Australian Agribusiness Review - Vol. 7 - 1999
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Wool in Western Australia
Ross Kingwell -
Visiting Senior Lecturer at the University of Western Australia
* The views expressed in this paper are the personal views of the authors and do not necessarily reflect those of the University of Western Australia or Agriculture Western Australia.
The wool industry in Western Australia, as in other parts of Australia, has experienced a prolonged downturn. Wool specialists have experienced negative farm business profit in most years of the 1990s. Sheep numbers have declined and the enterprise mix on many farms has shifted away from wool.
In this paper the wool industry R,D&E 1 response in Western Australia is discussed. In particular, the relative merits of investing in on-farm productivity and off-farm processing and promotion are reviewed. Conclusions are drawn about future research directions.
The wool industry in Western Australia has increased its reliance on taxpayers funds. Hence, R,D&E cannot focus solely on the degree to which farmers or others in the marketing chain mainly will benefit. Instead R,D&E needs to be directed to areas in which farmers or others in the supply chain will under-invest regarding the level of public benefits, and where the level of public benefit represents an attractive social return.
About a quarter of the nation’s wool clip comes from Western Australia. Hence, changes to the wool industry in Western Australia are likely to have national ramifications. As in other parts of Australia, wool production in Western Australia faces an uncertain future. For several years woolgrowers have experienced a downward trend in real farm-gate prices for wool. Specialist wool producers have recorded negative farm business profits for several years . There are concerns that many in the wool industry will become unviable should low real wool prices continue much longer. A related view, sometimes expressed, is that the wool industry is in irreversible decline.
This paper describes firstly the impact of the downturn in the wool industry on the level and nature of wool industry R,D&E in Western Australia. Secondly, the likely outcomes of different types of wool research funded within Western Australia are discussed. In particular, the merits of on-farm versus off-farm R,D&E are discussed and conclusions are drawn about their likely impact on the future of wool production in Western Australia.
Since 1994 Western Australia has produced around 164 kt of greasy wool per annum or approximately 25 percent of Australia’s wool clip. Despite the boom and bust conditions that have prevailed in the wool industry since the mid-1980s, the numbers of sheep shorn in Western Australia have not changed dramatically over that period (see figure 1). By contrast the numbers of sheep shorn in New South Wales rose to peak at 81 million in 1990/91 (ABARE, 1997) and by 1995/96 had fallen to 47 million. Across Australia, wool production and sheep numbers have been in decline since 1990/91 (ABS, 1999).
Figure 1: Numbers of Sheep Shorn 1988 to 1997
Source: ABARE (1998)
Although the number of sheep shorn in Western Australia has not altered greatly, the profitability of wool production has altered dramatically, especially since the late-1980s. For example, in 1988/89 average farm profit was over $69,000 in the sheep industry of Western Australia (ABARE, 1990). During much of the 1990s, however, average farm profit has been negative. In 1995/96, for example, average farm profit was around -$12,400. By contrast, average farm profit in 1988/89 for broadacre farming in Western Australia was about $74,500 and in 1995/96 was $49,200. Martin (1998) reported profiles of woolgrowers throughout Australia. He found that specialist woolgrowers in the south-west of Western Australia had average farm profits of around -$14,100 over the period 1994/95 to 1996/97.
For most years in the 1990s woolgrowers’ incomes have suffered from low wool prices. Since 1989 wool prices mostly have been less than 700 c/kg clean (see figure 2). The low prices are due to several influences. Firstly, although the wool stockpile administered by Wool International has declined, farmers have increased their stocks of wool held on-farm or in brokers’ stores. For example, using farm survey data, Martin (1998) estimated that in June 1998 these stocks amounted to 163,000 tonnes of unsold wool. Ashton and Lubulwa (1999) show that unsold wool held on farm and in brokers’ stores has more than doubled over the period 1995 to 1998. These stocks plus the levels of annual wool production, along with increases in stocks of processed wool, have prevented an escalation of wool prices, particularly in wool classes greater than 21 micron.
Secondly, the economic downturn in several Asian economies has reduced the demand for wool. Thirdly, substitute fibres for wool have remained price competitive. For example, low oil prices during much of the 1990s have enabled polyester prices to remain low (see figure 2). Aneja and O’Brien (1999) outline a range of current and future technological developments that ensure polyester prices will not only remain competitive but that new polymers will further challenge the market share of natural fibres like silk and wool.
Cotton prices are forecast to remain low (USDA, 1999), maintaining downward pressure on wool prices. The USDA (1999) is forecasting total U.S. cotton production in 1999/2000 to rise 18 percent from the previous year and the area of cotton harvested will be the highest since 1995. U.S. cotton exports in 1999/2000 are forecast to increase and its stocks of cotton are projected to increase by 750,000 bales to be 4.7 million bales. As a result, the implied stocks-to-use ratio for 1999/2000 is 30 percent. The higher stocks in the United States, plus the stocks in China, will maintain a downward pressure on cotton prices. Further, the greater adoption of genetically modified cotton varieties has been associated with increased farm yields and greater profits for farmers (Klotz-Ingram et al, 1999). The productivity improvement associated with these genetically modified varieties will assist cotton farmers to adjust to a period of lower cotton prices.
Figure 2: Fibre prices 1988 to 1999
the fibre prices are nominal prices expressed in US cents per kg
3. Strategic outlook for the wool industry in Western Australia
Developing forecasts, particularly medium or long term forecasts for agricultural industries is known to be difficult 1975). The collapse of wool profitability in 1990, for example, was not generally predicted. Richardson (1989) in a broad review of the wool industry suggested like many others that "The wool industry is presently in a sound phase of growth and could perhaps be said to be one of the main growth industries in Australia." (p.13); yet collapse in wool profits was under two years away. Certainly the Australian Wool Corporation (AWC) was not able to forecast accurately wool’s future in the late 1980s. Bardsley (1991) comments that the AWC committed a classic error of interpreting a temporary price spike, caused by a stockout, as a permanent structural shift in demand. More generally, in commenting about innovation and change in Australian agriculture this and next century, Godden (1999) observes how difficult is the task of anticipating many of the major changes.
Evidence from farm surveys over the last few years points to a relative decline in the importance of wool production and a shift in farm resources more towards cropping enterprises. Farm modelling of strategic change in the wheat-sheep zone of Western Australia (Bathgate and Kingwell, 1999) points to wool production declining in relative importance over the next decade but with wool nonetheless remaining part of farm production in many farming regions.
Given the large difference in the average profitability of crop-dominant versus sheep-dominant farms observed in farm surveys since the early 1990s (ABARE, 1996,1997, 1998b,1999) the reasons for pasture, and therefore wool production, being retained as part of profitable farming systems may not seem obvious. As pointed out by Bathgate and Kingwell, there are a number of factors at play.
Firstly, there remain large areas of land still not suitable for cropping which restricts the degree to which crop area can replace pasture area. Even though on some of these soils pasture may not grow well, the low cost of inputs required for pasture production often means they can be grown profitably to support livestock enterprises. Characteristics which make soils unsuitable for cropping are terrain, waterlogging and subsurface acidity which cannot always be ameliorated profitably. Waterlogging usually occurs in low lying, poorly drained clay soils. The lack of relief and hydraulic conductivity often makes draining these soils impractical. This is particularly so in the higher rainfall zones 2 where most specialist wool producers are situated. However even in the low rainfall areas that are predominantly cropped, there are areas of soil not profitable for grain production.
Secondly, pasture confers benefits on following crops. The benefits are large enough to compensate for the low returns that result in the years of pasture production. Pasture phases are used to improve the control of weeds that pose difficulties in some areas after more than four years of continuous crops (Young, pers. comm. 1998). Some growers are electing to reduce the frequency of cropping to delay the onset of weed resistance to herbicides, as part of a strategy to lessen the costs of managing herbicide-resistant weeds. Pasture phases in a rotation enable weed control to be achieved through grazing, mechanical methods and utilizing different herbicide groups.
Thirdly, wool and sheep production are a means of spreading price and production risks associated with farming. Wool and sheep enterprises tend to be low input systems with negatively correlated prices. Accordingly, for very risk-averse farmers, retaining sheep for wool to diversify farm enterprises can be part of a sensible risk management strategy.
Lastly, some farmers use wool production in their farming system as part of their response to combating the spread of salinity caused by rising water tables. To lower water tables requires increased water use to reduce deep percolation. It is clear that this cannot be achieved through continued reliance on annual crops. Trees and perennial species (eg lucerne) need to be included in the system and at present the main species of perennials that can be grown profitably in some drier areas are those used for fodder. Utilising this feed source in many cases requires retention of sheep. Also adoption of agro-forestry can involve use of sheep to eat pastures growing between young trees.
4. Implications for Wool Industry R,D&E in Western Australia
In the face of a decline in the relative importance of wool production in Western Australia what have been the R,D&E responses and what are the implications for future R,D&E for the wool industry in the State? What should be the focus of wool industry R,D&E in Western Australia? For example, should it focus more or less on improving farm productivity; or should it switch funds into off-farm areas such as the efficiency of processing, marketing and promotion? Should R,D&E focus more or less on public good issues?
At a national level, several studies (Lawrence and McKay, 1980; Knopke et al, 1995; Males et al, 1990; Layman, pers. comm.) have consistently reported lower growth in total factor productivity for sheep farming versus broadacre cropping. In the crop industries the profitability of many R&D innovations has compensated for a declining terms of trade. However, this has not been true for the wool industry where a significant decline in real farm income has occurred in the 1990s (ABARE, 1996,1997,1998b,1999).
At a time when the wool industry has struggled financially, the cotton industry has remained highly profitable. For example, in 1996/97 the average farm profit from dryland cotton production was $300,639 (ABARE, 1998) with a rate of return on capital of 14.5 percent. In the same year average farm profit in Western Australia’s mixed livestock-crop industry was $6,700; and only -$19,200 in the sheep industry. The rates of return to capital in these two industries were only 2.2 percent and -0.3 percent respectively (ABARE, 1998).
Despite large amounts spent on on-farm R,D&E, few markedly profitable changes have been developed and adopted in wool production in the 1980s and 1990s. Relative to the productivity gains observed in other agricultural industries, only mediocre change has occurred in the productivity of wool production since the early 1980s.
The likelihood of the wool industry continuing to display low productivity growth depends on the nature of current and future R&D findings and farmers’ adoption responses. In Western Australia recent R&D by the Wool Program of Agriculture Western Australia indicates some potential for improvement in wool productivity with rates of return on research funds competitive with those for crop research, even at low rates of adoption.
For example, new pasture varieties have been released to exploit niches within farming systems and to improve pasture production greatly (Revell et al., 1998; Geisbertz and Bathgate, 1998). Also inclusion of lucerne and its utilisation by sheep in various farming systems has been to boost average farm profits by over 10 percent (Bathgate et al, 1999). Economic analysis of genetic lines of sheep has indicated potential for substantial increases in profit through farmers using genetically superior lines. Trials conducted at various locations throughout the State have shown marked differences in wool cut and fibre diameter between flocks. Sheep from different flocks were run together on selected farms and production characteristics were measured and compared. The trial data were used to determine the difference in profitability of flocks when run on a typical farm in the major wool growing region of the State. There was over $80,000 difference in profit between the best and worst genetic lines in the trials .
There are also the foreseeable problems of herbicide-resistant weeds, waterlogged soils unsuited to cropping, increasing concerns about animal welfare and salinity abatement; all of which are R,D&E opportunities from which woolgrowers could benefit. There are also consumer demands for sustainable, low-input, chemical-free farming systems that encompass humane treatment of animals and which lessen greenhouse gas emissions. Delivering such systems for wool production will require R,D&E expenditure.
The need for continuing R,D&E that boosts wool productivity is essential if wool is to meet the market challenges from other fibres (Kelly and Marshall, 1993; Aneja and O'Brien, 1999). Whether or not continued investment in on-farm R,D&E is justified is both an empirical issue and a matter of judgement. Certainly, ex-ante analyses suggest some profitable opportunities exist. Against this is set the wool industry’s poor track record of productivity improvement. It is this poor record of productivity improvement, relative to that observed in other enterprises, combined with the prolonged down-turn in wool industry profits that have discouraged R&D investment.
As shown in figure 3 Agriculture Western Australia has shifted its taxpayer R,D&E allocation away from wool toward the grain and emerging industries and markets. Agriculture Western Australia (AGWEST) is the main provider of R,D&E services to the wool industry in Western Australia. Its reduced taxpayer funding of wool industry R,D&E has coincided with reduced wool R,D&E funding from the product levies of the wool industry. Similar reductions in wool R,D&E have occurred in some other Australian States.
Figure 3: Share of taxpayer funds allocated to some industry programs of Agriculture Western Australia: 1994/95 to 1999/2000
There has also been a further reallocation of these reduced R,D&E funds within the wool program of Agriculture Western Australia. Off-farm market development, supply chain management and promotion of WA wools have received an increase in funding relative to on-farm R&D.
In Western Australia the prolonged downturn in the wool industry prompted the Western Australian government to form a Wool Strategy Group. This group identified ways to improve industry viability and it advised on the allocation of research funding for wool within AGWEST. The group recommended a shift of resources to off-farm research and marketing, and consequently away from on-farm research. The aim of redirecting funds was to improve the demand for Western Australian wool in various ways, such as providing services to processors and promoting the distinct characteristics of wool from Western Australia. In part the justification for redirecting funds towards enhancing market opportunities was the perceived limited improvement in farm productivity of wool production during the 1980s and early 1990s, despite many years of R,D&E investment.
In mid-1998 the Wool Strategy Group commissioned The Marketing Centre to develop a strategic plan for the Western Australian wool industry. An initiative, called the Medici Plan, was presented to the State wool industry early in 1999.
Its main thrust was to build new supply chain partnerships between grower coalitions and downstream processors. This would reduce the multiple changes of ownership now affecting wool between farm gate and retail outlet, streamlining the process and making it more efficient and profitable for those involved.
While direct sale from grower groups to processors had been tried before, the long-term success of such arrangements was impeded by the lack of large, regular consignments from growers, leading to economies of scale for the processors. The Medici Plan was to secure long-term contracts for large lots of wool and to match these to stable grower coalitions.
Following several public meetings scores of woolgrowers indicated interest in becoming involved. A trial supply chain partnership has being developed with the British-based retailer Marks and Spencers. Major suppliers to Marks and Spencers are following the production process of eight different WA wool types from raw wool to garments. The technical performance these wools is being evaluated and any logistic and financial benefits from the improved supply chain partnership are being measured. Information from this trial will be used by Marks and Spencers in their subsequent retail buying decisions.
Besides the Medici Plan there are two broad aims of off-farm activity undertaken by the Wool Program of AGWEST. They are to improve the efficiency of processors (spinning and top making) and to increase the price received by growers through promotion (branding). It is widely acknowledged that off-farm research can result in benefits to growers through an increased or maintained demand for greasy wool. This occurs by maintaining or increasing demand for wool apparel through promotion, by reducing processing costs and by reducing transactions and handling costs in the supply chain; and hence improving the competitiveness of wool compared to other fibres. Failure to invest in these areas may leave the wool industry exposed to increased competition from other fibres.
Freebairn et al showed that funding for R&D off-farm provided benefits to primary producers that were as great as those provided by on-farm research. In some cases the benefits were even greater. They found the distribution of benefits was unchanged by the stage of the production process at which technological change occurred. The results were dependent on a number of key assumptions, one of which was that the elasticities of substitution between farm and non-farm inputs in the processing stages of the marketing chain were zero.
Scobie et al showed that these results were very dependent on this assumption. Mullen et al undertook an empirical study which showed that in the case of beef production a very low elasticity of substitution between farm and non-farm inputs had a marked impact on the proportion of research benefits accruing to primary producers. Holloway determined the distribution of benefits from processing research in the hog industry in the United States. He concluded that the assumptions regarding the elasticity of substitution between farm and non-farm inputs was crucial in determining distribution of benefits in the marketing chain. Furthermore the point in the chain at which the technological improvement was made influenced the distribution of benefits throughout the chain.
Mullen et al examined the impact of farm and processing research on the Australian wool industry and found that the wool industry was likely to gain more from farm production research than from research at other stages of the wool chain. Their findings were consistent with more recent work involving the development of a partial equilibrium model for the wool industry in Western Australia . Preliminary results of Layman indicate that the benefits to WA growers of a 1 percent cost saving at different stages of the market chain are greatest when made at the farm level. For example, a 1 percent cost-saving at the farm level generates benefits to farmers 10 times greater than those received by farmers from a 1 percent cost saving at the spinning and weaving stages of processing.
Although studies such as Mullen et al (1989) and Layman (1999) point to farmers benefiting more from on-farm research, nonetheless these studies and others identify farmers as beneficiaries of off-farm research. Some off-farm projects offer substantial benefits to farmers. For example, ABARE assessed the benefits accruing to growers from the development of new spinning technology by CSIRO. The new technology, known as Sirospun, decreased the unit cost of producing pure wool yarns by 25%. The benefits of the technology were spectacular generating an investment benefit cost ratio of 123:1 (Johnston et al, 1992) with growers share of the benefits depending largely on the elasticity of supply of greasy wool.
Another example is wool promotion. ABARE (1987) quantified the net benefits of wool promotion by the Australian Wool Corporation in the United States. The results of the study showed the demand for Australian wool increased in the United States as a direct result of the expenditure on promotion. The benefit cost ratio of promotion was shown to be 2:1, and the general conclusion regarding the cost effectiveness of promotion held for a range of assumptions. However, a number of other evaluations have examined the success of promotion and advertising of commodities in Australia and overseas (eg. Many of these programs have been successful at increasing the demand for the commodity, and this has resulted in benefits to growers. However, over the range of these evaluations of commodity promotions, wool has perhaps been one of the least successful (Ward, 1997).
The success of promotional programs tends to be proportional to their budgets. However, given current farm profits of specialist woolgrowers in Western Australia, it is unlikely that these farmers could be convinced to contribute sufficient funds to form an effective promotion budget for WA wool. Further, because WA wools go to various markets and due to ease of substituting other Australian wools for WA wools, it is unlikely that promotion of WA wools alone would evince demand responses in these markets sufficient to make the investment in promotion highly profitable.
At the national level, several commentators and analysts have expressed concerns over the size of investment in promotion relative to that of R&D (Beare, 1998; Piggott, 1998; Watson, 1998). Beare commented that:
On a per farm basis in 1996-97, ABARE estimates that specialist sheep producers spent the equivalent of 20 per cent of their farm cash operating surplus on promotion (ABARE 1997). This compares with an expenditure on R&D of under 3 per cent. (p.2)
After bemoaning the lack of data that could facilitate a thorough review of the efficacy of wool promotion Piggott concluded, on the basis of the limited data, that incremental promotion expenditure seemed to deliver few benefits to producers.
In practice farmers are not the sole funders of wool industry R,D&E. Woolgrowers contribute monies for R,D&E through their research levies and as taxpayers. However, in Western Australia the bulk of funds for wool industry R,D&E comes from other taxpayers and graingrowers.3 Further, the decline in sheep numbers and the associated decline in product levy-based R&D undertaken in WA has been greater than the decline in taxpayer-funded wool industry R&D in WA, causing a greater dependence on public funds.
Increased reliance on taxpayer funds means that R,D&E cannot focus solely on the degree to which farmers will benefit. For example, taxpayers would see little justification in activity that only benefitted farmers. Further, taxpayers would see little merit in supporting innovation that increased the economic surplus of firms and consumers overseas, unless there were subsequent trade benefits.
The common view, as expressed by Hussey (1996), is that public funds should only be used to fund R,D&E that is of a public good nature. Even this view requires qualification because some public goods (eg agronomic knowledge) have clearly defined end-users or beneficiaries (farmers) who can contribute to the provision of these goods by existing mechanisms such as R,D&E product levies. In short, public goods need not be funded solely from the public purse.
Regarding the use of taxpayer funds, Caswell argues that the well–being of consumers (as principal taxpayers) should be the primary focus of government policy, with market participants being of secondary concern. She argues that farmers are not different from other small businesses, and as such should be treated like those in other sectors of the economy. Her view is that government should not be involved in activities such as promotion and advertising but should ‘authorise and facilitate cooperatives and bargaining associations.’
The crucial issues involving use of taxpayers funds are firstly, what R,D&E areas will farmers or others in the supply chain under-invest in regarding the level of public benefits? For example, the land management practices of farmers may provide an inadequate level of environmental amenity to society. Secondly, what level of public benefit represents an attractive return on the investment? Allocating public funds to an activity that generates few benefits is a misuse of those funds.
Some possible examples of publicly-funded activity for the wool industry might be:
Note that public funds would not be required to fully fund such R,D&E, as most of the projects would have a private benefit component. Woolgrowers, through their product levies, would be expected to contribute to such projects. Such investments would be of benefit to farmers and could boost wool productivity and export performance, yet additional community benefits would be generated.
In forming a portfolio of R,D&E projects, against the backdrop of low farm incomes from wool production, the historical tendency for R,D&E activity has been to look off-farm. Walsh (1968) observed over 30 years ago about:
‘Australian farmers who, when caught in the cost-return squeeze, habitually grasp for off-farm solutions to their problems and neglect on-farm remedies.’ .
In spite of the understandable tendency to look off-farm, the preceding discussion has mentioned some on-farm R,D&E opportunities from which farmers can benefit. However, off-farm areas can also be profitable from the farmer’s perspective although, regarding innovation in processing, the benefits to a farmer are often dissipated by the stage of processing at which innovation occurs.
The need to invest in on-farm R,D&E and improved supply chains is consistent with the need to respond to the likely long run decline in real prices for wool. In the cotton industry, a direct competitor with wool, increases in cotton yields through biological and technical innovation have prevented a major loss in cotton’s market share to man-made fibres (Foster, 1995). Similarly, wool’s small share of the fibre market would be further eroded unless on-farm productivity improves. Such improvement enables growers to reduce the impact of declining real prices on profit. A study of marketing options, admittedly for crop producers rather than woolgrowers (Zulauf and Irwin, 1998), concluded that producers "will increase their probability of long-term survival by using their scarce resources to first maximize their production efficiency before chasing the allure of marketing profits. In other words, a good marketing program starts with a good program for managing and controlling the cost of production." (p.327,328).
In some circumstances woolgrower investment in later stages of processing may prove profitable to Western Australian farmers. Such profitability would depend on the uniqueness of WA wool and the efficiency, quality and reliability of its supply chain. If WA wools and their supply chain have no unique characteristics for which buyers or millers are prepared to pay premiums, then promotion of WA wools is unlikely to be a profitable long-term investment for Western Australian farmers. If wools from other regions are close substitutes for the Western Australian wools, or if supply chains elsewhere are more efficient or of better quality, then sustained price premia for Western Australian wools are unlikely to be offered.
The empirical evidence of Dewbre et al (1983) and Simmons and Ridley (1987) suggests a modest elasticity of substitution 4 between Australian wool and wool from other countries. However it is likely that wool from other Australian States could readily substitute for wool from Western Australia. Hence the benefits from advertising and promoting Western Australian wool may be limited by the ease of substitution.
If all wool industry R,D&E activity in Western Australia was funded solely by its woolgrowers then the allocation of resources to on-farm and off-farm activity would in many cases tend to favour firstly on-farm R,D&E, then reductions in supply chain transactions costs and improved efficiency of early-stage processing. However, as stated earlier, the wool industry has increased its reliance on taxpayers funds. Hence, R,D&E cannot focus solely on the degree to which farmers or others in the marketing chain mainly will benefit. Instead R,D&E will need to invest in areas in which farmers or others in the supply chain will under-invest regarding the level of public benefits
Although wool production seems destined to remain an important part of farming in Western Australia its relative importance and profitability have declined in the 1990s. Given the history of wool in the 1990s this paper explores the ramifications for R,D&E expenditure in Western Australia, particularly by AGWEST, the main funder and provider of wool industry R,D&E in the State. Returns to investment on and off farm and in private or public goods are discussed
This paper argues that, while woolgrowers do benefit from off-farm research and promotion, the ability of WA producers to uniquely capture these benefits is limited. The ease with which wools from other States could substitute for WA wool suggests that significant leakage of R,D&E benefits is likely. In addition it is argued that as wool R,D&E becomes more dependent on public funds then the R,D&E should be directed to projects that profitably generate public benefits that otherwise would not be provided.
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1 - R,D&E is research, development and extension.
2 - These zones are in the south-west where average annual rainfall is 500 to 750mm.
3 - The Grains Research and Development Corporation (GRDC) contributes a sizeable portion of funds to pasture research from which woolgrowers benefit.
4 - The elasticity of substitution is a measure of the ease and degree to which one input (eg Australian wool) can replace another input (eg wool from another country).