Adjustment in agriculture: agribusiness

Discussion Paper, Agribusiness and Economics Research Unit, Lincoln College, University of Canterbury (121, Vol 1): 103-112.

R.W.M. Johnson, Centre for Agricultural Policy Studies, Massey University

Summary

This paper reviews changes in the agribusiness sector since 1984. Evidence is based on available statistics and some anecdotal information. Considerable changes are identified in factor markets, input markets and service markets. Main features include rapid increases in factor productivity, stabilization of service prices (except interest), a decline in investment and a decline in balance sheet assets. Amalgamation and restructuring has occurred in the input and service industries and surplus capacity still exists at several points. Outputs can only be maintained at current high levels by disinvestment in the capital base. The agribusiness sector is likely to settle down at some new lower level of output and investment with increased levels of productivity in the medium term.

Key Words: Adjustment, Markets, Competition, Survival, Exit, Entry.

Introduction

This paper is concerned with the adjustment in New Zealand agribusiness. This is interpreted to mean economic changes in the micro-economy of agriculture as opposed to the more macro matters considered in the previous paper. By agribusiness we mean all those industries concerned with agricultural products from farm to final consumer although data and length considerations restrict the coverage mainly to the production, input and service industries of agriculture in New Zealand. The approach taken is to review changes in the factor, input and service markets to ascertain where changes in economic direction have occurred or where prices of resources or services have undertaken adjustment in response to recent policy and market environment changes. Unless otherwise indicated, statistical materials are drawn from "Situation and Outlook for New Zealand Agriculture, 1988" (MAF, 1988).

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Factor markets

The area farmed in New Zealand has not shown much change in recent years. There is a major adjustment, however in the total area farmed as land has been transferred from the Department of Lands and Survey to the Department of Conservation. The number of holdings continues to rise. This appears to be more to do with the coverage of the Statistics Department's questionnaire than changes in the number of full-time farms. Some authors have noted the emergence of a bimodal distribution of part-time small- holdings and full-time farms (Fairweather, 1986; Schroder, 1987). There are questions about the level of the real productive capacity of the land resource, which is largely unmeasurable, concerned as it is with fertilizer maintenance, weed control and other capital asset maintenance procedures.

There is little evidence of a major shift of labour from the farm sector. The number of working owners, full-time, part-time and casual employees recorded at June 30 have not changed perceptibily. There is, however, plenty of anecdotal evidence of off-farm part-time working arrangements and an increase in the number of working wives. Rewards for self-employed labour have declined markedly.

There has been a massive change in the level of farm investment (50% decline in nominal terms from 1985 to 1987). The fall in land development investment is greater than in other categories. This data therefore suggests that the capital base of farming is not even being maintained, and must be in fact declining at some as yet unmeasured rate. In the plant and vehicle area, normal replacement is being delayed, the age of the stock must be increasing, and greater maintenance costs are likely to be required.

Since 1982 there has been a large decrease in land sales values. As is well known, the large increase in land values in the period 1977-82 was not markedly associated with any changes in income earning capacity, but appears to be related to the then current tax provisions, the availability of development funds at concessional interest rates, and the floor price system then in place. Movements in aggregate sales values since 1982 appear to bear little relation to operating surplus, nominal GDP, real GDP, or net farm incomes, except that money incomes have also declined markedly since 1984-85.

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In 1987 the all farm sale price index appears to have stabilized after falling successively each year from 1982. Only grazing farms were selling at less than their 1986 values. In terms of butterfat and/or stock units 1987 land sale prices were generally lower in 1987 than in calendar 1986. These changes in land prices are reflected in the changing capital structure of pastoral farms. On average the value of land bUildings on sheep farms declined by 35% between 1984 and 1986 and on dairy farms by 19%. Market values of livestock have also declined while the average level of liabilities has remained constant on dairy farms but risen slightly on sheepfarms (to 1986). The cost of debt servicing has risen sharply under the new regime and these major changes in farm balance sheets are reflected in the following MAF data:

In 1987 the cost of debt servicing has risen further (sheep/beef farms 26%) and presumably debt/equity ratios have crept up a little further. The onslaught of deregulation was felt sooner on sheep farms and the overall decline in incomes has been greater. Presumably re-structuring of liabilities has not yet been reflected in the above data.

As MAF points out, average debt/equity ratios do not reflect what is happening at the margin. They state that in 1985-86, 24% of sheep farms had less than 50% equity (ratio of one) and that 5% of all farms had zero or negative equity. These farms have correspondingly higher levels of debt servicing - 24% of farms had debt servicing levels of 41% in 1986. A level of 25% of equity in total assets (equivalent to a debt equity ratio of 2.33) is considered to be the maximum position of exposure to be aimed at. The adjustment of existing farmers to revised asset valuations is a continuing process (well described by MAF) where considerable sacrifice, off-farm working, and restructuring of debt may all play a part.

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Finally in the factor market sector, the above changes have brought about a rapid increase in factor productivity since 1980. In terms of real GDP per labour unit, there has been a 5.3% per annum increase in factor productivity in total agriculture. Since the land input ("capital") has possibly declined in the last two years, total factor productivity has likely increased faster than 5.3% in this period. In terms of physical output per unit of physical current inputs, the Economic Service sheep farm sector has increased productivity by 4.7% per year in the period 1980-1988, and by 9.3% per year since 1984.

In both measures quoted the rate of increase has risen still higher in the period 1985-1988. This appears to be the normal response of productivity ratios when the sector is contracting and has been observed before by Philpott, Ross and Scobie. When investment and current inputs surge upwards the productivity ratios tend to fall.

Input markets

Fertilizer manufacture reached 2.5m tonnes in 1973 and 1974 and, after a cyclical decline in demand in the late 1970's, reached 2.3m tonnes in 1980. There has been a steady decline since 1980 in fertilizer output except in 1984-85. In the two years following 1985, fertilizer manufacture has halved. It is said the industry was operating at 50% of capacity in 1986 and possibly down to 30% in 1987 (Hoggard, 1987). Recovery to an output of 1.6 m tonnes was then thought possible i.e. around 58% of installed capacity.

In 1970 there were 13 manufacturing plants owned by 5 companies of which 10 had survived in 1986. The above authority believes 6 plants could now service the demand. Competition from imports has been opened up and a nitrogen plant installed at the gas field in New Plymouth.

This change in demand has had massive effects on distributors, both on the ground and in the air. Latest figures on the aerial spreading industry show a halving of flights and hours flown between calendar 1985 and 1987. The number of companies now involved has only declined marginally, though staff numbers are much reduced.

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Changes in other input markets can be examined indirectly by breakdown of the intermediate inputs matrix of the national income accounts. Between 1985 and 1988, nominal expenditure increased by 3.8% with an actual decline in 1986 and 1987. In real terms the value of inputs has fallen by 8% between 1984-85 and 1986-87. Changes in individual items in the input matrix from 1985 to 1987 in real terms are as follows:

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Traditionally, the downturn in receipts has always been reflected in the fertilizer and repairs and maintenance industries, but the demand for inputs has also significantly fallen in livestock purchases, feed and grazing, animal health, freight, and overheads. Weed and pest control and fuel and power demand have both risen in real terms. lower level of inputsThi~ also shows up as a lower level of demand for seasonal credit.

Service markets

Processing

For the last eight years the cost of processing/handling meat, wool and dairy products has been under considerable market and political pressure. In general, increases in these charges have been well below the general rate of inflation.

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In the period since 1984, there have been sharp increases in slaughter charges for NI cow and in meat handling charges for beef. Some of this charge may reflect the companies quoted by the Meat Board and not reflect the general trend. The remainder of meat processing charges have continued to be contained. Processing costs in the dairy sector, have also risen steadily since 1984, and tanker charges also nearly reach the general rate of inflation. Freight costs on butter have been contained more than adequately.

This containment of costs in the marketing channel is clearly of considerable political and economic interest. Such improvements would suggest major restructuring and productivity changes in the processing sector, and this has been put forward by a recent commentator (Rufus Dawe, Straight Furrow, 18 May). Attempts to locate the real data have not been successful to date.

In the meat industry there has been a major restructuring of ownership and plant closures. Three large North Island plants have been permanently or temporarily closed in the last three years. On the other hand, the removal of licensing in the meat industry has enabled 18 new processing plants to be opened or started construction (Dominion, April 8). These changes must bring about further rationalisation in due course, especially as regards by-product and skin processing and disposal. Considerable excess capacity currently exists and is being added to.

Profitability in the meat industry is also down going by the Waitaki International results. I understand farmers in the South Island benefited from the high schedules offered there last season, if not in the current season.

The exit of companies from the dairy processing sector has been taking place over a long period, and there appears to have been no recent acceleration in this trend. It is understood that the rate of investment in dairy product processing continues at a high level and this must auger well for the future.

Stock Firms

According to MAF statistics, trading bank advances to stock firms have declined in the last 3 years. On the other hand, stock and station advances to customers have risen steadily. Customers credit balances with stock agents declined but deposits for various terms have risen. This reflects a movement towards interest earning opportunities encouraged by the stock firms. Net debits of farmers with stock firms appear to have risen appreciably in 1986, but fallen in 1987. These statistics reflect very conservative management of funds and a lack of expansion of credit in the industry as a whole due to lack of demand. They also appear to conceal the bad debt situation and the possible wide differences that exist between viable and unviable accounts. Stock firms are required to participate in re-structuring proposals.

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There has, of course, been a major restructuring of the number of agencies in recent years with the demise of one of the traditional companies, but also with the entrance of a new company from Australia. Recently, this company has announced staff cuts of 150 in a total complement of 750 (Evening Post, June 14). Considerable internal rationalisation is evident among the existing companies, Knott, (1987) citing a reduction in staff from 460 to 285 in his company (Williams and Kettle). It is reported that more than 100 dealers in a farm equipment distribution network (Tulloch's) have gone out of business in the last two years (Dominion, June 9).

Finance

As with stock firms, statistics of trading bank advances to farmers do not reflect the wide disparity in individual farm debt situations. On average advances to the different types of farmers (sheep, dairy, other and services) have not increased in money terms since 1984 (MAF, Table 12). The trading banks have been the conduit whereby major cost increases have been imposed on farmers through interest rate policy.

There appears to have been a massive change in RBFC loan authorisations (MAF, Table II). Total concessional loans have dropped by two thirds from 1985 to 1987 with a major fall in loans for land development followed by land purchase. In some compensation, commercial lending by the RBFC doubled between 1985/86 and 1986/87, though total lending has sharply dropped. Accounts in arrears increased from 5 percent in 1982/83 to 11.5 percent in 1986/87, while the provision for doubtful debts increased from zero to $3.2 million. Interest rates to clients have only been slowly increased towards market rates. Since July 1986 there has been considerable restructuring of loans by the RBFC. Some of this restructuring has involved adjustment by other lenders as well. Applicants for restructuring totalled 8099 and 4706 have been approved for discounting, 699 restructured by other means and 2724 declined. Of the 8099, 4798 were sheep farms, 2571 dairy farms and 730 other farms. Most importantly, the farmers discounted owed the bank $696m prior to discounting of which $228m (33 per cent) or $50,000 per farm was written off.

As at 31 March 1987, the RBFC had not restructured its own balance sheet although the Minister of State Enterprises has stated publicly that the Bank was in no state to be privatized. More interesting perhaps, from the adjustment point of view, will be the extent of the write-down of the bank's assets when the accounts for the most recent financial year are finalized, and the consequent adjustment of liabilities.

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Landcorp has also introduced a restructuring programme for its farmer mortgagees. Discounting is used to establish new debt levels at around 70% of existing levels with an interest rate of 13%. Provision is made to "park" some of the debt interest-free until July 1989. A cash settlement offer is also available (NZ Farmer, April 27).

In the financial sector the question of entry and exit does not appear to affect the competitive position of the existing firms. The Reserve Bank (1986) argues that, apart from the RBFC, financial institutions are not seriously threatened by the farm debt problem, as rural lending represents a small proportion of their total debt portfolio. This observation appears to overlook the amalgamation and re-structuring of the major stock agency firms in New Zealand.

Conclusions

Without doubt the major cost of adjustment has been borne by the farmers themselves both in income and in equity terms. Some sharing of the burden of adjustment is evidenced by the financial sector arrangements and government backing for the Rural Bank. There is evidence that pressure has been brought to bear on some of the cost excesses in the marketing channel. This has probably been achieved by increased productivity, restructuring and reduction of profits. In current circumstances, these pressures are likely to continue, with further rationalisations and exits likely.

Output of the whole agricultural industry has largely been maintained to date, but at the expense of capital stocks and maintenance expenditures. This process must come to an end soon. In the medium to longer term, the capital stock will fall, a new lower level of outputs will be established, at lower expenditure and maintenance levels, but at higher productivity levels. The search for the right balance of market returns, exchange rates and internal cost pressures will need to continue until the appropriate position of the New Zealand tradeables sector is once again clearly delineated and established.

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References

1. Fairweather, J R, 1986, Farm Structure Change in New Zealand and Implications for Policy, Discussion Paper No. 99, Agribusiness and Economics Research Unit, Lincoln College.
2. Hoggard, K M, 1987, The Challenges Facing the NZ Fertiliser Industry, Farm Management News, Jan/Feb. 1987
3. Knott, J H, 1987, Changes in Stock and Station Services, Proceedings of Second Business Associates Workshop, Centre for Agricultural Policy Studies, Massey University.
4. Ministry of Agriculture and Fisheries, 1988, Situation and Outlook for NZ Agriculture 1988, Wellington.
5. Reserve Bank, 1986, The Rural Debt Problem, Reserve Bank Bulletin, December.
6. Schroder, W R, and A F McRae, 1987, Restructuring the Farm Business, Proceedings of Second Business Associates Workshop, Centre for Agricultural Policy Studies, Massey University.