Streetwise Professor

September 5, 2018

Nothing New Under the Sun, Ag Processing and Trading Edition

Filed under: Commodities,Economics,Politics,Regulation — cpirrong @ 2:30 pm

New Jersey senator Corey Booker has introduced legislation to impose “a temporary moratorium on mergers and acquisitions between large farm, food, and grocery companies, and establish a commission to strengthen antitrust enforcement in the agribusiness industry.”  Booker frets about concentration in the industry, noting that the four-firm concentration ratios in pork processing, beef processing, soybean crushing, and wet corn milling are upwards of 70 percent, and four major firms “control” 90 percent of the world grain trade.

My first reaction is: where has Booker been all these years?  This is hardly a new phenomenon.  Exactly a century ago–starting in 1918–in response to concerns about, well, concentration in the meat-packing industry, the Federal Trade Commission published a massive 6 volume study of the industry  The main theme was that the industry was controlled by five major firms.  A representative subject heading in this work is “[m]ethods of the five packers in controlling the meat-packing industry.”  “The five packers” is a recurring refrain.

The consolidation of the packing industry in the United States in the late-19th and early-20th centuries was a direct result of the communications revolution, notably the development of railroads and refrigeration technology that permitted the exploitation of economies of scale in packing.   The industry was not just concentrated in the sense of having a relatively small number of firms–it was geographically concentrated as well, with Chicago assuming a dominant role in the 1870s and later, largely supplanting earlier packing centers like Cincinnati (which at one time was referred to as “Porkopolis”).

In other words, concentration in meat-packing has been the rule for well over a century, and reflects economies of scale.

Personal aside: as a PhD student at Chicago, I was a beneficiary of the legacy of the packing kings of Chicago: I was the Oscar Mayer Fellow, and the fellowship paid my tuition and stipend.  My main regret: I never had a chance to drive the Weinermobile (which should have been a perk!).  My main source of relief: I never had to sing an adaption of the Oscar Mayer Weiner Song: “Oh I wish I were an Oscar Mayer Fellow, that’s what I really want to be.”

Back to the subject at hand!

Booker also frets about vertical integration, and this is indeed a difference between the 2018 meat industry and the 1918 version: as the Union Stockyards in Chicago attested–by the smell, if nothing else–the big packers did not operate their own feedlots, but bought livestock raised in the country and shipped to Chicago for processing.

I am a skeptic about market power-based explanations of vertical integration, and there is no robust economic theory that demonstrates that vertical integration is anti-competitive.  The models that show how vertical integration can be used to reduce competition tend to be highly stylized toys dependent on rather special assumptions, and hence are very fragile and don’t really shed much light on the phenomenon.

Transactions cost-based theories are much more plausible and empirically successful, and I would imagine that vertical integration in meat packing is driven by TCE considerations.  I haven’t delved into the subject, but I would guess that vertical integration enhances quality control and monitoring, and reduces the asymmetric information problems that are present in spot transactions, where a grower has better information about the quality of the cattle, and the care, feeding, and growing conditions than a buyer.

I’d also note that some of the other industries Booker mentions–notably bean and corn processing–have not seen upstream integration at all.

This variation in integration across different types of commodities suggests that transactional differences result in different organizational responses.  Grain and livestock are very different, and these likely give rise to different transactions costs for market vs. non-market transactions in the two sectors.  It is difficult to see how the potential for monopsony power differs across these sectors.

Insofar as the major grain traders are concerned, again–this is hardly news.  It was hardly news 40 years ago when Dan Morgan wrote Merchants of Grain.

Furthermore, Booker’s concerns seem rather quaint in light of the contraction of merchant margins, about which I’ve written a few posts.  Ironically, as my most recent ABCD post noted, downstream vertical integration by farmers into storage and logistics is a major driver of this trend.

To the extent that consolidation is in play in grains (and also in softs, such as sugar), it is a reflection of the industry’s travails, rather than driven by a drive to monopolize the industry.  Consolidation through merger is a time-tested method for squeezing out excess capacity in a static or declining industry.

Booker’s bill almost certainly has no chance of passage.  But it does reflect a common mindset in DC.  This is a mindset that is driven by simplistic understandings of the drivers of industrial structure, and is especially untainted by any familiarity with transactions cost economics and what it has to say about vertical integration.

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  1. Hi Prof

    We should also recall that position limits were reintroduced in 1917 because of grain price volatility FOB USEC. This was of course attributed to speculation. The German U-boat blockade of Atlantic seaports and the German’s army’s capture of the wheat producing region of western Russia were not considered as possible causes for grain price volatility.

    Some things don’t change. Next thing is France will surrender to someone.

    Comment by Green as Grass — September 6, 2018 @ 3:29 am

  2. Will our esteemed senator be claiming credit for the breaking up of vertical integration in the semiconductor industry? Almost all (non-memory) chip makers are fabless now, and even Intel and Samsung are not pure in their vertical integration, the former using TSMC for wireless chipsets and the latter hiring out foundry capacity. The divergence between design (fast moving, technically niche-y) and fabrication (incremental, capital intensive) drove the break-up. Vertical integration is not a one-way street.

    Comment by M. Rad. — September 6, 2018 @ 4:58 am

  3. Why is there never any anti-trustaction against the Federal government? Surely it monopolises such a large part of American life that it really should be split up. (Or y’all could try federalism, I suppose.)

    Comment by dearieme — September 6, 2018 @ 5:45 am

  4. “Next thing is France will surrender to someone.” What? in 1917 France didn’t surrender to anyone. She put up a doughty display.

    I must say that Americans are very churlish about France. What’s the problem? Do you resent her having won Yorktown for you?

    Comment by dearieme — September 6, 2018 @ 5:48 am

  5. Some potential TCE considerations regarding livestock (that relate back to one of Craig’s themes in ocean shipping):

    [T]he growth of long-term contracting between feedlots and beef processors and the prevalence of integrated slaughter and beef fabrication operations can also be understood in transaction-cost terms. Because of transportation costs, beef processing plants tend to be located near feedlots,
    which, in turn, tend to be located close to feed grain supplies. Hence, assets are to some degree site specific. In addition, “[m]odern kill lines and fabricating operations are designed to handle a specific quantity flow, and per unit costs increase rapidly at other volume levels” (Purcell, 1990: 1216). To assure the cost savings of high-speed production lines, processors need a steady
    flow of inputs. Efficient management of cattle stocks, meanwhile, requires immediate processing of fed cattle once they reach optimal slaughter weight; holding cattle in feed lots beyond that point is purely a holding cost. The cost of storage and the importance of timely processing becomes even greater once cattle are slaughtered. Absent transaction costs, there is no reason that scheduling economies could not be realized by simple communication and agreement between independent operators. What makes this prospect unlikely, and makes formal protective mechanisms desirable, is the prospect of hold ups occasioned by the quasi-rents accruing to prompt performance.

    Comment by Scott — September 6, 2018 @ 11:43 am

  6. @dearieme–I think that @Green is a fellow Brit 😉 And the English are in my experience more snarky about the French than the Americans. Frogs, and all that.

    And the phrase “cheese eating surrender monkeys” was uttered by Groundskeeper Willie (a Scotsman) in The Simpsons 😉 Though the French and Scots were historically allies.

    Speaking of which, you lot are seeming to be gearing up for another war with them. La Guerre des Coquilles St. Jacques. LOL.

    More seriously, yes, the French get a bad rap. They did collapse in 1870 and 1940, but the losses they suffered in 1914-1918 were appalling, yet they hung on. And they did pretty much knock the world around (on the European continent, anyways) for a good part of the 17th, 18th, and 19th centuries.

    Comment by cpirrong — September 6, 2018 @ 1:00 pm

  7. “I think that @Green is a fellow Brit”: in which case he deserves even more scorn, for adopting stupid American habits. Christ, he’ll be saying “out of left field” next.

    One may reasonably mock the frogs for many things but not for cowardice.

    Comment by dearieme — September 7, 2018 @ 3:49 am

  8. Love this thank you Professor! I would say Booker also fails to just look at empirical market movements. We just had JBS have to sell off their Five Rivers Cattle feed-yards in a massive transaction and Cargill finished selling all of their US feedlots sometime in 2017. The JBS one obviously came more so from the problems the Batista brothers are having, but nonetheless this was clearly the largest spin-off of feed-yards in quite some time now owned by a private commodities firm in NYC. If he wants to focus on some type of regulation maybe he should look inward to his friends over at Facebook or Amazon (I have a clear opinion on the former re need for non-discriminatory access but would be interested to hear your thoughts on the latter). Thanks for the work and beautiful intellectual capital as always – it is truly valued!!

    Comment by JPM — September 7, 2018 @ 7:28 am

  9. @JPM–Thank you. Glad you liked it. The information re the divestment of feed-lots by Cargill and JBS is quite interesting. Thank you for that. It would be interesting to see whether the private commodities firm has a contract with JBS, and if so, what the terms are.

    Re Facebook, Amazon, Twitter, Google, etc., you should read my post on regulating them as common carriers which would entail a non-discrimination requirement. To me that is the minimally invasive way of addressing what is clearly an inefficiency resulting from an exercise of market power inherent in network goods.

    Thanks again!

    Comment by cpirrong — September 7, 2018 @ 2:38 pm

  10. @Scott–thanks. Good to hear from you.

    So, in other words, “temporal specificity” 😉 That’s what came to mind when I was writing the post, but I didn’t have the factual basis–thanks for providing it.

    Comment by cpirrong — September 7, 2018 @ 2:39 pm

  11. @JPM. I did some quick googling, and see that yes, Pinnacle LLC (which bought Five Rivers Cattle) will continue to sell cattle to JBS. It would be interesting to see the contract.

    Similarly, Cargill entered into a “multi-year supply agreement” with the buyer of the feedlots it sold (Green Plains). Again, it would be interesting to see the contractual terms.

    Apparently, however, at least some market participants find that opportunism can be sufficiently constrained by contract that it is a superior alternative to vertical integration.

    I’d say “somebody should tell Cory!” but I know that it’s pointless to try to inform the clueless.

    Comment by cpirrong — September 7, 2018 @ 2:46 pm

  12. French did collapse in 1870 and 1940, but the losses they suffered in 1914-1918

    Comment by Carlos Olaaka — September 8, 2018 @ 1:57 am

  13. Drifting a bit off-topic, perhaps, but, regarding the reference to SWP’s post on FB/Goog not being eligible for common-carrier status, I would add that the incumbents’ monopoly power is entirely a creation of government regulation in the first place: copyright law. A reduction in scope of copyright (in particular, reversing Facebook v. Power Ventures) would weaken entrenching network effects, lower barriers to entry, bring freedom to markets (and social media users) without granting any new government enforcement power.

    Just about any enduring monopoly is the product of some government regulation. The telecom and rail monopolies were entrenched by access to rights-of-way, until technological advances made that less important. Airlines and trucking companies had government-licensed routes, until that was repealed, and so on. There is nothing intrinsic to free markets that says FB’s trivial contribution to the content of a web page binds its users to using approved client software to access it.

    Comment by M. Rad. — September 8, 2018 @ 7:33 am

  14. Craig – The above was a good back and forth on the cattle feedyard side. I had received word that African Swine Flu re hogs had wiped out north of 50% of their herd in Q3 last year. Duck farming exploded as a result and I think you’ll find an interesting corollary of nature’s chess game. Nature has its own way of punishing lack of transparency and systematical capital misallocation re China. Take a look at the African Swine Flu breakout relative to where these duck farms started to pop up.

    Also, I used to work at ICONIQ Capital an sent you an email back just because I freakin love your work (seriously it’s tough to find good blog reading). Now I’m building a drug delivery device so if you know anyone with Type-1 Diabetes feel free to drop me a line [email protected] and thank you for the constant wisdom brotha!!

    Comment by JPM — January 24, 2020 @ 9:21 pm

  15. @JPM–Thanks for the kind words. I will try to keep this blog a wisdom delivery device 😉

    Good luck on your venture. Here’s a heads up to others reading the comments.

    Very interesting re the duck farming boom in China. It’s very interesting that you post this comment on a day when the Corona virus story is going, well, viral. Talk about punishing their lack of transparency and systematic misallocation of resources. This time, however, those on two legs are the ones dropping dead.

    I read a tweet where someone suggested calling this the Chinese Corona Pathogen–CCP for short. That would be more than fitting. This pandemic is the spawn of mating of culture and communism.

    Back to ASF. I am guessing that it played a major role in the completion of Phase I of the trade deal.

    Good to hear from you–hope you keep coming back, and commenting when the spirit moves you.

    Comment by cpirrong — January 25, 2020 @ 12:12 pm

  16. @JPM–Reading the article you linked makes me wonder whether nature’s chess game may be even more twisted. So duck farming has exploded, and there is a unique duck corona virus. I wonder if there’s a connection with the current pandemic. These things mutate hella fast, and spread like crazy in China.

    I read an announcement this morning stating that they had gene sequenced the virus responsible for the current human pandemic. I wonder whether it is possible to trace its origins to the Duck Dominant Corona Virus.

    Comment by cpirrong — January 25, 2020 @ 12:24 pm

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