By William M. Snell
From Foresight, Vol. 5, No. 3
published 1998
Tobacco remains an important, controversial and uncertain component of the state’s agricultural economy. Despite increasing international competition, escalating health concerns, excise tax increases, enhanced regulatory activity and political uncertainty over the past couple of decades, the Kentucky tobacco industry has survived and has actually exhibited growth during the 1990s (Figure 1).
Figure 1: Value of Kentucky Tobacco Production, 1970-97
The value of Kentucky tobacco production has averaged over $825 million during the current decade, compared to averaging around $700 million during the 1980s and $450 million during the 1970s. Even after adjusting for inflation, the value of Kentucky tobacco production has grown in recent years and has been relatively stable over the past 10 years. Last year, despite some very challenging growing conditions, Kentucky farmers produced almost $950 million of tobacco—the fourth highest tobacco crop value on record. Marketing quotas provide the potential for Kentucky farmers to grow over $1 billion of tobacco in 1998. Despite the recent growth in the Kentucky tobacco economy, current political, social, and economic factors indicate the industry will likely experience a noticeable downturn in the near future, with the long-term picture remaining very uncertain.
Tobacco has traditionally been the state’s most valuable agricultural commodity, generally accounting for around 40 to 50 percent of the state’s annual total crop value and 20 to 25 percent of the state’s total agricultural cash receipts (Figures 2-3). These returns are produced on just over 1 percent of the total farmland in Kentucky. According to the latest available census data (1992), nearly 60,000 of Kentucky’s 88,000 farms grow tobacco, averaging less than five acres of tobacco production. The 1997 census data (to be released early next year) will likely reveal that some concentration has occurred in the Kentucky tobacco sector over the past five years. But the data will still portray an agricultural sector that is based primarily on a large number of small family farms. Tobacco is grown in 119 of Kentucky’s 120 counties and provides over $1 million of gross income annually to more than 100 Kentucky counties. Besides contributing to tobacco production, a significant portion of these dollars are used to pay off debt, support agricultural diversification efforts, and purchase goods and services in the local economy.
Figure 2: Distribution of Kentucky Crop Values, 1990-1996
Figure 3: Distribution of Kentucky Agricultural Cash Receipts, 1990-1996
While few can argue the importance of tobacco to the agricultural economy, there has been a lot of debate recently over the economic importance of tobacco to the state’s overall economy. Given the expansion of the nonagricultural economy in Kentucky, it is not surprising that tobacco, like any other single component of the state’s economy, is a relatively small percentage of the state’s diverse economy. Since 1990 the value of Kentucky tobacco production has (directly) accounted for 1.2 percent of the state’s total personal income. Accounting for multiplier effects, recent studies have estimated that the total tobacco industry (production and processing) contributes some 3 to 5.7 percent of the total value of goods and services produced in the state.
Although the economic importance of tobacco on a statewide basis is being overshadowed by expanding manufacturing, retail, and service sectors, tobacco remains a vital component of many rural economies throughout the state. Today’s local economies receive income from a wide variety of sources, including earnings from a host of agricultural enterprises, interest, dividends, government transfer payments, and nonfarm wages from local businesses, factories, public service jobs, etc. Given the diversity of income sources, one could argue that any single sector (or in the case of tobacco, a subsector of agriculture) directly providing more than 5 percent of total income base for a county is significant. A review of 1990-1996 data reveal that tobacco production directly accounted for more than 5 percent of the total personal income for 27 Kentucky counties with the total contribution (including direct, indirect and induced effects) being between 10 percent and 20 percent for many of these counties. A majority of these "tobacco-dependent" counties are located in areas that possess relatively high poverty rates, low educational attainment levels, and limited off-farm employment opportunities (see map). In fact, every one of these 27 "tobacco-dependent" counties have average per capita income levels and the percentage of citizens with a high school diploma is below the meager state average. Almost two thirds of these counties have experienced personal income growth below the state average over the 1990-1996 period. Thus, additional income-generating opportunities and educational achievements are very important to the long-term growth of these economies. In the short-term, though, a significant downturn in the tobacco economy will certainly have noticeable adverse effects on many of these "tobacco-dependent" local economies.
Map 1: Value of Tobacco Production as a Percent of Total Personal Income, 1990-1996
The fate of the Kentucky tobacco industry has been very vulnerable over the past couple of decades to the political environment facing tobacco in our nation’s capitol. This vulnerability swelled in 1998 as the U.S. Congress devoted considerable attention to a national tobacco settlement to address a changing legal environment and social attitudes towards tobacco consumption and the tobacco industry. Various proposals were offered and debated—many of which included significant tax increases, expanded governmental regulatory authority and additional marketing restrictions on the domestic tobacco industry. Initially, the major U.S. tobacco companies supported various legislative efforts dealing with tobacco marketing and regulations in exchange for future liability protection. However, an increasing settlement price tag, coupled with increased liability exposure, eventually induced the tobacco industry to fight against passage of comprehensive tobacco settlement legislation.
As part of the settlement discussions, policymakers and farm groups discussed various means to compensate tobacco farmers and rural communities for financial losses attributable to a settlement. Proposals ranged from providing farmer compensation for demand reductions associated with a continuing tobacco program to mandatory quota buyouts that would have phased out the federal tobacco program. Despite a considerable amount of attention to this issue, farm groups, lawmakers, and farmers failed to arrive at any consensus on the best means to protect tobacco farmers and their rural communities from likely demand declines originating from a tobacco settlement.
Eventually, the comprehensive tobacco settlement legislation (i.e., the McCain bill) died in the U.S. Senate. Other proposals surfaced in the U.S. Senate and the U.S. House of Representatives to address the tobacco settlement and more specifically, teen smoking. While the debate continues, the tobacco industry thus far has prevailed in preventing relatively large federal tax increases and regulatory actions as part of national tobacco legislation.
Failure to pass any national tobacco legislation was both beneficial and detrimental to tobacco farmers. On the positive side, many tobacco settlement proposals would have generated significant long-term adverse effects on an already declining domestic tobacco industry. However, many of these proposals also provided a financial means to protect tobacco farmers and rural communities from lower domestic tobacco demand that will likely evolve with or without a tobacco settlement. Although farmers did not receive any tangible results from the tobacco settlement talks in Washington, D.C., they were able to better inform many diverse national groups, lawmakers, and the national media on the tobacco program and the plight of the American tobacco farmer. As a result, tobacco farmers were successful in obtaining support from a variety of nontraditional alliances that may pay dividends in years to come. Tobacco settlement discussions continue, but recent legislative and nonlegislative tobacco settlement proposals presently do not offer any tobacco farmer compensation packages. The possibility of future compensation packages cannot be ruled out completely, but if available, will likely be offered at a much lower funding level compared to initial congressional farm-level compensation packages.
What does this mean for Kentucky tobacco farmers in the near future? Despite a short-term victory in their battle to ward off relatively large federal tax increases and expanded governmental regulatory control, U.S. tobacco companies still face a mounting number of lawsuits and the potential for additional future regulatory action and/or large excise tax hikes by federal and state governments. Consequently, the price of tobacco products will continue to rise steadily in the near future to finance state/federal tax increases and legal claims against the tobacco industry. This will prompt further declines in domestic consumption and entice consumers to switch to lower-priced products which generally contain less domestic tobacco. In addition, the export market is currently being plagued by increasing tobacco supplies, depressed prices, and the lingering Asian financial crisis. Collectively these factors will likely induce conservative buying patterns when the 1998-99 tobacco marketing season opens later this year, boosting inventory levels and grower marketing assessment fees, and prompting relatively large marketing quota cuts for 1999. Thus, rural Kentucky can expect a noticeable decline in tobacco income for the next several years relative to recent near-record income.
The structure and stability of Kentucky agriculture has been influenced greatly by the presence of a federal tobacco program. Despite Kentucky’s relatively small size, the Commonwealth possesses the fourth largest number of farms in the United States. In fact, Kentucky has more farms growing tobacco than 37 states have total farms. However, this structure could change significantly in the future, with the outcome hinging considerably on changes in the federal tobacco program.
The tobacco program has been in existence since the 1930s and can arguably be labeled as one of the most effective farm programs ever administered by the U.S. Department of Agriculture. Over the years, the program has accomplished many of the original goals of farm programs of providing income and price support for a large number of small family farms without incurring large government expenditures. Farmers have shown their support of the program via referendums (held every three years) which have consistently tallied over 90 percent approval of maintaining the program.
Despite farmer support for the program, political pressure to eliminate the federal tobacco program has been mounting in recent years. Some lawmakers question the federal government’s role in discouraging tobacco consumption while simultaneously supporting tobacco production. Farm leaders respond that the structure of the tobacco program (through production controls and price supports) artificially elevates the price of tobacco and thus is consistent with the government’s goal of reducing tobacco consumption. Consequently several health organizations support continuing the program.
The tobacco program is also vulnerable to the current political environment of reducing the federal government’s role in all of agriculture. Under the 1995 Farm Bill, Congress voted to phase out most other federal agricultural commodity programs as a means to provide farmers more planting flexibility, control government spending on agriculture, and to increase the overall international competitiveness of U.S. agriculture. However declining grain prices are currently prompting some lawmakers and farm groups to reevaluate the government’s role in farm programs.
The tobacco program has also been under attack recently regarding its cost to the federal government. The program "operates" at zero costs to taxpayers through marketing assessments collected from tobacco growers and tobacco buyers. However, there are some relatively small administrative costs associated with the program. Currently, farm organizations and lawmakers from tobacco-producing states are examining these costs which the industry may have to absorb to further insure the program’s existence.
Despite all the arguments provided by farm leaders, much uncertainty still exists over the future of the 60-year-old federal tobacco program. Kentucky would likely be affected more than any other tobacco-producing state if the program were eliminated. Abolishing the tobacco program would eliminate the value of quota, representing a major income loss to the more than 120,000 quota owners in Kentucky. While growers would benefit from not having to pay a rental (lease) fee for additional production rights, they would sacrifice price stability which is the primary reason most support the existing program. Without a program, price volatility would increase significantly and tobacco prices could easily fall 25 percent or more. Unlike other agricultural commodities, a futures market is not available for tobacco to aid farmers in managing price risk. Some growers would benefit without production control constraints, but there is no doubt that a major structural change in tobacco farming would certainly occur in Kentucky.
Without a tobacco program, production would tend to gravitate to the lowest-cost producers. Under the current structure of the tobacco program, small scale producers may have some cost advantages over larger producers given their access to family labor and the use of depreciated assets. However, small scale producers’ access to markets and credit and their ability to remain low-cost producers is questionable under the structure of a free market environment. Contracts offered by tobacco companies and dealers are the means of marketing tobacco in many countries. If a contract marketing system were to evolve, tobacco companies (or whoever would administer the contract system which could include dealers or warehouse owners) would likely initially seek existing tobacco growers who had access to large and productive tracts of land.
While the production response under a free market environment is unclear, a 500 million pound tobacco crop in Kentucky (anticipated production level for 1998) could be produced by around 10,000 farms (compared to the current 60,000 estimate) assuming tobacco production averaged just 20 acres per farm. A 10-acre average under a free market system would reduce the number of tobacco farms required to produce a 500 million pound crop by approximately 50 percent from its current level.
Although the location of tobacco production in a free market system is debatable, it certainly appears that eastern Kentucky’s tobacco economy would be very vulnerable without a tobacco program. On average, this region possesses the lowest yields, least available cropland per farm, and the lowest return to quota compared to other regions of the state. Unfortunately this area also possesses several of the tobacco-dependent counties discussed above. While central Kentucky currently maintains some advantage over tobacco production, yields, and existing infrastructure (e.g., barns, management), western Kentucky’s larger farms and productive cropland offer potential for shifting tobacco production more towards the western part of the state under a free market system. Given the current infrastructure available, tobacco production may initially stay in traditional tobacco producing states in the short-run, however, over time production could move into nontraditional areas based on production costs and quality considerations.
The drastic structural changes that may evolve absent a federal tobacco program have prompted some discussion of a privatized tobacco program. Under such a program, some nongovernment entity could be assigned by the U.S. Congress authority to control production and provide price support for growers. However, the success of such a system hinges greatly on the ability to control production, access to private financing and broad base support by the tobacco companies and growers—all of which would be difficult to achieve without the oversight of the federal government.
The U.S. and Kentucky tobacco industries have exhibited a lot of resiliency over the years. In recent years, the industry has achieved record highs for cigarette production/exports, tobacco trade balance and burley leaf exports, effective quotas and market prices. Despite a lot of external pressures on the industry, the overall demand for burley tobacco and thus marketing quotas for Kentucky farmers have remained remarkably stable during the past 30 years (Figures 4-5). However, these economic trends will be extremely vulnerable in the future political and legal environment facing tobacco. Consequently, long-term planning is certainly a challenge for everyone associated with the tobacco industry.
Figure 4: U.S. Cigarette Production, Consumption and Exports
Figure 5: Kentucky Burley Tobacco Basic Quota
In reality, the planning strategy for many tobacco farmers has not changed much over the years: focus on producing, harvesting, and marketing this year’s crop while looking over their shoulders at the political, social and economic issues that complicate the outlook for their livelihood. A partial list of the current unknowns that they face includes:
the future existence of the federal tobacco program
potential compensation from a tobacco settlement
tobacco tax increases
additional tobacco regulation
social attitudes towards tobacco
health issues related to tobacco
the tobacco companies’ future political dependency on tobacco growers
the working relationship/unity of tobacco farm organizations
price/quality competitiveness of U.S. leaf
political/economic environment in third world tobacco-producing/consuming countries
farm labor supplies
disease control
access to credit.
A large degree of risk and uncertainty is attached to the list above. This will prompt differing responses by farmers across the state in dealing with this risk. Many farmers will continue to evaluate various agricultural diversification strategies to supplement the potential of declining tobacco income. Others will continue to evaluate off-farm income opportunities, if available. But, given this list, what can tobacco-dependent farmers and rural communities anticipate in the future? This is extremely difficult to answer without knowing the political outcome of the tobacco program and tobacco tax increases, regulation and litigation. Nevertheless, some outcomes appear apparent.
The number of active tobacco farms/farmers will continue to diminish. The tobacco debate is beginning to wear down many farmers. They are consistently being bombarded with all the negatives associated with tobacco. The aging tobacco farm population is also a major factor that will accelerate concentration. Furthermore, net profit margins have been narrowing in recent years in response to low yields and the increasing cost of labor and disease control. Concentration will obviously escalate if the tobacco program is eliminated.
Average production size of remaining tobacco farms/farmers will likely increase. Consequently, tobacco dollars will be concentrated in fewer, but larger production units.
Tobacco production and income volatility will continue. Currently the tobacco program is structured to protect against price volatility, but at the expense of production (i.e., quota) volatility. Worldwide tobacco demand patterns are fairly consistent, but given the more than 100 countries producing tobacco, supply levels vary tremendously over time. Consequently this affects U.S. tobacco marketing quota volatility and would have a very pronounced effect on price volatility if the program is abolished.
Domestic tobacco consumption and thus leaf demand will continue to decline in response to rising tobacco taxes/prices, regulations and anti-tobacco related programs.
Growth potential still exists in the international market in response to personal income growth, freer trade, and tobacco marketing campaigns. Despite an increasing anti-tobacco movement overseas, worldwide burley consumption has been steadily increasing during the decade of the 1990s as foreign consumer preferences are changing more towards cigarettes containing burley tobacco. These changing demand patterns have enabled both U.S. cigarette and leaf exports to expand during the current decade. Increasing regulatory pressures on the domestic companies in the United States, coupled with the potential for expanding foreign markets, may entice an increased movement of manufactured tobacco products being produced overseas. This may temporary boost U.S. leaf exports, but over time leaf trade will be dictated by the price/quality competitiveness of U.S. leaf relative to foreign sources. Kentucky burley tobacco is noted worldwide as exhibiting superior quality characteristics for smoking flavor and aroma. However, the quality advantage of Kentucky burley has narrowed somewhat over time, while buyers have also become more price-conscious. Increasing supplies and price/quality competition from African and South American tobacco growers will continue to make it challenging for Kentucky tobacco farmers to capitalize on this expanding world market.
Collectively these political, social, and economic factors indicate that the Kentucky tobacco economy will likely decline from its recent near-record levels and these dollars will be concentrated among fewer farms. Nevertheless, the niche demand for Kentucky’s tobacco in the world market will enable the industry to remain a viable, important, yet volatile component of Kentucky agriculture for years to come. The challenge before farm leaders and lawmakers is to capitalize on increasing international opportunities for tobacco farmers while creating additional agricultural marketing and nonagricultural employment opportunities for farmers attempting to diversify their income base.
William M. Snell is an Associate Extension Professor in the Department of Agricultural Economics at the University of Kentucky.