China Country Report, 2004

Regoverning Markets: Securing Small Producer Participation in Restructured National and Regional Agri-food Systems -- China Country Report

By Xiang Bi, XiaoXia Dong, Jikun Huang, Dinghuan Hu and Scott Rozelle, Center for Chinese Agricultural Policy and Chinese Academy of Sciences

September 16, 2004

Executive Summary

UNIFIED PROCUREMENT AND SALE SYSTEM AND GRADUAL MARKET LIBERALIZATION

While China's economy is transferring from planned economy to market-oriented economy, China's agri-food market has experienced gradual liberalization from a state monopolized unified procurement and sale system to a diversified market system with private sectors taking over the state owned sectors.

In the unified procurement and sale system, products were classified into three categories according to the nature of marketing and price formation permitted by the government. Grain, cotton, oil seeds, etc. which was considered to be of strategic importance to the nation belonged to category I products. All category I products were procured by the state at quota prices for a compulsory amount. Category II products, including meat, vegetables, fruits, aquatic products etc., were procured at a certain percentage or quantities by the state. The extra products on top of procurement quota could be traded on local markets. Category III products were mainly for local use, not subject to state procurement, such as poultry non-exported fruits.

In case of vegetables and pork, supply and sale cooperatives procured agri-products and state owned enterprises retailed them to urban consumers with subsided prices. Although there were no wide spread rationing for these products, they were some level of rationing in some big cities. Urban consumers went to state owned food stores and purchase pork with meat coupons.

Since mid 1984 and early 1985, the market liberalization began with fruits,  egetables, and aquatic products, then to pork, eggs, etc., and as a result, marketing channels of these products rapidly expanded. Different market types developed along the channels, and farmers, government agencies, collectives, state farms, and private traders all became marketing bodies. In big cities, government's concern of securing urban consumption made the major supplementary food (i.e. vegetables, meat, and eggs) under rationed at local level until early 1990s.

Traditional markets i.e. wetmarkets, which was under restriction during the planned economy, came back to life soon after the reform. Local periodical markets in the rural area as well as the wetmarkets in the cities increased dramatically, and served as convenient places for agri-food exchange for both producers and consumers at local level. In the urban, state owned enterprises lost ground in the new market system under the competition of private sector in the wetmarkets and wholemakets.

With trade volume increased, wholesale market and professional traders developed from traditional small-scale retail markets. This is also a distinguish characteristics of liberalized agri-food market system compared with the unified procurement and sale system, as only state trading enterprises distributed products between regions in the latter system. Now there are wholesale centers in the region of production and near the main consumption cities.

The development of wetmarkets and wholesale markets has formed a marketing system for fresh agri-food, starting from producers-middleman (wholesalers in production region)-long distance traders---wholeslars in consumption regions---traders at city retail markets (wet markets). Study showed that in mid 1990s, more than 70% of vegetables consumed were via this type of supply chain. Food markets in rural area also developed, however, local markets (periodical or regular) still remained as major marketing channels for fresh agri-food exchange.

SUPERMARKET DEVELOPMENT AND IMPACTS TO CHINA'S AGRI-FOOD MARKET

Agri-food markets are changing again since supermarkets have entered China's market. The supermarkets first developed in south and east coast of China, and then in major northern cities, such as Beijing, Tianjin and Dalian. Recently, supermarkets are penetrating to western inland China. Consumers targeted by supermarkets were first rich and middle income group in the big cities, then expanded to lower income group and smaller cities.

Supermarkets at its early stage in China were small-scale shops and focused on food, especially processed food. The fresh agri-food marketing was brought to China with FDI entering supermarket sector. FDI pushed the development of domestic supermarket chains, and the dominating types of stores in supermarket sector now are big scale hypermarkets.

Before 1995, fresh agri-food sales in supermarkets were almost zero. Estimation showed that there is about 30% fresh agri-food now retailed via supermarket chains in China's big cities.

The current prevailing marketing system is faced with new changes brought by supermarket development. Wetmarkets used to be the main places for rural and urban consumers to purchase fresh agri-food, now supermarkets brought challenges to them. In the rural area, periodical markets seems to have reached peak and began to decline. In more developed rural area, supermarkets also appeared at town levels, but there was no fresh agri-food sold in this supermarket at town level yet. In the urban area, formal state owned food stores went privatized, bankrupted or taken over by modern chain stores. Domestic supermarket chains advanced aggressively to inland and secondary cities, aiming at taking over the market before more FDI enters China. The wetmarkets in cities, however, were depressed by government policy of converting them to modern supermarkets.

The current marketing channels are also influenced by the regional procurement and centralized distribution system, which is becoming a trend of supermarkets  development. The rise of supermarket and the increasing sales of fresh products in the supermarkets stimulated the development of specialized wholesaler and dedicated suppliers. To stabilize supplies and reduce the costs, these suppliers established contract relationships with producers directly.

DETERMINANTS OF CHANGES IN AGRI-FOOD MARKET

Income and population increases are positive factors driving the development of food markets in both urban and rural areas. Intuitional and infrastructure conditions may serve to boost and hold back the development of markets in rural area. Lack of credits and capitals, imperfect land markets might prevent permanent shops from replacing periodical markets. Improved infrastructure, such as road, boosted the periodical market activities. However, the level of development of infrastructure in rural areas remained lagged behind than in the cities, e.g. road, electricity, etc. These bottlenecks might hold back the further modernization of rural food market, especially the modern supermarket chains development in rural China.

Urbanization and rise of income are the major determinants of supermarket  development in China. The increase of women's participation in the competitive occupations, the improvement of infrastructure, such as road, and increase of education also bolstered the supermarket rise.

The government relaxation of FDI pushed the development of China. There have been several successful cases of FDI in supermarket sectors. With China's accession to WTO, the restriction of FDI in retail sector is expected to be lifted in December 2004, it is expected that more FDI will go to supermarket sector in China.

LINK WITH THE UPPER STREAM AGENTS

In recent years, supermarkets are shifting to centralized procurement and they choose dedicated suppliers instead of wholesale markets as their suppliers of fresh  roducts. The rapid rise of supermarkets in store units and sales requires steady supplies with large quantity and lower prices. The leading chains are setting their regional procurement center and distribution center to gain more bargaining power and reduce transaction costs. Signing contracts with dedicated suppliers, instead of bargaining on the wholesale markets, can reduce transaction costs, and dedicated suppliers usually provide logistics to each chain store, which also saved the costs of supermarkets.

These dedicated suppliers source their supply from wholesale markets, production base and outgrowers. They provide technical assistance to their outgrowers, and supervise their production. The contract enforcement with outgrowers is secured sometimes by coordinating with local government. There are Farmer's Professional Associations (FPAs) who provide services on grading, technical assistance, and marketing for its members. The direct contact with these agents helped farmers to gain more profits than other marketing channels.

POLICIES TO SUPPORT INCLUSION OF SMES

In 2002, The State Council issued the "Suggestions of boosting Agri-food processing industry", in which, the government plans to increase the infrastructure investment in agri-food processing industry, and promote technology innovation and improvement investment in the leading companies.

In 2004, the central government issued the "No. 1 Document" , which exclusively deals with agricultural and rural development. This document specifically pointed out that farmers professional associations, farmer wholesalers, and farmer middleman should be encouraged.

It is not easy for small farmers to become a member of outgrowers for suppliers, because processing enterprises or dedicated suppliers have high requirements on production base (e.g. land index, environment index and transportation index). The suppliers provided technical assistance and even inputs to the contracted outgrowers.

ISSUES FOR THE FUTURE AND POLICY RECOMMENDATIONS

Supermarkets development is influencing agri-food market in China, but to what extent the supermarket will change agri-food market in China is still not certain. The current perspectives held by some people might be over-estimated, giving the fact that, China still has a large rural economy with under developed infrastructure and lower income residents. Our estimation is, by 2020, China on the whole will have 35% of their fresh agri-food consumed come from supermarkets.

The policy of replacing wetmarkets with supermarkets seems to be pushed too hard. The alternative of managing wetmarkets is to improve infrastructure of the market place, improve quality inspection on the wetmarkets, and provide information to the traders on quality control and hygiene.

Under the outgrower scheme, farmers need to take more active role in this arrangement. From the producer's side, farmers' professional associations should be encouraged and granted with legal status. Law of the FPAs is expected to be promulgated. Furthermore, it is difficult for farmers to set up own FPAs, as capital is the biggest constraint. Policies and laws in favor of FPAs should be drafted to tackle these constraints faced by FPAs.