Agriculture: Economics and Policy In this chapter, we start by looking at the economics of agriculture, investigating the elasticity of demand and price trends of agricultural goods. We will then examine reasons that the farming industry has been declining, using supply and demand analysis to explain this as well as the repercussions of the changes in the market. We will also discuss the types and outcomes of government intervention and recent changes in farm policy. Chapter 20 Agriculture: Economics and Policy

Economics of Agriculture Extreme diversity Farm products and food products Short-run price and income instability Inelastic demand Fluctuations in output Fluctuation in demand Dependence on world markets Agriculture is an extremely diverse industry, comprising everything from cattle ranches and pig farms to vegetable plots and grain farms. Firms can be small, family-based farms, or large, multi-national conglomerates. Some products benefit from government support, while others must fend for themselves. Agriculture also includes both farm commodities, which are raw materials, and food products that are sold through restaurants or grocery stores. While agriculture remains a profitable industry, it is a declining industry, especially in the realm of the smaller operations. There are some serious issues in the industry. It suffers frequently from short-run price and income instability, which may prevent firms from entering the market. One major cause of the instability is the U.S. industry’s dependence on world markets. Many agricultural products come from other nations, which means the U.S. industry is sensitive to changes in those markets. LO1

Economics of Agriculture This table illustrates the dependency of U.S agriculture on world markets from 1950 – 2011. You can see the steady increase but continued variability over time. Source: Derived from the authors from Foreign Agricultural Trade of the United States, www.ers.usda.gov/Data/FATUS; and Bureau of Economic Analysis, www.bea.gov LO LO1 1

Economics of Agriculture This graph charts inflation-adjusted U.S. prices for cattle, hogs, corn and wheat during the second half of the 20th century. Note the volatility and general decline in prices. Whether the pattern will continue, of course, remains to be seen. Source: Author calculations using nominal values from Global Financial Data, globalfinancialdata.com, adjusted for inflation with the GDP deflator published by the Bureau of Economic Analysis, bea.gov LO1

The Long Run: A Declining Industry Supply increased rapidly Technological progress Demand increased slowly Inelastic with respect to income Population growth There are two primary contributors to the decline in the agriculture industry. The first is due to the fact that the supply has increased dramatically because of technological advances. Land that was once considered unsuitable for agriculture can now be farmed due to irrigation and other advances. The other factor is that demand has increased much more slowly, especially in the United States. This is because demand is tied to population growth, which has not been rapid. LO2O2

The Long Run: A Declining Industry Major consequences Increased minimum efficient scale (MES) Consolidation Agribusiness Massive exit of workers Farm labor 1.1% of labor force Farm-Household Income The actual consequences of the demand and supply changes over time support the predictions of the pure-competition model. Crop prices have declined as producers become more efficient, firms that are too small to take advantage of economies of scale get priced out of the market and the financial losses have resulted in a mass exodus of workers from the industry to other sectors of the economy. Huge agribusiness firms are left in some areas of farming. Traditionally the income of farm households was below that of nonfarm households but in recent years that trend has reversed. Some of that is due to increased farm subsidies and the fact that members of farm households increasingly hold jobs outside the farm. LO2

Economics of Farm Policy Subsidized since 1930s Support for agricultural prices, income, and output Soil and water conservation Agricultural research Farm credit Crop insurance Subsidized sale of farm products in world markets The main element of farm policy is the programs designed to support prices and income. In recent years, Congress has passed new farm legislation creating new forms of farm subsidies. We will look at some of the traditional systems of subsidies first, in order to better understand the revised versions. LO3

Economics of Farm Policy Rationale for farm subsidies Necessities of life “Family farm” institution Extraordinary hazards Competitive markets for output while inputs have significant market power There are many different reasons behind farm subsidies. At its basic element, as a society, we recognize the importance of farming. Obviously, without farms there would be little food and life would be much more difficult. It is therefore critical to insure that there are farms to provide food for the nation. Thus, it becomes necessary to help ensure that those farmers are able to earn a living wage. LO3

Economics of Farm Policy Agricultural Adjustment Act of 1933 established parity concept Particular real output results in same real income Preserve purchasing power Rationale for price supports The parity concept is the cornerstone of agricultural policy. The idea is that on a year-to-year basis for a fixed output of farm products, a farmer should be able to acquire a specific total amount of other goods and services. In other words, a particular real output should result in the same real income. Parity Ratio = Prices Received by Farmers Prices Paid by Farmers LO3

Economics of Farm Policy Economics of price supports Effective price floor Generates surplus output Gain to farmers Loss to consumers Efficiency losses Other social losses Environmental costs International costs Price supports, in effect, create price floors, which are minimum prices that the government will seek to maintain for certain farm products. These price floors can result in both positive and negative outcomes. The most obvious result will be a product surplus. Since the consumers are not willing to buy the quantity produced at the price floor, the government will end up buying the surplus to maintain the price. Price floors create benefits to the farmers at the expense of the consumers as they must pay higher prices and consume less. Society also loses because price supports create allocative inefficiency by encouraging an overallocation of resources to agriculture. In addition, there are environmental costs, international consequences and other social losses to consider. LO3

Economics of Farm Policy Reduction of surpluses Restricting supply Acreage allotments Bolstering demand Gasohol Biodiesel Corn-based ethanol The ethanol program Higher food prices Secondary effects There are several rationales for trying to reduce the surpluses produced by price support programs. Most programs focused on restricting supply through acreage allotments, which would limit the acres available to produce certain crops. Government has also focused on trying to increase demand for certain products in an attempt to use up the surplus. The government does this by funding research to find additional uses for the products. We can see this in the creation of alternative fuel sources that are based on corn products. The downside is that an unintended consequence of the new demand can be a decreased supply and higher price of the farm product for food production. LO3

Criticisms and Politics Criticisms of parity concept Criticisms of price supports Symptoms not causes Misguided subsidies Policy contradictions In recent years, it has become apparent that many farm policies are not working as intended. Economists can find no economic logic in the proposition that a bushel of wheat should buy the same product today as it did 100 years ago. The relative values of goods changed over time due to supply and demand. The price-support system suffers from similar criticisms. It can be argued that price supports treat the symptoms but not the root causes of the problem and, since they treat all farmers equally on a unit by unit basis, the smaller farmer who needs more support actually receives less support than the huge agricultural conglomerates. Farm policy has frequently resulted in contradictions. On the one hand, the government supports research seeking new uses for farm products and on the other hand, institutes acreage allotments to reduce the land available for production. LO4

The Politics of Farm Policy Public choice theory revisited Changing politics Declining political support World trade considerations Recent farm policy Freedom to Farm Act of 1996 Food, Conservation, and Energy Act of 2008 Direct payments Countercyclical payments (CCPs) Marketing loans Despite the criticisms, farm policy continues to provide price supports for many products. The public choice theory helps to explain why. Farmers are able to organize and lobby politicians for favorable treatment and since the cost per taxpayer may be small, there is little dissent. Other costs of the programs are hidden and indirect. In spite of this, there have been changes in recent years. There is declining support for agriculture policies as the farm population has declined. World trade considerations have also affected farm policy, as the U.S. has taken the lead to reduce barriers to world trade in agricultural products. Recent farm legislation has started to eliminate price supports and acreage allotments for many farm products. The FCE Act of 2008 continues the “freedom to plant” approach and provides revenue guarantees for farmers via direct payments, countercyclical payments, and marketing loans. LO5

The Sugar Program Price supports Domestic costs Import quotas Developing countries U.S. efficiency loss Global resource misallocation The continuing U.S. sugar program uses price supports and import quotas to guarantee a minimum price of sugar for domestic producers. This program has had significant effects, raising the domestic price of sugar 32% above the world price. The import quotas significantly reduce the export revenues of sugar-exporting countries, which are mainly are developing nations who need the revenue. It results in U.S. efficiency losses and global resource misallocation. The lobbying power of the industry, however, makes reform in this area difficult to achieve.