Mutual suspicions

The United States of America likes to present itself as the world’s foremost champion of open markets, free trade, and unfettered competition. However, there is one sector in which the US has historically run a market more akin to a command economy: agriculture. Over the last century, American agribusinesses have benefited from a munificent buffet of corporate welfare programs, ranging from direct price support and export subsidies to more subtle instruments like regulatory barriers written with domestic interests in mind.

Even the handouts from the American bread basket have been self-serving: Dimitris Diakosavvas, a senior economist focusing on US agriculture at the Organization for Economic Cooperation and Development (OECD), pointed out that many aid programs have actually been designed to subsidize US producers: "[US food aid] was once mostly related to whether a given commodity was in [domestic] surplus or not."

The policy mixture has helped boost the profits of large US agribusinesses, but it has come at the expense of US consumers and developing world farmers. "America’s agricultural polices are relics of a bygone era, a drag on our 21st century economy, and a blemish on America’s image in the world," wrote Daniel Griswold, director of the Center for Trade Policy Studies at the Cato Institute, in an article in the Journal of Commerce. "This sort of hypocrisy breeds resentment against US policies in general."

It has certainly bred resentment in China. In the US, only 1.3% of the workforce is engaged in farming, and their income is higher than the national average; political campaigns bewailing the plight of "the American small farmer" are usually funded by giant industrial agriculture concerns. Listening to the US complain about Chinese protection of its agricultural markets galls in a country where the small farmer is a still genuinely vulnerable socioeconomic class.

Small isn’t beautiful

Thanks to decades of policies locking the rural population out of the cities, nearly half of the Chinese population was still engaged in some form of agriculture as of 2002, mostly in relatively small-scale, low-technology enterprises. In 1999, China had an average of 0.39 hectares per farmer, compared to 58.46 hectares per US farmer. This combination of inefficiency and numerical strength makes China nervous about exposing its farmers to direct competition with US giants like Archer Daniels Midland (ADM.NYSE), Tyson Foods (TYS.NYSE) and Cargill.

Beijing has therefore taken steps to protect selected portions of its agricultural sector from the US agro-industry complex. US beef remains completely banned, and poultry has recently been subjected to punishing anti-dumping duties. Pork imports have resumed following a swine flu-related ban, but pest- and pathogen-related barriers remain.

The US has also blocked a wide variety of Chinese agricultural exports. Even after the US Department of Agriculture certified Chinese poultry processors to export to the US (provided they used imported meat), US congresswoman Rose DeLauro of Connecticut threw a wrench in the program by removing funding for implementation, irritating Chinese negotiators to no end. DeLauro argued in a letter to US Secretary of Agriculture Mike Johanns that the decision to allow Chinese processors to re-export processed poultry imported from the US made no business sense. She also suggested that the program could open a back door for smuggling in Chinese poultry.

However, an analyst at the US Department of Agriculture sympathized with Chinese frustration: "Food safety measures are supposed to be all science-based, which is why [the USDA] goes through the inspection process. You can’t just say ‘I think poultry from China is dangerous’." He added that China’s ban on US poultry is likely in retaliation for DeLauro’s interference. It also helps Beijing justify erecting less-than-scientific barriers against US products, most notably the ban on beef, which is based on dubious concerns about mad cow disease. Last month the WTO ruled against DeLauro’s bill, but the Chinese barriers remain.

Quid pro quo

There is more to the relationship than simple tit-for-tat. Beijing has formally stated that China needs to be self-sufficient in agriculture, and has pursued this goal with some qualifications, but without apology. This is not hypocrisy. The idea that agricultural policy should be developed according to the principle of comparative advantage is still widely questioned in both countries.

"I’m not sure I agree with the free market thesis," said Guo Huiyong, head analyst at Beijing Orient Agribusiness Consultants (BOABC). He believes that China should first satisfy its basic needs from its own farms, and only then begin importing. Bob Young, chief economist for the American Farm Bureau, also pooh-poohed the suggestion that Washington get out of agriculture. "It is difficult to imagine a world where governments will not be involved in something as basic as the nation’s food supply," he argued in a debate on the Council of Foreign Relations’ website.

At the same time, the US has a legitimate cause for concern about the quality of Chinese foods. "The Chinese livestock industry still has serious infrastructure shortages and hygiene problems," said Wang Ruojun, a researcher at the Agribusiness Research Center at China Agricultural University. Given valid concerns about disease transmission, economic and social instability, and strong emotional support on both sides for the idea that a strong nation should feed itself, full liberalization of agricultural trade between the US and China remains unlikely.

However, the political volume of complaints obscures the fact that a degree of halting progress has been made on both sides.

While the US continues to erect barriers against Chinese meat, it is spending much less money distorting the global market. "Support for US agriculture compared to other OECD countries is relatively low," said Diakosavvas of OECD. At around 10% (compared to an OECD average of 22%), the US support level is the third-lowest among OECD countries, trailing only Australia and New Zealand.

Chinese accusations of dumping aside, Diakosavvas also pointed out that the US is no longer pouring much money into propping up farmers. For example, Washington has put a mere US$10 million into dairy export incentives so far this year, down from US$146 million in 1999. Most of the export subsidy programs have also been terminated – with the notable exception of dairy products. Food aid is now delivered according to social criteria like nutrition, instead of being used to absorb surplus production.

China has also liberalized, opening the door to certain classes of US pork, soybeans and corn, all of which would seem to be key elements of Chinese self-sufficiency. However, these moves have provoked backlash from portions of China’s agricultural sector, and Beijing is paying a political price.

The soybean issue may be the most sensitive. Soybeans are by far the largest agricultural export from the US to China: In November 2009, US producers sold a record US$2 billion of soybeans into the Chinese market. The USDA estimates that total soybean exports from the US to China could hit 46 million tons in 2010, and 49 million tons in 2011. In March, state media published complaints by soybean producers in northeastern China that the flood of cheap US soybeans would put them out of business.

They are not alone. Chinese pork farmers are also saying that they are being forced to compete with liberalized US pork imports just when they need it least. "They’ve actually just lifted the ban [on US pork], but the Chinese pork industry is back in a trough after a recovery in 2009," said the USDA analyst. "Pork prices are down over 30% … Right now farmers are losing about RMB200 (US$29) per head." The result, he said, is escalating pressure on Beijing to ride to the rescue. 

Inflationary worries

Still, Beijing continues to resist calls to increase protection of the soybean or pork industries, and may well continue to liberalize its agricultural sector out of sheer pragmatism.

First, the government is worried about inflationary pressure, and food prices still make up a large portion of the official consumer price index basket: Food prices rose 6.1% in May, pushing consumer inflation up 3.1%. Too much price support for domestic farmers leverages a de facto tax on city dwellers, a potential source of public discontent. Chinese producers are aware of this concern: "We certainly don’t hope for an increase in prices," Ma Chuang, president of the National Livestock Association, told state media in April, in defense of the US poultry ban. "All we want in the long term is to compete on a level field." However, the same article noted that poultry product prices had increased 6% since the anti-dumping duty was leveled on American birds.

Second, protecting one agricultural sector can punish another. Imported corn and soybeans, for example, are mostly used for animal feed, which keeps pork prices low. "Feed costs are 75-90% of the cost of pig production," said Wang of the Agribusiness Research Center. "Everything is connected. If you increase [feed] prices, you increase the profits of grain farmers, but the meat producers suffer, so they increase their prices. It’s a kind of cycle."

Third is the complexity of China’s definition of "self-sufficiency." Andrzej Kwieci?ski, a senior analyst specializing in Chinese agriculture at the OECD, explained that land allocation can be a sticking point.

"If China wants to have food security based on self-sufficiency in grain production, production in this area will offset production in other areas, and impact rural incomes," he said. "You are changing the allocation of land to grains instead of fruit and vegetables, which can produce more income from the same amount of land."

As a result, Kwieci?ski said that China has already modified its definition of food security to exclude soybeans, as cheap imported soybeans help keep China self-sufficient in meat. He expects corn – also in demand by the country’s growing pharmaceuticals industry – to be officially excluded from the definition in the near future, for the same reason. Ultimately, however, he hopes China will adopt the OECD’s wider definition of food security: "Our definition includes not only the capacity to produce, but also the capacity to buy food on the open markets. But to do this, markets need to be reliable."

Sadly, the Chinese agricultural market is anything but. Influencing the production decisions of millions of small Chinese farmers is a Herculean task, given the market’s tendency to fluctuate wildly as farmers overproduce high-value commodities and under-produce low-value ones. Factoring in the delay between planting and harvest, this can lead to significant shortages and surpluses. The volatility has been so extreme that noodle chain Ajisen (0538.HK) recently announced plans to raise its own pork in China to ensure a stable supply.

At present there are four primary mechanisms available to smooth the cycle: government reserves, producer subsidies, foreign imports and soft persuasion. Of the four, Beijing prefers persuasion. "The government is always trying to convince farmers that prices are going to be good and they should plant grain this year," said the USDA analyst.

Of course, persuasion doesn’t always work – and even when it does, there’s the weather. China’s corn growing regions are suffering a dry spell this year, driving up corn prices and the costs of pork producers. Futures speculators in Chicago are already betting on increasing Chinese imports of American corn, and the US Grains Council has forecast that Chinese imports will exceed 1 million metric tons over the next 18 months.

Unfortunately, China doesn’t have many better options to moderate volatility while maintaining adequate supply. Wang of the Agribusiness Research Center said that agricultural futures could ultimately provide a better signaling mechanism to Chinese farmers than exhortations from the Ministry of Agriculture. However, while agricultural futures markets in Dalian and Zhengzhou have ramped up in volume, they remain relatively speculative and insulated from foreign participation. Another market moderating mechanism, crop insurance, remains immature, poorly marketed and therefore unpopular among farmers.

Nothing to worry about

Despite the concerns of Chinese farmers, a trader at an international grain trading company operating in China said that much of the impact of US imports is overstated. As an example, he pointed out that while Heilongjiang province is facing competition from US soybean imports, nearly all US soybeans are used for feed. Soybeans from Heilongjiang still make up the overwhelming majority of the beans Chinese people eat – which sell at a significant price premium. "In many ways, it’s a segmented market," he said.

US pork imports have also failed to make much of a dent. According the World Trade Atlas, in 2008, when US pork imports surged into China, 98% of the pork consumed in China was still produced domestically. And like soybeans, US pork exports are mostly lower-value products, composed primarily of offal that US consumers don’t want. The markets are also decoupled: Pork prices are currently low in China and high in the US, making a flood of US pork unlikely. In short, US imports have become a convenient scapegoat for problems caused by local inefficiencies.

In the long term, US exporters hope that China’s increasingly disproportionate ratio of population and income to arable land will force Beijing to throw open the silo doors. Chinese demand for meat is already diversifying away from pork into lamb, poultry, and beef; the OECD predicts that China will be a net importer of most kinds of meat, of dairy products and sugar by 2019, while becoming a small net exporter of grain. "Production will almost catch up with consumption, but not quite," said Kwieci?ski. The grain trader said he is betting on China increasing imports of land-intensive grains to free up land for other uses.

That may mean there is some cause for long-term optimism among US farmers. Beijing is slowly realizing that there is no direct relationship between self-sufficiency and profitability: Japan imports half of its pork, and yet maintains a profitable pork industry. The most likely future scenario is for China to remain "self-sufficient" in agriculture, according to a definition of self-sufficiency that allows for increasing amount of imports from the US.

"If you want to be self-sufficient, that’s great," said Wang of the Agribusiness Research Center. "But given the environment, the water, and the population here, I don’t think it’s possible."