AAEC 4305: Agricultural Policy

1. AAEC 4305: Agricultural Policy Fall 2007 Dr. Don Ethridge

2. Course sections • Review of key economic concepts • Intro. to policy • U.S. historical background • U.S. commodity policy • Policy in a global setting • Food policy

3. Key economic concepts for ag. policy • Market • Market demand • Elasticities • Relationship to incomes/expenditures • Market supply • Market equilibrium • Producer and consumer surplus

4. Definitions • Market—all buyers and sellers of a defined good in a defined time and space. • Market demand—relationship between quantity of a good that buyers will purchase per unit of time and the alternative prices of that good, other things constant.

5. Definitions (cont.) • Market supply—the relationship between the quantity of a good per unit of time that sellers will sell at alternative prices, other things constant. • Market equilibrium—the market condition at which all of the good offered for sale is bought.

6. Definitions (cont.) • Consumer (producer) surplus—the benefit obtained by consumers (producers) from being able to purchase (sell) all units of a good at the market price instead of having to pay (accept) the maximum (minimum) price for each unit bought (offered).

7. The “Magic” of Markets • No coercion. Markets operate based on individual optimizing decisions. There is no authority that forces individuals to make specific production or consumption decisions. • As an “unmanaged” system, it is, in fact, the most efficient system of large-scale organization ever conceived.

8. Efficiency • Markets tend to create economic efficiency. • Use A producers should be able to acquire the resources by outbidding use B and C producers. • So markets will tend to allocate resources to their highest valued use. • But what if prices do not accurately indicate consumer valuations of various goods and services?

9. “Market failure” • This leads to a situation referred to as market failure, which is a justification of interference with markets (through policy). • We will return to this issue after reviewing some key theories.

10. Producer and Consumer Surplus in a Functioning Market S Pareto Optimal allocation – You can’t make anyone better off without making someone else worse off. P* D Q*

11. Example of govt. intervention-price floor Supply Domestic Price Floor A B C Producers gain A, B, and C P* Consumers lose A, and B Demand Qd Q* Qs

12. Cost to Taxpayers if Surplus Dumped S Domestic Price Floor Ps A B C If government can dump surplus it will recover I and J D P* H E G F Pw Price of Surplus dumped on World Market D I J Qd Q* Qs

13. Intro. to policy • Definitions and classifications • Forces affecting agricultural policy • Reasons to study policy • Policy goals • Role of economics

14. Policy—a guiding principle leading to a course of action (programs) that is pursued by a government • Economic policy—pursued in management of national economic affairs • Agricultural policy—sectoral economic, natural rescource, and social policy

15. Forces affecting agricultural policy • Inherent instability • Golbalization • Technology • Food safety • Environmental concerns • Industry structure/industrialization • Politics/political system • Individual events

16. Why study policy? • No country has been willing to risk its basic necessities to free markets • All countries interfere with markets • All countries are affected by their own policies and policies of other countries

17. Policy problems • Price & income instability • Political instability • Poverty • Food safety • “Market failures” Note: Problems often eminate from industry structure.

18. Two Broad Categories Of Justification of Government Market Intervention • Market Failure • For some reason markets fail to work • Economics has a lot to say about when and why • Redistributional • Policy makers want to redistribute wealth • Economics has relatively little to say

19. Causes of Market Failure • Common property (non-excludable) goods. • “Unfair” market power. • Asymmetric information. • Externalities.

20. Non-excludable goods • Inherently can’t be exclusively consumed or defined as a common good. • National defense • Ocean fishing grounds • Government Responses. • Public provision • Regulate use of the common good • Provide incentives to encourage cooperative use

21. Unfair Market Power • Monopoly, Monopsony, Cartels • Government responses • Trust busting (anti-trust law) • Regulation • Facilitate equalization of market power • Cooperatives • Take over natural monopolies • Public utilities • Roads

22. Asymmetric Information • Market fails because of uncertainty: • Uncertain about characteristics of other party’s product (used cars) or behavior (unmonitored workers slacking) or about future events (weather) • Government responses • Mandatory price reporting • Mandatory livestock price reporting • Collects and disseminates information • USDA market reporting • Market grading • Fills the missing market • Crop insurance

23. Externality • The effect of one decision maker on another that is outside the market — market prices do not reflect full costs or benefits. • pollution that results from some production process. • Government responses • Taxes • Subsidies • Regulations

24. Agriculture/food sector policy goals • Market stability • Food security, safety, & health • Sustainability • International competitiveness

25. How economists contribute • Analyze policies and programs • Educate and provide advice

26. The policy process • 3 main groups in the U.S. • Diverse interests; many misperceptions • History of changing interests

28. Influence groups • Agricultural producer groups • Agribusiness organizations • Food nutrition & safety groups • Environmental & conservation groups • Political parties • Executive & congressional branches • Foreign countries & global organizations

29. Perceptions and Reality • Image: Due to economic hardships, farmers are becoming an endangered species. Who will produce our food? • Reality: The average income of U.S. farmers is well above that of the population as a whole. While the number of farmers declines, agricultural production continues to increase.

30. Image: Farming is environmentally benign and a naturally healthy occupation. • Reality: Farming is a principal source of environmental (particularly water) pollution and one of the most dangerous occupations in the U.S.

31. Image: Agriculture is a domestic industry that is highly dependent on domestic policy. • Reality: U.S. agriculture is an export industry highly dependent upon foreign markets and international economic forces.

32. Image: Agriculture is homogeneous and is the principal source of income in “farm states” • Reality: Agriculture is extremely diverse (agricultural interests are largely crop and region specific) and fewer than 12 percent of rural families receive the majority of their income from farming.

33. Image: U.S. Agriculture is made up of small family farms and exists in idealistic rural settings. • Realty: Fewer and larger farms.

34. Four broad historical periods of U.S. agricultural policy Pre-1930s • Building the infrastructure 1930 to mid-1960s • Depression & war years • Price supports and storage Mid-1960s to mid-1990s --Coupled direct payments Mid-1990s to present --Decoupled direct payments

35. Policy prior to the 1930s • General economic development—transportation (rail, roads, canals), postal (rural mail), Homestead Act (1862) • Institution building—USDA (1862), Land Grant Colleges (1862), Hatch Exp. Sta. (1887, 1890), Fed. Land Banks (1916), Coops (1922), PCAs (1933), etc. • Regulatory development—ICC (1887), Sherman Antiturst (1890), FDA (1906), meat inspection (1907), grain standards (1916), Pack. & Stockyards (1921), Commodity Exc. Auth. (1922)

36. Then came the 1930s • Great Depression for general economy, but 1920s for agriculture • Ag. Characteristics enabled assistance • Inherently unstable • Immobile resources • Farmers price takers • Rapid tech. change & productivity inc. • Low income & price elasticities Had rationale & means to assist farmers

37. 1930s-1960s progression • Ag. Marketing Act of 1929—1st “Farm Bill”; revolving fund to buy surplus & raise prices; failed because money went quickly. • AAA of 1933—price supports for reducing acres in wheat, cotton, corn, hogs, rice, tobacco, milk; financed by excise tax on processors.

38. Soil Conservation & Domestic Allotment Act of 1936—income parity instead of price parity goal; funding through Congress instead of processors; shift acreage to “soil conserving” crops. • AAA of 1938—reenacted provisions of 1936 act; created fed. crop ins.; initiated non-recourse loans. • WWII—strong demand & high prices; Congress raised support prices (didn’t cost much)

39. Post World War II acts • Extended high price supports based on parity concept • Maintained rigid acreage allotments • Agricultural Act of 1948 (90% of parity) • Agricultural Act of 1949 (“permanent” law) • Agricultural Act of 1954 • Agricultural Trade Development and Assistance Act of 1954 (PL-480) • Agricultural Act of 1956 (Soil Bank) • Agricultural Acts of 1958, 1962, and 1964

40. 1960s-1990s progression • After WWI, accumulated large government surpluses with high Treasury costs. No good way to get rid of stocks. • “Slippage.” Producers lobbied to keep acreage reductions to a minimum, took out least productive acres, and applied more inputs to remaining acres. • Potential for higher consumer prices.

41. “Globalization” began • Flex. exchange rates • Trade negotiations • World “food crisis” (1973-76) • Surpluses disappeared (high prices) • Unstable markets

42. 1965-1996 programs • Food and Agriculture Act of 1965 was a major shift in structure of programs (first to use direct payments) • Program structures stayed stable until 1996; minor exceptions were • Act of 1973 (target prices and deficiency payments. TP based on COP). • Act of 1977 (raised price and income supports; allowed removal of acreage controls) • Act of 1985 (reduced loan rates to allow markets to clear; “marketing loan” introduced to avoid stockpiles; CRP; Sodbuster & Swampbuster provisions) • Act of 1990 (planting flexibility; organic food standards) • Through all the acts until 1996, increasing % produced for free market by limiting eligible acres and yields

43. 1996-present • 1996-”freedom to farm”—decoupled income support payments (historical base; could shift land among program crops); deficiency payments, based on target prices, eliminated. • More recognition of global market • Direct income support decoupled from production • Land use restrictions relaxed • Act of 2002 brought countercyclical payments (reintroduction of TP & mktg. loan concept)

44. Some consequences of ag policies over time • Benefits largely capitalized into asset values • Reduced U.S. competitiveness in world markets • Fostered protectionist border policies • Distorted resource prices and use • Led to overinvestment in agriculture • Fostered some structural changes, retarded others • Reduced risks, supported tech revolution • Temporarily improved farmer incomes

45. Trends in ag support policies: 1970s to date • Less market distorting and more market-oriented • Less restrictive on producers • More trade oriented • More environmentally and consumer friendly • Very expensive; $15-25 billion/year • Less popular public support

46. Major components of U.S. commodity policy tools • Price supports • Production controls • Direct payments • Trade protection • Subsidized crop insurance

47. Price supports • Create surpluses • Handling of resulting surpluses • Government purchase • Non-recourse loan

48. Production controls • Acreage allotments, payments for idling land, marketing quotas • Have tended to reduce surpluses, but not eliminate them

49. Direct payments • Target prices have been the vehicle in US programs • Marketing loan has been a means of moving surpluses

50. Subsidized crop insurance • Commercial crop insurance has not been widely used in major crops • Subsidized crop insurance intended as a replacement for disaster relief • Effect has been to reduce risk, increase farm income stability, and increase commodity supply (through risk reduction)