Tobacco growers are facing tough times as cigarette
consumption shrinks and foreign producers edge them out of formerly
lucrative markets. Not only have U.S. exports
of tobacco leaf declined, but cigarettes manufactured in the
United States now contain more foreign tobacco than ever before—nearly
50 percent. Why is U.S. tobacco losing ground to other countries?
Price, mainly. With cheaper tobacco available on the world market,
U.S. tobacco is losing global and domestic market share.
U.S. tobacco imports have significantly increased due to price
competitiveness and higher leaf quality by overseas producers—the
result of improved cultivation and marketing techniques. In the
past, the superior quality of U.S. tobacco compensated for its
higher price. But the dramatic increase in the quality of foreign
leaf during the past 25 years no longer “protects” U.S.
tobacco.
As the quality gap between U.S. and foreign produced leaf narrows,
the price gap is increasing. In 2002, Japan, our leading and most
loyal tobacco customer, purchased leaf from Brazil for the first
time…and the U.S. share of world tobacco trade dropped to
8 percent, an all-time low.
Trade has always been an influential force in the global tobacco
market. The U.S. is unique in that it is both a big tobacco-producing
and consuming country. Countries that produce tobacco at low cost—Zimbabwe
and Malawi, for example—tend to consume little tobacco and
seek opportunities in lucrative markets, such as the European Union
and Japan, where little tobacco is grown and production is costly.
While trade policy reforms in the past decade have led to considerable
shifts in trade for many commodities, tariffs on tobacco in major
importing countries have always been relatively low.
Tobacco Program, Now 65 Years Old, Ready for Change?
This changing global environment—and the increasing competitiveness
of low-cost producing countries—is putting pressure on the
U.S. flue-cured and burley tobacco program. (These two types account
for 93 percent of U.S. tobacco output.) Created in 1938, the program
was originally designed to provide a steady supply of high-quality
leaf tobacco and to stabilize and support grower incomes through
price supports and marketing quotas (see “The Tobacco
Economy”).
The Tobacco Economy
Flue-cured and burley tobacco make up 93 percent of
the 890-million-pound U.S. tobacco crop. In 2002, the
value of the crop exceeded $1.5 billion. Flue-cured tobacco
is grown in North Carolina, Virginia, South Carolina,
Georgia, and Florida. Burley tobacco is grown in Kentucky,
Tennessee, Ohio, Indiana, Missouri, Virginia, and West
Virginia. About 80,000 farmers produce these two types,
using quota they own supplemented by leased quota. In
addition to the 80,000 active producers, nearly all of
whom own some quota, there are over 300,000 absentee
tobacco quota owners. Quota, which is tied to a specific
parcel of land, has economic value, so land with quota
commands a substantial premium at sale.
For many years, the United States was the largest tobacco
leaf exporter and importer by volume. U.S. leaf has always
been considered of high quality and is in demand by foreign
manufacturers. However, during the past decade, Brazil
has become the largest leaf exporter, with the U.S. generally
second or third. The U.S. is still the largest importer
of leaf, much of which is manufactured into cigarettes
that are then exported. Although exports are not as high
as during the mid-1990s, the United States still exports
more cigarettes than any other country. Between leaf
and cigarettes, tobacco makes a significant contribution
to the balance of trade. In 2002, tobacco leaf and products
contributed $1.7 billion to the trade balance. In the
past decade, its contribution has been as high as $5.9
billion.
Quota is the amount of flue-cured or burley tobacco leaf a producer
can sell during a given season and is a requirement for marketing
these two types of tobacco in the United States. That is, unless
a producer either owns quota or leases it from a quota owner, the
producer cannot sell these types. Quota levels are revised annually
according to recent demand and have declined drastically since
the 1990s, as U.S. cigarette consumption has dropped and imports
of tobacco leaf have risen.
The program also guarantees growers a floor price and a market
for flue-cured and burley leaf. But over the years, price supports
have risen and the discrepancy between U.S. and world leaf prices
has become steadily larger. In 1960, grower prices in the United
States averaged 60 cents per pound for flue-cured tobacco, compared
with 40 cents per pound in Zimbabwe. By 2000, the difference was
60 cents per pound. Likewise, in 1960, U.S. burley prices were
25 cents per pound above prices in Malawi. In 2000, the spread
was $1.40 per pound.
Because of the way the support price is calculated, the tobacco
program nearly always results in annual price increases. The price
depends on the average U.S. cost of producing leaf (which almost
always goes up from year to year) and recent annual prices. Higher
prices beget sliding demand (and greater imports), which results
in smaller quotas, because expected domestic demand and export
demand, significant factors in the quota calculation, are lower.
The downward spiral caused by higher prices—prices rise,
demand decreases, quotas shrink, but prices still continue to increase—is
the cause of much of the tobacco farmers’ woes…and
their current interest in a buyout.
In the late 1990s, legislators from tobacco-producing States proposed
alternatives to the quota program. Many of these proposals included
some form of buyout, in which the government would purchase the
quota from the owner in order to move the tobacco industry toward
a “free market” system. Quota holders would be compensated
for the loss of future income from renting their quota to others
or growing tobacco using their own quota.
At that time, the idea of a tobacco quota buyout program got mixed
reviews from tobacco farmers. Many older farmers supported a buyout
as a path to a secure retirement, but younger growers often preferred
the stability and revenue the program guaranteed. Drastic cuts
in quotas starting with the 2000 crop changed the picture. Quotas
in 2003 are only 63 percent of 1999 levels. As a result, the notion
of quota buyouts is now more favorably received by growers at auction
warehouses and country cafes in tobacco country. This renewed interest
has also united unlikely bedfellows: health advocates and tobacco
grower organizations. These groups have aligned to promote legislation
that couples a quota buyout with continued production controls
for growers and regulation of tobacco products by the Food and
Drug Administration (FDA). How did this turnabout happen, what
are options for reform, and what are the consequences of a traditional
U.S. cash crop “cashing out”?
Quota Buyout Seeks To Restore U.S. Competitiveness. .
.
Most tobacco leaf grown by U.S. producers follows one of three
paths. It can be sold to the domestic cigarette industry for cigarette
consumption here, sold to the domestic industry for manufacture
and export of cigarettes, or exported in its leaf form. No matter
which path the leaf follows, it faces competition from foreign
sources.
Cigarettes made by domestic manufacturers contain both U.S. and
foreign tobacco, with increasing amounts of the latter. High U.S.
tobacco prices, competition from upstart cigarette companies making
generic cigarettes, and large payments to States under the Master
Settlement Agreement MSA, (see “Master Settlement Agreement”)
have made large cigarette manufacturers receptive to less expensive
imported leaf—particularly given its increased quality.
Master Settlement Agreement
On November 16, 1998, 46 State attorneys general and
the major cigarette/smokeless tobacco product manufacturers
signed a Master Settlement Agreement (MSA) to reimburse
States for the cost of treating smoking-related illnesses.
The companies also provided funds to reduce teen smoking.
Previously, four States—Minnesota, Mississippi,
Florida, and Texas—had signed separate agreements
with the industry. One result of the settlement was an
unprecedented increase—that very day—of 45
cents per pack in wholesale cigarette prices. Interest
in the tobacco economy has broadened as States have become
accustomed to payments from the MSA. Because of the size
of the payments and the different ways they are used,
States are now financially dependent, to varying degrees,
on tobacco company payments. Key elements of the pact
include:
• $206 billion to be paid to States over 25 years.
• $1.5 billion over 10 years to support anti-smoking measures, plus $250
million to fund research into reducing youth smoking.
• Limitations on advertising.
• Ban on cartoon characters in advertising.
• Ban on “branded” merchandise.
• Limitations on sporting event sponsorship.
• Disbanding of tobacco trade organizations.
In addition to the MSA, sometimes known as Phase I,
cigarette manufacturers agreed to pay $5.15 billion to
tobacco growers over a period of 12 years, known as Phase
II. These payments were negotiated to compensate growers
and quota owners for potential reductions in tobacco
production resulting from the MSA.
The State of Maryland used part of its MSA payment as
a tobacco buyout, by paying tobacco producers who promised
not to grow tobacco. Because Maryland tobacco is a type
not covered by the Federal quota program and the State
program has substantively different objectives, this
buyout experience is not relevant for the proposed flue-cured
and burley buyout. The purpose of the Maryland buyout
was to reduce tobacco production and keep land in agriculture,
not to improve the viability of tobacco producers.
The inability of U.S. growers to rapidly adapt volume and price
to changing conditions puts them at a further disadvantage in the
global market. For instance, when production in Zimbabwe plummeted
due to political unrest and land reform, Brazilian roducers were
able to rapidly increase production and expand exports. But, because
of the quota program, U.S. growers are unable to take advantage
of opportunities in the world marketplace. Tobacco quota adjustments
are based on past, not current or future, market
conditions.
. . .And Boost Profitability
Despite increased foreign competition and the constraints of
the quota program, American tobacco farmers still find tobacco
a profitable crop—far more profitable than the alternatives.
An average grower in North Carolina produced 27 acres of tobacco,
about 54,000 pounds of leaf, in 1997, the latest year for which
detailed production data are available. Those 27 acres yield about
$100,000 of tobacco leaf. In comparison, the same 27 acres yield
about $6,500 of corn. Corn isn’t the only alternative, of
course. Niche crops can be profitable, but often markets are limited.
At the same time, growers are faced with shrinking quota. Without
access to sufficient quota, growers are unable to maintain the
economies of scale needed to keep their production costs down.
For those who farm using another’s quota—through leasing,
for example—growing tobacco is still profitable but less
so, at least on a cash basis, because they must compensate the
owner of the quota. Depending on the year, renting or leasing quota
can add up to 75 cents per pound, or nearly 40 percent, to a grower’s
expenses. The elimination of the cost of renting quota would enable
these producers to maintain profits at a lower price.
Those growers who own quota do not have the expense of renting
quota, but they must consider the opportunity cost to owning it—they
could sell it and use the money elsewhere. As the national quota
shrinks due to lower demand for leaf, competition for rental quota
further inflates the cost of growing tobacco, eating into producer
profits.
For all these reasons, grower interest in a buyout is at an all-time
high. Quota owners see an opportunity to exit the industry with
a generous payment. Growers who are currently leasing quota anticipate
a transition payment, elimination of quota rental payments if they
continue growing tobacco, and the potential for lower per-acre
production costs if they have greater flexibility to expand their
acreage.
What Might the Policy Future Hold?
A wide range of policy options exists. On one end of the policy
continuum is the total dissolution of the program—letting
market forces determine the location, volume, and price of tobacco
production. In this scenario (and others discussed below), total
U.S. acreage and acreage per farm would likely increase. Prices
would drop, imports would likely decline, and the U.S. share of
both domestic and global markets would increase. Land values formerly
propped up by the value of quota would decline during the adjustment
to a free market.
At various points between the free-market end of the continuum
and the restrictive end lie the buyout proposals currently being
debated in Congress. Many of these proposals originate from the
principles outlined in a 2001 Presidential Commission Report, Tobacco
at a Crossroad: A Call for Action. Under such proposals, quota
holders (owners) would typically receive a fixed payment per pound
for their quota, paid over a period of years. Currently, there are
about 400,000 quota owners, and they range from large, business-oriented
holders to former tobacco farmers and retired people. Producers
who do not own quota would be paid a transition payment to help
them adjust to a free-market environment and to encourage diversification
into other enterprises. During the mid-1990s, the 80,000 farmers
who grew flue-cured and burley tobacco planted 60 percent of their
tobacco using others’ quota (see “How a Buyout Proposal
Might Operate” below).
How a Buyout Proposal Might Operate
While the various buyout proposals being considered
carry different features, all of them include some
sort of buyout of quota. At the time of this writing,
all the proposals contain similar payment structures,
in terms of the amounts that would be paid to quota
holders and to producers.
The national flue-cured and burley tobacco quotas
are determined, according to statute, by a formula that
accounts for domestic and foreign demand for U.S. leaf.
An adjustment in the national quota is then applied
to each quota holder. For the purposes of a buyout,
payments to individual quota owners are prorated by
the share of each in the national quota poundage for
the base period, multiplied by $8. (The present value
of the future income stream from a pound of quota is
roughly $8.) An active producer/renter would receive
a transition payment of $4 per pound of tobacco, determined
by varying base periods depending on the proposal. (One
proposal pays an additional $2 a pound to those who
stop growing tobacco.) A quota owner who also produces
his or her tobacco would therefore be entitled to $12
per pound.
Growers would receive payments that vary according
to the proportion of quota they own or rent. In 1997,
the last year for which we have detailed data, growers
in North Carolina, the major flue-cured producing
State, each produced an average of 27 acres of tobacco,
about 54,000 pounds of leaf. During the 2002 season,
that was about $100,000 worth of leaf. To put it
in perspective, the same 27 acres would have produced
about $6,500 worth of corn. Since North Carolina
tobacco growers typically own about 33 percent of
their quota and lease the remaining 67 percent, a
grower would ultimately receive $142,560 in quota
payments and $216,000 in transition payments, or
$358,560. The owner of the leased quota would receive
$289,440 in quota buyout payments. Quota was high
in 1997, so payments may differ from this example.
A burley tobacco grower in Kentucky, where farms
average about 6 acres of tobacco production, produces
about 12,000 pounds of leaf. Based on an average
quota rental of 56 percent, a grower would receive
$42,240 in quota buyout payments and $96,000 in transition
payments for a total of $138,240. The owner of the
leased quota would receive $53,760.
Peanut quota buyout
Similar to the current tobacco program, the peanut
program was, until last year, a system that relied
on production limitations (quotas) to support prices
of peanuts (destined for domestic food consumption)
at levels generally well above those in international
markets. The 2002 Farm Act eliminated the quota system—allowing
domestic marketing of peanuts by any producer—and
compensated the former quota owners with a quota
buyout. Under the peanut quota buyout, peanut quota
owners were compensated with 55 cents per pound for
the loss of their quota rights—about $37,000
for an average North Carolina peanut grower using
27 acres to produce his/her peanut quota.
Unlike tobacco producers, however, peanut producers,
whether former quota owners or not, now may also
be eligible for other types of support (such as direct
payments, marketing assistance loans, counter-cyclical
payments) and are protected by high import tariffs.
Some proposals include licenses as a substitute for quotas, in
order to continue some form of control over production. Licenses
would differ from quotas in several ways. Licenses would be issued
to individuals and would stay with those individuals until the
license holder dies and passes the license on to someone else.
Licenses would not be bought, sold, or rented, and, therefore,
would not add to the cost of growing tobacco. As such, licenses
would negatively affect competitiveness less than quotas. Licenses
would also carry geographic restrictions to prevent production
from leaving traditional areas.
Price support at some level has also been proposed for a revised
tobacco program—with or without licensing. Lower levels of
price support would move policy along the continuum of policy options
toward a free-market orientation, while higher support levels would
be more protective. Price support could be continued indefinitely,
could provide a period of time for growers to acclimate to the
new economic environment, or could terminate altogether at a sunset
date. Price supports could be in effect for a producer’s
historical level of production, but not protect production above
that level.
Some policy proposals toward the restrictive area of the continuum
combine price supports and licensing with FDA regulation. These
proposals combine goals dear to both tobacco growers and health
advocates. From a health promotion perspective, a program that
enhances quality control and health and safety standards for tobacco
leaf is in the interest of the health community. Inspections for
pesticides and other chemicals at all levels of the production
chain is a goal that health advocates say would reduce harm from
tobacco products. Health advocates also want future tobacco crops
to be grown in traditional areas, where monitoring can be carried
out by knowledgeable people.
The status quo—the program that currently exists—is
at the most restrictive end of the continuum, where market forces
are constrained by various types of interventions. Current levels
of price supports are not competitive in world markets. Costs are
higher, because some production rights are controlled by nonproducing
quota owners. And, U.S. growers are increasingly noncompetitive
as imports increase, quota levels shrink, and the price support
level rises. Preservation of the status quo all but guarantees
continued decline in quota levels to the point where the U.S. tobacco
industry could become a minor supplier of tobacco.
Many Scenarios Are Possible
Tobacco continues to be an important U.S. crop, but recent world
market pressures on tobacco producers and continuing concern about
the health effects of cigarettes have renewed interest in proposed
buyout programs for tobacco quota holders. A buyout would eliminate
quota restrictions on tobacco production, but in most proposals,
some form of production control and price support would continue.
Eliminating quota rental costs, which inflate the price of U.S.
versus foreign leaf, would enhance U.S. competitiveness in domestic
and foreign markets.
Part of the impetus for a buyout is to increase the competitiveness
of U.S. tobacco by narrowing the gap between its price and that
of other countries. In a post-buyout environment, as the U.S. price
falls, purchases of U.S. tobacco would increase both domestically
and by foreign customers. Growers would respond to this increase
in demand as much as possible within the limits of the post-buyout
program. In a free-market, no-program environment, production would
increase rapidly. If constraints exist because of continued market
intervention, any increase would be slower.
Although health groups do not necessarily want tobacco production
to increase, they may accept smokers’ consuming U.S. tobacco
produced under a stringent regulatory environment with careful
inspections for banned chemicals. Linking the goals of a tobacco
quota buyout and FDA regulation of tobacco products has advantages
for both producers and health interests. Tobacco buyout advocates
can garner widespread support for an issue that affects only a
handful of States, and health regulation watchdogs get support
in States traditionally opposed to tobacco product regulation.
A post-program regime without geographical restrictions on tobacco
production could upend the structure of the U.S. tobacco industry.
Production may move to areas where larger, more efficient units
could be assembled. Production in areas such as the Piedmont or
hilly regions in Kentucky, where tract size is traditionally smaller,
likely would decline. Tobacco farms would grow bigger and the number
of growers would drop. And, some production would likely shift
to States that have never grown tobacco, along with attendant economic
consequences.
Tobacco
at a Crossroad: A Call for Action, by the President’s
Commission on Improving Economic Opportunity in Communities Dependent
on Tobacco Production While Protecting Public Health, 2001.