U.S. Agricultural Outlook In 1997

The U.S. agricultural economy is in a relatively strong position following record farm cash receipts of nearly $200 billion in 1996. Positive macroeconomic conditions continue to provide a supportive backdrop in 1997. The farm sector balance sheet is expected to improve again in 1997, as asset values rise more than debt increases. Total receipts are likely to decline slightly from last year's record, and overall production expenses, while held in check by lower feed costs, will rise modestly. Consequently, net cash farm income is forecast to decline to about halfway between the $57 billion of 1996 and the $49 billion of 1995. The pieces of several puzzles must come together before the final outcome will be determined. How low will wheat prices fall? What mix of field crops will farmers plant this spring? What are the risks of the downhill phase of the cattle cycle? And is price volatility becoming more of an issue today?

Fast Forward To 2005--Globally...

Robust growth in global import demand for agricultural products--driven by strong economic growth in developing and transition economies, market-oriented policy reforms, and rising per capita meat consumption in developing countries--will be the major force in international commodity markets through 2005.

In USDA's global baseline analysis, U.S. exports of high-value products, including meats and horticultural products, will continue to show strong growth, generally outpacing bulk exports and accounting for a growing share of U.S. farm exports. Strong U.S. export growth is also projected for bulk commodities in these years, particularly feed grains and wheat, driven largely by prospects for solid economic growth in developing countries. International bulk commodity supplies will tighten, slowing the long-term downward trend in inflation-adjusted prices. The extent to which global supplies will respond in an environment of firmer prices is a key uncertainty in the outlook.

...And Domestically

Since the U.S. is the world's leading grain exporter and a significant meat exporter, it stands to benefit from projected gains in international grain demand and higher commodity prices through 2005. And greater market orientation in the domestic agricultural sector under the new farm legislation puts U.S. farmers in a favorable position to compete in the global marketplace. As a result, the positive international outlook is echoed, for the most part, in the U.S. agricultural sector.

U.S. net farm income, in nominal terms, falls for 2 years from recent highs in 1996, then rises through 2005. This implies a steady outlook for real farm income--a definite change from recent trends. The agricultural sector relies increasingly on the marketplace for its income, as direct government payments fall through 2002 and represent less than 3 percent of gross cash income beyond 2000.

USDA's baseline scenario builds on recent trends and policy actions. A set of clearly defined assumptions underlies the projections, although events might occur that could greatly alter the actual outcome. Four principal assumptions interact to support the optimistic scenario: strong growth in demand; continuation of current domestic policy; multilateral and unilateral trade policy reform in other countries; and structural change in U.S. agriculture.

Food CPI To Climb 2.5-3 Percent

The Consumer Price Index (CPI) for food in 1997 is forecast to rise 2.5-3 percent, down from last year's 3.3-percent gain. Overall inflation (as measured by changes in the all-items CPI) is forecast to increase just over 3 percent. This should keep a lid on costs of food production and marketing--e.g., labor, packaging, transportation, and advertising--which account for about 75 percent of retail food costs. The away-from-home CPI is forecast to rise 2-3 percent in 1997, with the at-home component up 2.5-3.5 percent.

5th Year Of Rising Farm Credit Use

Demand for farm credit is expected to increase again in 1997 after growing since 1992. Total farm business debt--real estate and nonreal estate loans--is forecast to reach about $160 billion by the end of 1997, up about 2.7 percent from 1996 and the highest since 1985. Continued economic growth, relatively strong field crop prices, and increased farm incomes in 1996 are behind much of this year's expected expansion. Credit availability should be ample for agriculture and rural business borrowers in 1997, while general interest rates may rise slightly by the second half of 1997. Commercial banks in the first quarter of 1997 have continued to ease credit standards for business lending, including credit standards for small firms. Likewise, for the fourth quarter of 1996, roughly half of rural banks heavily involved in agricultural lending had loan-to-deposit ratios lower than desired. The easing of credit standards and the desire to expand business lending has led to a narrowing of business lending spreads (the difference between the loan rate charged by the bank and the bank's cost of funds) as well as greater availability of funds for business lending.

Exporters Target U.S. Asparagus Market

The U.S. is one of the world's largest producers and consumers of fresh asparagus. In the past, fresh asparagus was consumed in the U.S. only in the first half of the year, when domestic product was available. Thanks to soaring imports (mostly from Mexico and Peru)--up 74 percent in the 1990's--fresh asparagus is now available year-round. But imports arrive not only during the off-season. They also come in during the U.S. season beginning in January, reducing the early-season price premium. Because the U.S. market is mature and demand flat, the growth of fresh (and processed) asparagus imports poses serious challenges to the U.S. industry.

Well into 1997, the U.S. agricultural economy is in a relatively strong position. Farm cash receipts set a record of nearly $200 billion in 1996, with crop receipts rising substantially above the average of the 1990's and livestock receipts close to the average. This year, total receipts are likely to decline slightly from the record, as lower grain receipts reduce the total return to crops. But livestock receipts will rise as cattle more than offset the decline in dairy.

Overall production expenses, while held in check by lower feed costs, will rise a little. Consequently, net cash farm income is forecast to decline to about halfway between the $57 billion of 1996 and the $49 billion of 1995, making it about equal to the average of the 1990's. Areas of concern continue to be those farming regions affected by bad weather, and the financial pressures on cattle and dairy producers who have had to reduce cash balances or incur debt in 1996.

The farm sector balance sheet is expected to improve again in 1997 as asset values rise more than debt increases. Farm real estate values have risen every year since the mid-1980's, and a 5-percent increase is expected in 1997. Farmers will take on more debt for the fifth year in a row, but the overall debt-to-asset ratio is expected to decline to a healthy range of 14.5-15 percent.

Taxpayers will see stability in farm program costs, with direct government payments forecast at $7.6 billion for 1997, which would account for only 3.5 percent of gross farm income. By the time the 1996 Farm Act expires in 2002, government payments are expected to drop to 2.6 percent of gross farm income. Consumers will see a year of modest food price increases in 1997. Meat and dairy product prices will restrain food price increases, keeping them in the range of 2.5-3 percent. In 1996, food prices rose 3.3 percent above the 1995 level but below what many expected given the record-high levels of grain and milk prices.

The Macroeconomy Bodes Well For Agriculture

One can go a long way in assessing the prospects for agricultural markets by knowing how strong world food demand will be and how global crop yields will turn out. Although little is known yet about 1997 crop yields, it is possible to learn something about underlying demand by looking at its two major determining factors: global incomes and prices.

Global incomes appear to support strong food demand in 1997, which is good news for food exporting nations such as the U.S. Real global gross domestic product is expected to grow nearly 3 percent--roughly the same as last year's 2.9 percent, but up sharply from the 1.9-percent annual growth during 1990-95. This should help to keep global food demand strong despite high commodity prices.

Almost every major country in the world is expected to have positive real growth in 1997. Each of the 28 OECD economies is expected to grow for the first time in 10 years. The only drag continues to be the Newly Independent States of the former Soviet Union and the Baltics, where positive growth is still a couple of years away.

From a consumer's viewpoint, global commodity prices also look favorable. U.S. farm product export prices have fallen substantially from their second-quarter (1996) peaks and should continue to do so as grain supplies rebuild in 1997.

One price factor to watch in 1997 is exchange rates. The dollar is now about 20 percent stronger against the yen than in 1995. That has the effect of raising U.S. export prices and will partly offset some of the U.S. crop price declines in 1997. It will especially hurt meat and other high-value exports whose prices are not dropping in 1997. The stronger dollar will also add to the overall U.S. trade deficit, which will be a restraining factor in U.S. economic growth. Even so, the U.S. economy is expected to grow at about 2.5 percent during 1997.

Some positive news for U.S. exporters is that, although the dollar is strengthening generally, its real value--in agricultural trade-weighted terms--is now only moderately above the level of the past 2 years when measured against West European and Asian currencies, excluding Japan. And the Mexican peso continues to show stability at about 7.9 pesos per dollar.

Two key factors influencing farmers' costs are energy prices and interest rates. Farmers faced 11-percent-higher fuel costs in 1996, spending a total of $6.3 billion as crude oil prices rose from $17 a barrel in 1995 to more than $22 in late 1996. Fuel spending will be up a little in 1997, but crude oil prices are expected to drop back down toward $20 as the year unfolds.

Interest rates could be slightly higher in 1997, reflecting the above-trend growth in the U.S. gross domestic product of the past few quarters and the tighter labor market. However, the outcome will depend on the Federal Reserve Board, which will be considering the offsetting effects of lower expected food and energy price increases and lower prices for imports due to the strength of the dollar. Farmers' total interest expenses will likely be a little over $13 billion, about the same as in the past 2 years.

Behind the aggregate farm-sector numbers are varying circumstances across commodities that shape near-term conditions in agricultural markets and the U.S. farm economy. In addition, the pieces of several remaining puzzles must come together before this outlook becomes a certainty. These involve grain prices, planting flexibility, ethanol production, the cattle cycle, and price volatility.

Crop Market Developments

A year ago, this forum was deeply concerned about the looming shortage of grains and the prospect of a major disruption of livestock production and escalating consumer food prices. Corn, wheat, and soybean prices had seen a 10-16-month runup, and further price increases were anticipated. Grains did turn out to be in short supply, and prices soared to levels not predicted at this forum or anywhere else, as grain stocks reached record or near-record lows and domestic and export demand was strong.

A year later, the moderating effect of larger 1996 crops is evident. Monthly average farm-level wheat prices fell steadily from last May's record high to below $4 per bushel in January--a 31-percent drop. Corn prices declined by about 41 percent from the record high last July, leveling out to $2.63 per bushel in December and January. In contrast, soybean prices, while they declined 12 percent through November from their August peak, have increased since then to $7.16 per bushel in January.

Wheat prices are expected to remain under considerable pressure as U.S. and global carryover stocks rise, although not to high levels by historical standards. Last year's high wheat prices caused foreign wheat acreage to expand by 5 percent, resulting in a harvest of record or near-record crops. That was the largest annual increase in foreign wheat area recorded in the USDA database, which starts in 1960.

Reduced yields in the U.S. made it the only major wheat exporter with a decrease in wheat supplies in 1996/97. As a result, U.S. exports declined. U.S. wheat sales have plummeted in recent months as foreign exporters such as Argentina and Australia have traded aggressively. U.S. sales are expected to remain slow through this summer because of continued large exportable supplies in competing countries. For the 1997/98 season, U.S. wheat production is expected to be similar to this year. However, smaller crops are expected in all the major exporting countries except the European Union (EU). This should provide an opportunity for a recovery in U.S. exports from the reduced level of 950 million bushels expected this season. However, the degree of recovery will depend on the size of the U.S. crop, and on whether China's wheat imports bounce back from the 4 million tons expected this season to something nearer the 10-million-ton average of the previous 5 years. This year's corn prices may be relatively firmer than wheat. While corn carryover stocks are expected to more than double by September, they are still expected to be relatively tight, below 1 billion bushels. Feed and industrial uses are rising. However, exports will be down this season, as corn from Argentina, South Africa, and China, and barley from Canada and the EU, are providing increased competition. In 1997, U.S. production is forecast to rise again, but higher exports and domestic use during the 1997/98 marketing year are expected to limit the increase in carryover stocks to only about 300 million bushels by September of 1998.

Soybean stocks are declining, in contrast to wheat and corn. By this September, U.S. soybean stocks are projected to be the lowest in 20 years, which will mean an increase in farm-level soybean prices in 1996/97. What is going on?

First, Brazil had a reduced crop last year, which opened markets globally for the U.S. and even made Brazil a U.S. customer this past fall. Second, China imported record quantities in October-December--950,000 tons of soybean meal compared with zero the year before. That is nearly 8 percent of total world trade purchased in one calendar quarter by one country.

However, China's needs appear to be met, and record soybean production in both Argentina and Brazil has started coming to market. As a result, U.S. exports are expected to slow during the March-September period. In 1997, a modest increase in U.S. production and a return to a more typical export level is expected, which should raise 1997/98 carryover stocks and reduce prices.

For cotton, extremely tight U.S. stocks last summer led to imports of 800,000 bales, making the U.S. a large cotton importer. However, imports have slowed to a trickle since completion of the second-largest U.S. cotton harvest ever. Stocks will rise 80 percent by August, despite larger U.S. mill use buoyed by the continuing strong economy and increased cotton textile exports.

Raw cotton exports continue to decrease in the face of 10 straight years of flat global demand and reduced imports by China. In the Western Hemisphere, cotton use continues to grow, but elsewhere in the world, growth in textile demand is increasingly being met by manmade fiber, a challenge the U.S. cotton industry must deal with if exports are to grow in the future.

The rice outlook has taken a surprising turn, reflecting reduced returns to planting under the 1996 Farm Act. Production and exports were down in 1996 as expected. However, late harvests in Asia and tight long grain supplies worldwide boosted international prices in December and January. As a result, U.S. rice area may actually increase in 1997.

For sugar, the major development is the level of imports under the tariff rate quota in 1996/97. That level is now expected to total 2.27 million short tons, after the January tariff-rate-quota allocation of 220,000 tons was canceled because the forecast U.S. stocks-to-use ratio was above 15.5 percent. (The March allocation has been authorized.) Imports remain well above the legislated trigger of 1.5 million tons. Thus price support loans will continue to be nonrecourse.

Among fruits and vegetables, the recent Florida freeze demonstrates weather will play a critical role in production. Sharp losses of snap beans, squash, tomatoes, and peppers have boosted prices and will likely cause the consumer price index (CPI) for fresh vegetables during January to June to be more than double the pre-freeze expected increase.

Livestock Market Developments

One of the most startling developments in the recent outlook has been in the cattle market. First, the cattle cycle turned, and second, the export boom went flat. Over the past year and a half, drought, record-high feed grain prices, high hay prices, low cattle prices, and adverse winter weather have persistently forced cows to slaughter. In 1996, both calf and beef cow slaughter rose 24 percent.

Although large late-summer and fall placements into feedlots are keeping beef supplies up now, the January 1, 1997 U.S. cattle inventory showed the impact of ranchers' efforts to reduce herds. Cattle on farms and ranches totaled 101.2 million at the start of 1997, down more than 2 percent from the 103.5 million at the start of 1996 and the first decline in the U.S. cattle inventory since 1990.

Adding to the grief of ranchers, exports declined about 12 percent year-to-year during the second half of 1996 after growing a robust 20 percent above a year earlier in the first half. Exports had increased at an annual average rate of 16 percent fom 1991 to 1995. In Japan, where more than half of U.S. beef exports went in 1996, concerns over E. coli and BSE appear to have slowed consumption. In 1997, U.S. beef exports are expected to rise, especially in the second half, particularly to countries like Mexico and South Korea and to Japan, although the rising dollar is a new factor that could limit increases.

The hog inventory, like cattle, is down compared with a year ago, and pork production in early 1997 will likely be below last year's level. Producers indicated plans to increase farrowings in the first quarter of 1997, then pull back during the second. If they follow through, pork production would pick up by the third quarter, but for the year as a whole would remain about the same as in 1996. With production stable and increased exports expected, hog prices may average about $2 per cwt over the 1996 average of about $53.50 per cwt.

Outlook Puzzle Number 1:
How Low Will Wheat Prices Go?

Averaged over the 1980-95 period, farm prices for wheat bottom out in July at about 94 percent of the season-average and peak in May at 106 percent. Based on the forecast season-average price for wheat of $3.45 per bushel for 1997/98, monthly prices would reach a low of $3.25 per bushel in July and rise to $3.65 by May 1998.

However, in years of significant stock growth since 1980--that is, when stocks rose 20 percent or more from the previous year--wheat prices exhibited a different pattern, starting higher and declining earlier in the crop year and reaching a trough in late summer before generally rising through early May, but remaining below the price-pattern average across all years. Under this stocks-growth pattern, 1997/98 wheat prices would bottom out at about $3.35 in September and rise to $3.55 in May 1998.

Outlook Puzzle Number 2:
Will Ethanol Perform?

High corn costs led corn used in ethanol to fall to 396 million bushels in 1995/96, down 26 percent from a year earlier. Corn costs will be lower this year and gasoline prices a little higher than in recent years, so a recovery to 440 million bushels is expected for 1996/97. Further gains are expected in 1997/98, but it will likely be at least another year before corn use for ethanol reaches 1994/95's 533 million.

The peak ethanol production period is in the fall and early winter when high-fructose corn syrup (HFCS) production is down and the winter oxygenate program is in effect. But ethanol production this past fall did not snap back sharply, limiting this season's prospects, although year-over-year production increases are likely as the year progresses.

While corn used in ethanol between 1994/95 and 1996/97 is expected to drop by about 90 million bushels, corn for HFCS and beverage alcohol is expected to rise about 60 million. Increasing HFCS and beverage alcohol exports will help support corn industrial use while ethanol recovers.

Outlook Puzzle Number 3:
What Will Farmers Plant This Spring?

In 1996, 335 million acres was planted to principal crops, the highest level since 1986 and up nearly 17 million acres from 1995. With producers responding to rising prices, corn and wheat acreage accounted for 90 percent of the increase. Sorghum and soybean acreage was also up, while rice, cotton, and minor oilseed acreage was down.

The amount of cropland available for 1997 planting to principal crops is as large as last year, and as much as 1 to 2 million acres withdrawn early from the Conservation Reserve Program (CRP) in 1996 might be planted. About 22 million acres currently enrolled in the CRP are under contracts that expire at the end of September, and some of that acreage is likely to be available for 1998 planting.

Planted acreage this year is likely to be down slightly from 1996, largely because of plantings of other crops on failed wheat acres last year. Land that is planted to wheat, then replanted to another crop such as sorghum, is counted twice in the planted acres total. Total wheat acreage is expected to be down because of the 7-percent decline in winter wheat acreage and lower price expectations than a year ago for spring wheat plantings.

Corn and soybean acreage is likely to increase, capturing some of the wheat land. Corn could total 81 million acres, near where it might have been last year had planting weather not been bad. Soybeans, with current favorable prices, could reach 64.5 million acres or even exceed 65 million, the highest since 1984. Rice acreage may increase marginally to 2.9 million with favorable prices, and cotton acreage could decline slightly to 13.8 million, as feed grains and soybeans look attractive.

Although larger stocks of wheat and corn than a year earlier will be carried into 1997/98, U.S. grain stocks are relatively tight, and soybean stocks are the lowest since 1976. With normal weather, 1997/98 could see wheat production match 1996's 2.28 billion bushels and stocks rise toward 550 million bushels. Corn production could total close to 9.6 billion bushels, the second highest ever, and stocks could rise to more than 1.2 billion bushels.

Soybean production could total 2.5 billion, and with lower exports, stocks could rise to 220 million bushels. Season-average prices would be below 1996/97 and export supplies would rise. But U.S. crops will face especially strong competition, given large competitor supplies.

Outlook Puzzle Number 4:
What Are The Risks Of The
Downhill Phase Of The Cattle Cycle?

The 101-million-head inventory on January 1 marks the start of the downturn in the cattle cycle. Cattle cycles over the past several decades have averaged 6 years of cattle-number building, followed by 4 years of declining.

So for some time into the future, fewer calves will be born, fewer heifers will be retained, fewer feeder calves will be available to feedlots, fewer steers will be fed and slaughtered, and lower retail supplies of beef will be available. This could go on for several years. In 1996, beef production was up 1.2 percent. In 1997, a slight decline is expected, and in 1998, a decline of 4 to 5 percent.

Feedlots will have to pay more for a reduced supply of feeder cattle. If corn prices come down, feedlots will want feeder cattle even more. Feeder cattle prices could become quite strong next fall and into 1998. By late 1997, fed cattle could be over $70 per cwt, as they were this past fall, but feeder cattle could be in the mid-$70's, compared with the mid-$60's this past fall.

This will mean better news for cow-calf producers. After taking losses estimated at $18 per cow in 1995 and $39 in 1996, returns, although still negative, could improve in 1997. By 1998, returns should be strongly positive, which would provide an incentive to rebuild herds. But once that decision is made, the biological lags mean another 2-3 years before cattle inventories stop the decline.

Combine this story with the fact that grain stocks, particularly corn and soybean, remain relatively low. A bad weather year in 1997 could again cause high feed prices, resume the heavy herd liquidation, halt rebuilding of the hog breeding inventory, and set the stage for a serious increase in retail beef and other meat prices in 1998. Because meat and poultry accounts for 15 percent of the at-home CPI for food, such a scenario would be a concern for consumers.

Outlook Puzzle Number 5:
Is Price Volatility Really
More Of An Issue Today?

With low and capped marketing loan rates, minimal government stocks, and the elimination of acreage reduction programs, some are concerned that agricultural commodity prices will be more volatile. This concern has been amplified by tight grain stocks and the runup and decline in grain prices over the past 2 years. This, in turn, has affected livestock, poultry, and milk markets. A common premise is that prices will be more volatile without government intervention and with privately held stocks that are smaller than past levels of stocks owned or supported by the government.

Are prices now more volatile than in the past? For corn and wheat, both farm and futures prices were more volatile in 1996 than over 1991-95. Was this volatility indicative of an inherently less stable agricultural sector structure or, instead, the result of year-specific external factors such as weather? Further, whether this is indicative of more volatile prices in the years ahead remains to be determined.

Farmers and first buyers have reason to be concerned. Greater planting flexibility, trade liberalization, and more private stockholding tend to be stabilizing forces. But several factors suggest greater variability in the future. These include smaller government stocks and greater exposure to foreign policy shifts and foreign supply shocks as trade liberalization becomes more important.

From a producer perspective, more volatile prices than in the past could signal a need for risk management tools to deal with price and income variability. Moreover, producers can no longer transfer price risks to the government through high nonrecourse loan rates and storage subsidies. Instead, they will rely on private-sector risk management mechanisms.

In 1997, U.S. agriculture will continue to adjust to the increasing risks that accompany changes in domestic farm and trade policy as well as the profusion of emerging technologies and marketing arrangements. These risk-creating changes will also provide the chance to lower costs, improve products, shift risks, and open new markets internationally.

Robust growth in global import demand for agricultural products will be the driving force in international commodity markets through 2005. In USDA's global baseline, U.S. exports of high-value products (HVP's), including meats and horticultural products, will continue to show strong growth, generally outpacing bulk exports and accounting for a growing share of U.S. farm exports.

Strong export growth is also projected for bulk commodities, particularly feed grains and wheat, driven largely by prospects for solid economic growth in developing countries. U.S. bulk commodity exports are projected to expand more rapidly than during the 1985-95 period, helping to keep U.S. farm exports on a steady path of growth. International bulk commodity supplies will tighten, slowing the long-term downward trend in real prices (measured over the 1970-2005 period). The extent to which global supplies will respond in an environment of firmer prices is a key uncertainty in the outlook.

What Is USDA's Baseline?

Simply stated, USDA's annual baseline is a set of long-run, policy-dependent projections. The 10-year baseline is not a "forecast" in the traditional sense of the word. Few analysts, particularly those who worked on this baseline, would say with great confidence that wheat prices will average $4.80 per bushel 9 years from now, a number that is in the baseline. Rather, the baseline projections are intended to outline the path the agricultural sector will take under a given set of assumptions.

The baseline provides a neutral backdrop, a reference scenario for assessing impacts of alternative developments. Baseline projections reflect current law, a specific set of macroeconomic assumptions, a continuation of current agricultural policy, and "normal" weather--no shocks to the system are assumed. From a traditional forecasting perspective, it is this "no shocks" assumption which most differentiates the baseline from a forecast. Most analysts would accept the notion that unforeseen changes will occur sometime during the baseline period.

A USDA interagency product, the baseline is a tool for departmental decision making regarding long-term budget estimates, agricultural policy implementation, alternative policy scenarios, and other agricultural issues. It allows for performance of sensitive policy analysis--e.g.,what is the impact of an expanded European Union? or what is the impact of rapid economic growth in China?

Macro Outlook Positive For Agriculture

Prospects for stronger economic growth in developing and transition economies, a consistent scenario across most vendors of global macroeconomic forecasts, are a key driver of USDA projections. Economic growth rates in Asia, the largest global and U.S. market for agricultural commodities, are expected to continue to lead the world through 2005. China and Southeast Asia are likely to remain the fastest growing areas of the world, fueling sustained rapid expansion of per capita incomes, food demand, and diet diversification. Although growth is likely to slow somewhat in East Asia--Hong Kong, Japan, South Korea, and Taiwan--it will remain sufficient to yield steady gains in demand for an increasingly diverse diet. While strong Asian growth is not new to the outlook, the substantially improved economic prospects in other developing areas sets the 1997-2005 outlook apart from projections of the past 10-15 years.

Significantly faster income growth is anticipated in Latin America (including Mexico), North Africa, and the Middle East during 1997-2005. This favorable outlook is supported by progress made in implementing and sustaining economic and institutional reforms in many countries across these regions. At the same time, it is heavily dependent on the continuation of reforms. For the Middle East and parts of North Africa, improved prospects are also linked to the forecast of strengthening real petroleum prices.

Another important factor distinguishing the next 10 years from the last is the restoration of positive rates of economic growth in the transition economies of the Newly Independent States (NIS)--the 12 republics of the former Soviet Union--and the Baltic states, and, particularly, Central and Eastern Europe (CEE). The variability and eventual collapse of effective demand in these countries was a key influence on global markets during the last 10 years. Restoration of positive, if slow, rates of income growth should halt the declines in food demand and stabilize trade. And especially in the NIS and Baltics, increased market orientation and constrained budgets should reduce volatility in both economic growth and food trade.

Developing Countries Shape Ag Demand Prospects

The relationship between per capita income growth and the pattern of consumer demand in developing countries is the most critical demand relationship influencing the long-term food outlook. Particularly important is the relatively strong growth in meat and feed demand that typically occurs in developing countries with per capita incomes of $500-$5,000--e.g., Brazil, China, Malaysia, Mexico, and Thailand. The sustained rapid economic growth projected in Asia, combined with improved growth in Latin America, North Africa, the Middle East, and CEE, will lead to robust expansion of per capita meat consumption and demand for feeds.

Since most countries, and particularly developing countries, tend to produce meat domestically rather than import it, most of the trade impact of this feed-livestock expansion will be in energy and protein feeds. Also, many of these countries are at the stage of economic growth where food demand for wheat and vegetable oils tends to increase most rapidly.

Developing countries play a key role in boosting longer term prospects for agricultural commodity demand. Developing countries' demand growth will exceed world demand growth for all major commodities except rice. Demand growth in developing countries is highest in feeds, meats, and vegetable oils. Compared with growth in developed countries, demand growth in developing countries is sharply higher for feed grains and meals.

A key uncertainty in the global food outlook is China's large and dynamic economy, specifically its future demand (and supply) prospects. With its large population, dynamic growth, uncertain future policies, weak data, and diverse food sector, China's long-term outlook is likely to remain uncertain.

However, China provides a dramatic example of the pattern of food demand growth that occurs at a certain stage in developing countries. Food grain demand has shown little growth in per capita terms since the mid-1970's, while per capita demand for meats, feeds, and vegetable oils has soared. This pattern is expected to continue through 2005, with slower but still rapid growth in per capita meat and feed demand and little or no growth in per capita food use of wheat or rice.

Grain Area Up, Yield Trends Uncertain

Firmer prices and supportive policies are expected to lead to a recovery in global grain area during 1997-2005. In developed countries, the decline in grain area during 1980-95 was associated with sluggish global demand and supply management policies, primarily in the U.S. and the European Union (EU). During 1997-2005, grain area in developed countries is projected to rise with market incentives, increased planting in the U.S., and reduced land set-asides in the EU.

The transition economies--NIS and Baltics, and CEE--saw the largest declines in grain area during 1980-95. In these countries, grain area stabilizes and grows moderately during 1997-2005, predicated primarily on recovery of domestic, rather than foreign, demand. In general, the recovery in crop area is consistent with the pace of institutional and policy reform and occurs fastest in the Visegrad countries--Poland, Hungary, Czech Republic, Slovakia--and to a lesser extent, Russia.

In developing countries, the expansion of grain area slowed during 1980-95, but did not show the decline evident in other regions. Cropped area in developing countries is likely to continue to expand in areas where climate and water availability support additional intensive cultivation. Firmer prices are expected to contribute to grain area increases in both importing and exporting developing countries.

By commodity, the global crop area projections reflect the pattern of demand, with the strongest increases in coarse grain and wheat area. Rice area continues to reflect the slow upward trend in rice demand. Oilseed area growth is projected to slow as strengthening grain prices increase competition for land, slowing growth in soybean area and pulling some area out of rapeseed and other oilseeds.

Future trends in crop yields are probably the major uncertainty in the long-term outlook. Global yield growth appears to have slowed, although performance has varied by region, commodity, and time period. But how will investment in both variable and fixed inputs respond and raise yields in the longer term as prices strengthen?

The impact of increasingly market-oriented farm policies in the U.S., other developed countries, and developing countries is unclear. In Latin America and other developing regions, it is unclear how the improving macroeconomic climate will affect agricultural investment and productivity. Further, it is increasingly difficult to predict the pace of development and adoption of biotechnology-related advances that will be coming into use in the future.

Qualified by these uncertainties, the NIS and Baltics, and CEE, are assumed to undergo a significant recovery in yields for major crops. Somewhat slower aggregate yield growth occurs in both the developed and developing regions. Globally, wheat yield growth is projected to match the 1985-95 performance, and corn yield growth is projected faster, but these results are predicated largely on the anticipated, but highly uncertain, rebound in the transition economies. However, yield projections for the NIS and Baltics, and CEE, remain cautiously below historical highs, due in large part to uncertainty about the pace of reforms and prospects for productivity gains.

China is also expected to experience important yield growth. Official Chinese data indicate that yields for many crops, including wheat and corn, are high by world standards and suggest limited potential for future growth. However, there is also evidence to suggest that yields calculated from official data are biased upward because area harvested is significantly underestimated. The bias is judged to be particularly large for corn. As a result, USDA projections allow for substantial future yield growth from a lower level than indicated by official data. Results from China's agricultural census, currently underway, should help to clarify this issue.

Trade Prospects By Commodity

A summary of historical and projected growth rates in global imports shows that although growth is projected slower for several commodities, particularly some meats, projected demand remains strong for meats generally, and for feeds and wheat. Particularly important to the U.S. trade outlook is the stronger expected growth in import demand for coarse grain, wheat, and to a lesser extent, cotton.

COARSE GRAINS: Broad-based growth in coarse grain import demand will support the expanding feed-livestock sectors across developing regions, including China, South and Southeast Asia, Latin America, North Africa, and the Middle East. China's coarse grain imports are projected to rise more than 10 percent annually, and South and Southeast Asian imports, about 9 percent annually.

Annual growth in other developing regions is expected to be more modest, in the 3-4-percent range. East Asia, by far the largest regional feed grain market, is expected to show very little growth, as trade reforms make local meat production uncompetitive and a rising share of meat consumption is imported. EU imports are also likely to remain relatively flat, due to sluggish growth in domestic meat demand and to export constraints imposed by Uruguay Round (UR) export subsidy limits.

The NIS and Baltics, a key source of instability in global coarse grain trade during the 1980's and early 1990's, are expected to be a small player in the market during 1997-2005. Meat demand and production recovers slowly, and domestically produced meat remains uncompetitive with imported meats in key markets. With a smaller market presence and severe financial constraints, the NIS and Baltics are unlikely to be as large a source of instability in global coarse grain markets during the projection period.

The U.S. is expected to maintain its dominant two-thirds share of the global coarse grain market. EU competition, primarily barley, is likely to be constrained by the UR export subsidy limits throughout the projection period. While Argentina is expected to boost its corn exports, other traditional competitors are expected to be restrained by competition for cropland. The transition economies, primarily in CEE, are expected to be emerging competitors after 2000 when gains in U.S. corn area slow and prices strengthen. SOYBEANS AND MEAL: The long-term expansion of feed-livestock sectors in developing Asia, Latin America, North Africa, and the Middle East is expected to drive steady, robust growth in demand for soybeans and meal. Developing Asia, particularly China and Southeast Asia, is expected to be the fastest growing market, with imports expanding about 8 percent annually. Gains in these developing regions are projected to more than offset sluggish growth in feed demand in East Asia and the EU-15.

As was the case during the early 1990's, U.S. soybeans and meal are expected to maintain market share against South American competitors, with the U.S. share averaging 43-44 percent. Large gains in U.S. soybean yields relative to Argentina and Brazil are expected to continue to underpin U.S. supplies and competitiveness, particularly during the next 5 years.

WHEAT: As with feeds, income gains in developing countries are expected to drive stronger growth in wheat trade during 1997-2005. In many developing countries, per capita wheat consumption remains responsive to rising incomes and urbanization, while capacity to produce wheat efficiently is limited. In China, although per capita wheat consumption is not expected to grow, imports are expected to expand about 4 percent annually as water shortages continue to inhibit yield gains. The North Africa and Middle East market, also expected to sustain 4-percent annual import growth, is another key to wheat trade prospects. Wheat demand will respond to faster income growth in most of North Africa and the Middle East.

Limited production gains are expected in some countries because of limited potential for area or yield gains, and because market-oriented reforms are reducing government support. As with coarse grains, the NIS and Baltics will be a relatively small player in the global wheat market during 1997-2005, with much less scope to be a source of instability.

The U.S. wheat market share will recover from its 1996 decline and remain near its recent average of 34 percent through 2005. Prospects for U.S. wheat market share are closely linked to EU policy developments. EU market share is expected drop until about 2001, as its exports are constrained by UR export subsidy limits, but then rise when world prices are high enough to permit unsubsidized exports.

Gains in EU market share after 2000 are expected to come at the expense of less competitive emerging exporters, rather than U.S. sales. This scenario assumes a 12-percent EU land set-aside for 1998-2005, moderate appreciation of the European Currency Unit against the dollar, and limited changes to the administration of existing EU wheat intervention policies to permit internal market prices to drift below the intervention price (EU farm support price).

A smaller EU set-aside could increase its competitiveness after 2001, but would likely lead to rising supplies of barley that would be uncompetitive with wheat for domestic feed use and not exportable under UR export subsidy limits. A change in the EU Common Agricultural Policy to reduce the wheat intervention price would also increase EU competitiveness, but is considered unlikely outside of a formal enlargement agreement with CEE countries.

MEATS: The long-term outlook for global beef, pork, and poultry trade is largely dependent on developments in three large markets: East Asia, the NIS and Baltics, and for poultry, China. East Asian meat imports, dominated by Japan (beef, pork, and poultry) and South Korea (beef), expanded rapidly during the 1980's in response to strong consumer demand and negotiated increases in market access.

Based on already ratified multilateral trade agreements, East Asian meat import demand will grow steadily, as imports continue to substitute for relatively high-cost local production. However, import growth will remain slower than during the 1980's and early 1990's unless additional market access is negotiated. Large imports by the NIS and Baltics, principally Russia, were also a significant feature of world meat markets during the 1980's. The collapse of inefficient domestic production, combined with the availability of credits and subsidies for imports from the EU and the U.S. was the key factor in this trade. For 1997-2005, NIS and Baltics import demand will grow steadily, based on very modest growth in consumer demand combined with very slow progress in the development of beef, pork, or poultry sectors that can compete effectively with imports. A decline in the availability of subsidized meat exports from the EU will be a significant constraint on growth in NIS and Baltics pork and beef imports.

Imports by China, both direct and via Hong Kong, have been a source of rapid poultry trade expansion during the early 1990's. The rate of future growth in this trade is very unclear, in part because of uncertainty about how Hong Kong's accession to China will affect the administration of trade via Hong Kong. It is also possible that limitations imposed by inadequate refrigerated transport and storage may eventually slow trade growth. China's poultry imports slow from recent rates, but continue to show strong (10-percent) annual growth.

U.S. beef, pork, and especially, poultry have been very competitive in world markets, capitalizing on new market opportunities to grow more than 20 percent annually in volume during 1985-95. U.S. meat products are expected to remain highly competitive during 1997-2005, but given the outlook for slower growth in imports by East Asia, the NIS and Baltics, and China, and the baseline assumption of no new market access agreements, U.S. meat export growth is projected to slow significantly. U.S. meat export volume grows about 6 percent annually, with value growing somewhat more slowly, as lower quality products continue to account for a growing share of U.S. exports.

COTTON: After showing little growth from 1985 to 1995, world cotton trade is projected to expand about 1.2 percent annually during 1997-2005, the result of strengthening developing-country demand and prospects for slow production growth in the NIS and Baltics, and China. Import demand in more developed regions, including East Asia, will continue to slide, as spinning moves to lower cost regions. These declines are expected to be more than offset by rising imports in Southeast Asia, Latin America, and China. Slow growth in both imports and exports is expected for the NIS and Baltics, as demand gradually strengthens and only limited production gains are achieved.

The U.S. is projected to remain the largest exporter of raw cotton, maintaining roughly a 25-percent market share, while many competitors reduce raw cotton exports and channel supplies into consumption or exports of textiles and value-added products.

U.S. Export Outlook Remains Robust

The nominal value of U.S. farm exports grows at a robust 4-percent annual rate during 1995-2005, reaching nearly $80 billion by 2005. High-value products (HVP's) continue to lead the growth in U.S. agricultural exports, expanding about 5 percent annually. U.S. bulk commodity exports are also projected to show strong gains--more than 3 percent per year.

Each of the major categories of U.S. HVP exports--meats, fruits, and vegetables--is expected to show strong, steady annual growth of 5-7 percent in value terms. These U.S. products are expected to remain highly competitive in their major markets, primarily East Asia, Canada, and Mexico. However, U.S. exports of these products are unlikely to sustain the rapid pace of the past 10 years, particularly since no new market access agreements are assumed to occur. During 1985-95, market opening agreements with East Asian countries and NAFTA partners made these markets the key sources of U.S. HVP export growth.

Significantly stronger annual growth in the value of bulk commodity exports is expected to be a key source of strength in the U.S. trade outlook, and in the rural economy. Faster growth and firmer prices than during the last 10 years are projected for U.S. exports of most bulk commodities, particularly for coarse grains, wheat, and cotton. However, unlike HVP exports, which generally depend on the more stable income and food demand growth of higher income markets, bulk commodity demand and prices will be closely linked to the more fragile prospects for economic growth in developing and transition economies.

USDA Agricultural Baseline Assumptions

USDA's 10-year baseline projections cover agricultural commodities, agricultural trade, and aggregate indicators such as farm income and food prices. The projections in the current report, Agricultural Baseline Projections to 2005, Reflecting the 1996 Farm Act, were completed in December 1996 and reflect a composite of model results and judgmental analysis of the agricultural sector through the year 2005. The projections reflect major agricultural policy decisions made through mid-November 1996 and include short-term projections from the November 1996 World Agricultural Supply and Demand Estimates.

The baseline projections incorporate provisions of the 1996 Farm Act and assume the new law is extended through the end of the baseline in 2005. These projections provide a starting point for discussion of alternative farm policies. The categories of critical long-term assumptions in the baseline include: U.S. and international macroeconomic conditions; U.S. agricultural and trade policies; funding for U.S. agricultural export programs; foreign economic, agricultural, and trade policies; growth rates of U.S. and foreign agricultural productivity; and normal (average) weather.

Changes in any of these assumptions can significantly alter the projections, and actual conditions that emerge will alter the outcomes. Among the more critical assumptions are those involving agricultural policy and macroeconomic conditions.

The Conservation Reserve Program (CRP) is reauthorized in the 1996 Farm Act. Maximum CRP area is set at 36.4 million acres. The new law permits the Secretary of Agriculture to re-enroll current land at contract expiration and to enroll new land to replace acreage leaving the CRP through expired contracts or early termination.

Over 20 million acres of CRP contracts expire in 1997. Enrollments in 1997 are assumed to keep the CRP from falling below 30 million acres. Enrollments in subsequent years are assumed to gradually increase the CRP to over 36 million acres by 2001.

The baseline assumes full compliance with all bilateral and multilateral agreements affecting agriculture and agricultural trade. Projections assume full compliance with the internal support, market access, and export subsidy provisions of the Uruguay Round GATT Agreement. The baseline assumes no accession to the World Trade Organization by the Newly Independent States (NIS) of the former Soviet Union, the Baltics, China, or Taiwan; no enlargement of the European Union (EU) beyond its current 15 members; and no expansion of the North American Free Trade Agreement. Agricultural and trade policies in individual foreign countries are assumed to continue to evolve along their current paths.

The baseline assumes that no new bilateral or multilateral agreements occur during the 1997-2005 period. Although a number of such agreements could emerge, given the World Trade Organization (WTO) mini-round scheduled for 1999 and potential agreements on WTO accession and EU-15 enlargement, the provisions and timing of potential agreements are uncertain.

Annual quantity and expenditure levels for the Export Enhancement Program (EEP) are assumed to be in compliance with GATT reductions, which require that by 2000, subsidized exports be reduced by 21 percent in volume and by 36 percent in budget outlays from 1986-90 levels. However, the 1996 Farm Act reduced total EEP funding during fiscal years 1996-99 from the maximum levels permitted under the GATT agreement. The 1997 Agriculture Appropriations Act further lowered the fiscal 1997 EEP level.

The 1996 Farm Act authorizes P.L. 480-Title I agreements with private entities in addition to foreign governments and broadens the range of commodities available for P.L. 480 programs. Total P.L. 480 program levels are assumed constant in the baseline for fiscal 1998 and later years. Program levels for other trade promotion and credit programs, including the Market Access Program and the GSM-102 and GSM-103 credit guarantee programs, are assumed constant in the baseline.

Domestic macroeconomic assumptions include deficit reduction that balances the Federal budget by 2002. This results in lower interest rates, higher productivity, and stronger growth in Gross Domestic Product. Baseline global economic growth averages about 3 percent annually over the next decade, well above growth during the first half of the 1990's. Macroeconomic growth in developed countries averages about 2.5 percent through 2005 as these economies rebound from growth slowdowns in the mid-1990's.

Market reforms lead to projected economic growth for the NIS and Baltics, and the countries in Central and Eastern Europe, following years of economic decline during the transition from centrally planned economies. Aggregate growth for developing countries over the next 10 years is projected to average about 5.5 percent, somewhat faster than over the past decade.

Strong U.S. export growth is the principal impetus for relative prosperity projected for the U.S. crop and livestock sectors from 1997 to 2005. World economic growth and trade liberalization provide increased opportunities for U.S. exports during this period.

In USDA's 1997 baseline, U.S. exports rise from this year's forecast of $56 billion to $80 billion by 2005. Exports of high-value products increase faster than bulk exports and account for a growing share of U.S. farm exports. In particular, meat and horticultural export values rise significantly through 2005.

Strong export growth is also projected for bulk commodities, particularly feed grains and wheat. U.S. bulk commodity exports expand more rapidly than during the 1985-95 period, helping to propel total U.S. farm exports to an average annual growth rate of about 4 percent through 2005. The export share of U.S. farm-product use grows significantly for corn, grows slightly for wheat and soybeans, and drops for rice and cotton, which experience rapidly growing domestic demand in the face of only marginal area gains.

Since the U.S. is the world's leading grain exporter and an important meat exporter, it stands to benefit from projected gains in international grain demand and higher commodity prices. And greater market orientation in the domestic agricultural sector under the new farm legislation puts U.S. farmers in a favorable position to compete in the global marketplace. As a result, the positive international outlook is echoed, for the most part, by the U.S. agricultural sector.

U.S. Demand To Rise For Major Crops

Strong growth in U.S. grain use leads to rising prices and greater acreage planted to most major field crops. Except for rice, exports are the major factor in this growth.

Productive capacity for U.S. crops is projected to rise due to increases in resource and input use and in productivity. Planted area for major crops rises 10-15 million acres above average plantings of the past 5 years. The increased area is drawn into crop production, based on market incentives, from acreage that producers previously chose to idle. For most crops, yields are projected to rise at or near their long-term trends. These gains in part reflect the acquisition of some agricultural land by larger, generally more efficient farms, continuing a long-term trend.

Conservation Reserve Program (CRP) acreage drops temporarily from the recent level of 33 million acres to about 30 million as land enrollment falls short of contract expirations, but then rebounds to over 36 million acres by 2001. However, with the CRP remaining above 30 million acres, the balance between productive capacity and projected demand tightens significantly as the land base is pressured. Most land enrolled in the CRP is in areas traditionally planted to major field crops, thus limiting the response of planted acreage to rising prices and net returns. This, together with strong world demand, pushes grain prices up.

In the near term, food and feed grain prices drop from the abnormal highs of recent months, but the outlook over the longer term is for a slow rise in prices. Big productivity gains occur for U.S. soybeans and other oilseed crops, maintaining a U.S. edge over other major producing countries. Gains in productivity and efficiency lead to lower production costs, leaving the U.S. well-positioned to meet the strong growth in demand projected for the oilseed sector.

For U.S. cotton, yield and acreage gains will provide the production needed to meet the strong growth in demand--particularly domestic demand--over the next decade. For cotton to compete successfully with other crops for more acreage, prices will have to follow those of grain and oilseeds. The U.S. specialty crops sectors also thrive, and the U.S. becomes a net exporter of fruits by 2000.

Domestic demand for most crops is projected to grow slightly faster than population. Notably stronger growth in domestic use of rice reflects a greater emphasis on dietary concerns as well as the increasing numbers of Americans of Asian and Latin American origins.

Livestock Stabilizes, Poultry Booms

U.S. livestock production will continue to undergo adjustments over the next few years in response to recently high feed costs, although differences in biological production lags among livestock sectors affect the pace of these adjustments. Nonetheless, the outlook for lower feed prices than in 1995/96, replenishment of forage supplies, continued low inflation, and domestic and export demand strength point to positive producer returns, encouraging increasing red meat and poultry supplies. However, as feed costs accelerate after 2000, gains in meat production slow, particularly red meats.

Cattle herds will likely stabilize beyond the year 2000 at about 97 million head, although shifts toward a breeding herd of larger cattle and heavy slaughter weights partially offset the need for expanding cattle inventories to previous levels. Beef production continues to be dominated by fed beef, to satisfy domestic and foreign demand for higher quality beef.

The U.S. pork sector will continue to evolve into a more vertically coordinated industry. Larger, more efficient pork producers will market a greater percentage of the hogs over the next 10 years. Pork production grows slowly from just under 18 billion pounds in 1995 to nearly 20 billion by 2005. However, accelerating feed grain prices beyond 2000 reduce producer returns and curb gains in hog inventories and production. The U.S. becomes an increasingly important net pork exporter over this period.

U.S. poultry production continues to expand as broiler meats gain an increasing share of total meat consumption. Poultry meat will be less expensive than other meats, so consumers can purchase more poultry meat per dollar. Production gains for turkey follow projected growth in the domestic and export market for processed products. Continued competition in the world poultry meat market holds U.S. poultry exports to moderate gains.

The price situation for meats and livestock is similar to that of crops--moderate growth in nominal terms but with real prices dropping. Over the longer term, feed prices will rise at rates similar to the general inflation rate. As a result, livestock producers do not experience any real (inflation-adjusted) increase in feed prices. At the same time, increases in feed efficiency, coupled with other production and marketing efficiency gains, push down real livestock production costs. The net result is that efficiency gains offset real farm-price declines for livestock, benefiting livestock producers.

Record total meat supplies are projected through 2005, although red meat production gains are small. Consumers purchase more meat, but a larger proportion is poultry, as per capita consumption of red meats declines. Declining real meat prices, along with increases in real disposable income, allow consumers to buy more total meat with a smaller proportion of disposable income.

.U.S. Farm Income Stabilizes

In light of the commodity-specific highlights, the U.S. farm income outlook is quite optimistic. Net farm income, in nominal terms, falls from recent highs to $36 billion in 1998, then rises through 2005. This implies a steady real farm income outlook--a definite change from recent trends. The agricultural sector increasingly relies on the marketplace for its income, as direct government payments fall through 2002 and represent less than 3 percent of gross cash income beyond 2000.

Both crop and livestock receipts are up, due to larger production and higher prices. However, production expenses also rise, with expenses for nonfarm-origin inputs rising faster than expenses for farm-origin inputs.

Farm asset values increase less rapidly than in the early 1990's, mainly because of slowing gains in agricultural land values. Increases in farm debt are not beyond the ability of farmers to service the debt. Farm lenders have largely recovered from the problems of the 1980's, so the availability of credit will not be a major concern. Debt-to-asset ratios remain flat at close to 15 percent, well below levels of the mid-1980's. With asset values increasing more than debt, farm equity rises slowly.

After declining from recent high levels, increasing nominal farm income, combined with rising farm equity, means relative stability in the financial condition of the farm sector. However, the sector will be highly competitive, and the trend toward fewer but larger farms continues.

Consumers benefit as food inflation grows more slowly than general inflation (continuing a long-term trend), even though disposable income spent on food is influenced by a continued trend of substantial purchases of food away from home. By 2005, expenditures for meals eaten away from home account for almost half of total food spending.

Behind The Projections

The outlook's general picture of growing international demand and strengthening global prices in the 1997-2005 period has direct implications for the welfare of the whole range of stakeholders in the domestic agricultural sector. Because of the diversity and interdependence of different players in U.S. agriculture, it is rare that an outlook scenario suggests that both producers of crops and livestock, as well as consumers, are well off or better off. Typically, for example, if grain prices are high (a good outlook for grain producers), livestock producers are likely to be hurt. Or if prices received by farmers for livestock products are high, consumers pay higher prices at the retail level.

Tradeoffs across subsectors and market participants are the rule. However, this year's domestic outlook for the 1997-2005 period reflects the exception to that rule. Farmers--whether crop producers or livestock producers--and consumers appear better off. Four principal factors interact to create this optimistic projection.

First, strong growth in export demand is the catalyst for the rapid increases in commodity use and the steady increase in nominal commodity prices. Reduced trade barriers under the GATT agreement, combined with strong global economic growth, particularly in developing countries, are behind the rise in world agricultural trade and U.S. crop exports.

Second, domestic policy and policy assumptions support a positive agricultural outlook. Planting flexibility introduced by the 1996 Farm Act facilitates the market's response to changing demand for U.S. agricultural commodities. In addition, USDA's baseline operates under the assumption that production flexibility contract payments (program payments) to farmers continue beyond the expiration of current legislation in 2002. This helps to explain why crop producers are better off, in the aggregate, despite lower real prices. Third, trade agreements and unilateral trade policy reform in other countries allow U.S. farmers to better realize competitive gains from their comparative advantage in many agricultural products, while reinforcing the advantages of freedom to respond to market signals.

Fourth, structural change in U.S. agriculture continues, via consolidation and concentration, and provides economies of scale that increase efficiency above and beyond technological change. In addition, increases in vertical coordination of several activities in the food production and marketing chain help to explain why consumers will face lower real food prices.

What Are The Uncertainties?

In creating a baseline scenario that builds on recent trends and policy actions, USDA is not saying that the "everyone wins" outcome will truly come to pass. The baseline is not a forecast. Any number of events might occur that could greatly alter the actual outcome. For example, the assumption that production flexibility contract payments continue is not a forecast that they will. Since future policy is unknown, the baseline assumes no change as a simplification. By keeping assumptions clear and straightforward, baseline users can easily adjust the projections to fit different versions of the underlying assumptions, which is particularly useful in areas of strong uncertainty.

Weather, as always, is the wild card. But several other factors play an important role in determining the direction and outcome of the U.S. agricultural sector into the next century. For example, government policy can take almost as many wild turns as weather. No change is assumed in current U.S. agricultural policy beyond 2002.

Unilateral foreign policy change is another big source of policy uncertainty. For example, the European Union (EU) could establish larger cropland set-aside rates than was assumed. Such a scenario would likely reduce EU grain exports and as a result, support international grain prices and improve U.S. competitiveness in international grain markets.

Multilateral or regional trade agreements could determine future directions for agriculture. Whether this would bode well or poorly for various U.S. stakeholders depends on the nature of any agreement's development. For example, EU enlargement could significantly decrease export demand for some U.S. agricultural commodities and food products. But accession of a few major countries, such as China, to the World Trade Organization could expand U.S. market access by increasing the number of countries playing by the same international trade "rules" as the U.S.

Strong income growth in developing economies is a major reason for the optimistic scenario outlined by the international baseline. Weaker growth would mean lower global trade, lower U.S. exports, and lower agricultural commodity prices.

Supply response, both domestic and international, determines the agricultural sector's performance in responding to market signals. Yield assumptions do not explicitly account for changes that could occur as a result of biotechnological breakthroughs. In addition, potential productivity changes that may result from the 1996 Farm Act are excluded, principally because a good deal of uncertainty remains about how domestic supply is going to respond in the absence of acreage reduction programs and deficiency payments. There is even greater uncertainty about the nature of foreign supply response. Experience in the recent past suggests that foreign supply can be highly responsive to price signals and can adjust very rapidly.

Energy prices and their stability over time are a perennial concern. However, there is no empirical basis for assuming a new energy crisis or anything other than a trend extension for energy prices. If energy price instability occurs, it could have a big impact on the outlook.

The prospect of declining U.S. and global grain stocks has generated considerable uncertainty, particularly since enactment of the 1996 Farm Act. Following several years of adjustments from recent unusually tight market conditions and high prices for many crops, long-term trends in supply and demand balances imply tightening stocks-to-use ratios and strengthening nominal prices for crops, especially beyond 2000. In particular, U.S. and global grain stocks-to-use ratios tighten relative to historical standards, as budgetary pressures and a continued commitment to market forces encourage governments to refrain from financing large grain stocks.

What this means for the outlook with respect to price volatility and food security remains uncertain. On the one hand, a range of factors--e.g., globalization of markets, trade and agricultural policy liberalization, and advances in telecommunications that allow electronic trade and link foreign and domestic futures markets--suggest that stocks have become less important to price stability. On the other hand, price levels are inversely related to stock levels, and as stocks decline, higher prices might make food security harder to assure in low-income countries.

In addition to the above uncertainties, a variety of issues that are currently central to the domestic agricultural economy--e.g., income risk management and sustainability--are not addressed in the baseline. The 1996 Farm Act's removal of traditional income safety-net mechanisms effectively transfers income variability risk from the government to farmers. Although baseline projections assume no shocks, normal variations in supply and demand will occur in the future. U.S. farmers will have to make strategic use of risk management alternatives to buffer a portion of this potentially greater income volatility.

Some farmers will expand their use of futures and options markets, possibly using new instruments such as yield contracts. Many producers continue to use crop insurance for yield protection and may expand coverage using revenue insurance now available in some areas. Other alternatives to manage risk include diversification of production, contracting in advance for the future sale of the commodity, integrated ownership, and involvement with more value-added processing beyond the farm gate. The baseline does not address which risk management mechanisms farmers will adopt or what their adoption will mean for production or average income levels.

The economic, ecological, and social conditions underlying the baseline analysis, or implied by the resultant outlook, may or may not continue. This consideration introduces more uncertainty about whether pathways suggested by the current outlook can be maintained over time.

In summary, the baseline is a "conditional scenario analysis," designed for comparative purposes. Whether or not an individual agrees with the underlying assumptions, the baseline serves as a clear reference tool from which alternate outcomes may be derived by changing those assumptions.

The Consumer Price Index (CPI) for food in 1997 is forecast to rise 2.5-3 percent, down from last year's 3.3-percent gain. The 1996 increase was the largest since 1990 when food was up 5.8 percent, and was slightly above the 2.9-percent increase for all goods and services.

The away-from-home component of the CPI is expected to increase 2-3 percent in 1997, compared with 2.5 percent in 1996. The higher Federal minimum wage, which went into effect in fall 1996, had minimal impact on the away-from-home index that year. While some upward pressure on the away-from-home index was expected, competition among restaurants and fast-food establishments remained strong and prevented the pass-through of higher wage and raw material costs to consumers. The at-home component of the CPI is expected to increase 2.5-3.5 percent in 1997, down from the 3.7-percent rise in 1996.

In spite of high grain prices last year, four major factors prevented a large runup in food prices in 1996 and should keep a lid on the impact of any commodity price advances this year. First, overall inflation (as measured by changes in the all-items CPI) remained stable at 3 percent in 1996 and is forecast to increase just above 3 percent in 1997. This means that costs related to food production and marketing--e.g., labor, packaging, transportation, and advertising--which account for about 75 percent of retail food costs, are not expected to increase substantially.

Second, the farm-value proportion of the U.S. food dollar, which has been on a declining trend and which stood at 22 cents in 1995, is expected to be about the same in 1996 and 1997. With a lower farm-value proportion (compared with 37 cents in 1973), retail food prices are determined less by farm commodity prices and more by market conditions for labor, packaging, and advertising, as well as by competition among firms.

Third, the trend of increasing economies of size in the agricultural sector is expected to continue. In particular, larger and more specialized pork, poultry, and beef (feedlots) operations have led to slower rising per-unit production costs.

Fourth, the away-from-home food sector, primarily restaurants and fast-food establishments, is much larger than two decades ago. Purchases of food away from home accounted for 47 percent of total food dollars spent in 1995, up from about a third in 1973, and are expected to be about the same in 1996 and 1997. A large away-from-home sector lessens the impact of rises in grain or other farm commodity prices on the overall food price index.

Changes in prices for away-from-home items are influenced more by developments in the nonfarm markets and by competition among restaurants and fast-food establishments, than by increases in farm commodity prices. The away-from-home food market has been very competitive since the recession of the early 1990's. Rising grain prices from late 1995 through summer 1996 affected feed costs as well as retail prices for beef, pork, poultry, eggs, dairy products, and cereal and bakery products. Because these food categories account for over a third of the at-home food dollar, price changes for these items can have a significant impact on the at-home CPI, which measures prices of purchases primarily from grocery stores and supermarkets. Although retail prices increased for most food categories in 1996, prices actually fell for three food categories--beef and veal, fresh vegetables, and nonalcoholic beverages.

Large beef supplies along with weakened export demand provided U.S. consumers with plentiful supplies, leading to the beef and veal CPI falling 0.3 percent in 1996. Beef production is expected to be about the same in 1997, which should push up the CPI for beef and veal by 1-3 percent.

Retail pork prices increased nearly 10 percent in 1996, due to lower pork output, fast-paced exports in the first half of the year, and brisk demand for bacon in the fast-food industry. With 1997 pork production likely to remain near 1996 levels and export demand strong, the CPI for pork is expected to increase 3-5 percent in 1997.

Prices for other meats increased 3.6 percent in 1996 and are expected up 1-3 percent in 1997. Other meats include highly processed food items, with prices influenced more by the general inflation rate than by the cost of the meat inputs.

Large supplies of oranges and western U.S. apples and should moderate fresh fruit prices in first-half 1997. The fresh-fruit CPI is expected to rise 3-5 percent in 1997, after posting a 7-percent increase last year. Domestic sugar production declined about 7 percent in 1996, as high prices for alternative crops and lower grower returns caused some producers to reduce sugar beet plantings. Along with lower sugar output, price increases for high-fructose corn syrup contributed to higher retail prices for selected sugar-related food items in 1996, boosting the CPI for sugar and sweets by 4.5 percent. With total sugar supplies expected up slightly in 1997, the CPI for sugar and sweets is expected to increase 2-4 percent in 1997.

The Advisory Commission to Study the Consumer Price Index (CPI) presented its final report to the Senate Finance Committee in December 1996. The report asserts that the overall CPI has overstated changes in the cost of living and that persistent and large overstatements have existed since the 1970's. The Commission's best estimate of the historic overstatement is 1.1 percentage points per year (adjusted for changes already made in the index), which results from four kinds of bias.

New product/quality improvement bias results from a failure to account for quality improvements associated with new products. The Commission attributed somewhat more than half of the overall bias in the total CPI to new product bias, a problem that is very difficult and time-consuming to solve. Formula bias results from an inappropriate aggregation of price changes.

Substitution bias results from lags in adjusting to changes in consumer expenditure patterns, particularly in response to changes in relative prices.

Outlet bias results from failure to account for the price effects of changes in retailing. The CPI includes price changes only within retail outlets, not across outlets.

The bias in the food-at-home CPI is higher than for the overall CPI--probably closer to 1.9 percentage points per year--and is due primarily to the last three sources of bias. The Bureau of Labor Statistics (BLS), which publishes the CPI and has done much of the research identifying the sources of bias, is introducing changes that will have a noticeable effect on the food-at-home CPI.

In January 1995, BLS made a technical change in the way new price observations are introduced to the index. The previous method attached too much importance to items whose prices were rising and not enough importance to items whose prices were falling. The likely effect on the food-at-home CPI is to reduce its growth by 0.4 percentage points per year, starting in 1996.

BLS also began publishing experimental versions of the index, aimed at better handling other formula bias issues. The experimental indexes appear to reduce growth in the overall CPI by 0.25 percentage points per year, growth in the food-at-home CPI by 0.7 percentage points per year, and growth in the fresh fruit and vegetable index by 4.5 percentage points per year. The agency will begin publishing the experimental series in early 1997, and there is a good chance the new approach will be included in the official CPI by 1998. Steps could be taken to handle substitution bias in the CPI, but that would require additional funding to substantially expand annual household consumption surveys. Further, the adjusted index would be published with a lag. Because of the expense and the publication time lag, such steps are less likely. Outlet bias is estimated to have added 0.25 percentage points to the food-at-home CPI over the last decade. This estimate may decline if structural change toward larger and lower priced food stores slows.

You may also contact CONSENSUS at:
Consensus, Inc.
P.O. Box 411128
Kansas City, Missouri 64141
rsalva@aol.com

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