Sandhusker
Well-known member
Cattle Marketing Agreements:
Good for the Individual Feeder; Bad for the Group
OCM Economics Fellow
Dr. Robert Taylor
Captive supply advocates argue that marketing agreements are good for both feeder and packer because they reduce the need to haggle over the price . Based on such assertions, many people, including notable Federal Judges and some economists who should know better, immediately jump to the conclusion that if marketing agreements are good for the individual then they are good for the industry.
Not so. There is a fundamental logical error in such reasoning, which is referred to as the fallacy of composition. A fallacy of composition arises when one infers that something is true of the whole from the fact that it is true of some (or even every) part of the whole.
A common example of the logical fallacy is that any person can get a better view at a football game by standing. Of course, if one stands, then others stand because their view was blocked. If everyone stands, no one gets a better view. In fact, if standing people start moving around looking for an even better view, as they tend to do, then most people get a worse view than with all sitting. It is thus a fallacy to conclude that just because an individual can get a better view by standing, all would get a better view by standing.
A logical fallacy exists with marketing agreements if the base price in such arrangements is tied to the cash market, as is typical. This contract feature alters packer's economic incentives. The aggregate market consequence is that cash prices are below truly competitive levels; furthermore, as the proportion of slaughter coming from marketing agreements increases, the more depressed cash price becomes.
Feeders who sell on the cash market are thus obviously harmed by marketing agreements. What feeders with marketing agreements often fail to recognize is that, as a group, they are also equally harmed because their agreements are tied to the (sub-competitive) cash market price.
The three Federal Appeals Judges who upheld Judge Strom in striking the Jury decision in Pickett v. Tyson/IBP asserted that,
"If a packer's course of business promotes efficiency and aids competition in the cattle market, the challenged practice cannot, by definition, adversely affect competition.
Wrong! Either the Judges erred in not understanding that "economic efficiency" has many meanings, or they committed the fallacy of composition. Just because a business practice increases economic efficiency to some market participants does not necessarily mean that aggregate market efficiency will be increased. It can be shown using very basic economic reasoning that marketing agreements, because they distort packer's economic incentives, will decrease (not increase) aggregate market efficiency as long as the reduced transaction costs (from not haggling over price) is less than the efficiency loss due to sub-competitive prices.
The Circuit Judges supported their fallacious reasoning with a Federal Judge's opinion in Griffin v. Smithfield Foods (a captive supply hog case) that,
… The PSA (Packers & Stockyards Act) was designed to promote efficiency, not frustrate it."
Because marketing agreements have a base price tied to the cash price (or to an
in-plant price) they do indeed frustrate aggregate economic efficiency and thus
violate the PSA.
Even livestock economists, many of whom have been accused of being packer-friendly, have condemned captive supply arrangements that have a base price tied to the cash market price:
"Contracts with a formula arrangement where the base price is either a cash market in which the packer/processor is an active buyer or a plant average price paid for the week prior to delivery offer the wrong incentives. Whether buyers attempt to manipulate the cash market to which the contract price is tied is somewhat immaterial because the incentive to do so is present and is undeniable." Dr. Wayne Purcell, VPI, 2000
"… the practice of tying a formula base to an in-house average spot market price does distort packers' incentives and has the potential to result in harm to
livestock producers. We suggest that the Secretary (of Agriculture) should consider regulations designed to prohibit this practice." Dr. John Schroeter, Iowa State University, 2000
"… base prices based on plant averages (which is a cash price) are not recommended and this has been a position I have held for a long time." Dr. Ted Schroeder, Kansas State University, 2000
It is especially noteworthy that a significant group of livestock economists made the following recommendation to NCBA in 1999:
"(NCBA should) adopt a policy position opposed to contractual arrangements between cattle feeder/producer and packer when the base price is tied to a cash market in which the buying packer is active in buying fed cattle and/or when the base price is tied to plant or firm prices paid or cattle costs into the plant(s) for some time period prior to the date of delivery with the reasons for the policy position coming from the inappropriate incentives of this approach and from the need to restore integrity to the pricing system. The incentives facing buyers when price is tied to markets in which they are large buyers are not consistent with confidence and integrity of the pricing process." Drs. Wayne Purcell, Clement Ward, Ted Schroeder, Rodney Jones, James Mintert, James Trapp, Barry Goodwin, Matthew Holt, and DeeVon Bailey
There are three critical characteristics of the cattle market that lead to cash prices below truly competitive levels. These are the disproportionate market power of packers, asymmetric information favoring the packer-buyer over the feeder-seller, and marketing agreements with a base price tied to the cash market. The most evil of these is marketing agreements with a base price tied to the cash market price. On this, economists agree. Recently proposed Captive Supply Reform legislation (H.R. 4257) would correct this problem, and thus be a significant first step in restoring competition to cattle markets. RT
Good for the Individual Feeder; Bad for the Group
OCM Economics Fellow
Dr. Robert Taylor
Captive supply advocates argue that marketing agreements are good for both feeder and packer because they reduce the need to haggle over the price . Based on such assertions, many people, including notable Federal Judges and some economists who should know better, immediately jump to the conclusion that if marketing agreements are good for the individual then they are good for the industry.
Not so. There is a fundamental logical error in such reasoning, which is referred to as the fallacy of composition. A fallacy of composition arises when one infers that something is true of the whole from the fact that it is true of some (or even every) part of the whole.
A common example of the logical fallacy is that any person can get a better view at a football game by standing. Of course, if one stands, then others stand because their view was blocked. If everyone stands, no one gets a better view. In fact, if standing people start moving around looking for an even better view, as they tend to do, then most people get a worse view than with all sitting. It is thus a fallacy to conclude that just because an individual can get a better view by standing, all would get a better view by standing.
A logical fallacy exists with marketing agreements if the base price in such arrangements is tied to the cash market, as is typical. This contract feature alters packer's economic incentives. The aggregate market consequence is that cash prices are below truly competitive levels; furthermore, as the proportion of slaughter coming from marketing agreements increases, the more depressed cash price becomes.
Feeders who sell on the cash market are thus obviously harmed by marketing agreements. What feeders with marketing agreements often fail to recognize is that, as a group, they are also equally harmed because their agreements are tied to the (sub-competitive) cash market price.
The three Federal Appeals Judges who upheld Judge Strom in striking the Jury decision in Pickett v. Tyson/IBP asserted that,
"If a packer's course of business promotes efficiency and aids competition in the cattle market, the challenged practice cannot, by definition, adversely affect competition.
Wrong! Either the Judges erred in not understanding that "economic efficiency" has many meanings, or they committed the fallacy of composition. Just because a business practice increases economic efficiency to some market participants does not necessarily mean that aggregate market efficiency will be increased. It can be shown using very basic economic reasoning that marketing agreements, because they distort packer's economic incentives, will decrease (not increase) aggregate market efficiency as long as the reduced transaction costs (from not haggling over price) is less than the efficiency loss due to sub-competitive prices.
The Circuit Judges supported their fallacious reasoning with a Federal Judge's opinion in Griffin v. Smithfield Foods (a captive supply hog case) that,
… The PSA (Packers & Stockyards Act) was designed to promote efficiency, not frustrate it."
Because marketing agreements have a base price tied to the cash price (or to an
in-plant price) they do indeed frustrate aggregate economic efficiency and thus
violate the PSA.
Even livestock economists, many of whom have been accused of being packer-friendly, have condemned captive supply arrangements that have a base price tied to the cash market price:
"Contracts with a formula arrangement where the base price is either a cash market in which the packer/processor is an active buyer or a plant average price paid for the week prior to delivery offer the wrong incentives. Whether buyers attempt to manipulate the cash market to which the contract price is tied is somewhat immaterial because the incentive to do so is present and is undeniable." Dr. Wayne Purcell, VPI, 2000
"… the practice of tying a formula base to an in-house average spot market price does distort packers' incentives and has the potential to result in harm to
livestock producers. We suggest that the Secretary (of Agriculture) should consider regulations designed to prohibit this practice." Dr. John Schroeter, Iowa State University, 2000
"… base prices based on plant averages (which is a cash price) are not recommended and this has been a position I have held for a long time." Dr. Ted Schroeder, Kansas State University, 2000
It is especially noteworthy that a significant group of livestock economists made the following recommendation to NCBA in 1999:
"(NCBA should) adopt a policy position opposed to contractual arrangements between cattle feeder/producer and packer when the base price is tied to a cash market in which the buying packer is active in buying fed cattle and/or when the base price is tied to plant or firm prices paid or cattle costs into the plant(s) for some time period prior to the date of delivery with the reasons for the policy position coming from the inappropriate incentives of this approach and from the need to restore integrity to the pricing system. The incentives facing buyers when price is tied to markets in which they are large buyers are not consistent with confidence and integrity of the pricing process." Drs. Wayne Purcell, Clement Ward, Ted Schroeder, Rodney Jones, James Mintert, James Trapp, Barry Goodwin, Matthew Holt, and DeeVon Bailey
There are three critical characteristics of the cattle market that lead to cash prices below truly competitive levels. These are the disproportionate market power of packers, asymmetric information favoring the packer-buyer over the feeder-seller, and marketing agreements with a base price tied to the cash market. The most evil of these is marketing agreements with a base price tied to the cash market price. On this, economists agree. Recently proposed Captive Supply Reform legislation (H.R. 4257) would correct this problem, and thus be a significant first step in restoring competition to cattle markets. RT
