Transition Economies: INTERNATIONAL AGRICULTURE AND TRADE        June 11, 1998
May 1998, WRS-98-2  
              Approved by the World Agricultural Outlook Board
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Economics Editors
William Liefert (202) 694-5156
Nancy Cochrane (202) 694-5143

Authors
Carlos Arnade
Britta Bjornlund
Nancy Cochrane
Mildred Haley 
Roger Hoskin
Olga Liefert
William Liefert
David Sedik
Michael Trueblood

Technical Editor
Diane Decker

Production/Design
Wynnice Pointer-Napper
Victor Phillips, Jr.

Cover Photo

INTERNATIONAL AGRICULTURE AND TRADE REPORTS
TRANSITION ECONOMIES
Situation and Outlook Series

Contents
Summary
Restructuring of the Livestock Sectors in the Transition
Economies of the NIS and Central and Eastern Europe
Russian and Ukrainian Agriculture and Trade Outlook to 2005
Agricultural Enterprise Restructuring and Land Reform in Russia,
1991-95: An Efficiency Analysis
List of Tables
List of Figures

Preface

The articles presented in this report are drawn from the major
research projects of the Market and Trade Economics Division of
ERS concerning agriculture in the transition economies of Central
and Eastern Europe and the New Independent States.

The term "New Independent States" (NIS) used throughout this
report refers to the 12 countries that comprised the former USSR. 
The "Baltic" countries (Estonia, Latvia, Lithuania) are not
included in the NIS as they were not recognized by the United
States as part of the then Soviet Union.  The 12 NIS countries
are the Russian Federation, Ukraine, Belarus, Kazakstan, Moldova,
Armenia, Azerbaijan, Georgia, Uzbekistan, Turkmenistan,
Kyrgyzstan, and Tajikistan.

The phrase "terms of trade" referred to throughout the report
means the terms, or prices, at which agricultural producers
"exchange" output for inputs.  It is measured by comparing
agricultural output prices to input prices, such that if input
prices rise relative to output prices, the producers' terms of
trade worsen, or deteriorate.  The concept of terms of trade can
apply to any situation in which there is exchange of goods, such
as the terms (prices) at which a country trades its exports for
imports.  However, unless otherwise indicated, the phrase is used
in this report as defined above.

Throughout the report, "economic reform" in the transition
economies is defined as changes in institutions and policies that
help foster the development of a market economy.  Institutional
reform includes privatization and the creation of market
infrastructure, such as systems of market information, banking
and finance, and commercial law.  Macroeconomic reform policies
include reducing inflation, tightening monetary and fiscal
policy, and stabilizing the exchange rate.  Trade liberalization
is defined as reducing direct state management of trade, as well
as specific trade controls, such as tariffs and quotas.

Acknowledgments

Appreciation for review of the contents of the report is extended
to: F. Surls, C. Christensen, M. Shane, M. Bohman, and C. Foster
of the Economic Research Service; N. Morgan and S. Sheffield of
the Foreign Agricultural Service; and G. Bange and G. Rector of
the World Agricultural Outlook Board.

Keywords: Trade, forecast, meat, grain, livestock sector,
transition economies, relative prices, privatization, farm
structure, private sector, institutional reforms, land markets,
market infrastructure, efficiency, restructuring, reform.

Summary

Economic Reform's Initial Impact Has Been Lower Production, Lower
Productivity

Economic reform in the transition economies of Central and
Eastern Europe and the New Independent States (NIS) of the former
USSR has initially reduced both agricultural output and
productivity. The livestock industry has been particularly hurt. 
The main way by which agricultural output can rebound in the transition
economies is
through productivity growth, which by lowering costs of
production, would make domestic output more competitive with
foreign imports.

The first of three articles presented in this report examines
restructuring in the livestock sector; the second presents
long-term forecasts (to 2005) of Russian and Ukrainian agricultural
production and trade; and the third analyzes the effect of reform
on the economic efficiency of Russian crop producers. 

The main effect of economic reform on agriculture in the
transition economies has been the severe contraction of the
livestock sector.  Since reform began, both livestock inventories
and output in most countries of the region have dropped 30-50
percent.

The contraction has been mainly due to the reform policies of
price and trade liberalization, which means that the downsizing
has been an inevitable part of market reform.  Price
liberalization and the reduction of producer subsidies have led
to a worsening of producers' terms of trade (as input prices rose
much more than prices for output).  With trade liberalization,
producers were suddenly exposed to higher quality and less
expensive agricultural imports.  In some countries, all this was
compounded by disruption following land reform and the
liquidation of agricultural cooperatives.

However, in certain transition economies, such as Poland and
Hungary, the livestock sector is beginning to stabilize, and even
rebound.  For example, hog inventories have stopped falling in
both countries, and poultry numbers are clearly rising.  The main
reasons for the resurgence are that productivity (especially of
feed) and the quality of output are improving, and the
institutional supports for market-oriented agriculture are being
created.  All these developments allow domestic producers to
compete better with imports, and even to export certain products. 
Incentives to improve productivity and quality of output have
been greater in Poland and Hungary than in the slower reformers
because the two countries have more extensively privatized their
agriculture and enacted policies to prepare for accession to the
European Union. 

Although Poland and Hungary are among the faster reformers of the
region, Russia and Ukraine are the transition countries whose
agriculture most affects world markets.  USDA forecasts that
Russia will remain a major importer of meat, with net imports at
about 2.5 million tons by 2005.  The forecast assumes slow
recovery in GDP, which will increase consumer demand, and only
modest productivity growth within the livestock sector.  The
moderate growth in productivity will not be sufficient to
overcome Russia's current comparative cost disadvantage in meat
production.

Russia is forecast neither to return to the large grain imports
of the pre-reform period nor to become a large grain exporter. 
Net grain imports by 2005 are predicted at about 2.5 million
tons, the bulk being wheat.  Ukraine, however, is forecast to be
a modest net exporter of grain.

The main way that agriculture in the transition economies can
become more competitive on the world market is by raising
productivity, that is, getting more output from a given amount of
input, which would reduce unit costs of production.  A concept
related to productivity is economic efficiency, defined for
producers as attaining maximum output from a given quantity of
inputs.  The Economic Research Service is completing a study that
examines the efficiency of Russian crop producers during the
reform period.  The study finds that although under reform
agricultural efficiency has generally decreased throughout the
country, those regions that were more efficient under the Soviet
regime have experienced only a slight decline in efficiency. 
However, those regions that were less efficient have suffered a
major decline in efficiency under reform.

A likely explanation is that farms that were relatively less
efficient at the beginning of reform, say because of poor
management, have had a harder time coping with the challenges of
reform.  They have therefore performed even less well than before
compared with more efficient farms.  Yet, farms in less efficient
regions are likely to be favored with state subsidies, which have
the effect of both keeping the farms in business and reducing
incentives to improve performance.

The study also concludes that farms tend to be more inefficient
(1) the larger they are (in area); (2) the more heavily
subsidized they are; and (3) the more diversified they are in
their output mix.  The last point indicates that Russian farms
become more efficient the more they specialize in producing crops
in which they have a comparative cost advantage.

Restructuring of the Livestock Sectors in the Transition
Economies of the NIS and Central and Eastern Europe

Among five transition economies, Poland, Hungary, Romania,
Russia, and Ukraine, Poland and Hungary have advanced the
farthest in the restructuring of their livestock sectors. Their
relative success is due to more extensive privatization, reform
of marketing infrastructure, and policies aimed to prepare for EU
accession. All five countries face common obstacles, however,
such as undeveloped land markets, lack of a rural credit system,
and a relatively immobile labor force.
[Nancy Cochrane, Britta Bjornlund, Mildred Haley, Roger Hoskin,
and Olga Liefert]

One of the most dramatic adjustments that took place once the
economies of Central and Eastern Europe (CEE) and the New
Independent States (NIS) began to be liberalized was a virtual
free fall in the livestock sector. Consumer and producer
subsidies were nearly or completely eliminated, and producers
were exposed to international competition. Consumer demand for
meat plummeted and producers were increasingly squeezed between
falling output prices and skyrocketing production costs. The
result was a drastic decline in livestock inventories of all
categories. Between 1990 and 1995, hog numbers fell 48 percent in
Hungary and 38 percent in Russia; cattle numbers fell 27 percent
in Russia and 46 percent in Romania.

Seven years after the beginning of the transition, this decline 
appears to have ended in some of the transition economies while
continuing in others. In Poland and Hungary, for example, hog
numbers have been fairly constant in the last 2 years and poultry
numbers are actually rising. Inventories are still falling,
however, in Russia and Ukraine, and cattle numbers continue their
decline throughout the region.

This paper examines the restructuring of the livestock sectors of
five different countries: Poland, Hungary, Romania, Russia and
Ukraine. We define restructuring as the reallocation of all
factors of production--land, labor, and capital, as well as
material inputs--in response to the changes in relative prices
that came with the transition. When faced with higher prices,
producers throughout the region rapidly adjusted by decreasing
their use of material inputs, but the movement of land, capital,
and to some extent labor has been more problematic. Countries
such as Poland and Hungary have gone the furthest in the
restructuring process, while others are only now beginning
serious changes. As we examine the changing structure of
livestock markets in the five countries, we will attempt to
enumerate some of the policy and institutional factors that have
allowed restructuring to progress further in some countries than
in others. We will end with some projections regarding the future
structure of the livestock sectors in these countries and
directions for further research.

Background: Causes of the Restructuring

Though restructuring in the five countries began at different
starting points, it was triggered by similar developments. Each
country's livestock sector endured common shocks including a
worsening terms of trade (ratio of output to input prices),
integration into the world economy requiring competition with
foreign producers, and falling consumer demand for livestock
products following the removal of consumer subsidies and lowered
real income.

Price and Trade Liberalization

The impact of price and trade liberalization was much greater on
the livestock sector than the crop sector because both producers
and consumers of livestock products were very heavily subsidized
under communism. Price liberalization substantially reduced
consumers' real income (as prices increased more than wages and
salaries), and thereby lowered purchasing power. Demand for meat
products is quite sensitive to changes in income, while demand
for staple products, such as bread and potatoes, is less
sensitive. The result was an almost immediate drop in consumer
demand for meat.

With exposure to the world market and the reduction of subsidies,
livestock producers faced an abrupt increase in production costs.
Prices throughout the economy adjusted immediately to reflect
real costs of production. For the livestock sector, the result
was worsening terms of trade--prices of agricultural inputs rose
by a greater percentage than output prices. From 1991 to 1996,
for example, farmgate prices for all meats in Russia rose only
about 25 percent as much as prices for mixed feed. In recent
years livestock producers' terms of trade have started to
stabilize at a level that better reflects real costs. But because
prices for energy and fuel in Russia and Ukraine are still kept
below world prices, further price liberalization is likely to
worsen these countries' agricultural terms of trade.

Exposure to world competition has proven a great shock to the
livestock sectors. The region has been generally uncompetitive in
livestock production vis-a-vis the world market, in terms of both
price and quality. The collapse of CEMA (Counsil for Mutual
Economic Assistance) trade arrangements and uncompetitive local
livestock sectors allowed a flood of imports from the west. In
particular, poultry imports from western countries have surged in
both Russia and Ukraine. Although Poland, Hungary, and Romania
were traditional exporters of poultry to the former Soviet Union,
they  have not been able to compete in the NIS market with
exports from western countries, particularly the United States.
Pork imports to the region have also grown substantially.

Changes in Farm Structure

Early in the transition, state farms and cooperatives, more so in
the CEE's than in the NIS countries, were privatized,
restructured, or liquidated. This process was generally
accompanied by a wholesale transfer of animals into private
hands. The new owners lacked adequate facilities to keep the
animals and could not afford proper feed, which led to widespread
slaughter or export of live animals. In many cases, prize
breeding animals were slaughtered. Animals that remained on large
state-owned complexes usually did not fare any better. The state
complexes were often heavily indebted and short of cash. Even
when supported by soft loans from the government, they still
lacked the finances to maintain proper feed rations and have
significantly reduced herds in response.

Response of Livestock Producers

Drastic changes in relative prices as well as changing
agricultural policies and institutions have demanded marked
adjustments for livestock producers throughout the region. The
private sector share of animal production and meat output has
increased significantly in all the countries (tables 1 and 2).
But this shift has been slower in NIS countries, such as Russia
and Ukraine, than in the CEE countries. Moreover, decisions of
new private producers are strongly influenced by their
relationships with the former state owned enterprises--both the
"transformed" state and cooperative farms and the processing
enterprises.

Feed is the main input and cost component in meat production, and
feed productivity (live weight gain per unit of feed) declined in
all the countries in the early years of the transition. The
decline stemmed directly from a shift to lower cost feed
ingredients. Farmers, no longer able to afford a balanced feed
mix for animals, sharply reduced the use of costly mixed feeds,
switching to lower concentrated feeds that are poorly balanced
with proteins and other supplements. Hog producers switched from
high protein grains and oilmeal to less costly concentrated feed;
cattle producers turned away from relatively expensive
concentrated feed in favor of forage crops and pasture grazing.

In the CEE's hogs fared better through these changes than poultry
or cattle, while cattle fared better in the NIS. Poultry are more
dependent on high quality protein feed and suffered more from the
deterioration in feed quality. Cattle in the CEE's were severely
affected because of changes in the dairy market plus the
wholesale liquidation of cooperatives. Cattle throughout the
region are mainly dairy cattle; beef comes from culled cattle and
young bulls. Dairy products were very heavily subsidized under
the communist system, and the removal of those subsidies greatly
reduced the supply and demand for dairy products. Cattle also
demand more land, and with the liquidation of cooperatives in the
CEE's, cattle were often distributed to private producers who did
not have the land on which to keep them. In contrast, collective
farms in the NIS, where cattle were concentrated, have been
transformed into corporate farms, but remain largely intact, such
that more land is available for grazing. Hogs in the NIS, on the
other hand, were concentrated on huge complexes that have been
hit hard by the restructuring process.

[Begin BOX]

The Lessons of Transition for Agriculture

ERS has begun a research project to identify the lessons of
transition for agriculture, given that sufficient time has now
elapsed since reform began for lessons to emerge. The lessons
should help western policy makers and agencies advise the current
transition countries on agricultural reform. They should also
help in future work in any remaining unreformed centrally planned
economies, such as Cuba and North Korea, should they also begin
to reform.

One lesson evident from the restructuring of the livestock sector
is that as an inherent part of market reform, production of
certain goods must fall. Reform means that consumers' preferences
replace planners' desires as the driving force in determining
output. Production of those goods favored by planners but not by
current consumers will inevitably drop, particularly when price
liberalization leads to prices that reflect the real costs of
production.

The downsizing of the livestock sector has raised concerns among
both eastern and western policy makers about potential food
security problems. As explained in this article, the contraction
is not the result of a supply-side breakdown in production
capability. It is simply a correction to the overexpansion of
food production in the countries before reform. Per capita
consumption of most food remains high compared to both
nutritional requirements and consumption in other countries with
roughly the same level of per capita real income.

Although certain groups suffer from deficient diets, this is
mainly a problem of poverty and inadequate purchasing power. Two
groups are the most vulnerable to food insecurity. The first is
pensioners and other state dependents, whose benefits from the
state social welfare system are inadequate. The second is workers
who lose their jobs because their employing industries are
producing goods favored by the old regime but not by current
consumers. The most cost effective way to help these groups is
through well-targeted transfers of money income, as well as
retraining for those made unemployed.

Other more specific lessons of transition for agriculture can be
found in the reform experience of countries such as Poland,
Hungary, the Czech Republic, and the Baltic States, which are
reforming their agriculture more quickly than Romania, Bulgaria,
and the NIS. In the former group, agricultural output is rising
(or at least not falling as much as in the slower reforming
countries), the quality of output is improving, and institutional
reform--particularly privatization and creation of market
services that support agriculture--is proceeding more quickly.
All of these factors are evidence of faster progress toward
market reform. By analyzing the reasons why certain transition
countries are reforming their agriculture and food economies more
quickly and effectively than others, one can identify lessons for
the slower reformers. An approach we will follow will be to
identify the obstacles to agricultural reform that all transition
economies face, and then explain how the faster reforming
countries are surmounting these reform hurdles.
[William Liefert]
[End BOX]

Response of Russian and Ukrainian Producers

In 1997, aggregate animal inventories and meat production in both
Russia and Ukraine were down for the eighth straight year
(figures 1-3). Since 1991, the year the Soviet Union broke up,
Russian cattle inventories have decreased by 44 percent (with
cows down 30 percent). Russian hog numbers declined by about 55
percent, and poultry by 50 percent (table 3). 

Falling inventories and declining animal productivity in Russia
and Ukraine have led to sharp decreases in production of all
types of meat, milk, and eggs (table 4). Since 1991, total meat
output (beef, pork, poultry, and mutton) has dropped almost 50
percent in Russia, and 55 percent in Ukraine. In both countries
poultry production has declined the most (65 percent in Russia
and 72 percent in Ukraine), followed by pork at more than 50
percent in Russia, and beef at more than 40 percent (figures 3 to
6).

The terms of trade deteriorated most significantly for poultry
producers and the least for beef producers, even though farmgate
prices for poultry have increased the most since 1991, and beef
prices the least. The explanation for this apparent paradox is
that poultry production depends heavily on certain inputs,
specifically mixed feed and energy (fuel), which during the
Soviet period were extremely low in price relative to other costs
of production (poultry was mainly produced in the highly
subsidized large-scale state complexes). Price liberalization
caused input prices to increase significantly. Although farmgate
prices for poultry producers have risen substantially, input
prices faced by these producers have risen proportionately more,
thereby worsening the terms of trade more than for other meat
producers. Beef production, on the other hand, is less energy
-intensive, and also allows for greater substitution of forage
crops and pasture grazing for mixed feed.

Feed productivity has continued to worsen in Russia and Ukraine,
where feed conversion rates are currently about four times higher
than U.S. rates for beef output, and three to four times higher
for pork. Declining feed productivity has coincided with falling
animal productivity (output per animal). In Russia from 1990 to
1996, annual weight gain per animal dropped about 45 percent for
both cattle and hogs. In Ukraine the decrease during 1990-1995
was 40 percent for cattle and 49 percent for hogs. 

Poor animal health care and genetics, as well as improper culling
of herds, are responsible for the falling animal productivity.
For 6 consecutive years (starting 1991) in Russia and Ukraine,
births rates per animal declined, death rates rose, and animal
slaughter weight fell. The rates showed marginal improvement in
1997 in Russia.

Falling animal productivity has led to longer feed-out times for
livestock. For example, in 1996, the feed-out time for hogs was
nearly 18 months compared to less than a year in 1990. Comparable
U.S. feed-out times are about 6 months. Longer feed-out times
effectively substitute labor for expensive manufactured feed.
On-farm produced feed is the main input. Feed-out times for cattle
are also longer.

The declining terms of trade and resulting shifts in feeding
practices can be observed in both the state and private sectors.
The majority of the decline in output, however, has occurred in
the state sector, while the private sector has been able to
maintain output. The share of livestock inventories and meat
products produced in the private sector continues to grow. In
1997, household farms accounted for 40 percent of Russian hog
numbers, up from 18 percent of 38 million head in 1991. The
private sector's share in meat output is even greater than its
share in livestock inventories. Thus, 35 percent of private hog
inventories in Russia in 1996 provided 65 percent of all pork
produced. The corresponding numbers for Ukraine are 45 and 75
percent.

Developments in Russia and Ukraine can be explained to a great
extent by the path that has been taken toward privatization and
the relationships that have developed between the state and
private sectors. The private sector in both countries is
dominated by household plots as opposed to true private farms.
Household plots existed parallel to the state and collective
farms during the Soviet period, while private farms are the
genuine "children" of market reform. According to official
statistics, state farms provide 47 percent of meat output,
household plots 52 percent, and private farmers less than 2
percent. Among the three types of livestock producers in Russia
and Ukraine, the first two have developed over time a strong
interdependence. In contrast, true private farms have not been
able to develop to their potential.

The household plots. Even before the breakdown of the Soviet
Union, household plots produced a lion's share of livestock
products. The state farms had no incentives to produce beyond the
state-imposed administrative levels of output. Farm workers had
strong incentives to minimize their labor committed to the
collective work activities of the farm (subject to disciplinary
constraints), while maximizing work and output at their household
plots. In this way a symbiosis developed between state and
collective farms and private plots, where neither could survive
without the other. The state farm got cheap (though unproductive)
labor, providing in return a small but guaranteed income, social
welfare support, and access (illegal though widespread) to farm
resources such as feed, energy, infrastructure, and
transportation. This relationship has persisted and become
stronger during the reform period. Even as inputs became more
expensive and scarce for farms, farm workers continued to
"procure" farm resources (feed in particular) for their own
purposes.

Private farms face greater difficulties. Unlike household plots,
whose share in livestock production and inventories is large and
has been growing since the beginning of reform, the share of
private farms in livestock output has been insignificant
throughout the reform period. Private farms operate under
different conditions than former state and collective farms and
household plots, in ways that discourage livestock production.
These conditions involve initial investment, financial security,
access to inputs, infrastructure, support services, and marketing
opportunities. 

o  To start a livestock operation requires a substantial initial
investment to acquire a herd, the investment being much larger
than that required to begin crop production. Because of
institutional constraints enumerated below, commercial credit is
difficult to obtain. Household plots on the other hand do not
require any initial investment to produce livestock goods, as
peasants can get animals virtually free from their "mother" state
farms.

o  Inputs crucial for livestock production (feed and energy) are
largely free for the household plot producers, who procure them
from their mother farm. In contrast, private farmers must not
only pay full price for inputs, but also find suppliers in the
first place.

o  Livestock output per animal suffers without support services
(animal health care and genetics, proper culling of herd).
Private farmers usually can not afford such services, while
household plots get them for free as part of the state farm
infrastructure.

o  Household plots do not have to market the majority of their
livestock products. A significant part of output is consumed by
the producers or bartered with neighbors, while the rest is sold
either to the mother farm (mostly milk, which is then sold to
large processors) or at the local market (transportation often
provided by the mother farm). Private farmers must market
perishable goods in an unfriendly institutional environment. They
have to tap into a distribution system, rent or invest in
refrigeration capacity, storage, and transportation all things
that household plotholders can get virtually for free.

o  Household plotholders enjoy not only guaranteed minimum
income, health care and retirement benefits (though these
benefits are not overly handsome) from their mother farm, but
also face almost no business risk, given that their mother farm
functions as a resource base. Private farmers are completely on
their own functioning in a somewhat hostile political
environment.

Soft Budget Constraint Inhibits Restructuring of State Farms. 
While the majority of former state and collective farms in Russia
and Ukraine have been "corporatized" or "privatized," in most
cases farm management has not changed. Farms continue to be
subsidized by the state through soft loans and indirect
subsidies. Often, government subsidies to the farms are provided
in kind, frequently through the provision of inputs. This leads
to distortions in resource allocation. It also prevents the
development of private credit markets.

Payment in kind has increased due to the lack of circulating cash
especially within the state sector. The shortage of cash
payments, along with high transactions costs associated with
official marketing channels (see below), has caused spontaneous
markets to appear on the streets. Fresh meat products, for
example, can be found at these markets at prices that are as much
as 30 to 40 percent lower than in city markets. Because of the
poor economic situation on most farms, it is likely that payments
in kind will increase. At the same time, low incomes will
stimulate growing sales at the farmers' markets and fewer sales
in the state sector retail shops.

All farms have adjusted in their use of production factors.
Because of the transition, prices of material inputs and capital
have risen substantially, whereas land is virtually free, and
wages are very low. Thus producers have a strong incentive to use
as much land as possible and to shift to labor intensive
production practices. Household producers made this adjustment
very quickly and were able to maintain their absolute level of
production. The state farms, however, because of continued
availability of soft loans, have not been forced to make the
complete adjustment, and output has fallen accordingly.

But the situation is changing for Russian producers. Beginning in
1994 the Russian government significantly reduced state subsidies
to the former state and collective farms. The budget cuts
weakened support flows from these farms to household plots, which
promptly hurt their operations. The result was a decrease in
inventories of all species in the household plots between 1994
and 1997.

The Response of Producers in Romania

Romania's situation is similar to that of Russia and Ukraine in
that until the elections of 1996 its government was reluctant to
move forward quickly with the reforms. Large state-owned
livestock complexes still have a substantial presence, and much
of the processing sector is also stated owned. Also, like Russia
and Ukraine, the private sector is dominated by very small farms
operating on a low level of technology. But a major difference is
that the symbiotic relationship between private farmers and the
state and cooperative farms was broken early in the transition.
Cooperatives were liquidated and their land was distributed to
former owners in 1991. Thus Romania's private farmers were forced
to survive without the assistance of a "mother farm."  Romania's
private farms have survived, but most are subsistence farms and
do not produce for the market.

While the cooperatives were liquidated, the state livestock
complexes continued intact, with few changes in their management,
and there was very little privatization of the state owned
processing and distribution enterprises. The result was a highly
segmented livestock market, characterized by many small private
farms competing in markets with large state conglomerates. In the
early years of the transition, there was a substantial drop in
animal numbers as animals moved into the private sector. In
response, the government implemented a variety of subsidies,
border controls, and other support measures, which mainly
benefited the state farms. The result of this heavy government
support was the apparent turnaround in 1996 (figures 7-9).

In February 1997, Romania's new government launched an ambitious
program of economic reform that included the elimination of
government assistance programs, liberalization of prices,
reduction of import tariffs, and privatization of state livestock
operations. The goal was to privatize all the state complexes by
the end of 1998. But, as of December 1997, the situation was as
shown in the table below.

The combined effect of the privatization process and the removal
of subsidies was a substantial drop in inventories of all
species. As of October 31, 1997, cattle numbers fell 6 percent
from a year earlier, hog numbers fell 12.5 percent, and poultry
12.8 percent. Virtually all the decline was in the state sector;
private sector numbers of all species remained constant.

As a result, the share of livestock on small private farms has
increased. The animals from these farms, however, do not enter
the market. This has created a difficult situation for consumers.
Supplies of meat in the retail shops has shrunk, and prices have
increased accordingly. The share of imports in consumption has
risen, but border tariffs remain high (60 percent for poultry,
for example), contributing to the high retail prices.

The coming year will be a test of the extent to which Romanian
producers are able to respond to market forces. Retail and
wholesale meat prices are high, and feed grain prices are very
low because of surplus production and difficulties with exports.
Furthermore, many producers receive grain as payment in kind for
land they lease to the associations. One would expect producers,
particularly hog producers to respond by expanding herds. Some
producers very likely will increase their herds. But many
producers are far away from the major grain producing areas and
transporting grain to those areas is very expensive. It is also
unclear how many of the complexes will have the financial means
to invest.

The Response of Producers in Poland and Hungary: Moving to the
Next Stage

In contrast to some of their neighbors, Poland and Hungary may
have seen a stop in the steady decline of hog and poultry
inventories. Poultry numbers are definitely on an upward trend.
Only cattle numbers are still declining. In particular:

o  Hog numbers have bottomed out and appear to be on an upward
trend in Hungary. There was never such a clear downward trend in
the Polish hog sector. Instead the sector has settled into a
clearly defined hog cycle, responding rapidly to fluctuations in
world grain prices. Thus, Polish hog numbers are expected to
recover in 1998 from a dip in 1997 due to high feed prices, but
this does not necessarily represent an upward trend. There is
potential for long term expansion in both countries, but it is
not yet clear just how much.

o  Poultry production is booming in both countries. The sector
has been able to respond rapidly to increased consumer demand. In
part, this is due to the shorter production cycle, which makes it
easier to increase poultry numbers rapidly. Another reason is
that even before the transition, procedures for contracts between
poultry processors and private producers were well established.
As is the practice in western countries, processors would provide
baby chicks and feed to producers and take delivery of the
finished birds at a price established in advance. Producers thus
had a head start in adapting to the demands of a capitalist
market.

o  Cattle numbers have stabilized in Hungary but are still
declining in Poland. The herds are still mainly dual purpose
dairy and beef, and the numbers are influenced mainly by
developments in the dairy market. There has been an attempt in
both countries to introduce beef cattle (Hereford-Angus), but
there is not a tradition of eating high quality beef in either
country and domestic demand for American-style steaks has not yet
developed. Hungary has a larger herd of beef cattle than Poland,
but Hungarian beef cattle are produced almost entirely for
export.

Significant in both countries, however, is the emergence of a
significant class of commercially oriented private producers, who
recognize the importance of meeting the quality standards of
foreign markets. Both countries have a substantial number of
producers who still produce mainly for their own consumption. But
even in Poland, where the average farm size is still just 8
hectares (up from 7 in 1990), there is a growing number of
producers with 50 or more animals who produce mainly for the
market. In Hungary, around half the animals belong to corporate
farms, many of which are foreign owned.

The result has been a trend towards higher quality feed
ingredients and more efficient use of them. In both countries the
ratio of kilograms of feed to kilograms of live weight gain for
poultry is around 2 to 1; the ratio for hogs is close to 3 to 1.
The improvement has been particularly impressive in Poland, where
feed ratios of 6 to 1 were quite typical for hogs in 1989. Polish
farmers have almost entirely abandoned the practice of feeding
potatoes, replacing them with grains. Preparing potatoes for use
as feed is regarded as very labor intensive, and apparently the
value of labor has increased to the point where this is not
regarded as economic. Only the very smallest two-hog farms still
feed potatoes.

In both countries the commercially oriented producers have
reacted quickly to changing demands of foreign markets. For
example, Hungary exported huge numbers of live pigs to Western
Europe in response to demand for feeder pigs in France and
Germany and an outbreak of hog cholera in the Netherlands.
Hungary has developed entire subsectors, among them beef cattle
and turkey,  specifically for export to the west. In Poland,
several processing plants have developed lines for production of
low quality sausage specifically for export to the NIS. Poles
have also been importing mechanically deboned meat, which is
prohibited on the domestic markets, for reexport to the NIS.

Response of the Downstream Sector

The removal of subsidies and exposure to world competition also
had a strong impact on the meat processing sector in the
transition economies. At the beginning of the transition, the
processing industry was dominated by state owned packing plants.
These tended to be inefficient and technologically outdated. In
many cases they were too large and not conveniently located,
resulting in high costs. Because of the fall in consumer demand,
they began to work below capacity, raising per unit costs still
higher. Facing competitive world prices, they were  unable to
raise prices to cover their costs. Instead they sought to
maintain profits by using whatever market power they had to limit
producer prices.

The initial response was privatization from below, with the start
up of new, small-scale firms. In marked contrast to the trend in
many market countries towards the concentration of production
units, the restructuring resulted in the downsizing of operations
and the development of small- scale production by many units.
These newly private firms have presented increasing amounts of
competition both in the purchase of raw materials and the retail
market. But purchases of domestic production by these firms is
hampered by poor transportation and the difficulty of arranging
deliveries from a large number of small producers. Lack of
sufficient refrigerated storage also makes it difficult for these
firms to buy large quantities.

Low producer prices and delays in payment forced livestock
producers increasingly to market or barter meat directly to
consumers. Direct marketing from producer to consumer is evidence
of market reforms, as producers pursue alternative marketing
channels in place of selling output solely to former state
processing enterprises. On the other hand, it results in low
efficiency in the meat sector, higher production costs and
prices, and non-standardized meat products of a fluctuating
quality.

Very little of the private sector production in Russia, Romania,
and Ukraine ever enters the market. Even in Poland and Hungary,
where the share of marketed output by private producers is
significant, there remains a large segment of production that is
either consumed on farm or sold to small-scale slaughterhouses
that do not meet standards for export and mainly serve the low
end of the domestic market.

A major challenge for Russia, Ukraine, and Romania has been
eliminating the direct state role in the marketing system and
reorienting it to a role of supporting the development of market
infrastructure. Abolishing state commodity procurement has come
slowly to Russia, and even more slowly to Ukraine. Romania's
parastatal agency, Rom Cereal, which provided free or subsidized
inputs and served as the sole buyer of grain, was broken up only
in late 1995. Through the creation and subsequent reorganizations
of the Federal Food Corporation, Russia has made repeated
attempts to limit state procurement programs. Official Russian
statistics, however, continue to refer to purchases by regional
meat processing plants as state procurement.

With privatization, many of the former state processing plants in
Russia became private monopsonies, as livestock producers had few
alternatives to selling to these "new" enterprises. Producers
have increasingly bypassed processors by selling directly on the
open market. Many Russian meat processing operations located near
the large urban markets of Moscow and St. Petersburg actually
prefer importing meat to maintain  processing capacity over
contracting for domestic meat.

Poland and Hungary have made substantially more progress towards
privatizing the processing sector. The processing industry in
Hungary is 100 percent privatized (thanks largely to foreign
investment). The Polish meat processing industry only about 60
percent privatized. However, even in companies where the state
retains a share, managers are under pressure to keep the
companies afloat without support from the state treasury. Failing
plants are allowed to go bankrupt; they are not bailed out with
soft loans.

In all the transition economies marketing margins have risen
substantially. Both consumers and policy makers, dismayed by the
rapid rise in food prices while farmgate prices have fallen, tend
to blame the phenomenon on continued monopoly power of the
downstream enterprises. But the situation is more complicated. In
part the rise in margins is simply the result of the removal of
subsidies. In some cases, it is also due to true value added (the
quality and appearance of Polish processed foods has improved
markedly since 1989, adding to the cost of the final product).
But the rise in margins is also the result of high transactions
costs. Plants operate under capacity, which raises per unit
costs. Transportation and storage facilities are inadequate.
Another source of increased transactions costs is risk. Decision
making is hampered by poor market information, the lack of
uniform quality standards increases risk, and enforcement of
contracts is minimal.

These bottlenecks in the distribution sector explain the apparent
anomaly that processors may tend to import raw livestock product
that is more expensive than domestic production. The transactions
cost of buying domestic production can wipe out the savings that
might result from buying cheaper meat. In addition, uneven
quality and unreliable delivery of domestic output make imports
more attractive.

The Role of Policy Reforms and Institutional Reforms in the
Restructuring of Livestock Sectors

At the root of the differing degrees of restructuring in the
transition economies are fundamental differences in the paths
that the countries have chosen towards market reform. The factors
influencing the restructuring process fall into two general
categories: policy reforms and institutional reforms.

The Role of Policy Reforms

Macroeconomic stability has largely been achieved in Hungary and
Poland. Inflation is down almost to single digits in both
countries, the currencies are internally convertible at
relatively stable exchange rates, and interest rates are
declining. The macroeconomic climate is thus much more conducive
to long range planning and investment. In addition, stability
makes these countries more attractive to foreign investment.

Romania, Russia, and Ukraine, have now achieved a degree of
macroeconomic stability similar to Poland or Hungry, but the
approach was more gradual, and the prolongation of the process
has slowed the restructuring. The three countries were initially
reluctant to implement measures likely to cause political or
social fallout. Russia and Ukraine have now reduced their
inflation to less than 20 percent, but this was achieved 4 or 5
years after Poland and Hungary reached this point. True
restructuring cannot take place until some degree of
macroeconomic stability is achieved. An environment of high
inflation and extreme price volatility is too risky to attract
investment needed to restructure livestock enterprises.

Price and trade liberalization. Russia, Ukraine, and Romania also
took a more gradual approach to price and trade liberalization.
In Poland and Hungary, the governments took bold initiatives from
the beginning of their transitions to reduce state support and to
liberalize prices. The result was that input and output prices
quickly settled at the world level. The adjustment for livestock
producers in Russia, Ukraine, and Romania has been more difficult
because these countries maintained price controls on meat and
meat products much longer than in Poland and Hungary. In an
attempt to protect the consumer and maintain consumption levels
of meat, these governments, in effect, pursued policies that
served to prolong the price-cost squeeze on producers.

While liberalization of foreign trade was an early part of
reforms in all NIS and CEE countries, the rapid influx of Western
food products at competitive prices generated protectionist
tendencies. Although Poland and Hungary have recently implemented
more protectionist policies, these policies are disciplined under
the WTO and are relatively transparent. In Russia and Ukraine,
however, claims of weakening food security were heard from the
start of the transition and this mind-set continues to justify
government intervention. Only recently have the livestock sectors
in these countries begun to feel the need to adjust to real
market conditions.

Prospects for EU integration. The prospect of eventual EU
accession increasingly dictates agricultural policies in Hungary
and Poland and has encouraged the livestock sectors to take
positive steps toward market integration. Processing plants are
being encouraged to upgrade so that they can meet EU standards.
Various measures are being taken to induce producers to grow
leaner hogs. Hogs in both countries are rapidly approaching 60
percent lean content. Polish plants that produce more than 250 kg
of pork per week must have equipment to measure the fat content
precisely and are required to pay a premium for high lean yield
over 60 percent and a discount for lean content under 60 percent.

Hungary provides a variety of subsidies and price supports to
encourage plants to raise their lean yield standards. The system
of guaranteed prices has been replaced by a set of target prices.
But this support only applies for hogs slaughtered at plants
applying EU standards. In addition, any Hungarian producer who
trades in an ordinary sow for a pedigreed animal can receive a
subsidy of 30 percent of the value of the new sow. But he must be
a member of the Breeders Association and he must use boars or
semen provided by the Association. This subsidy is not attractive
for small producers, since these high quality animals must be
raised in good conditions, which raises production costs.

Poland's intervention in the meat market is much less pervasive
than Hungary's. But like Hungary, much of Polish support to
livestock producers is intended to encourage the development of
larger units that will be able to produce according to EU
standards. Poland's Agency for Agricultural Markets (AMA) carries
out intervention purchasing of hogs, but plants authorized to
purchase on behalf of the AMA must be licenced to export and must
meet EU standards. Furthermore, all carcasses that are purchased
must meet the EUROP standard.

But the price and trade policies pursued by Hungary and Poland
have disadvantages. In response to pressure from producers
damaged by trade liberalization of 1990, the Polish and Hungarian
governments have implemented increasingly interventionist price
and trade policies. These include high import tariffs, guaranteed
minimum prices supported through intervention purchasing and
export subsidies, and a variety of credit subsidies. In one
sense, it is a sign of success that producers have responded to
many of the incentives provided by their governments. On the
other hand, these policies, particularly in the case of Hungary,
seriously distort production decisions and incur high budget
costs.

[Begin BOX]

Teaching Supply and Demand in a Transition Economy

Over the last 7 years ERS has provided technical assistance in
several of the CEE and NIS countries. The core of the ERS program
has been to teach counterparts in these countries to prepare
commodity market reports that analyze the factors affecting
supply and demand for specific commodity markets and provide a
short term forecast. One of the biggest challenges has been to
convey an understanding of the role of prices in balancing supply
and demand for a commodity.

During the communist period prices of inputs and outputs were
fixed, and production targets were set by the central planners.
Production often fell short of the targets, and because of low
prices set by the governments, output almost always failed to
satisfy consumer demand. One could almost say the prevailing rule
was that "demand is greater than supply."  The solution to
lengthening lines in the retail shops was to exhort workers to
increase output.

There is still a tendency among policy makers in the region to
view the drops in production with alarm and to try to implement
measures intended to "stimulate production."  The authors of the
commodity reports are greatly tempted to use the reports as
vehicles for giving advice to producers. But their goal is not to
tell producers how to increase profits, but how to increase
output. They criticize the producers for not following the proper
technologies. The authors understand that producers are
responding rationally to changes in relative prices when they use
their own seeds instead of hybrid seeds, fail to apply the
optimal mix of fertilizers, or engage in direct grain feeding of
livestock. But at the same time they condemn such practices as a
failure in farm management.

Although they fully understand that producers have adjusted their
cultivation practices to minimize their costs, analysts continue
to calculate "normative costs of production."  They use a set of
technological norms that specify the optimal quantities of
fertilizers necessary to maximize yields. They then multiply
these norms by current input prices to derive the cost of
production. The same analysts will then argue that the government
should set a minimum price based on the normative costs plus a
"normative profit."

Calculation of demand also tends to be based on rigid norms
--dietary norms developed by the central planners. This thinking
leads to the confusing statement in the commodity reports that
"demand was not met."  To an economist such a statement makes
little sense in that prices are generally free, and it can be
readily observed that there are no lines in the retail shops. But
this reflects a fundamental difference in interpretation of the
word "demand."  To an economist, demand is the quantity that
consumers are willing to buy at a given price. To a former
central planner, demand is calculated according to nutritional
norms. Because prices have risen, most consumers cannot afford to
buy enough to meet these norms, leading to the conclusion that
demand was not met.

The central planners thus calculated both supply and demand
according to rigid norms in a way that does not allow for the
substitution of goods in response to changes in relative prices.
Even now, 7 years later, many policy makers have difficulty
comprehending a fundamental principle of a market economy: that
there is no fixed optimal mix of input use for producers or
consumption for consumers. Changes in relative prices constantly
change the optimal mix of inputs and the basket of consumer
goods.

These misperceptions have led to misguided policies. With
production falling and the perception that demand is not being
met, policy makers conclude that they have a food security
problem. One type of response can be seen in supply-side measures
to "stimulate production," including minimum prices, high border
tariffs, or input and credit subsidies. Such measures can distort
production decisions and can slow down the restructuring process.
If such measures are based on normative rather than actual costs
of production, they can be even more distorting. 

In addition, in many countries such measures have tended to favor
the remaining state or "corporate" farms. This bias comes from
the perceived need to preserve large scale farming. But this
thinking reflects a very rigid view of the "optimal farm size." 
In fact, there is no fixed "optimal" farm size: the optimal farm
size depends on the resource base of an individual country and
the relative prices of land, labor, and capital. A fully
functioning land market will quickly reveal the optimal farm
size, but policy makers fear that an unfettered land market will
lead to an undesirable farm structure.

Even more damaging are measures intended to hold down food prices
for consumers. These take the form of controls on producer prices
or processors' margins and export controls (taxes, quotas, or
outright bans). The inevitable result is falling output, rising
consumer prices, and the eventual need to import.

There is a clear need to teach the fundamental principles of
economic theory. But there is a need for further debate on the
most effective way to communicate these principles. We are
dealing with 45 years of deep conditioning to think in a
different way. There is a deep distrust of markets and a strong
reluctance to accept the risks that accompany free markets. The
analysts we work with are often very well trained in mathematics
and have little difficulty understanding a theoretical
presentation of economic principles. But the ability to
internalize such principles and apply them to everyday decision
making does not automatically follow. Economics training needs to
be very applied, drawing constantly on real life examples that
are relevant to someone growing up in a centrally planned system.
[Nancy Cochrane]
[End BOX]

The Role of Institutional Reforms

A major impediment to domestic and foreign investment in the
region's livestock sector is the lack of the institutional
infrastructure needed to support the development of markets. The
necessary institutions include clearly defined property rights,
bankruptcy procedures, enforcement of contracts, a credit system,
and market infrastructure. These institutions are better
developed in Poland and Hungary than in the other countries, but
are not fully developed even there. The lack of such institutions
greatly inhibits the free movement of factors of production and
slows the transition from a sector dominated by subsistence
farming to a truly commercial livestock sector. Even where
relative prices might favor expansion of a given species,
producers are often unable to respond to those signals because of
a lack of institutional support.

Enterprise privatization. In Poland and Hungary, production and
processing are mostly privately owned and managed. Because Poland
has a long tradition of private agriculture and private land, the
privatization of state enterprises was adopted quickly and
easily. Hungary very quickly privatized all agricultural land and
transformed the cooperative farms into various types of corporate
farms. These units, in contrast to those in the other three
countries, are truly free of state control and must operate on a
hard budget constraint. In Russia, Ukraine, and Romania the
privatization and restructuring of farms and other agribusinesses
remain well behind that in Poland and Hungary.

A significant share of state ownership in the production and
processing of livestock and other products inhibits the options
of private producers in several ways, which have been noted
above. State production units tend to receive a disproportionate
share of state subsidies, giving them an advantage over private
producers. State dominance of marketing channels limits marketing
options and thereby tends to depress producer prices and leads to
direct marketing. State ownership of grain storage and feed mills
also raises production costs for private producers.

Much of the success in Poland and Hungary can be attributed to a
relatively well-defined legal structure surrounding privatization
in these countries. Property rights and bankruptcy procedures are
clearly defined in Poland and Hungary, in sharp contrast to
Russia, Ukraine, and Romania. A failing meat processing plant is
allowed to go bankrupt in Poland and Hungary, for instance,
whereas in Russia or Ukraine the plant would most likely be
supported with soft loans and inputs. Around 75 percent of all
former state farms in Russia are unprofitable and nearly all
livestock enterprises continue to operate in the red.

In 1998, Russia is expected to put in place a legal mechanism for
financially unviable farms to declare bankruptcy. But it remains
to be seen if Russia's government has the will to enforce this
legislation. Romania, which passed bankruptcy legislation in
1991, has yet to implement a strong enforcement mechanism.

The privatization process has been hindered by an overvaluation
of the enterprise assets that in effect dissuades potential
buyers, both domestic and foreign. Technologically outdated
plants can be attractive to investors if priced low enough. Only
Poland, the Czech Republic, and Hungary have moved substantially
to allow the market to "price" fixed plant and equipment. Some
assets will be liquidated while others will be salvaged or
renovated. Excess unpriced capacity also inhibits investment in
new plant and equipment because the value of existing assets is
unknown.

A somewhat different type of constraint exists in Romania, where
the Ministry of Privatization strongly discourages potential
investors from purchasing just part of an existing enterprise.
Many of Romania's enterprises are vertically integrated, and an
investor who just wants to buy the slaughterhouse, but not the
production unit or network of retail shops, is discouraged.

Another serious impediment to farm privatization is the need to
decouple social and other services provided by farms and reassign
these functions to municipal governments. These services are
expensive to provide and act as a severe drain on potential
profits. Few potential investors want to take on such
obligations.

Development of Land Markets. The development of functioning land
markets is also critical to functioning agricultural markets.
Poorly functioning land markets prevent the movement of land to
its most efficient use. The lack of a land market also hampers
the mobility of labor and other resources. In Ukraine, for
example, an individual owning a plot of land has little
opportunity to sell or lease the plot and move into a more
profitable or desirable profession. Hence, labor remains tied to
the land. In many of the countries, land owners still do not hold
title to their plots, so the land cannot be used as collateral
for needed agricultural loans.

In Poland, land is privately owned with clear titles, and there
are no legal restrictions on sales or lease. Yet in practice the
land sale market is extremely thin. There is not much demand for
land because agriculture still is not considered profitable. At
the same time, owners of land remain reluctant to sell because of
a lack of employment opportunities outside agriculture. And the
lack of market information and a network of real estate brokers
makes it difficult for those who are interested in buying or
selling land to find each other. There is also very little credit
available for land purchases.

In Hungary, only individuals may own land; restructured
cooperatives and commercial companies can only lease land.
Hungary's land restitution process led to the development of very
small and very large farms--there are no medium size units
--and this situation has changed little since 1992.

Land markets are completely lacking in Russia and Ukraine. While
members of the former collective and state farms received rights
to shares of land, the absence of titles impedes their ability to
take a plot of land and to farm it privately, or to sell or lease
it. While private family farms grew rapidly during the early
1990s when new laws were passed, they currently comprise only
around 5 percent of agricultural land, and only account for
2-4 percent of livestock output in Russia and Ukraine.

Similarly in Romania, although the land is privately owned,
nearly half of the land owners have yet to receive the legal
title to it. And while 80 percent of agricultural land is
privately owned, there remains a 5-year moratorium on the sale of
agricultural land. Because the members of the former collective
and state farms in Russia, Ukraine, and Romania received their
rights to plots of land free of charge, there is even less of an
incentive to use it efficiently. The land adopts  a negative or
zero value, and farmers tend to overuse and abuse the land
without consequence.

The most obvious consequence of the lack of a functioning land
market is the failure to develop economies of scale. Even if
prices encouraged the expansion of a herd, expansion is difficult
if the producer cannot acquire additional land. This has led to
the preponderance of subsistence farming. Even Poland's small
private farms, averaging around 8 hectares, have not evolved into
larger, consolidated units. For example, 63 percent of Poland's 1
million hog farms have less than 20 hogs and account for 14
percent of total numbers. Of the 1.4 million cattle farms in
Poland, only 2 percent have more than 20 head. These 2 percent
account for 21 percent of cattle.

In countries where titles and ownership rights are not clarified,
even more serious problems arise. Producers will not care for
land they do not own. In several of the countries, cattle are
grazed on communal land, leading to overgrazing and soil erosion.

Market Infrastructure. The market infrastructure (transportation,
storage and handling facilities, processing and retail networks,
communications, and market information) inherited from formerly
command economies was heavily centralized and designed to meet
the state's needs. It is entirely inadequate for smoothly
functioning markets.

There have been significant improvements in the physical
infrastructure in Poland and Hungary. Highways have been
upgraded, public transportation has improved, and telephone
communications are more reliable. This improvement was made
possible largely through foreign investment and technical
assistance. The improved infrastructure has reduced transaction
costs and has helped to attract foreign investment.

Russia, Romania, and Ukraine, however, have seen very little
investment in market infrastructure. In Russia and Ukraine,
transport services are centered around railroads, and limited
highways are deteriorating. It is estimated that Russian
transportation costs from farmgate to consumer are 20-40 percent
of the costs of production. Because the existing market
structures are geared toward serving large cooperative and state
farms, emerging private producers face severe infrastructural
limitations. Private producers increasingly bypass normal
marketing channels and sell their products directly to the
customer.

Market information--broadly disseminated reports of daily prices
on different markets--is essential to the efficient movement of
goods from a surplus to a deficit region of the country. Market
news reporting is now well developed in Poland and Hungary and is
improving in Russia, but reporting remains at best rudimentary in
the other two countries. In Romania, the EU PHARE Program spent a
considerable sum of money to develop a network for price
reporting. But the Ministry of Agriculture keeps the information
for its own internal use and does not disseminate it. Large
producers--state and private--have their sources of information,
but the lack of widely available market information is a severe
handicap to small, private producers. Low cost, publicly
available information would help level the playing field, so that
small producers can compete.

Labor Laws and the Social Safety Net. Institutions and laws must
be established to address new labor and other social problems
that arise from adjustments in the farm workforce. Redefinition
of health and social security programs, the establishment of job
retraining services, and the development of  market-based
management and economics programs in the educational system are
vital parts of the transition.

Labor mobility in all the countries is hampered by housing
shortages and a mismatch of skills. There is a strong demand for
well-trained technical workers in the cities, but with the
closure of many basic manufacturing enterprises, there is little
demand for low skilled labor that might want to leave the farm.
This impedes efficient resource allocation and the consolidation
of farms.

As long as social welfare functions remain tied to the state
farms, workers will be reluctant to leave the collective to start
a private farm. They not only face increased risk and
difficulties acquiring inputs and marketing output, but they may
lose access to health care, pension rights, and even housing.

Credit. A market-oriented rural finance system is essential for
the successful restructuring and privatization of livestock
farming in all the transition economies. For example, a hog
producer may believe that changes in relative prices of hogs and
feed would make it profitable to expand his operation. But
producers rarely have enough cash to purchase additional animals
or feed, let alone invest in a new barn or small feed mill.
Without access to long and short term credit, many producers will
not be able to respond rationally to changes in the market.

Despite several experiments in Russia to offer farm credits more
efficiently, an effective short-term commercial credit system is
still lacking. Ukraine remains even further behind. Romania still
lacks a developed private and competitive banking sector.

In Ukraine, credit to the agricultural sector in the past 2 years
has been allocated mainly through advances the government
provides through procurement contracts. The government, in
effect, offered zero interest budgetary loans. Because of the
financial insolvency of the state, however, payments were made
only after significant delays. It was even more common for the
state to pay in-kind, causing addition distortions in resource
distribution.

Another major obstacle to credit operations in Russia, Ukraine,
and Romania is that because land cannot be used as collateral,
farms must rely on commodity output or physical capital and
equipment for guaranteeing loans. And because many farm
operations are unprofitable and banks have little interest in
foreclosing on obsolete farm equipment, little credit is extended
on a short-term commercial basis.

Rule of Law. Russia, Ukraine, and Romania lag significantly
behind Poland and Hungary in the development of a market-based
legal framework. These countries still have the mind-set that
middlemen, who trade rather than produce, are "parasites." 
Widespread corruption and the ever present "mafia" still impede
commerce in many cases. The inconsistent application of the law
and the random enforcement of penalties continue to undermine
business transactions, as does the ad hoc recognition of property
rights by regional governments. Such conditions greatly increase
the risk of investment.

Looking to the Future

For countries such as Romania, Ukraine, and Russia, it remains an
open question whether their governments will make real progress
in removing the institutional obstacles to the full restructuring
of the livestock sectors. If they do, and there begins to be free
movement of land, labor and capital, the coming decade should see
the consolidation of household plots into commercially viable
farms and emergence of a class of true corporate farms operating
on a hard budget constraint. Only under these conditions can we
know whether these countries have the potential to become net
exporters of livestock products.

But an equally realistic scenario is one in which there is little
progress in institutional reform. Under such a scenario,
livestock could continue to be divided among small subsistence
farms and inefficient, quasi-privatized corporate farms. In this
case there will likely be further declines in livestock
inventories in the short term, as governments find themselves
unable to subsidize state farms at the current level. But
eventually the declines will halt, and these countries could
exist for several years at a low level equilibrium.

Future developments in Hungary and Poland will be increasingly
dictated by their progress towards EU accession. Completion of
institutional reform will be a prerequisite for membership, and
the principal question is when rather than whether these reforms
will be complete. Thus the questions of interest are the future
net trade position of these countries and changes in factor
intensities within livestock production and processing
industries, and between meat production and non-agricultural
sectors.

[Begin BOX]

Future Directions for Research

ERS is currently constructing a modeling framework to answer
questions posed in this paper: How changes in output prices,
input prices, subsidies, wage policies, and investment affect the
livestock sectors in transition economies.

The purpose of this modeling exercise is to develop a
theoretically consistent framework for each country's meat
production (including the entire sector from production to
retailing) and non-agricultural sectors, with explicit inclusion
of factor (land, labor, and capital) markets. The primary
modeling objective is to be able to simulate varying degrees of
factor mobility, in order to measure medium and long-term
structural implications for meat production in transitional
economies.

A comparison of scenario results with a base solution will allow
calculation of the following:

o  changes in equilibrium quantities of livestock and poultry
production (cattle, hogs, poultry, eggs, and milk), and
processing (beef, pork, and dairy products), and consumption; 

o changes in net trade position for meats (beef, pork, poultry),
eggs, and dairy products;

o  changes in factor intensities within livestock production and
processing industries, and between meat production and non-agricultural
sectors.

Thus, for a given market scenario, model results will tell us
whether production of a given species (cattle, hogs, poultry,
dairy) is growing or declining, and whether the production is
being processed or traded live. Changes in factor intensities of
livestock/poultry production and processing will provide insight
into whether or not, for example,  hog production is more, or
less, land, (or labor, or capital) intensive. Thus, an increase
in the land-to-labor ratio for hog production would suggest that
hog production operations were getting bigger, and more labor
efficient. Changes in capital stocks accumulation will indicate
directions of investment, both within the meat production sector,
between agricultural and non-agricultural sectors of a given
country, and between the given country and the rest of the world.
Increasing stocks indicate expected high relative returns and
positive structural development.
[End BOX]

Russian and Ukrainian Agriculture and Trade Outlook to 2005

USDA forecasts that in the long run Russia will remain a major
importer of meat, but only a small net importer of grain. By the
middle of the next decade, Russian meat imports are projected at
about 2.5 million tons annually, almost half being poultry meat.
Annual net imports of grain are forecast to be about 2.5 million
tons, the bulk being wheat. Ukraine is projected to be a small
meat exporter, and a somewhat larger exporter of grain. [William
Liefert and David Sedik]


This article forecasts Russian and Ukrainian agricultural
production and trade to the year 2005, specifically for meat and
grain. The projections are from an ERS model of the world
agricultural economy, the Country-Link System, which generates
forecasts for agricultural production, consumption, and trade.
The Country-Link System consists of 46 individual country or
regional models, all of which are partial equilibrium and dynamic
in nature, covering 22 commodities.

Forecast Assumptions

The main assumptions behind the forecasts are: (1) after a couple
more years of little or no growth, real GDP in Russia and Ukraine
begins to grow at about 3 percent annually during 2000-2005; (2)
productivity growth in the livestock sector is modest; for
example, from 1997 to 2005 grain feeding efficiency rises 15
percent (which means by 2005 feed efficiency will still be 10
percent worse than in 1990, because of the large decline from
1990 to the present); (3) area for most grains falls about 5
percent; (4) yields in the grain sector increase over the
projection period about 5 percent (total, not annually), though
to less than pre-reform levels; and (5) commodity-specific trade
policies remain unchanged, which means import tariffs continue at
current levels, and no import quotas are established.

According to official statistics, in 1997 real GDP in Russia rose
for the first time since reform began (by 0.4 percent), while
Ukraine's GDP fell only 3.2 percent, compared to drops of 10
percent or more in all previous reform years. This performance
supports the assumption that by 2000 real GDP in both countries
will be growing about 3 percent annually, particularly given that
the official macroeconomic figures probably still fail to capture
some new private enterprise.

The assumed levels of growth in productivity in the livestock and
crop sectors rest on the supposition that the extreme worsening
in farms' terms of trade over the reform period and declining
state subsidies will motivate farms to use inputs more
productively. Crop producers have already begun to use inputs
more efficiently, as shown by the fact that production has
declined much less than input use. In addition to worsening terms
of trade, crop producers have had to adjust to a severe reduction
in subsidies. Although livestock producers have so far not shown
much improvement in productivity, the decline in feed efficiency
has ended (at least in Russia). Subsidies to livestock producers,
though still larger than for crop producers, continue to drop.
Tightening budget constraints should eventually motivate
livestock producers to use inputs more efficiently.

However, given the huge potential for agricultural productivity
growth in Russia and Ukraine, as indicated by the large
productivity gap between these countries and the developed West,
the assumed growth in Russian and Ukrainian productivity to 2005
is modest. The growth is expected to result mainly from farms
using inputs more efficiently, because of their worsening
financial condition, but without any substantial change in the
way production is organized and managed. Major productivity
growth requires institutional reform (involving such matters as
land reform and privatization) that would more fundamentally
improve producers' incentives to use inputs more productively.
Such reform in Russia and Ukraine has so far been slight, and
evidence does not suggest that major reform will be attempted
soon. In both countries agriculture remains dominated by the
former state and collective farms, which have done little since
reform began to change their organization, management, and work
incentive systems.

The absence of land markets in particular has hurt Russian and
Ukrainian agriculture, in three ways. First, without land
markets, land is a (nearly) free good for managers. Thus, it is
overused in farming, as cultivation is pushed to low-yielding
marginal land. Second, without land markets, land, which should
be a farm's primary asset, cannot function as collateral for
loans to fund capital investment. Third, land is not only
virtually free for farms, but also inalienable. Because farms do
not risk losing their land, regardless of how unprofitable they
might be, management can pursue objectives other than
productivity-raising cost minimization or profit-maximization
(such as rent seeking or maintaining worker employment).

ERS assumes that grain area continues its gradual fall, as the
overexpansion of production to marginal land during the Soviet
period continues to be corrected. However, crop area remains
higher than it would be if well-functioning land markets were
created. 

Although trade controls in Russia and Ukraine could increase
somewhat in the near term, over the next 5-8 years trade policy
in the two countries is likely to become only marginally more
protectionist. Current policy is not overly restrictive. Import
tariffs for most agricultural products range from 10 to 35
percent, and few quantitative restrictions exist.

Pressure is growing in both countries to increase protection for
agriculture, such that in 1998 trade restrictions could increase
a bit. One reason is that in the last few years the currencies of
both countries have appreciated substantially in real terms,
which makes imports cheaper relative to domestic output. Russia
is also upset about what it perceives as unfair anti-dumping
actions taken against itself by various countries (mainly the
European Union), and might retaliate.

Yet, there are two countervailing reasons why in the longer term
Russia and Ukraine are unlikely to adopt agricultural trade
policies that are strongly protectionist. The first is that they
have a large interest in joining the World Trade Organization,
with Russia well along in the accession process. If the countries
become members, they will have access to institutional
mechanisms, from dispute settlement to clear rules on safeguards
and anti-dumping measures, with which to address their trade
concerns. The second reason is that anti-protection consumer
interests remain strong, particularly in Russia. Urban
politicians, such as Moscow's mayor Luzhkov, continue to defend
the interests of their food-consuming constituents.

The modeling assumption that trade policies in Russia and Ukraine
remain unchanged over the projection period therefore appears
generally valid, given that any increase in protection is likely
to be marginal, and the forecasts are not overly sensitive to
small increases in trade restrictions.

Forecast Results

The assumed rise in real GDP over the projection period increases
consumer demand, and therefore consumption, for meat (as
indicated in tables 1 and 2 by summing production and net trade
in 2005). The anticipated productivity growth in Russian
livestock operations allows domestic producers to satisfy much of
the increased demand for meat, as meat output expands to 5.5
million tons by 2005. However, some of the increased demand is
met by rising imports, which by 2005 equal 2.5 million tons. This
indicates that Russian productivity growth will be insufficient
to make the country competitive in meat production vis-a-vis the
world market. In other words, Russia's comparative disadvantage
in meat production will continue, due to high costs of primary
production and processing. Almost half of Russia's meat imports
will be poultry meat. In Ukraine, all the increased consumption
of meat is satisfied by additional domestic output, as indicated
by the unchanging meat trade balance (low exports continue).

Production of grain in Russia and Ukraine rises modestly over the
projection period (compared to output in 1995-96). Although
Russian meat production is forecast to increase about 15 percent,
this does not stimulate more demand for feed grain, given our
assumption that Russian feed grain efficiency improves 15 percent
over the projection period. The assumed drop in area of about 5
percent also offsets the assumed rise in yields of 5 percent.

By 2005 Russia is forecast to import about 2.5 million tons of
grain (mainly food wheat), while Ukraine is projected to export
this amount. Contrary to predictions by certain Western observers
at the beginning of reform, Russia is not projected to become a
net grain exporter. Most of Ukraine's grain exports should go to
Russia and other NIS countries.

The tables indicate that forecast changes in Russian and
Ukrainian agricultural production, consumption, and trade over
the projection period are much more modest than the changes that
have occurred from the beginning of reform to the present. Reform
policies have already caused substantial restructuring by
generating major changes in the two main elements that influence
producers' and consumers' decisions to produce, buy, and sell
goods:  prices and consumer income. Price liberalization
fundamentally changed prices by having them move to reflect real
costs of production, while integration into the world economy
caused domestic prices to move toward world market levels. Price
liberalization also reduced consumers' real income, as prices
rose by a greater percentage than wages and salaries.

In Russia and Ukraine, price and trade liberalization began
sufficiently long ago (the early 1990s) that real prices and
incomes are now stabilizing. Consumers' real income has generally
stopped falling, while agricultural producers' terms of trade are
no longer deteriorating, and for some Russian producers are even
improving.

With the fundamental reform-induced restructuring caused by
changing prices and declining real incomes now playing itself
out, future changes in Russian and Ukrainian agricultural
production and trade will have to come from two other main
developments: (1) growth in GDP, which by raising consumer income
would increase demand for foodstuffs; and (2) productivity growth
in agriculture, which would improve competitiveness by lowering
production and distribution costs. By 2000 both countries should
be growing in real terms. The increase in consumer demand from
rising GDP should expand consumption and imports of foodstuffs
(or reduce exports if the country is a net exporter of the good
in question), but not stimulate much additional production.
Output would not rise significantly because the countries are
generally free trading:  any growth in domestic demand can be
easily satisfied by increased imports at the existing world
price. Domestic producers would expand production to meet the
additional demand only if they were paid higher prices to cover
their rising costs of production.

In the absence of increased trade protection, domestic producers
can increase output only through competitiveness-enhancing
productivity growth. The poor outlook for institutional reform in
agriculture (particularly at the farm level) weakens the
prospects for high productivity growth. Although Russian and
Ukrainian agricultural interests continue to lobby strongly for
greater import restrictions, over the long term they will
probably have only limited success in changing trade policy. If
so, Russian imports of meat should not only remain high, but
spurred by rising incomes, continue to grow.

Agricultural Enterprise Restructuring and Land Reform in Russia,
1991-95:
An Efficiency Analysis

Most major producing regions were relatively efficient before
economic restructuring began on Russia's corporate farms, and
most have maintained this status. However, several inefficient
regions have become even more inefficient. The variation in
efficiency can be explained by economic and institutional
factors, including shocks in relative prices, average farm size,
state marketing channels, degree of privatization, subsidy
levels, and movement towards crop specialization. [David Sedik,
Michael Trueblood, and Carlos Arnade]

The economic transition in the agricultural sectors of the New
Independent States and Eastern Europe has two ongoing, distinct
processes. The first is the transformation of the economic policy
environment in which agricultural enterprises function. Policy
changes under the transition include price liberalization, the
opening of the economy to foreign trade, the establishment of a
legal system capable of enforcing contracts, and the partial
elimination of subsidies and restrictions on private production.
These changes give farms incentives to reallocate resources
toward a pattern more consistent with consumer demand and
unsubsidized costs of production. The second process is the
transformation of the farms themselves, so they can survive
within this new market environment. The two phenomena associated
with this producer transition are the growth of private sector
output (on private farms and plots) and the restructuring of
former state and collective farms (hereafter referred to as
corporate farms).

Previous studies of agricultural enterprise restructuring in
Russia have relied on farm-level survey data in five provinces
(oblasts). The studies' conclusions can be summarized as follows:

o  Most farms (95 percent) have complied formally with the
decrees mandating reorganization into shareholding (corporate)
farms and divestiture of state-owned land;

o  Most shareholding farms are managed internally like collective
farms of the past, but with more administrative autonomy and less
financial security;

o  Markets for commercial agricultural land have yet to develop.
Neither legislators nor farm managers and employees see much
usefulness in allowing land markets that might facilitate
borrowing (with land as collateral), investing, and modernizing.

In this article, we summarize the results of a forthcoming ERS
study in which we estimate and explain patterns in technical
efficiency of crop production on large corporate farms in Russia.
By technical efficiency, we mean the physical relationship
between inputs and outputs. We are only able to gauge efficiency
of corporate farms in the oblasts within Russia and their
efficiency relative to each other, and not to global standards of
efficiency (for a discussion of methodology, see box, "Measuring
and Explaining Efficiency").

Using previously unavailable oblast-level data from 70 (out of a
total 89) regions during 1991-95, we address the following
questions: (1) What has been the pattern of the relative average
(1993-95) levels of technical efficiency of crop production by
region? (2) What has been the pattern in the changes in technical
efficiency by region due to reform from 1991 to 1995?  (3) What
economic and institutional factors explain the pattern in the
levels of technical efficiency?  And, (4) Does it appear that
farms in different regions of Russia are engaging in real or
"passive" reform (see box, "Issues Involving Farm
Restructuring")?

Technical Efficiency of Russian Crop Production by Region, 1993-95

We first examine the relative levels of crop production
efficiency by region in Russia for 1991 through 1995. However,
below we report on the 3-year average for 1993-95 of the annual
efficiency measures for each region in Russia. We identify which
oblasts are able to produce the most crop output (measured in
inflation-adjusted aggregate value terms) with the least physical
inputs in each year. These oblasts exemplify what is known as the
"production frontier" (for each year), since they define the best
practice performance. From this frontier, it is possible to
measure the relative efficiency for the rest of the oblasts for
each year from 1993 to 1995. In our study, an efficiency score
of, say, 0.80, indicates that an oblast should have been able to
increase its output by another 20 percentage points for its given
input levels.

Figure 1 shows the 3-year average level of efficiency of crop
production in corporate farms on a scale from 0 to 1 for 1993-95,
where a grade of 1 indicates that crop production in the region
was the most efficient. The highest levels of crop production
efficiency were in the North Caucasus, the Volga Valley, parts of
the Central Black Soil region (around Moscow), an area around St.
Petersburg, and parts of West and East Siberia.

We are inclined to believe that corporate farms in some oblasts
performed better than in others because of higher quality
management, understood in a broad sense. This is the usual reason
given for variations in efficiency in the literature. However,
the quality of management depends partly on institutional-environmental
factors. For instance, expectations about loan
forgiveness (which reflects the softness of the farm budget
constraint), as well as undeveloped markets for land and labor,
farms size, and other factors, all influence managerial
decisions, which in turn influence the efficiency with which
farms operate.

It is important to recognize that farm managers may be "rational"
while allowing the technical efficiency of their farms to fall.
For example, farm managers may pursue goals other than maximizing
profits or minimizing costs, such as retaining workers or land,
rent-seeking, or seeking to carry out the wishes of the local
authorities. Moreover, if an oblast is relatively remote and
faces very high transportation costs, it may be prudent to be
relatively self-sufficient.

Changes in the Technical Efficiency of Russian Crop Production by
Region, 1991-95


We next examine the changes in efficiency scores of each region
from the pre-reform year of 1991 to 1995 (4 years after the
beginning of price reform). We estimate that the average
efficiency score of Russian regions declined from 0.70 in 1991 to
about 0.54 by 1995. Figure 2 shows the percentage changes in the
level of crop production efficiency from 1991 to 1995 for
selected oblasts.

The main picture that emerges is that those areas that were
efficient in 1991 have been holding their own, while the
efficiency of areas that had low efficiency in 1991 has
deteriorated quite rapidly. In other words, the variation in the
efficiency performance of oblasts in the Russian Federation
increased rapidly. Despite the tendency to grant soft loans to
corporate farms (which, it must be said, has become less common
in the past few years), the economic shocks that have hit
agriculture in the past few years caused less efficient farming
oblasts to become even less efficient. Oblasts that have stayed
relatively efficient include Astrakhan', Novosibirsk, Krasnodar,
and Kursk. Some of the oblasts that have deteriorated the most
include Pskov, Khakassia, Karachay-Cherkassia, and Kurgan.

How do we explain this pattern of changes?  We can only
conjecture, based on our formal work on explaining the levels of
technical efficiency (reviewed in the following section), as well
as our qualitative knowledge of the patterns of change in Russian
agriculture in the past few years. However, the following
scenario is consistent with the observed changes in efficiency of
crop production by corporate farms in the past few years. The
pattern is consistent with what one would expect following the
liberalization of prices with trade under a situation of soft
budgets for the relatively inefficient producers. As corporate
farms experience negative changes in their terms of trade, those
regions with an economic advantage in crops (low-cost producers)
continue to produce, while regions with an economic disadvantage
in crops cut production significantly. However, production does
not cease in these regions altogether, for two reasons. First,
oblast governments and corporate farms are reluctant to cease
production of crops such as grain or sugar beets, for example,
because of concerns about self-sufficiency or keeping processors
employed. Second, soft loans or favors compensate corporate farms
for such behavior that is often at odds with pure profit
maximization. 

The above scenario accounts for the continued production of crops
in regions that have an economic disadvantage in their
production. However, how do we account for the significant
worsening of the efficiency of relatively inefficient producers? 
According to our research, it is precisely the poor performers
that tend to receive soft loans, that have a softer budget
constraint. However, soft budget constraints tend to encourage
behavioral inertia, thus hindering less efficient farms from
improving their performance. Soft loans primarily for less
efficient farms tend to increase inefficiency on these farms.

Explaining the Level of Technical Efficiency in Russian Regions

Next, we estimate the impact of several factors that we believe
explain the static efficiency scores discussed above. The
following factors were considered: precipitation, temperature,
employees per corporate farm, average farm size (in hectares),
percent of crops marketed through state channels, portion of the
value of crop production raised privately, percent of
agricultural land in private farms, changes in relative output
and input prices, subsidies as a percent of total farm revenue,
and crop concentration. 

We found the following factors were very important in explaining
the relative efficiency of corporate farm crop production by
oblast:

o  Average farm size: Larger farms tended to be least efficient.
This finding suggests that farms in Russia, on average, employ
too much land in crop production. This is not surprising, because
the average corporate farm in Russia is six times larger than the
largest farms in the United States.

o  Size of labor force:  This finding suggests that labor is
scarce on corporate farms, a result consistent with what we know
about labor use on corporate farms before reforms. Before
reforms, state and collective farms traditionally employed
military troops, students, and other city dwellers during the
harvest period to augment their labor force.  Now that these
practices have been curtailed, labor shortages, particularly
during harvest, are probably severe. As a result, for corporate
farms identical in all other respects, the added benefit of
employing another worker most likely exceeds the extra cost of
keeping that worker. 

This result may appear surprising, as joint stock companies with
soft budget constraints in transition economies often retain
excess labor, so that the added benefit of employing another
worker is small compared to the extra cost of keeping that
worker. However, our study concerns exclusively workers employed
in crop production. It's possible that corporate farms tend to
retain excess labor for livestock production, but our study did
not include the livestock sector. Temporary labor was and is not
used for livestock production, only for crops. The results of our
study highlight important differences between the two sectors. 

o  Changes in the agricultural terms of trade (the ratio of
output prices to input prices): The more agricultural terms of
trade worsened, the more farms were forced to improve their
efficiency. Such improvement through adversity reflects the fact
that price shocks on the input side led to more rational use of
inputs, especially fertilizers, which were previously overused.

o  Temperatures: Hotter than normal temperatures and occasional
droughts in critical growing months in some oblasts led to sharp
declines in output after inputs had already been used, which had
the effect of showing up as a decrease in efficiency.

o  The portion of crops produced in the private sector: Most crop
production (by value) in the private sector is produced on small
(0.5 to 1 hectare) private plots attached to the large corporate
farms. We found that the greater the share (by value) of crop
output produced in the private sector (primarily on these private
plots, engaged in intensive cultivation of fruits and
vegetables), the less efficient was crop production on corporate
farms. We believe this results from the widely reported pilfering
of corporate farm inputs (including labor time) by private plot
holders. Increases in production on these plots, leading to
increased pilfering, would tend to lower the apparent efficiency
of corporate farms.
 
The following factors do not determine efficiency as strongly,
but still appear to have a significant impact:

o  Percent of crop marketed through state channels: The more
output that went through old state marketing channels, the less
inefficiency there was. This suggests that oblasts that relied on
the old channels did not have to incur short-run search and
transaction costs and were able to minimize efficiency losses.

o  Percent of land held privately (not collectively): Although
land held by corporate farms is formally privatized, it is owned
collectively. Most agricultural land held privately and not
collectively is employed in private farms (rather than private
plots), which raise field crops such as wheat and sunflower
seeds. The oblasts in which corporate farming was most efficient
tended to support the most private farming as well. This result
appears to indicate that a either a legacy of successful farming
or less risky natural conditions in certain oblasts encourages
both well-managed corporate farms and private farm
entrepreneurialism.

o  Subsidies as a percent of revenues: The higher percentage of
subsidies (compared to total revenues), the more inefficient are
corporate farms. This suggests that government support policies
amount to subsidizing the least efficient corporate farms, and/or
that support policies tend to encourage less efficient
production.

o  Crop specialization. The more concentrated the crop mix, the
more efficient corporate farm production in the oblast. This
result is consistent with the hypothesis that specializing in
products in which a region has an economic advantage tends to
mitigate efficiency losses.

Our research identified several policy implications for improving
efficiency of Russian farms. One important factor is land policy.
Our results indicate that the large corporate farms are
inefficient. While this is not surprising for those who have
followed collective agriculture for years, it points to a rather
elementary (but politically impossible at this time) way to
improve the efficiency of Russian agriculture: Reduce farm size.

The second area in which efficiency could be improved by policy
measures is the granting of soft government loans, exemplified
here by subsidies as a portion of revenues. It is clear that the
granting of subsidies to less efficient farms is highly
correlated both with the year-by-year efficiency scores and with
the worsening of efficiency as well.

Third, adverse movement in relative output and input prices
appears to be correlated with higher levels of efficiency, as
well as lower losses of efficiency. This adverse movement mainly
reflects the rise in input prices, which were previously kept
artificially low. The policy implication from this result is that
the more liberalized are input prices for farms, the more
efficient those farms tend to be. 

Lastly, the more specialization in crop production that occurred
from 1991 to 1995, the more efficient the farms. This is a clear
argument for allowing farms to specialize in the crops in which
they have a comparative advantage.


Are Russian Regions Engaging in Real or "Defensive" or "Passive"
Restructuring?

The general pattern of declining efficiency scores over time is
consistent with earlier studies that concluded Russian corporate
farms have been engaging, on the whole, in passive restructuring.
One of the most interesting parts of our study, however, is the
large variation in performance observed among oblasts. What can
explain the generally good performance over time of the small
number of oblasts with the highest efficiency scores?  We are
inclined to believe that managers in the most efficient oblasts
are doing a better job of adjusting to the shocks of the past few
years. These managers have minimized falls in efficiency, despite
difficult conditions that have caused the badly managed farms to
incur efficiency declines of 20 percent. In as much as better
management is a part of  real restructuring, farms in the best
performing oblasts appear to have engaged in real restructuring.

[Begin BOX]
Measuring  and Explaining Efficiency

Measuring efficiency. In our study, we employed two methods to
measure technical efficiency so that we could cross check and
verify our findings. One method was a statistical approach known
as stochastic frontiers. The other was a linear programming
approach known as data envelopment analysis (DEA). Although the
results presented in this article are the stochastic frontier
results, the DEA results were very similar. Both methods only
give an indication of relative efficiency for a particular set of
observations, not some absolute or global standard. So in this
case, we can only measure the relative efficiency scores for the
74 oblasts within Russia, but we can not make any judgements of
how these oblasts might compare against provinces or states
outside of Russia.

With the stochastic frontier method, output is statistically
predicted by examining input levels and assuming a mathematical
form. The difference between the actual output and predicted
output is known as the residual or error term. If, with
stochastic frontiers, the error term is found to be not random,
it is explored further. The technique statistically decomposes
the error term into a component measuring the degree of
inefficiency and the normal random error component.

The DEA method takes a completely different approach. This method
challenges the conventional statistical approach by assuming that
the upper level observations of a scatterplot are not due to
random error, but in fact represent the most efficient
observations (which conforms to textbook definitions of a
production function). These observations are enveloped by linear
segments to approximate a smooth production function. From this
frontier envelope, each unit is measured in terms of its distance
to the frontier.

Both methods have advantages and disadvantages, which we discuss
in our study. Each method can be employed with several
variations, which we also explored.

Explaining efficiency. In our study, we not only measure
technical efficiency, but we also attempt to explain technical
efficiency. For this part, we use an extension of the stochastic
frontier model recently developed by Battese and Coelli (1995).
In this model, technical efficiency is estimated for each oblast
by forming a production frontier with conventional inputs (land,
labor, etc.), that allows for the measurement of inefficiency. In
addition, a set of variables is regressed on the efficiency
scores that purport to explain the differences (for example,
privatization, crop specialization, price shocks, etc.).
[End BOX]

[Begin BOX]
Issues Involving Farm Restructuring

Genuine restructuring involves serious changes in four areas of
farm operation: management and control, internal organization of
the business, modernization through capital investment, and
social services provided by the enterprise. Of these, management
leadership and capital investment might be considered the most
critical ingredients. Genuine restructuring of Russian
enterprises is usually associated with (1) significant hardening
of the enterprise budget constraint, (2) significant outside
ownership of the enterprise, and (3) institutions promoting good
corporate governance, such as accurate financial disclosure,
democratic boards of directors, and independent shareholder
registers.

Real restructuring should be distinguished from what some
researchers call "defensive" or "passive" restructuring of the
survival-oriented enterprise (SOE). In the face of the severe
uncertainty that is characteristic of the transition period, SOEs
place predominant emphasis on current cash flow, rather than
long-run asset value. As SOEs, there are very good reasons to
suppose that Russian corporate farms engage predominantly in
"passive" rather than genuine restructuring. Russian corporate
farms continue to operate under a soft budget constraint (under
which they receive soft loans), are organized as closed
partnerships, and are run predominantly by the old state and
collective farm managers.

Passive restructuring might be characterized by the following:
  
o  Limited adjustment in the product mix. Corporate farms
continue to produce livestock, for example, despite large
financial losses.
o  Continued soft budget constraint. Overdue loans are
continually forgiven, allowing corporate farms to avoid
bankruptcy.
o  Modest land adjustment. Corporate farms do not pay land rents.
And because there are no land markets, there is little cost to
holding land.
o  Limited expansion of private plot production. The small size
of private land holdings limits the capacity to develop private
output.

The obvious and important question about efficiency is whether it
is a measure of real restructuring or of simply "passive" changes
in farm operation?  The answer, we believe, is a little of both.
The more positive change in efficiency we see, the more likely we
are seeing something that qualifies as real restructuring. The
more negative changes in efficiency, the more likely that we are
observing not genuine, but passive restructuring of corporate
farms.
[End BOX]

List of Tables
Table   Page
 1. Share of private sector in livestock inventories, 1991-97
 2. Share of private sector in meat output, 1991-97
 3. Livestock inventories by type of ownwership, January 1, 1991-97
 4. Output of livestock products by type of ownwership, 1991-97
 5. Status of state pork and poultry complexes, December 1997,
Romania
 6. Production and trade for meat and grain, Russia
 7. Production and trade for meat and grain, Ukraine

List of Figures
Figure  Page
 1. Cattle inventories, January 1, 1970-98, Russia and Ukraine
 2. Swine inventories, January 1, 1970-98, Russia and Ukraine
 3. Poultry inventories, January 1, 1970-98, Russia and Ukraine
 4. Beef and veal production, 1970-97, Russia and Ukraine
 5. Pork production, 1970-97, Russia and Ukraine
 6. Poultry production, 1970-97, Russia and Ukraine
 7. Cattle inventories, January 1, 1970-98, Hungary, Poland, and
Romania
 8. Swine inventories, January 1, 1970-98, Hungary, Poland, and
Romania
 9. Poultry inventories, January 1, 1970-98, Hungary, Poland, and
Romania
10. Beef and veal production, 1970-97, Hungary, Poland, and
Romania
11. Pork production, 1970-97, Hungary, Poland, and Romania
12. Poultry production, 1970-97, Hungary, Poland, and Romania
13. 1993-95 efficiency level, Russia
14. Changes in efficiency, 1991-95, Russia
END_OF_FILE