Background Papers to the. Fourth Workshop Jointly Hosted by. the State Secretariat for Economic Affairs (seco) and the World Trade Institute (WTI)

Transcription

1 Staatssekretariat für Wirtschaft Secrétariat d Etat à l économie Segretariato di Stato dell'economia AGRICULTURAL EXPORTS AS ENGINE OF GROWTH FOR DEVELOPING COUNTRIES? PRESENTATION OF A CASE STUDY ON INTERNATIONAL TRADE IN TOBACCO Background Papers to the Fourth Workshop Jointly Hosted by the State Secretariat for Economic Affairs (seco) and the World Trade Institute (WTI) 11 TH JUNE 2004 * * * Paper No. 2 World Markets and Trade in Tobacco Author: Krista Lucenti (Economic Research Fellow) (Draft: May 2004) Draft for Discussion NOT FOR CITATION

2 TABLE OF CONTENTS ABSTRACT... 3 EXECUTIVE SUMMARY INTRODUCTION Background and context of study Purpose of the Study CONSUMPTION, PRODUCTION STRUCTURES, AND INTERNATIONAL TRADE OF TOBACCO LEAF Tobacco as a Commodity From Seed to Cigarette The determinants of international demand for unmanufactured leaf tobacco Cigarettes as a Commodity Consumption of Cigarettes Factors influencing cigarette consumption Looking to the future: How will cigarette consumption affect tobacco leaf production? The Production of Tobacco Leaf Background Trends in production Tobacco Leaf Market Characteristics Cigarette Manufacturing and Tobacco Leaf Usage Trends in production of cigarettes Types of tobacco used in cigarette manufacturing production trends and forecasts International Trade in Tobacco Leaf and Tobacco Products International Trade in Tobacco Leaf International trade in cigarettes Impact of trade liberalization on trade in tobacco and tobacco products CONCLUSION BIBLIOGRAPHY APPENDICES... 57

3 ABSTRACT Future demand for tobacco leaf seems to depend on two opposing forces which will determine the demand for cigarettes: Increased population and income effects in developing countries and decreasing consumption in developed countries due to health concerns, tighter regulations, and decreased governmental support. Production of tobacco leaf will respond to these demand trends and will continue to shift towards countries with increasing demand, low production costs, few production restrictions, good transportation networks, and access to international markets. If support for tobacco regimes in developed countries continues to wane, a further shift of tobacco leaf production towards developing countries is expected. Many argue that developing countries will automatically benefit but this underestimates the complexity of businesses FDI decisions. The effects on local farmers in developed countries could be disastrous should government subsidy programs be phased out. Farmers in developing countries who currently benefit from GSP preferences may also find themselves worse off. Diversification into other crops is not always easy or as profitable as tobacco. In fact, resources would be needed to facilitate this transition, resources perhaps from taxes levied on cigarettes. In developed countries, many argue that there is an inherent contradiction between supporting tobacco production on the one hand and providing funds for the control and reduction of smoking on the other. Given the known health risks, providing funds for the production of tobacco leaf, whilst subsequently providing funds for reducing cigarette consumption, seems to be both inefficient and reckless.

4 EXECUTIVE SUMMARY 1. The demand for tobacco leaf is driven primarily by the growing demand for cigarettes. As a primary input, the trends in production and trade of tobacco leaf are largely determined by cigarette consumption patterns both in developed and in developing countries. By 2025, the World Bank estimates that 1.6 billion people will smoke; yet, this statistic hides the growing discrepancy between consumption in developed and developing countries. In the last ten years, there has been a decrease in overall consumption in developed countries, but a growing demand for cigarettes and other tobacco products in developing countries, and in particular China, India, and Indonesia with their increasing populations and rising incomes. 2. Tobacco is a heterogeneous product. The properties of tobacco and its usability differ according to variety, location, system of production, or curing method. For instance, soil and weather conditions help determine the size, color, flavor, and thickness of the leaf. Each combination of soil, climate, etc. produces a unique style of tobacco sought after by manufacturers on behalf of consumers. 3. The main tobacco types used for cigarette production are flue cured, burley, and oriental. In the popular blends, each different type contributes to the overall product, e.g. Fluecured provides flavor, burley imparts the bang, and oriental supplies the aroma. 4. Growers sell their tobacco crop to leaf dealers, who in turn, select, process, and treat the leaf for sale to the cigarette manufacturers. It is often the leaf dealers and the cigarette manufacturers who determine the price paid to the growers. The leaf may be sold either via auction, by contract, or by marketing arrangement. 5. The demand for tobacco leaf is determined by the demand for cigarettes. It is notably determined by global control measures, income and demographics of its consumers, the cigarette expansion strategies, technological progress in manufacturing, and to some extent, social customs. 6. There are four basic types of cigarettes: American blend, English ( Virginia ), dark aromatic, and Turkish. Most brands are blends of tobacco, the preference being for American and English blends, hence the demand for flue cured tobacco. 7. Since 1970, cigarette consumption has increased significantly in low and middle income countries whilst increasing only slightly in developed countries. Some factors that 4

5 influence cigarette consumption are: population growth and the increase in income per capita; taxation and regulatory issues; technological factors of production; government policies and health awareness; and trade liberalization. 8. The share of total production of tobacco leaf by growers in developing countries is increasing due to the low cost of labor and inputs, and improved quality. In contrast, decreasing consumption of cigarettes and hence leaf, as well as declining support by governments for production in developed countries. 9. The major producers of tobacco leaf are China, the U.S., India, Brazil, Turkey, Zimbabwe, Malawi, and the European Union. Together they account for more than 80 percent of world production. 10. In developed countries, much of this production is subsidized through elaborate governmental schemes aimed at propping up domestic industries. In contrast, many developing countries receive little support from their governments but rather receive inputs and incentives from the large multinationals. 11. Around 30 percent of world tobacco production is exported and traded internationally. Export volumes are determined by policy measures, variations in international demand, and supply shocks. For some developing countries, tobacco exports are a large percentage of total exports and GDP. However, few manufacture and export cigarettes. Cigarette production is still controlled mainly by manufacturers in developed countries and large state monopolies. 12. Tobacco leaf and cigarettes are characterized by tariff escalation: countries set low tariffs on inputs (leaf) but high tariffs on the more capital intensive processed good (cigarettes) to protect domestic industries. Negotiators must endeavor to remove this distortion. 13. Market factors will continue to shift production towards developing countries. However, in addition to this, trade diversion will also be the result of ongoing multilateral negotiations on agriculture, though there are winners and losers in this scenario. The effects on local farmers in developed countries could be disastrous should government subsidy programs be phased out. Farmers in developing countries who currently benefit from GSP preferences may also find themselves worse off. 14. In addition, given the known health risks, providing funds for the production of tobacco leaf, whilst subsequently providing funds for reducing cigarette consumption, seems to be both inefficient and reckless. 5

6 1. INTRODUCTION 1.1 Background and context of study The demand for tobacco leaf is driven primarily by the growing demand for cigarettes. As a primary input, the trends in production and trade of tobacco leaf are largely determined by cigarette consumption patterns both in developed and in developing countries. Cigarette smoking is increasing at an alarming rate. In the year 2000, over one billion people smoked worldwide. By 2025, the World Bank estimates that 1.6 billion people will smoke, the increase due mainly to population growth and increased consumption. 1 Yet, this statistic hides the growing discrepancy between consumption in developed and developing countries. In the last ten years, there has been a decrease in overall consumption in developed countries, but a growing demand for cigarettes and other tobacco products in developing countries, and in particular China, India, and Indonesia with their increasing populations and rising incomes. Total per capita cigarette consumption increased in developing countries by 3.7 percent annually within the same period whilst per capita consumption in the developed countries grew only by about 0.4 percent. 2 Tobacco leaf and cigarettes are legally traded and profitable commodities, subject to domestic and international regulation and rules. With few exceptions, cigarette consumption is largely unrestricted. In fact, it forms part of the social custom of many societies. In addition, the production and consumption of tobacco and tobacco products both benefit and stress the social and economic resources of governments and citizens of both developed and developing countries. The World Bank estimates that given current smoking patterns, roughly 500 million people will die from tobacco use, more than half of these children and teenagers. By 2030, the Bank estimates, tobacco products are expected to account for around 10 million deaths per year, the single biggest cause of death worldwide. Specifically, by 2020, seven of every 10 people killed by smoking will be from a developing or least developed country. 1 The World Bank Curbing the Epidemic: Governments and the Economics of Tobacco Control, Washington: the World Bank, Food and Agriculture Organization (FAO) of the United Nations, Projections of Tobacco Production, Consumption and Trade to the Year 2010, Rome,

7 Governments in developed countries have initiated regulations to decrease smoking prevalence in their countries. Recently, Ireland, Norway, and Sweden all imposed bans on smoking in bars and restaurants. These trends look unlikely to be reversed. Future demand for tobacco leaf seems to depend on two opposing forces which will determine the demand for cigarettes: Increased population and income effects in developing countries and decreasing consumption in developed countries due to health concerns, tighter regulations, and decreased governmental support. A recent study from the Food and Agriculture Organization ( FAO ) (2003) suggests that the expansion of cigarette demand in developing countries is expected to drive the tobacco leaf economy at least until Production of tobacco leaf will respond to these demand trends and will continue to shift towards countries with increasing demand, low production costs, few production restrictions, good transportation networks, and access to international markets. If support for tobacco regimes in developed countries continues to wane, a further shift of tobacco leaf production towards developing countries is expected. Moreover, if agricultural markets are liberalized during the Doha round, tobacco leaf producers in some developing countries, assuming their export availabilities continue to expand, are expected to benefit from increased market access and trade diversion. However, the distributional effects of tariff liberalization may not be positive for all countries. Some exporting countries may be worse off if markets continue to liberalize and preferences are eroded. This in turn will have an effect on expectations of cigarette production. Prioritizing the negative effects of tariff escalation (which affects tobacco manufacturing) and reducing the level of tariffs on imported cigarettes, will both increase FDI and shift production to some developing countries, and increase overall trade in cigarettes. 1.2 Purpose of the Study The aim of this study is to determine which countries are likely to gain from liberalization of trade in agricultural markets, and in particular, in tobacco leaf markets. The country case studies will examine the effects of liberalization on domestic production and exports on specific countries. Given the growing momentum for negotiations on agriculture and market access at the multilateral level, an examination of the tobacco leaf trade may serve as guidance to the effects of growing liberalization and increasing demand on developing 7

8 countries. In addition to trade liberalization, changing and increasing consumption patterns are expected to benefit tobacco leaf producers in developing countries. But will this liberalization come at a price? Given that the health effects of smoking are well known, is it good to liberalize a commodity that is dangerous to health? With this in mind, I will approach this objective in the following manner: Section 2.1 will describe tobacco leaf as a commodity. Section 2.2 will trace the evolution of tobacco from seed to cigarette and look at the major players. Section 2.3 will outline the factors that determine international and domestic demand for tobacco leaf by examining the trends in the consumption of cigarettes and the determinants for investment by tobacco and cigarette companies. Section 2.4 will examine the determinants of international supply of raw tobacco 3. Particular attention will be paid to trends in production of leaf and to market characteristics and industry behaviour. Section 2.5 will look at cigarette manufacturing and tobacco leaf usage. Section 2.6 will look at international trade in tobacco leaf and cigarettes including trends in exports and with emphasis on the effect of exports from developing countries. In addition, it will also examine the effects of trade liberalization on tobacco trade. Finally, Section 3 will provide concluding remarks. Other sections of this report will examine the legal and regulatory structure and provide case studies of the raw tobacco regimes of particular countries. 2. CONSUMPTION, PRODUCTION STRUCTURES, AND INTERNATIONAL TRADE OF TOBACCO LEAF 2.1 Tobacco as a Commodity The tobacco plant originated with the native Indian tribes of the Americas and came to Europe in the late 15 th century during the colonization of the continent. Commercial tobacco farming began in the British colony of Virginia in the early 1600s and rapidly became the most exported crop in the State, mainly harvested through slave labor. Despite some technological improvements in harvesting techniques, growing tobacco leaf is still considered labor intensive. 3 The terms tobacco leaf, raw tobacco, and unmanufactured tobacco will be used interchangeably. The terms cigarettes and manufactured tobacco will be used interchangeably. 8

9 Tobacco is a heterogeneous product. The properties of tobacco and its usability differ according to variety, location, system of production, or curing method. For instance, soil and weather conditions help determine the size, color, flavor, and thickness of the leaf. Each combination of soil, climate, etc. produces a unique style of tobacco sought after by manufacturers on behalf of consumers. Standardization is based primarily on the curing method i.e. air, sun, fire, and flue curing, location of production of leaf, and the end use of the leaf i.e. cigarette, cigar. Further classification includes the position of the leaves on the stalk and the color, quality, and ripeness of the leap at harvest. For example, flue cured tobaccos are separated into geographical divisions: United States, Brazil, Zimbabwe, or China. Within these geographical divisions, the tobacco is further identified according to distinctive characteristics, e.g. Old Belt or Middle Belt in the United States, Highveld and Lowveld in Zimbabwe. See Appendix 1 for the commodity classification for tobacco leaf. Box 1: Types of Tobacco Burley: Light air cured tobacco cured under natural atmospheric conditions, usually without the use of supplementary heat (except to prevent damage in damp weather). Usually medium in body, light tan shaded toward red to reddish brown in color, mild in flavor. Used mainly in cigarette blends. Burley is desired because of its flavor and aroma. Burley is also used in pipe tobaccos and plug and twist chewing tobaccos. Flue Cured: Tobacco cured under artificial atmospheric conditions by process of regulating the heat and ventilation without allowing smoke or fumes from the fuel to come in contact with the tobacco. Oriental: A type characterized by a strong aromatic leaf that is sun cured (sometimes referred to as Turkish). The plant is usually small with a large number of short leaves. Oriental is used mainly in cigarettes. Dark Air & Sun Cured: Dark tobacco types cured under atmospheric conditions, usually without the use of supplemental heat. The air cured is shaded during curing, the sun cured is not; usually medium to heavy in body and used in pipes, cigars, homemade and native cigarettes, snuff, and chewing tobacco. The only dark air and sun cured tobaccos to enter international trade in significant quantities are the cigar types. Source: USDA Foreign Agricultural Service The main tobacco types used for cigarette production are flue cured, burley, and oriental. 4 In the popular blends, each different type contributes to the overall product, e.g. Flue cured provides flavor, burley imparts the bang, and oriental supplies the aroma. Of these types, flue cured tobacco is dominant among the various types of tobacco used in cigarette manufacturing: 4 Given this, this chapter will focus more on these three types of tobacco. 9

10 Figure 1: Tobacco types, shares of total volume used in cigarette manufacturing (1998) Burley 15% Dark Airsun Cured 13% Flue Cured 60% (Dark) Fire Cured 1% Light Air Cured 1% Oriental 10% Source: FAO (2003) Quality of the leaf varies from country to country. Some countries produce high quality leaf tobacco, whilst others produce mainly filler of low grade. In general, some factors relate to the physical, chemical, visible, and sensory properties of the leaf and of the smoke. In addition, the preparations of the leaf (harvesting, drying, curing) all have an effect on the quality of the leaf. More specifically, [t]he sugar and nicotine ratios of the leaf account for the overall aroma and flavor of the tobacco leaf. The quality of the leaf is determined by its color, texture, body, thickness, strength, flavor, aroma, rate of burn, and processing quality. Quality is expressed in grades. The US Department of Agriculture (USDA) recognizes 117 official grades of tobacco. (van Liemt, 2002:3) Tobacco is grown in more than 100 countries, and in nearly all climatic zones with the exception of arid and cold temperate regions. However, tobacco is a native of the subtropical zone and grows best within this area. The basic requirements are: frost free days for growth Sufficient irrigation, soil aeration, and soil nutrients Adequate sunlight and warmth to induce the necessary biochemical and physiological processes 5 5 See 10

11 Tobacco can be grown in a wide range of soils, each type requiring specific soil properties to produce leaf of good quality. In particular, the required combination of thorough soil aeration and liberal moisture supply is most likely to occur in sands sandy loam soils which are used almost exclusively in the production of flue cured leaf. Heavier soils are more suited to the production of cigar filler, dark air cured and dark fire cured types where the resulting leaves are thicker, heavier, darker colored, more oily, stronger and slower burning. In soils for these tobacco types, aeration can become more restricted and the balance between aeration and available moisture more critical. 6 In contrast, burley is grown successfully on highly fertile but heavier silt loam soils whilst Oriental tobacco requires thin, somewhat infertile soils with low nitrogen content. This type of soil is usually located on the foothills of mountains or on the lower slopes. 7 International trade is determined by the demand for a particular type of tobacco leaf, which, as mentioned earlier, depends on the conditions and particularities of each region. The demand for flue cured tobacco in cigarettes (based on the established preference for it worldwide) has created increased exports from the United States to the rest of the world, including top flue cured producing countries. This will be taken up in greater detail in Section From Seed to Cigarette The progression from growing leaf to selling the cigarette is specific to each country. The following section will trace the role of all agents involved in the tobacco leaf and cigarette manufacturing and look at the market characteristics of both industries. The following diagram should act as a reference throughout. 6 Ibid. 7 Ibid. 11

12 Figure 2: From Seed to Cigarette Government Taxes Government Tariffs Stock Balances Domestic Consumers Foreign Consumers Set Q and P Set Q and P Stock Balances State Monopolies Cigarette Manufacturers Set Q and P Supply Set Q and P Set Q and P Tobacco Leaf Dealers Supply Tobacco Growers Source: Authors own. Figure 2 demonstrates the flow of tobacco leaf from the growers to cigarette consumers (or to un committed stocks held by tobacco leaf dealers and monopolies). It also highlights the market characteristics (i.e. who determines international demand, supply, and price) and flow of revenues to governments. Growers may be large industrialized farms (heavily subsidized in some cases) or smaller, labor intensive plots in others. As seen in Section 2.5.2, different types of tobacco are grown in different regions of the world. The choice of tobacco leaf to grow depends on demand, climate, and resources available. Tobacco growers sell the harvested raw tobacco either directly to state monopolies or to tobacco leaf dealers. In some cases, if the grower has cured the leaf himself, the cigarette manufacturer will buy it directly from him. 8 Tobacco leaf dealers or state monopolies are involved in the financing of inputs, selection, purchase, shipment, processing, packing, and storing of green leaf (fresh, raw tobacco) from the growers. Leaf dealers do not manufacture cigarettes or other tobacco products. Leaf dealers set the prices and the quantities with the 8 See for evidence of this. 12

13 raw tobacco grower. Sometimes, the dealers will provide the inputs (seeds, fertilizers) in exchange for set prices on tobacco leaf. 9 The method of sale to the leaf dealers or monopolies depends on the arrangement in a particular country. In most cases, a grower will sell its yield to dealers via auction, marketing agreements, or set contracts. State monopolies generally have fixed contracts with growers. Whether it is by contract or by auction, the leaf dealers purchase the raw tobacco and organize for shipment to their processing plants. In order for green leaf tobacco to be packed in bales or hogsheads, it must be treated. This treatment includes drying and removing the stems and eliminating foreign substances mixed with the leaf. Once the processing is completed, the tobacco is packed and stored in warehouses until such time as it aged sufficiently (this can take up to two years with some varieties). At this time, the processed leaf is sold on to manufacturers for use in cigarettes. In the case of monopolies, often they act as both the tobacco dealer and the cigarette manufacturer. The cigarette manufacturers transform the leaf into rolled tubes, package them, and sell them either to domestic consumers or to both domestic consumers and foreign customers. Any unused balances for both the dealer and the manufacturer are stored. In the case of manufactured cigarettes, this is more difficult since cigarettes are not good for long term stockholding. Processed tobacco, unlike its leaf form, becomes stale very quickly; in addition, the cost of storage of packaged cigarettes is much higher than for leaf. Since cigarettes cannot be stored, manufacturers adjust quickly to changes in demand by a corresponding change in production rather than by a change in stockholdings. As for the flow of monies, once consumers purchase a pack of cigarettes, the total amount is redistributed, in differing proportions depending on the country, for the tobacco itself, for non tobacco materials, for manufacturing, for wholesale, retail and transports, for federal tax, for state or local tax (where applicable), and in some cases, for import duties. In general, more money is filtered towards paper, filters, and packaging than towards the tobacco itself. For example, in the United States, for every dollar spend on tobacco, four cents is for the tobacco itself, seven cents is for non tobacco materials, 43 cents is for manufacturing, 21 cents 9 See WHO, 13

14 for wholesale, retail, and transport, 11 cents for federal tax, and 15 cents for state and local taxes. 10 Since import duties are prohibitive on cigarettes in the United States, little of this money goes towards import taxes. In developed countries, the bulk of this amount goes towards the manufacturers, the government, and the leaf dealers. Very little of it goes to the growers who receive the farm gate prices. 2.3 The determinants of international demand for unmanufactured leaf tobacco Cigarettes as a Commodity The demand for tobacco leaf is determined by the demand for cigarettes. In order to understand this relationship, as it is not a one to one correspondence, the following section will examine consumption, production, and trade patterns and trends for manufactured tobacco. The demand for cigarettes in a particular country is notably determined by global control measures, income and demographics of its consumers, the cigarette industry expansion strategies, technological progress in manufacturing, and to some extent, social customs. Eighty percent of all tobacco leaf 11 is used in the production of cigarettes whilst a small minority is used for cigars, bidis (Indian cigarettes), etc. There are four basic types of cigarettes: American blend, English ( Virginia ), dark aromatic, and Turkish. Most brands are blends of tobacco i.e. American blends contain 45 to 50 percent flue cured, 30 to 45 percent light air cured (usually burley) and 15 to 20 percent oriental. Dark aromatic types are made from dark air cured tobacco and some oriental. In contrast, English cigarettes are made from flue cured 12 and Turkish types are made from entirely from oriental tobaccos. 13 The rising trend in global consumption of American blend cigarettes, and to some extent, the English type, has led to the increased demand for flue cured tobacco. 10 WHO, Manufacturing Tobacco, in Tobacco Atlas, 11 FAO (2003), Projections of Tobacco Production, Consumption, and Trade to the Year 2010, Rome. 12 Flue cured means the artificial curing (or drying) system by which metal pipes ( flues ) are used to distribute heat in curing barns as a means to remove all of the natural sap and moisture from tobacco leaves. (van Liemt, 2002) 13 USDA Foreign Agricultural Service 14

15 2.3.2 Consumption of Cigarettes While consumption of cigarettes is either constant or dropping in some countries, more people worldwide are smoking and smoking more, according to the World Health Organization ( WHO ). 14 The following Chart highlights the increasing trend in the number of cigarettes smoked between 1880 and 2000: Figure 3: Global Cigarette Consumption, billions of sticks Billions of sticks Year Source: WHO, Cigarette Consumption, in Tobacco Atlas, Since 1970, cigarette consumption has increased markedly in low and middle income countries. The following Figure demonstrates that global consumption trends have been driven by developing countries: 14 The WHO estimates that by 2030, due to increased population (approximately 2 billion more people), the absolute number of smokers will increase. In addition, though male smoking is decreasing, female smoking is expected to continue increasing especially in developing countries. 15

16 Figure 4: Consumption, by millions of pieces, Developing Developed World Source: FAO Statistics, The trend in developing countries is largely determined by trends in China. In particular, the levelling out of consumption in the 1990s has been attributed to stockpiles of cigarettes in China during this time. 15 As of 2001, the following countries ranked highest for the number of cigarettes consumed by its citizens: China (1,674 bn), EU 15 (632 bn), U.S. (461 bn), Japan (326 bn), Russia (329 bn), Indonesia (211 bn) and Brazil (109 bn). 16 Between 1970 and 2001, aggregate consumption in developed countries increased by 10 percent whereas consumption in developing countries increased by nearly 35 percent during the same time. This increase is most noticeable in China and India, driven mainly by factors relating to population and income. However, though aggregate consumption in developed countries has increased, per capita consumption has decreased. According to FAO (2003), the overall decrease in consumption per capita in developed countries is due to various factors: 15 See FAO (2003) 16 WHO, Cigarette Consumption, in Tobacco Atlas, 16

17 Income and population growth are slowing down; An increasing awareness of the health effects of smoking in conjunction with antismoking campaigns and regulations, bans on consumption and advertisement; and Increased taxation As a result, the proportion of adults who smoke has declined even though women are increasingly picking up the habit Factors influencing cigarette consumption Population Growth and the increase in Income per capita Cigarette consumption has increased globally due to population and income growth. World population increased by 1.7 percent annually between 1970 and 2001, ranging from 0.6 percent in developed countries to over 2 percent in developing countries. 17 World income also increased during the same period by almost 3 percent annually, and in China particularly where income growth was 8 percent. This overall increase in population and the increase in income per capita in developing countries imply that consumers have more money to spend on cigarettes than before Taxation and Regulatory Issues The resistance to privatization and to opening up markets has often stemmed from governments desire to retain revenue from taxes on cigarettes. Governments can benefit from sales or import tax revenues, profits, or a combination of all three. However, government revenues accounted for by tobacco taxes depends on the country; less than 10 percent in all countries, less than 2 in most. Table 1: Government Income from tobacco, percentage tax as a proportion of total government revenue, 2000 China 9.05% Nepal 5.40% Russia 8.00% Brazil 4.88% Greece 7.72% Argentina 4.00% Source: WHO, Price Policy, in Tobacco Atlas, 17 FAO (2003) 17

18 For those countries where cigarette and tobacco leaf manufacturing is controlled by state monopoly, manufacturing also provides revenue in addition to taxes. See the case study on China for an example of an industry controlled by a state monopoly Technological factors of production Another important factor relating to consumption patterns of cigarettes since 1970 are the technological advances in manufacturing. The introduction of filter tipped cigarettes and filler tobacco, in addition to the introduction of shorter and lighter cigarettes, has reduced the amount of tobacco leaf needed per cigarette. It is estimated that filters reduced tobacco leaf use by as much as 30 percent 18 since the 1970s. These technological advances include: 1) Increasing the volume of tobacco leaf so less is needed to fill the cigarette ( expansion process or DIET 19 ) 2) Using reconstituted tobacco made from remnants into paper. The paper is then expanded and flavored to seem like real tobacco. 20 Another factor influencing the demand for tobacco leaf is the rapid growth of sales in light cigarettes. Light or mild cigarettes use more filler and expanded tobacco than full flavor cigarettes. Light cigarettes and ultra light cigarettes use 20 percent and percent respectively, of expanded tobacco Government Policies and Health Awareness The costs to both the individual and to society of smoking has led governments and intergovernmental organizations to determine policies aimed at decreasing the consumption 18 FAO (2003) 19 Dry Ice Expanded Tobacco, or DIET, dominates the market for expanded tobacco. This technology soaks cut tobacco in liquid carbon dioxide (CO2) under high pressure and at very low temperatures. The subsequent hightemperature heating process causes the frozen leaf cells to expand, as the CO2 is rapidly boiled off, creating DIET. Critics say that although DIET has served the industry well for many years, it has several drawbacks, including relatively high capital and operating costs and high energy and CO2 consumption, in addition to the effect of the process on tobacco quality. It is estimated that in the future, 10 percent of full flavor brands, 20 percent of light cigarettes, and between percent of the ultra light variety will use expanded tobacco. See T. Tuinstra, Tobacco Journal International, backissues/jul2001/story1.asp. 20 Golden Leaf, Barren Harvest, Campaign for Tobacco Free Kids, November 2001, campaign/global. 18

19 of cigarettes in developed countries and, subsequently, of tobacco leaf. The costs to the individual of smoking are: Lost earnings due to illness and death Higher individual medical costs (where government schemes are not comprehensive) Lower productivity The costs to society of smoking are: Lost tax revenue due to the illness and death of its citizens Higher medical costs where government schemes are comprehensive or somewhat so Reduction in revenue due to smuggling Environmental damage Foreign exchange losses Lower productivity as a nation due to lower productivity of its citizens 21 In the case of tobacco leaf harvesters, many suffer from tobacco sickness (when nicotine is absorbed through the skin causing nausea, vomiting, and possibly increased heart rates and bloody pressure), and illness caused by pesticides. In addition to providing revenue, taxation of cigarettes is the most effective method of preventing youths from taking up smoking and for ensuring that smokers bear the costs that they impose on governments and non smokers (when smuggling is low). In addition, other non price measures used to help reduce smoking are the publication of research findings, bans on consumption, labeling requirements, restrictions on advertising, and anti smoking programs Trade Liberalization The continued liberalization of markets in goods and services, particularly in previously closed economies, will contribute significantly to the increase in consumption of cigarettes. Since the Uruguay Round, tariffs have come down on both raw tobacco and manufactured tobacco. In addition, bilateral and regional agreements have continued to remove obstacles to trade in cigarettes. The removal of trade barriers will introduce more variety and competition into the domestic markets will stimulate demand for cigarettes, and in turn, lead to reduction 21 WHO World Tobacco Day 2004, wntd2004_ brochure_ en.pdf 19

20 in the prices for tobacco products. As barriers come down, cigarette multinationals are able to export more to developing countries in particular, where tariffs have traditionally been higher. Moreover, aggressive marketing campaigns in developing countries will be possible once markets are more liberalized. The introduction of competition laws and greater protection of investment has also led to the entrance of more cigarette multinationals through FDI. Should the Singapore Issues be accepted, countries will need to implement laws that will further support the presence of multinationals. FAO (2003) maintains that the results of various studies show that cigarette consumption in newly liberalized economies increased by about 10 percent more than it would have if markets had remained closed. In fact, as Taylor et al (2002) point out, increasing globalization and the strong positive relationship between globalization and cigarette consumption in lowand middle income countries, impels these countries in particular to adopt strong tobacco control policies if reducing the health consequences of tobacco is important. Without these policies, increased trade liberalization will lead to higher costs on both the individual and society caused by cigarette smoking Looking to the future: How will cigarette consumption affect tobacco leaf production? Given the expected increase in the adult population growth and the impact of other factors determining demand, the expected number of smokers will reach 1.32 billion by However, it is mainly the effect of population growth and rising income per capita that will lead to stronger demand for cigarettes, and by consequence, for tobacco leaf. FAO estimates that income growth may have, other things being equal, a potentially strong positive impact on tobacco demand that amounts to an average annual growth rate of 0.6 percent in developed countries, 3.8 percent in China and 2.4 percent in other developing countries. 23 It is expected that the increased demand caused by population growth and rising incomes will be mitigated to some extent by increased taxation and rising health awareness. 22 World Bank 23 FAO (2003) 20

21 Insofar as changes in demand for cigarettes lead to changes in demand for tobacco leaf, technological factors of production reducing the amount of tobacco per cigarette and the increased demand for light cigarettes, are two factors that prevent a one to one relationship. To some extent, the demand for tobacco leaf will depend not only on the demand for cigarettes, but also on the tastes of consumers and on technological improvements by manufacturers. The FAO (2003) study has estimated the likely consumption and production patterns for tobacco leaf to the year Using a standard commodity model, the study undertakes two alternative scenarios: 1) Baseline scenario: assumes continuation of present policies with respect to leaf production support 24 and cigarette consumption taxation which leads to no changes in real prices in this scenario; and 2) Policy scenario: assumes the adoption of strong policy measures against cigarette consumption and tobacco leaf production that include reducing support programs and increasing taxation on cigarettes i.e. consumer prices increase by 30 percent and production support would be reduced by 40 percent in developed countries and 20 percent in developing countries. Their results indicate the following: Under the both scenarios, there will be an overall increase in world tobacco leaf consumption, driven mainly by demand for cigarettes in developing countries, particularly China. However, tobacco consumption per adult is declining overall; it is just masked by the fact that tobacco use is expanding with population; World leaf production will increase under both scenarios, albeit less so under the policy scenario. The shift in production to developing countries will continue; by 2010, developing countries share of world tobacco leaf production will hit 87 percent. 24 The different case studies will examine the tobacco leaf production support regimes in various countries. Given that the amount of protection varies from country to country, the baseline scenario will highlight cross country differences in future levels of consumption, production, and trade. 21

22 2.4. The Production of Tobacco Leaf Background Depending on the resources and agricultural capacity of the country, the size of tobacco leaf farms may vary. In certain developing countries, the average farm size is small; a portion is devoted to tobacco related activities and the rest is devoted to subsistence farming. 25 In addition, FAO (2003) notes that the small size of farms, in conjunction with sharecropping arrangements, often leaves farmers little choice but to grow tobacco (since it is known to have a higher yield per hectare and revenue than most other crops). Since tobacco farming is labor intensive and often depends on seasonal labor, this also helps to explain the need to keep things small. Since tobacco can be produced in a variety of climates and soils and is more resilient to the elements than other crops (weather can be a factor ultimately), it is an attractive commodity for developing countries. In terms of profitability, tobacco is by far the most lucrative of all crops. Its yield per hectare of land used is unsurpassed. The attached country case studies will confirm this. In fact, often no viable income generating alternative to tobacco is available for most countries. In addition, given that tobacco can grow in many different climates, it outperforms other commodities. Its relative labor intensity also contributes to local employment in developing countries where mechanization is modest. Given the returns in tobacco production, it is clear why many developing countries choose to grow tobacco since alternative crops cannot be grown economically on their small farms. The share of total production of tobacco leaf by growers in developing countries is increasing due to the low cost of labor and inputs and improved quality. In contrast, decreasing consumption of cigarettes and hence leaf, as well as declining support by governments for production in developed countries. 25 See case studies and in particular Brazil for an example of small farm size. 22

23 Trends in production Today, tobacco leaf is produced in more than 100 countries. The major producers of tobacco leaf are: China, the United States, India, Brazil, Turkey, Zimbabwe, Malawi, and the European Community. Several of these countries will be examined in further detail in the case studies. These eight countries produce more than 80 percent of world production of tobacco leaf. The following figure demonstrates the concentration of production in China particularly, and to a lesser extent, the U.S., India, and Brazil: Figure 5: Tobacco Leaf shares of total production, average by country Rest of World 22% Indonesia 2% India 8% Turkey 3% Brazil 7% USA 9% Zimbabwe 3% EU (15) 5% Malawi 2% China, Main 39% Source: FAO Tobacco Statistics, Developing countries share of world production is roughly 77 percent, an increase of more than 20 percent since Production in developed countries has decreased by a half a million tonnes since 1970, or roughly 36 percent. The opposite trend has occurred in developing countries where production increased by 300 percent between 1970 and 1997 and tapered off between 1997 and Developing countries produce roughly 5 million tonnes of tobacco. Further, global production is expanding: China s production expanded at 3.8 percent annually, Brazil s at 3.0 percent, India s at 2.5 percent, Malawi s at 5.8 percent and Zimbabwe s at 4.9 percent. 26 FAO tobacco statistics, 23

24 This should be seen against the negative growth of 1.5 percent experienced by the developed countries. 27 World production of tobacco leaf peaked in 1992 and Given the imbalance between production and consumption, stock balances increased during this period and put downward pressure on prices. By 1995, stock balances were at their peak and prices were at a record low. Due to these low price levels and stockpiles, production fell by almost 2 million tonnes in As a result, the demand for leaf increased thereby pushing international prices upwards. Stock balances vary with different types of tobacco. In some cases, there is an excess amount and in others, a shortage. Tobacco leaf, unlike cigarettes, is easily stockpiled. This is due to several reasons: Quality does not decrease with storage; Like many agricultural products, it is difficult to predict the production of volumes of different types and in different regions. In order to prevent any shortages, manufacturers often keep stocks to avoid shortages of any one type of tobacco used in their blends. Stocks act as a price stabilizer from harvest to harvest. This prevents price increases, for example, as a result of a poor harvest. However, the volatility in stock levels between 1995 and 1997 did have an effect on prices. The following figure highlights the close relationship between production and consumption since With the exception of the mid 1990s, tobacco production has closely followed demand: 27 FAO (2003:8). Incidentally, due to political problems during the last few years, Zimbabwe has decreased its presence on the international tobacco market. This will be covered in greater detail in the Zimbabwe case study. 24

25 Figure 6: Tobacco Leaf Production and Stock Balances, by volume Stock Balances Stock Balances Opening Balances Closing Balances Source: FAO Statistics, In addition, production of tobacco leaf has increased substantially in the last 30 years due mainly to increases in yield rather than in the area used for tobacco leaf. Improvements in growing and harvesting technology have led to less land being used for tobacco leaf crops. The following figure highlights this trend: 25

26 Figure 7: Tobacco Area Harvested and Yields per Hectare, ,000,000 25,000 4,500,000 4,000,000 20,000 3,500,000 Area harvested (Ha) 3,000,000 2,500,000 2,000,000 15,000 10,000 Yield Hg/Ha Devʹd Countries Ha Devʹg Countries Ha Devʹd Countries Yield Devʹg Countries Yield 1,500,000 1,000,000 5, , Source: FAO Statistics, What are immediately noticeable are the differences in variation of area harvested between developing and developed countries. Depending on the country, the decrease in the ratio between the area harvested and the yield since 1990 in developing countries, is due to technological improvements, cooperation agreements with foreign multinationals for knowledge sharing, diversification into non tobacco business, or a sustained government effort. See country case studies for the specific reasons behind this trend. The recent and relative stability of the ratio between the area harvested and the yield of tobacco leaf in developing countries points to the fact that developing countries have played a large part in leaf and cigarette multinationals global strategy and that this relative stability is good for development Tobacco Leaf Market Characteristics The following section will look at both the growers market and the processing market for tobacco leaf. By doing so, the capacity of countries to export tobacco leaf will begin to emerge. This will be covered in the following section. 26

27 Support regimes in the growers market Effect on prices and production In many developed countries, tobacco leaf growers benefit from highly subsidized agricultural programs. In some cases, the subsidized tobacco leaf provides cigarette manufacturers with cheap inputs. Often the quotas set are based on the price of tobacco the cigarette companies would like to pay. In other cases, the cigarette companies agree to prop up the local tobacco leaf production (see Switzerland case study). However, in some countries (see EU), there is an apparent contradiction between the product related subsidies to growers and the social concerns and costs of smoking. These regimes also have an effect on tobacco leaf trade in developing countries where leaf is cheaper to produce and receives less support than in the developed countries. The EU and U.S. country case studies will articulate this more clearly. In contrast to these support regimes, growers in many developing countries do not benefit from similar arrangements. Whilst some markets are still dominated by state monopolies, most have been privatized during the last ten years. Selling off state owned tobacco enterprises has the effect of transferring control of cigarette or tobacco leaf markets from state companies to the cigarette and tobacco leaf dealers multinationals. Instead of gaining market share as trade liberalization gradually opens markets in a national monopoly dominated market, the multinationals are able to acquire a dominant market share effective immediately. Of course, this position allows the multinational to manipulate the market far more comprehensively then if he had acquired a small market share. The result for some growers is that farm gate prices (those received by the grower) are too low for growers to diversify into different crops and creates a poverty trap. The country case studies consider the effects of local and foreign support regimes on output The tobacco leaf industry The tobacco leaf market (which includes selection, processing, storage, shipping, etc.) is characterized either by a few multinationals, state monopolies (where applicable), marketing boards, or producers co operatives. See individual country case studies for the particularities of the tobacco leaf industry. In general, all producer activities are tightly controlled by a small number of multinational tobacco leaf corporations. In the absence of 27