Market-Oriented Agricultural Policy: Its Relevance

for 1985* Bruce Gardner

Congressional debate on farm commodity legislation is taking place in a “crisis” atmosphere. This may make it difficult for decision makers to understand that gov- ernment programs and other policy actions are part of the problem. Traditional pro- grams, which rely on commodity supply and demand manipulation, no longer work well. Congress should move to a phased market-oriented agriculture program which would make farmers better off in the long run and make consumers and taxpayers better off in both the short run and long run.

Congressional deliberation on 1985 farm commodity legislation took shape in an atmosphere of economic gloom that rivaled the 1930s. The key elements of the situation are:

0 a substantial number of farms (93,000 in the USDA’s estimate) under severe financial stress and threatened with business failure;

0 the average value of US farmland per acre has declined for 4 consecutive years, after having never declined for more than 2 successive years in 1940-1980, and the rate of return to investment in farm assets has turned negative;

0 farm commodity prices have returned to pre-1972 levels in real terms; since 1980 the federal government has spent about $12 billion dollars annually to support farm prices and incomes, conducted the largest acreage reduction program ever in 1983, and since 1978 has extended $6 billion in new economic emergency loans to financially pressed producers.

These facts are the background for 1985 legislation. What policies do they suggest? The first three items might clinch the case for government action to aid farmers, were it not for the fourth. The traditional commodity programs apparently are not working, so what can be done?

An approach that appears reasonable is to ask, what has caused these devel- opments, and then use policy to remedy the causes. Causes of the weakened market for US farm commodities since 1980 include expanded production abroad,

*Portions of this material were presented at an American Enterprise Institute Conference on Agricultural Policies in Washington, DC, January 29, 1985, and at the National Agribusiness Policy Symposium, Memphis, TN, in February 1985. Comments of participants on both of these occasions are appreciated.

Bruce Gardner is a Professor in the Department of Agricultural and Resource Economics, University of Maryland.

Agribusiness, Vol. 1, No. 3, 219-225 (1985) 0 1985 by John Wiley & Sons, Inc. CCC 0742-4477/85/030219-074gO4.00

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other countries’ protectionism and export subsidies, reduced export demand due to the strong dollar, overexpansion of US production, and high support prices reducing our competitiveness in world markets. These causes overdetermine the observed events, in the following sense. What we observe is lower (real) com- modity prices than in the 1970s, with excess supply at the support level. The support prices keep market prices from being even lower, especially for grains and diary products, and lower prices would induce more exports. But it does not seem appropriate to attribute the weak markets to the support prices, for the grains. In dairy it looks more like a case of imposing unrealistic support levels on a relatively stable supply/demand situation, with the support price then calling forth more output than can be sold at the support level. Here it makes sense to tag the support program as the cause of the surplus.

One can go further to identify causes of the strong dollar: reduced US inflation and high real interest rates. And further, the high interest rates can be attributed in part at least to the large US budget deficit. With respect to the trade policies of other countries, the US has helped to create the climate for at least some of this protectionism by its own protection of US industrial products and agricultural products like sugar, dairy products, and meat. In addition, the US export restric- tions of the mid-1970s and 1980, and the Payment-in-Kind (PIK) acreage controls of 1983 have been cited as factors behind the expansion of foreign agricultural output.

Causes of the financial disaster facing some farmers are typically a substantial decline in asset values for those who borrowed heavily to buy land or used land as security for heavy capital investment in 1975-1980, coupled with high interest rates and reduced cash flow. The unfortunate debtor is thus unable to service the existing debt while the deteriorated balance sheet makes it impossible to postpone payment by borrowing more. Farmers in this situation who experienced inadequately insured crop failures at the same time, as occurred in some areas, are fairly sure to be doomed financially if they were highly levered. A cause of trouble in some instances is an initial high leverage due to emergency FmHA credit provided to precarious farm enterprises under the Emergency Agricultural Credit Act of 1978. Farmers in danger of bankruptcy now are not only victims of the current downturn but also include some who would normally have gone out of business in the earlier downturns of 1978 and 1982.

What about remedies? Some economists argue that the commodity markets will strengthen if we move toward balancing the budget, and that accordingly the best farm policy is prudent fiscal policy. The presumed mechanism is: first, a decline in the deficit reduces real interest rates; second, a decline in real interest rates reduces the foreign exchange value of the dollar; third, a reduction in the value of the dollar stimulates exports; and fourth, increased exports drive up commodity prices. If any of these linkages should fail, there would be no appreciable price effect. The first two are really economic unknowns as a practical matter. Although some legislators have taken up the call for prudent fiscal policy as a substitute for farm commodity programs, farm interest groups appear to be reluctant to accept this idea. Their scepticism is understandable. It would seem prudent of farmers to give first priority to maintenance of the traditional programs.

The problem with traditional programs is that they work through commodity supply and demand manipulation and consequently can increase farmers’ prices by only three general mechanisms: (1) reducing supply, (2) increasing demand,

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or (3) making deficiency payments to farmers. Mechanism (1) no longer works well because demand is too elastic. More telling than any econometric studies on this point are the results of the PIK program and the tobacco program in the 1980s. Mechanisms (2) and (3) are unattractive because they are too costly to taxpayers. $12 billion per year under the Agriculture and Food Act of 1981 has clearly been insufficient. A commitment to expand the scale of expenditure sufficiently to bail out farmers who are in trouble looks like a budgetary black hole.

Moreover, all elements of the current farm economy are not as depressing as the initial listing of problems suggests. On the financial situation, note first that I do not call it a “crisis.” The press and TV in 1985 have been rife with farm spokesmen and experts declaring a farm crisis, some even comparing it to the Depression of the 1930s. But US agriculture as a sector is in nothing like the conditions of the 1930s. A crisis is a situation that has become so harmful as to be unsustainable-the victim will either have a turnaround or else become defunct, but things cannot continue chronically as they are. US agriculture is not in a crisis in this sense.

The debt of the US farm sector is estimated as of January 1, 1985, at $212 billion. This is almost a record high, although debt was slightly higher in 1983. However, farm assets total $1022, giving the sector as a whole a net worth of $810 billion. This is an 11% decline from the peak farm equity value of $910 billion in 1981, but is still healthy. The commercial segment of agriculture, which I take as the roughly 660,OOO farms selling $40,000 or more of farm products per year, has an average net worth of about $780,000 per farm.’.2

Moreover, while commodity prices are low and will in all likelihood continue their long-term trend decline as technological advances continue to outweigh demand growth, it seems likely that commercial-scale farms ($100,000 or more in sales) can cover costs at current and prospective prices and generate normal nonfarm returns to labor and capital i nve~ ted .~ Incomes of these producers remain well above nonfarm income levels.

These considerations-the high cost of programs that would bail out the farmers who really need help, the lack of need for help among the majority of commercial- scale farmers, and the possibly predominant role of macroeconomic and inter- nationql economic forces-suggest abandoning the traditional programs and mov- ing to a market-oriented agriculture. This is essentially the aim of the Reagan Administration’s proposal for 1985 legislation, which would phase down and out both target-price and loan-rate protections, and would abandon supply manage- ment. This proposal was hailed in Congress-as being dead on amval. This is a shame in my view because unregulated farming would constitute a substantial net gain for the US economy as a whole.

Some arguments against the market approach have sufficient merit, however, to give pause; the remainder of this article considers them.

First, as many have asked recently, how can we put our agriculture on a free- market basis when there is no free market internationally? Every government in the world that can print up laws and put a team of bureaucrats on the field regulates its own agricultural or food sector. These departures from free markets are not all bad for US farm interests. The Soviets, by their grain production policies, have provided the US with a good if erratic export market. Other countries, by exploiting their farmers through price ceilings, have reduced their

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production and increased their need for imports. However, the policies of Japan and Europe especially have been harmful to US farm interests. These policies call for a US response. But the response should be in terms of negotiation, trade- war threats, and liberalization of our own protectionism in manufacturing and some imported agricultural commodities, notably sugar. Traditional commodity programs are not the best response, especially PIK or other production control measures. These mainly increase the market for our competitors and provide a price umbrella for them.

A second argument against the market option is that our own government policies placed the farm sector in the current situation, so the government has an obligation to get it out. There is some truth to this proposition, but it is much overplayed. The injunction of Secretary Butz to “plant fence-row to fence-row” is cited as causing overproduction, the argument for government assistance being that producers should be compensated for losses incurred while following USDA advice. This is like asking my broker for compensation for my losses on a stock he recommended that I buy. We have to suppose that people are adults and in the end make decisions based on their own best judgment, which they must then live with.

The restrictions on agricultural exports, especially to the Soviet Union, that were imposed in the mid-1970s and in 1980 are also over-sold as causes of current difficulties. Evidence of their long-term effects just is not there. It is true that our export competitors have expanded output, but it is not plausible in concept or apparent in the data that this has occurred in order to fill the gap in world markets caused by prospective US embargoes. It makes more sense that the EEC became an exporter due to its internal policies enacted for internal purposes, that China, India, Argentina, and other countries expanded their output as a result of their own policy reforms and development plans, not really in response to any US policy.

Other governmentally created problems are that high real interest rates, hence the strong dollar and weak exports, are in part a consequence of macropolicy, so that the US farm sector is asked to bear a disproportionate share of the costs of the battle against inflation. It is also plausibly said that tax breaks available to people with high nonfarm income who invest in agriculture have generated part of the overcapacity that we see now for some commodities.

It seems clear that these and other actions of government have created problems for US agriculture. The question is what to do about it? After all, the government makes choices about many policy variables that create unexpected costs through- out the economy, and it would be hopeless to try to attempt to compensate all the losers (or tax the winners). The clearest policy implication from past embar- goes, macroeconomic policies, and so forth is that policy shocks should be avoided. Thus the restrictions that Congress has imposed on Presidential authority to establish an embargo or related trade restriction are an appropriate policy response. But it is not clear that policy resonse beyond this is warranted.

It has been said that our own protection of US nonagricultural industries, such as manufacturing-the so-called voluntary restraints on auto and steel imports- create a case for subsidizing agriculture as a “second-best” policy. There are two problems with this argument, one economic and one political.

The economic issue is how much the protection of manufactured imports has affected farm prices. For example import restraints in manufacturing do not have

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a downward effect on returns in farming exactly the same as the upward effect on the car and steel industries. The effect is diffused throughout all exporting industries, through the international capital markets, and even to some extent into markets for nontraded goods. It is very difficult to estimate the overall effect because of the indirect influences through the exchange value of the dollar and interest rates. Conventional analysis is probably correct in looking for the primary causes of farm price weakness in factors other than US protectionism-monetary policy, the federal deficit and interest rates, and the global commodity supply and demand picture. In short, the biggest deficiency payment for corn, say, that is justified to offset protection of manufacturing is likely to be much less than the current 4.0 to 50 cents per bushel.

On the political point, it might be possible to devise an exactly tuned set of conservation and acreage retirement programs and modest target price payments to just offset distortions imposed elsewhere. But this would be a substantial departure from current programs-perhaps costing $1 billion per year instead of $12 billion. What are the chances that Congress would ever enact such a program? Advocates of unregulated commodity markets are often accused of being naive; but what could be more naive than to think Congress would enact a program embodying such fine-tuned and analytically demanding calculations? Moreover, the one thing legislators will be counting with great sophistication-votes from their constituents-does not impel the construction of programs tailored to econ- omists’ recommendations. In the political arena what we are likely to get-and have experienced, in my opinion-are programs that from the viewpoint of the nation as a whole are worse than no programs during most of the post-World War I1 period. Thus, my point is not that the market option is optimal by any means, but just that the market option is better than what we are likely to get by trying to improve things through political direction of the markets.

Policy directed specifically at farms in financial trouble has appeal, but involves many difficult issues. Just stretching out farmers’ debt repayment schedules will only postpone the inevitable unless something changes fundamentally for either the individual borrower or the commodity prices. Since we cannot rely on either change, a viable policy will necessarily have a bailout component, either forgiving some debt or refinancing at a lower interest rate. This is what the Reagan Administration’s current plan does, on a modest scale. While some in Congress wanted to go much further, there are good arguments against a bailout substantial enough to save all or most of the farms that are in trouble. One is an argument based on fairness; bailing out the improvident investors in agriculture gives them a competitive advantage not enjoyed by those who were more careful. Second, the signal that losses from investments in land that turn sour will be mitigated means that less care will be exercised in future land purchases, with the aggregate effect that land prices will be artificially held up.

A third argument against a free-market option is that there is a social gain from reducing commodity market instability, that risk-averse producers would underinvest and the farm sector would under perform when wide and unpre- dictable price swings occurred in an unregulated market. There is a point worth serious attention here, but acceptance of the argument does not necessarily support the 1981 Act Programs. It supports the establishment of purely stabilizing programs, such as buffer stocks that bring high prices down as well as low prices up. It supports the establishment of insurance programs, like crop insurance and

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perhaps price insurance. But it does not mean that price insurance should be given away free to producers, or tied to set-asides, as has been done with the target-price programs. Price insurance could just as well be sold, by government through its ASCS offices or by the private sector thrwgh put options on commodity exchanges (perhaps retailed by elevators, brokers, or other middlemen). Indeed, the mute to policy reform that makes most sense to me is simply to begin to charge commercial-scale farmers for the target-price protection they receive, e.g., corn producers could pay 20 cents per bushel to guarantee a $3.00 price.

A fourth and final argument against the market option is that farmers are in a weak bargaining position such as against middlemen who handle farm products and businesses which supply goods and services to farmers (fertilizer, pesticides, seed, machinery, etc). However, even if the underlying idea is accepted, price support programs are not the appropriate response. Rather it is the establishment of farmer-owned cooperatives for farm supplies and services and marketing that can be justified along these lines.

This leads to the issue of how agribusiness as opposed to farmers would fare in ail unregulated agriculture. Two factors worth noting are: unregulated parkets would probably mean less stable supplies and prices of raw agricultural com- modities, which can pose problems for handlers and processors; and permanently higher prices and reduced output would be harmful to agribusiness. It is some- times said that higher prices for farm products need not be harmful to middlemen because they can pass through their cost increases to final consumers (unlike farmers). However, this argument fails to consider that with higher consumer prices the market will shrink. For example, sugar refiners can and did mark up the price of refined sugar to cover increased costs of raw sugar as the US tightened import controls. But higher prices resulted in such a large shift in demand for refining services as people used less sugar that big problems for that industry resulted. The problem of excess capacity is exacerbated if commodity programs rely heavily on production controls. The PIK program is a fine example of this. Lack of a market for some inputs and excess capacity for handling commodities in some cases caused real problems. Thus, the main interest of agribusiness in commodity programs is to avoid production controls.

SUMMARY

While moving toward market orientation would be costly for grain, cotton, and dairy producers in the next few years, over the longer term, commercial-scale farming will be just as viable without farm program protections; moreover, failure to price according to market realities would result in a substantial shrinkage of the US market.

Consumers and taxpayers will be better off in both the short and long run without farm programs. (In this sense it is wrong to say that we now have a “cheap food” policy.)

There are several reasonable arguments against complete laissez faire-the lack of free markets internationally, the role of government in causing current economic problems in agriculture, the instability of unregulated commodity mar- kets, and lack of farmers’ bargaining power in the markets they depend on. However, the traditional and current commodity programs are not an appropriate response to any of these problems.

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Finally, it should be noted, even though not discussed here, that acceptance of a market option does not necessarily imply that current programs should be eliminated overnight. It is important to have a smooth transition away from current programs. This could be accomplished through a phased in requirement that farmers pay for target-price protection.

REFERENCES

1. U.S. Department of Agriculture. “Economic Indicators of the Farm Sector,” ECIFS 3-3, Sep-

2. Executive Office of the President, Economic Report of the President-1985, Washington, DC,

3. Luther Tweeten, “Farm Financial Stress and Farm Income,” American Enterprise Institute

tember 1984.

February 1985.

Conference on U.S. Farm Policies, Washington, DC, January 1985.