THE WORLD SUGAR MARKET AND REFORM
Prepared by Mr A.C. Hannah, Chief Economist, ISO for the for the Sugar and Beverages Group, Commodities and Trade Division. Tables and charts have been left out due to space limitation.
While it is commonly perceived that the current world sugar market is more stable than it was the extent to which it has changed is not always appreciated. Chart 1 shows the world raw sugar price from 1970 to 1996. It is clear that from 1988 the annual variation has been much less than the previous two decades, although the averages are rather similar: 11.22 cents/lb. for 1988 - 1996; 10.45 cents/lb. from 1979 to 1986; and 11.37 cents from 1970 to 1978. But if we look at deviations from the mean, the turnaround is even more dramatic. Chart 2 shows deviations from the mean; expressed in percentages of the average, from 1922 to 1996. The percentage deviation from the mean from 1988 to 1996 was only 13.1 percent. Contrast this with 1979-86 at 52.3 percent, 1970-78 at 53.7 percent and 1961-69 at 47.8 percent. The deviations are less in the latest decade by a factor of 4. You have to go back 40 years to the immediate post-war period, 1952-1960, when there were two effective back-to-back ISAs (1953 and 1958) to find a comparable period of stability (13.2 percent) but it was also a special case - from the depression up to the war raw sugar prices were uniformly depressed, averaging just 1 cent/lb. from 1931 to 1939. But the decade 1922-30 also exhibited the "traditional" high variation at 29 percent. So, except for two decades of special circumstances - effective ISAs and depressed prices - sugar prices were, up to 1987, exceptionally volatile since 1922.
What has happened to change the characteristics of the sugar price formation process so dramatically? The answer lies in the change in the average price elasticity facing the market. In the 1970s and up to the early 1980s the import market was dominated by developed countries - largely US, Japan and Canada - which characteristically have very low or even zero price elasticities - that is, a change in the price does not produce a concomitant change in imports or consumption. In practical terms, when prices rose sharply in 1974 and 1980 these countries did not reduce the level of their imports, providing further impetus to the price rises and explaining why prices reached such unprecedented levels in those years. Why this lack of reaction? First and foremost, they are high income countries and sugar consumption represents only a tiny proportion of disposable income. Secondly, in both US and Japan 85 percent of sugar is used in products (dominated at that time by soft drinks) and the corporate buyers were more concerned about preserving market share for their products than they were about the price they paid for the raw material. In the 1970s the high income developed countries accounted for more than two thirds of the import market (Chart 3). By 1996 this situation had become almost reversed: the relative share of developing countries was almost 60 percent of the market (Chart 3).
Two reasons can be cited for this reversal: 1) The exceptionally high prices of 1974/75 led to the development of the HFCS industry in the US and to a lesser extent, Japan. This process was reinforced by the 1980 sugar price boom. US and Japan sugar consumption and imports were displaced by the growth in HFCS consumption. US net imports fell from 5 million tonnes in 1974 to 3 million tonnes in 1980 and to only 690 thousand tonnes in 1987. Japanese imports fell from 3.34 million tonnes in 1974 to 1.78 million tonnes by 1987. In absolute terms developed country imports fell from 14.229 million tonnes in 1974 to 12.788 million tonnes in 1980 and to 9.577 million tonnes in 1987. 2) At the same time developing country imports grew, triggered by the first oil price shock in 1973 and led by oil exporting sugar importing countries. The second oil price shock of 1980 reinforced this trend, and after 1981 sugar prices fell and developed country imports also fell so that the proportion of the market taken up by developing countries continued to grow (Chart 3).
The consequence of this gradual but inexorable change in the structure of the import market was that by the late 1980s the market was dominated by developing countries with, on average, higher price elasticities. Consequently, when prices rose, less was purchased, and vice versa, so that prices became, as we have seen, much more stable; in the average range of 9 to 13 cents/lb.
It might be wondered why I place so much importance on the achievement of reasonable price stability by the sugar market. The reason is simple: the massive price instability so characteristic of the sugar market in the past made rational planning in the industry impossible and further contributed to instability. Sugar is a special agricultural product. It is highly capital intensive because it requires mills and factories for final processing. The capital intensity means that long-term planning is essential. This situation is exacerbated because sugar cane (accounting currently for 70 percent of world sugar production) is a multi-year crop, typically 5 to 7 years. It is therefore extremely difficult to match production with price conditions and there is an in-built tendency to overproduce, driving prices downwards in surplus years.
Therefore the attainment of stability, from 1988, has been a very important and historic development, making forward planning and coordination of supply and demand much easier, and contributing further to stability. This new found stability should not be compromised in any way.
There is another cogent reason why the new found stability of the sugar market should be maintained. Since the price booms of 1974 and 1980 sugar has had to live with a direct competitor - HFCS. And, HFCS substitutes for sugar directly in its most dynamic use sector, soft drinks. In the US, where HFCS has developed most, the cost of production of HFCS is currently estimated at between 8 and 12 cents/lb., depending on the age of the capital stock. So the present "cap" on world sugar prices at around 15 cents/lb. is vitally important. If prices were sustained above 15 cents/lb. for a long period, the scale of investment seen in HFCS after 1974 and 1980 would be in danger of being repeated, on a world scale, leading to a shrinking of the market for sugar at the same time as sugar production increased in response to the higher prices; leading inevitably to very low prices and a return to the historical instability sugar suffered before the established itself in 1988.
When the Uruguay Round began in 1987 some arguments were made to show that the sugar sector, in particular, was in need of reform. I will discuss three of them.
As mentioned before, it is universally agreed that the Uruguay Round did nothing to change the situation for sugar. I believe that this is a rather harsh judgement. It is true that the US avoided reform through a semantic trick (operating the quota system through very high and very low tariffs) and that Japan set very high initial tariffs, but it seems to me that the replacement of the variable levy of the EU by a reducible tariff was an immense breakthrough for the long term future. Over a suitably lengthy period of time it could lead to the removal of the EU from the export market.
The second round of GATT/WTO will begin in 1999 and it is said that sugar, having achieved little in the first round, will be targeted. This worries me greatly, since when politics and dogma take over a complex and delicate market, its stability can be compromised. We are all aware of the cautionary tale of BSE in the UK.
In the early 1980s politicians in the UK decided that regulations governing animal feeds were unnecessary and swept them away. Unscrupulous feed manufacturers introduced diseased animals into the food chain and the result was an upsurge of mad cow disease. Now the UK beef industry is in chaos. I dont of course suggest an exact parallel in the case of sugar, only that the consequences of reform should be studied and thought carefully about and nothing done to upset the balance of the market. Completely free markets sometimes have perverse consequences.
There are good arguments for maintaining diversity of supply for the world sugar market. A market which moves in the direction of being supplied mainly by three or four exporters is in danger of becoming too dependent. Sugar is particularly vulnerable to weather conditions - hurricanes and drought and now El Niņo - and if a major supplier is affected and other suppliers have been suppressed by reform, there is the possibility that prices will be forced up into the danger zone above 15 cents/lb. where further substitution by HFCS could occur. Inevitably, a broad spectrum of suppliers will have a wide range of costs of production and some will be more dependent on preferential markets, like the ACP countries which also have legitimate socio-economic factors to take into consideration. But that is the market mechanism we have inherited, and it works, and it would be foolish to sacrifice stability to the good of low cost of production.
Currently, as well, there is room for all in the market. From 1982 until 1994 the market stagnated, averaging around 24 million tonnes. Then in 1995 the market rose by 4 million tonnes (17 percent) to 28 million tonnes. Preliminary figures for 1996 show that this improvement has been maintained. The growth has occurred largely through declines in production in some Asian countries, notably Indonesia and Philippines, and their situation is unlikely to improve dramatically in the next few years, so that there is every likelihood that a market of 28 million tonnes will be maintained. While remembering to thank India for not exporting its surplus, exporters should note that the current market is adequately but not over supplied, and that prices are reasonable for efficient producers. A stable market is a well supplied market. World net exports from 1982 to 1996 are shown in Chart 4.
There is another area that should not be neglected in the next WTO Round - the interests of developing importing countries. Sugar, because it has an industrial as well as an agricultural aspect, is a very useful engine of development, and sugar industries have been developed in many developing countries precisely to aid in development. In most cases these industries have a higher cost of production than the efficient exporters, and use border protection to allow their industries to survive in the face of cheaper imports. In many cases these countries have, under the current WTO Agreement, reduced the tariff on sugar to the minimum required to protect their industries. An example in Egypt. Egypt, has a well developed sugar industry producing about 1.1 million tonnes of sugar, mostly cane. The rest of its consumption requirements, around 750-800,000 tonnes are imported. Egypt has entered at Marrakech a bound tariff rate of 20 percent ad valorem, the absolute minimum required to protect the domestic industry. Any reduction would jeopardise the future of the domestic industry. The question has to be asked, do Egyptian farmers have to be bankrupted in order to make Australian, Brazilian and Thai farmers richer? Arguments for reform based purely on efficiency and consumer welfare suggest they do. But surely governments have a sovereign and a legitimate right to protect an industry that has an important role in their development and, if that industry fails, for which they would have to bear the social costs. Table 1 shows that many developing importing countries have substantial sugar industries, and in some cases policies aiming at self-sufficiency in order to save on valuable foreign exchange. In 1995, developing importing countries produced 19 million tonnes of sugar (16.2 percent of world production). If a substantial part of this production was put at risk by radical reform the efficient exporters would not be able to respond quickly with higher production, world prices would rise substantially and the world sugar market would be in the danger zone for HFCS substitution.
There is another, overlapping, area where radical reform could have counterproductive consequences. According to Landell Mills, the average world cost of production for beet is 70 percent higher than for cane (Chart 5). If these figures are accurate, and they come from an authoritative source, little or no beet production could survive without protection. In 1995 world beet production was 35.9 million tonnes, 30.7 percent of total world production. Again, and obviously, it would be beyond the limits of exporters to replace this quantity of production.
So the question becomes, not that protection could or should be removed, but by how much and how fast, without damaging the structure of the world sugar economy.
To sum up the arguments of the previous section:
1) Protection is an integral part of the world sugar economy affecting a substantial part of world sugar production:
(million tonnes raw value - 1995)
2) Further expansion in efficient exporters is limited, perhaps to 5 million tonnes.
3) Developing importing countries have sugar industries which contribute to development, but which require protection. If social costs are taken into account, these countries have good arguments to preserve and even expand their industries.
4) The level and pace of reform should take account of the above 3 qualifications.
The impression may have been given that I am against reform. Far from it; I support the reform process as long as it does prejudice the "new" stability of the market and so long as all costs, including social costs, are taken into account. The world sugar economy is very delicately balanced, and it would be counterproductive to make reforms which in the medium term diminish the size of the market for sugar and depress prices.
My suggestion is that the breakthrough of the tariffication of the first round is built upon in further phased reductions, where feasible and justified, leaving adequate time for adjustments by the producing countries whose protection will be reduced and adequate time for suppliers to take compensating steps to fill the gap. The limits for expansion in exporting countries should be examined and this would represent a guide to the overall limit on the timing and end result of the reform.