 quota is experienced. The rental rate for quota is the market=s value for the return to the right to sell tobacco. Quota owners that rent their quota to growers earn this return. It is also appropriate to think of growers (most of whom own quota as well as rent quota from non-growing quota owners) as earning the rental rate as a return to their own quota. When price is reduced the return (rental rate) on quota falls reducing income from quota ownership to both growing and non-growing quota owners.
At the same time, if reducing price results in more tobacco being sold, then growers earn larger returns on their management, labor, and fixed assets. Low quotas, especially unexpected quota declines (as has been the case in recent years), dramatically reduce grower earnings. Earnings on specialized assets for tobacco production (greenhouses, curing barns, etc.) may be eliminated completely by declining quotas.
In light of these price/quantity relationships and their effects, the following options are presented.
1. Maintain the current tobacco program without changes in support prices. Unmanufactured exports would continue their downward trend. Eventually, the quota could decline to a level that reflected mostly domestic purchases. Domestic purchases may recover from their current very low levels as manufacturers lower inventories to desired levels. For flue-cured tobacco this could eventually imply a quota of between 400 and 500 million pounds. Political intervention likely would be required if periods of high stabilization stocks occur. Interruptions in foreign supplies, such as caused by weather, unexpected change in exchange rates, or political unrest could slow or interrupt the trend to lower quota levels. Quota return per pound (rental rates) will increase resulting in total quota returns falling less than in the case of a price reduction. Grower earnings on management and fixed assets continue to decline with most specialized tobacco assets having a near zero value.
2. Lower price supports while keeping the current tobacco program, as was done in the 1980=s. If historical relationships between price and quantity sold are still valid then quotas would be expected to rebound over 3 to 5 years after the price support reduction. Return per pound (rental rates) and total returns to quota would decline. Grower earnings on management and fixed assets would increase as the quota increased. However, this scenario is dependent on whether or not historical price/quantity relationships still hold. Some degree of market power is still required for this option to have the desired effect of increasing quotas. Market power would continue to erode with the likely results being additional program modification after a number of years. Such an option could include changes in regulations or compensation designed to move quota from non-growers to growers. This could alleviate policy dilemmas where non-grower quota owner and grower interests conflict.
3. Lower price support to close to the free market price of tobacco with significant modification of the tobacco program. Lowering price supports to below the price that U.S. tobacco would sell for with unregulated production likely would cause exports to rebound and domestic cigarette manufacturers to increase use of U.S. tobacco even if U.S. tobacco has little remaining market power in the world tobacco market. Price would decline to the free market price for tobacco, probably in the range of $1.10 to $1.30 per pound for U.S. flue-cured tobacco. U.S. tobacco production and sales would increase significantly. Expanded U.S. tobacco production would take world market share away from foreign tobacco producers, such as Zimbabwe with little effect on total tobacco consumption.Maintaining price supports at some level below expected market price would provide a safety net for farmers when world tobacco prices fell unexpectedly. This would be an important feature of this option, since world tobacco prices can be very volatile. Figure 1 illustrates the volatility of Zimbabwean versus U.S. tobacco prices