Sugar Industry Research Paper

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Sugar has been an important commodity historically due to a variety of factors, including the human appetite for sweet foods and drinks, the complementarity that sugar brings to the other flavors in food, its preservation and fermentation properties, and the calories it provides. Sugar (or more precisely sucrose) was first prepared in India. It was brought back to the Western world by the Greek conqueror Alexander the Great in 325 bce. Trade in sugar was further expanded in the Mediterranean region by the Arab conquest of the sixth century ce. Improvements in the crystallization process expanded the sugar trade (especially in the form of molasses) in the twelfth century. However, the limited supply of sugar in the international market caused refined sugar to be relatively costly until the production of sugar by European colonies in the Americas grew after 1700. This expansion, coupled with improvements in refining technologies that reduced unwanted tastes in the sweetener, caused sugar to replace other sweeteners such as honey, becoming the dominant sweetener over time. While demand for sugar remained relatively unaffected by the introduction of non-nutritive sweeteners, in the early twenty-first century the dominance has been challenged, particularly in the United States, by high fructose corn syrup (HFCS). The competition between sugar and HFCS raises several policy questions.

Historical Trade Patterns

The fact that the expansion of production and trade of sucrose was largely linked to the European colonization of the Americas had significant implications for the institutional arrangements in the international sugar market in place at the beginning of the twentieth century. Specifically colonization of the Americas as well as other parts of the globe in the eighteenth and nineteenth centuries was at least partially driven by economic considerations of the countries involved. Restrictions were placed on the countries with which colonies could trade. Raw goods produced in the colonies were required to be sold in the mother country and significant import restrictions existed to encourage the purchase of manufactured goods to each respective European power. This enabled the European powers economic benefits from the colonization of the New World.

Another byproduct of the rise of sugar in European colonies in general and in the Americas in particular was the linkages between sugar and slavery. As described by B. W. Higman in his 2000 article for Economic History Review, the rise of the sugar economies in the seventeenth through the nineteenth centuries in the Caribbean has been labeled as “The Sugar Revolution.” This revolution has been associated with several empirical facts, including the increased importance of monoculture, the replacement of small farms with plantations, and the increased use of black slaves. The movement toward monoculture and increased farm size has proven not to be unique to sugar; however, certain characteristics of sugar production may make the crop more susceptible to the establishment of plantations. The relationship between sugar and slavery may be more systematic. The exact reason for this linkage is unclear. One explanation for this linkage could be the presence of scale economies. In 1977 Mark Schmitz found evidence of significant economies of scale in Antebellum sugar production in Louisiana, which used slavery. Further evidence of the economies of slavery-based agriculture can be found in Robert Fogel and Stanley Engerman’s 1977 work.

The elimination of slavery in the colonial powers and the United States in the nineteenth century changed the institutions in the labor relationship. Slaves were replaced with contract labor, but the use of contract labor in the sugar plantations implied a radical change in the source of that labor. Before 1770 one-half to two-thirds of the contract labor destined for the British Caribbean and other North American colonies came from Europe. However, the contract labor for the sugar plantations was predominantly non-white. This shift also implied significant changes in the terms of the labor contract. In addition, the reduction of the availability of contract labor from countries such as India undoubtedly accelerated the introduction of labor-saving technology to the industry.

The entanglement of European powers in the trade of sugar also contributed to the first significant alternative sweetener. The British blockade of European ports during the Napoleonic wars led to the development of a viable sugar beet industry in France. In the twenty-first century sucrose from sugarcane and sugar beets share the global market for refined sugar. The expansion of sugar beet production in the second half of the nineteenth century followed a host of factors—including the abolition of slavery in Britain and France and the expansion of grain imports from Russia—that reduced the profitability of grain crops in Europe.

The decline in the price of sugar had two divergent impacts on the economy. First, lower sugar prices reduced the cost of a primary input for a variety of industries (i.e., bakeries, breweries, and the makers of jams). Second, lower sugar prices impoverished producers in the colonies. The same policy scenario applies to the present-day United States. Sugar tariffs pit the interest of sugar producers against the interests of confectionary manufacturers. The ultimate dispensation of this debate depends on the relative political power of each sector through rent-seeking behavior. One response to the declining sugar prices both in the nineteenth and in the twenty-first centuries is the establishment of import tariffs or quotas to increase the domestic price and, thereby, protect domestic sugar producers.

Modern Sugar Market

Despite the end of European colonial rule, many of the tariff agreements continue to follow the trade patterns established in colonial times. With the emergence of the European Union (EU) as an economic union in the closing years of the twentieth century, agricultural policy coalesced into the Common Agricultural Policy (CAP) of Europe. The CAP established a system of tariffs to protect domestic producers from foreign competition. Historically, African, Caribbean, and Pacific (ACP) sugar producers were given access to the European market under the CAP through the Sugar Protocol of the Lome Convention and its successor the Cotonou Agreement.

At the beginning of the twenty-first century, most countries that support their internal sugar price use a form of the tariff rate quota (TRQ) which is allowed under the Uruguay Round Agreement on Agriculture. The TRQ is a system of two tariffs. The first tariff allows the sale of a fixed quantity (or minimum access) of a commodity at a lower or first tier tariff. Any quantity of that commodity imported above this fixed quantity is charged a higher (typically prohibitive) tariff. Given that the second tariff level is prohibitive, the country can increase the price received by domestic producers by reducing the fixed quantity imported under the first tier tariff. This is the policy instrument used by both the United States and the EU to increase the price of sugar for their respective producers. However, apart from supporting domestic producers, the TRQ gives countries in the EU a mechanism to honor its commitments to the ACP. Specifically, former colonies can be allocated portions of the minimum access quantity, in essence giving ACP countries access to a higher internal price of sugar at a low tariff rate. The United States allocates its first-stage quota in a similar way to a group of forty countries.

Apart from its grounding in historical trade patterns, the international sugar market is also affected by a myriad of regional and global trade agreements. Regional trade agreements involve a small number of countries in the same geographic region. In this context, the agreements forming the EU are a regional trade agreement. Other regional trade agreements include the North American Free Trade Agreement (NAFTA) and proposed trade agreements such as the Free Trade Area of the Americas (FTAA). The effect of each of these trade agreements on sugar markets is dependent on the role sugar plays in each group of economies.

An example of the ambiguous role regional trade agreements play in the sugar market can be found in NAFTA. As discussed, the sugar price in the United States is protected by a system of tariffs. From this perspective both freer trade with both Canada and Mexico raise critical issues. First, while Canada does not pose a direct threat to the U.S. sugar industry from production, the TRQ on sugar prohibits pass-through imports of sugar into the United States through Canada. However, NAFTA still allows for the importation of sugar containing products from Canada, increasing the competition for confections in the United States and reducing the demand for sugar. For example, lower sugar prices contributed to Kraft Foods’ decision to move the production of Life Savers candy entirely to Canada in 2003.

A different set of problems was raised by the potential effects of Mexican sugar production on the U.S. sugar market. Mexico’s government has historically been involved directly in its sugar industry through its ownership of its sugar mills and other policies but had divested these holdings as a part of its economic liberalization program in the late 1980s. In recognition of the potential competition from Mexico, NAFTA includes specific provisions governing Mexico’s access to the U.S. sugar market. Many of these provisions are concerned with Mexico’s status as a net sugar producer. Specifically, since Mexico imports sugar and other sweeteners, the domestic producers wanted to be protected from pass-through sugar (i.e., sugar purchased at lower world market prices for sale at protected U.S. prices). Hence, Mexico was granted dutyfree access to the U.S. market for 7,258 metric tons of sugar. If Mexico obtained the status of a net sugar-surplus producer, the quota would be expanded to 25,000 metric tons in years 1 to 6 and 250,000 metric tons in years 7 to 15. Some controversies have arisen in the implementation of these provisions. Specifically, the original provisions were restricted to becoming a net sugar-surplus producer, ignoring the potential impact of alternative sweeteners such as HFCS. This raised the possibility of substituting HFCS for sugar especially in the manufacture of soft drinks to enhance Mexico’s net surplus of sugar.

In the mid-2000s the URAA of the WTO remains the most relevant multilateral trade agreement facing the international sugar market. Within this context, it is important that the TRQ format of the EU and the United States is the sanctioned agricultural policy and thus completely legal under the WTO. The primary question is then whether significant changes to these accepted instruments will occur in the Doha round of WTO negotiations started in 2001. At its inception, increases in market-access were primary to the Doha round discussion on agricultural trade. One idea is to increase market access by expanding the minimum access portions of the TRQs.

Sugar Production

Various domestic factors affect the production of sugar and institutions within the U.S. sugar market. As discussed, sugar prices in the United States are supported by a TRQ. Adding a layer of complication, the government supports the domestic price of sugar by providing a nonrecourse loan for raw sugar at 18 cents per pound and refined sugar produced from sugar beets at 22.9 cents per pound, according to 2002 statistics (Haley and Suarez 2002). If the market price falls below 18 cents per pound, producers (or more accurately sugar mills) store their raw sugar and receive a loan from the government of 18 cents for every pound of raw sugar placed in storage. If the market price for sugar rises over 18 cents per pound plus any interest accrued, they take the sugar out of storage, sell it at the prevailing market price, and repay the loan. However, if the market price for sugar does not exceed 18 cents per pound plus accrued interest during the marketing year, producers simply forfeit sugar in storage to the government in fulfillment of the loan. While the nonrecourse loan program for sugar is typical for agricultural commodities in the United States, it is encumbered by the Dole Amendment, which requires the sugar program to be operated at no cost to the government.

Certain characteristics of sugar production have implications for vertical integration in the market channel for sugar. Sugar is produced from two different primary crops: sugarcane and sugar beets. While the end product (i.e., sucrose) is identical for each process, each crop implies a different market channel. The production of sugarcane typically occurs in tropical or subtropical climate zones. The stalks containing the sucrose are removed from the field for milling that produces a raw form of sugar that is relatively stable. The raw sugar is then later refined into table sugar, removing impurities that may affect the flavor. Technical considerations require that these mills be located close to production. When the stalks are harvested in the field the sucrose content of the sugarcane starts to deteriorate. Further, the sucrose content of standing sugarcane deteriorates after a freeze.

Following Coases’s paradigm (1937) that the boundaries of the firm are determined by the comparison of transaction costs with the diseconomies of scope, the technical characteristics of sugarcane are conducive to the vertical integration of production of processing of sugarcane. Specifically, in Coases’s paradigm the boundaries of a firm are dictated by a comparison of transaction costs and diseconomies of scope. In this case transaction costs include the possibility of using a thin market to extract monopolistic rents while the diseconomies of scope involve the economic costs of carrying out an activity that is outside of the firm’s specialization. In the case of sugarcane, the potential deterioration of quality gives rise to the possibility of monopolistic rents. The possible economic losses of economic rents more than offset the economic costs of diversification into processing facilities. Viewing the transaction from the other side, the diversification into sugarcane production insures a steady supply of sugarcane into the future, reducing the risk of investment.

Production of sucrose from sugar beets does not face the same climatic constraints as sugarcane. Further, the sucrose content of sugar beets is more stable than sugarcane, extending the period for the extraction of sucrose from sugar beets. Thus sugar beet producers have less impetus for vertical integration than producers and processors of sugarcane.

Finally, any discussion of the sweetener markets, particularly in the United States, is not complete without reference to HFCS. HFCS is a liquid sweetener derived from corn that can be used in production of soft drinks and other industrial uses. It is typically conceded that sugar tariffs in the United States provided the incentives for the commercial development of HFCS production. However, while HFCS is a perfect substitute for sugar in many applications, it lacks the baking quality to replace sugar completely. The interaction between sugar and HFCS prices is then dependent on the saturation of specific sweetener markets. For example, HFCS is easily used in the production of soft drinks and, because it is typically priced lower than sugar, dominates the sweetener market for this market. Thus the relationship between HFCS and sugar prices depends on the substitutability of the use at the margin.

Bibliography:

  1. Coase, Ronald H. 1937. The Nature of the Firm. Economica 4 (16): 386–405.
  2. Engerman, Stanley L. 1983. Contract Labor, Sugar, and Technology in the Nineteenth Century. Journal of Economic History 43 (3): 635–659.
  3. Fogel, Robert W., and Stanley L. Engerman. 1977. Explaining the Relative Efficiency of Slave Agriculture in the Antebellum South. American Economic Review 67 (3): 275–296.
  4. Greene, Gretchen. 1998. Transitions in the Mexican Sugar Industry. PhD diss., University of Florida.
  5. Haley, Steven L., and Nydia R. Suarez. 2002 U.S. Sugar Policy and Prospects for the U.S. Sugar Industry. In Sugar and Related Sweetener Markets in the Twenty-First Century: International Perspectives, eds. Andrew Schmitz, Thomas H. Spreen, William A. Messina Jr., and Charles B. Moss, 241–258. London: CAB International.
  6. Higman, B. W. 2000. The Sugar Revolution. Economic History Review 53 (2): 213–236.
  7. Josling, Timothy. 2002 The Place of Sugar in Regional and Multilateral Trade Negotiations. In Sugar and Related Sweetener Markets in the Twenty-First Century: International Perspectives, eds. Andrew Schmitz, Thomas H. Spreen, William A. Messina Jr., and Charles B. Moss, 13–30. London: CAB International.
  8. Moss, Charles B., and Andrew Schmitz. 2002 Trade in HFCS: Cointegration with Substitute Goods. In Sugar and Related Sweetener Markets in the Twenty-First Century: International Perspectives, eds. Andrew Schmitz, Thomas H. Spreen, William A. Messina Jr., and Charles B. Moss, 299–314. London: CAB International.
  9. Polopolus, Leo C. 2002 World Sugar Markets and Entangled Government Programs. In Sugar and Related Sweetener Markets in the Twenty-First Century: International Perspectives, eds. Andrew Schmitz, Thomas H. Spreen, William A.
  10. Messina, Jr., and Charles B. Moss, 1–12. London: CAB International.
  11. Pryor, Frederic L. 1982. The Plantation Economy as an Economic System. Journal of Comparative Economics 6: 288–317.
  12. Schmitz, Andrew, and Charles B. Moss. 2001. Vertical Integration in Production and Marketing: The Case of Sugar in the United States. International Sugar Journal 103 (1234): 443–446, 461.
  13. Schmitz, Mark D. 1977. Economies of Scale and Farm Size in the Antebellum Sugar Sector. Journal of Economic History 37 (4): 959–980.

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