American Journal of Agricultural Economics Advance Access published November 24, 2012 MARKET POWER,MISCONCEPTIONS, AND MODERN AGRICULTURAL MARKETS RICHARD J. SEXTON Although microeconomics textbook writers many other textbook writers: “Thousands of Downloaded from continue to point to agricultural markets as farmers produce wheat, which thousands of examples of competitive markets, in real- buyers purchase to produce flour and other ity probably none are, especially in light of products. As a result, no single farmer and no dramatically increased concentration in food single buyer can significantly affect the price manufacturing (Rogers 2001) and grocery of wheat,” (p. 8). Yet, the U.S. Department of retailing (McCorriston 2002; Reardon et al. Justice (1999) sued to prevent the merger of http://ajae.oxfordjournals.org/ 2003), emphasis on many dimensions of prod- Cargill and Continental Grain Company,alleg- uct quality and differentiation (Saitone and ing that, “Unless the acquisition is enjoined, Sexton 2010), and the rapid increase in vertical many American farmers likely will receive coordination through integration and contracts lower prices for their grain and oilseed crops, (MacDonald and Korb 2011; Goodhue 2011). including corn, soybeans, and wheat.”1 Sales For the basic precept of a competitive mar- from the production of the “thousands” of ket to hold, namely that all buyers and sellers farmers in Canada, the second-largest wheat are price-takers, three conditions must be met: exporting country, were until August 1, 2012, under the control of a single state trader, and at Libraries-Montana State University, Bozeman on March 20, 2013 • Buyers and sellers must be small relative wheat is a highly differentiated product based to the total size of the market, meaning upon protein content and other factors (Wil- there must be many of each; son 1989; Lavoie 2005). Indeed, Lavoie (2005) • The products of all sellers must be homo- showed econometrically that the Canadian geneous in the eyes of buyers; Wheat Board was able to influence the price • Information in the market place must be of Canadian wheat, which directly contradicts perfect, so that all buyers and sellers are the price-taking claim. aware of the prices being charged and the When researchers have pursued imperfect characteristics of the products being sold. competition issues in agricultural markets, the traditional focus has been food manufacturers’ I don’t know of any modern agricultural mar- and on occasion retailers’ market power over ket that meets all three of these conditions. consumers (Connor et al. 1985; Marion 1986). Most don’t meet any of them. For example, The market-power pendulum has, however, consider the classic case of the wheat market swung increasingly to focus upon processors’ offered by Pindyck and Rubinfeld (2009) and and occasionally retailers’ roles as buyers from farmers,as reflected in the competition policies proposed, and to some extent implemented, in the 2002 and 2008 farm bills, and now under Presidential Address. consideration with the impending 2012 farm Richard J. Sexton ([email protected]), Professor and Chair, Department of Agricultural and Resource Economics, University bill. of California,Davis and member,University of California Giannini As a profession we have only begun to under- Foundation ofAgricultural Economics.The author is grateful to Ian Sheldon and seminar attendees at Ohio State University for helpful stand the implications of increasing prod- comments on this paper and to colleagues and graduate students uct differentiation and vertical coordination at UC Davis who contributed to the research which provides the backdrop to the present paper. Presented at the 2012 AAEA annual meeting, Seattle, WA. 1 The merger ultimately was allowed to proceed, but only after Invited addresses are not subjected to the journal’s standard the firms agreed to divest themselves of 10 grain elevators in seven refereeing process. states (MacDonald 1999). Amer. J. Agr. Econ. 1–11; doi: 10.1093/ajae/aas102 © The Author (2012). Published by Oxford University Press on behalf of the Agricultural and Applied Economics Association. All rights reserved. For permissions, please e-mail: [email protected] 2 Amer. J. Agr. Econ. among firms for market performance and concentration is rising over time (Kaufman distribution of benefits among participants. 2000; Rogers 2001). For example, the average A key point of this paper is that we must 4-firm concentration ratio (CR4) in 15 key not focus on concentration alone when think- food-manufacturing industries (comprising ing about departures from perfect competition 41% of total food-processing sales) in 2002 in modern agricultural markets, nor in eval- was 56% compared to 45% in 1982 (U.S. uating their performance. Rather, the trends Government Accountability Office [GAO] towards greater concentration and vertical 2009). Particular concern has been expressed coordination, along with increased emphasis regarding rather dramatic increases in con- on product quality and differentiation, must centration in livestock processing. The leading be considered and evaluated jointly. Although four firms slaughtered 64% of all U.S. hogs Downloaded from such an expanded focus can greatly compli- in 2007, compared with 32% in 1985, while cate efforts at formal modeling, conclusions CR4 for steer and heifer processing rose generated from such analyses are likely to dif- from 41% in 1982 to 84% by 2007 (Johnson fer significantly from those based upon tradi- and Becker 2009).2 Relevant procurement tional market power analyses that have tended markets for farm products, depending upon to ignore product differentiation and vertical the commodity,may be localized in geographic http://ajae.oxfordjournals.org/ coordination. scope due to high costs of transportation, In what follows, the recent evolution of meaning that national concentration ratios agricultural markets in the dimensions of con- may vastly understate the level of buyer centration, product differentiation and qual- concentration in relevant geographic markets ity, and vertical coordination and control for raw agricultural products. is discussed. If these developments render Leading grocery retailers have emerged as the perfect competition model inappropriate, dominant players in the food chain worldwide. what are the consequences of its application? In the United States national CR4 in food I provide some answers based upon work I retailing, only 16.8% in 1992, increased almost at Libraries-Montana State University, Bozeman on March 20, 2013 have conducted with colleagues and graduate continuously, to 35.5% in 2005. However, students over the past several years. How- because consumers are distributed geograph- ever, the core analytical framework for that ically and incur significant transaction costs in research, a flexible, homogeneous-product traveling to and from stores, relevant retail oligopoly/oligopsony model, may itself be too markets are localized in geographic scope. restrictive to capture essential features of mod- Average grocery retailing CR4 in 2006 for 229 ern agricultural markets. I thus offer some key metropolitan statistical areas based on analysis stylized facts that characterize many of today’s of Nielsen Market Scope data was 79.4%. agricultural markets and arguably will charac- terize even more in the near future. I argue Product Quality and Differentiation that these stylized facts are fundamental to how these markets operate, but they are too often The dimensions of food quality that are valued ignored in economic analyses. Finally, I sketch by consumers have expanded rapidly. In addi- ways in which these features might be incorpo- tion to traditional characteristics such as taste, rated into our analysis, and indicate the likely appearance, convenience, brand appeal, and consequences of doing so. healthfulness, characteristics of the production process (e.g. usage of chemicals, sustainability, location, or confinement conditions of ani- mals), marketing arrangements (in particular, Key Trends in the Structure of U.S. their “fairness”), and implications of produc- Agricultural Markets tion and consumption of the product for the environment also matter increasingly to some I emphasize market conditions in the United consumers. States for the sake of brevity, but the same Empirical studies have demonstrated con- evolutionary forces are impacting markets sumers’ willingness to pay for differenti- worldwide in both developed and developing ated product attributes such as organic, pro- economies. duced with sustainable practices, produced in Concentration The U.S. food industry is highly concentrated 2 CR4 in cattle processing is now higher due to the JBS acquisi- at both the retail and processing stages, and tion of the Smithfield cattle operations in 2009. Richard J. Sexton Market Power, Misconceptions, and Modern Agricultural Markets 3 particular geographic locations, certified safe, downstream trading partner restraining the and marketed under fair-trade practices. behavior of its upstream suppliers in terms An additional critical dimension of product of varieties produced, inputs used, production quality is its consistency. If firms are differen- schedules, handling practices, etc. By control- tiating themselves based on quality attributes ling the use and application of key inputs, of their products, they must ensure a consis- downstream firms address moral hazard issues tent supply of products capable of attaining the that could