With the change in administration and controversies still swirling around the COVID-related market disruptions, there are many active conversations and policy proposals focused on concentration and pricing in cattle markets. Many of my colleagues have had smart things to say on these topics. To mention just a few, check out the recent hearing of the U.S. Senate Ag Committee featuring testimony by Glynn Tonsor, Mary Hendrickson, Dustin Aherin, Mark Gardiner, and Justin Tupper, or see this piece by economists Derrell Peel, David Anderson, John Anderson, Chris Bastian, Scott Brown, Steve Koontz, and Josh Maples, or some previous writing by Koontz.
One of the main issues being debated is that, over time, fewer fed cattle are being sold in the cash or spot market. Rather, cattle are increasingly sold via various formulas or contracts. The rub is that most of the contracts use the cash market price as base to which premiums and discounts are add or subtracted. That is, a relatively small percentage of trades are determining the price for a relatively large number of cattle. Are there “enough” transactions in the spot, cash market to truly reflect market fundamentals and facilitate price discovery (and some have argued, to prevent “market manipulation” by any one party)? This is actually an old problem facing agriculture as concentration and consolidation has occured. For example, Bill Tomek has a seminal paper from 1980 on thin markets entitled “Price Behavior on a Declining Terminal Market.”
Some of the current policy proposals involve a mandate or requirement that packers buy a certain percentage of their cattle in the spot market. This approach would, presumably, improve price discovery. However, it comes at a cost. Many of the current contracts reward beef quality. Might quality, and thus consumer demand, fall if such incentives were eroded? More fundamentally, it can be noted that the increasing trend away from cash markets reflects voluntary choices on the part of producers and packers, who both presumably see some benefit in pursing alternative marketing arrangements relative to the cash market. Mandating a certain percent of trades occur on the cash market would require some producers to sell in the cash market who presumably would have preferred to sell by contract or formula. That’s a cost.
That said, there could also be benefits from more cash trades. Those benefits might be thought of as a type of public good because, as pointed out in some of the aforementioned testimony and writings, improved price discovery doesn’t necessarily mean higher prices for producers. Rather, it means that any given trade is likely to be more reflective of market fundamentals vs. “noise” or other idiosyncrasies (see the Tomek article for a deeper treatment of the issue).
So, there are benefits and costs to mandating more cattle be sold in the cash market. You can click on the aforementioned links to see for yourself where most of the economists wind up on this issue. My point here isn’t to weigh in on that topic per se. One role of academics, advocated most effectively in Roger Pielke Jr’s book The Honest Broker is to try to expand the opportunity set of ideas.
If the goal is to increase price discovery, are there more efficient ways to do that than mandate a certain percentage of cattle be sold on the spot market? Or, are there ways to make a mandatory cap less costly on the system?
A few thoughts (other, related ideas, have been offered by many of the folks I linked to previously).
A mandate might be made more efficient if accompanied with a "cap and trade" system. If each packing plant must buy a certain percent of cattle on the cash market, a secondary market could be created for this federally assigned "obligation to buy cattle." Each packer would have a mandated obligation to buy a certain number of cattle in a certain amount of time. They can either fulfill that obligation by buying cattle OR by buying “offsets” from another packer or entity. These offsets essentially transfer the obligation to buy cattle in the spot market from another packer to another packer (or another entity).
Prices in this secondary “offset” market would reflect the cost of requiring additional cash transactions. More importantly, this approach would ensure that those cattle being bought and sold on the cash market are those most efficiently sold in that manner. While perhaps a bit crazy, there are active secondary markets like this for fuel, where refineries are federally required to buy and blend a certain amount of biofuels (see this explanation of RINs), and there are similar schemes to mitigate pollution in the most cost-effective way (see this piece about SO2 cap-and-trade).
The futures market is another area where price discovery for cattle occurs, and even in the absence of many cash trades, the futures price is relevant particularly given that live cattle futures contracts can be settled with physical delivery of cattle. If futures markets are also "too thin," why not have the mandate act on the futures price rather the physical animals per se? That might reduce transactions cost.
If the issue of price discovery is really a public-good issue, there is a very large economics literature on these topics. From a purely technocratic standpoint, one way to discourage free-riding is to tax the behavior (in this case, it would mean a tax on transactions not in the cash market). Or, one might subsidize sales in the cash market (how are the subsidies funded?). How would the efficiencies of these tax and subsidy policies compare to a mandate?
Or, perhaps we academics can take a page out of Nobel Prize winning economist Elinor Ostrom’s book, and sit back and see what norms and practices emerge to help solve this particular tragedy of the commons.