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A review by the Federal Reserve Bank of Chicago Business Conditions What's happening to meat prices? 11 Federal Reserve Bank of Chicago Restrictions on world trade Worldwide concern about the state of the international economy, including restric tions on international trade, has intensified since August 15, 1971, when the President announced that the United States would no longer redeem foreign dollar claims in gold, and imposed an import surtax affecting over 50 percent of U. S. imports. Other events of major importance for the interna tional economy that occurred in 1971 included the completion of negotiations ex panding the European Economic Communi ty (EEC) from six to ten members as of January 1, 1973 (if candidate countries rati fy the treaty), and U. S.-sponsored volun tary import quotas on textiles—and at tempts to negotiate import quotas on steel —with major foreign producers. As a finale to the year, the final set of tariff reductions agreed upon in 1967 during the Kennedy Round of tariff negotiations became ef fective on January 1, 1972. Still, the focus of attention during 1971 for foreign trade experts increasingly cen tered on the distortions existing in the fi nancial and trade markets of the world. That U. S. producers felt intensified compe tition from foreign producers is seen in the deterioration of the U. S. merchandise trade balance—a $4.7 billion decline from the 1970 level to a deficit of $2.0 billion (census basis), the first U. S. trade deficit in the twentieth century. Disequilibrium in financial markets contributed to a record balance-of-payments deficit of $29.6 billion (on an official reserve basis). As these dol lars streamed into Europe and Japan, pres sures on governments to “do something” finally culminated in December with a com bination package of foreign currency re valuations, a dollar devaluation, and an agreement by the United States and its ma jor trading partners to at least discuss re ductions in nontariff distortions to trade. The importance of multinational nego tiations on nontariff trade distortions have long been stressed by the United States. Nontariff distortions in trade have been influential in reducing U. S. competitive ness in world markets. The December cur rency realignment and the trade agreements reached in early February 1972, while not a replacement for full-scale negotiations, do constitute a “foot-in-the-door” that hope fully will be followed by agreement for broader negotiations under the sponsorship of the General Agreement on Tariffs and Trade (GATT). In the February agreements, the European Economic Community and Japan indicated they would support multi national negotiations to begin in 1973. In addition, the EEC and Japan made several concessions on imports of U. S. agricultural products, and Japan reduced several indus trial import restrictions, including those on computers and automobiles. Since W o rld W a r II When World War II ended, much of the world economy lay in ruins. Government officials in the free world understood that the success of the rebuilding job would de pend in large part on international trade, and that the job would be difficult, if not impossible, under the extremely restrictive trade policies of the prewar period. In an Business Conditions, February 1972 attempt to formulate Average tariff levels before (1967) new rules for internaand after (January 1, 1972) tional trade, the InterKennedy Round—selected categories national Trade O r EEC Japan U. K. U. S. ganization (ITO) was 1967 1972 1967 1972 1967 1972 1967 1972 proposed under the (P e rc e n ta g e o f C .I .F . v a lu e ) auspices of the United Electrical machinery 14.2 9.1 17.8 10.8 20.1 12.4 13.6 7.1 Nations. The attempt Nonelectrical machinery 11.9 15.6 10.0 14.2 11.1 6.4 6.0 8.6 failed. But in 1947, Transportation equipment 9.9 18.4 13.9 20.0 11.0 15.4 7.1 3.5 and springing directly Base metals & metal out of the previous products 11.0 7.1 12.8 9.9 6.3 9.0 7.0 8.5 endeavor, came the Stone, ceramic, & glass 16.9 16.4 10.3 products 14.1 21.0 15.0 9.5 8.0 G eneral Agreement 20.6 16.9 Textiles 21.4 20.1 23.5 13.6 16.0 12.6 on Tariffs and Trade 6.4 6.7 Pulp and paper 10.7 7.5 10.9 5.5 16.6 13.2 (GATT).1 Over the 12.0 6.2 9.3 4.8 Mineral products 9.4 5.5 9.9 7.5 years, GATT guide Manufactured imports 14.3 9.9 17.6 10.7 17.8 10.8 13.5 8.6 lines have provided a Industrial imports 12.8 8.1 13.5 9.6 15.5 9.5 16.6 10.6 yardstick nations use SOURCE: Preeg, Ernest H., Traders and Diplomats, The Brookings Institution, to gauge their own ac Washington, D. C., 1970. tions and those of others in matters of progress toward their further reduction will international trade relationships. Unfortu be painfully slow. And all has not been nately, the agreement has often been abused progress, for while some artificial trade dis when nations felt vital short-term interests tortions have been eliminated in recent were at stake. But GATT does supply a years, there have been new ones added. platform for continuing trade negotiations Whether the net effect has been toward and, in fact, has been a major force in promoting reductions in tariff barriers. fewer restrictions is not always clear. Major world governments have intensified T ariff b a rrie rs to tra d e their conscious examination of the artificial impediments distorting international trade, A tariff often protects domestically-pro and the result is a concerted effort to re duced products from the competition of im duce, rather than increase, these distortions. ports by raising the price of the import While much has been accomplished over relative to its nontariff price. While a tariff the years in reducing nontariff distortions, may be an impediment to trade in that it and while progress has been made in identi interfers with the allocation of resources among nations, it does retain price as the fying distortions that remain, it is obvious allocating factor determining supply and de that the distortions are legion and that* mand. The quantity imported is not directly JGATT is adhered to by the United States and affected—rather, because the price of the other countries under a “protocol of provisional application.” Basically, the General Agreement on import is higher due to the tax, fewer goods Tariffs and Trade sets down rules of conduct in are imported. international trade and specifies maximum levels for individual tariff rates. Under GATT auspices, the “ Dillon 3 Federal Reserve Bank of Chicago 4 Round” of tariff negotiations in 1960, fol lowed by the more extensive “Kennedy Round” (extending from May 1964 to June 1967) resulted in significant reductions in tariffs on nonagricultural goods for the ma jor trading nations of the noncommunist world. With the final tariff reductions, which went into effect January 1, 1972, it is estimated that U. S. tariffs are 36 per cent lower, that common external tariffs of the EEC are 37 percent lower, and tariffs of both Japan and the United Kingdom are 39 percent lower than they were prior to the first reduction in 1968. Average tariff rates for all industrial imports subject to duties have been estimated at 8.1 percent for the EEC, 9.5 percent for Japan, 9.6 percent for the United States, and 10.6 per cent for the United Kingdom. (See table.) Averages can be misleading in determin ing the degree of protection afforded by what might appear to be a relatively high or a relatively low average tariff. A very high rate, that is to say a rate high enough to effectively prohibit the importation of a product, will not show up in the averages because nothing is imported to which the prohibitive rate applies. Nevertheless, there has been a lowering in tariff levels, as well as a narrowing in the difference between average tariff rates of major trading coun tries. Not only did average tariff levels de cline, but the decline was proportionately greater for high-tariff countries. In terms of average tariff levels, the differences among countries are quite small. This does not mean, however, that the small differential carries over to specific products or cate gories of products. For example, the aver age tariff level for transportation equipment entering Japan is 13.9 percent, while the comparable level imposed on U. S. imports is 3.5 percent. The average level for U. S. imports of textiles is 20.1 percent, while the comparable average level for EEC textile imports is 12.6 percent. Tariff rates for spe cific items will show far wider variations than indicated by the averages. Nominal tariff rates are easy enough to identify. They are published in a nation’s tariff schedule. It would be too simple, how ever, to say that a 20 percent tariff on im ported shirts means the same thing in two different countries. The tariff might be ap plied to the value of the shirt at the port of export, or the value at the port of import (including shipping costs), or on the price of a comparable domestically-produced shirt. Each of these methods of valuation results in a different effective tariff on the import, and consequently different levels of protection for domestically-produced goods. Differences among nations in their product valuation procedures remain a point of fric tion in trade liberalization negotiations. It is worth noting that in a case like this it is the procedure itself that constitutes the trade distortion. The U. S. Government generally applies its tariff schedule rates to the free on board (F.O.B.) price of imports at the foreign port. European countries, Japan, and other major trading countries (excepting Canada) apply their tariff schedule rates to the cost of imports, including insurance and freight (C.I.F.), at their port of entry. A politically serious valuation contro versy centers on the American Selling Price (ASP) valuation, used in connection with benzenoid chemicals, certain rubber-soled footwear, and canned clams. Under this procedure, the import tariff is based on the higher price of comparable domesticallyproduced products rather than the price of the imported product. The ASP has long been a rallying point Business Conditions, February 1972 for European countries in discussions of re ducing trade restriction. The ASP is espe cially irritating to foreigners because it is a vestigal remains of an arbitrary valuation system generally outlawed by GATT in 1947. The U. S. Government, in Kennedy Round negotiations in 1967, agreed to its elimination subject to legislative approval as part of a separate package on tariff and nontariff distortion concessions. Although ASP was initiated in 1922 to protect the then newly-developing chemical industry, the Congress, so far, has not determined to terminate it. N o n ta riff b a rrie rs to tra d e legislated nontariff barriers represent the hard core of the problem—barriers such as the negotiated “voluntary” export quotas compound the problem. A major impeding factor is that many nontariff barriers are not specifically related to trade, or any other single area. Broad-scale enabling legislation authoriz ing concessions is difficult to draft because it would have to specify the limits and con ditions of concessions permissible on con ceivably everything from health and safety standards, to patent requirements, to quota restrictions. Groups with vested interests in such things could not be expected to stand idle while the barricades are dismantled for the sake of freer foreign trade. The valuation controversy surrounding imports, while tied to tariffs, moves one C a ta lo g of n o n tariff b a rrie rs to trad e into the realm of nontariff barriers to trade. It is within the area of nontariff barriers Import quotas that the most serious, present day disloca tions occur. Since the conclusion of the Import quotas, one of the most obvious Kennedy Round, the U. S. Government nontariff barriers to trade, are a tool fa has repeatedly proposed consideration of a vored by governments desiring to protect possible new round of GATT-sponsored selected domestic industries from the com trade negotiations to deal with nontariff petition of imports, or desiring to regulate barriers and their undesirable consequences. the amount of expenditures on certain prod GATT is developing a detailed inventory of ucts in their domestic market. An example existing nontariff barriers to trade, a neces of the latter is the tendency prevalent sary basis for negotia tion when formal dis cussions eventually Quantitative restrictions on imports take place. Value of imports subject to Even if negotiations Proportion of imports subject quantitative restrictions to quantitative restrictions aimed toward the re Industrial Agricultural Industrial Agricultural duction of nontariff (b illio n d o lla r s ) (p e rc e n t) barriers were to begin EEC 0.9 2.6 4.3 33.7 tomorrow, the pros United Kingdom 0.7 1.1 4.7 21.9 pect for any signifi Japan 1.4 0.8 11.4 27.9 can t re d u c tio n in United States 5.1 1.2 16.5 21.6 their magnitude or Compiled from: John C. Renner, "National Restrictions on International Trade," in number lies well in United States International Economic Policy in a Interdependent World, Commission the future. Existing on International Trade and Investment, Vol, 1. July 1971, Washington, D. C. Federal Reserve Bank of Chicago among the less developed countries to im pose tight import quotas on luxury goods. Quantitative restrictions imposed by in dustrial countries most often are applied to agricultural products, plus a few categories of industrial goods. In 1970, quantitative restrictions were applied to about 22 per cent of the value of U. S. and U. K. agri cultural imports. Comparable percentages for Japan and the European Economic Community were 28 and 34 percent, re spectively. (See table.) The EEC’s high degree of quantitative restriction on the value of agricultural imports is reflected in the fact that nearly 60 percent of their ma jor agricultural import categories are cov ered, at least in part, by quantitative restric tions. The United States, on the other hand, imposes import quotas on only 7 per cent of its agricultural import categories. The United Kingdom employs quantita tive restrictions relatively sparingly as com pared with the numbers used by the EEC, Japan, and the United States. Import licenses 6 Import licensing is a highly flexible form of restriction commonly used by Japan, by European countries, and by the less devel oped countries. Import licenses constitute a potentially serious deterrent to trade be cause of the low degree of visibility associ ated with licensing arrangements in most countries, and because of the uncertainty surrounding the issuing of licenses. A prime example of how licenses can rigidly control imports is the U. K.’s requirement that coal and solid fuels be imported under license. But the licensing authority does not issue licenses for coal, thereby barring all imports of coal. This fact causes considerable frus tration in the U. S. coal industry which would be competitive, pricewise, if per mitted entry into the U. K. market. Export subsidies Export subsidies are commonly used in international trade to expand exports, to gain a market advantage, or to dispose of excess production in a foreign market so as not to cause a disruption in prices in the home market. Subsidized exports tend to disrupt the markets to which the products are shipped, as well as the markets of thirdcountry competitors. Countries of the EEC are among the most prominent users of ex port subsidies. Direct export subsidies for the EEC’s agricultural exports are a particular sore point with the United States. The Common Agricultural Policy (CAP) of the EEC sup ports high internal prices for many grains, and for dairy and poultry products. These high domestic prices are buffered from the competition of lower world prices by a tariff called a variable levy which raises the prices of specific imported commodities to the level of the supported domestic prices. In this way, imports are effectively restricted; furthermore, high domestic prices encour age expanded domestic production. When this situation leads to surplus production, the surplus is placed on the world market at subsidized prices, thereby cutting into the third-country markets of other leading ag ricultural exporters. The United States has countered EEC subsidies in some instances by instituting export subsidies of its own. Another case of export subsidies, one be coming increasingly prevalent, is where a government actively subsidizes the financing of exports. The willingness and ability of a government to grant tax deferrals on goods exported, as in the case of the new U. S. Domestic International Sales Corpo ration Program (DISC), to provide loan Business Conditions, February 1972 guarantees, and to provide funds directly to exporters at low interest rates, oftentimes are key factors in whether an export sale will be made. The Japanese government, for example, is especially aggressive in promot ing low-cost financing for exports. In 1971, the Export-Import Bank of the United States received authority to participate more actively in export financing. Dumping When products are exported to a foreign market and sold at a price that is lower than that on the domestic market, it is called “dumping”—economists call this practice price discrimination. This practice may be a disrupter of markets and if it leads to injury is not sanctioned by GATT. As a defense against dumping, injured countries are permitted by GATT to impose offset ting import taxes called antidumping duties to negate the price advantage the foreign producer obtains by pricing abroad at less than in the home market. Domestic component requirements Minimum domestic component require ments are a form of nontariff barrier often used by less developed countries, as well as by some developed countries, in the attempt to nurture their infant industries. These re quirements typically stipulate that a certain proportion of the value of the final product must be composed of components that origi nate in the importing country. Countries attempting to develop an automotive in dustry, for example, often require that key subassemblies be manufactured internally, or that a minimum proportion of foreign cars sold internally be assembled domesti cally. These regulations have the effect of forcing foreign car producers to assist in the industrial development of the country if they wish to sell cars in that market. A more subtle form of the domestic com ponent requirement is tied to tariff sched ules. Developed as well as developing coun tries regularly apply higher tariff rates to manufactured or processed forms of pri mary products than to the primary product itself. There is a higher tariff on refined sugar and ground coffee than on raw sugar and coffee beans. Thus, imports incorporat ing foreign processing are discouraged to a greater extent than are raw products. The less developed countries find the imposi tion of this trade barrier by the industrial countries especially galling because it re tards their industrial development by in hibiting their ability to compete in foreign markets with higher-value processed goods. Financial controls Some of the least visible nontariff trade restrictions are those involving financial and currency controls. The characteristic that makes this type of control of unusual significance is that currency restrictions on international commercial transactions— such as foreign exchange rates, monetary flows, interest rates on government obliga tions, and a nation’s balance-of-payments position—are tied in with governmental image-making and national prestige. Were the roots of prestige not so deep, nontariff barriers involving financial and currency controls would be among the easiest of all barriers to overcome. Arbitrary controls over foreign exchange introduce widespread uncertainty in inter national commercial transactions. Typically, exchange controls are used by governments to attack the symptoms rather than the politically difficult causes of an undesirable balance-of-payments situation. The onagain, off-again international monetary Federal Reserve Bank of Chicago turmoil of recent years has caused coun tries to establish exchange controls to pro tect their currencies against speculation, hindering trade in the process. The mone tary realignment agreed upon in December 1971 has permitted elimination of many of the exchange control barriers that were in the process of being erected. While it is true that exchange controls can be implemented in such a way as to be an effective deterrent to speculative capital flows and no more than a nuisance to trade, they also can be applied in a manner that makes trade a very expensive proposition. A common example is regulations requir ing that a currency deposit cover all or part of the value of an import shipment. "Buy-at-home" policies Among the most conspicuous nontariff barriers to trade are “buy-at-home” policies. The United States is probably the most ob vious practitioner of this form of restric tion in that she is open and above board about it. For years, the “Buy American” Act has imposed, in addition to the tariff, a special restraint on federal procurement of foreign goods. A recent example of this practice of promoting domestic goods over foreign goods is a section in the U. S. Reve nue Act of 1971 which provides for the ex clusion of foreign-made investment goods from the investment tax credit allowed on similar U. S.-made goods. The provision was so odious to our major trading partners that the United States agreed that it would not be implemented as a condition of the international monetary accord reached in December 1971. Western European countries typically do not employ “buy-at-home” laws per se. They do, however, follow the practice of “closed bidding.” Closed bidding, poten tially more restrictive than buy-domestic policies, effectively bars foreign firms from even submitting bids. Thus, whether the price is competitive with that of domestic producers makes little difference. Closed bidding is particularly prevalent in the realm of government procurement. A related practice, based on the buydomestic concept, is that of requiring that a minimum proportion of funds provided for foreign aid be used to purchase goods and services from the donor country. “TiedAid” may reduce the real value of aid to a country by forcing it, if it accepts the aid, to buy at a higher cost than necessary. Nontariff barriers like these are difficult to dismantle because they are usually ad ministratively and arbitrarily imposed. Of ten legal statutes do not identify their ex istence and, therefore, cannot be repealed. Administrative convention would have to be changed either by general agreement or by legal imposition of an “open tender” requirement. Health and safety restrictions Nontariff barriers related to health and safety include a broad and growing group ing of regulations, some of which promote the general well-being of the population while incidentally restricting trade, and some of which promise to serve the general well-being of the population but actually do little more than restrict trade. To a greater or lesser degree, such regulations are neces sary, but they do make international trade more expensive than it would otherwise be. When an importing country requires safety tests on a product that has been adequately tested in the exporting country, it amounts to one more barrier to hurdle. If destructive testing is required, the direct cost of the import is consequently increased. Business Conditions, February 1972 Measurement standards In the near future, measurement stan dards will become a problem peculiar to the United States. The Canadian government is committed to adopting the metric system of weights and measures, and the British gov ernment is in the process of converting. Once these nations go metric, the United States will be the only major trading nation still using a nonmetric system. In 1971, the National Bureau of Standards published a report recommending that the United States convert to the metric system. U. S. trade now lost due to nonmetric measures is due largely to higher product costs primarily because of higher development costs associ ated with using the nonmetric system. P re fe re n tia l trad in g arran g em en ts Preferential trading arrangements, dis couraged by the international community until recent years, represent a method of distorting trade flows that cuts across tariff and nontariff barriers alike. One of the most rapidly growing forms of trade distor tions, they involve a major shift away from the Most Favored Nation principle that has been an acceptable practice in international trade since the 1930s. The Most Favored Nation principle holds that a trade conces sion granted to one nation will be granted to all other trading partners. When the European Economic Com munity was formed, a number of African nations associated with individual members of the EEC (usually through former colonial status), but not members of the EEC, were granted special access to the markets of all EEC members. Since then, the EEC has also granted some Mediterranean nations preferential trading rights, and late in 1971 the EEC announced plans to extend pref erential arrangements to those members of the European Free Trade Association (EFTA) that did not apply for membership in the EEC (Austria, Finland, Iceland, Por tugal, Sweden, and Switzerland). At no point has the EEC extended similar conces sions to all trading nations, thus putting these actions in direct violation of the Most Favored Nation principle, and putting non participating nations at a disadvantage. The United States also is a party to limit ed preferential trade agreements, such as the Canada-U. S. auto agreement. (See Busi ness Conditions, November 1968). More over, the United States has proposed pref erential agreements with the less developed countries to help further their economic developments. The EEC and Japan already have adopted preferential measures with many of the less developed countries. The increasing prevalence of preferential trade agreements is a major point of con tention between the United States and the EEC. While the U. S. concern is naturally in its own self-interest, there is a basic economic problem in agreements which dis regard the Most Favored Nation principle. An economically undesirable redirection of the world’s resources occurs if selective trade concessions direct trade away from efficient low-cost producing nations—na tions that may not be party to the prefer ential trade agreements—and direct trade toward high-cost producing nations included in such agreements. Sum m ing up Trade-distorting policies of nations result from an intricate combination of political and economic reasoning. They may come out of actions specifically intended to dis criminate against foreign-produced goods in order to protect domestic jobs and in dustry. Or, at the other extreme, they may Federal Reserve Bank of Chicago occur as a secondary effect to a regulation whose intended purpose is guarding the safety and well-being of the population. Trade barriers that are formal, with strict legal standing—such as tariffs, import quo tas, legislated buy-domestic policies—are based on law; and laws can be changed, given an appropriate political climate. In formal barriers, especially those subject to administrative whim, are sometimes diffi cult just to identify, compounding the prob lem of their elimination. Informal barriers must be first recognized, and accepted as significant. This is not an easy task in itself. If they are to be removed, the removal must be through an administrative change of heart, or through legislation that restricts the imposition of the barriers themselves. The current flurry of activity centering on bilateral trade negotiations is aimed at lessening the number of nontariff barriers and at shoring up the international commit ment to the Most Favored Nation principle. The United States already has served notice that she will make a strong push to open a new multilateral “round” of trade negotia tions directed especially at the elimination of nontariff barriers. The EEC and Japan now appear receptive to participating in such negotiations in 1973. More open trade among nations would be well served by a concerted multinational effort to reduce existing nontariff barriers, and to guard against erecting new ones. Glossary of trade terms 1. Trade distortion: A situation in which higher value than the raw product, the absolute tariff is higher on the finished good. If the differential is large enough, only raw material will be imported, and all of the finished product will be pro duced domestically. In such a case, the effective tariff on the finished good is “prohibitive,” providing a high degree of protection for the domestic processing in dustry, while the nominal rate may be, in fact, relatively low. 7. Dumping: The practice of selling a prod uct in a foreign market at a price below the price in the domestic market—price discrimination. 8. Export subsidy: The practice by a govern ment of subsidizing the exportation of goods. This may be accomplished through direct cash assistance, tax deferrals on profits gained through exporting, tax credits for indirect taxes applied to ex ports, subsidized interest rates to assist export financing, and so on. 9. Most Favored Nation principle (MFN): Any trade concession agreed to with a single nation will be extended to all other nations. 2. 3. 4. 5. 6. 10 trade between or among nations is affect ed by actions of government or business in such a way as to disrupt the allocation of world resources and decrease the net welfare of the nations involved, or of third-party nations. Tariff: A tax on imports applied as a percentage of the value of the product (ad valorum tariff), as an unvarying level (specific tariff), or as some combination of the two. Quota: A quantitative limitation on the physical amount of an import. Nontariff barrier (NTB): A broad cate gory referring to trade restrictions other than tariffs. Nominal tariff: Tariff rate reported in a nation’s tariff schedule. Effective tariff: The effective tariff is determined by the degree of protection it affords the domestic industry. For ex ample, the same ad valorum nominal tariff rate may be applied to a raw prod uct and a finished good made of the raw product. Because the finished good is of Business Conditions, February 1972 W hat’s happening to meat prices? Rapidly rising meat prices amidst national wage and price controls have dismayed con sumers and are viewed by some as a threat to public confidence in Phase II of the Ad ministration’s anti-inflation program. Retail prices of beef during the last two months of 1971 rose 3 percent, and pork went up 2 percent. Compared to a year earlier, beef and pork prices were up 12 percent and 7 percent, respectively. Meat prices continued their upward spiral in the new year, with January beef prices up 3 percent from a month earlier and pork prices up 5 percent. The sharp price advances stem largely from a strong rise in consumer demand at a time when farm production of livestock was on the decline. Food p rices—pre- and post-freeze During the past several years, accelerat ing costs of processing and distribution rather than the cost of food commodities per se have been the major factor behind rising food prices. About three-fifths of every consumer dollar spent for food goes to pay for direct labor, transportation, utili ties, and all the other services associated with moving food from farmer to consumer. The sum total of these costs associated with a typical supermarket basket of farm foods advanced over 11 percent from 1969 through 1971. In contrast to the unbroken upward spiral of “nonfood” costs, the cost attrib utable to raw food commodities fluctuated, with the average for 1971 falling below the 1969 level. The price and wage freeze and Phase II apparently broke the upward momentum of food processing and distribution costs, at least temporarily. During the last four months of 1971, the proportion of food costs attributable to processing and distri bution actually declined, while that attribut able to raw commodities increased 5 per cent. Raw agricultural commodities—in cluding livestock—were exempted from controls both during the freeze and in Phase II. Probably the exemption was allowed be cause of the mammoth job of policing the prices of an industry with so many small and geographically-dispersed producers. Government officials also may have been persuaded that “market forces” alone were adequate to restrain agricultural prices, especially since farm prices were declining Sharply rising livestock prices . . . dollars per cwt. 1971 11 Federal Reserve Bank of Chicago generally at the time controls were initiated. Under Phase II guidelines, meat processors and retailers are allowed to “pass through” higher costs that are directly associated with higher prices paid for livestock. Thus, as market forces shifted in the fourth quar ter of 1971 and livestock prices began to rise, so did prices at the retail meat counter. W o rk in g s of " th e m a rk e t" Agricultural production and prices are often subject to disruptive fluctuations be cause of the many small producers, the lack of an industrywide discipline on produc tion, and because agricultural production is a biological process subject to the effects of weather, disease, and animal physiology. Although government programs have stabi lized the crop sector, at least partially, the 1970 corn blight demonstrated once again the uncontrollable nature of the agricultural production process. The livestock-meat sector of agriculture is especially characterized by cyclic produc- . . . led to rising retail meat prices in 1971 Supplies lag d em an d cents per pound 12 J F M tion and prices. Moreover, demand for live stock, as well as other farm products, is such that a small change in supplies results in a much larger change in prices in the opposite direction. Thus, a small drop in livestock supplies in a given period will re sult in sharply higher prices only to be fol lowed a year or so later (depending on the species involved) by increased production and sharply lower prices. Recent experience provides such an example. At the beginning of 1971, farmers were receiving $15 per hundredweight for hogs— the lowest price in seven years. Beef steers and heifers were averaging only $28 per hundredweight. In January 1972, only a year later, hogs were selling at $22.70 per hun dredweight—49 percent higher—and beef steers and heifers, at over $34 per hundred weight, reached a 20-year high. The low prices during the latter part of 1970 and through much of 1971, coupled with short corn supplies because of a blightreduced 1970 crop, caused farmers to cur tail livestock feeding, especially hog feed ing. But early in 1971, the general economy began to rebound from a recessionary low, and consumer meat demand strengthened. A M J J A S O N D Beef supplies in 1971 were only about 1 percent larger than in 1970. From Jan uary through September, supplies averaged 2 to 3 percent above year-ago levels, but then dropped below a year ago in the fourth quarter due to 5 percent smaller supplies in December. Pork output in 1971 averaged 10 percent higher than a year earlier, but nearly all the increase occurred in the first half. In October, hog slaughter dipped below a year earlier, and by December pork production slipped 5 percent below a year earlier. Business Conditions, February 1972 Meat supplies smaller at the end of 1971 pounds per person * ‘ Commercial slaughter supplies. Long dock strikes reduced the flow of meat imports in 1971 also. Imports, which typically account for 5 percent of the total meat supply, declined nearly 3 percent in 1971. Imported meat generally finds its way into such processed items as luncheon meat, hot dogs, and canned meats. Meat supplies in the latter part of 1971 were only slightly smaller than in late 1970 —a year of unusually large supplies, espe cially of pork. But relative to demand, meat was in much shorter supply than a year earlier. Although changes in demand are not as readily measured as changes in supplies, the primary indicators suggest that consumer demand for meat was very strong in the latter part of 1971. The U. S. population grew by 2.2 million by the end of 1971. More importantly, as in other recent years, the greatest proportional increase occurred among teenagers and young adults, the big gest meat-eaters in the population. A strengthening of the general economy was probably the most important factor fueling demand for meat in 1971. Although the economy still had weak spots, it was certainly more robust than it had been in 1970. Per capita disposable personal income for 1971 measured in terms of 1958 dollars gained 3 percent, compared to an increase of 2 percent the year before. And despite much unemployment, the total number of persons employed grew steadily throughout 1971. By December, there were 2.8 million more employed persons in the nation than there had been a year earlier. As more peo ple found jobs or went back to work, meat likely appeared more often on the weekly menu. With demand outstripping supplies, prices at all levels of the livestock-meat market ing channel moved higher in late 1971. Farm prices increased most rapidly. This is evidenced by the sharp increases in the “farm value” component (often called the farmer’s share) of the retail meat dollar. Rising meat consumption is influenced by more people and more money percent 1967=100 13 Federal Reserve Bank of Chicago The Department of Agriculture computes the proportion of the retail cost of meat per pound attributable to the farmer’s share, the charges of processors and distributors, and the retail markup. The farm value of choice beef in December 1971 was nearly 28 percent higher than a year earlier. For pork, the increase was almost 36 percent. The retail prices of beef and pork in creased less in percentage terms. Choice beef averaged over $1.08 per pound in De cember—12 percent higher than a year ear lier. Retail pork prices in December aver aged 73 cents per pound—less than 7 percent above the year before. Not much re lie f in sigh t 14 Cattle and hog prices in 1972 continued to increase from their December 1971 levels and were 7 percent and 30 percent, respectively, above December levels during February. Retail meat prices, which lagged the earlier farm price increases, have ac celerated, and in January alone beef prices were 3 percent higher than a month earlier and pork prices jumped nearly 5 percent. Even though farm prices may continue to work somewhat lower in the months ahead, retail prices are likely to hold firm or possi bly increase, reflecting a rebuilding of mar gins and increases in processing and distri bution costs associated with food marketing. Livestock supplies are expected to remain relatively tight throughout most of 1972. Hog marketings are expected to remain well below year-earlier levels, and cattle marketings may be only moderately larger. Last fall’s pig crop (June-November) was about 8 percent smaller than a year earlier according to Department of Agriculture estimates. The smaller pig crop has already been reflected in smaller marketings last December and January. In fact, hog sup plies were down by 14 percent in January from a year earlier, a greater decline than the December estimates of the Department of Agriculture had indicated. Through midFebruary, hog marketings were averaging 12 percent less than a year earlier. Either the estimates contained sizable error or marketings will be “bunched” in the latter part of the quarter. Pigs on farms that will be marketed mostly in the second quarter numbered about 7 percent less than a year ago. Farmers indicated they intended to re duce winter farrowings (December-May) by 10 percent, which should keep hog market ings down by a similar amount through early fall of this year. Low corn prices relative to hog prices have caused and will continue to cause farmers to feed hogs to heavier market weights—a factor which swells supplies more than numbers alone indicate. In Jan uary, hogs were averaging two pounds per head heavier than a year earlier. Never theless, the reduced marketings will hold hog prices well above the depressed levels that prevailed through most of last year, perhaps by as much as 50 percent this sum mer, although prices will decline seasonally in the fall. Cattle marketings are likely to be moder ately larger in 1972. A January 1 Cattle on Feed report estimated that first-quarter marketings would be 7 percent larger than a year ago. But preliminary information for January indicates marketings were down 2 percent from a year ago. And more tentative data for mid-February show mar ketings averaging about 1 percent below a year earlier. Either the January estimates were incorrect, or the increase in market ings in the remainder of February and in March will have to be substantially greater than 7 percent. Marketings in the second Business Conditions, February 1972 quarter, based on weight groupings of cattle on feed in January, may be only 2 percent above a year ago. Somewhat larger increases over a year ago are likely for the second half of 1972. Like hog producers, cattle feeders have an incentive to feed their animals to heavier slaughter weights because of abundant and relatively cheap feed supplies this year. Thus far in 1972, however, slaughter weights have not shown any significant increase. A possible explanation for this may be that in the past few months cattle have been placed on feed at younger ages, and these animals reach the desired market grade at lighter weights. The moderate increase in cattle market ings and substantially lower hog marketings suggest total meat supplies in 1972 will re main relatively tight. Greater than usual retention of young animals to increase the breeding herds of both cattle and hogs could moderate supplies even more. M e at im ports The possibility of raising meat import quotas in 1972 to augment domestic pro duction has been suggested as a means of easing the upward pressure on retail prices. Normally, imports make up about 5 percent of total meat supplies, and about threefourths of these imports are beef. An in crease in meat quotas of perhaps 6 to 7 per cent has been suggested for this year. This would translate into a less than 0.5 percent increase in total supplies. The bulk of imported meat is used in such processed items as frankfurters, lunch eon meats, and canned or frozen products. Some imported meat also is used in lowerpriced meats, such as hamburger. Thus, an increase in imported supplies could have a dampening effect on prices of these items which, in turn, could work to moderate further increases in higher-priced cuts. The timing of an increase in imported supplies could strengthen its impact. Since the first quarter will have passed by the time any in crease is implemented, an increase in imports would come sometime in the remaining three quarters of the year. But with or without an increase in imports, total meat supplies are likely to remain tight relative to demand through most of 1972. Larger consumer after-tax incomes, a slowdown in the rate of inflation with a resulting increase in real purchasing power, and a probable lower rate of unemployment all will contribute to increased demand for meat in 1972. Total consumer outlays on all food likely will accelerate from last year’s increase of 5.5 percent, with outlays for meat pacing the increase. Retail meat margins averaged lower in 1971 cents per pound II III 1970 IV I II III 1971 IV 15 Federal Reserve Bank of Chicago At this juncture, the prospective demand and supply situation suggests livestock prices probably reached their peak this winter but probably will remain high throughout most of 1972 when compared to recent years. R e ta ile rs m a y recoup m arg in Although retailers are allowed to “pass through” their additional costs due to higher livestock prices, these increases apparently have not yet been fully reflected in retail prices, as evidenced by the decline in re tailers’ meat margins. Margin, as used here, is the difference between the price the re tailer pays processors for the meat and the price the retailer sells it for. All costs such as labor, utilities, etc., plus profits are in cluded. During the fourth quarter of 1971, the retail margin for beef declined nearly 7 percent, and shrank 9 percent for pork. Falling retail margins are typical in pe riods of rapidly rising farm commodity prices, but margins are usually rebuilt when farm prices decline. This year is not likely to be an exception. Margins can in crease by virtue of retail prices declining more slowly than farm prices, but the small decline anticipated for livestock prices in 1972 is not likely to cause retail prices to decline. Moreover, other costs will continue to creep upward, contributing to higher prices. Therefore, margins are likely to in crease as retailers maintain or raise their prices even though livestock prices decline. The Department of Agriculture recently estimated that food prices at the supermar ket will increase by 4 percent in 1972, com pared to a 2.5 percent increase last year. Meat prices are likely to be a main con tributing factor behind the increase. “WHAT TRUTH IN LENDING MEANS TO YOU” A Spanish version of this Federal Reserve System leaflet has been issued by the Board of Governors as part of its responsibilities under the Truth in Lending Act. What Truth in Lending Means to You, in Spanish, is now available, and you may ob tain copies by sending requests directly to: Circulars and Publications Department, Federal Reserve Bank of Chicago, Box 834, Chicago, Illinois 60690. BU SIN ESS C O N D IT IO N S is p u b lish ed m o n th ly b y the F e d e ra l R ese rve B a n k of C h ic a g o . Ja c k L. H e rv e y w a s p r im a rily resp o n sib le fo r the a rtic le "R e strictio n s on w o rld tr a d e ," an d D ennis B. S h a rp e fo r "W h a t's h a p p e n in g to m eat p ric e s?" Su b scrip tio n s to Business Conditions a re a v a ila b le to the p u b lic w ith o u t c h a rg e . For in fo r m atio n co ncern ing b u lk m a ilin g s , a d d re ss in q u irie s to the Research D e p a rtm e n t, F e d e ra l 16 Reserve B a n k of C h ic a g o , B o x 8 3 4 , C h ic a g o , Illin o is 6 0 6 9 0 .
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