Concerns about consolidation in the pork industry, unequal bargaining power, poorly written contracts, and inadequate dispute settlement procedures have led members of state legislatures and the U.S. Congress to propose legislation to more heavily regulate the industry. These laws would limit packer ownership of livestock (to limit or prevent vertical integration) and regulate the content of production and marketing contracts used in so-called “virtual” integration.
In January 2003, a bill was introduced in the U.S. Senate to make it unlawful for a packer to own, feed, or control livestock more than seven business days before slaughter. If enacted, the bill would allow hog packers 18 months to comply and packers of any other type of livestock a maximum of 180 days to comply. The bill would exempt from the ban packing operations owned by cooperatives whose members are livestock producers and provide livestock to the operation, as well as small packers that own only one plant or process fewer than 100,000 hogs or 125,000 head of cattle per year.
A recent publication from the Farm Foundation reported some states are imposing regulations specific to hog production contracts, including “clear disclosure to the purchaser of all risks of the contract; prohibition of confidentiality clauses; prohibition of binding arbitration in contracts; recapture of capital investment protection by allowing cancellation of contracts only after notice and an opportunity to cure problems; and identification and banning as an unfair trade practice use of the tournament pay system, or ranking system, to determine payment under production contracts.”
Many of these efforts may be well intended, but they are unnecessary and likely to be counterproductive. There is no evidence packer ownership of livestock is inhibiting competition or leading to higher prices for consumers. A recent study by eight agricultural economists found, “none of the impacts [associated with contracting] have approached what the Department of Justice and Federal Trade Commission use as a regulatory standard to assess non-competitive behavior.”
Producers themselves are generally satisfied with their contracts. Glenn Grimes et al. reported that contract growers rated their contracts an average of 4.9 on a scale of 1 to 6, with 6 being very satisfied. Contractors (the owners of the hogs) rated the contracts at 4.6, even though many have suffered significant losses over the past five years.
When contract producers were asked what they would do when their current contract expires, 80 percent said they would attempt to renew their contract with the current company. Only 9 percent said they would attempt to go with a different company, and 4 percent said they would go independent.
Poor drafting and less-than-adequate understanding of contracts can lead to risk transfers that are not apparent until a quality or quantity issue arises. It is tempting to endorse industry-specific legislation in the name of advancing clarity and fairness, but common law and statutes already on the books prohibit fraud and misrepresentation. If misinformation and deception are problems, then farm organizations and information brokers should guide smaller and unsophisticated producers through the negotiation and contract-writing process.
Legislation that is industry-specific–designed to produce greater “clarity and fairness” in hog production contracts, for example–often restricts entry by new firms and benefits insiders, who economists call “rent seekers.” The valid interests of small producers should not be used to disguise legislation that actually seeks to prohibit or curtail the use of contracts.
Vertical integration and production contracts are reasonable business responses to consumer demands for branded products with reliable quality, as well as the increased mechanization and specialization of the industry. Prohibiting or curtailing vertical integration or the use of production contracts would be detrimental to all market participants, including and even especially consumers.
Ross Korves ([email protected]), an agricultural economist, is the author of a Heartland Policy Study on integration in the pork industry. He has written extensively on economic trends affecting U.S. agriculture and the livestock industry. From 1980 to August 2004, he was an economist with the American Farm Bureau Federation.