Agricultural policy objectives The farm problem Economics of Food Markets Lecture 3 Alan Matthews

Lecture objectives To examine stated objectives of government intervention in agricultural markets To review explanations why farm incomes may have a tendency to lag behind non- farm incomes To discuss alternative patterns of agricultural adjustment

Extensive government intervention in agri-food markets Most countries adopt an active agricultural policy. Evidence that policy addresses significant and widespread socio-economic issues. High share of EU spending on agriculture High levels of border protection High transfers from consumers and taxpayers to agriculture (OECD PSE estimates)

Rationale for agricultural policy food security instability of agricultural markets lagging farm incomes maintenance of the rural population/rural development environmental and landscape benefits - the multifunctionality of agriculture

Food security Market-determined size of agricultural sector may mean relying on food imports Food security often equated with food self- sufficiency What is risk to food supply in developed countries? –Sources of risk (war, disease, climate) –Input markets may be more vulnerable than product markets –Risk a function of diversification of import sources –Huge overproduction in relation to subsistence needs –Self-sufficiency not necessarily the most efficient response (stocks, supply contracts)

Objectives of the Common Agricultural Policy Article 39 objectives –to increase agricultural productivity –to ensure a fair standard of living for the agricultural community –to stabilise markets –to ensure the availability of supplies –to ensure that supplies reach consumers at reasonable prices Generally, income objectives dominate farm policy objectives in developed countries, although rarely defined very explicitly

Sources of price instability P P Q Q

The cobweb model of price instability - where supply is a function of lagged price

..but some problems Even cycles require equal supply and demand elasticities Naïve expectations mechanism Observed cycles tend to be twice as long as those predicted by model Note that price and output instability offset each other from the point of view of revenue or income instability … but basic insight remains valid

Declining terms of trade Demand grows slowly because of slow population growth and Engel’s Law Supply grows more rapidly due to technological change Treadmill effect Rising living standards in nonfarm sectors

Why does farm labour market not return to equilibrium? With downward pressure on farm incomes, we expect outmigration from farming to restore relative incomes; why does this not happen? ‘love of farming’ – nonpecuniary considerations Market imperfections – barriers to movement Human capital explanation – markets do work Fixed asset theory – resources trapped in agriculture

Illustration fixed asset theory Acquisition cost Salvage value Demand for labour (MVP) 1 Demand for labour (MVP) 2 P Q3Q3 Q2Q2 Q1Q1 Q Supply of labour Labour supply should fall from Q 1 to Q 2 as a result of the fall in the demand for labour, but decision to exit is made with respect to the salvage price, so labour Q 1 Q 2 is trapped in the sector

Agricultural adjustment and the farm problem price instability in a supply-demand framework caused by low price elasticities of supply and demand agricultural adjustment in a supply-demand framework: the ‘treadmill’ of technical change together with Engel’s Law drives food prices down and leaves farms unviable technological change and input substitution also encourage farm amalgamation and lower the demand for labour in agriculture low farm incomes result from ‘sticky’ labour supply response –barriers to exit –neoclassical human capital explanation –fixed asset theory

The pattern of agricultural adjustment Changes in resource use – reduction in labour input accompanied by intensification through greater use of variable and capital inputs Changes in output mix – farm diversification into niche, exotic or higher value added activities Increased size of farm business and increased specialisation Reduction in farming activity – either through part-time farming and pluriactivity or through retirement and exit growing concentration of production and output on larger farms accompanied by the growing marginalisation of small- scale farming, leading to increased differentiation in farming Differences in survival strategies depends on the resource base of the family farm and family circumstances.

Recommended readings Gardner – Farm Problem See also Matthews 2003 in Lecture1