This project aims fundamentally at understanding the complex relationships linking smallholder livestock production, policy distortions, market discrimination and environmental externalities in Brazil. The central objective is to test a general hypothesis according to which smallholder livestock production may face difficulties in competing large scale production for reasons not only related to scale economies. Possible competitive disadvantages of small producers may well be associated to policy and market distortions favoring larger producers, to higher costs related to internalizing pollution effects, or yet to higher transaction costs in the input and output markets.
As a point of departure it is intended to gather information to document two characteristics of the Brazilian livestock sector:
i. What is the importance of smallholder livestock production and its growth in Brazil?
ii. To what extent the share of livestock output produced by smallholders is declining?
If that share is indeed declining, possible causes will be sought by looking to assess whether this displacement is due to (a) policy distortions, (b) market discrimination, (c) differences across farms in the capture of environmental externalities, (d) changing product requirements in the marketplace (animal health, food safety, quality, etc.), (e) higher transaction costs facing smallholders in reducing their competitiveness.
Once causes for declining share of smallholder are identified, some institutional innovations will be examined in terms of its potential to keep small-scale farms competitive within market economy framework. The degree to which theses innovations may contribute to poverty alleviation and to sound environment strategies will be assessed.
How important is the livestock in Brazil? According to CEPEA, the livestock sector (farm and industry) is of salient importance in economic terms in Brazil as it represents 8.4% of the country's GDP. The farm sector alone represents 42% of the livestock sector's GDP.
Regarding the livestock performance, it is known that over the last 15 years the average annual growth rate of the poultry sector was 9.3% and that of the swine sector was 7.9%. Most of this performance has been attributed to productivity increases that led to substantial price reductions: 50% for poultry and 38% form swine during the nineties. As a result poultry and swine domestic consumption increased at a yearly rate in excess of 5% at the same that poultry exports grew at about 17% and those of swine at almost 70% per year. Milk production increase was lower, reaching an annual average rate of 3.4%. Prices of milk fell nonetheless 47% in the nineties, but that was due probably to subsidized imports and/or overvalued currency, which impacted negatively the sector, particularly the smallholders.
Are small-scale producers relevant from the production point of view? Small-scale producers play a fundamental role in livestock production in Brazil. Family farms, with less than about 100ha, represent 89% of the Brazil's farms and occupy 20% of the land, and are responsible for 52% of the value of the production (VP) of milk, 58% of swine and 40% of poultry. In fact, family farms are significant producers of most of the agricultural crops as well as, for instance: 49% of VP of corn, 32% of soybeans.
Regarding changes in the size distribution of livestock production the most significant changes has been observed in the milk sector. For instance, according to census data, around 58 thousand milk farmers are reported to have left milk production between 1985 and 1996, probably as a consequence of low prices. Another evidence, suggesting strong scaling-up process, comes from the farm milk supply data to the 12 major dairy industries: only between 1996 and 1998, the number of suppliers fell by 28% and supply by farm increased by 37%.
In the poultry sector, the production size distribution changed as well from 1985 to 1996: in the south the strongest increase took place in the stratum of farms with more than 5000 birds while in the central west region concentration took place in the stratum of more than 10000 birds. For swine, the size distribution is much less concentrated than for poultry, but experienced a concentration in the larger production stratum (more than 201 saws) both in the south and in the central west region, although small-scale farms (less than 50 saws) still hold 41% and 58% shares in the south and in the central region.
How is the livestock production geographically distributed in Brazil? The regional distribution of livestock in Brazil indicates that for poultry around 50% of the inventory is located in the south and 8% in the central west region and these shares tended to increase over the nineties in both regions, that is, the Brazilian production is concentrating in these two regions. As for swine, the south holds a share of 42% that is increasing, while the central west regions has an approximately stable share of 9%.
In many countries most of poultry production is now produced under contract. Smallholder poultry production systems still exist in Brazil but similar to larger scale systems usually through contracts to larger firms. As a matter of fact, it is estimated that close to 95% of poultry production take place under contract in Brazil. For swine, it is estimated that integration reaches between 60% to 80% of the production in the south and about 50% to 60% in central west region.
It has been observed that contractors, both from swine and poultry sectors, have encouraged - providing financial resources - the increase in scale of their suppliers so as to reduce the integrators operations costs associated with delivering inputs, technical assistance, and picking up animals from many smallholders with limited number animals. Apparently producers with better managerial ability, big or small, were preferred in the credit concession process. One possible reason explaining the incentive to both big and small farmers would be the interest of industries to keep a balanced size distribution of animal suppliers, in order to avoid excessive market power in the hands of large scale producers.
Livestock industries in Brazil vary in terms of the degree of concentration. The higher degree of concentration is observed in poultry sector, where the largest four companies are responsible for 64.5% of total production. For swine the share of the four largest companies reaches 30.5 %. In dairy sector, the corresponding share is 17%. However, 52% of the milk production in Brazil takes place in the informal market, so that, considering only the formal market, the share of the four largest dairy companies would be 32%.
Where is small-scale production located? In Brazil small-scale poultry and swine production has historically been located in the south. They still remain there, but larger operations are now being built in the central west. It is expected that the small-scale producers market share will decline as these large-scale operations take over more of the market. In Brazil small-scale dairy producers have been scattered throughout Brazil, but in the North, Northeast and South they represent more than 90% of the producers, while in the Southeast and Center West there are less small farmers, but they still represent more than 70%.
With the current changes taking place in the external and internal market environments of the domestic livestock industry, there is no compelling indication that smallholders will retain their traditional foothold in these sectors. In fact many have already disappeared, particularly in the milk sector. Whether part of them has increased their size, or moved to other parts of the industry such as processing is unclear.
For the milk sector, the subsidized imports, the overvalued currency and the adoption of a new expensive assembling system were harmful to small-scale farmers in the nineties. The imports issue was circumvented in 2001 when Brazil adopted imports restricting measures (tariffs and entry prices) and the exchange rate problem was dealt with by the change to a flexible regime in 1999 which resulted in devalued rates. Two factors may play relevant roles as to the future of small-scale dairy farmers. In the short run the changes in raw milk collection system may be the dominant factor: will the small farmers be able to make the necessary investments to adjust to new sanitary and quality requirements? In the short but also long run the exchange rate behavior will be of fundamental importance: will the rate remain at the current devalued level thus inhibiting imports and possibly favoring exports?
Small-scale or family farms (with less than 100 ha) are very important in terms of the contribution to farm output in Brazil. With the exception of rice, sugar cane, orange and soybeans, family farms contributed with 40% or more of the farm production of the 18 major Brazil's crops in 1995/96. This group of farms is also responsible for 81% of swine and poultry productions, and 55% of the milk production. These livestock productions are also the fastest growing farm activities in Brazil.
Interestingly enough, among the agricultural crops, only soybeans and corn productions, used as animal feed, and sugar cane have been growing significantly (above 3% per year) in Brazil. One may conclude that it is the livestock sector that is leading and pulling a major part of farm sector as a whole in Brazil in the last two decades. Summing up it is possible to say that there is an interdependence among small and large scale farms: although larger farms hold larger shares of grain production, they depend on a significant extent on smaller livestock farms (and/or of course on external markets) to sustain the demand their crop production.
Family farms are also important because they produce the bulk of food in Brazil, a country in which 32% of the population yet lacks income enough to eat properly. Food security in fact has been classified as high priority by the public administrations in the nineties. Recognizing the overall importance of family farms, agricultural policy has changed to less credit and price support to commercial farms and more credit programs directed to small-scale producers. The extent to which small farms have had enough access to these programs is not well established yet. Simultaneously relatively substantial resources have been allocated to agrarian reform. Very recently EMBRAPA indicated the intention to direct a special focus to technological needs specific to family farms.
The excellent productive performance of the livestock sector in the last two decades has been associated with increasing concerns related to possible environmental impacts of this unparalleled growth. Increasingly, the national environmental laws and regulations, initially directed at industrial production activities, are now being aimed at agricultural activities as well, particularly on livestock production. Waste pollution for regions of the state of Santa Catarina is emblematic. It is a matter of concern as well the impact of better enforcement of environmental regulation particularly on smallholders: will smallholder producers be able to reasonably comply with the set effluent standards for permits and will they withstand the additional cost of investing in waste treatment facilities, as well as the pollution charges that would be meted out for exceeding critical levels of livestock waste effluents? The enforcement of environmental regulations has implications for the survival of smallholder livestock producers.
Smallholders, or family farms, are important and numerous in Brazil. More than 4.3 million farms - employing 13.8 million workers - are classified within this category. If they are not competitive, their continuous displacement of the market will have huge social and economic impacts. Prices of all livestock products, for example, experienced severe declines over the nineties as productivity increased and, in the case of dairy, as economy was open to low-priced imports under overvalued exchange rates. The strong competition among concentrated supermarket chains also explains the observed trend on prices. During this period of time, farmers were forced to continuously cut costs to remain in the market since as price takers, both large and small farms - competing in the same market - had to strive to cover at least the variable costs in the short run. It is possible that small-scale farms have been harmed the most.
When analyzing farms of different size care must be taken of several intervening factors. First there is the question of whether or not livestock production is subject to technical scale economies. If technology is such that smaller firms operate with lower average costs, then disadvantaged smallholders will sooner or later leave the market, which will be dominated by a few large firms.
In addition to the economies of scale issue, that may be present or not, other factors must be considered. Such issues as environmental effects and regulations and policies that may affect small and large-scale farms differently should be examined. Since the creation of negative externalities gives an edge to some producers, the investigation of 'economies of scale' requires seeing whether large-scale producers capture the benefit of negative externalities on a higher basis per unit of output than small-scale producers. The capacity of some farms to still remain competitive under the conditions of mitigating environmental externalities must depend on how efficiently various producers are able to capture these associated environmental costs. It may differ among farms according to the commodity in question or scale of operations. It may matter whether or not there is a market for the by-products that have potential for creating environmental externalities. It remains a question, too, on whether or not the explicit capturing of environmental costs would result in differences in profits.
Changes in product attributes required by the market or by government regulations (food safety, product consistency and reliability of supply, animal welfare etc.) may be harder for smallholder farmers to meet. There may be qualitative differences in output, where premiums and discounts are exercised, either by the perceived reputation of the seller of the output, or by simple visual inspection or yet by scientifically determined characteristics of the livestock sold.
Another possible reason for the displacement of smallholders may be related to market price discrimination or alternatively to effective transactions costs advantages of large-scale producers. Price discrimination is said to occur if and when price differences are not related to costs differences. In other words, if transaction costs favors the large-scale producers, then the evidence of lower price being paid to small farmers are not necessarily a result of price discrimination. Then transaction costs differences - and not price discrimination -may be the relevant force in excluding the asset-poor and information-poor. The challenge is to be able to show to what extent they may explain the price differences. For instance, it has been observed price differentials among products of large and small-scale producers. This has been verified for dairy, but may be true for other livestock products too. Farm gate prices for products may not be uniform for all farms and differences may be related to several factors. The distance of the farm to the market and whether product is pick-up by buyer or delivered by the farmer are relevant when analyzing price differentials. Possibly, too, there are economies of scale in the assembly of products by buyers (traders) of livestock.
In the dairy sector the lack of financial resources to comply with bulk collection system, including refrigeration procedures, may result in lower prices paid to smallholders or force them out of the formal market. The establishment of the above allows the identification of entry-points for reducing policy distortions and facilitating the development of market organizations for smallholder livestock producers. Subsequently, directions can be mapped on how the specific transaction costs can be reduced by public policy, with possibly societal welfare improvement results. For instance, the government has taken steps to finance the investments that are needed for small dairy producers to participate in the new milk assembly systems. It is unknown, however, whether the full amount of necessary funds were provided. Small dairy farmers have been stimulated to organize themselves as a consortium to facilitate credit access and share the costs of new equipments. The joint management of the consortium activities has been a rather difficult task.
Vertical coordination has shown to affect significantly cost structures of farms. To the other stakeholders in the market (independent producers), the large integrators in the broiler industry may have been a formidable force to contend with. As a result today more than 90% of the poultry production is integrated. In the swine sector independent and integrated systems live together, but it is not clear to what extent this is stable situation. It remains to be determined whether integrated system is more efficient than the independent one and the size of that advantage. Is vertical integration more advantageous to large farms? If vertical integration works better for large firms, presumably resulting in the bigger reduction of transaction costs associated with unreliability of supply and product quality, can the organization be adjusted so that it accommodates the production activities of smallholders? In other words, should we expect displacement of smallholders either under the integrated system or the independent one? Is integration an arrangement viable for the survival of smallholders?
Another perhaps more relevant hypothesis regarding vertical coordination is related to its possible impact upon the financial stability of the sector. According to it farmers joining an integrated system would be assured a reasonably stable average return over the market cycles. This is particularly important if we consider the frequently wide production and price variations specially in the market for grains, by far the major components of livestock costs. For instance, between February/2002 and February/2003, domestic corn prices increased by 85%, soybean prices by 74%, swine prices by 11%, milk and poultry prices by 45%. Independent farmers - like swine producers - are subject to such oscillations leading to extremely variable economic results. In markets like those the association with large, financially solid companies may a sound strategy from a risk management point of view.
The research will focus on several issues relating scale economies, environmental impacts on profits, transactions costs related to size and vertical integration. A list of such specific issues follows:
1) Is there a systematic difference in the profit per unit output between large farms and small farms?
2) Is feed conversion ratios different for large and small farmers?
3) Is there a difference between integrated and independent and cooperative firms as far as unit profits are concerned?
4) Is there a difference between integrated and independent and cooperative firms as far as conversion ratios are concerned?
5) Do large farms systematically receive higher prices for output than small farms?
6) Do large farms systematically pay lower input prices? For what inputs this can detected?
7) Are there output prices differences within the between integrated system between large and small farmers?
8) Are there input prices differences within the integrated system between large and small farmers? For what inputs this can be detested?
9) Are large farmers better educated than the small ones?
10) Does education leads to higher profits?
11) Are integrated farmers better educated than the independent ones?
12) Are poultry farmers better educated than the swine and milk ones?
13) Do some farms have higher expenditures per unit of output than others on environmental mitigation costs?
14) If so, is this correlated with scale, density of animals, location (proximity to residential centers; to centers of economic activity), or certain regions (types of soils)?
15) Are sales of manure and other non meat/dairy products associated with livestock production a significant part of the farmers' profit?
In view of the research issues listed above, the following hypotheses were formulated to be tested with data collected through a field survey:
1) Unit profit is higher for large-scale producers.
2) Feed conversion ratios are higher for large-scale farmers.
3) Unit profits are higher for integrated farms than for independent or cooperative farms.
4) The conversion ratios are higher for integrated farms.
5) Large farmers receive higher prices for output than small farms.
6) Large farmers pay lower prices of input.
7) Larger farmers received higher output prices in integrated system.
8) Larger farmers pay lower input prices within the integrated systems.
9) Large are farmers better educated/ trained than the small ones.
10) Higher education leads to higher profits.
11) Integrated farmers are better educated/ trained than the independent ones.
12) Poultry farmers better educated/ trained than the swine and milk ones
13) Small farms, other things equal, have higher expenditures per unit of output on environmental mitigation costs.
14) Farms with higher density of animals have higher expenditures per unit of output on environmental mitigation costs.
15) Farms located near to residential centers or to centers of economic activity have expenditures per unit of output on environmental mitigation costs.
16) Farms located in the central west region have lower expenditures per unit of output on environmental mitigation costs.
17) Sales of manure and other non meat/dairy products represent a significant part of the small farmers' profit.