Back to Kentucky's Coal Industry: Historical Trends and Future
OpportunitiesBy William M. Snell
University of Kentucky
From Exploring the Frontier of the Future: How Kentucky Will Live, Learn and
Work
pp. 155-161, published 1996
Tobacco has long been an important agricultural commodity for Kentucky. But, it also has been an extremely controversial one. The tobacco debate has intensified during the 1990s. Existing and proposed regulations and restrictions, excise tax increases, the smoking and health debate, social attitudes towards tobacco use, legal suits, and international competition provide much uncertainty for the future of the tobacco program, tobacco farming, and many of Kentucky’s rural economies. Despite the serious issues facing Kentucky tobacco farmers, an expanding international market for U.S. tobacco and tobacco products has enabled the industry to survive, and in some areas, actually grow during the 1990s. Last year the U.S. tobacco industry established record highs for cigarette output, cigarette exports, and trade balance. Leaf imports were down considerably from earlier years, and growers received record high net market prices for their crop in 1995. Despite these achievements, though, many dark clouds remain above the tobacco industry. This chapter reviews recent trends in the Kentucky and U.S. tobacco industries, overviews the current U.S. tobacco situation and outlook, and discusses the potential implications of the current political, economic and legal issues facing the state’s number one agricultural commodity.
Much of Kentucky’s rural economy has developed around the tobacco industry. Tobacco is grown in 119 of the Commonwealth’s 120 counties. More than 100 Kentucky counties will have tobacco sales exceeding $1 million this year. In several Kentucky counties, tobacco farming directly accounts for more than 10 percent of the total personal income from all income sources. According to a U.S. Department of Agriculture (USDA) study, 17 of the nation’s 20 most tobacco-dependent counties are in Kentucky, most of them located in regions with limited off-farm employment opportunities.
Kentucky is the largest producer of burley and dark tobaccos and the nation’s most tobacco-dependent state. While North Carolina grows more tobacco than Kentucky, tobacco accounts for a larger percentage of agricultural income in Kentucky relative to North Carolina. Tobacco generally accounts for 40 percent to 50 percent of Kentucky’s crop receipts and 20 percent to 30 percent of Kentucky’s total agricultural cash receipts. The 1992 Census of Agriculture revealed that tobacco accounts for more than 40 percent of the net cash return from agricultural sales in Kentucky.
Unlike other facets of agriculture, tobacco has generally remained connected with small family farms. According to the latest (1992) Census of Agriculture, 59,000 of Kentucky’s 89,000 farms grow tobacco. This represents nearly 50 percent of the total number of farms growing tobacco in the United States. The average tobacco farm in Kentucky possesses 113 acres, with fewer than five acres of tobacco grown. While consolidation has been occurring over the past couple of decades, the concentration of tobacco farms has occurred at a slower pace in Kentucky, relative to other tobacco states.
Figure 1: Value of Kentucky Tobacco Production
Kentucky’s tobacco farmers have experienced significant adversity over the past three decades. Government regulations, health findings, taxation, and foreign competition have continued to threaten the existence of the Kentucky tobacco industry. Despite these challenges, the Kentucky tobacco industry has survived—and actually grown. The value of tobacco production in Kentucky has averaged $816 million during the 1990s (1990-1995), compared to average of $705 million during the 1980s, $443 million during the 1970s, and $250 million during the 1960s. Based on projected production and prices, the 1996 Kentucky tobacco crop will likely again exceed $800 million.
Tobacco’s economic impact reaches beyond the farm gate. Tobacco farmers purchase a wide variety of goods and services associated with producing the crop, and they utilize the cash generated from the crop to generate additional economic activity in local agricultural and nonagricultural businesses. Total income multipliers reveal that every $1 million increase in Kentucky tobacco income generates a $3.7 million total (direct and induced) effect on the state’s economy. Multipliers reveal that Kentucky tobacco production and processing accounts for around 5.7 percent of the state’s total economy. Local, state and national governments receive more than $15 billion of tax revenues from the sale of tobacco products. (Kentucky’s net excise tax collections from tobacco product sales totals around $18 million.) In addition, the tobacco industry contributes around $6 billion to the country’s trade mix, which is currently in a deficit exceeding $100 billion annually. Thus, the economic viability of tobacco production in Kentucky (and surrounding states) reaches beyond the state’s agricultural economy.
Approximately 93 percent of the tobacco produced in Kentucky is burley tobacco, which is used primarily in the manufacturing of cigarettes. The remaining 7 percent of Kentucky’s tobacco production is comprised of dark air- and dark fire-cured tobaccos, which is used mainly in smokeless tobacco products. Smokeless tobacco consumption in the United States has been increasing in recent years, which has certainly benefited the agricultural economies in several western Kentucky counties.
U.S. cigarette consumption peaked in the early 1980s. During most of the 1980s and early 1990s, cigarette consumption in this country declined 2 percent to 3 percent annually. Despite an escalated antitobacco movement, U.S. cigarette consumption leveled off in 1995 and appears to be relatively flat in 1996. Stabilizing domestic cigarette consumption and soaring U.S. cigarette exports resulted in U.S. cigarette production establishing a record high level in 1995, which is expected to be surpassed in 1996.
Higher cigarette output has increased the leaf requirements of domestic manufacturers. Demand for domestic burley leaf was severely hampered during the early 1990s with the increasing use of imported tobacco to supply an increasing market for generic (value priced) cigarettes. However, the combination of domestic content legislation (requiring domestic manufacturers to use at least 75 percent U.S.-grown tobacco in their blends or face significant financial penalties), increasing cigarette output, and a reduction in the market share of generic cigarette sales has strengthened the demand for domestic tobacco. Although (in response to a GATT ruling) the domestic content law was replaced in 1995 by a much less restrictive tariff rate quota system, imports, while increasing, currently remain well below the record high levels of the early 1990s.
Figure 2: U.S. Cigarette Consumption and Production, 1950-1996
In addition to improvements in domestic demand for U.S. burley, export demand for U.S. burley is also on the rise. Tight world burley supplies coupled with an increasing demand for blended cigarettes worldwide has enabled U.S. burley exports to rebound in 1996. Collectively U.S. burley domestic use and export demand are expected to total near 600 million pounds for 1996—approximately the average level over the past 25 years.
The international market presents both challenges and opportunities for the Kentucky tobacco industry. Despite increasing antitobacco efforts overseas, worldwide consumption of tobacco continues to grow—and it is growing more for burley tobacco than other tobacco types. This increasing world market has spawned much competition overseas, especially in certain developing countries (e.g., Brazil, Argentina, Malawi, and Zimbabwe) where tobacco represents a major source of income and foreign exchange. While the volume of U.S. burley tobacco exported has increased over the years in response to a growing worldwide demand for the American-blended cigarette, the United States has experienced a significant decline in world market share. Much of this can be attributed to increased price and quality competition from foreign tobacco-producing nations.
Figure 3: U.S. Burley Disappearance, 1960-1995
The current tight supply of burley tobacco in the world market is putting upward pressure on world burley prices. This situation, coupled with stable U.S. burley prices is resulting in an improved U.S. burley price competitive position. However, anticipated production increases overseas will likely cause the U.S./foreign price differential to increase in the near future. Thus foreign burley-producing countries will likely be able to continue to increase their exports relative to the United States amidst this price-conscious world tobacco market environment. But this growth will likely occur in markets that presently, and for the foreseeable future, cannot afford U.S. tobacco. Thus, the United States may be able to sustain a consistent, dependable—but not growing—niche market for high-quality burley tobacco. This assumes that the United States continues to have adequate export supplies available, addresses quality perception issues, and constrains export price growth.
On the domestic front, farm leadership has reason for concern over future import levels. The tariff rate quota import policy will provide domestic manufacturers with an opportunity to import a considerably higher level of burley and flue-cured tobacco than under the domestic content law. This relaxed trade policy environment coupled with increasing foreign burley supplies at more competitive prices will undoubtedly cause imports to increase in the near future. This situation will be exacerbated by U.S. burley production shortfalls relative to the quota.
Increasing international competition continues to force farm group leaders and policymakers to evaluate the provisions of the tobacco program. The U.S. tobacco program has arguably been one of the most successful agricultural programs ever administered by the U.S. Department of Agriculture. Unlike other agricultural programs, the tobacco program over the years has achieved the original basic goal of providing price and income protection for a large number of small family farms without incurring large government outlays. However, the tobacco program has been the focus of attack for many years. Proposals to eliminate or dramatically alter the program are brought up annually in the U.S. Congress. Earlier this year tobacco state lawmakers were successful in defeating a House of Representatives proposal to deny crop insurance and extension services to tobacco farmers by a margin of only two votes (212-210). The unprecedented 1996 Farm Bill did not address the tobacco program as tobacco is under permanent legislation. Although the tobacco program "operates" as a no-net-cost program, farm group leaders are skeptical whether the tobacco program can survive amidst the changing federal farm policy environment.
Abolishing the federal tobacco program would eliminate the value of the quota, representing a major income loss to quota owners. Price volatility would increase significantly and U.S. tobacco prices would fall by 20 percent to 25 percent or more without a production control/price support program. A price decline of this magnitude would likely reduce the number of family farms growing tobacco by more than 50 percent and would be devastating to many small rural communities that depend on tobacco income, but lack off-farm employment opportunities. Even with much lower and volatile prices, U.S. tobacco production without a tobacco program would likely increase in concentrated low-cost production areas, depending on the successful adoption of lower cost production technologies and the political/regulatory environment for tobacco. The elimination of the tobacco program would also have adverse effects on land values, property tax bases, and the sale of agribusiness goods and services in certain rural areas. Without a tobacco program, tobacco companies would have access to lower cost domestic and foreign leaf, resulting in slightly lower cigarette prices (and thus slightly higher cigarette sales) and/or higher tobacco company profits.
The design of the tobacco program (i.e., price supports and production control) has been well-supported by the quota owners, producers, and the tobacco companies over the years. If the federal program is eliminated, the question becomes: Can a production control/price support program be designed without governmental assistance (i.e., privately operated)? Program financing and maintaining effective production controls become critical and challenging issues surrounding a privatized program.
In addition to international competition and program issues, perhaps the most serious threats currently facing Kentucky’s tobacco industry are regulatory and legal. In August 1996, the Clinton Administration has granted the Food and Drug Administration (FDA) authority to regulate tobacco products to reduce youth smoking. The tobacco companies and farm organizations have stated that they oppose youth access to tobacco products, but are fearful of FDA attempting to gain broad jurisdiction over the sale of tobacco products to all consumers. In response to this threat, the tobacco industry is challenging FDA regulation in courts on the grounds that Congress never intended for the FDA to regulate tobacco. Tobacco farm policymakers and some tobacco companies are supporting legislative efforts to address the youth smoking issue.
The tobacco industry is also facing a large number of class action suits. The lawsuits accuse tobacco companies of concealing evidence that smoking is addictive and manipulating nicotine levels to "hook" smokers. In May, a federal appeals panel dismissed a potential multibillion dollar national class action suit against U.S. cigarette manufacturers. This issue now has been diverted to a series of state class action suits.
The outcome of these regulatory and legal issues facing the industry remains unclear. What is clear is that they could have a potentially devastating impact on the U.S. tobacco industry and the Kentucky agricultural economy. What also is clear is that given the financial resources at risk, most of these issues will likely be tied up in court for many years to come.
Given the uncertainty of the tobacco program and the overall tobacco economy, tobacco farmers and farm organizations are examining and experimenting with diversification strategies to supplement the potential decline in tobacco income. Tobacco farmers have been advised for decades that they need to diversify, and many farming operations have. Despite various degrees of diversification, however, many remain extremely dependent upon a crop with a very uncertain future.
Diversification in many parts of tobacco-growing regions is limited for a variety of reasons. The major reason cited by tobacco farmers is the profitability and the stability of returns for tobacco relative to other enterprises. While some fruit and vegetable crops under favorable growing and marketing conditions may rival or even exceed the net returns of tobacco in some years, there is no single crop (or livestock) enterprise available that will consistently generate the level of tobacco returns for a large number of small family farms.
Successful diversification efforts often also entail discovering and maintaining a niche market for some commodity. Additional competition by a few producers or sudden and unexpected changes in market windows may cause prices and profits in these markets to fall abruptly. Even if some farmers are willing to take on less profitable enterprises with more price risk, land characteristics (e.g. farm size, topography, soil quality), labor resource constraints, limited marketing outlets, large capital investments, and the degree of management often limit many tobacco farmers from expanding or adopting new enterprises. For many tobacco farm families, diversification or complete abandonment of tobacco production simply means part- or full-time employment off the farm.
Another potential reason cited for lack of diversification among tobacco farmers is age. The majority of tobacco farmers are over 50 years of age. They have heard the likely downfall of tobacco for decades, yet tobacco demand and use remains relatively high. Many of these tobacco farmers are reluctant to invest in riskier enterprises that may have the potential to generate long-term returns comparable to tobacco. Some have attempted alternative crops in the past with mixed to poor results. Given their age, plus limited labor, capital and managerial resources, these farmers will allocate their resources to the enterprises that generate the greatest short-term economic return. For many, this enterprise mix continues to be led by tobacco.
For some Kentucky farmers diversification strategies may include tobacco for use in alternative or extended uses. According to scientists, the tobacco plant is one of the easiest and most economical plants to manipulate genetically. Genetically engineered tobacco can be used in the production of various items including pharmaceuticals, vaccines, industrial enzymes, insecticides, and personal care products. Research and product development using bioengineered tobacco are still very much in their infancy. Presently it appears evident that a market will develop for genetically engineered tobacco. However, with no established market at this time, it is difficult to surmise the potential economic effects at the farm level. In the immediate future, it appears that this technology will lead to a niche market for a small subset of tobacco growers to supplement tobacco grown for traditional uses. The longer term prospects for tobacco farmers are still unclear.
Despite the limitations facing tobacco farmers, some diversification is occurring beyond traditional enterprises. Both the Kentucky Farm Bureau and the Burley Tobacco Grower’s Cooperative have recently initiated programs that will likely enhance diversification opportunities for Kentucky tobacco farmers. In addition, the state’s Department of Agriculture and the University of Kentucky’s College of Agriculture are allocating more resources towards agricultural diversification. These supplemental enterprise efforts will likely reduce Kentucky’s dependence on tobacco over an extended period.
The tremendous amount of political, economic, legal, and social uncertainty surrounding the tobacco industry makes outlook projections for this controversial crop extremely difficult and risky. The current factors shaping the tobacco outlook lead to more questions than answers.
While the industry has experienced much volatility over the past couple of decades, the trend line for Kentucky burley quota since the early 1970s is basically flat at 400 million pounds. Dark tobacco acreage allotments, while down in 1996, have rebounded considerably from their lows in the 1980s. Thus, despite all the serious attacks on tobacco, Kentucky tobacco production has not drastically declined as many have predicted over the years. But can the Kentucky tobacco industry survive in the future?
Presently, tight world tobacco supplies and growing world demand are increasing the need for burley tobacco which may result in higher production quotas for Kentucky farmers in 1997. Despite escalated educational campaigns on tobacco use and health, tobacco consumption continues to grow modestly worldwide. This trend is not expected to reverse abruptly in the near future. Thus, demand for tobacco worldwide is expected to remain near current record levels leading into the 21st century. However, tobacco consumption in traditional markets for U.S. tobacco and tobacco products is stagnant or declining. Most of the growth in the world market is occurring in markets that presently cannot afford U.S. tobacco or U.S. tobacco products. Presently, U.S. demand is relatively strong in response to tight world supplies. However, world burley production is increasing, which will eventually put pressure on farm group leaders to once again address price competition. Even if the farm leadership decides in the future to lower price supports for U.S. tobacco, it remains questionable whether U.S. burley producers collectively would increase supply to meet the anticipated increase in demand. Thus, the ability of the U.S./Kentucky tobacco producer to take advantage of the growing world market is limited, given the current tobacco program and the cost structure of many existing growers.
Figure 4: Kentucky's Basic Burley Quota, 1971-1996
Domestically, additional taxation, regulation, and health issues will likely result in the industry reverting back to annual declines in U.S. cigarette consumption. Tobacco leaf imports under the new tobacco trade policy have the potential once again to become a serious threat to the domestic tobacco grower. Furthermore, protection for the small family tobacco farm is jeopardized by the potential dismantling of the tobacco program. Finally, the legal challenges currently facing the tobacco industry could eventually have very serious negative ramifications for the entire industry.
While it is difficult to estimate the potential economic effect of these issues facing the tobacco industry, we can expect that the factors mentioned above will induce a significant change in the structure of tobacco farming in Kentucky and surrounding states leading into the 21st century. Increasing cost pressures and alternative resource opportunities will likely continue to erode interest in growing burley tobacco in Tennessee and North Carolina. Consolidation is occurring slowly for Kentucky’s tobacco industry, but it is occurring and will continue. The number of farm quotas has declined from over 150,000 in the early 1990s to around 130,000 in 1996. The pace of future consolidation hinges greatly on program changes and program survival. Obviously, the elimination of a price support/production control program will greatly accelerate tobacco farm consolidation. Farm labor/barn space limitations, increasing off-farm employment opportunities, declining profitability of tobacco, the antitobacco movement, and the long-term outlook for tobacco are collectively resulting in a declining interest in growing the crop in some areas of the state. The number of tobacco producers will likely fall at an accelerated rate, with a continuing emphasis on part-time farming and off-farm employment. Livestock and horticultural production will likely receive additional attention in these traditional tobacco growing areas. While proving beneficial to certain producers, it is unclear whether these supplemental/alternative agricultural enterprises (suitable for the existing tobacco farm resources) will be able to generate large enough economic returns to sustain the majority of small to midsize family farms in these rural areas. Thus, the high cost of production in tobacco-dependent regions that are not able to lure attractive off-farm employment opportunities will likely be challenged in the future to achieve much additional economic growth.
Alternatively, the tobacco economies in the more efficient tobacco-growing regions of the state may be able to compete quite effectively in a future environment of intense international competition and major changes (or possibly elimination) of the U.S. tobacco program. The niche market for high-quality U.S. burley may enable some Kentucky tobacco farmers to maintain current tobacco production or perhaps increase production under a program elimination scenario. Quality is still a major factor in determining manufacturer purchasing patterns. Premium cigarette sales have been increasing the past several years in the United States relative to generic cigarettes which should aid domestic growers. Furthermore, the anticipated increase in purchasing power in various parts of the world will likely continue to boost the demand for competitively priced/higher quality cigarettes. Although tobacco leaf quality has improved overseas, the growing and curing conditions in Kentucky still provide Kentucky farmers with a distinct quality advantage over their competitors in other parts of the world. The questions now become how large of a market and what is the quality price premium?
Thus, while the structure of tobacco farming in Kentucky will likely change significantly in the near future, a slowly declining domestic market coupled with overseas demand patterns suggest that the Kentucky tobacco industry will still be a viable economic sector in the years to come. This does not suggest that the Kentucky tobacco economy will once again approach the record $1 billion crop of 1982. But the niche demand for Kentucky’s tobacco in the world market will likely enable the industry to achieve $500 to $900 million crops in the immediate future. (As detailed above, though, this income will be concentrated in fewer farming operations in the future which certainly presents challenges to policymakers and community leaders in areas lacking off-farm employment opportunities). However, even this potential outcome is immensely dependent on the uncertain future political, regulatory and legal actions affecting the U.S./Kentucky tobacco industries.
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