Written Testimony of Organization for Competitive Markets

Written Testimony of
Organization for Competitive Markets

 
Presented by
Michael C. Stumo
General Counsel
 
Before the USDA’s Public Forum on
Captive Supplies in the Livestock Sector

 
Denver, Colorado
September 21, 2000
 
OCM
Organization for Competitive Markets
P.O. Box 6468
Lincoln, NE 68506
 
Tel: 662.476.5568
Fax: 208.275.6421
www.competitivemarkets.comTable of Contents

Executive Summary. 1
Part One:  OCM’s Response to Questions Submitted by the Secretary. 3
Question 1: Anticompetitive effects of captive supplies. 3
Question 2: Suggestions for further regulations. 3
Question 3: Consolidation, alleged efficiencies and competition. 4
Question 4: Positive and negative effects of captive supplies. 5
Question 5: Competition and rural communities. 6
Part Two: OCM Analysis of Proposed Rule on Captive Supply Practices. 8

I.      Introduction. 8
II.      The Secretary Possesses  the Authority to Promulgate Rules Limiting Captive Supply and Price Discrimination under the Packers and Stockyards Act 8
A.    Congress delegated unsurpassed legislative-style rulemaking ability to the Secretary under the Packers & Stockyards Act 8
B.    Facts found by the Secretary will not be second guessed, especially where, as here, such facts are general and legislative rather than specific and adjudicative. 9
C.    The Secretary has tremendous authority to determine which technical evidence and expert opinions he will accept in the rulemaking process. 10
III.         The Evidence and Well-Accepted Economic Theory Shows that Captive Supplies Violate the P&S Act 11
A.    Studies are unanimous in finding a negative correlation between captive supplies and prices  11
B.    Reliance on well-accepted economic models show that captive supplies cause lower prices  12
C.    The unprecedented intertemporal arbitrage theory posited by Schroeter and Azzam to explain how captive supplies might not cause lower prices is implausible. 14
D.    Thin markets increase the ability for manipulation. 15
E.    Captive supplies limit or eliminate the ability of producers to hedge price risk through the futures markets. 16
F.     Captive supplies cause declines in futures market prices. 16
IV.        Industry Claims of Efficiency or Other Benefits are Unrelated to the P&S Act 17
A.    If the Secretary concludes that captive supplies has the effect of controlling or manipulating the market, or that they are unfair, efficiency arguments are not applicable. 17
B.    Even if there are benefits to partial integration, those benefits are unaffected by the WORC rule  18
V.    Conclusion. 20
Part Three: OCM Analysis on Proposed Price Discrimination Regulations. 21
A.    The Secretary should promulgate a rule on price discrimination in the hog and cattle markets  21
B.    A rational price discrimination rule should define allowable reasons for discrimination and disallow all others as violative of public policy. 23
C.    An evidentiary burden shifting provision should also be included in a price discrimination rule  24
  
Executive Summary
 
The Organization for Competitive Markets (OCM) would like to thank the Secretary and the Department of Agriculture for investigating whether to promulgate rules dealing with competition problems in the livestock industry.  OCM is a multidisciplinary nonprofit organization with a mission of reclaiming the agricultural marketplace for independent farmers, ranchers and rural communities.  Our membership includes farmers, ranchers, attorneys, agricultural economists, rural sociologists, anthropologists, nonprofit leaders and business persons. 
 
The core focus of OCM is competition policy in the agriculture sector.  In our view, a diverse, atomistic structure at all levels of the food system is most likely to allocate resources properly and produce beneficial results for the broader public.  As we the number of firms declines at the farm input level, the processor level, the food manufacturing level and the retail level, the result is an incremental decrease in vigorous price competition.  Sometimes the reduction in competition is subtle, only detectable by those participating in the market daily.  At other times, the reduction in competition can actually be measured through aggregate numbers.
 
Many have made claims of efficiency gains.  Efficiency is “probably the most confusing word in economics” and efficiency measures are of “severely limited usefulness.”[1]  More significantly, under the present industry structure, alleged benefits from efficiency are not widely distributed, notably not to farmers or consumers.  This is a misallocation of resources problem.  The depressed agricultural sector in the context of a booming economy does not lend support to those who tout efficiency.  The Department of Justice sensibly treats efficiency claims as suspect in merger review analysis.  This is because the information is exclusively held by the firm, claims are self-serving, and often the predicted efficiencies do not materialize.  Lastly, there is no evidence that the supply chain industry model produces the most efficient results.
 
In any event, the main drivers of efficiency are competition and innovation by many firms.  A diversified structure spurs such competition and innovation while allocating resources more widely and beneficially.  Thus, a diverse food industry structure serves the public interest best.
 
In livestock agriculture, horizontal concentration was predicted by proponents to result in benefit to the food sector.  Unfortunately, decision makers have long ignored competition problems arising from concentration.  To the astonishment of many, concentration proponents claimed that three firms in a sector truly results in vigorous competition.  We see today that producers and consumers did not benefit.  The processors benefited. 
 
Captive supply is the recent destructive trend.  Now there are not only fewer bidders, but the remaining bidders are much more passive because they have distributed supply through non-price means: forward contracts, production contracts, marketing agreements and packer ownership.  This gives packers more control over inventory but transforms them into passive bidders that can procure the balance of their supply through conservative bidding.  Spot market transactions are priced lower, are lower in volume, and the thin market increases the risk of manipulation.
 
Our analysis will show that the known facts, analyzed through proper economic models, prove the common sense conclusion that captive supply harms price. 
 
We will hear from some, in this hearing, whom the current system is benefiting.  It is natural that they will try to protect the preferential position they hold, despite the harm caused to others.  The packers who are enjoying record profits do not want to share the benefits properly with the rest of the system should the Secretary decide to increase competition in the marketplace.  Those feedlots which enjoy preferential benefits from marketing agreements do not want to bite the packers’ hand that feeds them.  Further, those representing the packers and the preferred feedlots will not give testimony which harms their interests.  The Secretary can take these factors into account when weighing the credibility of the testimony. 
 
This written testimony is submitted in three parts.  Part One presents the written questions which the USDA will orally present to each hearing witness followed by OCM’s answers to those questions.  Part Two is a full and considered presentation which will show that the law, the facts and the expert opinions show that the Secretary should propound the rule submitted by the Western Organization of Resource Councils (WORC) and that he can do so without fear of losing an administrative appeal. 
 
Part Three advances a rationale for propounding a carefully considered rule to respond to the problem of price discrimination in the agricultural marketplace.  Price discrimination results in a misallocation of resources throughout the production sector.  It increases the pressure on those producers who are receiving market bids in the lower range of the spectrum to leave agriculture.  If price discrimination is allowed to continue, there will always be favored producers and non-favored producers.  The latter subset of producers are more likely to be forced out of production agriculture and the overall attrition rate will continue at an increased speed.
 
In summary, 85% of the respondents in the 2000 Iowa Farm and Rural Life Poll stated that it is problematic to allow so few food companies to control so much of the food system.  This is contrary to the position of the few, powerful voices that advocate a small number of partially or fully integrated supply chains. 

Part One:  OCM’s Response to Questions Submitted by the Secretary
 
1.      What evidence or information do you have that demonstrates that forward contracting or packer ownership of livestock manipulates, controls prices or has other anti-competitive effects, or is likely to do so in the future?  Would the prohibition of certain types of captive supply or of packer ownership of livestock effectively limit packer market power to affect market price?  What other consequences would result from such a prohibition?[2]
 
(a)  Studies unanimously show that there is always a correlation between higher captive supplies and lower prices.  As to causation, well accepted economic models reveal that the most likely explanation is that captive supplies actually cause lower prices.  These models include auction theory and experimental economics.  Further, captive supplies give rise to thin spot markets which are more subject to manipulation or control by the few, powerful packers.  Additionally, the portion of livestock which sets the price each day is less than the full volume of spot livestock reported because many cattle and hogs receive only one bid, not competitive, multiple bids.  Lastly, from a futures market perspective, every piece of information received by floor traders due to captive supply is negative as to price.  Thus, futures prices are bid lower.   
 
(b)  The prohibition of certain types of captive supplies would limit packer market power in the following ways.  First, all packers would have to bid aggressively for cattle in the marketplace.  Basic economic theory is clear that if there is even one of the few packers which becomes a passive bidder, prices will suffer.  With the current system, all packers are often passive bidders.  Second, transforming the currently thin market which results in price discovery into a broad and deep market will lessen packer ability to manipulate or control prices and be more reflective of true supply and demand.
 
(c)  If captive supplies are required to be openly and publicly bid upon rather than traded through secret agreements, all benefits worthy of public policy consideration will be preserved.  Risk management, value-based procurement, and identity preservation are not harmed.  There is no public policy argument in favor of packers owning livestock.  This form of captive supply should be banned.  Packers can recoup their costs through a divestiture sale transaction and focus upon profits elsewhere.
 
2.   What, if any, further regulatory actions should be considered by USDA under the P&S Act to reflect structural changes in the livestock sector?[3]
 
A rule outlawing price discrimination should be promulgated.  Price discrimination is a tremendous problem for farmers and ranchers.  There is an overwhelming disparity in prices paid among producers for like quality livestock.  For example, in hogs the spread is often fifteen dollars per carcass hundredweight between the low and high ends for 49-50% lean animals.  In cattle, we know that marketing agreement cattle receive higher prices than spot market cattle of like grade and quality.
 
The price discrimination is occurring for reasons that violate public policy with the result of forcing farmers and ranchers out of business.  The Secretary should define public policy as to unjust pricing differences in setting substantive and procedural rules.  The substantive rules should disallow all discrimination in prices except for the common sense reasons of grade, quality, special production methods, transportation and time of delivery.  Other reasons for price differentials, such as keeping a plant running at full capacity, should be disallowed as violative of public policy.
 
The procedural rules should address evidentiary burden shifting in enforcement cases for public and private plaintiffs.  Such a provision should state that a plaintiff can prove a prima facie case with a showing that a packer paid different prices for animals of like grade and quality on a given day.  The packer can then defend by showing that the reason for the price discrimination falls within one of the predetermined categories stated above.  If the packer puts on no evidence, the plaintiff wins.  If the packer falls within one of these “safe harbors”, it must also show that the price differential was cost justified. 
 
Further, OCM supports rules under consideration for packer record keeping and contracting.  OCM looks forward to commenting on these rules in the future to help insure that they are responsive to producer needs.
 
3.   There are two sides to the argument on consolidation and concentration in the marketplace.  What evidence do you have to support a contention that greater efficiencies result from consolidation in the marketplace?  What evidence do you have to support a contention that consolidation or concentration result in a decline of competition in the marketplace?
 
(a)  First, efficiencies are irrelevant to market manipulation.  If a packer is intentionally or unintentionally manipulating the market, there is no law that considers efficiency a defense. 
 
Second, efficiencies are difficult to prove.  Efficiency is “probably the most confusing word in economics” and efficiency measures are of “severely limited usefulness.”[4]  The information is solely in the hands of the packer and protected as proprietary information.  Public information is incomplete and subject to serious dispute.  Note that the merger guidelines for the Department of Justice treat efficiency claims with a critical eye.  Such claims must be substantiated, there must be confidence that they will materialize, and they are usually not admitted as evidence in an antitrust case due to relevance problems.  The Secretary should be similarly critical of such claims.
 
Third, there is no evidence indicating that benefits from alleged efficiencies are passed on to producers or consumers.  When hogs traded at eight to ten dollars per hundred weight, consumer prices did not respond.  The recent drop in cattle prices has not been transmitted to the consumer.  Those standing between the farmer and consumer receive the benefits.  A competitive marketplace is more likely to drive efficiency, allocate resources properly and reflect true supply and demand. 
 
Fourth, it is disingenuous to claim that there is only one road to efficiency.  There are many ways to structure an industry.  There is no proof that one structure is appreciably more efficient than other structures.  Full competition by many firms has driven efficiency very hard in other contexts, most notably the agricultural production sector.  Thus, other public policy considerations should control.
 
(b)  The evidence that consolidation or concentration result in a decline of competition in the marketplace is discussed in response to question 1 above.  Further, Heffernan (The Influence of the Big Three: ADM, Cargill and ConAgra, 1999) presents an added theory.  That theory is that economic power comes from “exit power.”  In a relationship between two or more individuals, groups, or organizations, the party that has the least to lose from ending the relationship has the most power in the relationship.  Since meat packers have many choices for procurement and farmers have three to four choices (or one in many cases), the packer has far more exit power than the farmer.  If we take one packer out of the buying, either due to captive supplies, closure or merger, established economic theories predict a lessening of competition.  These predictions correlate with farm prices and the declining farm share of the food dollar which we see today.
 
National policy has focused on the “bigger is better” trend for decades.  This policy has resulted in agriculture being nearly the only sector which is impoverished in this booming economy.  Unfortunately, those supporting the consolidation policies of the past have not admitted failure and people still listen to them.
 
4.   What are the positive and negative effects of the various marketing arrangements – i.e., forward contracts, marketing agreements, packer feeding – on maintaining and sustaining competitive markets?  Please explain how market effect, particularly with reference to price discovery and transparency, support your view.
 
The positive effects of captive supply include risk management for the select few who have such preferential agreements.  Risk management will not be harmed by the adoption of the WORC rule.  Further, there are many risk management options available other than market distorting procurement mechanisms. 
 
However, captive supply as risk management ironically eviscerates use of the futures markets as a risk management tool.  The written testimony of commodity broker Luke Schwieterman (recently submitted for the written record) shows that captive supplies cause cash price fluctuations that result in wild basis fluctuations.  According to Schweiterman, the price fluctuation eliminates the ability to predict the basis, as was formerly the case.  Without a minimally predictable basis, proper hedging cannot occur.  Thus, any risk management benefits by the captive supply feedlots ruins the futures market as a risk management tool for a large portion of non-speculative market participants.
 
Other negative effects of captive supply are lower prices due to increased passivity in packer buying, and an increased likelihood of market manipulation, whether intentional or not.  No one argues that thin markets are good.  No one argues that thin markets produce more and better information.  A tremendous portion of procurement is internalized and the information is not publicly disclosed. 
 
Further negative effects are price discrimination (between marketing agreement cattle and cash cattle for like quality), the lack of pricing information for both cash and futures market participants, and reduced ability to hedge.  See also answer to question 1.
 
5.   Is there any evidence demonstrating the link between the degree of openness and competition in livestock markets and the economic sustainability of rural communities?
 
Lack of competition for livestock means lower prices.  Captive supply, as shown above, means lower prices and price discrimination.  Lower prices and price discrimination results in farmers leaving agriculture.  Fewer farmers in rural communities mean less customers for mainstreet businesses in small towns.  The recent 2000 Iowa Farm and Rural Life poll conducted by Iowa State University showed that at 70 to 80% of farmers do business at local feed stores, supermarkets and other businesses. 
 
Further, rural sociological and anthropological studies which have studied the issue find that when a large number of smaller scale, closely held farms which provide labor, management and capital are replaced by large-scale farms characterized by absentee ownership, rural communities are significantly harmed economically and socially.  Every time a family farm fails, it is a significant tear in the rural fabric.  A large number of “tears” is very destructive.
 
A key component to the captive supply paradigm in poultry, hogs, and to a lesser degree cattle, is that one firm owns a very large number of animals and pays others on a piecemeal type basis to care for the animals.  This system replaces the independent farmers that owned the livestock and reaped the profits from the sale of the livestock.  Even today these farms spend most of that money near the farm, providing the economic foundation of rural communities.  In contrast, vertically integrated operations are much less likely to support local businesses.[5]
 
Recently the Kerr Center released a case study on vertical integration and industrial swine production in Texas County, Oklahoma.[6]  The study provides a good example of what may happen to rural communities as competitive livestock markets disappear under the shadow of captive supplies.  The study points out vertically integrated mega hog farms that replace the independent hog farms “[n]ot only . . . fail to deliver high paying, quality jobs that lend stability to the community, they export the profits out of the community.”[7]  Most, if not all, of the residual profits from the production of hogs now flow out of the community to the stockholders of the corporation, decreasing the income of the rural community.
 
Thu and Durenberger in an introduction to a book examining the relation of industrialized hog production note the following consequences of increased vertical integration:
 
Ownership, management, and labor become separated both economically and socially.  In one form, producers contract with large companies or corporations to produce hogs.  In these “risk-sharing” ventures, the farmer produces hogs owned by someone else following a standardized production protocol specified by the contractor.  In such a system, wealth and profits are extracted from local economic systems which, even where standards of living increase, become increasingly dependent on control from outside systems.[8]
 
Very few rural communities have transitioned successfully away from agriculture.  This is because production agriculture is a diverse, atomistic structure spreading dollars widely and keeping them in the community.  No one argues that any other industry distributes dollars among rural areas as effectively.
 

References for Question 5:
 
Goldschmidt, Walter, As You Sow: How Industrialized Farming is Changing the American Way of Life. New York: Harcourt Brace and Co., 1947.
 
Miner, Horace, Culture and Agriculture: An Anthropological Study of a Corn Belt County, Ann Arbor, Michigan: U of Michigan Press, 1949.
 
Office of Technology Assessment, Technology, Public Policy, and the Changing Stucture of American Agriculture, Washington, D.C., U.S. Congress, 1986.
 
Kendall Thu, Editor, Understanding the Impacts of Large-Scale Swine Production. Iowa City, Iowa: The University of Iowa, 1986.
 
USDA-EPA, Draft National Strategy for Animal Feeding Operations. September
11. Washington, D.C., 1986.
 
Salamon, Sonya A., The View from Anthropology: Discussion of Castle’s Conceptual Framework. American Journal of Agricultural Economics 80(3):637-639, 1998.
 
Part Two:  OCM Analysis of Proposed Rule on Captive Supply Practices
 
I.             Introduction
 
This analysis by the Organization for Competitive Markets will show that the known facts about captive supplies coupled with established economic theory show that the Secretary should propound the rule submitted by the Western Organization of Resource Councils (WORC) in order to protect and increase competition in the agricultural marketplace.  The WORC rule would require captive supplies to be subjected to an open, public bidding process.  This analysis further shows that the Secretary a choice to adopt the WORC rule would not be reversed in an administrative appeal.
 
II.            The Secretary Possesses  the Authority to Promulgate Rules Limiting Captive Supply and Price Discrimination under the Packers and Stockyards Act.
 
A.  Congress delegated unsurpassed legislative-style rulemaking ability to the Secretary under the Packers & Stockyards Act.
 
The nature of the Congressional delegation of authority under the Packers & Stockyards Act (P&S Act) is the broadest possible pursuant to the Constitution.  This rulemaking authority is quasi-legislative and leaves wide latitude for policy choices.  When passing the P&S Act, Congress purposely used broad language with the intention that the Secretary exercise “complete inquisitorial, visitorial, supervisory, and regulatory power over the packer, stockyards, and all activities connected therewith.”[9]  Congress used broad language in the Act so that the Secretary could adjust enforcement to industry change.[10]  For instance, the Act does not expressly allow or prohibit closed contracts or price discrimination.  The Act charged the Secretary with deciding whether these types of activities harm independent livestock producers. 
 
Section 407 of the P&S Act grants the Secretary the express authority to promulgate regulations:  “The Secretary may make such rules, regulations and orders as may be necessary to carry out the provisions of this Act . . . .”[11]   This is the broadest grant of policy making power to an agency that the U.S. Constitution allows.  When an agency is charged with enforcing such a statute, the Supreme Court requires that reviewing courts allow great deference to the agency’s decision:
 
      If Congress has explicitly left a gap for the agency to fill, there is an express delegation of authority to the agency to elucidate a specific provision of the statute by regulation.  Such legislative regulations are given controlling weight unless they are arbitrary, capricious, or manifestly contrary to statute.[12]
 
The question then is whether a decision by the Secretary to promulgate rules regulating captive supply is arbitrary.[13]  “An agency action is arbitrary and capricious if the agency fails to demonstrate in the record that it has examined the relevant data and articulated a satisfactory explanation for its actions.”[14]  Or, as the Supreme Court has stated, an agency’s decision is arbitrary where there is no “rational connection between the facts found and choice made.”[15] 
 
B.  Facts found by the Secretary will not be second guessed, especially where, as here, such facts are general and legislative rather than specific and adjudicative.
 
Just as questions of law are reviewed under the arbitrary standard, so are findings of fact.[16]  The Secretary has tremendous discretion as to which facts he will accept and which facts he will not accept.  The nature of these facts are not specific or adjudicative facts, but rather are general or legislative facts.[17]  This is a significant distinction between factfinding in rulemaking as versus enforcement.  Thus, the Secretary’s primacy in factfinding is incredibly difficult for a court to question or overturn.
 
The Grain Inspection, Packers & Stockyards Administration (GIPSA) and the Office of General Counsel (USDA) position as to the standard by which reviewing courts scrutinize regulations promulgated under the P&S Act is that “[I]f a reasonable person who reviewed the evidence would find that the Act was likely to be violated if the complained of activity continued, then the Secretary could prohibit the activity through the regulatory process.”[18]  The reasonableness standard is also known as the ‘substantial evidence standard’.[19]  Our analysis respectfully disagrees with this uncited assertion.  The law states that the ‘arbitrariness’ standard applies in this situation and provides the Secretary with greater discretion. 
 
The two standards differ in that “[c]ourts have recognized that the substantial evidence [reasonableness] standard requires greater judicial scrutiny of an agency decision then does the arbitrariness standard.”[20]  The reasonableness standard is used in formal adjudication, such as when a circuit court reviews the agency’s decision in an administrative action against a particular person; the more lenient ‘arbitrary and capricious’ standard is used when a court reviews an informal rulemaking, which the WORC Petition seeks.[21]  This difference is significant because the applicable “arbitrariness” standard provides the Secretary with greater authority in issuing regulations that affect livestock markets.[22]
 
Additionally, judicial review in an adjudicative context, such as the IBP Beef Marketing Group case, is backward looking at past facts.  Conversely, rulemaking is forward looking and inherently speculative and predictive.  This forward looking perspective allows far less ability for a court to second guess the Secretary’s finding of facts, determination of policies and acceptance of expert theories in the context of court review.
 
C.                                   The Secretary has tremendous authority to determine which technical evidence and expert opinions he will accept in the rulemaking process.
 
When reviewing rules that require technical expertise issued under a statute where an agency is charged with preventing harm, the D.C. Circuit provides great deference.  In the case of a precautionary-style statute, courts do not require direct causation.  “[W]here, as here, the statute is ‘precautionary’ in nature, the evidence ‘uncertain or conflicting’ and the ‘regulations designed to protect the public health,’ the court ‘will not demand rigorous step-by-step proof of cause and effect.’”[23]  The P&S Act is a precautionary statute designed to prevent “potential injury by stopping unlawful practices in their incipiency” and “proof of a particular injury is not required.”[24]
 
Further, the agency may utilize its own expertise, or those of other experts it chooses to credit, to fill in gaps in direct evidence.  “The Administrator may apply his expertise to draw conclusions from suspected, but not completely substantiated, relationships between facts, from trends among facts, from theoretical projections from imperfect data, from probative preliminary data not yet certifiable as ‘fact,’ and the like.”[25]
 
The D.C. Circuit, which would review any challenge to a rule the Secretary may issue, echoed this approach in a case dealing with the Federal Energy Regulatory Commission’s valuation of petroleum shipped on Alaska pipelines.  Here the court recognized that “[w]here the necessary analysis ‘requires a high level of technical expertise, we must defer to the informed discretion of the responsible federal agencies.’”[26]
 
The notion of increased deference to agency decisions relating to technical matters that are within the agency’s expertise also applies to decisions within the USDA.  In Southwest Center for Biological Diversity v. Glickman,[27] the court reviewed the Secretary’s decision to sell salvage timber.  As to deference and the specter of conflicting expert evidence, the court stated:
 
A deferential approach is “especially appropriate where, as here, the challenged decision implicates substantial expertise.”  Mt. Graham Red Squirrel v. Espy, 986 F.2d 1568, 1571 (9th Cir. 1993) . . . See FCC v. National Citizens Comm. for Broadcasting, 436 U.S. 775, 813-14 (1978) (where the agency’s particular technical expertise is involved, the court must be particularly zealous in guarding the agency’s discretion).  “When specialists express conflicting views, an agency must have discretion to rely on the reasonable opinions of its own qualified experts even if, as an original matter, a court might find contrary views more persuasive.”  Marsh v. Oregon Natural Resources Council, 490 U.S. 360, 378 (1989).[28]
 
Beyond facts that have been proven, the Secretary may also make policy on issues in which “insufficient data is presently available to make a fully informed factual determination.”[29]  Where research in an area is not yet developed, “the agency necessarily enjoys the broad discretion to attempt to formulate a solution to the best of its ability on the basis of available information.”[30]  A court will uphold a regulation unless the regulation is “so implausible that it could not be ascribed to a difference in view or the product of agency expertise.”[31]
 
Given this extremely deferential standard that courts grant to the Department in this type of technical rulemaking, the Secretary can be assured that a rule limiting captive supply would survive a challenge.  Transforming secret captive supply procurement methods to a true market bidding system is a duty that the Secretary owes farmers and ranchers.
 
III.          The Evidence and Well-Accepted Economic Theory Shows that Captive Supplies Violate the P&S Act.
 
A. Studies are unanimous in finding a negative correlation between captive supplies and prices.
 
Each and every study on the issue of the captive supply/price relationship has found a negative correlation.  The recent Shroeter and Azzam analysis found that the “[a]verage price in the region’s spot market for cattle tends to be relatively low in weeks in which delivery of cattle from non-cash sources are relatively high, other things equal.”[32]  In fact, Schroeter and Azzam conclude that “a robust empirical relationship was found in every case:  The slaughter of cattle procured by non-cash means and contemporaneous spot market prices are negatively related at the regional level.”[33]  The results “when taken at face value, suggest that the impact of non-cash procurement methods on price is reasonably substantial.”[34] 
 
This study echoes numerous others that have considered the relationship between captive supplies and prices.[35]  There is no study which has found otherwise.  Thus, the Secretary must make a finding acknowledging this correlation as there is no substantial evidence to the contrary.
 
B. Reliance on well-accepted economic models show that captive supplies cause lower prices.
 
The difficulty perceived by the Secretary’s staff in considering a rule on captive supply has been an alleged lack of evidence of causation.  Does captive supply cause lower prices, or is there another causative factor?  Well established economic theories, in combination with the known facts, answer the question by concluding that captive supplies are the causative factor.
 
Captive supplies lead to less active bidders in the market, and therefore a lower price.  Schroeter and Azzam recognize this effect on bidding:  “When a packer enters the spot market knowing that a relatively large proportion of its typical slaughter volume is committed, for the near-term future, in the form of already scheduled deliveries of cattle procured by non-cash means, it will usually want to purchase correspondingly fewer spot market cattle.  This can normally be accomplished with relatively conservative bidding.”[36]  Sexton observes that “[e]ven a cursory analysis of the spot market bidding process reveals that it is heavily skewed in favor of the packers, and any forces that diminish a packer’s incentives to bid aggressively for cattle are likely to adversely affect cash prices.”[37]  Because of the concentration disparity, Sexton concludes that it is likely that the conservative bidding described by Schroeter and Azzam will affect prices.[38]
 
Captive supplies effectively remove a bidder from the market for a certain percentage of livestock because the packer no longer needs to actively bid in the open market for the percentage of cattle it has captive.  McLaren discusses the dynamic that adding one more bidder to a market will either increase the price, or at the very least not change the price.[39]  Thus, removing a firm can only lower the price, or possibly not change the price.  As the American Meat Institute and others in the cattle industry admitted in a recent Memorandum filed with a federal district court in Missouri, “[t]he fewer the number of buyers, the more likely it is that the price will go down.”[40]  Captive supplies removes one or more buyers from the open market, and therefore has the effect of manipulating or controlling the market.
 
Further, captive supplies exacerbate the problems inherent in the current bidding process for cattle.[41]  “A bidding process where the same three or four buyers interact repeatedly through time and among many sellers is a process that is tailor made for bidder collusion.”[42]  Factors which evidence the fact that the current bidding process reflects packers’ power to implement a system that is favorable to them include:
 
1. Bidding only occurs in one relatively short time window per week, such as 30 minutes to two hours once per week, in a take-it-or-leave-it format rather than true negotiation;
2. A nonprice, queuing mechanism is used to distribute cattle to buyers, wherein the first bidder has priority in the case of ties; and
3. Whole dollar bidding, rather than fractions of dollars.
 
Each of these factors is likely imposed by the packer side of the market, reflecting packer ability to not bid aggressively.  Conversely stated, such conventions are impossible for sellers to create or impose.  The short bidding window is strange, to say the least, when a packer is killing cattle five to six days per week.  It facilitates “panic selling” by buyers, rather than back and forth price negotiation. 
 
Aggressive bidding is also stifled by the “queuing mechanism” used by buyers.[43]  This queuing mechanism provides that the first bidder receives two advantages:  the first bidder has the priority in the case of tie bids, and the first bidder has the opportunity to revise his bid if someone increases the bid.  “Whole dollar” bidding conventions increase the likelihood of tie bids (assuming the seller receives more than one bid).  The actual facts show that typically all bids on a particular lot are the same. [44]  The dynamic leads to the anticompetitive result that “queuing and not pricing determines who gets the cattle,” according to Dr. Sexton at the University of California, Davis.[45]
 
Captive supplies are an additional, but probably the most important, force that evidences a packer’s diminished incentive to bid aggressively for cash cattle.  Almost all observers recognize that captive supply results in a packer being able to bid more conservatively.  Both auction theory and experimental economics find that when there are three or four buyers, and one becomes a passive bidder, price is depressed.  Captive supply allows at least one, if not all, packers to become more passive bidders.  Thus, the price is likely to be lower due to the less aggressive nature of full bidding in a totally competitive market.  Cattle are distributed to buyers without bidding. [46]
 
Other studies have examined the reason underlying the fact that as captive supplies increase, price decreases.  For instance, Love points out a study that found that as a firm increases the use of captive supply, “aggregate demand in the market is reduced and spot prices in the input market are reduced.”[47]  In other words, captive supplies have the effect of controlling the aggregate demand of a market.
 
The behavioral models discussed above, with the relevant facts established, require the Secretary to adopt a rule to eliminate the harm captive supplies cause to market competition. 
 
C. The unprecedented intertemporal arbitrage theory posited by Schroeter and Azzam to explain how captive supplies might not cause lower prices is implausible.
 
Schroeter and Azzam recognize the robust negative correlation between captive supplies and prices.  Yet they argue against a finding of causation.  Rather, they propose a heretofore unheard of “intuitive model” which hypothesizes an intertemporal arbitrage ability exclusively executed by marketing agreement feedlot managers.[48]  Schroeter and Azzam claim, without factual or theoretical support, that the market participants (participating in marketing agreements) are “undoubtedly quite good forecasters of price.”[49]  They allege that captive supply feedlot managers decide to schedule their cattle to take advantage of a fluctuating market.  The causation related upshot of this theory is that higher spot prices cause more captive supply because feedlot operators dump their marketing agreement cattle to lock in the higher spot prices.  Not only does this theory have no support in the literature, it does not make sense for several reasons.
 
As reviewer Cranfield points out, this “intertemporal argument is weak, as it does not reflect, or even allow for the possibility that those active in the cash market will take advantage of the same profit making opportunities as those using captive supplies.”[50]  Sexton points out that the conceptual flaw in Schroeter and Azzam’s argument is “their failure to consider that participants in the cash market have the same incentives.”[51]  Thus, spot market sellers – many of which price the cattle on the week prior to delivery – would also schedule their cattle to take advantage of higher prices.  This dynamic would offset or overwhelm any potential arbitrage actions of the captive supply sellers.  Thus, higher prices could not cause higher prices.  There are no facts or credible theories allowing the Secretary to conclude otherwise. 
 
Dr. Alan Love points out in his review of the Texas Panhandle analysis at least three other models predict “that vertical integration, or contracting, can have a depressing effect on spot market input price in markets characterized by partial vertical integration.”[52]  Professor DeeVon Bailey has similar reservations.[53]
 
Another major weakness in the Schroeter and Azzam argument is that it lacks “a well-defined model of packerbuying behavior.”[54]  Would the more powerful market participants, the packers, allow this arbitrage to continue thereby increasing their procurement cost?  Doubtful.  Without a model looking at packer behavior, it is impossible to give credibility to a theory that attributes significant arbitrage ability to one sector of the market participants (i.e. exclusively marketing agreement sellers) on the weaker side of the transaction.
 
Thus, the only credible economic models conclude, when the facts are inserted, that captive supplies are highly likely to be the causative factor in depressing price.  This result confirms common sense.  Thus, the Secretary should promulgate the WORC rule.
 
D. Thin markets increase the ability for manipulation.
 
Apart from the issue of causation, increased non-price procurement through captive supplies result in a thin cash market.  The increased likelihood of manipulation or control of this increasingly thin market is reason enough to propound the WORC rule.
 
The overwhelming majority of long term contracts are derived directly or indirectly from the spot market price (because commodities future trading rely significantly on cash market information, forward contracts are derivatively affected by the spot price).  It is uncontested that the existence of captive supplies thins the spot market, thereby increasing the likelihood of manipulation.  Schroeter and Azzam recognized that as the spot market becomes thinner, “spot prices will become increasingly less reflective of the forces of supply and demand.”[55]  They further state that, “[w]hen a packer anticipates an unusually large volume of marketing agreement deliveries in a given week, there is an obvious incentive to try to reduce the formula’s base price so as to reduce the price that will have to be paid for the formula-priced cattle.”[56]
 
Depending on the region, cattle procured through captive supplies vary between 25 to 50%, with some weeks approaching 100%.  Hogs are approaching 75% captive supply. 
 
But the spot market is even thinner than the reported numbers suggest.  OCM has found that many of the cattle and hogs traded in the open market are not subject to competitive bidding.  Producers in areas where there are several packers often receive only one bid either because captive supplies decrease aggressive packer bidding or due to “relationship livestock” where a producer has a relationship with a packer buyer and sends all the animals to that packer without bidding every time.  Further, many producers live in areas where there is only one available packer.  In those areas it is impossible to get more than one bid.
 
There is a significant history in the agricultural and non-agricultural field where thin markets have been manipulated.  The 1996 Mueller and Marion study of the cheese exchange is only one example.
 
To increase aggressive bidding on all cattle and hogs, and to reduce the likelihood of market manipulation, captive supplies should be traded on the open market with all players having access.  A broader and deeper market such as this will be more reflective of supply and demand factors.
 
E.  Captive supplies limit or eliminate the ability of producers to hedge price risk through the futures markets.
 
The written testimony submitted by Luke Schwieterman, a commodities broker in Western Kansas, presents facts showing that the cash price fluctuations connected with captive supplies in the cattle market make hedging difficult.  Producers have historically hedged price risk through the futures markets.  Proper hedging requires a market which behaves in a somewhat predictable manner with regard to basis.[57]
 
The cash market gyrations associated with captive supplies result in unpredictable basis.  When the basis fluctuates too much, the risk management benefit of hedging is eliminated.  Thus, captive supply further harms market participants by taking away a major method of price protection – hedging inventory in the futuresmarkets.  Thus, captive supplies should be openly traded to add to, rather than subtract from, full market information and proper reflection of true supply and demand factors.
 
F. Captive supplies cause declines in futures market prices.
 
Futures markets are ideally a proper reflection of cash market supply and demand factors.  Les Messinger, in testimony submitted for this hearing, conveys that each and every piece of information derived from market conditions relating to captive supplies has a depressing impact on futures prices.  Messinger has been a live cattle future trader at the Chicago Mercantile Exchange for the past 30 years.
 
From the perspective within the live cattle pit at the CME:
 
“Information is the lifeblood of proper pricing by floor traders.  The result of captive supplies is that the practice drives futures prices down.  Captive supply practices limit information which is necessary for a market to reflect true supply and demand factors.  Further, the little remaining cash market information that traders are able to gather is controlled by the packing industry – rather than other sources – and generally carries a negative bias.”[58]
 
The type of information related to captive supplies which provides significant downward pressure on cattle futures includes:
 
1. Packers have secured enough cattle under their control so that the perception of the futures industry is that they will rarely ever have to bid higher to buy cattle.
2. No realistic cash market exists during the trading week until Thursday or Friday when packers bid for the remainder of their kill, thereby depressing futures prices.
3. When bidding does occur on the cash market, it usually lasts only for about an hour.[59]
 
Messinger adds that : “The general consensus among those of us who process market information in the CME live cattle pit is that packers control the cash markets through the use of captive supplies.  Futures prices are significantly and negatively affected by that perception.  Further perceptions are that prices will only rally as far as packers will allow them to go before taking action to stop them through manipulating captive supply deliveries.  Because the futures market lives on information, these perceptions on information become reality in that they are reflected in the price of live cattle contracts.”[60]
 
Messinger closing remarks strongly recommend that captive supplies be ended or subjected to open, public bidding.
 
“It is my recommendation that the Secretary end captive supply practices unless long term agreements aretransformed into an open bidding process which produces a larger volume of information that is less likely to be controlled by the packers.  When there is more information that is less under the control of one side of the transaction, the bias is not skewed in one direction.”
 
This evidence is difficult for an economic study to rebut.  As a result, the WORC rule should be promulgated.
 
IV.       Industry Claims of Efficiency or Other Benefits are Unrelated to the P&S Act
 
A. If the Secretary concludes that captive supplies has the effect of controlling or manipulating the market, or that they are unfair, efficiency arguments are not applicable.
 
It is to be expected that the packing industry will argue strenuously to preserve a non-price system of procurement which benefits them at the expense of others.  The Secretary can take this motivation into account when determining which claims to accept or reject.
 
Packers often argue, for example, that the use of captive supplies provides them certain positive results, such as the packer being able to fully utilize its capacity.  Yet the P&S Act is not designed to maximize packer profits.  It is designed to prevent certain packer practices which are unfair or have the effect of manipulating or controlling prices.  Under section 202(e), if a packer practice has the effect of manipulating or controlling the market, the practice violates the Act.  There is no law that includes the rule of reason analysis in Section 202(e).  Thus, a practice that has the effect of manipulating or controlling prices is a per se violation of the Act. 
 
Because the Secretary has both correlation and causation, as explained above, with regard to the effect of captive supplies on price, section 202(e) grants the Secretary authority to promulgate the WORC rule.  Thus, no rule of reason style justifications apply.  Packer efficiency is irrelevant.  The reasons for feedlot operators entering into agreements is not a consideration.  Food safety and trace back ability are similarly irrelevant. 
 
Though there is a lack of consensus as to whether the rule of reason is applicable at all to the P&S Act, the Seventh Circuit, a non-controlling authority, has said the terms unfair, unjust, undue and unreasonable do require the Secretary to utilize the rule of reason analysis under sections 202(a) and (b).[61]  Assuming, without conceding, that the rule of reason is relevant under sections 202(a) and (b), the Secretary is not bound to import the full contours of antitrust law defenses into the P&S Act. 
 
The Secretary, pursuant to his quasi-legislative rulemaking ability, can determine the weight and priority he attributes to certain justifications.  For example, efficiency claims are of little relevance, and almost never proven, under antitrust law.  There is no reason to assign higher priority here.  Under the rule of reason analysis, there is no law which requires food safety and trace back ability to be considerations.  Further, issues of full capacity at packing plants should be given little priority. 
 
Conversely, the Secretary can assign high priority to an effect of lowering prices.  He can also give high priority to the risk of market manipulation.  If there are relevant justifications determined by non-agricultural antitrust law, the Secretary can choose to give them less weight than courts have done in the past.  It would be difficult for a reviewing court to challenge those policy judgments.
 
B. Even if there are benefits to partial integration, those benefits are unaffected by the WORC rule.
 
The meat industry has long argued that benefits exist to justify captive supplies.  Assuming, without conceding, that these benefits exists, the WORC petition does not eliminate them.  Packers would still have the ability to contract for future deliveries.  The WORC Rule simply demands that the contracts be available in an open market.  Similarly, there is no evidence that the rule would hinder packers’ ability to maintain their plant capacities, undertake value-based pricing, or achieve identity preservation.  The rule would merely address the most negative aspects of captive supplies:  the depressing effect that the use of captive supplies has on the price and the increasingly thin open market which is more subject to manipulation.
 
A recent position paper by economists funded by the American Meat Institute (Marvin Hayenga, Ted Schroeder, John Lawrence, Dermot Hayes, Tomislav Vukina, Clement Ward and Wayne Purcell) lists reasons why packers prefer to enter into contracts.  The first of these is reduced costs, primarily because packers are better able to run at nearer to full capacity.[62]  The AMI paper concludes that “[s]uch sizeable cost savings serve as a major motivation for beef packers to develop non-price means such as contracts and marketing agreements to better coordinate cattle flows into beef packing plants.”[63]  Does this mean that packers would like to maintain an adequate supply by using mechanisms that do not require them to increase the price to increase supply?  There are no studies which show that packers are unable to fill their plants without non-price procurement.  Additionally, P&S Act was not passed to help packers run at full capacity with confidence.
 
In any event, the WORC rule would not hinder the packers’ ability to contract.  If packers want to line up a portion of their supply months in advance, they may do so.  But they must offer that contract on an open market and set a fixed base price.  The claimed “sizeable cost savings” can then be partially bid back into the cattle.  The increased packer profit should not come from captive supplies’ effect of manipulating or controlling the price.
 
The AMI study also cites risk management as one of the reasons packers and producers prefer to contract.[64]  Packers reduce the risk of running the plant at less than optimal capacity.  This argument is the same as the reduced cost argument. 
 
The AMI paper concludes that producers who choose to contract do so to reduce the risk of not being able to market their cattle at the most optimal time.  The factual basis for this claim is highly suspect.  Yet, the WORC rule would allow this risk management to continue.  Producers who wish to contract cattle for future delivery may do so under the WORC Rule.  The regulation would merely require that the contract be available on the open market and that the packer would have to set the base price of the cattle in the contract. 
 
As Cranfield states:  “If marketing agreement cattle are used to manage risk, with the unintended effect of lowering spot market prices, then it would seem prudent for any regulatory agency to recognize the role of risk management when making policy decisions. . . .  [The WORC Petition] has the benefit of allowing regional captive supply markets to evolve in a manner that reflects regional supply and demand conditions, and allows for more transparent pricing mechanisms to be used.”[65]
 
Citing value-based pricing as another reason for contracting,[66] the AMI paper somehow assumes that carcass merit pricing may only occur in secretly negotiated contracts.  It notes a number of analysts that have argued that the cattle industry must improve information flow to provide incentives for what customers demand.  Value based pricing is not prohibited under the WORC rule.  In fact, value-based pricing occurs in the spot market.  Cattle can be sold on a grid or through other mechanisms using a base price and quality premiums.  Nothing prevents the openly traded contracts from contemplating grade or other quality characteristics.
 
Finally, the AMI paper cites the need for identity preservation for food safety reasons so that the consumer knows that the meat is raised GMO free or has the ability to trace back to the source.  Nothing in the WORC rule would discourage packers from tracking the meat from the feedlot to the grocery store shelf.  If packers wish to acquire livestock that were raised a certain way, then they can make that part of the restriction of the contract when it is offered to the public.  Identity preservation is a mere record-keeping function unconnected with captive supply.  Low-tech approaches such as affidavits and on-site feedlot inspections are available.  In fact, the openly bid contracts can include such specifications.  High-tech methods of trace back such as computer chip implants could also be used.  Captive supply is not crucial to this issue. 
 
V.           Conclusion
 

Thus, the evidence clearly shows that the marketplace and farmers would be well served if captive supplies in hogs and cattle were required to be traded in an open bid system with a firm base price attached.  A decision to promulgate the WORC rule, would be, in practice, immune from reversal if it is challenged in an administrative appeal.  OCM requests, in the strongest possible terms, that the Secretary do so.
Part Three: OCM Analysis on Proposed Price Discrimination Regulations
 
A. The Secretary should promulgate a rule on price discrimination in the hog and cattle markets.
 
Beyond the effect of captive supplies on the market, one of the practices that harms independent farmers the most is the unjust discrimination suffered in prices.  Small to mid-size producers who lack bargaining power receive less favorable terms than larger farmers.  In many instances, this price discrimination occurs for no justifiable reason.  All farms are harmed by the manipulation of the market by the packers’ use of captive supplies.  Small farmers are doubly wounded because of unjust price discrimination.
 
The analysis by Schroeter and Azzam of data collected by GIPSA concerning cattle purchases in the Texas Panhandle found that cattle purchased on the spot market received less than those with the same quality procured through captive supply.[67]  This finding comports with previous studies that examined the relationship between spot market prices and prices for livestock purchased under a captive arrangement.[68] 
           
Packers will argue that paying large producers more per head is justified because of some type ofefficiency.  As the Department of Justice (DoJ) realizes, these efficiency arguments can sometimes be very speculative.  GIPSA should adopt DoJ’s attitude toward efficiencies as stated in DoJ’s Horizontal Merger Guidelines:
 
Efficiencies are difficult to verify and quantify, in part because much of the information relating to efficiencies is uniquely in the possession of the merging firms. Moreover, efficiencies projected reasonably and in good faith by the merging firms may not be realized. Therefore, the merging firms must substantiate efficiency claims so that the Agency can verify by reasonable means the likelihood and magnitude of each asserted efficiency, how and when each would be achieved (and any costs of doing so), how each would enhance the merged firm’s ability and incentive to compete, and why each would be merger-specific. Efficiency claims will not be considered if they are vague or speculative or otherwise cannot be verified by reasonable means.[69]
 
As discussed earlier, when the Secretary finds that a practice is likely to injure competition, the practice violates the P&S Act.  Discriminating against smaller farmers for such reasons as efficiency that cannot be articulated or quantified injures the ability of those farmers to compete. 
 
This price discrimination makes it impossible for many farmers to survive.  A focus on packing plant efficiency over fairness in pricing is in direct opposition to the spirit of the P&S Act.  As the legislative history indicates, the Act is intended to “permit the meat producer to exist” and “to make the business for the producer more profitable.”[70]  With these goals in mind, factors beyond efficiencies must also be examined to truly understand the nature of price discrimination.  Because Congress intended the P&S Act to be “a most far-reaching measure” that extended “farther than any previous law in the regulation of private business,”[71] the Secretary should consider the full scope of harmful effects of price discrimination. 
 
For instance, small farmers operate in a market environment in which they have relatively little bargaining power.[72]  As a recent commentator, Jon Lauck, notes, “Recent jurisprudence has given greater attention to the relative strength of firms in adjacent markets.  The recognition of bargaining power disparities between buyers and sellers could signal greater attention to the problem of disorganized farmers selling into concentrated markets occupied by powerful firms.”[73]  This recognition of the disparities in bargaining power has caused some courts to look at some vertically aligned markets in a different light.[74]  An examination of these cases brings Lauck to conclude:
 
In tandem with judicial recognition of the importance of monopsony power, the buyer-power defense creates a rationale for scrutinizing the power of buyers relative to sellers.  Thousands of farmers, for example, are hard-pressed to muster the market power necessary to check the powerful food companies who buy their products.  Farmer marketing is characteristically disorganized and “fragmented,” similar to the descriptions [in caselaw].[75]
 
This concept of buyer-power is even more grave in the case of smaller sellers.  Arguably, some of the largest feedlots or hog companies have the power to sit across the table from the big meatpackers and negotiate with more power through high volume.  Small producers, however, are often relegated to take-it-or-leave-it offers that are less favorable than those offered to large producers.[76]  In considering rules to prohibit unjust price discrimination, the Secretary should consider this disparity in bargaining power.
 
Courts in recent years have also recognized the anticompetitive effects of information disparities in markets.[77]  Most significantly, the Supreme Court’s decision in Eastman Kodak Co. v. Image Technical Services expanded the notion of market power to include the relevant costs and difficulties for certain types of firms to gather information.[78]  “Kodak suggests that market power may be found wherever ignorant buyers can be exploited through individualized bargaining.”[79] 
 
As the Secretary considers whether to promulgate rules that regulate the livestock industry, especially as to price discrimination, he should also consider the great information disadvantage that small farmers suffer as opposed to packing firms and large sellers.  “When the prices paid for a commodity vary widely, indicating that some sellers did not find the highest bidders in the market, information problems are in evidence.”[80] 
 
A quick look at the current voluntarily reported prices in the hog market reveals a gaping disparity.  Reported prices generally reveal price differences of between 20 and 25% of the total price. For instance, as I write this testimony on September 6th, the prices per hundred pounds of carcass for a hog that is 49-50% lean on the AMS Western Cornbelt closing report range from $43.25 to $58.10.  This means that hogs of the same quality, purchased on the same day, range nearly $15 cwt.  Packers are able to segregate the sellers who do not have the access or means to compile pertinent market information and reduce the price.  This lack of information is not a justifiable reason to discriminate in pricing.
 
Though recent efforts by Congress and the USDA may help to level the disparities of information, because this wild range in prices continues even though publicly reported, the problem will likely remain.  Thus, rules should be propounded to prevent discrimination and protect all producers from pricing which does not reflect the full value for their product in the marketplace.
 
B. A rational price discrimination rule should define allowable reasons for discrimination and disallow all others as violative of public policy.
 
GIPSA should promulgate rules that define the terms “undue preference” and “unjust discrimination.”  Because the terms remain undefined, there is a lack of certainty in the marketplace.  Ad hoc, I-know-it-when-I-see-it enforcement is a poor substitute for predictability and rational enforcement.  The best way to accomplish this goal is to address: (1) the type of premiums allowed, (2) the level of the premiums, and (3) who the premiums are offered to. 
 
As to the type of premiums, they should be limited to quality differences, time-of-delivery differences, quantifiable differences in procurement and handling, and production methods which enhance product value.  These allowable premiums would come into play as allowable defenses in a litigation context after the Secretary/plaintiff put on his case-in-chief.  Thus, the packer would have to prove that it discriminated for a lawful reason.  Any other premiums, such as cost savings from running plants at full capacity, or the size of the producer, should not be allowed because such reasons for discrimination are not contemplated in the P&S Act’s policy to protect livestock sellers.
 
As to the level of premiums, they must be based on the value of the service or condition being paid for through the premium.  For example, if a premium based upon delivery time is allowable, the level of that premium could not be $30/cwt on hogs because that amount would be far greater than its real value. 
 
Additionally, as to whom the premium is offered, a meat packer could not merely offer that premium to a chosen few producers while withholding it from other producers who qualify.  If a producer qualifies for a premium that others receive, he/she should receive it.  A new regulation must address this potential loophole as well.
 
It is amazing that no Secretary has defined “undue preference” and “unjust discrimination” through a rule at any time in the eighty year history of the P&S Act.  This administration should correct this error.
 
C. An evidentiary burden shifting provision should also be included in a price discrimination rule.
 
Currently, the lack of clarity as to the evidentiary burden shifting rules, in addition to the lack of definition of undue or unjust, means that a public or private plaintiff has difficulty proving a case under sections 202(a) and (b).  What is a justifiable reason for discrimination?  Must the plaintiff disprove all potential justifications that the defendant may conjure?  What is a prima facie case under the P&S Act in an enforcement proceeding or in private litigation?
 
The Secretary should promulgate a rule defining a prima facie case which a public or private plaintiff must show to prove a violation of the P&S Act.  This technique is common in other federal laws, such as employment discrimination law.  It would operate in a court proceeding as follows.  Initially, the Secretary would be required to prove that one producer, for example, was paid less than another producer for similar livestock. 
 
Then the burden is shifted to the packer to prove a valid reason for that difference in payment.  The packers defense would be limited by the reasons delineated above provided that they were cost justified.  If the packer puts on no evidence, the Secretary or private plaintiff wins.  If the packer effectively shoulders its burden, then the Secretary/plaintiff has an opportunity to respond.
 
Thus, the Secretary should exercise his authority to prevent this harm in the marketplace through promulgating the type of price discrimination rule presented above.————————————————————————

[1] Morrison-Paul, Katherine J., Productivity and Efficiency in the U.S. Food System (April 2000) (quoting Pope (1987) and Ladd (1987)).
[2] This question is answered fully in OCM’s full written analysis of the WORC rule (Written Testimony, Part One, Section III) below.
[3] This question is answered more fully in OCM’s analysis of a proposed price discrimination rule (Written Testimony, Part 3). 
[4] Morrison-Paul, supra, note 1.
[5] See Rod Smith, Acquisitions Give Smithfield Pronounced Role in U.S., World, Feedstuffs, September 4, 2000, at 6, 17 (noting that Smithfield’s acquisition of Carroll’s and Murphy will save the largest hog producer and processor in transportation and purchasing costs).
[6] North Central Regional Center for Rural Development, Bringing Home the Bacon?:  The Myth of the Role of Corporate Hog Farming in America.
[7] Id. at ES-5.
[8] Kendall M. Thu and E. Paul Durrenberger, Pigs, Profits, and Rural Communities 7 (1998).
[9] House Report No. 77, 67th Cong., 1st Sess. 2 (1921).
[10] 61 Cong. Rec. 1887 (1921).  Congressman Anderson noted that “the provisions of this legislation as to the packers must be more or less elastic in order that they may keep pace with the state and development of the industry.”
[11] 7 U.S.C. §228(a). 
[12] Chevron, U.S.A., Inc. v. Natural Resource Defense Council, Inc., 467 U.S. 837, 843-44 (1984).
[13] See Administrative Procedure Act, 5 U.S.C. §706(2)(A).
[14] Rocky Mt. Helicopters, Inc. v. FAA, 975 F.2d 736, 737 (10th Cir. 1992).
[15] Bowman Transp, Inc. v. Arkansas-Best Freight Sys., Inc., 419 U.S. 281 (1974).
[16] Charles L. Koch, Jr., Administrative Law and Practice 125 (1997) (“Generally, factfinding in rulemaking is reviewed under the arbitrariness test.”).
[17] Id.
[18] GIPSA, Review of Western Organization of Resource Councils Petition for Rulemaking 16 (August 29, 1997) (hereinafter GIPSA Review). Note that although the Secretary is given more discretion than the reasonableness, even if the reasonableness standard applies, the Secretary would have the discretion to promulgate a rule limiting captive supplies.  If a reasonable person was told that study after study indicated that as captive supplies increase, price decreases, that person would conclude that the Secretary has the authority, if not the duty, to regulate these captive supplies.  This is especially true given that one of  the Secretary’s main tasks under the P&S Act is to “safeguard farmers and ranchers against receiving less than true market value of their livestock.”  Bosma v. USDA, 754 F.2d 804, 808 (8th Cir. 1984) (citing H. Rep. No. 1048, 85th Cong. 2d Session, reprinted in 1958 U.S.C.C.A.N. 5212, 5213).
[19] Koch, supra note 12, at § 10.1[3] (2nd ed.) (1997) (“Between de novo review and unreviewability are two word formulas requiring either reasonableness (usually expressed by the term ‘substantial evidence’) or arbitrariness review.”).
[20] Id. (citing e.g.  National Audobon Soc. v. U.S. Forest Service, 46 F.3d 1437, 1445 (9th Cir. 1993); AFL-CIO v. OSHA, 965 F.2d 962, 970 (11th Cir. 1992)).
[21] Koch, supra note 12, at §10.3.
[22] As to policy making, again the agency enjoys great latitude:  “Agencies have substantial authority in the legitimate exercise of policymaking and courts should limit their review to ensuring that the policymaking authority exists under the statute and that the agency took care in the exercising of that discretion.  Resolution of policy questions in rulemaking must be subjected to only limited review.”  Id. at §11.24 (citing Chevron, 467 U.S. at 845).
[23] American Mining Congress v. U.S. EPA, 902 F.2d 962, 968 (D.C. Cir. 1990) (considering regulations issued under the Clean Air Act and quoting Ethyl Corp. v. EPA, 541 F.2d 1, 28 (D.C. Cir. (en banc), cert denied, 426 U.S. 941 (1976)).
[24] Daniels v. United States, 242 F.2d 39, 42 (7th Cir. 1957), cert denied, 354 U.S. 939, reh’g denied, 355 U.S. 852 (1957); Bowman v. USDA 363 F.2d 81, 185 (5th Cir. 1966), quoting Daniels.
[25] American Mining Congress, 902 F.2d at 968 (quoting Ethyl Corp. v. EPA, 541 F.2d 1, 28 (D.C. Cir. (en banc), cert denied, 426 U.S. 941 (1976)).
[26] OXY USA, Inc. v. F.E.R.C., 64 F.3d 679, 690 (D.C. Cir. 1995).
[27] 932 F.Supp. 1189 (D. Ariz 1996) (aff’d 100 F.3d 1443).
[28] Id. at 1193.
[29] Industrial Union Department, AFL-CIO v. Hodgson, 499 F.2d 467, 473-76 (D.C. Cir. 1974) (considering a rule promulgated by the Department of Labor on standards for exposure to asbestos).
[30] Id. at 474 n.18 (citing Permian Basin Area Rate Cases, 390 U.S. 747, 811 (1968)).
[31] Hughes River Watershed v. Johnson, 165 F.3d 283, 288 (4th Cir. 1999) (citing Motor Vehicle Mfrs. Assn. v. State Farm Mut., 463 U.S. 29 (1983)).
[32] John R. Schroeter and Azzedine Azzam, Econometric Analysis of Fed Cattle Procurement in the Texas Panhandle 46 (November 1999).
[33] Id. at 6.
[34] Id.
[35] See Mingxia Zhang and Richard J. Sexton, Captive Supplies and the Cash Market Price:  A Spatial Markets Approach 1 (May 5, 1999) (citing other studies that have documented inverse relationship between captive supplies and price); Schroeter and Azzam, supra note 28, at 15.
[36] Schroeter and Azzam, supra note 28, at 7.
[37] Richard J. Sexton, Review of Texas Panhandle Study 4 (March 1999).
[38] Id. at 4.
[39] H. Alan Love, Review of Texas Fed-Cattle Investigation 5 (May 1999).
[40] Memorandum in Support of Motion for Temporary Restraining Order in Hampton Feedlot, Inc., et al. v. Nixon, (Western District of Missouri, Central Division, 1999).
[41] Not only the bidding process, but market power itself cuts against the seller.  See John A. Cranfield, Review of Texas Panhandle Study 3 (March 2000) (“Results from Schroeter (1988) and other research using market power models (for example, Azzam and Pagoulatos (1990), Koontz, Garcia and Hudson (1993), Koontz and Garcia (1997), among others) suggest that beef packers can exert influence on the price they pay in live cattle markets.”).
[42] Sexton, supra note 33, at 4.
[43] Id. at 4.
[44] Ronald Fescoe, Review of Texas Panhandle Study 6 (May 1999).
[45]  Sexton, supra note 33, at 4.  Yet another example of the skewed bidding process is the convention that bidders only bid in whole dollars.  Id.  This harms sellers because the bidders will bid up to his marginal revenue, but never more.  Therefore, if the marginal revenue is $73.75, the most a packer will bid is $73. 
[46] See generally, Sexton, Richard, Written testimony submitted to USDA-GIPSA for September 21, 2000 hearing.
[47] Love, supra note 35, at 5 (citing Winand Emons, Good Times, Bad Times, and Vertical Upstream Integration, 14 International Journal of Industrial Organization 465 (1996)).
[48] Schroeter and Azzam, supra note 28, at 8.
[49] Id.
[50] Cranfield, supra note 37 (citing the Review conducted by Richard J. Sexton for GIPSA).
[51] Sexton, supra note 33, at 5.
[52] Love, supra note 35, at 6.
[53] Bailey, DeeVon, Letter to GIPSA dated April 1, 1999.
[54] Cranfield, supra note 37, at 4. 
[55] Schroeter and Azzam, supra note 28, at 10.
[56] Schroeter and Azzam, supra note 28, at 64.
[57] Schweiterman, Luke, Written testimony presented to USDA-GIPSA, September 21, 2000.
[58] Messinger, Les, Written testimony presented to USDA-GIPSA, September 21, 2000.
[59] Id.
[60] Id.
[61] Armour & Company v. United States, 402 F.2d 712 (7th Cir. 1968).
[62] Marvin Hayenga, et al., Meat Packer Vertical Integration and Contract Linkages in the Beef and Pork Industries:  An Economic Perspective  47-49 (May 22, 2000) (hereinafter AMI Paper).
[63] Id.  at 48.
[64] Id. at 49.
[65] Cranfield, supra note 37, at 14-15.
[66] AMI paper, supra note 53, at 49-50.
[67] Schroeter and Azzam, supra note 28, at 29.  The report noted that the “significant price premia for marketing agreement cattle” were adjusted for quality. 
[68] Schroeter and Azzam, supra note 28, at 13 (stating that other economists, including Love and Burton, and Ward have cited evidence that packers pay more for cattle procured through marketing agreements than cattle purchased on the open market).
[69] U.S. Department of Justice and Federal Trade Commission, Horizontal Merger Guidelines § 4.
[70] Statement of Representative Tincher, 61 Cong. Rec. 1809 (1921).
[71] House Report No. 77, 67th Cong., 1st Sess. 2 (1921).
[72] Jon Lauck, After Deregulation:  Constructing Agricultural Policy in the Age of “Freedom to Farm,” 5 Drake Journal of Agricultural Law 3, 8 (2000) (hereinafter After Deregulation) (noting that the “inequality of bargaining power” suffered by farmers has been “a persistent theme in agricultural policy debates for over a century,” and was an important motivation in much significant legislation, including the Interstate Commerce Act, the Sherman Act, the Clayton Act, the Capper Volstead Act, and the Agricultural Fair Practices Act.).
[73] Jon Lauck, Toward an Agrarian Antitrust:  A New Direction for Agricultural Law, 75 North Dakota Law Review 449, 474 (1999) [hereinafter Agrarian Antitrust].
[74] See generally United States v. United Tote, Inc., 768 F.Supp. 1064, 1085 (D. Del. 1991) (recognizing that a merger that would increase the market power of a business that deals with horse tracks would leave the smaller facilities unprotected against anti-competitive price increases); FTC v. Cardinal Health, Inc., 12 F.Supp. 34, 60 (D.C. Cir. 1998) (noting that independent pharmacies lacked power to bargain effectively with large wholesalers, stating “independent pharmacies have little leverage, as evidenced by the considerably higher upcharges they have to pay in comparison to thte retail chains and institutional GPO’s).
[75] Lauck, Agrarian Antitrust, supra note 66, at 476.
[76] See Mary Lou Steptoe, The New Merger Guidelines:  Have They Changed the Rules of the Game?, 61 Antitrust L.J. 493, 502 (1993).  In analyzing a market where the seller enjoys a power advantage (as opposed to the livestock market) Steptoe states:  “Relatively few industries will sell solely to large customers.  Far more common will be situations in which some buyers are large and some are small.  In such cases the large buyers may be able to protect themselves from supracompetitive pricing while the small buyers cannot.  If the seller is able to price-discriminate between these tow classes of customers, it will be able to raise the prices that it charges the smaller buyers.”
[77] Lauck, After Deregulation, supra note 63, at 36-42.
[78] Id. at 36 (citing Eastman Kodak Co. v. Image Technical Services, 504 U.S. 451, 473-47 (1992)).
[79] Thomas C. Arthur, The Costly Quest for Perfect Competition:  Kodak and Nonstructural Market Power, 69 N.Y.U.L.Rev. 1, 15 (1994).
[80] Lauck, Agrarian Antitrust, supra note 64, at 480 (citing George Stigler, The Organization of Industry 172 (1968)).

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