and safety is not achieved easily and reminded everyone that upgrading meat slaughter facilities is a long-term task.

Many counties have posted reports and decrees about their work on the campaign. An October 2012 report from Fei County in Shandong says officials began organizing inspections of the county's 22 designated slaughterhouses in March. They found many of the small ones lacked proper equipment and facilities and plans were made to refurbish 12 of them, including 2 newly-built facilities. A long list of equipment was purchased: offices, holding barns, 4780 square meters of concrete, 300 meters of hanging rails, 26 mechanical hoists, 5 shaver/dryers, 13 splitting saws, an incinerator for disposing of carcasses, posters and lists of regulations to hang on walls, and improvements in quarantine and inspection record-keeping. All this was accomplished by raising 2.9 million yuan (about $460,000). In October, officials approved 13 slaughter facilities for continued operation.

A 2010 report reveals that Fei County officials have been trying to address food safety problems in hog slaughter for a number of years. The big problems were pumping water into hogs before they are slaughtered,  selling meat from dead or sick animals and spent sows, and unlicensed, un-inspected butchers.

The Fei County report expressed frustration over the problem of pumping water into pigs. They set up "strict checks" for this behavior but noted that it is hard to gain control. At the time, most slaughter facilities lacked equipment to test for this. Slaughter facilities were asked to put up a bond at the beginning of the year. If they were caught pumping water into pigs, fines would be deducted. If they had no violations they would get the funds back at the end of the year, plus an award.

The county also was concerned about the frequent sale of meat from sick and dead pigs, especially on the outskirts of the city. The county set up a complaint system that included a telephone hot line for reporting illegal butchers and sale of bad meat. Calls were kept confidential and callers could get cash rewards if their complaints were verified. They got 5 calls, of which 4 were verified and they had records of 11 other complaints. Officials raided four illegal butchers and stopped the sale of 300 kg of diseased meat.

Slaughterhouses were required to keep records on inspections, certificates and sick pigs. Most facilities did not have adequate facilities to dispose of diseased carcasses and used "simple" methods (if they didn't sell the meat). In early 2010 the county brought in a set of disposal equipment and six facilities had proper equipment.

The experience of a town in Guangdong Province's Mei County in 2009 illustrates why it is so challenging to impose "safe" supply chains that eliminate the vicious competition that characterizes rural China.

Chengdong Town had about 30 pork dealers who rode motorcycles out to villages, collected pigs, had them slaughtered, and sold the pork. They bought pigs at 6.2 yuan/500g and sold the pork at 12 yuan/500g, making 150-250 yuan per day.

Then one day a notice appeared on an alley wall announcing that the town was building a new slaughterhouse that would be operated by a boss from somewhere else. Within a month the slaughterhouse was built and opened. Only pork from this slaughterhouse would be permitted for sale in the town. Traders would not be allowed to buy pigs from farmers on their own, nor could they buy pork elsewhere and sell it in the town.

One of the traders, Old Zhang, was puzzled by these regulations but he had to make a living. He and other traders hopped on their motorcycles and went to the gate of the new slaughterhouse to buy pork. They were surprised to find that the slaughterhouse had raised the price to 7.5 yuan/500g. The price was 1.2 yuan higher than before and Old Zhang spent an extra 130 yuan daily on his purchases. "Under pressure from the local government," Mr. Zhang had no choice but to buy the more expensive pork.

The slaughterhouse kept raising the price--it went up 35 percent by the end of the year. In the villages where they sold the pork, incomes were limited and the vendors claim they couldn't raise the price enough to pass on the higher cost of pork. Daily earnings by pork vendors fell to 30-80 yuan daily from the previous 150-250 yuan. The slaughterhouse also reduced the price they paid for pigs, from 6.2-6.5 yuan to 5.4-5.6 yuan/500g.

In May 2009, the Chengdong town government allowed vendors to buy pigs from farmers and have them slaughtered at the designated slaughterhouse for a fee of 15 yuan. However, as Old Zhang prepared to start buying pigs the town government announced that only 4 people would be allowed to conduct this business.

The frustrated pork vendors in Chengdong went on strike, but they could only hold out two days without income. Mr. Zhang appealed to the local news media. Officials explained that regulations required this arrangement, but Mr. Zhang described it as a "regional monopoly" that would have a "chain reaction" with the slaughterhouse taking all the profit.

"Ultimately rural people will have to either eat high-priced pork or not eat pork," said Old Zhang.

After reading a story like this, it's easier to see why illegal butchers and meat trade might spring up. There is money to be saved, profits to be made, and the participants might even feel like they're "sticking it to the man."

Tuesday, February 5, 2013

Stalemate on China Cotton Prices

In 2011 China introduced a price floor policy that was intended to "stabilize" the cotton industry. Instead, it may have sown the seeds of the industry's demise.

This blog has reported on the cotton fiasco several times over the past year: the mountain of cotton last December, tangled cotton policy in October, and the surge in cotton reserve purchases in 2011. Authorities bought about half of the 2011 cotton crop and have bought about 80 percent of the 2012 crop to stockpile in reserves. The domestic cotton price is about 60 percent higher than the international price. Auctions of stockpiled cotton from past years were held in January but less than half of it found buyers. Textile companies are using imported cotton, chemical fiber, imported yarn, are short of cash, or shutting down for an extended period ahead of the Chinese new year holiday.

China's price floor policy was intended to "stabilize" the industry by giving cotton producers and textile enterprises more certainty about expected prices. The February 4 Peoples Daily referred to it as "straightening" prices by preventing big swings. The policy is predicated on the notion that market price fluctuations send "wrong" signals to producers that are destabilizing. The alternative is to use a "cost-plus" pricing strategy that raises the price floor every year by adding a "reasonable" profit to the cost of production.

In 2011 they set a price floor when global cotton prices were sky-high. By the time the 2011 cotton harvest came around, global prices were less than the Chinese price floor. In the economic planner's perfect world, the low cotton prices would have been a temporary phenomenon. They would have stockpiled cotton during the period of low prices and then sold it back into the market when prices bounced back the following year.

That didn't happen. Global cotton prices went even lower in 2012 and China stockpiled even more cotton. They now have around 10 million metric tons (mmt) in storage. By comparison, this year's production is estimated at 7.4 mmt. According to the Peoples Daily, at the end of 2012 imported cotton cost 13,000 yuan per metric ton and Chinese cotton cost 19,000 yuan. In February 2013 there is no sign of cotton demand bouncing back and no prospects for global prices to converge with Chinese prices.

Chart from Peoples Daily showing China 
and international price of cotton over the past 12 months.

A magazine article in Liaowang News Weekly reported on the cotton conundrum. They report that the differential between Chinese and international cotton prices widened from 3000 yuan in 2011 to as much as 6000 yuan. Textile companies can manage a differential of 2000 yuan, but lose competitiveness when they have to pay more than that for raw materials.

The cotton "market" has become disjointed. In Xinjiang--which accounts for half of China's production--the government is the only customer. A private trader reports to Liaowang that virtually all cotton business this year is trading government reserves.

A cotton industry expert from South China Agricultural University calls the cotton reserves "a test of the government's financial ability." He estimates that the government will spend 170 billion yuan on purchasing reserves, interest, and management expenses.

The government seems willing to prevent a decline in cotton production at any cost. Another expert from a cotton industry institute in Xinjiang describes the government as "overwhelmed by the financial pressure of the reserves." But, the expert says, "If they don't purchase [the cotton], the market will fluctuate, impoverish  farmers and reduce cotton production."

The interests of cotton farmers and textile enterprises--historically aligned--are now at odds. One cotton industry representative said of the high floor price for cotton, “Farmers interests need to be protected, but the textile industry also needs protection." He went on to argue that, in effect, the protection of farmers will be of no use if textile companies are driven out of business by expensive cotton.

A cotton industry association official said, "The cotton industry chain is long and someone is bound to be made worse off and someone is bound to benefit."

The Xinjiang expert warns that the cotton industry is at a critical juncture. If the cotton reserve corporation sells the cotton at international prices it will take a huge loss. If the reserves are sold into the domestic market, it will depress cotton prices and discourage production, exactly what the price floor was intended to prevent.

In the Tarim basin of Xinjiang, cotton reportedly is being stored outdoors "like mountains" because there is no space in warehouses. Bottlenecks (and perhaps expense) prevent it from being transported out of the region. More cotton keeps coming into reserves and not much goes out.

An official at the National Development and Reform Commission (NDRC)--which sets these policies--doesn't seem to have any idea what to do. He was quoted by Liaowang with this pithy analysis: “The cotton temporary reserve faces two choices: the price needs to be a little higher to stabilize cotton production; but considering the competitiveness of the textile industry, not too high.”

Usually the NDRC announces the price floor for the new year around March. In the last two years, they set the cotton price floor at 10 times the support price for wheat. A 9.8 percent increase in the wheat price has been announced which implies an even higher cotton price in 2013 if they follow this practice again. That would make it even harder to dispose of the cotton stockpile and force authorities to buy even more cotton this year.

The cotton industry association conducted a planting intentions survey for 2013 which showed that one-third of farmers intend to reduce cotton plantings this year, against 12 percent who plan to increase. Eleven percent are undecided, waiting to see how market conditions and policies fall out. The association estimates a 4.5-percent decrease in cotton area based on these numbers.

Officials are giving no signals as to what they might do. They worry that a decrease in price might lead to a sharp decline in cotton output. Although there is no mention in Liaowang, another risk is unrest in Xinjiang. However, Xinjiang farmers seem pretty satisfied--88 percent say they will plant the same area in cotton this year. This is in stark contrast to the Shandong-Hebei-Henan region where 41 percent of farmers say they plant to cut cotton plantings this year. These numbers suggest that China will continue to build its mountain of cotton in the Xinjiang desert, a thousand miles from the nearest clothing factory.

Officials set the cotton price floor based on the notion that markets send wrong signals. The corollary is that government officials are better than markets at setting prices. However, the officials seem to have been caught by surprise by the decline in cotton price in 2011. Who would have thought record-high prices in 2010 would stimulate production around the world and send prices crashing down in a tepid demand environment?

Officials in China apparently thought thought the decline in demand for cotton would be a temporary phenomenon. However, their policy may make it permanent. Elevated cotton prices in China discourage cotton use and reduce the odds that demand will ever bounce back. High cotton prices encourage textile enterprises to import yarn, substitute chemical fiber for cotton, or move overseas. Given China's declining competitiveness in textiles these changes may be permanent and there may never be an opportunity to dispose of the mountain of cotton accumulated over the past two years.

Markets are right more often than government officials.

Monday, February 4, 2013

Grain Subsidies To Be Linked to Output

There is a propaganda barrage on this year's "Number 1 document" in Chinese news media this week. Most of the new initiatives are continuations of trends that have been reported here, but there are a few new details.

The February 4 Peoples Daily offers a collection of readings to hammer home the importance of the document's policies, including one article, "Agricultural Subsidies Will No Longer Be Sprinkled Like Sesame Seeds and Salt" which asserts that subsidies will now be linked to actual area planted in crops and focused on major production areas and large-scale farms. It also reiterates the importance of subsidizing governments in agricultural production regions.

After China joined the WTO in 2001 officials implemented a system of subsidies that sprinkled subsidies like salt over the countryside. Anyone who had a land holding could get a 10-yuan subsidy for each mu of land he held. In most places the land-holder got the subsidy regardless of what he planted. That was a relatively easy way to distribute subsidies since almost every village had records of land-holdings that were the basis for assessing taxes on farmers. It also made the subsidy "decoupled" since it wasn't linked to actual production, which meant that it didn't count toward the cap on subsidies imposed by WTO rules.

This subsidy method provoked a lot of rumbling in the countryside. Many farmers got subsidies for "grain" land that was abandoned, turned into fish ponds or had a house built on it. The subsidies were derided as "land subsidies" rather than "grain subsidies." Farmers who rented land from others and actually planted crops got nothing. In some places farmers collected subsidies but left their land uncultivated.

The Peoples Daily article points out that the key to "keeping the rice bowl of over 1 billion people firmly in their own grasp" is to protect and mobilize farmers to plant grain, generate local [officials'] enthusiasm for grain, and give those who plant something to look forward to. In other words, the "decoupled" approach to subsidies is out the window now.

The call for increasing the "strength" of subsidies and "tilting" new increases in subsidies toward major production regions, large-scale farms, farmer cooperatives and "new-style business operators" is not new. What is new is the intent to transform the "sprinkling like sesame seeds and salt" subsidy approach. The new approach is to give subsidies based on actual, verified area planted and to give subsidies to those able and willing to plant crops.

This is how these words may be interpreted:
"actual"=based on the area planted, not a historical base.
"verified"=some official will have to verify that the area reported is true.
"willing"=subsidies will be paid to farmers who are inclined to actually grow crops.
"able"=subsidies will be steered away from elderly and infirm landholders to active farmers.

This sounds simple on paper, but it will be a monumental task to implement. There are some 240 million landholdings, each with an average of say 5-to-6 plots. That's over 1 million plots of land to keep track of and verify what's planted on each one.  Provincial and local finance officials report that basing subsidies on actual planted area would be impossible to administer and verify. While Chinese government hackers are busily harvesting vast amounts of data from overseas computer servers, the government has no accurate records on what crops their own farmers are planting.

A more important aspect of farm subsidies is the subsidization of local government officials. The Peoples Daily emphasizes an important new goal of improving the financial ability of county governments in farm production areas to reach the national or provincial average. Toward that end, the government will keep implementing and improve "awards" to major grain, oilseed, and hog producing counties, an ecological compensation system, and a land protection mechanism. Peoples Daily reports the intent to set up a mechanism for supplementing local financial revenue to address fiscal shortfalls.

Traditionally, most agricultural programs and infrastructure investment in China was the financial responsibility of local governments. However, the fiscal capacity of rural governments has fallen far behind that of cities, leading to an erosion of agricultural investment and lackadaisical implementation of agricultural programs.

Finally, the Peoples Daily praises the system of minimum prices and "temporary reserve" measures that "straighten" prices. These policies are credited for engineering a steady rise in prices each year that prevents big harvests from depressing prices and impoverishing farmers. The principle is a type of "cost-plus" pricing for farmers in which a "reasonable" profit is tacked on to production costs. The temporary reserves are to be expanded and the timeliness and efficiency of market interventions is to be improved. Low-income city residents are to get subsidies to compensate them for increased food prices.

China is quickly getting entangled in a web of subsidies. North America and Europe had a hard time untangling their subsidy webs in the 1980s and 90s and China is reinventing the same entanglement.

Dairy Industry Modernization Squeezes Small Farmers

The Hohhot Daily recently described the difficult transition to "modern" dairy farming currently underway in China. The country's dairy industry was jump-started in earlier decades by recruiting small farmers who saw dairy cattle as a road to riches. But today's dairy cattle have become susceptible to disease and need high quality feed, putting producers under intense cost pressure. Many small-scale producers are giving up their dairy cattle for an urban wage while the industry tries to boost commercial-scale farms.

50-year-old Wang Zhanwei smiles wistfully as he recalls the 1980s when he first took up dairy farming in Inner Mongolia. At that time every farmer's dream was to have a dairy cow, and two cows were enough to support of family. The price was only 0.2 yuan per 500g, but life was happy and comfortable.

Wang sighs as he recalls the increase in production costs in recent years. As costs rose faster than the milk price, many farmers sold or killed off their cows and quit.

The main cost component is feed. Rising feed costs pushed many farmers to cut corners on animal nutrition to save on costs. The health of dairy cattle deteriorated accordingly and so did the quality of milk, forming a "vicious circle." The poor quality of milk contributed to the melamine adulteration that decimated the industry after 2008. (Melamine was added to fool tests for protein content.)

Most farmers know how to raise cattle well. Mr. Wang doesn't skimp on feed quality; he views the health of cattle as a kind of capital for the future.

Another Inner Mongolia farmer, 68 year-old Pan Yijin, says today's dairy cattle have become "effeminate" (娇气--frail or delicate). If you're not careful, they are always getting mastitis or some other disease. He says cattle have become more vulnerable to disease, resulting in many farmers losing confidence in dairy production.

The article asserts that the veterinary service system has not kept up with the extremely rapid growth in Inner Mongolia's dairy production. Disease outbreaks are common and difficult to control. The reporter was told that about 30 percent of dairy cattle in the area around Hohhot are infected with subclinical or full-blown mastitis. When farmers see signs of mastitis they treat the cow with pharmaceuticals and can't sell the milk for half a month. Farmers can't tolerate the lost income when they only have a couple of cows.

[To be fair, a google search indicates that infection rates of 30% are not unusual around the world.]

People in China's dairy industry are emotional about the fallout from the 2008 melamine adulteration incident.  Since then, the dairy industry has been the focus of food safety regulation. There has been a push for raising cattle in larger-scale operations, either "cow hotels" where farmers keep their animals in a group or company-operated farms. A large number of small farmers quit dairying in 2009 after the melamine crisis, but since then more have continued to quit. Farmers interviewed by the reporter also describe a loss of trust and a "collapse of the honesty principle" among farmers.

In Shen Lan Dai village the number of dairy cattle has fallen from 200 to about 40. The volume of milk is not enough to support the village's milk-collection station. Mr. Li, the manager of the station, says he can't eat or sleep because he worries that the station will be shut down.

Eight years ago, farmer Duan came from Hebei Province to raise dairy cattle in an Inner Mongolia village. Since then net returns have been falling and he has seen a lot of neighbors selling off their cattle. Duan has to make his cattle pay because he has no land and is not registered as a local resident. He has nothing to fall back on. Duan hopes to take his eight cattle to another place that has a better environment and better prices for raising dairy cattle.

Many "farmers" are becoming "workers." Duan's son has no interest in dairy farming. The younger Duan went to work in the city and is now studying in a vocational school.

The 12th five-year plan calls for support to push commercial-scale dairy production. This article says local authorities invested in 17 scale farms in 2012 and bought 77,000 cattle. An earlier dimsums post reported on this campaign and its slow progress.

Large farms are not necessarily better-managed or more profitable than small farms. Where are they going to find knowledgeable managers to operate these farms? Will hired workers on big farms do a better job milking cows than  small farmers who own their cows?

An article that studied mastitis infection in Tanzania found that milking practices and sanitation of housing were the main cause of infections--more important than the breed--and smallholder farms were more efficiently operated than large-scale operations in the area where the study was conducted.

The Hohhot Daily article asserts that increasing the scale of farms is not the ultimate objective. Improving science and technology is identified as the key. However, the confidence in technology also may be misplaced. The Tanzania study found that breeds were not as important in preventing infection as the techniques and care used to milk the cattle--for example, ensuring that the udder is completely emptied after milking.