3 TOBACCO IN THE PEOPLE’S REPUBLIC OF CHINA

3.1 INTRODUCTION

The People’s Republic of China (China) is the largest tobacco producer in the world. In 1999, production of leaf tobacco was about 2.4 million tonnes, or nearly one-third of world output. Most tobacco was processed into cigarettes for domestic consumption. In 1998, total output of cigarettes reached about 83 billion packs (20 pieces/pack), representing more than 30 percent of world cigarette production. It was estimated that over 320 million Chinese were smoking and nearly 500 million Chinese were second-hand or passive smokers, which made China the world largest cigarette consuming country and hence most vulnerable to smoking health hazards.

Tobacco has been a very profitable product in China, in particular for the government. With less than one percent of sown agricultural land, tobacco production, along with manufacturing processes, generated about RMB 95 billion in tax and profit for the government in 1998, while the whole agricultural sector contributed only RMB 40 billion to government tax revenue. Total government revenue reached RMB 987.6 billion in 1998, but nearly one-third was used to subsidize state loss-making enterprises, which resulted in net revenue of RMB 654.1 billion before adjustments to include other government financing. As a result, taxes and profit from tobacco production accounted for nearly 15 percent of government net income. Given such an important role in government revenue, tobacco production has long been controlled by the government. While many industrial and agricultural enterprises have been partially or fully free of government control following the economic reforms of the past two decades, the government passed the “Law of the People’s Republic of China on Tobacco Monopoly” in 1992 to re-enforce the state monopoly on tobacco. Obviously, to explore the current development and future trends in tobacco production, consumption and trade, one must bear in mind the importance of their contribution to government revenue and the monopoly structure for production, marketing and trade.

3.2 PRODUCTION OF TOBACCO

Since economic reforms were launched in 1978 and the tobacco monopoly law came into effect in 1992, production of tobacco is examined for three periods: 1970-1978, 1979-1992 and 1993-1999 to take into account policy effects (see Table 3.1).

Production of tobacco in China increased during the past three decades. Average annual outputs were 0.965, 2.106 and 2.921 million tonnes for the periods 1970-1978, 1979-1992 and 1993-1999, respectively. Since average unit yields did not increase during that time, the increase in production is attributable entirely to the expansion of planting area. The average planting area reached 1.75 million hectares between 1993 and 1999, 213 percent more than between 1970 and 1978. Yields declined a little over this time, largely due to the extension of tobacco production into marginal land and into non-traditional tobacco producing areas. The lack of skills and unfavourable agronomic conditions in these new production areas lowered the average yield in the country. Although almost every province in China plants tobacco, production has been concentrated in a few provinces, namely Yunnan, Guizhou, Sichuan (including the newly established municipality of Chongqing) and Henan. These four provinces accounted for nearly 60 percent of the total planting area in 1999.

Growth in tobacco production has, however, slowed in recent years. The annual growth rate was 6 percent between 1970 and 1978, 12 percent between 1979 and 1992, but only 1 percent between 1993 and 1999. The high level of production in 1997 resulted in an accumulation of stocks, and production remained well below that level for the subsequent two years.

Table 3.1: Area, yield and output of tobacco leaf, 1970-1999

Chinese production of tobacco shows substantial volatility from year to year, and for the period 1979-1992, the standard deviation was 0.79 million tonnes against a mean of 2.11 million tonnes. For instance, production in 1981 was 66 percent higher than the previous year, while in 1986 it fell 30 percent compared with 1985. Although the volatility between 1993 and 1999 was lower than between 1979 and 1992, it was still very significant. Variations in yield were responsible for some of the fluctuations of production, but the major factor was the changes in planted area. The changes in yields from one year to the next over the past three decades have never been more than 15 percent, except for 1986, when severely bad weather swept several major producing regions. The planted area, however, experienced changes of more than 40 percent up or down from year to year during the same period. This volatility has often been attributed to direct government intervention under the central planning system.

3.3 PRODUCTION PLANNING AND MARKETING

Under the Law of the People’s Republic of China on Tobacco Monopoly, the central government essentially controls tobacco production. The State Planning Committee issues a procurement plan, which is implemented by it agencies at the county level. Based on this plan, the China Tobacco Leaf Production Procuring and Sale Corporation, a business unit of the State Tobacco Monopoly Administration, signs procurement contracts with tobacco growers through its local agencies. Planting areas are specified in the contract. Inputs for tobacco production, such as seed and fertilizer, may also be specified and provided by state tobacco companies at fixed prices, which may be lower than the market prices. These implicit input subsidies may not have important impacts on tobacco growers’ production decisions because they are constrained by state tobacco companies procurement contracts and have to sell all their output to the state at the fixed procurement price. On the government side, the cost of subsidies on inputs is paid off by lower procurement prices. The limited impact of input subsides is also attributed to the government’s monopoly on the marketing of tobacco leaf.

Under the law, the state tobacco corporations are sole buyers for all tobacco leaf produced by growers. No tobacco leaf produced under state plans can be traded in the market, and no individual or company is eligible to trade tobacco. Tobacco growers have to sell their entire production to the state at the procurement prices set by the state, based on standard grades. The state tobacco company has to purchase, at the fixed prices, all tobacco leaf produced by growers on the contracted planting areas.

Any exchanges of tobacco leaf among provinces and within provinces should be based on plans made by the state or provincial planning department. Without government permission, no tobacco leaf may be transported from one place to another. The government has effective control through planning production, contracting areas, setting prices and controlling marketing.

Local governments are also directly involved in controlling tobacco production. They implement the production plan assigned by the state planning department and assist state tobacco companies to negotiate and sign production contracts with tobacco growers. In return, local governments collect 20 percent so-called special agriculture product tax once the state tobacco companies have purchased tobacco leaf from tobacco growers. As a result, such tax revenue constitutes a major part of local government budgetary income in the major tobacco producing provinces. For instance, Xiao Shi Qiao, a town in Yunnan, had total revenue of RMB 3.2 million in 2000, of which RMB 2.3 million came from the special agricultural product tax on tobacco.

3.4 DEMAND FOR TOBACCO LEAF

Since most tobacco is used for the production of cigarettes, demand for cigarettes essentially determines the use of tobacco leaf in China.

National statistics show that annual per capita consumption increased from 38 packs in 1980 to 70 packs in 1995, but subsequently contracted to 65 in 1999 (Table 3.2). With an estimated 320 million cigarette smokers in China, annual consumption of cigarettes by each smoker would be about 240 packs (see appendix on Consumption Statistics).

Table 3.2: Cigarette consumption, price and income

Sources: China Statistics Bureau, China Statistical Yearbook, various issues.

Demand patterns for cigarettes are undoubtedly more complex than for most consumer products and, in China particularly, factors other than price and incomes may affect demand:

There are more than 1 000 different brands of cigarettes, with a price range for popular brands of RMB 2 to RMB 40. The large number of brands and huge price differences provide substantial scope for smokers to switch types of cigarettes rather than adjusting the quantity consumed in response to changes in prices. Apart from failing to reduce consumption, such a measure might be counterproductive if, as seems likely, the lower quality cigarettes were more harmful to health.

• Cigarettes, in particular brand name cigarettes, have been one of the most popular gifts in China over the past decades. The standard demand theory may not apply for gift products, demand for which may be largely determined by other economic and non-economic factors.

• There has been increasing publicity of the health hazards associated with smoking, with restrictions on smoking in public places, including schools. In addition, policy changes have shifted some of the cost of health care to the individual. It has been reported that increasing numbers of smokers over 40 years of age are quitting smoking because of concerns over health. This has contributed to a decline in smoking since 1995.

Household survey data show that the decline in cigarette consumption evident in many provinces since 1995 has not resulted in any increase in consumption of food and other agricultural commodities. For instance, according to the 1999 China Rural Household Survey, national average cigarette consumption per rural household member declined by more than 20 percent, from 30 packs in 1995 to 23.6 packs in 1998 (Table 3.3). Since the average price of cigarettes changed little between 1995 and 1998 the decline in cigarette consumption coupled with increased incomes would enable households to purchase greater quantities of other goods. However, there were only small increases in household expenditures on food items. In fact, household expenditures in 1998 for cereal and for non-cereal item were about 8 percent and 4 percent less than the previous year, respectively. The most significant increases in household expenditures were seen in transport, communication, education and entertainment, as well as in housing.

Table 3.3: Per capita living expenditure in rural households, 1980-98

In the 1960s and 1970s, cigarettes were rationed, but the government has had no direct control over cigarette consumption since 1980. Smokers no longer need government-issued coupons to buy cigarettes from retailers. The abandoning of cigarette rationing in the late 1970s was largely responsible for the initial spike of cigarette consumption in the early 1980s. However, there are other ways by which the government influences consumption of cigarettes. Under the Tobacco Monopoly Law, any enterprise or individual engaging in the retail sale of tobacco products must obtain a tobacco retail licence from the Tobacco Monopoly Administration. The government also sets the prices of cigarettes. Under the law, the Tobacco Monopoly Administration, together with the State Price Administration, sets prices for certain selected brands of cigarettes. Prices of other brands of cigarettes are set by the Tobacco Monopoly Administration or its provincial administrative agencies, with reference of the prices set for selected brands. Prices of these cigarettes are determined by the Tobacco Monopoly Administration without direct involvement of the State Price Administration.

The state monopoly in cigarette manufacturing has an important impact on the demand for tobacco leaf. There are about 150 state-run cigarette manufactures in China. Under the monopoly law, production of cigarettes in all manufactories was controlled directly by the State Planning Committee and the Tobacco Monopoly Administration through an annual production plan for each factory, which not only set the total output target, but also the quotas for different grades and brands of cigarettes. Once the total output target was set, demand for tobacco leaf was also set.

Technology changes in the cigarette manufacturing processes have also had significant impacts on demand for tobacco leaf. The adoption of modern cigarette manufacturing equipment and the introduction of new processing technologies and materials, such as tobacco-inflating and tobacco-reconstitution processes, have contributed greatly to reducing the volume of leaf needed in cigarette manufacturing (Table 3.4). According to the State Tobacco Monopoly Administration, the quantity of tobacco required to produce one cigarette now is about only two-thirds of that required fifteen years ago. In 1985, 41.26 tonnes of tobacco was used to produce one million packs of cigarettes. In 1998, one million packs of cigarettes required only 27.8 tonnes of tobacco. While the quantity of tobacco leaf used was essentially unchanged between 1985 and 1998, cigarette output increased by nearly 50 percent.

Table 3.4: Technical change and tobacco use

3.5 TRADE IN TOBACCO AND CIGARETTES

China’s production and consumption of tobacco are huge, while trade has been of limited importance during the past few decades. During the 1980s, total exports of tobacco were around 30 000 tonne/year, accounting for less than 2 percent of total output. However, exports increased during the 1990s, and in 1998 they exceeded 100 000 tonnes, or more than 4 percent of total output. Exports of cigarettes exhibited a similar pattern. In 1980, about 300 000 packs of cigarettes were exported, but this trade had reached 1.14 billion packs - 1.3 percent of total cigarette production - in 1998. Imports of cigarettes have fluctuated over the past decades. The highest imports were recorded in 1996, about 8 billion packs, while in 1998 they were only 0.17 billion packs, which was roughly the same level as the early 1980s.

Market developments have little impact on trade because exports and imports of both tobacco and cigarettes are managed by the government. Under the law, the State Tobacco Monopoly Administration is the sole agency allowed to trade in tobacco. A special agency under the State Tobacco Monopoly runs all imports and exports of tobacco leaf and cigarettes. No individuals, state or private enterprises are allowed to engage in trade in tobacco leaf and cigarettes. Moreover, state permits are needed for all imports. In addition to tobacco products, trade in all tobacco manufacturing equipment and materials used in cigarette production are managed by the government. Foreign investment in the tobacco industries is also under state control. Any foreign enterprises wishing to engage in manufacture of either cigarettes or tobacco and cigarette processing equipment must obtain a licence from the State Monopoly Administration. Currently, there are no foreign enterprises engaged in cigarette production in China, although several joint ventures have been established for production of auxiliary materials for cigarettes.

In addition to the import licence requirement, all imports of tobacco leaf and cigarettes are subject to tariffs. The permitted tariffs were 65 percent, but the actual tariff applied was 36 percent in 1999. In its commitments for WTO accession, China agreed to cut its average tariffs over all imports to 17 percent from 22 percent, allow foreign investment in its telecommunications industry, and open up its markets in other ways to foreign banks, food products, insurance companies and the entertainment industry. There was no specific commitment to the tobacco industry. It was reported, however, that a multi-national tobacco manufacturer was in discussion with the government regarding the establishment of a cigarette factory in China. If tariffs applied to tobacco and cigarette imports were to be reduced by the average reduction applying to all imports, i.e. by 24 percent, the price of popular foreign cigarettes sold in China might fall from about RMB 14 per pack to RMB 13 per pack, which is unlikely to induce any significant increase in demand for imported cigarettes. In terms of flavour and taste, imported cigarettes differ from those to which Chinese smokers are accustomed, and the price would still be higher than popular local brands.

3.6 ECONOMIC SIGNIFICANCE OF TOBACCO AND CIGARETTE PRODUCTION

3.6.1 Tobacco production and rural employment

Tobacco is a labour intensive crop in China. According to the 1997 national production and cost survey, total labour use in tobacco production was 46.2 workdays per Mu (1 Mu = 0.067 ha), which was more than twice that of other, food crops, such as rice and maize. However, tobacco is grown as a monocrop each year, while other crops are double cropped annually. Thus, wheat plus sugar cane (Yuanan and Guizhu are important sugar cane production regions) or oilseed plus cotton (Henan is a major cotton production province) or wheat in winter and rice in summer, require total labour use similar to if not greater than that for monocropped tobacco. For instance, oilseed plus cotton requires 54.3 workdays/Mu, which is higher than that needed for tobacco production. In particular, more labour would be needed if tobacco growers shifted to producing vegetables, which is in general the most labour intensive agricultural activity in China. Thus, substitution of tobacco by other crops would not necessarily result in lower employment in agriculture. This can be seen from the patterns of planting shown in Table 3.5.

The total area planted to tobacco in China dropped from 2.35 million hectares in 1997 to 1.36 million hectares in 1998, a decline of about 42 percent. In Yunnan, Guizhou, Sichuan and Henan, the tobacco areas in 1998 dropped by 43, 54, 35, and 26 percent compared to 1997. However, none of these provinces experienced any decline in total cropping areas. For instance, in Yunnan province, where about 10 percent of total agricultural land was used to produce tobacco leaf in some years, the tobacco area was reduced from 570 000 ha in 1997 to 323 000 ha in 1998. Despite this reduction, the total area used for all agricultural production remained constant at 5.23 million hectares in both 1997 and 1998. Land withdrawn from tobacco production was immediately used for other crops. This reinforces the suggestion that labour withdrawn from tobacco production might not become unemployed, but be transferred other crops.

Tobacco growing households shifted land to different crops in response to the reduction in area planted to tobacco. While the area planted to tobacco dropped by nearly 250 000 ha, Yunnan increased the area under food crops, sugar cane and vegetables, and similarly in Guizhou. While the area of food crops increased in Sichuan, the area under vegetables and oilseed species increased when the area of tobacco contracted. In Henan province, the increase in area under vegetables more than offset the reduced tobacco area. The various responses to the sharp decline in tobacco production indicate that alternative crops to tobacco were available and tobacco growing households made their production decisions based on market opportunities.

The structure of tobacco farming in China allows tobacco farmers to change their production with relatively little difficulty in response to changes in government procurement contracts. Small-scale growers have dominated agricultural production since the introduction of the production responsibility system in 1979. The average farm size in the major tobacco production provinces is about 0.3-0.4 ha, of which only about one third to half is allocated to tobacco production. There are very few specialized tobacco producers: most produce food and other crops for household consumption alongside tobacco production. This means that they also have the skills needed for producing other crops.

Another important feature of the small-scale and diversified tobacco growers in China is that tobacco production is undertaken largely using manual labour. With little fixed capital, the costs of adjustment in a switch between crops is trivial. The diversified production skills of household labour and low costs of adjustment provide households with both technical and economic capability to compensate promptly to any reduction in tobacco production.

The existence of huge numbers of marginal tobacco growers might also contribute to the insignificant impact that sharp changes in production have on rural employment. The expansion in tobacco production over the past decade was largely due to new entrants. It was reported that, at its peak in 1997, there were nearly 20 million rural households engaging in production of tobacco leaf, which was more than double the number in 1985. However, according to the State Tobacco Monopoly Administration, the number of tobacco growing households dropped to around 8 million in 1999 as the tobacco planting area contracted from 2.1 million hectares in 1997 to 1.2 million hectares in 1999. Most of the households that exited tobacco production were newer producers. These producers had less skill than average and the agronomic conditions in the marginal areas were not as good as in the traditional tobacco producing areas.

Table 3.5: Planting area in major tobacco producing provinces, 1997 and 1998

Sources: Provincial Statistical Yearbooks of Yunnan, Guizhou, Sichuan and Henan, 1998 and 1999.

3.6.2 Tobacco production and rural household income

Contrary to the situation in many countries, tobacco appears not to be the most profitable crop in China (Table 3.6). Although tobacco leaf prices reached a peak in 1997, the gross profit of tobacco production measured by per unit area of land was lower than for cotton and sugar cane production. The gross profit of tobacco production was RMB 678.3/Mu in 1997, which was significantly lower than the RMB 804.3/Mu for sugar cane and RMB 791.5/Mu for cotton. Income per workday of labour in producing tobacco (RMB 14.7) was lower than for soybeans (RMB 26.9), sugar cane (RMB 22.0), rice (RMB 21.1) or cotton (RMB 20.4). A major reason for farmers planting tobacco was that there was no market risk. Once they receive a contract from the government, the price is guaranteed. Other agricultural crops carry significant price risks. Moreover, since the State Tobacco Monopoly Administration was profitable, it had no difficulty in paying cash to farmers once the harvest was delivered. Other state agencies, which largely rely on government budget allocations and bank credits, have sometimes had difficulties in making immediate payment.

Income data for the major tobacco producing provinces and counties verify that tobacco production is no more profitable than other crops. For instance, in Yunnan, the total area planted to tobacco dropped by about 46 percent between 1997 and 1998, and output tumbled from 1.1 million tonnes to less than 0.6 million tonnes. At the average price of tobacco leaf, RMB 7.5/kg, the loss of revenue due to less tobacco output in 1998 would have been around RMB 4 billion, nearly 20 percent of total agricultural revenue in 1997. However, a comparison of provincial agricultural revenues and average household income showed a slight increase in total agricultural revenue in 1998, suggesting that the sharp decline in revenue from tobacco production was more than offset by the increase in revenue from production of other crops.

Tobacco growers in some regions, such as those with poor agronomic conditions and without irrigation, could face significant income risk if they had to reduce their tobacco production. Those growers who reside near urban areas would face less income risk because tobacco income accounts for a much smaller proportion of total household income and off-farm employment would offer alternative income opportunities.

Table 3.6: Production cost, profit and labour productivity for major agricultural crops, 1997

Note: 1 Mu = 0.067 ha
Source: Rural Statistical Yearbook of China, 1999.

3.6.3 Government revenue

The Chinese government operates tobacco businesses, and thus profits as well as taxes contribute to government revenue, providing 10 percent of total central government revenue in 1998. About 40 percent of the total revenue was spent on agricultural investment, education, health care, social welfare and defence.

At the regional level, particularly in the tobacco-dependent provinces such as Yunnan and Guizhou, tobacco production and cigarette manufacture have played much more important roles in government finances and provincial development. In particular, many local governments rely on the Special Agricultural Crop Tax for their revenue. Since this tax is based solely on revenue from tobacco leaf, a decline in tobacco production would result in lower tax revenue.

Cigarette manufacturing is a key generator of revenue for local governments. For instance, the 1 429 state-owned enterprises in Yunnan had total sales of about RMB 69.1 billion in 1998, while 8 cigarette manufacturing plants accounted for about 53 percent of total provincial industry sales, at RMB 36.2 billion. Cigarette manufacturing was the single largest sector in the province, ahead of chemical manufacturing, which had revenue of only RMB 5.1 billion. Cigarette manufacturers are among the few profitable state-owned industries, having paid provincial government corporate profit tax at the rate of 38 percent. From the total provincial government revenue of RMB 16.8 billion, various tax revenues from tobacco production and cigarette manufacturing accounted for nearly 70 percent. About 45 percent of total revenue was used for provincial rural development, education, social welfare and industry development. Guizhou was similar, with cigarette manufacturing accounting for more then 30 percent of provincial government revenue.

As a key industry in several provinces, cigarette manufacturers have played significant roles in local community development, such as the developments of Da Yin Jie Town, one of the towns close to China’s largest cigarette manufacturer, Hongta Group, where, over the past decades, its industrial revenue grew from less than RMB 200 million to more than RMB 2.2 billion, of which about RMB 2 billion was from producing cigarette accessories. The rapid growth in revenue derived from production of cigarette accessories made it one of the richest towns in the province. Raising taxes on cigarettes, which, in turn, increases the price of cigarettes, would in many countries result in higher government tax revenue and reduce demand for cigarettes. As the Government owns much of the cigarette industry in China and effectively receives profits from the industry as well as receipts of taxes, the relationship between these two would need to be carefully evaluated by a government contemplating increasing taxes.

3.7 CONCLUDING COMMENTS

Cigarette consumption reached a peak in the early 1990s, and it may be that any future growth will, at most, be limited. Slower population growth, increasing awareness of the health hazards of smoking, as well as nationwide reforms in health services, may preclude any significant growth in cigarette consumption in the coming decades. Technical progress in cigarette manufacturing may lead to further relative reduction in the use of tobacco per cigarette produced. It is expected that total tobacco production will fluctuate around 3 million tonnes in the next few years unless there were to be a significant government initiative aimed at reducing smoking.

The structure of both agriculture and the tobacco market are important factors determining the response of growers to changes in demand for tobacco, and the economic consequences of those changes. The results of this study suggest that a gradual reduction in demand for tobacco would have only a small impact on rural employment and household income, as tobacco farms are generally small, diversified and not mechanized. This situation enables tobacco growers easily to shift away from tobacco production to other crops, because household members have the skills required to produce other crops. With labour being the major input, adjustment costs are low.

Any reduction in smoking would be accompanied by diversification of manufacturing from cigarette production to other activities, so the dependence on cigarette production for revenue would decrease over time. However, there may be some justification for some assistance to growers to help them shift away from tobacco production to other crops. The underdeveloped marketing system and infrastructure often discourages farmers from producing other cash crops. Better roads, timely market information, developments in local processing facilities and easy access to transport would all facilitate the adjustment that may be required. With continuing economic growth, the demand for many agricultural products could be expected to increase, so that crops grown in place of tobacco are unlikely to be without a market.

3.8 APPENDIX ON CONSUMPTION STATISTICS

Estimates of cigarette consumption based on national data were very different from the statistics from the urban and rural household survey. According to China Statistical Yearbook 1999, the national average level of cigarettes purchased per capita based on the household survey was only 27.25 packs for urban households in 1998, while Rural Statistical Yearbook of China 1999 reported 23.6 packs for each member in rural households during the same period. Reports from provincial statistics revealed similar information to the household survey results. For instance, in 1997, average per capita cigarette purchases were 30 packs and 26 packs for urban and rural households, respectively, in Sichuan province, which accounts for about 10 percent of the total population. Thus, there exists a big gap in the data for per capita cigarette consumption between the aggregate statistics (66 packs) and the statistics from household survey (less than 26 packs).

Several factors may contribute to this discrepancy between national statistics and household survey statistics.

Trade in cigarettes accounted for a significant portion of cigarette production. In 1998, 1.14 billion packs of cigarettes were exported while about 0.2 billion packs were imported. The net exports accounted for about 1 percent of production. Therefore, the national statistics based on sales of cigarettes may overstate actual cigarette consumption.

At the same time, the household survey might under-report cigarette consumption. Cigarettes have been a very popular gift over the past decades. Households might not report the purchase of cigarettes when used as a gift. Many hotels, restaurants, bars, teahouses, night clubs and entertainment places sell cigarettes. When cigarettes were bought and consumed in these places, they might not be recorded as household purchases. Moreover, as many young members in rural households were working in cities all the year, their purchase of cigarettes might not be recorded in the household survey.

No attempt has been made in this study to make any adjustments to the published statistics of cigarette consumption.