fedgazette

Small hog farms losing ground

Large operations and Southeast producers pose challenge to small Ninth District hog farms

Edward Lotterman - Agricultural Economist

Published April 1, 1996  |  April 1996 issue

What will happen to hog production in the Ninth Federal Reserve District? Are traditional hog farmers destined for oblivion? Like their neighbors who milk cows (fedgazette, January 1995), Upper Midwest hog producers face substantial challenges as livestock production experiences ongoing technological change in production methods and dramatic developments in competition from other regions. While hog farming in the Minneapolis district has changed somewhat more slowly than in other regions, the pace of such change may pick up in the next few years.

The current transition in hog production has provoked heated debate in the media and on the floors of legislatures in most hog-producing states. Extreme voices on both sides tend to frame the question in terms of a clash between good and evil, small family farms vs. greedy corporations, progress and efficiency vs. sentimentality.

In economic terms, the debate is fairly clear. As in recent developments in the dairy industry, the relative efficiency of different sized operations is one issue. Do large operations inherently have lower costs than smaller operations, and if so, why? Is the cost advantage of larger operations such that they will inevitably displace smaller ones? Or can the two coexist for some time?

Again, as in the dairy sector, there is also a question of the relative advantages of different geographic areas. Is the Southeast, especially North Carolina, an inherently cheaper place to raise hogs than the Upper Midwest, and if so, why? If much or all of the Southeast's advantage stems from less stringent environmental regulations, is this an efficient outcome that simply reflects North Carolina society's greater tolerance of a nuisance, or is it an inefficient outcome resulting from poor information in that state's policymaking that permits high levels of damage to its resources.

The current issues in the hog sector thus mimic those in dairying in several ways, with a few striking differences: Environmental and nuisance externalities play a much larger role in the hog debate than in dairying, and while the policy debate in dairying has focused on federal policies, that regarding hogs is completely within state legislatures. Unlike dairying, there are no federal policies regarding hogs, and the public policy issues are largely state ones dealing with pollution control or restrictions on corporate ownership of farms.

Midwest hog farms challenged

Growing corn and raising hogs have been important complementary activities for Midwestern farmers since the time of European settlement. But as the 1980s turned into the 1990s, traditional hog-producing states increasingly felt the threat of competition. The nature of this threat is perceived in two ways. First, some fear that competition from larger units, inside or outside the region, will displace traditional family-owned hog farms, and that the quality of rural life or social structure of urban communities will suffer as a result. Secondly, many fear that hog production in the Upper Midwest will decline in absolute terms as well as in market share. An actual decline in production, they argue, will lead to declines in related businesses such as feed milling, trucking and meatpacking.

In the Ninth District, most hogs are produced in eastern South Dakota and southern Minnesota. While Wisconsin's reputation is that of a dairy state, it is also a major hog producer, largely in the southern tier of counties outside district boundaries. At any given time there are 7.5 million hogs on roughly 20,000 farms in the district. Most are family farms, both in terms of ownership and labor supply, and few sell more than 5,000 head per year.

But output is highly skewed. In Minnesota, farms selling fewer than 500 hogs each year constitute over 60 percent of all hog farms, but sell less than 15 percent of all hogs. Farms selling 500 to 5,000 hogs make up 37 percent of farms, but produce 68 percent of all hogs. Finally, the 0.8 percent of farms selling more than 5,000 head per year sell about 7 percent of all hogs. Given hogs' short reproductive cycles and rapid weight gain, the number of hogs sold and slaughtered each year is greater than the number on farms at any given time. In the district, nearly 15 million are sold for slaughter each year with a farm value of about $1.5 billion. From 1987 to 1992, the number of Ninth District farms with hogs declined by about 15 percent, but output grew by nearly the same degree.

Given this absolute growth in output, some may find it surprising that Upper Midwestern hog producers worry about losing out to other areas. But numerous farmers and input suppliers in Iowa and Minnesota have called for legislative changes with regard to environmental rules and corporate ownership that would allow them, in their view, to compete more effectively with the Southeast and Southwest.

These calls for changes in the rules of the game have been highly contentious, even within rural communities. Many other farmers oppose such changes, arguing that they will lead to the more rapid demise of the family farm. "If we open the gates and let any size operation in, we are going to be down to 10 farms per county when our children grow up," said one farmer quoted in a Minnesota farm newspaper. Rural and urban environmentalists argue that such changes will harm local and regional ecosystems.

But input suppliers, packing plant owners and workers, as well as truckers and lenders, argue that if the Midwest does not compete more effectively, they will lose their livelihood also. "Hog producers have always been a good part of our business," said an Olmstead County, Minn., independent banker at a recent public meeting. "If these huge units that are too big for us to finance take over, we'll lose out." Hence the very visible controversy in the media and in state legislatures for the past three years.

The size issue

Many observers think that hog production is destined to follow the path set by broilers: concentration into large industrial production units owned or financed by corporations, in which workers will mostly be hired hands or contractors. Indeed, many of the large operations in other states were started by individuals or firms with experience in this type of poultry production, and the external appearance of large hog and large poultry facilities is very similar to the lay person driving by.

Large-scale hog production is certainly technically feasible. But as in other questions about the structure of agriculture, the extent of economies of scale is debatable. Iowa State University agricultural economist John Lawrence examined total production costs for operations of various sizes in the Midwest and compared these costs to those experienced in large North Carolina units. He found that the North Carolina units' costs were about 10 percent below that of a 250 sow Midwest operation. But this cost advantage dropped to less than 2 percent against a 650 sow operation, and at 3,400 sows Midwest production was cheaper than in the Southeast. While a 650 sow operation is large for the Midwest, it still can be handled largely with family labor and financed by traditional agricultural banks.

Some analysts argue that large units' competitive edge comes from access to cheaper credit. "I can sell commercial paper and get funds for expansion at half of what a small farmer has to pay at his local bank," said the CEO and principal shareholder of National Farms at a Federal Reserve Bank of Kansas City 1994 conference. That corporation built some of the very largest hog facilities in the United States, but has since divested all its hog operations.

Moreover, Federal Farm Credit system institutions are becoming more aggressive in funding mid-size, farmer-owned facilities, and some rural banks are reportedly cooperating to fund expansions by existing customers. Thus while very large corporate-owned operations may have somewhat lower short-term borrowing costs, there does not seem to be a shortage of credit for expansions by existing producers.

Very large facilities may have a marketing edge in that they can offer virtually daily deliveries of genetically uniform animals to packers. "I'm not sure the smaller producers will ever manage to get the same genetics and the same uniformity," argues one officer of Agribank, a regional Farm Credit Service bank based in St. Paul, Minn. But some family-operated units seem to come close. "We're selling about one semi-load a week," says a former Minneapolis Fed advisory council member from southwest Minnesota, who sells on a carcass grade and yield basis rather than liveweight. Existing smaller producers in Minnesota, Wisconsin and Iowa are also reportedly forming cooperatives or associations to jointly market animals raised on individual farms.

On balance, it appears that while the trend to larger units will continue, this does not necessarily mean that all such units are beyond the scope of family-owned businesses. Nor is the cost advantage of new, large facilities so pronounced that current producers will not be able to recover costs in their existing facilities.

The location question

"The Midwest, with its historical advantage of lower feed costs, has the greatest opportunity," says Purdue University agricultural economist Chris Hurt. That assertion is largely supported by many observers. Unlike dairying, where the arid climate of the Southwest may confer comparative advantage, there apparently is no inherent reason why the Southeast's climate or resources are necessarily more favorable for hog production.

While it no longer takes 20 bushels of corn to produce a hog, feed costs remain a major component of hog production. In the past five years, hog production in the Southeast has grown more rapidly than corn production, and the region is a net corn importer with higher prices than in the Midwest. As feed prices rise in the Southeast along with the proportion of nonlocal feedstuffs, that region's relative advantage may erode further.

"They are just expanding in our state because they know they can get away with things here that they can't elsewhere," argued one North Carolina opponent of further expansion in that state. Her views are shared by many others. In much of the debate in both the Southeast and Midwest, voices on both sides of issues focus on comparative state policies regarding forms of business organization and environmental rules.

Is business organization crucial?

Minnesota, Iowa and Wisconsin all have "family farm" laws that restrict or prohibit farming operations by corporations other than small, closely held ones. These laws have been attacked by people who fear that the hog industry, including processing, will simply move over time to other states. Most of the expansion in very large facilities in the last decade has taken place in states that do not have such laws. Missouri, which has similar legislation restricting corporate ownership of agricultural enterprises, exempted a tier of its poorer northern counties as a regional development measure. A number of corporate-owned facilities were erected as a result, and the pros and cons in terms of employment, local economic activity and the environment are still being hotly debated.

While such extremely large facilities have not yet been built in the district, numerous large noncorporate operations have been constructed. In 1994 the Minnesota Pollution Control Agency issued 101 permits for hog operations larger than 2,500 head, and nearly as many in 1995. Many were in the 8,000 head to 10,000 head range. These 101 permits represented a doubling of the number of such facilities in operation. An 8,000 head facility is some 20 times larger than the average hog operation in the district.

Thus while some economists and input suppliers decry the loss in economic efficiency by banning corporate farming, it is not clear that such bans pose much of a barrier to adoption of new technology or expansion of hog production in states where they apply.

The environmental question

Environmental issues are unquestionably the most contentious ones in all states where hogs are produced. Opponents of change argue that the economies of scale ascribed to large operations result from the fact that such units are allowed to handle manure in a way that regularly causes noxious odors and that potentially can pollute ground and surface water.

Growing hogs produce a great deal of waste. An animal that grows from 40 pounds to 230 pounds in 14 weeks has to eat a lot of feed. The excretions from such an animal are far greater than that of an adult human. A rule of thumb is that 10,000 hogs produce as much waste as a city of 25,000. Cities that size have to spend millions of dollars on sewage treatment plants while hog farms simply use concrete tanks or earthen lagoons to hold manure until it cam be spread on cropland. Increasing the size of livestock operations violates a cardinal rule in environmental science—the ability of ecosystems to assimilate organic pollutants is usually greater when the pollutants are dispersed than when concentrated.

Odor problems and water pollution have been the center of a fierce debate in North Carolina in the past year, making news as far away as in the New York Times and The Economist. "Hog odor is by far the most emotional issue facing the pork industry," says a recent article in the North Carolina News and Observer. Odors do not grow linearly with the size of operations, they grow faster. Susan Schiffman, a Duke University psychologist and nationally recognized odor expert, found, in a recent study partially funded by Carolina hog producers, that manure gasses were just as concentrated 1,500 feet from some facilities as right outside the buildings. She also found that odor levels at some farms were 27 times higher than the level at which humans begin to sense them. Odor is also an issue in Iowa and Minnesota, although at a somewhat lower level since odors are generally less of a problem in winter.

Water pollution is the other potential external cost of large-scale hog production that is highly contentious. In 1994 and 1995 there have been a number of well-publicized spills, including one of 22 million gallons in eastern North Carolina and smaller ones in Iowa and near Lake Benton, Minn. In 1995 the water pollution resulting from hogs became the primary policy question in North Carolina, and a state study showed that the majority of hog lagoons were inadequate and posed a threat of leakage or failure.

"I want to send a very clear message to operators of large hog farms, shape up or ship out," North Carolina Gov. Jim Hunt said last August. The sharpness of his tone is notable in that he had long been a supporter of hog expansion, and was criticized for the degree of influence major contributors from the hog industry seemed to have in his administration. The farm with the 22 million gallon spill was fined $110,000 and regulations are being tightened by the North Carolina Legislature.

On balance, it appears that environmental problems associated with larger hog operations are real, and will place an upper limit on expansion as long as measures are taken to limit external costs of such facilities. While some argued in the past that North Carolina residents simply had different preferences than those in the Midwest, that they were less bothered by hog-related odors or pollution, the public outcry in that state in the last 12 months indicates that is not true. It seems likely that pollution regulations may soon pose as large a barrier to expansion in the Southeast as in the Midwest, though whether existing operations will be forced to upgrade their facilities is still an open question.

What does the future hold?

In a static world, the outlook for hog production within and outside the Ninth District is fairly clear. Production will continue to grow in nontraditional areas, but probably not at the rate of the past decade. Increasing costs for both feed and waste disposal will curb such rapid growth. Within the district most new facilities will be substantially larger than in the past, but this will simply be the continuation of a long trend. Most, if not all, will still be family enterprises, but with a higher proportion of hired labor than in the past.

Existing producers will likely be able to recover costs associated with existing facilities and make modest profits, but are not likely to reproduce such facilities on a similar scale as they wear out. The number of commercial, as opposed to hobby, producers will continue to fall.

But the world is not static. As 1995 progressed and 1996 began, market forces were developing in a manner so as to make such predictions—and many of the issues so hotly debated in North Carolina and the Upper Midwest—more conjectural. For at least three decades, change in hog production has largely been on the supply side, as genetic and technological changes lowered production costs in real terms.

Demand was largely stagnant as hog producers suffered from declining per-capita consumption of pork. In the 25 years from 1968 to 1993, annual pork consumption fell from 66 to 49 pounds per person. In the same period, per capita poultry consumption increased by one-third. Just as for sheep producers, the pork industry has never benefited from the burgeoning fast food industry as did beef and chicken producers. Nor do they expect much improvement in domestic consumption, given current concerns about dietary fat and in spite of the drastic reduction in fattiness achieved in recent decades by selective breeding. More recently, hog prices were very low from late 1994 to late 1995 as a result of cyclical expansion in output.

But in recent months, hog prices have recovered somewhat from the historic lows set in late 1994. This recovery was largely unanticipated by extension economists and other market analysts and largely attributable to a demand factor—increased pork exports to Pacific Rim countries.

Such meat exports are a ray of hope. Most of the fastest growing economies of the world are in East Asia, a region where pork is traditionally well-liked. So for the first time in decades, changes on the demand side may be as important as changes in supply.

Similarly, recent developments in feed grain markets, largely driven by export demand, may also affect long-term as well as short-term profitability for hog producers. Following the 1995 harvest, corn prices began a seemingly inexorable rise to record highs in nominal terms, again largely on the basis of exports to Asia, principally China. While some politicians were off by a factor of 15 or so in their estimates of what one additional egg eaten by each Chinese would do to U.S. corn exports, the general lesson of the power of rising incomes and improving diets in populous Asia is clear. Barring political crises or an unprecedented series of bumper crops, grain prices are likely to remain higher through the end of the century than they were in the last 15 years as a result of growing world demand.

Thus, the future is not entirely clear. On one hand, the trend toward larger hog production units is likely to continue, as it has for four decades. There may be additional growth in output in the Southeast and on the High Plains, although probably not at the pace seen in the last five to 10 years.

Feed costs will squeeze producers of all sizes in the short-term, but a combination of rising export demand and the inexorable workings of the hog cycle will probably mean higher profit margins in 1997. Most new facilities are likely to be large, whether owned by corporations or families, but existing producers are likely to be able to make at least modest incomes in their present facilities in the mid-term. And hogs will probably be an important part of agriculture in the Ninth District for some time to come.

Related articles, fedgazette, January 1999:
Contract pricing complicates hog markets
How much should pork prices drop?
Is agriculture in crisis?
The porcine slaughter of the innocents [Web only]


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