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Archives for July 2005

The Sugar Industry and Corporate Welfare

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By Jason Lee Steorts 
First published by The National Review, July 18, 2005

Editor’s note: While the author makes some absurd statements in his advocacy for the so-called Central American “Free Trade” Agreement, this is an excellent case study in how even relatively small special interest groups can extract billions of dollars in taxpayer subsidies so long as we allow large private investment in politcal campaigns.

In a hall of fame for corporate-welfare queens, the sugar industry would occupy a place of special honor. For decades, powerful sugar growers have gotten politicians to enrich them with a protectionist scheme that inflates domestic sugar prices to the detriment of American consumers, American manufacturers, American farmers, and the American economy as a whole. In that congeries of absurdities known as U.S. farm policy, sugar’s sweet deal stands out as perhaps the most damaging and least defensible program. Now, more than ever, it needs to be scrapped.

The program allows sugar processors to take out loans from the USDA by pledging sugar as collateral. The loan rates – 18 cents per pound for cane sugar, 22.9 cents per pound for beet sugar – are significantly higher than average world sugar prices. These loans must be repaid within nine months, but processors also have the option of forfeiting their sugar to the government in lieu of repaying their debt.

This arrangement effectively guarantees that the processors receive a price for their sugar that is no lower than the loan value: If prices fell below that level, they would simply forfeit their sugar and keep the government’s money. In order to avoid that scenario, the USDA must prop up the domestic price of sugar. It does this by controlling supply through two mechanisms. First, it sets quotas on how much foreign sugar can be imported without facing prohibitive tariffs; second, it regulates the amount of sugar that domestic processors can sell.

The consequence is that sugar in the U.S. has, over the past decade, cost two to three times the average world price. The sugar industry likes to point out that the program requires no government outlays, since processors repay their loans each year (assuming the government keeps sugar prices sufficiently high). This argument is sound if one regards the sugar program as a question of federal bookkeeping, but that is only because, in this case, the government does an uncharacteristically efficient job of plundering taxpayers to pay off a special interest: It simply cuts itself out as middleman. Each time you buy sugar or a product made with sugar, the difference between the price you pay and the lower price you would pay absent the sugar program’s dirigisme c an be thought of as a sugar tax. Unlike most taxes, this tax never finds its way to government accounts. Instead, it passes directly from your pocket to the sugar industry’s profit statements.

A GAO study found that, between 1989 and 1991, the sugar tax cost American consumers an average of $1.4 billion per year. By 1998, that number had risen to $1.9 billion. Other costs are borne by manufacturers who use sugar as an input. Faced with high domestic prices, some confectioners have moved to countries without sugar price supports, such as Canada. Others have simply shut down. A study commissioned by the Sweetener Users Association found that between 7,500 and 10,000 jobs were lost from 1997 to 2003 as a result of high sugar prices. Seven thousand candy-making jobs have been lost in Chicago alone over the past decade. If opportunity costs are taken into account, those numbers certainly underestimate the sugar program’s impact on employment: Without the program, resources currently devoted to sugar production would shift to more efficient sectors of the economy and create new jobs.

The sugar program is a case study in how small, concentrated interests can trump larger but more diffuse ones. By any measure, the U.S. sugar industry is minuscule. It employs only 62,000 people and comprises less than 0.5 percent of U.S. farms. But because it profits so richly from the current protectionist scheme, it has a powerful incentive to keep that scheme in place.

It does so by donating extravagantly to political candidates. One lobbyist who works with trade issues says, “[The sugar industry] is collecting monopoly rents. Any industry in a position of collecting monopoly rents will spend back a significant portion of those rents to maintain those monopolies.” Although sugar accounts for just 1 percent of U.S. farm receipts, 17 percent of all campaign contributions from the agricultural sector between 1990 and 2004 came from the sugar lobby.

Perhaps no political investment has brought a higher return. The GAO report found that sugar producers gain around $1 billion a year from the artificially high prices that the sugar program guarantees. Some growers have gotten exceedingly rich – most notably the Fanjul brothers of Florida, who are worth hundreds of millions of dollars, and whose cane-growing company Flo-Sun contributed $573,000 to candidates in the last elections. The Fanjuls befriend politicians with bipartisan pragmatism. José Fanjul donates generously to Republican campaigns; Alfonso is a lifelong Democrat whose clout is so great that Bill Clinton once interrupted a meeting with Monica Lewinsky to take his phone call.

Apart from large cane growers like the Fanjuls and their rival, U.S. Sugar Corp., the sugar lobby is dominated by consortia of sugar-beet farmers in the upper Midwest. Individually, these farmers are small, but they are highly organized and can bring enormous pressure to bear on the politicians who represent them. The single largest sugar donor in the 2004 elections, with total contributions of $851,000, was American Crystal, a sugar-beet cooperative in the Red River Valley of North Dakota and Minnesota.

CONTRA CAFTA 
Nowhere does the sugar lobby pursue its interests more ferociously than in debates on free trade. Having successfully lobbied the Bush administration to exclude sugar from the recently ratified free-trade agreement with Australia, sugar producers are now determined to kill the Central American Free Trade Agreement, on which Congress will vote sometime this summer.

CAFTA, which would eliminate most trade barriers between the U.S. and Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua, and the Dominican Republic, is, if anything, embarrassingly deferential toward the sugar lobby. After its full implementation over a 15-year period, it would allow participating states to increase their sugar exports to the U.S. by only 1.7 percent of current U.S. sugar production. The sugar industry is nevertheless intransigently opposed to the pact, and has rejected every suggested compromise.

If the sugar lobby derails CAFTA, its success will, once again, represent the triumph of the few at the expense of the many. CAFTA would bring modest but not insignificant economic gains to both the U.S. and Central America. Perhaps more important, it would advance efforts to create a Free Trade Area of the Americas, and would strengthen the Central American middle class while making the economic and legal systems of participating states more open and transparent. This, in turn, would shore up democracy in the region at a time when Daniel Ortega has resurged as a destructive force in Nicaragua and the anti-democratic message of Venezuela’s Hugo Chávez gains ever-wider currency throughout Latin America.

These advantages notwithstanding, it would be understandable for a legislator to oppose CAFTA in the sincere belief that it would be, on balance, bad for his state. What is remarkable is that the sugar industry has won “no” votes from legislators whose constituencies would clearly benefit from CAFTA.

Among U.S. states, the top two exporters to the CAFTA region are Florida and Louisiana, at number one and number two, respectively. A study by James A. Richardson of Louisiana State University estimates that, after one year, CAFTA could boost Louisiana’s sales in all industries by $339 million and create 2,769 new jobs. The U.S. Chamber of Commerce predicts that, in the same time, CAFTA would increase Florida’s sales by $985 million and create 7,008 new jobs; after nine years, those numbers would rise to $5.2 billion and 36,982. CAFTA would be widely beneficial not only to manufacturing concerns in Florida and Louisiana, but also to agricultural interests, of which sugar is but a small part. The sugar industry comprises 2.4 percent of Louisiana’s farms and 16.5 percent of its farm income; in Florida, it comprises 0.3 percent of farms and 8.7 percent of farm income. Yet the sugar lobby has somehow overridden all competing interests, with the result that almost no one from the congressional delegations of Louisiana and Florida is supporting CAFTA. (The heroic – or simply rational? – exceptions are Reps. Jim McCrery and William Jefferson in Louisiana, and, in Florida, Reps. Katherine Harris, Ileana Ros-Lehtinen, and E. Clay Shaw Jr.)

It is deeply exasperating that a tiny sector on which CAFTA’s effect would be almost negligible is within striking distance of scuttling the agreement. The obstinacy of sugar producers looks especially unreasonable when one considers that protectionism has increased their share of the domestic market from 55 percent in the late 1970s to 89 percent in 2002, and when one notes that population growth over the next decade is likely to increase demand for sugar, thereby offsetting any lost income to the industry.

Seen from another perspective, however, the sugar lobby’s alarm is understandable. Owing to a trade dispute, Mexico does not export as much sugar to the U.S. as is allowed under NAFTA. A resolution of that dispute – along with the complete elimination in 2008 of tariffs on Mexican sugar imports – could put U.S. producers under intense pressure from their competitors south of the Rio Grande. And while the sugar provisions in CAFTA might not amount to much, ratification of the pact would set the precedent that sugar is not off the table in future trade negotiations. With the Bush administration moving forward on talks with Thailand, Colombia, and South Africa – sugar producers all – the domestic sugar industry is probably right to suspect that the end draws nigh.

What the industry’s instinct for self-preservation will not allow it to acknowledge is that this is precisely as it should be. The United States has no reason to grow sugar, and every reason not to. It is a simple question of comparative advantage, as Dennis Avery, a former agriculture analyst for the Department of State, explains: “Yields of sugar in the tropics are twice as high and the costs half as high as growing sugar in temperate regions.” The U.S. sugar program thus defies both nature and economics; in guaranteeing an artificially high price for sugar, it encourages American farmers to plant sugar instead of crops they could grow more efficiently. Ending the domestic sugar program would require them to switch to the crops they should have been growing all along.

While liberalizing world farm trade would probably put a stop to domestic sugar production, it would also, according to Avery, mean that U.S. farmers who now grow sugar beets “could sell wheat to China and India, and make far more money than they do from this sugar.” Cane growers in Florida and Louisiana would have a somewhat harder time of it, since little else could grow on their lands. In the case of the Fanjuls, one is consoled by the thought that they won’t find themselves on welfare rolls any time soon. Smaller farmers could be compensated for their loss, and their transition eased by a gradual phase-out of the sugar program.

The benefits of ending domestic sugar production would not be merely economic; Avery sees liberalized farm trade as “both the leading environmental issue and the leading trade issue in the world.” Given long-term population trends, countries will have to specialize in crops for which they have a comparative advantage – or else undertake policies with disastrous environmental consequences. “We’re headed for a world in which we’re going to feed not 6.3 billion people, but close to 9 billion; and instead of a billion people affording high-quality diets, we’ll probably have 7 billion,” Avery says. “We’ll need nearly three times as much farm output worldwide. So instead of clearing the world’s remaining 16 million square miles of forest [for agriculture], we need to triple yields on land we’re already using. That means getting higher sugar yields in Brazil, and higher grain and oil-seed yields in the Red River Valley.”

HOW TO LOBBY BACK 
No matter what advantages would issue from the elimination of the sugar program, domestic producers will not acquiesce in the removal of their government-mandated profit margins. What is needed, then, is a more effective opposition to the sugar lobby.

While such an opposition would lack the organizational advantage of representing highly concentrated interests, it could exploit the fact that discontent with the sugar program transcends traditional political divides. A coalition to oppose the sugar lobby could draw support from free-trade advocates on the right, manufacturing and agricultural interests that stand to benefit from trade liberalization, and consumer groups that object to high sugar prices. On the left, many environmentalists favor farm-trade liberalization for the reasons discussed above, and are opposed to sugarcane farming in Florida because of the damage it inflicts on the Everglades. Groups concerned with the elimination of global poverty, such as Oxfam, are quick to point out that the U.S. sugar program, along with European export subsidies for sugar-beet growers, depresses world sugar prices and keeps cane-growing tropical nations poorer than they need to be.

As WTO members move toward final agreement on the Doha round of trade-liberalization talks, protectionist schemes for sugar and other crops will grow ever harder to defend. The EU has just announced a plan to cut its sugar subsidies by 39 percent; to the degree that its member states consent in liberalizing their sugar industries, pressure for U.S. reform will increase. Meanwhile, the sugar industry’s opposition to CAFTA has alienated agricultural lobbies traditionally sympathetic to sugar growers. Many such groups suspect that the exemption of sugar from the Australian free-trade agreement resulted in their getting fewer concessions in that pact than they otherwise would have won. John Frydenlund of Citizens Against Government Waste says, “There always has been a circle-the-wagons attitude in agriculture as far as protecting each other is concerned, but I think this time most of the rest of agriculture is starting to look at the sugar lobby as being off the reservation and out only for themselves.” Such frustration already appears to be influencing politicians. Trent Lott, expressing his annoyance with the sugar industry, recently said, “I’ve been in the unholy agricultural alliance for 33 years. I’ve voted for every damned ridiculous agricultural program and subsidy conceived by the minds of men. But I may not anymore.”

The real test will come in 2007, when the next farm bill is negotiated. Reformers should seek nothing less than the total dismantling of the sugar program. To achieve that end, they must begin moving public opinion in their favor now. Their case shouldn’t be too hard to make. They can simply ask Americans what reason there is to continue a policy that hurts consumers, costs jobs, harms the environment, sabotages U.S. trade relations – all to line the pockets of farmers who cannot survive in a competitive market. One suspects a solid majority will reply that there is no good reason at all.

© 2005 National Review

How Costco Became the Anti-Wal-Mart

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By Steven Greenhouse
First published by the New York Times, July, 17, 2005

Editor’s Note: While Costco unquestionably provides better jobs than Wal-Mart and its Sam’s Club division, is its overall impact much better when community, environmental and other concerns are weighed? We urge you to consider that doing your business with community-based enterprise is usually the most responsible choice. See our Independent Business section for more on the topic.

Jim Sinegal, the chief executive of Costco Wholesale, the nation’s fifth-largest retailer, had all the enthusiasm of an 8-year-old in a candy store as he tore open the container of one of his favorite new products: granola snack mix. “You got to try this; it’s delicious,” he said. “And just $9.99 for 38 ounces.”

Some 60 feet away, inside Costco’s cavernous warehouse store here in the company’s hometown, Mr. Sinegal became positively exuberant about the 87-inch-long Natuzzi brown leather sofas. “This is just $799.99,” he said. “It’s terrific quality. Most other places you’d have to pay $1,500, even $2,000.”

But the pièce de résistance, the item he most wanted to crow about, was Costco’s private-label pinpoint cotton dress shirts. “Look, these are just $12.99,” he said, while lifting a crisp blue button-down. “At Nordstrom or Macy’s, this is a $45, $50 shirt.”

Combining high quality with stunningly low prices, the shirts appeal to upscale customers — and epitomize why some retail analysts say Mr. Sinegal just might be America’s shrewdest merchant since Sam Walton.

But not everyone is happy with Costco’s business strategy. Some Wall Street analysts assert that Mr. Sinegal is overly generous not only to Costco’s customers but to its workers as well.

Costco’s average pay, for example, is $17 an hour, 42 percent higher than its fiercest rival, Sam’s Club. And Costco’s health plan makes those at many other retailers look Scroogish. One analyst, Bill Dreher of Deutsche Bank, complained last year that at Costco “it’s better to be an employee or a customer than a shareholder.”

Mr. Sinegal begs to differ. He rejects Wall Street’s assumption that to succeed in discount retailing, companies must pay poorly and skimp on benefits, or must ratchet up prices to meet Wall Street’s profit demands.

Good wages and benefits are why Costco has extremely low rates of turnover and theft by employees, he said. And Costco’s customers, who are more affluent than other warehouse store shoppers, stay loyal because they like that low prices do not come at the workers’ expense. “This is not altruistic,” he said. “This is good business.”

He also dismisses calls to increase Costco’s product markups. Mr. Sinegal, who has been in the retailing business for more than a half-century, said that heeding Wall Street’s advice to raise some prices would bring Costco’s downfall.

“When I started, Sears, Roebuck was the Costco of the country, but they allowed someone else to come in under them,” he said. “We don’t want to be one of the casualties. We don’t want to turn around and say, ‘We got so fancy we’ve raised our prices,’ and all of a sudden a new competitor comes in and beats our prices.”

At Costco, one of Mr. Sinegal’s cardinal rules is that no branded item can be marked up by more than 14 percent, and no private-label item by more than 15 percent. In contrast, supermarkets generally mark up merchandise by 25 percent, and department stores by 50 percent or more.

“They could probably get more money for a lot of items they sell,” said Ed Weller, a retailing analyst at ThinkEquity.

But Mr. Sinegal warned that if Costco increased markups to 16 or 18 percent, the company might slip down a dangerous slope and lose discipline in minimizing costs and prices.

Mr. Sinegal, whose father was a coal miner and steelworker, gave a simple explanation. “On Wall Street, they’re in the business of making money between now and next Thursday,” he said. “I don’t say that with any bitterness, but we can’t take that view. We want to build a company that will still be here 50 and 60 years from now.”

If shareholders mind Mr. Sinegal’s philosophy, it is not obvious: Costco’s stock price has risen more than 10 percent in the last 12 months, while Wal-Mart’s has slipped 5 percent. Costco shares sell for almost 23 times expected earnings; at Wal-Mart the multiple is about 19. Mr. Dreher said Costco’s share price was so high because so many people love the company. “It’s a cult stock,” he said.

Emme Kozloff, an analyst at Sanford C. Bernstein & Company, faulted Mr. Sinegal as being too generous to employees, noting that when analysts complained that Costco’s workers were paying just 4 percent toward their health costs, he raised that percentage only to 8 percent, when the retail average is 25 percent. Editor’s note: It would have been helpful if the reporter informed readers of Mr. Kozloff’s salary.

“He has been too benevolent,” she said. “He’s right that a happy employee is a productive long-term employee, but he could force employees to pick up a little more of the burden.”

Mr. Sinegal says he pays attention to analysts’ advice because it enforces a healthy discipline, but he has largely shunned Wall Street pressure to be less generous to his workers.

“When Jim talks to us about setting wages and benefits, he doesn’t want us to be better than everyone else, he wants us to be demonstrably better,” said John Matthews, Costco’s senior vice president for human resources.

With his ferocious attention to detail and price, Mr. Sinegal has made Costco the nation’s leading warehouse retailer, with about half of the market, compared with 40 percent for the No. 2, Sam’s Club. But Sam’s is not a typical runner-up: it is part of the Wal-Mart empire, which, with $288 billion in sales last year, dwarfs Costco.

But it is the customer, more than the competition, that keeps Mr. Sinegal’s attention. “We’re very good merchants, and we offer value,” he said. “The traditional retailer will say: ‘I’m selling this for $10. I wonder whether I can get $10.50 or $11.’ We say: ‘We’re selling it for $9. How do we get it down to $8?’ We understand that our members don’t come and shop with us because of the fancy window displays or the Santa Claus or the piano player. They come and shop with us because we offer great values.”

Costco was founded with a single store in Seattle in 1983; it now has 457 stores, mostly in the United States, but also in Canada, Britain, South Korea, Taiwan and Japan. Wal-Mart, by contrast, had 642 Sam’s Clubs in the United States and abroad as of Jan. 31.Costco’s profit rose 22 percent last year, to $882 million, on sales of $47.1 billion. In the United States, its stores average $121 million in sales annually, far more than the $70 million for Sam’s Clubs. And the average household income of Costco customers is $74,000 – with 31 percent earning over $100,000.

One reason the company has risen to the top and stayed there is that Mr. Sinegal relentlessly refines his model of the warehouse store — the bare-bones, cement-floor retailing space where shoppers pay a membership fee to choose from a limited number of products in large quantities at deep discounts. Costco has 44.6 million members, with households paying $45 a year and small businesses paying $100.

A typical Costco store stocks 4,000 types of items, including perhaps just four toothpaste brands, while a Wal-Mart typically stocks more than 100,000 types of items and may carry 60 sizes and brands of toothpastes. Narrowing the number of options increases the sales volume of each, allowing Costco to squeeze deeper and deeper bulk discounts from suppliers.

“He’s a zealot on low prices,” Ms. Kozloff said. “He’s very reticent about finagling with his model.”

Despite Costco’s impressive record, Mr. Sinegal’s salary is just $350,000, although he also received a $200,000 bonus last year. That puts him at less than 10 percent of many other chief executives, though Costco ranks 29th in revenue among all American companies.

“I’ve been very well rewarded,” said Mr. Sinegal, who is worth more than $150 million thanks to his Costco stock holdings. “I just think that if you’re going to try to run an organization that’s very cost-conscious, then you can’t have those disparities. Having an individual who is making 100 or 200 or 300 times more than the average person working on the floor is wrong.”

There is little love lost between Wal-Mart and Costco. Wal-Mart, for example, boasts that its Sam’s Club division has the lowest prices of any retailer. Mr. Sinegal emphatically dismissed that assertion with a one-word barnyard epithet.

Still, Costco is feeling the heat from Sam’s Club. When Sam’s began to pare prices aggressively several years ago, Costco had to shave its prices – and its already thin profit margins – ever further.

“Sam’s Club has dramatically improved its operation and improved the quality of their merchandise,” said Mr. Dreher, the Deutsche Bank analyst. “Using their buying power together with Wal-Mart’s, it forces Costco to be very sharp on their prices.”

Mr. Sinegal’s elbows can be sharp as well. As most suppliers well know, his gruff charm is not what lets him sell goods at rock-bottom prices – it’s his fearsome toughness, which he rarely shows in public. He often warns suppliers not to offer other retailers lower prices than Costco gets.

When a frozen-food supplier mistakenly sent Costco an invoice meant for Wal-Mart, he discovered that Wal-Mart was getting a better price. “We have not brought that supplier back,” Mr. Sinegal said.

He has to be flinty, he said, because the competition is so fierce. “This is not the Little Sisters of the Poor,” he said. “We have to be competitive in the toughest marketplace in the world against the biggest competitor in the world. We cannot afford to be timid.”

Nor can he afford to let personal relationships get in his way. Tim Rose, Costco’s senior vice president for food merchandising, recalled a time when Starbucks did not pass along savings from a drop in coffee bean prices. Though he is a friend of the Starbucks chairman, Howard Schultz, Mr. Sinegal warned he would remove Starbucks coffee from his stores unless it cut its prices. Starbucks relented.

“Howard said, ‘Who do you think you are? The price police?’ ” Mr. Rose recalled, adding that Mr. Sinegal replied emphatically that he was.

If Mr. Sinegal feels proprietary about warehouse stores, it is for good reason. He was present at the birth of the concept, in 1954. He was 18, a student at San Diego Community College, when a friend asked him to help unload mattresses for a month-old discount store called Fed-Mart.

What he thought would be a one-day job became a career. He rose to executive vice president for merchandising and became a protégé of Fed-Mart’s chairman, Sol Price, who is credited with inventing the idea of high-volume warehouse stores that sell a limited number of products.

Mr. Price sold Fed-Mart to a German retailer in 1975 and was fired soon after. Mr. Sinegal then left and helped Mr. Price start a new warehouse company, Price Club. Its huge success led others to enter the business: Wal-Mart started Sam’s Club, Zayre’s started BJ’s Wholesale Club and a Seattle entrepreneur tapped Mr. Sinegal to help him found Costco.

Costco has used Mr. Price’s formula: sell a limited number of items, keep costs down, rely on high volume, pay workers well, have customers buy memberships and aim for upscale shoppers, especially small-business owners. In addition, don’t advertise – that saves 2 percent a year in costs. Costco and Price Club merged in 1993.

“Jim has done a very good job in balancing the interests of the shareholders, the employees, the customers and the managers,” said Mr. Price, now 89 and retired. “Most companies tilt too much one way or the other.”

Mr. Sinegal, who is 69 but looks a decade younger, also delights in not tilting Costco too far into cheap merchandise, even at his warehouse stores. He loves the idea of the “treasure hunt” — occasional, temporary specials on exotic cheeses, Coach bags, plasma screen televisions, Waterford crystal, French wine and $5,000 necklaces — scattered among staples like toilet paper by the case and institutional-size jars of mayonnaise.

The treasure hunts, Mr. Sinegal says, create a sense of excitement and customer loyalty.

This knack for seeing things in a new way also explains Costco’s approach to retaining employees as well as shoppers. Besides paying considerably more than competitors, for example, Costco contributes generously to its workers’ 401(k) plans, starting with 3 percent of salary the second year and rising to 9 percent after 25 years.

ITS insurance plans absorb most dental expenses, and part-time workers are eligible for health insurance after just six months on the job, compared with two years at Wal-Mart. Eighty-five percent of Costco’s workers have health insurance, compared with less than half at Wal-Mart and Target.

Costco also has not shut out unions, as some of its rivals have. The Teamsters union, for example, represents 14,000 of Costco’s 113,000 employees. “They gave us the best agreement of any retailer in the country,” said Rome Aloise, the union’s chief negotiator with Costco. The contract guarantees employees at least 25 hours of work a week, he said, and requires that at least half of a store’s workers be full time.

Workers seem enthusiastic. Beth Wagner, 36, used to manage a Rite Aid drugstore, where she made $24,000 a year and paid nearly $4,000 a year for health coverage. She quit five years ago to work at Costco, taking a cut in pay. She started at $10.50 an hour – $22,000 a year – but now makes $18 an hour as a receiving clerk. With annual bonuses, her income is about $40,000.

“I want to retire here,” she said. “I love it here.”

© 2005 New York Times

We also have archived an earlier story from the Wall St. Journal on this theme: Costco’s Dilemma: Is Treating Employees Well Unacceptable for a Publicly-Traded Corporation?