Thursday, April 19, 2007
Escaping from Farm Programs
Since the 1920's, economists,
policymakers and farmers have been at odds over the need for programs to
deal with the tendency for output to increase faster than consumption
and with the large variation in commodity output. For the most part,
economists have argued for reliance on the free market and the
competitive system to cure these problems. However, farmers have
asserted that they were at a disadvantage in the market compared with
other industries and needed help to get a fair deal. Policymakers
listened to their farmer constituents and sold their ideas to consumers
and taxpayers. They justified market interference on the basis that
family farmers were the backbone of our society. They pointed to
depressed farm incomes and suggested that our food security should be
guarded. They argued that an income transfer to farmers was, thus, a
good idea.
Policymakers and their farmer constituents designed intervention programs to raise total income for the sector and average incomes of commercial producers of program commodities above free market levels. The programs control prices, hold stocks, idle land and transfer income. As the various administrations have operated the programs they have provided annual price floors for program commodities. During most the past 65 years, these floors exceeded short run market clearing levels. Over the entire 65 year period, they have exceeded long run free market prices. Thus, the price floors have encouraged production which was larger than the market could clear. The excess over sales accumulated in government storage programs, and resulted in attempts to reduce production to avoid further accumulations. For producers of program commodities, incomes and asset values were higher than they would have been in the absence of the programs. Producers of program commodities became dependant on, or coupled to, income support programs.
The Food Security Act of 1985 (FSA) moved a step toward market orientation by allowing price floors and commodity prices to decline. Income support to producers of program commodities was maintained through direct payments based on program yield and program acreage. The income support was achieved at a substantial increase in budget cost because the direct payments replaced hidden transfers from consumers.
As a result of the increased budget cost, the variability and size of the program budget became a major policy issue. The purpose of the income transfer and effectiveness of the program in achieving income stability was questioned and was considerable debate over whether these income transfers should continue.
At issues as we move toward a new Farm Program is whether commodity producers deserve a larger than free market share of income? Does the government have a role in providing for market stability even if it does not provide an income transfer? Such questions will only find answers in Congress through legislation.
Since the beginning of commodity programs economists have rather consistently argued for market orientation in agriculture with prices free to signal the need for more or less resources committed to production. However, the lack of a clearly defined statement of the sources of market failure and lack of sound economic programs to address the fundamental problems has often blunted their arguments for program reform.
The following evaluates how a free agricultural market diverges from the economists'competitive norm and to suggests how Federal programs could ease long run price discovery in a market oriented system.
THE COMPETITIVE MARKET NORM
At the center of the agricultural policy issues is the underlying faith of our society in the value of the free market in allocating resources and returns. Economist rely on competitive markets as a norm or standard. The assumptions of competitive market theory are a scale against which they measure economic performance. They argue that only in cases of market failure would an economy be better off with Government intervention. Pressure to cut government interference and move to a free market stems from a belief that competitive markets are effective, efficient and equitable. That is, competitive markets will result in just the right use of resources to produce just the right quantity of a commodity. And, according to the competitive theory free trade results in countries producing according to their comparative advantage.
Most economists believe that it would be desirable for the market to pass the "appropriate" economic signals through from consumers to producers concerning the quantity of resources to use in the production of commodities and how much to produce. They seldom specify the type of signal, but most infer that prices are the appropriate mechanism. In a free and competitive market the market price adjusts to bring about an equilibrium between the quantity supplied and the quantity demanded. Price provides the signal for adjustments in production and consumption. This competitive theoretical framework assumes perfect knowledge and instantaneous adjustment to equilibrium for long run and short run positions. That is, there is no short run. Capital, labor and current expenditures adjust eliminating excess resources. And, no stocks are carried in the system.
DEPARTURE FROM FROM THE NORM
Although the competitive model is a useful tool for analysis, the market for farm commodities departs from the rigid assumptions of the perfect market model. Specifically, there is a lack of perfect knowledge; production and consumption do not adjust simultaneously; random shocks affect production; there is not a fixed relationship between units of input and units of output; and production is seasonal, but consumption is continuous. Although producers can plan for an expected output and estimate how that output might vary, they have no basis for determining how output will vary in any one year. Producers make planting decisions on the basis of an expected price and an expected set of cost relationships. These would permit them to earn a return over variable cost sufficient to cover some or all of fixed cost. However, it would be coincidence if expected cost and actual cost or expected price and actual price coincided.
Probability theory offers no assistance in bringing expectations together with reality. It merely consists of the mathematics of the distribution of possibilities for situations which can not be empirically identified. (1) Thus, the quantity shock that occurs because of yield and weather variability is a non trivial condition. We can know the likely hood of a particular shock, but we have no information at planting time on whether that shock will occur in a particular year. Although nothing else changes, weather will bring about a mismatch between expected and actual yield and therefore expected and actual prices. Because the market allocates actual supply among demands rather than allocating expected supply among expected demands, determining the existence of fundamental shifts in demand or supply caused by economic forces requires several production periods.
Although many argue that market orientation will strengthen agricultural markets, some evidence shows that fitting agricultural production more closely to the competitive norm may not be good for the agriculture in either the short run or long run. McCalla and Carter argue that "... if production agriculture is a competitive island surrounded by varying degrees of concentration in markets, then deducing conclusions about the advantage of a return to a free market from theoretical constructs may not be valid"(3). However, consequences of government price fixing include (1) a heavy burden on the public treasury, (2) higher taxes, (3) higher cost of living, and (4) over stimulation of production for the protected commodity. In spite of these problems, agriculture programs from 1933 to 1985 have by one means or another established a floor price for program commodities by acquiring stocks and limiting production or marketings to set prices. A persistent problem remained through the existance of the programs. Policymakers could not establish a floor price belowr the long run market price and they therefore had difficulty clearing out stocks from farmer or Government held reserves. This is not surprising because income support through price supports, with out relying on the public treasury, requires that demand be inelastic and prices must be higher than the long run average free market price.
Although the legislators and program managers usually assumed the problem to be a chronic excess production problem that resulted in a low income problem, they relied on weather related production variability to extract them from the long run problem of stock accumulation. The stock accumulation was the result of excess production created by the price support effort. However, production variability is an ineffective procedure for emptying out storage bins, unless large acreage reduction programs restrict production to a level short of expected demand.
Using price as the trigger variable to initiate a Government action prevents the price from serving as a true measure of the need for production in future periods. Fixed current prices do not provide a sound base for forming expectations concerning future prices. Fixed prices also distort market allocation of the current year's crop and truncation of the expected price distribution on the lower end causes the expected price faced by the consumer to be higher than the price floor.
CONTINUING MARKET AND POLICY FAILURE
D. Gale Johnson, in an evaluation of agricultural policy, said "The policies of the 1950's were concerned with attempting to protect agriculture from changing conditions."... "The policies of the 1960's were reasonably effective in aiding agriculture to adjust to the inevitable resource transfers and the relative contraction of the farm sector."(2) In the Johnson context, policies of the 1980's tended to protect the sector from changing conditions rather than allow the sector to make the inevitable resource transfers.
Speaking to the subject of policy failure, Johnson has said: "If my analysis of the flexibility of resource allocation in agriculture is approximately correct, small errors in program formulation will very soon result in substantial cost to taxpayers, and possibly in difficulties in maintaining our pre-eminent position as a great agricultural exporter." In other words, it is relatively easy to create significant excess capacity in agriculture. if prices or payments are inconsistent with the underlying demand and supply situation. When agricultural output is greater than the demand, at politically acceptable levels of prices, a long time and large income transfers are required to eliminate the excess productive capacity and avoid major shocks to the production sector.
Price floors above long run market price levels are a major cause of excess production, but removal of such floors will not result in a stable market for agricultural commodities. Changing technology will result in a continuing expansion of production with a given set of resources. Producers have no means of retaining the benefits of cost reductions and real prices will trend downward as output increases faster than the combined effects of population and income shift demand.
In addition, a lack of homogeneity in the costs of production and marketing, resulting from differences in size, management, technology and location, will produce continuing excess capacity disequilibrium. Loss of resources from the sector will occur regardless of the form of policy. Because costs vary among firms, any price level below the average variable cost of the highest cost firm will in the result in the inevitable resource adjustment. Some firms will leave the sector while others continue to earn returns above of their variable and, perhaps, total production cost. Unlike industrial assets under excess capacity situations, land retains it's basic productivity. Frequently the assets of the exiting firms are recombined with those of the more profitable firms and production expands or cost decline or both. With no change in demand, or with demand shifting more slowly than supply, price will decline forcing additional firms to exit. However, production does not, necessarily, fall, because continuing consolidation of assets will occur. In the very long run, with firms exiting the sector a homogeneity of sorts may be achieved, permitting an equilibrium. Or, as concentration continues an oligopolistic system will be developed which permits some control of output at a level allowing the least competitive firm to remain in production because allocation of market shares has occurred.
ADJUSTING TO THE MARKET
Past price support policies caused more resource employment in crop production than the level needed to meet domestic and export demand at current prices. Stocks have accumulated. Removing excess capacity from the sector requires that real prices for output and real earnings must fall to force disinvestment from the sector.
Allowing real earnings to fall to the point that forces many of resources out of the sector is a painful treatment of the problem. In 1922, Henry A. Wallace, discussing the problem of heavy production against slack demand and addressing the possibility of market intervention said: "... in the long run every economic evil creates its own cure. If prices of farm products continue sufficiently long enough below cost of production, there will eventually be forced into bankruptcy enough farmers so that there will be no longer a disastrous surplus. At the same time there will be readjustments of land values, wages, etc., which will lower the production costs. "Henry A. Wallace, (4). However, avoiding the adjustment is impossible on a long term basis and easing the adjustment process becomes complex. Expansion of demand (shifting demand) at a fast enough rate to keep prices from falling seems economically and perhaps biologically impossible. Arbitrarily establishing a rigid price floor or a target price results in price certainty and provides the wrong information about future profitability. Tying price floors to current production costs results in distortion of returns in a manner that escalates future costs. This results in higher support levels in the future, higher production costs and an upward ratchet effect on support prices.
On the other hand, allowing the market to set prices without accounting for random disturbances from weather distorts the longer run economic signals. Prices changes from changes in demand or changes in technology and output are the economically determined signals that we wish to have transmitted.
WORKABLE OPTIONS
The critical aspect of any market oriented system is that the programs should not directly set prices and induce greater disequilibrium conditions. Providing protection against random shocks to the system need not distort long-term market signals if the shocks are due entirely to weather and yield quantity triggers rather than price triggers are used to initiate stock acquisition and dispersal. Also, stock acquisition must be limited to the yield increment.
Preventing the dynamic effects of the heterogeneous structure from driving prices down is difficult to achieve without inducing greater excess production. However, the most likely feasible solution may be some type of resource diversion (long term acreage diversion program) that diverts resources from production without fixing prices. With prices free to move according to true demand and supply shifts the cost of resource diversion program would be diminished.
CONCLUSIONS
Without price fixing programs, the agricultural sector would continue to experience a high degree of quantity and price variability from yield shocks. Also, the sector would continue to experience price disequilibrium, because of heterogeneity, even after the excess capacity induced by current programs is removed.
To achieve improved long run price discovery flexibility in prices is essential. To treat chronic excess capacity through Federal programs resources must leave the sector through positive adjustment programs and prices must adjust to economic stimuli. Prices must react to rationalize the market if income declines as a result of a change in the business cycle or if demand shifts as a result of a change in foreign exchange rates.
Programs that attempt to provide for price stability must use quantity changes as triggers and prices must be free to move with long run supply and demand conditions.
REFERENCES
1. Boulding, Kenneth E., "Normative Science and Public Policy", Economic Analysis and Public Policy, ed. Day, Richard H., Iowa State Press, Ames, Iowa, 1982
2. Johnson, D. Gale; "Food Production and Marketing: A Review of Economic Developments in Agriculture"; Food and Agriculture Policy; American Enterprise Institute for Public Policy; Washington D.C., March 10-11, 1977
3. McCalla, Alex F. and Carter, Harold O. "Alternative Agricultural and Food Policy Directions for the U.S. with Emphasis on a Market-Oriented Approach.
4. Wallace, Henry A., "Adjusting Production to Demand Benefits Both Farmers and the Public", Ames, Iowa, Dec. 28, 1922
Policymakers and their farmer constituents designed intervention programs to raise total income for the sector and average incomes of commercial producers of program commodities above free market levels. The programs control prices, hold stocks, idle land and transfer income. As the various administrations have operated the programs they have provided annual price floors for program commodities. During most the past 65 years, these floors exceeded short run market clearing levels. Over the entire 65 year period, they have exceeded long run free market prices. Thus, the price floors have encouraged production which was larger than the market could clear. The excess over sales accumulated in government storage programs, and resulted in attempts to reduce production to avoid further accumulations. For producers of program commodities, incomes and asset values were higher than they would have been in the absence of the programs. Producers of program commodities became dependant on, or coupled to, income support programs.
The Food Security Act of 1985 (FSA) moved a step toward market orientation by allowing price floors and commodity prices to decline. Income support to producers of program commodities was maintained through direct payments based on program yield and program acreage. The income support was achieved at a substantial increase in budget cost because the direct payments replaced hidden transfers from consumers.
As a result of the increased budget cost, the variability and size of the program budget became a major policy issue. The purpose of the income transfer and effectiveness of the program in achieving income stability was questioned and was considerable debate over whether these income transfers should continue.
At issues as we move toward a new Farm Program is whether commodity producers deserve a larger than free market share of income? Does the government have a role in providing for market stability even if it does not provide an income transfer? Such questions will only find answers in Congress through legislation.
Since the beginning of commodity programs economists have rather consistently argued for market orientation in agriculture with prices free to signal the need for more or less resources committed to production. However, the lack of a clearly defined statement of the sources of market failure and lack of sound economic programs to address the fundamental problems has often blunted their arguments for program reform.
The following evaluates how a free agricultural market diverges from the economists'competitive norm and to suggests how Federal programs could ease long run price discovery in a market oriented system.
THE COMPETITIVE MARKET NORM
At the center of the agricultural policy issues is the underlying faith of our society in the value of the free market in allocating resources and returns. Economist rely on competitive markets as a norm or standard. The assumptions of competitive market theory are a scale against which they measure economic performance. They argue that only in cases of market failure would an economy be better off with Government intervention. Pressure to cut government interference and move to a free market stems from a belief that competitive markets are effective, efficient and equitable. That is, competitive markets will result in just the right use of resources to produce just the right quantity of a commodity. And, according to the competitive theory free trade results in countries producing according to their comparative advantage.
Most economists believe that it would be desirable for the market to pass the "appropriate" economic signals through from consumers to producers concerning the quantity of resources to use in the production of commodities and how much to produce. They seldom specify the type of signal, but most infer that prices are the appropriate mechanism. In a free and competitive market the market price adjusts to bring about an equilibrium between the quantity supplied and the quantity demanded. Price provides the signal for adjustments in production and consumption. This competitive theoretical framework assumes perfect knowledge and instantaneous adjustment to equilibrium for long run and short run positions. That is, there is no short run. Capital, labor and current expenditures adjust eliminating excess resources. And, no stocks are carried in the system.
DEPARTURE FROM FROM THE NORM
Although the competitive model is a useful tool for analysis, the market for farm commodities departs from the rigid assumptions of the perfect market model. Specifically, there is a lack of perfect knowledge; production and consumption do not adjust simultaneously; random shocks affect production; there is not a fixed relationship between units of input and units of output; and production is seasonal, but consumption is continuous. Although producers can plan for an expected output and estimate how that output might vary, they have no basis for determining how output will vary in any one year. Producers make planting decisions on the basis of an expected price and an expected set of cost relationships. These would permit them to earn a return over variable cost sufficient to cover some or all of fixed cost. However, it would be coincidence if expected cost and actual cost or expected price and actual price coincided.
Probability theory offers no assistance in bringing expectations together with reality. It merely consists of the mathematics of the distribution of possibilities for situations which can not be empirically identified. (1) Thus, the quantity shock that occurs because of yield and weather variability is a non trivial condition. We can know the likely hood of a particular shock, but we have no information at planting time on whether that shock will occur in a particular year. Although nothing else changes, weather will bring about a mismatch between expected and actual yield and therefore expected and actual prices. Because the market allocates actual supply among demands rather than allocating expected supply among expected demands, determining the existence of fundamental shifts in demand or supply caused by economic forces requires several production periods.
Although many argue that market orientation will strengthen agricultural markets, some evidence shows that fitting agricultural production more closely to the competitive norm may not be good for the agriculture in either the short run or long run. McCalla and Carter argue that "... if production agriculture is a competitive island surrounded by varying degrees of concentration in markets, then deducing conclusions about the advantage of a return to a free market from theoretical constructs may not be valid"(3). However, consequences of government price fixing include (1) a heavy burden on the public treasury, (2) higher taxes, (3) higher cost of living, and (4) over stimulation of production for the protected commodity. In spite of these problems, agriculture programs from 1933 to 1985 have by one means or another established a floor price for program commodities by acquiring stocks and limiting production or marketings to set prices. A persistent problem remained through the existance of the programs. Policymakers could not establish a floor price belowr the long run market price and they therefore had difficulty clearing out stocks from farmer or Government held reserves. This is not surprising because income support through price supports, with out relying on the public treasury, requires that demand be inelastic and prices must be higher than the long run average free market price.
Although the legislators and program managers usually assumed the problem to be a chronic excess production problem that resulted in a low income problem, they relied on weather related production variability to extract them from the long run problem of stock accumulation. The stock accumulation was the result of excess production created by the price support effort. However, production variability is an ineffective procedure for emptying out storage bins, unless large acreage reduction programs restrict production to a level short of expected demand.
Using price as the trigger variable to initiate a Government action prevents the price from serving as a true measure of the need for production in future periods. Fixed current prices do not provide a sound base for forming expectations concerning future prices. Fixed prices also distort market allocation of the current year's crop and truncation of the expected price distribution on the lower end causes the expected price faced by the consumer to be higher than the price floor.
CONTINUING MARKET AND POLICY FAILURE
D. Gale Johnson, in an evaluation of agricultural policy, said "The policies of the 1950's were concerned with attempting to protect agriculture from changing conditions."... "The policies of the 1960's were reasonably effective in aiding agriculture to adjust to the inevitable resource transfers and the relative contraction of the farm sector."(2) In the Johnson context, policies of the 1980's tended to protect the sector from changing conditions rather than allow the sector to make the inevitable resource transfers.
Speaking to the subject of policy failure, Johnson has said: "If my analysis of the flexibility of resource allocation in agriculture is approximately correct, small errors in program formulation will very soon result in substantial cost to taxpayers, and possibly in difficulties in maintaining our pre-eminent position as a great agricultural exporter." In other words, it is relatively easy to create significant excess capacity in agriculture. if prices or payments are inconsistent with the underlying demand and supply situation. When agricultural output is greater than the demand, at politically acceptable levels of prices, a long time and large income transfers are required to eliminate the excess productive capacity and avoid major shocks to the production sector.
Price floors above long run market price levels are a major cause of excess production, but removal of such floors will not result in a stable market for agricultural commodities. Changing technology will result in a continuing expansion of production with a given set of resources. Producers have no means of retaining the benefits of cost reductions and real prices will trend downward as output increases faster than the combined effects of population and income shift demand.
In addition, a lack of homogeneity in the costs of production and marketing, resulting from differences in size, management, technology and location, will produce continuing excess capacity disequilibrium. Loss of resources from the sector will occur regardless of the form of policy. Because costs vary among firms, any price level below the average variable cost of the highest cost firm will in the result in the inevitable resource adjustment. Some firms will leave the sector while others continue to earn returns above of their variable and, perhaps, total production cost. Unlike industrial assets under excess capacity situations, land retains it's basic productivity. Frequently the assets of the exiting firms are recombined with those of the more profitable firms and production expands or cost decline or both. With no change in demand, or with demand shifting more slowly than supply, price will decline forcing additional firms to exit. However, production does not, necessarily, fall, because continuing consolidation of assets will occur. In the very long run, with firms exiting the sector a homogeneity of sorts may be achieved, permitting an equilibrium. Or, as concentration continues an oligopolistic system will be developed which permits some control of output at a level allowing the least competitive firm to remain in production because allocation of market shares has occurred.
ADJUSTING TO THE MARKET
Past price support policies caused more resource employment in crop production than the level needed to meet domestic and export demand at current prices. Stocks have accumulated. Removing excess capacity from the sector requires that real prices for output and real earnings must fall to force disinvestment from the sector.
Allowing real earnings to fall to the point that forces many of resources out of the sector is a painful treatment of the problem. In 1922, Henry A. Wallace, discussing the problem of heavy production against slack demand and addressing the possibility of market intervention said: "... in the long run every economic evil creates its own cure. If prices of farm products continue sufficiently long enough below cost of production, there will eventually be forced into bankruptcy enough farmers so that there will be no longer a disastrous surplus. At the same time there will be readjustments of land values, wages, etc., which will lower the production costs. "Henry A. Wallace, (4). However, avoiding the adjustment is impossible on a long term basis and easing the adjustment process becomes complex. Expansion of demand (shifting demand) at a fast enough rate to keep prices from falling seems economically and perhaps biologically impossible. Arbitrarily establishing a rigid price floor or a target price results in price certainty and provides the wrong information about future profitability. Tying price floors to current production costs results in distortion of returns in a manner that escalates future costs. This results in higher support levels in the future, higher production costs and an upward ratchet effect on support prices.
On the other hand, allowing the market to set prices without accounting for random disturbances from weather distorts the longer run economic signals. Prices changes from changes in demand or changes in technology and output are the economically determined signals that we wish to have transmitted.
WORKABLE OPTIONS
The critical aspect of any market oriented system is that the programs should not directly set prices and induce greater disequilibrium conditions. Providing protection against random shocks to the system need not distort long-term market signals if the shocks are due entirely to weather and yield quantity triggers rather than price triggers are used to initiate stock acquisition and dispersal. Also, stock acquisition must be limited to the yield increment.
Preventing the dynamic effects of the heterogeneous structure from driving prices down is difficult to achieve without inducing greater excess production. However, the most likely feasible solution may be some type of resource diversion (long term acreage diversion program) that diverts resources from production without fixing prices. With prices free to move according to true demand and supply shifts the cost of resource diversion program would be diminished.
CONCLUSIONS
Without price fixing programs, the agricultural sector would continue to experience a high degree of quantity and price variability from yield shocks. Also, the sector would continue to experience price disequilibrium, because of heterogeneity, even after the excess capacity induced by current programs is removed.
To achieve improved long run price discovery flexibility in prices is essential. To treat chronic excess capacity through Federal programs resources must leave the sector through positive adjustment programs and prices must adjust to economic stimuli. Prices must react to rationalize the market if income declines as a result of a change in the business cycle or if demand shifts as a result of a change in foreign exchange rates.
Programs that attempt to provide for price stability must use quantity changes as triggers and prices must be free to move with long run supply and demand conditions.
REFERENCES
1. Boulding, Kenneth E., "Normative Science and Public Policy", Economic Analysis and Public Policy, ed. Day, Richard H., Iowa State Press, Ames, Iowa, 1982
2. Johnson, D. Gale; "Food Production and Marketing: A Review of Economic Developments in Agriculture"; Food and Agriculture Policy; American Enterprise Institute for Public Policy; Washington D.C., March 10-11, 1977
3. McCalla, Alex F. and Carter, Harold O. "Alternative Agricultural and Food Policy Directions for the U.S. with Emphasis on a Market-Oriented Approach.
4. Wallace, Henry A., "Adjusting Production to Demand Benefits Both Farmers and the Public", Ames, Iowa, Dec. 28, 1922
Wednesday, April 18, 2007
Excess Capacity in Agriculture
Two fundamental problems in
agricultural markets result in the inability of agriculture to arrive a
long run economic equilibrium. The first, yield variability, has been
address in separate papers. The second, structural excess capacity, is
the subject of this blog.
INTRODUCTION
"I clearly recognize that in the long run every economic evil creates its own cure. If prices of farm products continue sufficiently long enough below cost of production, there will eventually be forced into bankruptcy enough farmers so that there will be no longer a disastrous surplus. At the same time there will be readjustments of land values, wages, etc., which will lower the production costs. Economic affairs always work themselves out if you leave them alone. However, it is equally certain that they will work themselves out even though you tamper with them. The disadvantage of tampering is that those who do the tampering are likely to be reviled by about half the population." Henry A. Wallace, Dec.28, 1922 (17).
Discussions, seminars, and symposiums have been conducted prior to consideration of every new farm bill. For the most part, the arguments focused on the desirability of providing for a market orientation in agriculture, although there has not been agreement on the meaning of market orientation. During the discussions, the term has been allowed to remain ambiguous, perhaps in the hope that consensus could be reached without clarity of definition. However, lack of an agreed upon definition of market orientation and a clear statement of the intent of commodity programs, has made it difficult to determine how to modify programs to achieve a more market oriented condition or, to determine how non-market oriented diverges from the "norm" or standard of perfect competition.
Digression on Programs vs Policies
What we call farm policy is, instead, a collection of programs to control price, hold stocks, and transfer income. In fact, the only consistent aspect of the programs has been the attempt to support incomes. The record of the programs, as they have been administered over their 40 year history, is that they have provide a price floor for program commodities and this floor has resulted in excess production which was stored and which resulted in attempts to reduce production. The net result was that incomes and asset values were higher than they would have been in the absence of the programs. From the record, one would conclude that the major goal of the programs was to keep income above free market levels. Despite this, however, protection against price variability has often been cited as a major objective. But no consistent policy has been articulated by Congress, farm groups or the several Administrations since the 1930's. The collection of programs has been variously interpreted by economist and policy analysts as providing income support, price stability, protecting the food supply, and protecting the family structure of agriculture.
The argument has been frequently made that current commodity programs are not working(12). However, since no statement of purpose has been articulated for the programs, it is difficult to evaluate how well they are or are not performing. The evidence available suggest that the cost of the programs has been higher than some thought desirable. Also the benefits of the programs went to producers with large farms. And, programs supported income but did little to lessen price variability or provide for stable budget cost. In fact, it is the variability and size of the program budget that appears to have been at issue rather than the effectiveness of the income transfer or the effectiveness of the program in achieving market stability.
This paper identifies issues associated with commodity policy; develops a rationale for and suggests a possible definition of market orientation; examines how the sector would behave under market orientation; evaluates the process of transition; and evaluates whether there is a continuing need for Government involvement in agriculture, because of the potential for market failure. No attempt is made to provide empirical estimates of the effects of alternative programs. These will be reserved for succeeding reports. This report relies on economic theory to suggest interactions and directions.
COMPETITIVE MARKETS
Competitive markets are a norm or standard by which economists measure economic performance. The argument is made that only in cases of market failure would an economy be better off with Government intervention. The pressure to move to market orientation stems from a belief that competitive markets are effective, efficient and equitable allocators of resources and output. That is, competitive markets will result in just the right amount of resources used to produce just the right amount of a commodity with equitable compensation for resources.
Past intervention by Government to support incomes of certain groups of producers above market clearing levels was based on the premise that market failure caused incomes in the farm sector to be below those in the non farm sector. It was deemed equitable, therefore, to provide a larger income to farmers by transferring it from taxpayers and consumers. Presently there is considerable debate over whether these income transfers should continue. That is, over whether commodity producers still deserve a larger share of the pie or whether the actions of Government to support producer incomes is causing the sector to be less profitable than it would be under free market conditions. Also at issue is whether there is a role for the Government to provide for market stability even if it does not provide for an income transfer. And, if market stability is a concern how can it be provided?
Some farm groups tend to support continued income transfers to the sector and in particular to producers of specific commodities. Others tend to suggest that the sector is no longer deserving of income transfers but rather deserves some protection from the capriciousness of the market which comes about through variability induced by weather and by the actions of foreign Governments (17).
Although it is often argue that a market orientation will strengthen agriculture, there is considerable evidence that making agricultural production more competitive may not be good for the sector in either the short run or the long run. McCalla and Carter, citing Dorfman, Samuelson, Josling and Galbraith; argue that "... if ... production agriculture is a competitive island surrounded by varying degrees of concentration in markets, then deducing conclusions about the advantage of a return to a free market from theoretical constructs may not be valid"(8). They argue that the evidence is not clear that agriculture will be better served by a return to a free market. Also, it is not clear that domestic consumers would benefit.
There dose seem to be agreement, among those involved in the debate, that a market oriented agriculture does not mean a total withdrawal of Government from commodity markets. What is missing, however, is a reason why continued involvement of the Federal Government would be required or why it would contribute to better market performance.
Market Signals from Competitive Markets
Most economists suggest that it would be desirable for the market to pass the appropriate economic signals through to producers concerning the quantity of resources to use in the production of commodities and, by inference, how much to produce. They also suggest that it would be desirable for signals to be sent to the consumer about how much to consume. The type of signal to be sent is seldom specified but most infer that prices are the appropriate mechanism to provide the signal. In a free and competitive market, where no buyer or seller is large enough to affect the market price and where everyone has equal and perfect information, output will be allocated among consumers efficiently by the changing market price signals. The market price adjusts to bring about an equilibrium between the quantity supplied and the quantity demanded. That is, it provides the signal that adjustments must be made. However, this theoretical framework assumes perfect knowledge and instantaneous adjustment to equilibrium which is simultaneous for long run and short run positions, ie., there is no short run. Capital, labor and current expenditures adjust so that no excess resources are used in production.
Non Simultaneity of Price and Quantity Changes
The market for farm commodities has several aspects that depart from the rigid assumptions of the perfect market. Specifically, imperfect knowledge; production and consumption do not adjust simultaneously; production is stochastic; and, to the extent that it is affect by weather, random and normally distributed; and, there is not a fixed relationship between units of input and units of output. Although producers can plan for an expected output and, given sufficient experience, estimate how that output might vary, they have no basis for determining how much, or in what direction, output will vary in any one year. Planting decisions of producers are made on the basis of an expected price and an expected set of cost relationships that would permit them, under expected conditions, to earn a return over variable cost sufficient to cover some or all of fixed cost. However, because of the random nature of yield variability, it would be coincidence if expected cost and actual cost or that expected price and actual price coincided. Probability theory is of no assistance for it, according to Boulding, "... is merely the mathematics of the distribution of 'possibilities' ... in situations which can not be empirically identified"(1). Thus, the quantity shock that occurs because of yield and weather variability is a non trivial condition. If no other changes occurred, weather would distort the market by bringing about a mismatch between expected and actual yield and therefore expected and actual prices. As a result, it often takes several production periods to determine the existence of fundamental market changes, that is, shifts in demand or shifts in supply caused by economic forces. This is so because the market determined price allocates the actual supply with demand rather than allocating expected supply.
Floor Prices
Agriculture programs from 1938 to 1985 have by one means or another attempted to establish a floor price for program commodities to address what was perceived to be a low income problem for the sector as a whole. A defense of the floor price was conducted by acquiring stocks and limiting production or marketings. But, a persistent problem remained. That is, it was exceedingly difficult, if not impossible, for policymakers to establish a floor price to protect income, which would allow the long run market price to be above the floor by a sufficient amount to clear stocks out of farmer or Government held reserves. This should not be surprising. In order to support income through price supports in a market, demand must be inelastic and prices must be higher than the long run average free market price. The inelasticity of demand has been a major source of problems in setting program parameters because an implicit assumption of the programs has been that variability would be sufficient to empty out the storage. However, this cannot occur unless supply (production) is somehow restricted. Thus, although the legislators and the program managers assumed the problem to be a low income problem, they relied on variability to extract them from the long run excess capacity problem, which they had, in part, created by the supply control effort. For most of the historical period, long run prices appeared to be below the floor price. As a result, stocks accumulated in Government ownership as nonrecourse loans were forfeited.
The focus on price as the trigger variable to initiate a Government action prevented the price from serving as a true signal for production in future periods. That is, current year prices were not a sound basis for forming expectations concerning future prices. Also market allocation of the current year's crop was distorted because the distribution of expected price was truncated on the lower end and the expected price faced by the producer was necessarily higher than the price floor.
D. Gale Johnson has said that "The policies of the 1950's were concerned with attempting to protect agriculture from changing conditions."... "The policies of the 1960's were reasonably effective in aiding agriculture to adjust to the inevitable resource transfers and the relative contraction of the farm sector."(6) The policies of the 1980's, thus far, have again tended to "protect" the sector from changing conditions.
CONDITIONAL POLICY
Stepping back from current programs and considering the prospects for a long term policy for agriculture, it is possible to conceive a framework with both income support and reduction in price variability as objectives. It is also possible to develop programs to support either of these objectives. However, a clear articulation of the policy is required. D. Gale Johnson calls this to our attention quit forcefully. "The most critical assumption is the future level of net income of agriculture. For the years ahead we can not rule out a decline in net agriculture income of 10 percent and a decline of farm operator income of somewhat more. If this were to occur there would probably be some downward pressure on real estate values, unless the income decline were thought to be temporary." He continues: "If my analysis of the flexibility of resource allocation in agriculture is approximately correct, small errors in program formulation will very soon result in substantial cost to taxpayers, and possibly in difficulties in maintaining our preeminent position as a great agricultural exporter. It will, in other words, be relatively easy to create significant excess capacity in agriculture by providing incentives, through prices or payments that are inconsistent with the underlying demand and supply situation. Experience has shown clearly that when agricultural output is greater than the demand at politically acceptable levels of prices, a long time and large income transfers are required to eliminate the excess productive capacity."(6)
Just and Rausser have provided a basis for a new look at commodity policy (7,8). They argue that inflexibility in commodity programs has resulted in policy induced variability [instability] in commodity markets, making decision making by farmers and policymakers even more risky than it would be without commodity programs. They conclude that policy that is conditional in its response to economic conditions will be more likely to result in the transmission of appropriate signals to producers and consumers. Daft concludes that "The principle strength of the chapter by Richard E. Just and Gordon Rausser is its non traditional view of commodity policy. The authors assume that the reduction of risk and uncertainty is the principal justification for commodity policy. After reviewing the recent track record, they find that commodity policy, itself, has often been a source of instability rather than a cure for it. They attribute much of this policy failure to the attempt by legislators to establish future legislation on past economic conditions. When future conditions deviate from the assumed state, as they inevitably do, policy failure has resulted." "...Just and Rausser conclude that legislators should stop trying to anticipate conditions and, instead, adopt policies that would respond automatically to changes in sector economic variables." "As an illustration, they suggest that the Government agree to purchase 1 million bushels of grain for every one cent per bushel that the market price falls below a specified target price."
While Rausser and Just have performed a major service in providing a new perspective on commodity policy, a further extension of their approach will clarify the fundamental farm policy problem.
INSTABILITY, VARIABILITY, RISK AND UNCERTAINTY
According to Offutt and Blanford, "An unambiguous definition of instability would provide the ideal starting point for the selection of an appropriate empirical indicator [of risk]. Unfortunately the concept of instability is nebulous because the perception of what constitutes unstable behavior is largely subjective." "... Variability and instability can not necessarily be equated and require an implicit or explicit judgment be made as to what constitutes 'unacceptable variability'."(11)
For our purposes, it is not necessary that a judgment be made concerning whether or not variability is or is not acceptable. Rather, the issues are: is it measurable, is it reducible and to what extent are variability and uncertainty separable.
For the purpose of this paper it will be convenient to view risk as the measurable variation in a normal random variable, such as yield, with a quantifiable probability distribution of the "possibilities". Uncertainty will be considered as being exemplified by supply or demand shocks to the system that are the result of policy or economic variables where the result is expected to be a systematic change or structural change. Such actions are unmeasurable in an expectations framework and no probabilistic statement can be constructed concerning their occurrence or outcome.
Much of the research related to variability is associated with the stock holding function and the potential for determining an optimal level of stocks with a concept of covering negative supply deviation 80, 90, or 95 times out of 100. In reality, there can be no optimal stock level for any particular year. Because output for the coming season is a random variable, the optimal stock level must also be a random variable. Given an expectation of production variability one can construct an expectation of the level of stocks that would offset the production deviations. One cannot however anticipate, identify and offset supply and demand shifts as a result of policy or production changes.
The Just and Rausser argument, that conditional policy will allow the free market to function while providing stability, presumes that it is possible operate as though it was possible to control price and still allow the market to clear because of quantity variability. The conditional policy response suggested by Just and Rausser reacts to both physical and economic phenomenon and attempts to shield the producer or slow the effect of real supply and demand changes as well as the effects of random yield shocks. They presume that conditional control of the effects of other economic forces on price will reduce the likelihood of policy induced instability. However, Just and Rausser do not consider the possibility and implications of policy induced excess capacity as the result of conditional intervention which prevents the full impact of supply and demand shifts from being realized because of the manipulation of the market price.
Pass Through of Market Signals
While it is possible to mathematically estimate a number for the coefficient of variatation of price, the number is meaningless unless the price variation is random and normally distributed with mean zero. Historical price data contain both random and systematic changes and there is little reason to believe that the deviation will be normally distributed or that the estimate will be unbiased. There is, however, reason to believe that in the absence of market intervention policies the effects of weather would, over time, be normally distributed and it would be possible to remove the weather related effect from prices. It would also be possible to estimate the effects of a stocks management program that reacted to weather variation by acquiring, for example, yield in excess of expected normal and disposing of stocks if yield is less than expected normal.
Under conditions where long term supply and demand were in balance the smoothing effect on quantity would result in a stablity of domestic consumption and a stable supply for export. Such a stocks management policy would minimize the impact of domestic weather variation on commodity prices. All other factors would be reflected in the market including demand and supply shifts as a result of technology or changes in financial or macro policy variables. The effects of weather in importing countries and on competing exporters would also be transmitted through the market. Also the impact of their policies would be felt.
Some have viewed the wide price changes of the 1970's as an indication of increasing variability in the market and concluded that the random forces causing such disturbances may increase in the future. However, many of the events of the seventies appear to have been systematic structural changes which, in connection with random yield disturbances resulted in a confusing set of prices. For example, entry of the Soviet Union into the market on a major scale to aquire grain for livestock feed was a systematic change rather than a random event, as was the decision by the Chinese to buy wheat rather than tighten their belts, and the decision of the U.S. to raise loan rates and target prices rather than let farm income decline in the late seventies. Even the weather shocks on foreign yields are transmitted to our markets through a set of systematic filters that distort the random nature of the yield variability. Thus, the most truly random influence in the market is the effect of domestic weather on domestic yields. All other changes fall into the category of uncertainty or instability. And, it is these changes that are structural or systematic in nature that should be reflected in market price signals.
Implication for Stock Holding
Numerous studies of price variability and variability of quantity marketed, through domestic and export channels, have been conducted. Most have assumed that deviations in price from trend or deviation of production from trend were normally distributed random variables with mean zero (12,14,15). Therefore, the analysts also assumed that the probability of the actual deviating being less than a specified number is also a normally distributed random variable. However, the normal random variable assumption does not appear to be a correct specification of the behavior of either production or price. Many of the forces in the market are systematic and result in deviations that do not have zero mean. This is not to say that a mathematical representation with the sum of the deviations equal to zero cannot be constructed. But that such a construct is an erroneous representation of the forces causing market prices and quantities to change.
Under conditions where long term supply and demand were in balance, the smoothing effect of a reactive policy to acquire positive increments to trend yield and store them until they could be disposed of in periods of low yields would result in stability of supply for the domestic and export markets. Such a stocks management program would minimize the impact of domestic weather variation on commodity prices. All other factors would be reflected in the market including demand and supply shifts as a result of technology or changes in macro or policy variables.
Sharples and Slaughter suggest that "Adding to or releasing from buffer stocks in response to changes in quantity produced would stabilize the major source of food price variance in a closed system. That is, if operated world wide, such a program would provide reasonably stable food supply and prices. Theoretically, a buffer stock managed by such a quantity rule would stabilize prices with minimal interference with the allocation function. Prices would be free to respond to changes in demand [and changes in supply], and the allocation signals so generated would not be clouded by the noises of price changes in response to production variances occasioned by weather vagaries." However, they dismissed the quantity rule because production worldwide is difficult to measure and the size of the quantity buffer stock may preclude the response required. While they suggest that the price rule may be appropriate, they recognize that it runs the danger of obscuring allocation signals generated by non-random supply and demand shifts. "This suggests that the programs have built in self corrective features in order that the reserve acquisition and release prices adjust in accordance with the long un moving equilibrium."
Worldwide rationality on stockholding policy would imply that all producing countries would store the positive deviations from trend yield and dispose of them during periods of negative deviations. Storing more than the positive deviations from trend would require that in some year the market would have less available than had been planned for by producers or expected by consumers. Storing less than the positive deviations means that the probability of incurring a shortfall in stocks is increased because the positive increment from yield has not been stored but consumed and future consumption must be reduced below what it could have been if stocks had been retained.
If the U.S. changes its' policy from encouraging excess production with supported prices to free market pricing, then the appropriate response to changes in export demand would be to allow the market to clear, with the exception that the U.S. would stand ready to buy or sell the additions to or shortfalls from trend yield on whatever acreage was planted. Under such conditions the U.S. would not export its' domestic variability from weather on to the world market.
THE ARGUMENT OF CONTINUING MARKET FAILURE
Heterogeneity in the cost of production and marketing, which is the result of heterogeneity in size, management, technology and location will result in continuing excess capacity disequilibrium and loss of resources from the sector regardless of the form of policy. Because costs vary among firms, any price level within the range of total cost will result in some firms being driven out of the production while others continue to earn returns in excess of their production cost. As a result the assets of the exiting firms will be recombined with those of the more profitable firms and production is likely to expand or cost decline or both, because of the efficiency of the acquiring firm. With no change in demand, price is likely to decline and additional firms will be forced to exit. Continuing consolidation of assets will occur until a homogeneity of sorts is achieved or until an oligopolistic system is developed which permits some control of output that will allow the least competitive firm in the production structure to remain in production because allocation of market shares has occurred.
Policy analysts have identified two basic factors that have been important for agriculture policy determination in the United States. One is a tendency for output to increase faster than consumption. The other is a high degree of variation in commodity output and price variation, which results in variation in earnings. The purpose of this analysis is to explore the causes of excess capacity and price variation and identify how various types of policies and programs might be used to assist in overall adjustment of the farm sector.
The following analysis attempts to separate the various reasons for price and income changes and suggests how particular policy tools may relieve or exacerbate price and income stability and excess capacity problems.
SUPPLY/DEMAND SHIFTS CAUSE CAPACITY AND VARIABILITY PROBLEMS
Prices are the result of the simultaneous interaction of supply and demand. Therefore, before corrective policy actions are taken, it is important to understand whether the changes in price are the result of shifts in supply or demand or some combination of the two. It is also essential to understand whether the shift is a result of short-term or long-term phenomena. Lack of clarity in identifying the source of the change in price or in the reason for a particular price level can lead to a choice of policies that exacerbate rather than correct the perceived problem.
The unique aspects of agriculture are that agricultural production is subject to the random impact of weather and food is basic to survival. There is, thus, a general concern that some groups within the population (either domestic or world population) will have insufficient income to acquire sufficient nutrition for their existence at market determined prices.
Humanitarian Aspects
A humanitarian goal of society is that no one starves regardless of their ability to purchase food. To achieve this goal, output must be greater than the free market would be expected to achieve. This can be achieved by a shift in demand by transferring income to the disadvantaged (for example, through food stamps or other direct income transfers) or by a shift in supply making commodities available to certain segments of society at subsidized prices or through donations. This aspect of agricultural puts it somewhat in the nature of a public utility which must provide service to all segments of society.
Enhancement of the effective demand or expansion of the quantity marketed, is complicated by the biological nature of the production process, the random disturbances in the market created by weather and the inelasticity of demand for the product. These biological factors produce short-run changes in market supply (quantity available for consumption) that make discovery of long run prices extremely difficult and therefore longer term investment and subsidy decisions are frequently made from erroneous price expectation. Improvement of long run price discovery is the primary focus of the remainder of this paper.
BIOLOGICAL NATURE OF THE PRODUCTION PROCESS
Because agriculture is a biological process, it is subject to seasonality, perishability of output, weather related problems and environmental problems including insects, disease, and weeds. Environmental consideration preclude agricultural production in some regions and enhance it in others and alter the feasible output mix in a particular geographic area. To some extent these biological considerations are manageable. That is, we have the ability to modify the environment so that supplies can be obtained at prices that permit adequate returns to the producer for investing in the environmental modification technology. In the following sections, the various biological factors and the implications of allowing the sector to deal with them under free market conditions were considered in a paper presented to SAEA in Feb 1987.
To this point the discussion has focused on the impact of biological factors and weather changes on farm prices and farm income. This section focuses on supply and demand shifts resulting from economic forces.
Demand Shifts
Demand shifts occur because of changes in population, taste and preferences, and income. They may also result from policy decisions made about, and applied to, other sectors of the economy. The demand shifts may be temporary (a few quarters) or they may be permanent. Whatever the cause, a decrease in demand (a shift to the left of the demand schedule) results in consumers buying less of the commodity at any schedule of prices. If no change in the supply occurs, the result of the demand change will be that the price will fall and some smaller quantity will be consumed. In order to achieve an equilibrium some resources must be removed from production. In a free market this occurs because revenue is reduced to the point where it is unprofitable for some producers to produce the commodity and resources are transferred to other employment or underemployed. Setting prices above the new equilibrium level, to maintain producer revenue, results in the accumulation of stocks (inventories). If the demand reduction is permanent or extended, a rigid price floor results in continuous stock accumulation.
Supply Shifts
Changes in supply occur primarily because of changes in technology, changes in the relative price of inputs or changes in the real price of inputs relative to output. For example, adoption of a new technology may result in the ability to produce more grain from the same resources and lower the cost of grain per bushel. Such a change means that at any schedule of prices more grain would be offered for sale. As in the case of a reduction in demand fixing the price above new equilibrium will result in accumulation of stocks.
External Policy Impacts
In addition to the impact of normal economic forces in a free market economy, the farm sector is subject to the impact of Government intervention in other sectors. For example, supply shifts occur as result of tax policy changes that encourage businesses to make investments. In particular, the use of investment credit and accelerated depreciation cause more resources to be employed in the production of crops than would be used without these investment incentives. Tax policy that allows the write off of farm losses against other income provides an incentive to continue farm production even though losses are being incurred. The net effect is to keep more resources employed in production than would be employed without the tax incentive.
Credit policy also encourages the employment of more resources in the sector to the extent that it provides interest subsidies or makes loans available to producers who could not obtain funds through commercial channels.
Monetary and fiscal policy have a substantial impact on the demand for commodities though their impact on business cycles and domestic income and though their effect on foreign exchange rates. Under a restrictive monetary policy which keeps U.S. interest rates above those in other countries the dollar tends to valued higher relative to the currency of potential importers. Thus, prices for U.S. commodities are inflated in the export market and the net effect is the same as if the U.S. supply was shifted left or as if an export tax were imposed on U.S. goods.
Presented with such problems policy makers are often disposed to create exceptions to a policy or to provide for offsetting special conditions. For example, to offset the impact of restrictive monetary policy on farm commodities, export subsidies may be instituted. The result is that the consumer and the taxpayer pay a higher price for the commodity, transfer income to the farmer and subsidize the foreign buyers.
Using farm commodity policy to protect farmers against price and income variability or against "low" incomes is to treat the symptom rather than the problem. Price and income changes occur in response to shifts in supply or demand . The cause of the problem must be uncovered be for a treatment can be proposed. If the source of the problem is outside the sector then perhaps that is the place to develop corrective policy, if such policy is needed. If tax laws are encouraging excess resources in production then a change in the tax law would be in order. If the problem occurs because of forces that are the result of random weather shocks then appropriate tools can be developed to react to but not anticipate weather changes.
ALTERNATIVE FUTURES AND THE IMPLEMENTATION OF POLICY
The need for and the effectiveness of agricultural policy will be determined by the continued certainty of yield variability and by the relative change in output and consumption trends.
If consumption is rising coincident with or faster than output, real prices will tend to remain flat or rise slightly. On the other hand, if output is tending to rise faster than consumption, real prices will tend to fall.
In part, because of past price support policies, more resources are employed in crop production than the level needed to meet domestic and export demand at current prices and stocks are tending to accumulate. To remove the excess capacity from the sector, real prices for output and real earnings must fall to levels which force disinvestment from the sector, resources must be acquired from producers and removed from production, or demand must grow more rapidly than output for an extended period.
Allowing real earnings to fall to the point where a large number of resources are forced out of the sector is a painful solution. Expansion of demand (shifting demand) at a fast enough rate to keep prices from falling appears to be economically impossible. The most feasible solution appears to be some type of resource diversion in combination with stability programs. Achieving the appropriate balance is complicated by the random variation of weather which results in highly variable yields and therefore highly variable prices which gave inappropriate signals for long-term resource commitments. Arbitrarily establishing a rigid price floor or a target price without regard to longer term market forces results in price certainty and has a high probability of providing the wrong type of information about future profitability. Tying price floors to current production costs results in distortion of market signals in a manner that tends to escalate future costs. This results in higher support levels in the future, higher production costs and in a rachet effect on support prices. On the other hand, allowing the market to set output prices without accounting for random disturbances from weather distorts the longer run economic signals that occur from changes in demand or changes in technology and output. These are the economically determined signals that we wish to have the market transmit.
Providing protection against random shocks to the system need not distort long-term market signals if the shocks are not the result of economic forces that is, if they are due entirely to weather. However, if income declines as a result of a change in the business cycle, providing price protection against the shift in demand will result in commitment of more resources in production than would be required. Or, if demand shifts as a result of a change in foreign exchange rates, establishing a price floor could result in a greater reduction in trade than would result from a market determined price.
SUMMARY
The previous discussion suggests that, farm commodity producers are subject to the risk of low levels of income because of the impact of weather and economic forces on the production, marketing consumption and prices of the commodities they produce. Because agricultural production is a biological process which results in the disassociation of the commitment of resources to the production process and the output of those resources, and because rainfall and temperature are not subject to the control of the producer the relationship between committed inputs and output is not fixed. Because the input/output relationship is not fixed and the impact of weather is random in nature, the producers best expectation of the price for the next crop year is likely some average of historical prices. If resources are committed with the expectation of normal yields and prices and the output results in a significantly better or poorer crop, prices and incomes can be dramatically altered, although the producers planned appropriately given their limited information.
Historically, society has recognized this risk and has attempted to protect producer from the most severe aspects of a random loss of income and consumers from the loss of the commodity. In the l930's, programs were established to put a floor under prices and thus prevent farm income from falling during periods of excess production. In order to support prices, nonrecourse loans were made. The loan rate became the price floor and crops not sold were forfeited to the Government.
As income increased, production at the supported price increased and stocks accumulated in Government storage as markets failed to clear and loans were forfeited. To limit stock accumulations, various marketing controls and production controls--largely through acreage diversion and acreage allotment programs--were instituted. In the l970's, with acreage diversion and export subsidy programs in place to help clear stocks, supplies diminished and prices rose rapidly. To prevent rapid price increases in the future, a farmer-owned reserve was introduced. A set of target prices and deficiency payments were established to, in part, guarantee an income transfer to producers who cooperated in supply control and stocks management programs while the loan rate or price floor was to be set near market-clearing levels.
Although there may be differing points of view as to how farm policy should be accomplished, the basis for a future farm policy appears to be linked to the following premises.
l. There is a societal belief and general consensus that farmers should receive some degree of protection from the random force of weather.
2. There is a need to hold some level of stocks against the possibility of a shortage of production but stocks should not be permitted to accumulate to the point where they will not be removed by short crop years.
3. Current year market prices do not allocate resources to the production of commodities in an efficient manner in the short run because of the temporal dislocation of inputs and production and because output is to some extent random. In the long run, resources will tend to be allocated by output prices if long run market signals can be determined.
4. Neither the Government nor the farmer can correctly anticipate or forecast the outcome of a specific crop at planting time except by chance, therefore, programs should be designed to be reactive to crop output rather than anticipate crop output.
5. Because commodity prices have been supported above market clearing levels in the majority of years since the l930s the sector currently employs excess resources in the production of price supported commodities.
6. Market prices will efficiently allocate output among consumers.
7. Protecting farmers from downside income risks requires two forms of programs. One to protect individual producers from the loss of a crop due to random weather events that are localized in nature and another to protect all producers from the price depressing impact of an exceptionally large crop.
8. Consumers desire some form of protection against scarcity from a short crop.
9. Tax payers desire to minimize Government expenditures.
REFERENCES
1. Boulding, Kenneth E., "Normative Science and Public Policy", Economic Analysis and Public Policy, ed. Day, Richard H., Iowa State Press, Ames, Iowa, 1982
2. Brake John R., "Short Term Credit Policies for Dealing With Farm Financial Stress and Their Impacts on Structure and Adoption of New Technologies. Speech ;Cornell, Ithaca, N.Y., 1985
3. Daft, Lynn M., Discussion Alternative Agricultural and Food Policies and the 1985 Farm Bill; Ed. Rausser, Gordon C. and Farrell, Kenneth R.; National Center for Food and Agricultural Policy, Resources for the Future, Washington, D.C.p 135
4. Harl Neil E., "Proposal for Interim Land Ownership and Financing", Iowa State University, Ames, Iowa Jan."1985
5. Hathaway, Dale E. "Grain Stocks and Economic Stability: A Policy Perspective ;Analysis of Grain Reserves: A Proceedings "ERS, USDA, Washington, DC, August, 1976.
6. Johnson, D. Gale;"Food Production and Marketing: A Review of Economic Developments in Agriculture";Food and Agriculture Policy; American Enterprise Institute for Public Policy; Washington D.C., March 10-11, 1977
7. Just, Richard E."Automatic Adjustment Ruless For Agricultural Policy Controls", American Enterprise Institute of Public Policy Research, Washington, D.C., Nov 1987
8. Just, Richard E. and Rausser, Gordon C.; Uncertain Economic Environments and Conditional Policies; Alternative Agricultural and Food Policies and the 1985 Farm Bill; Ed. Rausser, Gordon C. and Farrell, Kenneth R.; National Center for Food and Agricultural Policy, Resources for the Future, Washington, D.C
9. McCalla, Alex F. and Carter, Harold O. "Alternative Agricultural and Food Policy Directions for the U.S. with Emphasis on a Market-Oriented Approach.
10. Miller, Thomas A., "Increasing World Market Fluctuations and U.S. Agriculture: A Summary of Implications", NED, ERS, USDA 1984, ERS Staff Report #AGES 84920
11. Offutt, Susan E. and Blandford, David, "A Review of Empirical Techniques For the Analysis of Commodity Instability" Department of Agricultural Economics, Cornell Uni, Ithaca, New York 14853
12. Sharples, Jerry A. and Slaughter, Rudy W.Jr, "Alternative Agriculture and food Policy Directions for the U.S. With Emphasis on Stability of Prices and Producer Income: Alternative Directions for the United States and Implication for Research" Policy workshop Washington DC, Jan 1976, ERS, Farm Foundation and W.A.E.R.C.
13. Spitze, R.G.F. and Martin, Marshall A. Analysis of Food and Agricultural Policies for the Eighties. No. Central Regional Res. Bull. 27l. Ag. Expt. Sta., Univ. of IL, Nov. l980.
14. Walker, Odell L and Nelson, A.Gene, "Agricultural Research and Education Related to Decesion-Making Under Uncertainty: An Interpretive Review of Literature", Agri.Exp.Sta., RR P747 March 1977, Oklahoma State Uni., Stillwater, OK
15. Walker, Rodney L, Sharples, Jerry A. and Holland, Forest, "Grain Reserves For Feed Grain And Wheat in the World Market" Analysis of Grain Reserves A Proceedings, ERS, USDA Washington, DC, Aug 1976
16. Walace, Henry A., "Adjusting Production to Demand Benefits Both Farmers and the Public", Ames, Iowa, Dec. 28, 1922
17. Weber. Mark F. "Views on 1985 Farm Legislation of Agricultural and Consumer Organiziations", Policy Research Notes, Issue 19a, ERS, USDA, Feb 1985
18. Zelner, James A. and Price, J. Michael;"Automatic Adjusters and Farm Commodity Programs: The Case of Stock Triggers"; Speech presented at Southern Agricultural Economics Association Meetings; Biloxi, Mississippi, Jan, 1985
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INTRODUCTION
"I clearly recognize that in the long run every economic evil creates its own cure. If prices of farm products continue sufficiently long enough below cost of production, there will eventually be forced into bankruptcy enough farmers so that there will be no longer a disastrous surplus. At the same time there will be readjustments of land values, wages, etc., which will lower the production costs. Economic affairs always work themselves out if you leave them alone. However, it is equally certain that they will work themselves out even though you tamper with them. The disadvantage of tampering is that those who do the tampering are likely to be reviled by about half the population." Henry A. Wallace, Dec.28, 1922 (17).
Discussions, seminars, and symposiums have been conducted prior to consideration of every new farm bill. For the most part, the arguments focused on the desirability of providing for a market orientation in agriculture, although there has not been agreement on the meaning of market orientation. During the discussions, the term has been allowed to remain ambiguous, perhaps in the hope that consensus could be reached without clarity of definition. However, lack of an agreed upon definition of market orientation and a clear statement of the intent of commodity programs, has made it difficult to determine how to modify programs to achieve a more market oriented condition or, to determine how non-market oriented diverges from the "norm" or standard of perfect competition.
Digression on Programs vs Policies
What we call farm policy is, instead, a collection of programs to control price, hold stocks, and transfer income. In fact, the only consistent aspect of the programs has been the attempt to support incomes. The record of the programs, as they have been administered over their 40 year history, is that they have provide a price floor for program commodities and this floor has resulted in excess production which was stored and which resulted in attempts to reduce production. The net result was that incomes and asset values were higher than they would have been in the absence of the programs. From the record, one would conclude that the major goal of the programs was to keep income above free market levels. Despite this, however, protection against price variability has often been cited as a major objective. But no consistent policy has been articulated by Congress, farm groups or the several Administrations since the 1930's. The collection of programs has been variously interpreted by economist and policy analysts as providing income support, price stability, protecting the food supply, and protecting the family structure of agriculture.
The argument has been frequently made that current commodity programs are not working(12). However, since no statement of purpose has been articulated for the programs, it is difficult to evaluate how well they are or are not performing. The evidence available suggest that the cost of the programs has been higher than some thought desirable. Also the benefits of the programs went to producers with large farms. And, programs supported income but did little to lessen price variability or provide for stable budget cost. In fact, it is the variability and size of the program budget that appears to have been at issue rather than the effectiveness of the income transfer or the effectiveness of the program in achieving market stability.
This paper identifies issues associated with commodity policy; develops a rationale for and suggests a possible definition of market orientation; examines how the sector would behave under market orientation; evaluates the process of transition; and evaluates whether there is a continuing need for Government involvement in agriculture, because of the potential for market failure. No attempt is made to provide empirical estimates of the effects of alternative programs. These will be reserved for succeeding reports. This report relies on economic theory to suggest interactions and directions.
COMPETITIVE MARKETS
Competitive markets are a norm or standard by which economists measure economic performance. The argument is made that only in cases of market failure would an economy be better off with Government intervention. The pressure to move to market orientation stems from a belief that competitive markets are effective, efficient and equitable allocators of resources and output. That is, competitive markets will result in just the right amount of resources used to produce just the right amount of a commodity with equitable compensation for resources.
Past intervention by Government to support incomes of certain groups of producers above market clearing levels was based on the premise that market failure caused incomes in the farm sector to be below those in the non farm sector. It was deemed equitable, therefore, to provide a larger income to farmers by transferring it from taxpayers and consumers. Presently there is considerable debate over whether these income transfers should continue. That is, over whether commodity producers still deserve a larger share of the pie or whether the actions of Government to support producer incomes is causing the sector to be less profitable than it would be under free market conditions. Also at issue is whether there is a role for the Government to provide for market stability even if it does not provide for an income transfer. And, if market stability is a concern how can it be provided?
Some farm groups tend to support continued income transfers to the sector and in particular to producers of specific commodities. Others tend to suggest that the sector is no longer deserving of income transfers but rather deserves some protection from the capriciousness of the market which comes about through variability induced by weather and by the actions of foreign Governments (17).
Although it is often argue that a market orientation will strengthen agriculture, there is considerable evidence that making agricultural production more competitive may not be good for the sector in either the short run or the long run. McCalla and Carter, citing Dorfman, Samuelson, Josling and Galbraith; argue that "... if ... production agriculture is a competitive island surrounded by varying degrees of concentration in markets, then deducing conclusions about the advantage of a return to a free market from theoretical constructs may not be valid"(8). They argue that the evidence is not clear that agriculture will be better served by a return to a free market. Also, it is not clear that domestic consumers would benefit.
There dose seem to be agreement, among those involved in the debate, that a market oriented agriculture does not mean a total withdrawal of Government from commodity markets. What is missing, however, is a reason why continued involvement of the Federal Government would be required or why it would contribute to better market performance.
Market Signals from Competitive Markets
Most economists suggest that it would be desirable for the market to pass the appropriate economic signals through to producers concerning the quantity of resources to use in the production of commodities and, by inference, how much to produce. They also suggest that it would be desirable for signals to be sent to the consumer about how much to consume. The type of signal to be sent is seldom specified but most infer that prices are the appropriate mechanism to provide the signal. In a free and competitive market, where no buyer or seller is large enough to affect the market price and where everyone has equal and perfect information, output will be allocated among consumers efficiently by the changing market price signals. The market price adjusts to bring about an equilibrium between the quantity supplied and the quantity demanded. That is, it provides the signal that adjustments must be made. However, this theoretical framework assumes perfect knowledge and instantaneous adjustment to equilibrium which is simultaneous for long run and short run positions, ie., there is no short run. Capital, labor and current expenditures adjust so that no excess resources are used in production.
Non Simultaneity of Price and Quantity Changes
The market for farm commodities has several aspects that depart from the rigid assumptions of the perfect market. Specifically, imperfect knowledge; production and consumption do not adjust simultaneously; production is stochastic; and, to the extent that it is affect by weather, random and normally distributed; and, there is not a fixed relationship between units of input and units of output. Although producers can plan for an expected output and, given sufficient experience, estimate how that output might vary, they have no basis for determining how much, or in what direction, output will vary in any one year. Planting decisions of producers are made on the basis of an expected price and an expected set of cost relationships that would permit them, under expected conditions, to earn a return over variable cost sufficient to cover some or all of fixed cost. However, because of the random nature of yield variability, it would be coincidence if expected cost and actual cost or that expected price and actual price coincided. Probability theory is of no assistance for it, according to Boulding, "... is merely the mathematics of the distribution of 'possibilities' ... in situations which can not be empirically identified"(1). Thus, the quantity shock that occurs because of yield and weather variability is a non trivial condition. If no other changes occurred, weather would distort the market by bringing about a mismatch between expected and actual yield and therefore expected and actual prices. As a result, it often takes several production periods to determine the existence of fundamental market changes, that is, shifts in demand or shifts in supply caused by economic forces. This is so because the market determined price allocates the actual supply with demand rather than allocating expected supply.
Floor Prices
Agriculture programs from 1938 to 1985 have by one means or another attempted to establish a floor price for program commodities to address what was perceived to be a low income problem for the sector as a whole. A defense of the floor price was conducted by acquiring stocks and limiting production or marketings. But, a persistent problem remained. That is, it was exceedingly difficult, if not impossible, for policymakers to establish a floor price to protect income, which would allow the long run market price to be above the floor by a sufficient amount to clear stocks out of farmer or Government held reserves. This should not be surprising. In order to support income through price supports in a market, demand must be inelastic and prices must be higher than the long run average free market price. The inelasticity of demand has been a major source of problems in setting program parameters because an implicit assumption of the programs has been that variability would be sufficient to empty out the storage. However, this cannot occur unless supply (production) is somehow restricted. Thus, although the legislators and the program managers assumed the problem to be a low income problem, they relied on variability to extract them from the long run excess capacity problem, which they had, in part, created by the supply control effort. For most of the historical period, long run prices appeared to be below the floor price. As a result, stocks accumulated in Government ownership as nonrecourse loans were forfeited.
The focus on price as the trigger variable to initiate a Government action prevented the price from serving as a true signal for production in future periods. That is, current year prices were not a sound basis for forming expectations concerning future prices. Also market allocation of the current year's crop was distorted because the distribution of expected price was truncated on the lower end and the expected price faced by the producer was necessarily higher than the price floor.
D. Gale Johnson has said that "The policies of the 1950's were concerned with attempting to protect agriculture from changing conditions."... "The policies of the 1960's were reasonably effective in aiding agriculture to adjust to the inevitable resource transfers and the relative contraction of the farm sector."(6) The policies of the 1980's, thus far, have again tended to "protect" the sector from changing conditions.
CONDITIONAL POLICY
Stepping back from current programs and considering the prospects for a long term policy for agriculture, it is possible to conceive a framework with both income support and reduction in price variability as objectives. It is also possible to develop programs to support either of these objectives. However, a clear articulation of the policy is required. D. Gale Johnson calls this to our attention quit forcefully. "The most critical assumption is the future level of net income of agriculture. For the years ahead we can not rule out a decline in net agriculture income of 10 percent and a decline of farm operator income of somewhat more. If this were to occur there would probably be some downward pressure on real estate values, unless the income decline were thought to be temporary." He continues: "If my analysis of the flexibility of resource allocation in agriculture is approximately correct, small errors in program formulation will very soon result in substantial cost to taxpayers, and possibly in difficulties in maintaining our preeminent position as a great agricultural exporter. It will, in other words, be relatively easy to create significant excess capacity in agriculture by providing incentives, through prices or payments that are inconsistent with the underlying demand and supply situation. Experience has shown clearly that when agricultural output is greater than the demand at politically acceptable levels of prices, a long time and large income transfers are required to eliminate the excess productive capacity."(6)
Just and Rausser have provided a basis for a new look at commodity policy (7,8). They argue that inflexibility in commodity programs has resulted in policy induced variability [instability] in commodity markets, making decision making by farmers and policymakers even more risky than it would be without commodity programs. They conclude that policy that is conditional in its response to economic conditions will be more likely to result in the transmission of appropriate signals to producers and consumers. Daft concludes that "The principle strength of the chapter by Richard E. Just and Gordon Rausser is its non traditional view of commodity policy. The authors assume that the reduction of risk and uncertainty is the principal justification for commodity policy. After reviewing the recent track record, they find that commodity policy, itself, has often been a source of instability rather than a cure for it. They attribute much of this policy failure to the attempt by legislators to establish future legislation on past economic conditions. When future conditions deviate from the assumed state, as they inevitably do, policy failure has resulted." "...Just and Rausser conclude that legislators should stop trying to anticipate conditions and, instead, adopt policies that would respond automatically to changes in sector economic variables." "As an illustration, they suggest that the Government agree to purchase 1 million bushels of grain for every one cent per bushel that the market price falls below a specified target price."
While Rausser and Just have performed a major service in providing a new perspective on commodity policy, a further extension of their approach will clarify the fundamental farm policy problem.
INSTABILITY, VARIABILITY, RISK AND UNCERTAINTY
According to Offutt and Blanford, "An unambiguous definition of instability would provide the ideal starting point for the selection of an appropriate empirical indicator [of risk]. Unfortunately the concept of instability is nebulous because the perception of what constitutes unstable behavior is largely subjective." "... Variability and instability can not necessarily be equated and require an implicit or explicit judgment be made as to what constitutes 'unacceptable variability'."(11)
For our purposes, it is not necessary that a judgment be made concerning whether or not variability is or is not acceptable. Rather, the issues are: is it measurable, is it reducible and to what extent are variability and uncertainty separable.
For the purpose of this paper it will be convenient to view risk as the measurable variation in a normal random variable, such as yield, with a quantifiable probability distribution of the "possibilities". Uncertainty will be considered as being exemplified by supply or demand shocks to the system that are the result of policy or economic variables where the result is expected to be a systematic change or structural change. Such actions are unmeasurable in an expectations framework and no probabilistic statement can be constructed concerning their occurrence or outcome.
Much of the research related to variability is associated with the stock holding function and the potential for determining an optimal level of stocks with a concept of covering negative supply deviation 80, 90, or 95 times out of 100. In reality, there can be no optimal stock level for any particular year. Because output for the coming season is a random variable, the optimal stock level must also be a random variable. Given an expectation of production variability one can construct an expectation of the level of stocks that would offset the production deviations. One cannot however anticipate, identify and offset supply and demand shifts as a result of policy or production changes.
The Just and Rausser argument, that conditional policy will allow the free market to function while providing stability, presumes that it is possible operate as though it was possible to control price and still allow the market to clear because of quantity variability. The conditional policy response suggested by Just and Rausser reacts to both physical and economic phenomenon and attempts to shield the producer or slow the effect of real supply and demand changes as well as the effects of random yield shocks. They presume that conditional control of the effects of other economic forces on price will reduce the likelihood of policy induced instability. However, Just and Rausser do not consider the possibility and implications of policy induced excess capacity as the result of conditional intervention which prevents the full impact of supply and demand shifts from being realized because of the manipulation of the market price.
Pass Through of Market Signals
While it is possible to mathematically estimate a number for the coefficient of variatation of price, the number is meaningless unless the price variation is random and normally distributed with mean zero. Historical price data contain both random and systematic changes and there is little reason to believe that the deviation will be normally distributed or that the estimate will be unbiased. There is, however, reason to believe that in the absence of market intervention policies the effects of weather would, over time, be normally distributed and it would be possible to remove the weather related effect from prices. It would also be possible to estimate the effects of a stocks management program that reacted to weather variation by acquiring, for example, yield in excess of expected normal and disposing of stocks if yield is less than expected normal.
Under conditions where long term supply and demand were in balance the smoothing effect on quantity would result in a stablity of domestic consumption and a stable supply for export. Such a stocks management policy would minimize the impact of domestic weather variation on commodity prices. All other factors would be reflected in the market including demand and supply shifts as a result of technology or changes in financial or macro policy variables. The effects of weather in importing countries and on competing exporters would also be transmitted through the market. Also the impact of their policies would be felt.
Some have viewed the wide price changes of the 1970's as an indication of increasing variability in the market and concluded that the random forces causing such disturbances may increase in the future. However, many of the events of the seventies appear to have been systematic structural changes which, in connection with random yield disturbances resulted in a confusing set of prices. For example, entry of the Soviet Union into the market on a major scale to aquire grain for livestock feed was a systematic change rather than a random event, as was the decision by the Chinese to buy wheat rather than tighten their belts, and the decision of the U.S. to raise loan rates and target prices rather than let farm income decline in the late seventies. Even the weather shocks on foreign yields are transmitted to our markets through a set of systematic filters that distort the random nature of the yield variability. Thus, the most truly random influence in the market is the effect of domestic weather on domestic yields. All other changes fall into the category of uncertainty or instability. And, it is these changes that are structural or systematic in nature that should be reflected in market price signals.
Implication for Stock Holding
Numerous studies of price variability and variability of quantity marketed, through domestic and export channels, have been conducted. Most have assumed that deviations in price from trend or deviation of production from trend were normally distributed random variables with mean zero (12,14,15). Therefore, the analysts also assumed that the probability of the actual deviating being less than a specified number is also a normally distributed random variable. However, the normal random variable assumption does not appear to be a correct specification of the behavior of either production or price. Many of the forces in the market are systematic and result in deviations that do not have zero mean. This is not to say that a mathematical representation with the sum of the deviations equal to zero cannot be constructed. But that such a construct is an erroneous representation of the forces causing market prices and quantities to change.
Under conditions where long term supply and demand were in balance, the smoothing effect of a reactive policy to acquire positive increments to trend yield and store them until they could be disposed of in periods of low yields would result in stability of supply for the domestic and export markets. Such a stocks management program would minimize the impact of domestic weather variation on commodity prices. All other factors would be reflected in the market including demand and supply shifts as a result of technology or changes in macro or policy variables.
Sharples and Slaughter suggest that "Adding to or releasing from buffer stocks in response to changes in quantity produced would stabilize the major source of food price variance in a closed system. That is, if operated world wide, such a program would provide reasonably stable food supply and prices. Theoretically, a buffer stock managed by such a quantity rule would stabilize prices with minimal interference with the allocation function. Prices would be free to respond to changes in demand [and changes in supply], and the allocation signals so generated would not be clouded by the noises of price changes in response to production variances occasioned by weather vagaries." However, they dismissed the quantity rule because production worldwide is difficult to measure and the size of the quantity buffer stock may preclude the response required. While they suggest that the price rule may be appropriate, they recognize that it runs the danger of obscuring allocation signals generated by non-random supply and demand shifts. "This suggests that the programs have built in self corrective features in order that the reserve acquisition and release prices adjust in accordance with the long un moving equilibrium."
Worldwide rationality on stockholding policy would imply that all producing countries would store the positive deviations from trend yield and dispose of them during periods of negative deviations. Storing more than the positive deviations from trend would require that in some year the market would have less available than had been planned for by producers or expected by consumers. Storing less than the positive deviations means that the probability of incurring a shortfall in stocks is increased because the positive increment from yield has not been stored but consumed and future consumption must be reduced below what it could have been if stocks had been retained.
If the U.S. changes its' policy from encouraging excess production with supported prices to free market pricing, then the appropriate response to changes in export demand would be to allow the market to clear, with the exception that the U.S. would stand ready to buy or sell the additions to or shortfalls from trend yield on whatever acreage was planted. Under such conditions the U.S. would not export its' domestic variability from weather on to the world market.
THE ARGUMENT OF CONTINUING MARKET FAILURE
Heterogeneity in the cost of production and marketing, which is the result of heterogeneity in size, management, technology and location will result in continuing excess capacity disequilibrium and loss of resources from the sector regardless of the form of policy. Because costs vary among firms, any price level within the range of total cost will result in some firms being driven out of the production while others continue to earn returns in excess of their production cost. As a result the assets of the exiting firms will be recombined with those of the more profitable firms and production is likely to expand or cost decline or both, because of the efficiency of the acquiring firm. With no change in demand, price is likely to decline and additional firms will be forced to exit. Continuing consolidation of assets will occur until a homogeneity of sorts is achieved or until an oligopolistic system is developed which permits some control of output that will allow the least competitive firm in the production structure to remain in production because allocation of market shares has occurred.
Policy analysts have identified two basic factors that have been important for agriculture policy determination in the United States. One is a tendency for output to increase faster than consumption. The other is a high degree of variation in commodity output and price variation, which results in variation in earnings. The purpose of this analysis is to explore the causes of excess capacity and price variation and identify how various types of policies and programs might be used to assist in overall adjustment of the farm sector.
The following analysis attempts to separate the various reasons for price and income changes and suggests how particular policy tools may relieve or exacerbate price and income stability and excess capacity problems.
SUPPLY/DEMAND SHIFTS CAUSE CAPACITY AND VARIABILITY PROBLEMS
Prices are the result of the simultaneous interaction of supply and demand. Therefore, before corrective policy actions are taken, it is important to understand whether the changes in price are the result of shifts in supply or demand or some combination of the two. It is also essential to understand whether the shift is a result of short-term or long-term phenomena. Lack of clarity in identifying the source of the change in price or in the reason for a particular price level can lead to a choice of policies that exacerbate rather than correct the perceived problem.
The unique aspects of agriculture are that agricultural production is subject to the random impact of weather and food is basic to survival. There is, thus, a general concern that some groups within the population (either domestic or world population) will have insufficient income to acquire sufficient nutrition for their existence at market determined prices.
Humanitarian Aspects
A humanitarian goal of society is that no one starves regardless of their ability to purchase food. To achieve this goal, output must be greater than the free market would be expected to achieve. This can be achieved by a shift in demand by transferring income to the disadvantaged (for example, through food stamps or other direct income transfers) or by a shift in supply making commodities available to certain segments of society at subsidized prices or through donations. This aspect of agricultural puts it somewhat in the nature of a public utility which must provide service to all segments of society.
Enhancement of the effective demand or expansion of the quantity marketed, is complicated by the biological nature of the production process, the random disturbances in the market created by weather and the inelasticity of demand for the product. These biological factors produce short-run changes in market supply (quantity available for consumption) that make discovery of long run prices extremely difficult and therefore longer term investment and subsidy decisions are frequently made from erroneous price expectation. Improvement of long run price discovery is the primary focus of the remainder of this paper.
BIOLOGICAL NATURE OF THE PRODUCTION PROCESS
Because agriculture is a biological process, it is subject to seasonality, perishability of output, weather related problems and environmental problems including insects, disease, and weeds. Environmental consideration preclude agricultural production in some regions and enhance it in others and alter the feasible output mix in a particular geographic area. To some extent these biological considerations are manageable. That is, we have the ability to modify the environment so that supplies can be obtained at prices that permit adequate returns to the producer for investing in the environmental modification technology. In the following sections, the various biological factors and the implications of allowing the sector to deal with them under free market conditions were considered in a paper presented to SAEA in Feb 1987.
To this point the discussion has focused on the impact of biological factors and weather changes on farm prices and farm income. This section focuses on supply and demand shifts resulting from economic forces.
Demand Shifts
Demand shifts occur because of changes in population, taste and preferences, and income. They may also result from policy decisions made about, and applied to, other sectors of the economy. The demand shifts may be temporary (a few quarters) or they may be permanent. Whatever the cause, a decrease in demand (a shift to the left of the demand schedule) results in consumers buying less of the commodity at any schedule of prices. If no change in the supply occurs, the result of the demand change will be that the price will fall and some smaller quantity will be consumed. In order to achieve an equilibrium some resources must be removed from production. In a free market this occurs because revenue is reduced to the point where it is unprofitable for some producers to produce the commodity and resources are transferred to other employment or underemployed. Setting prices above the new equilibrium level, to maintain producer revenue, results in the accumulation of stocks (inventories). If the demand reduction is permanent or extended, a rigid price floor results in continuous stock accumulation.
Supply Shifts
Changes in supply occur primarily because of changes in technology, changes in the relative price of inputs or changes in the real price of inputs relative to output. For example, adoption of a new technology may result in the ability to produce more grain from the same resources and lower the cost of grain per bushel. Such a change means that at any schedule of prices more grain would be offered for sale. As in the case of a reduction in demand fixing the price above new equilibrium will result in accumulation of stocks.
External Policy Impacts
In addition to the impact of normal economic forces in a free market economy, the farm sector is subject to the impact of Government intervention in other sectors. For example, supply shifts occur as result of tax policy changes that encourage businesses to make investments. In particular, the use of investment credit and accelerated depreciation cause more resources to be employed in the production of crops than would be used without these investment incentives. Tax policy that allows the write off of farm losses against other income provides an incentive to continue farm production even though losses are being incurred. The net effect is to keep more resources employed in production than would be employed without the tax incentive.
Credit policy also encourages the employment of more resources in the sector to the extent that it provides interest subsidies or makes loans available to producers who could not obtain funds through commercial channels.
Monetary and fiscal policy have a substantial impact on the demand for commodities though their impact on business cycles and domestic income and though their effect on foreign exchange rates. Under a restrictive monetary policy which keeps U.S. interest rates above those in other countries the dollar tends to valued higher relative to the currency of potential importers. Thus, prices for U.S. commodities are inflated in the export market and the net effect is the same as if the U.S. supply was shifted left or as if an export tax were imposed on U.S. goods.
Presented with such problems policy makers are often disposed to create exceptions to a policy or to provide for offsetting special conditions. For example, to offset the impact of restrictive monetary policy on farm commodities, export subsidies may be instituted. The result is that the consumer and the taxpayer pay a higher price for the commodity, transfer income to the farmer and subsidize the foreign buyers.
Using farm commodity policy to protect farmers against price and income variability or against "low" incomes is to treat the symptom rather than the problem. Price and income changes occur in response to shifts in supply or demand . The cause of the problem must be uncovered be for a treatment can be proposed. If the source of the problem is outside the sector then perhaps that is the place to develop corrective policy, if such policy is needed. If tax laws are encouraging excess resources in production then a change in the tax law would be in order. If the problem occurs because of forces that are the result of random weather shocks then appropriate tools can be developed to react to but not anticipate weather changes.
ALTERNATIVE FUTURES AND THE IMPLEMENTATION OF POLICY
The need for and the effectiveness of agricultural policy will be determined by the continued certainty of yield variability and by the relative change in output and consumption trends.
If consumption is rising coincident with or faster than output, real prices will tend to remain flat or rise slightly. On the other hand, if output is tending to rise faster than consumption, real prices will tend to fall.
In part, because of past price support policies, more resources are employed in crop production than the level needed to meet domestic and export demand at current prices and stocks are tending to accumulate. To remove the excess capacity from the sector, real prices for output and real earnings must fall to levels which force disinvestment from the sector, resources must be acquired from producers and removed from production, or demand must grow more rapidly than output for an extended period.
Allowing real earnings to fall to the point where a large number of resources are forced out of the sector is a painful solution. Expansion of demand (shifting demand) at a fast enough rate to keep prices from falling appears to be economically impossible. The most feasible solution appears to be some type of resource diversion in combination with stability programs. Achieving the appropriate balance is complicated by the random variation of weather which results in highly variable yields and therefore highly variable prices which gave inappropriate signals for long-term resource commitments. Arbitrarily establishing a rigid price floor or a target price without regard to longer term market forces results in price certainty and has a high probability of providing the wrong type of information about future profitability. Tying price floors to current production costs results in distortion of market signals in a manner that tends to escalate future costs. This results in higher support levels in the future, higher production costs and in a rachet effect on support prices. On the other hand, allowing the market to set output prices without accounting for random disturbances from weather distorts the longer run economic signals that occur from changes in demand or changes in technology and output. These are the economically determined signals that we wish to have the market transmit.
Providing protection against random shocks to the system need not distort long-term market signals if the shocks are not the result of economic forces that is, if they are due entirely to weather. However, if income declines as a result of a change in the business cycle, providing price protection against the shift in demand will result in commitment of more resources in production than would be required. Or, if demand shifts as a result of a change in foreign exchange rates, establishing a price floor could result in a greater reduction in trade than would result from a market determined price.
SUMMARY
The previous discussion suggests that, farm commodity producers are subject to the risk of low levels of income because of the impact of weather and economic forces on the production, marketing consumption and prices of the commodities they produce. Because agricultural production is a biological process which results in the disassociation of the commitment of resources to the production process and the output of those resources, and because rainfall and temperature are not subject to the control of the producer the relationship between committed inputs and output is not fixed. Because the input/output relationship is not fixed and the impact of weather is random in nature, the producers best expectation of the price for the next crop year is likely some average of historical prices. If resources are committed with the expectation of normal yields and prices and the output results in a significantly better or poorer crop, prices and incomes can be dramatically altered, although the producers planned appropriately given their limited information.
Historically, society has recognized this risk and has attempted to protect producer from the most severe aspects of a random loss of income and consumers from the loss of the commodity. In the l930's, programs were established to put a floor under prices and thus prevent farm income from falling during periods of excess production. In order to support prices, nonrecourse loans were made. The loan rate became the price floor and crops not sold were forfeited to the Government.
As income increased, production at the supported price increased and stocks accumulated in Government storage as markets failed to clear and loans were forfeited. To limit stock accumulations, various marketing controls and production controls--largely through acreage diversion and acreage allotment programs--were instituted. In the l970's, with acreage diversion and export subsidy programs in place to help clear stocks, supplies diminished and prices rose rapidly. To prevent rapid price increases in the future, a farmer-owned reserve was introduced. A set of target prices and deficiency payments were established to, in part, guarantee an income transfer to producers who cooperated in supply control and stocks management programs while the loan rate or price floor was to be set near market-clearing levels.
Although there may be differing points of view as to how farm policy should be accomplished, the basis for a future farm policy appears to be linked to the following premises.
l. There is a societal belief and general consensus that farmers should receive some degree of protection from the random force of weather.
2. There is a need to hold some level of stocks against the possibility of a shortage of production but stocks should not be permitted to accumulate to the point where they will not be removed by short crop years.
3. Current year market prices do not allocate resources to the production of commodities in an efficient manner in the short run because of the temporal dislocation of inputs and production and because output is to some extent random. In the long run, resources will tend to be allocated by output prices if long run market signals can be determined.
4. Neither the Government nor the farmer can correctly anticipate or forecast the outcome of a specific crop at planting time except by chance, therefore, programs should be designed to be reactive to crop output rather than anticipate crop output.
5. Because commodity prices have been supported above market clearing levels in the majority of years since the l930s the sector currently employs excess resources in the production of price supported commodities.
6. Market prices will efficiently allocate output among consumers.
7. Protecting farmers from downside income risks requires two forms of programs. One to protect individual producers from the loss of a crop due to random weather events that are localized in nature and another to protect all producers from the price depressing impact of an exceptionally large crop.
8. Consumers desire some form of protection against scarcity from a short crop.
9. Tax payers desire to minimize Government expenditures.
REFERENCES
1. Boulding, Kenneth E., "Normative Science and Public Policy", Economic Analysis and Public Policy, ed. Day, Richard H., Iowa State Press, Ames, Iowa, 1982
2. Brake John R., "Short Term Credit Policies for Dealing With Farm Financial Stress and Their Impacts on Structure and Adoption of New Technologies. Speech ;Cornell, Ithaca, N.Y., 1985
3. Daft, Lynn M., Discussion Alternative Agricultural and Food Policies and the 1985 Farm Bill; Ed. Rausser, Gordon C. and Farrell, Kenneth R.; National Center for Food and Agricultural Policy, Resources for the Future, Washington, D.C.p 135
4. Harl Neil E., "Proposal for Interim Land Ownership and Financing", Iowa State University, Ames, Iowa Jan."1985
5. Hathaway, Dale E. "Grain Stocks and Economic Stability: A Policy Perspective ;Analysis of Grain Reserves: A Proceedings "ERS, USDA, Washington, DC, August, 1976.
6. Johnson, D. Gale;"Food Production and Marketing: A Review of Economic Developments in Agriculture";Food and Agriculture Policy; American Enterprise Institute for Public Policy; Washington D.C., March 10-11, 1977
7. Just, Richard E."Automatic Adjustment Ruless For Agricultural Policy Controls", American Enterprise Institute of Public Policy Research, Washington, D.C., Nov 1987
8. Just, Richard E. and Rausser, Gordon C.; Uncertain Economic Environments and Conditional Policies; Alternative Agricultural and Food Policies and the 1985 Farm Bill; Ed. Rausser, Gordon C. and Farrell, Kenneth R.; National Center for Food and Agricultural Policy, Resources for the Future, Washington, D.C
9. McCalla, Alex F. and Carter, Harold O. "Alternative Agricultural and Food Policy Directions for the U.S. with Emphasis on a Market-Oriented Approach.
10. Miller, Thomas A., "Increasing World Market Fluctuations and U.S. Agriculture: A Summary of Implications", NED, ERS, USDA 1984, ERS Staff Report #AGES 84920
11. Offutt, Susan E. and Blandford, David, "A Review of Empirical Techniques For the Analysis of Commodity Instability" Department of Agricultural Economics, Cornell Uni, Ithaca, New York 14853
12. Sharples, Jerry A. and Slaughter, Rudy W.Jr, "Alternative Agriculture and food Policy Directions for the U.S. With Emphasis on Stability of Prices and Producer Income: Alternative Directions for the United States and Implication for Research" Policy workshop Washington DC, Jan 1976, ERS, Farm Foundation and W.A.E.R.C.
13. Spitze, R.G.F. and Martin, Marshall A. Analysis of Food and Agricultural Policies for the Eighties. No. Central Regional Res. Bull. 27l. Ag. Expt. Sta., Univ. of IL, Nov. l980.
14. Walker, Odell L and Nelson, A.Gene, "Agricultural Research and Education Related to Decesion-Making Under Uncertainty: An Interpretive Review of Literature", Agri.Exp.Sta., RR P747 March 1977, Oklahoma State Uni., Stillwater, OK
15. Walker, Rodney L, Sharples, Jerry A. and Holland, Forest, "Grain Reserves For Feed Grain And Wheat in the World Market" Analysis of Grain Reserves A Proceedings, ERS, USDA Washington, DC, Aug 1976
16. Walace, Henry A., "Adjusting Production to Demand Benefits Both Farmers and the Public", Ames, Iowa, Dec. 28, 1922
17. Weber. Mark F. "Views on 1985 Farm Legislation of Agricultural and Consumer Organiziations", Policy Research Notes, Issue 19a, ERS, USDA, Feb 1985
18. Zelner, James A. and Price, J. Michael;"Automatic Adjusters and Farm Commodity Programs: The Case of Stock Triggers"; Speech presented at Southern Agricultural Economics Association Meetings; Biloxi, Mississippi, Jan, 1985
Monday, April 16, 2007
The Evolution of Programs
Historically agriculture has been subject to periods of surplus and
scarcity. During periods of "shortage" and strong demand farmers have
responded to strong prices and prospects of high income levels by
expanding production. Production increased through advances in
productivity and the addition of land, labor and capital. As supply
growth outpaced demand growth - prices and farm income declined.
Similarly, during bust periods, characterized by low commodity prices
and farm income, resources were removed or idled inorder to reduce
production and bring demands and supplies into balance.
This is characteristic of U.S. agriculture prior to the 1930s - boom and bust periods. During the Civil War prices and income were high. However, as the war ended supplies grew and prices and income fell. Similarly strong demand and high prices stimulated by World War I provided the necessary incentives to expand production. After WW I and through the 1920s commodity prices and income trended downward.
Agricultural policies are the result of the resolution of conflict. They begin with divergent views about what should be done and end with a compromise between groups. They are carried out through compromises between the apparent or understood intent of laws and regulations and the personal philosophies and interest of policy administrators. Policies are, therefore, ambiguous to some degree. They leave room for interpretation. Policies are often rationalized to some unintended program objective after programs are written into law or regulation. Programs that were undertaken as an implimentation of a policy in dealing with some acute economic, social or political problem acquire a body of data and arguments in their defense that may be quite different from the original justification for the program or policy. Programs whose functions have been fulfilled are often continued for reasons quite different from those intended at the start of the program. Programs thus evolve over time, taking on different purposes and often supporting policies far different from their initial purpose.
Pre World War I
Prior to the First World War policies affecting agriculture were largley development policies focused on developing the fontier and expanding production. This single objective was facilitated by land settlement programs, support of the family farm concept, and increased agricultural productivity. A sound and expanding agriculture would complement industrial growth and economic prosperity. In 1862, a number of acts were passed that "opened the west" and established the importance of agriculture, from a Federal perspective. The Homestead Act granted acreage to those willing to improve the land and live on it for 5 years. The Morrill Land Grant College Act established agriculture as a mainstay at Colleges and Universities. The U.S.D.A. was established in 1862. Also, Congress subsidized development of the transcontinental railway system - to assist in transporting agricultural commodities. Eventually legislation was enacted to support research at agricultural experiment stations (Hatch Act 1887), extend the land grant college concept to black colleges in the South, and to provide Federal funds for agricultural extension (Smith-Lever Act - l914).
Three additional acts that significantly influenced agricultural development in the early 1900s were the Reclamation Act of 1902, the Federal Farm loan Act (1914), and the Capper-Volstead Act (1922). The Reclamation Act provided federal funding for irrigation development which enabled agriculture to expand in the West. The Federal Farm Loan Act established the Farm Credit System which gave farmers access to subsidized credit. The Capper-Volstead Act exempted agricultural cooperatives from the Sherman Antitrust Laws and allowed these organization to increase in number, size and power.
The 1920's -- Program Initiated
To a large extent today's farm commodity programs are a result of the economic chaos that affected agriculture in the 1920's. As the result of a decline in exports, the introduction of mechanical power for hauling freight and people, and the introduction of the tractor for agricutural production the capacity of agriculture to produce far exceeded the demand for its output. As the result of the shift to mechanical power some 50 million acres were released from production of feed for draft animals. At the same time land was being added to the productive base through expansion onto the plains and grass land and through massive irrigation and reclaimation projects. These forces along with the declines in both domestic consumption and exports in the early 1920's resulted in a rapid fall in farm prices while prices of manufactured goods continued to rise.
Farmers sought relief from, what they percived to be, selective economic depression in agriculture through the introduction of bills in Congress to support prices through the purchase of commodities. A more complex approach to price support was to be achieved through the McNary-Haugen Bills which were primarily programs to remove surpluses from domestic markets through export dumping. Although the bills failed to pass in Congress or were vetoed by the President, they brought a focus to the farm policy debate. The quest for "economic justice" for farm people, for "Equality for Agriculture", was lead by George Peak who believed in a natural balance between agriculture and industry and felt that agricultural commodities should be priced such that their puchasing power was maintained on a par with industry.
In 1929, Congress created the Federal Farm Board and povided it with $500,000,000 to purchase commodities in order to support their prices. The funding proved to be inadaquate and the Board with no ability to control production was seen to be a failure. In 1932, the Board recommended legislation which would "provide an effective system for regulating acreage or quantites sold" inorder to raise prices and incomes for producers of commercially traded commodities.
The forerunners of current commodity programs were created in the 1930's to raise the income of producers of "basic" commodities (commodities which were important in commercial markets) by restricting market supply. The Agricultural Adjustment Act (AAA) was to be a self supporting program to bring about supply restriction through processor taxes. Revenues were to be use to make allotment payments to producers who set aside up to 20 percent of their acreage. The Secretary of Agriculture proclaimed a 15 percent acreage reduction for contracting farmers to be eligible for payments on the 1934 crop.
In the Case of the U.S. vs. Butler, often referred to as the Hoosic Mills decision, the Supreme Court on January 6, 1936 declared the processor tax and production control provisions of the AAA unconstitutional. Thus, the self-financing provisions were eliminated and supply control was disrupted for a short period. To responed to the short-term crisis and replace the production control provisions of the AAA, Congress rushed through the Soil Conservation and Domestic Allotment Act of 1936 by February 29, 1936, less than 2 months after the Hoosic Mills Decision. Under the 1936 Act, acreage reduction was to be achieved through conservation programs, however, the program failed to restrict output.
The Agricultural Adjustment Act of 1938 brought about stronger Federal intervention in the market. The term parity was introduced into legislation for the first time and the Secretary was required to make nonrecourse loans for producers of corn, wheat and cotton. Nonrecourse loans were at the option of the Secretary for rice and tobbacco. Loans were set at a fixed percentage of parity. In addition, producers were to receive parity payments to bring their return as close to parity as possible with available funds. Because program benefits, from higher prices and parity payments, were tied to production, the larger and the more efficient a producer the larger the benefits to that producer.
The Commodity Credit Corporation was established by executive order in 1933, which provided loans to cotton producers enabling growers to hold their cotton until prices improved. For fruits and vegetables, production controls were supplemented by marketing agreements. Quotas were implemented for sugar.
1940s - Abortive Attempts of Price Support Flexibility
Despite the use of acreage allotments and marketing quotas, commodity inventories began to increase in the late 1930s, particularly those owned and controlled by the government. Yield growth helped to make production controls ineffective. By 1939, direct government payments accounted for 35 percent of net cash income and 30 percent in 1940. However, WW II stimulus improved export demand and as a result prices strengthened and direct government payments fell to 13 percent of net cash income in 1941. WW II postponed the need to address growing surpluses and government costs in the 1940s.
Government price supports which were set between 52 and 75 percent of parity in 1938 were above market cleaning levels as surpluses started to become burdensome. However, the improvement in the industrial sector provided Congress with the impetus to raise support for agricultural commodities up to 85 percent of parity (for those commodities which producers had not disproved marketing quotas). Later legislation over 1941 and 1942 period raised support to 90 percent for some commodities and extended the level of support at these high levels to 1948. By 1945 more than l00 commodities were supported at high (above market clearing) levels. During the war years supports rose and supply control requirements declined.
As the war ended debate arose as to what direction supports should take - high fixed supports as in the War years or flexible more market oriented dependant on existing supplies. The Agricultural Act of 1948 favored flexible supports over time. However, supports would remain at near the 1948 levels for 1949 plantings. The 1948 act also revised the parity price formula specifying farm - nonfarm relationships dependant on current (10 years) period to account for productivity and then faster changes since the early 1900s. This would also support levels to decline beginning in 1950. The surplus problem facing policy makers in the late 40s was contributed to by the adoption of hybrid seed for corn and the full transition to "tractor power" as opposed to horse power.
Because prices were expected to collapse following the close of the war the Steagall Amendment was enacted in 1941 to keep prices at war time levels for two years. The amendment expired December 31, 1948. Although there was a growing bipartisan and multi-commodity group consensus that flexible price supports were desirable, the Agricultural Act of 1948 extended high price supports for one more year, after which flexible price supports based on a percentage of parity were to become effective. However, surpluses accumulated and in an act of expediency the Agricultural Act of 1949 pegged price supports at 90 percent of parity through 1950.
After 1951 cooperating producers of basic commodities could receive support levels between 75 an 90 percent of parity (if marketing quotas were not disapproved). Additional refinements to the parity pricing formula were made on the 1949 Act which general merged the price index level.
The outbreak of the Korean War on June 25, 1950 lead to a continuation of high price supports through 1952 for national security purposes and neither acreage allotments or marketing quotas were in effect for the 1950 or 1951 crops of wheat, rice, corn or cotton and stocks held by the CCC accumulated rapidly.
The 1950's -- Recognition of and Dealing with Excess Capacity
Flexibility in price supports was again deferred by Congress in July 1952 though by passing legislation to provide for 90 percent of parity for the 1953 and 1954 crops, if producers had not disapproved of marketing quotas.
Acreage allotments were reinstated for corn for the first time since WW II and marketing quotas were proclaimed for wheat and cotton and continued for tobacco and peanuts. Yet, 90 percent of parity loan rates resulted in the rapid accumulation of stocks by the CCC. The application of acreage allotments to a crop like corn caused expansion of production of nonallotment crops and depressed prices. It was becoming apparent that the rigidity of allotments did not allow for efficient production adjustment.
In recognition that rigid and high loan rates were incompatible with real economic conditions, the Eisenhower Administration moved to implement the adoption of flexible price supports. The Agricultural Act of 1954 set price supports at 82.5 to 90 percent of parity in 1955 and 75 to 90 percent of parity thereafter. A portion of CCC stock holdings were to be set aside and disposed of by export, donation and disaster relief.
The export market was first considered by Congress in the passage of Public Law 480 in 1954. This Act proved to be of major importance in assisting in the disposal of stocks yet it was limited in scope to sales for soft currencys, emergency relief and bartering for strategic material.
Although support prices were made flexible, the range of flexibility was not sufficient to slow the growth in output to an equilibrium situation with demand growth. Pressure from increasing stocks resulted in the establishment of the Soil Bank by the Agricultural Act of 1956. Because prices were above world levels, direct sales in world markets were not occurring and output restrictions seemed imperative. The Soil Bank was designed to take cropland out of production. Composed of an Acreage Reserve and a Conservation Reserve, the soil bank attempted to deal with both short-term and long-term problems.
The Acreage Reserve was an annual program that replaced the acreage allotment. Under the program farmers could reduce the acreage devoted to a crop below their allotment and be paid for diverting it to conserving uses. In 1957 the program had 21.4 million acres out of production, but it was terminated after 1958 because it was condemned as a high cost program that was ineffective in controlling production.
The Conservation Reserve was viewed as a measure to deal with the longer term adjustment of resources out of agriculture. Contracts were signed for a maximum of ten years for whole farms and for cropland to be diverted to conservation uses. By 1960, 28.6 million acres were under the program. The last land left the reserve in 1972. The 1956 Act also began a two tiered pricing system for rice with export rice supported at a different level that domestic rice.
The 1960's -- Direct Payments and Acreage Reduction
By 1960, the high price supports of 1953 had given way to generally lower and more flexible prices however neither the lowering of prices nor the restrictions on acreage had been able to bring about an equilibrium between output growth and demand growth. The export market while increasing slowly, through PL-480, was not moving grain at prices as high as our domestic support levels. Stocks reached record levels.
The decade year of the 1960 saw a fundamental shift in programs from price support to direct income support payments and from voluntary acreage reduction to diversion programs.
Beginning in 1961 Congress passed a bill giving the Secretary of Agriculture authority to make payments to producers in cash or certificates to achieve acreage reduction of at least 20 percent for corn and grain sorghum. Payments were made on 50 percent of their normal yield. If they withheld an additional 20 percent they were paid on 60 percent of normal yield.
The Food and Agriculture Act of 1962 continued the voluntary acreage reduction program but broke new ground by separating price support and income support payments. Loan rates on corn were allowed to decline to near the world price level. A direct income supplement of $.18 a bushel of normal yield was made to support farmer incomes if farmers complied with acreage reduction programs. The combination of large acreage reduction programs and world level loan rates resulted in a significant decline in grain stocks during the 1960 and by 1970 CCC stocks were approaching zero. However, the cost of direct income support payments rose rapidly and reached $3.8 billion in 1969.
The 1970's -- Foreign Market Dependency
Throughout the 1970's production capacity and export growth were issues. Farm programs increasingly built in inflation adjustments.
In the early 1970's a combination of acreage reduction and export subsidy programs, a series of devaluations of the U.S. dollar, and short crops in the USSR and India emptied the U.S. bins. Because of the Russian grain sale in 1972, grain prices rose rapidly. The Agriculture and Consumer Protection Act of 1973 expanded the concept of market orientation and introduced target prices and deficiency payments to replace the price support payments of the previous 10 years. Deficiency payments were to be made only when prices fell below the target price.
The short run situation of strong export demand and low stocks gave rise to a concern about the long run availability and stability of the market. General inflation in the economy and rising prices for fuel and fertilizer created increasing concern over costs of production. The initial target was fixed abitrarily by legislation and had no relationship to market conditions. In later years they were to adjusted by an index of the cost of production.
Yet, there was an effort to maintain the market orientation of the programs by keeping loan rates low relative to market prices. For cotton, loan rates were set at 90 percent of the price of U.S. cotton in world markets. Corn loans were well below the market. As the export market remained strong, more and more people came to believe that the future would be a period with more years of scarcity than of surplus. On the strength of tight markets lenders provided money to farmers to by land and machinery at higher and higher prices.
The Food and Agricultural Act of 1977 was an accommodation to the general inflationary spiral raising loan rates and target prices well above previous levels and above the recommendations of the Administration. Target prices changes were tied to changes in cost of production. A Farmer Owned Grain Reserve (FOR) was created to provide for the possibility of extended nonrecourse loans to farmers in order to provide for a buffer stock to encourage farmers to manage stocks. To encourage participation in the FOR farmers were offered an advance storage payment. Stocks were to remain in the reserve until market prices exceeded release prices.
Although exports remained strong in the late seventies grain was rapidly accumulating in the FOR. Market prices fluctuated with several shocks to the export market and program management became a complex game of balancing the entry and exit of stocks from the FOR.
The 1980's -- Changing Direction; Liberalization
The 1980's brought about the full realization that farm programs cannot be developed in isolation of macroeconomics and international competitiveness. Domestic policies have been clearly seen to have international market implications that alter the actions of consuming and and competitor nations. The beginning of the 1980's saw a reversal of world market conditions.
The value of the dollar rose sharply. Production increased in the consuming nations and our competitors were under-pricing the the U.S. in the world market.
In order to keep grain off the market and out of the CCC the loan rate on FOR grain was increased above the rate for regular CCC loans. Market prices declined and in 1981 dropped below the FOR loan rate for corn and approached the FOR rate for wheat.
Initial efforts toward a 1981 Farm Bill recognized the need for greater market orientation and a reduction in budget costs. However, with the export market turning sour, farmers were applying pressure for greater income protection. The farm sectors performance in 1981 was worse than expected and prices were well below 1980 levels. The grain provisions of the 1981 Act were a Congressional experiment in legislated prices base on expected rapid inflation in production cost.
World wide recession, a continuing strong dollar, and large increases in output dashed hope that the market would recover in 1982. Season average prices for corn and wheat were below the loan rate. Deficiency payments rose sharply. Rigid price floors were again creating stock piles as U.S. commodities were priced out of the market.
PIK, the largest acreage reduction program in the history of farm programs, was introduced in 1983. A total of 82 million acres wase enrolled under the PIK program with payment at 80 percent of production for all crops but wheat and at 90 percent of production for wheat. A combination of PIK and drought in 1983 cut stocks sharply and prices rose much more than anticipated. The bins were refilled in 1984.
The Food Security Act of 1985 introduced a general realization that world markets are a controlling factor in U.S. agriculture. Price supports were reduced from levels projected in the 1981 Bill and farmer incomes have been upheld by direct government payments. Export enhancement programs along with the declining value of the dollar and a modest recovery in world market have resulted in a turn around in exports. Acreage reduction programs and payments in CERTs have reduced stocks. Marketing loans for rice and cotton have made us competitive at world prices.
The evolution of programs has been conditioned by short-term economic and political conditions. Emergency measures once enacted have evolved into long-term programs that often had different objectives and impacts than those intended in the original legislation. Throughout most of the history of the programs the importance of market pricing has been stressed on a bipartisan basis. Yet, political expediency has resulted in a 55 year history of price support programs. A full recognition that income support through ridged prices is unfeasible over the long term is required in order to move to a market oriened program.
Multilateral efforts to bring about rationality in world markets by removing domestic and export market programs that interfere with prices and distort trade are essential to remove the excess capacity problem.
This is characteristic of U.S. agriculture prior to the 1930s - boom and bust periods. During the Civil War prices and income were high. However, as the war ended supplies grew and prices and income fell. Similarly strong demand and high prices stimulated by World War I provided the necessary incentives to expand production. After WW I and through the 1920s commodity prices and income trended downward.
Agricultural policies are the result of the resolution of conflict. They begin with divergent views about what should be done and end with a compromise between groups. They are carried out through compromises between the apparent or understood intent of laws and regulations and the personal philosophies and interest of policy administrators. Policies are, therefore, ambiguous to some degree. They leave room for interpretation. Policies are often rationalized to some unintended program objective after programs are written into law or regulation. Programs that were undertaken as an implimentation of a policy in dealing with some acute economic, social or political problem acquire a body of data and arguments in their defense that may be quite different from the original justification for the program or policy. Programs whose functions have been fulfilled are often continued for reasons quite different from those intended at the start of the program. Programs thus evolve over time, taking on different purposes and often supporting policies far different from their initial purpose.
Pre World War I
Prior to the First World War policies affecting agriculture were largley development policies focused on developing the fontier and expanding production. This single objective was facilitated by land settlement programs, support of the family farm concept, and increased agricultural productivity. A sound and expanding agriculture would complement industrial growth and economic prosperity. In 1862, a number of acts were passed that "opened the west" and established the importance of agriculture, from a Federal perspective. The Homestead Act granted acreage to those willing to improve the land and live on it for 5 years. The Morrill Land Grant College Act established agriculture as a mainstay at Colleges and Universities. The U.S.D.A. was established in 1862. Also, Congress subsidized development of the transcontinental railway system - to assist in transporting agricultural commodities. Eventually legislation was enacted to support research at agricultural experiment stations (Hatch Act 1887), extend the land grant college concept to black colleges in the South, and to provide Federal funds for agricultural extension (Smith-Lever Act - l914).
Three additional acts that significantly influenced agricultural development in the early 1900s were the Reclamation Act of 1902, the Federal Farm loan Act (1914), and the Capper-Volstead Act (1922). The Reclamation Act provided federal funding for irrigation development which enabled agriculture to expand in the West. The Federal Farm Loan Act established the Farm Credit System which gave farmers access to subsidized credit. The Capper-Volstead Act exempted agricultural cooperatives from the Sherman Antitrust Laws and allowed these organization to increase in number, size and power.
The 1920's -- Program Initiated
To a large extent today's farm commodity programs are a result of the economic chaos that affected agriculture in the 1920's. As the result of a decline in exports, the introduction of mechanical power for hauling freight and people, and the introduction of the tractor for agricutural production the capacity of agriculture to produce far exceeded the demand for its output. As the result of the shift to mechanical power some 50 million acres were released from production of feed for draft animals. At the same time land was being added to the productive base through expansion onto the plains and grass land and through massive irrigation and reclaimation projects. These forces along with the declines in both domestic consumption and exports in the early 1920's resulted in a rapid fall in farm prices while prices of manufactured goods continued to rise.
Farmers sought relief from, what they percived to be, selective economic depression in agriculture through the introduction of bills in Congress to support prices through the purchase of commodities. A more complex approach to price support was to be achieved through the McNary-Haugen Bills which were primarily programs to remove surpluses from domestic markets through export dumping. Although the bills failed to pass in Congress or were vetoed by the President, they brought a focus to the farm policy debate. The quest for "economic justice" for farm people, for "Equality for Agriculture", was lead by George Peak who believed in a natural balance between agriculture and industry and felt that agricultural commodities should be priced such that their puchasing power was maintained on a par with industry.
In 1929, Congress created the Federal Farm Board and povided it with $500,000,000 to purchase commodities in order to support their prices. The funding proved to be inadaquate and the Board with no ability to control production was seen to be a failure. In 1932, the Board recommended legislation which would "provide an effective system for regulating acreage or quantites sold" inorder to raise prices and incomes for producers of commercially traded commodities.
The forerunners of current commodity programs were created in the 1930's to raise the income of producers of "basic" commodities (commodities which were important in commercial markets) by restricting market supply. The Agricultural Adjustment Act (AAA) was to be a self supporting program to bring about supply restriction through processor taxes. Revenues were to be use to make allotment payments to producers who set aside up to 20 percent of their acreage. The Secretary of Agriculture proclaimed a 15 percent acreage reduction for contracting farmers to be eligible for payments on the 1934 crop.
In the Case of the U.S. vs. Butler, often referred to as the Hoosic Mills decision, the Supreme Court on January 6, 1936 declared the processor tax and production control provisions of the AAA unconstitutional. Thus, the self-financing provisions were eliminated and supply control was disrupted for a short period. To responed to the short-term crisis and replace the production control provisions of the AAA, Congress rushed through the Soil Conservation and Domestic Allotment Act of 1936 by February 29, 1936, less than 2 months after the Hoosic Mills Decision. Under the 1936 Act, acreage reduction was to be achieved through conservation programs, however, the program failed to restrict output.
The Agricultural Adjustment Act of 1938 brought about stronger Federal intervention in the market. The term parity was introduced into legislation for the first time and the Secretary was required to make nonrecourse loans for producers of corn, wheat and cotton. Nonrecourse loans were at the option of the Secretary for rice and tobbacco. Loans were set at a fixed percentage of parity. In addition, producers were to receive parity payments to bring their return as close to parity as possible with available funds. Because program benefits, from higher prices and parity payments, were tied to production, the larger and the more efficient a producer the larger the benefits to that producer.
The Commodity Credit Corporation was established by executive order in 1933, which provided loans to cotton producers enabling growers to hold their cotton until prices improved. For fruits and vegetables, production controls were supplemented by marketing agreements. Quotas were implemented for sugar.
1940s - Abortive Attempts of Price Support Flexibility
Despite the use of acreage allotments and marketing quotas, commodity inventories began to increase in the late 1930s, particularly those owned and controlled by the government. Yield growth helped to make production controls ineffective. By 1939, direct government payments accounted for 35 percent of net cash income and 30 percent in 1940. However, WW II stimulus improved export demand and as a result prices strengthened and direct government payments fell to 13 percent of net cash income in 1941. WW II postponed the need to address growing surpluses and government costs in the 1940s.
Government price supports which were set between 52 and 75 percent of parity in 1938 were above market cleaning levels as surpluses started to become burdensome. However, the improvement in the industrial sector provided Congress with the impetus to raise support for agricultural commodities up to 85 percent of parity (for those commodities which producers had not disproved marketing quotas). Later legislation over 1941 and 1942 period raised support to 90 percent for some commodities and extended the level of support at these high levels to 1948. By 1945 more than l00 commodities were supported at high (above market clearing) levels. During the war years supports rose and supply control requirements declined.
As the war ended debate arose as to what direction supports should take - high fixed supports as in the War years or flexible more market oriented dependant on existing supplies. The Agricultural Act of 1948 favored flexible supports over time. However, supports would remain at near the 1948 levels for 1949 plantings. The 1948 act also revised the parity price formula specifying farm - nonfarm relationships dependant on current (10 years) period to account for productivity and then faster changes since the early 1900s. This would also support levels to decline beginning in 1950. The surplus problem facing policy makers in the late 40s was contributed to by the adoption of hybrid seed for corn and the full transition to "tractor power" as opposed to horse power.
Because prices were expected to collapse following the close of the war the Steagall Amendment was enacted in 1941 to keep prices at war time levels for two years. The amendment expired December 31, 1948. Although there was a growing bipartisan and multi-commodity group consensus that flexible price supports were desirable, the Agricultural Act of 1948 extended high price supports for one more year, after which flexible price supports based on a percentage of parity were to become effective. However, surpluses accumulated and in an act of expediency the Agricultural Act of 1949 pegged price supports at 90 percent of parity through 1950.
After 1951 cooperating producers of basic commodities could receive support levels between 75 an 90 percent of parity (if marketing quotas were not disapproved). Additional refinements to the parity pricing formula were made on the 1949 Act which general merged the price index level.
The outbreak of the Korean War on June 25, 1950 lead to a continuation of high price supports through 1952 for national security purposes and neither acreage allotments or marketing quotas were in effect for the 1950 or 1951 crops of wheat, rice, corn or cotton and stocks held by the CCC accumulated rapidly.
The 1950's -- Recognition of and Dealing with Excess Capacity
Flexibility in price supports was again deferred by Congress in July 1952 though by passing legislation to provide for 90 percent of parity for the 1953 and 1954 crops, if producers had not disapproved of marketing quotas.
Acreage allotments were reinstated for corn for the first time since WW II and marketing quotas were proclaimed for wheat and cotton and continued for tobacco and peanuts. Yet, 90 percent of parity loan rates resulted in the rapid accumulation of stocks by the CCC. The application of acreage allotments to a crop like corn caused expansion of production of nonallotment crops and depressed prices. It was becoming apparent that the rigidity of allotments did not allow for efficient production adjustment.
In recognition that rigid and high loan rates were incompatible with real economic conditions, the Eisenhower Administration moved to implement the adoption of flexible price supports. The Agricultural Act of 1954 set price supports at 82.5 to 90 percent of parity in 1955 and 75 to 90 percent of parity thereafter. A portion of CCC stock holdings were to be set aside and disposed of by export, donation and disaster relief.
The export market was first considered by Congress in the passage of Public Law 480 in 1954. This Act proved to be of major importance in assisting in the disposal of stocks yet it was limited in scope to sales for soft currencys, emergency relief and bartering for strategic material.
Although support prices were made flexible, the range of flexibility was not sufficient to slow the growth in output to an equilibrium situation with demand growth. Pressure from increasing stocks resulted in the establishment of the Soil Bank by the Agricultural Act of 1956. Because prices were above world levels, direct sales in world markets were not occurring and output restrictions seemed imperative. The Soil Bank was designed to take cropland out of production. Composed of an Acreage Reserve and a Conservation Reserve, the soil bank attempted to deal with both short-term and long-term problems.
The Acreage Reserve was an annual program that replaced the acreage allotment. Under the program farmers could reduce the acreage devoted to a crop below their allotment and be paid for diverting it to conserving uses. In 1957 the program had 21.4 million acres out of production, but it was terminated after 1958 because it was condemned as a high cost program that was ineffective in controlling production.
The Conservation Reserve was viewed as a measure to deal with the longer term adjustment of resources out of agriculture. Contracts were signed for a maximum of ten years for whole farms and for cropland to be diverted to conservation uses. By 1960, 28.6 million acres were under the program. The last land left the reserve in 1972. The 1956 Act also began a two tiered pricing system for rice with export rice supported at a different level that domestic rice.
The 1960's -- Direct Payments and Acreage Reduction
By 1960, the high price supports of 1953 had given way to generally lower and more flexible prices however neither the lowering of prices nor the restrictions on acreage had been able to bring about an equilibrium between output growth and demand growth. The export market while increasing slowly, through PL-480, was not moving grain at prices as high as our domestic support levels. Stocks reached record levels.
The decade year of the 1960 saw a fundamental shift in programs from price support to direct income support payments and from voluntary acreage reduction to diversion programs.
Beginning in 1961 Congress passed a bill giving the Secretary of Agriculture authority to make payments to producers in cash or certificates to achieve acreage reduction of at least 20 percent for corn and grain sorghum. Payments were made on 50 percent of their normal yield. If they withheld an additional 20 percent they were paid on 60 percent of normal yield.
The Food and Agriculture Act of 1962 continued the voluntary acreage reduction program but broke new ground by separating price support and income support payments. Loan rates on corn were allowed to decline to near the world price level. A direct income supplement of $.18 a bushel of normal yield was made to support farmer incomes if farmers complied with acreage reduction programs. The combination of large acreage reduction programs and world level loan rates resulted in a significant decline in grain stocks during the 1960 and by 1970 CCC stocks were approaching zero. However, the cost of direct income support payments rose rapidly and reached $3.8 billion in 1969.
The 1970's -- Foreign Market Dependency
Throughout the 1970's production capacity and export growth were issues. Farm programs increasingly built in inflation adjustments.
In the early 1970's a combination of acreage reduction and export subsidy programs, a series of devaluations of the U.S. dollar, and short crops in the USSR and India emptied the U.S. bins. Because of the Russian grain sale in 1972, grain prices rose rapidly. The Agriculture and Consumer Protection Act of 1973 expanded the concept of market orientation and introduced target prices and deficiency payments to replace the price support payments of the previous 10 years. Deficiency payments were to be made only when prices fell below the target price.
The short run situation of strong export demand and low stocks gave rise to a concern about the long run availability and stability of the market. General inflation in the economy and rising prices for fuel and fertilizer created increasing concern over costs of production. The initial target was fixed abitrarily by legislation and had no relationship to market conditions. In later years they were to adjusted by an index of the cost of production.
Yet, there was an effort to maintain the market orientation of the programs by keeping loan rates low relative to market prices. For cotton, loan rates were set at 90 percent of the price of U.S. cotton in world markets. Corn loans were well below the market. As the export market remained strong, more and more people came to believe that the future would be a period with more years of scarcity than of surplus. On the strength of tight markets lenders provided money to farmers to by land and machinery at higher and higher prices.
The Food and Agricultural Act of 1977 was an accommodation to the general inflationary spiral raising loan rates and target prices well above previous levels and above the recommendations of the Administration. Target prices changes were tied to changes in cost of production. A Farmer Owned Grain Reserve (FOR) was created to provide for the possibility of extended nonrecourse loans to farmers in order to provide for a buffer stock to encourage farmers to manage stocks. To encourage participation in the FOR farmers were offered an advance storage payment. Stocks were to remain in the reserve until market prices exceeded release prices.
Although exports remained strong in the late seventies grain was rapidly accumulating in the FOR. Market prices fluctuated with several shocks to the export market and program management became a complex game of balancing the entry and exit of stocks from the FOR.
The 1980's -- Changing Direction; Liberalization
The 1980's brought about the full realization that farm programs cannot be developed in isolation of macroeconomics and international competitiveness. Domestic policies have been clearly seen to have international market implications that alter the actions of consuming and and competitor nations. The beginning of the 1980's saw a reversal of world market conditions.
The value of the dollar rose sharply. Production increased in the consuming nations and our competitors were under-pricing the the U.S. in the world market.
In order to keep grain off the market and out of the CCC the loan rate on FOR grain was increased above the rate for regular CCC loans. Market prices declined and in 1981 dropped below the FOR loan rate for corn and approached the FOR rate for wheat.
Initial efforts toward a 1981 Farm Bill recognized the need for greater market orientation and a reduction in budget costs. However, with the export market turning sour, farmers were applying pressure for greater income protection. The farm sectors performance in 1981 was worse than expected and prices were well below 1980 levels. The grain provisions of the 1981 Act were a Congressional experiment in legislated prices base on expected rapid inflation in production cost.
World wide recession, a continuing strong dollar, and large increases in output dashed hope that the market would recover in 1982. Season average prices for corn and wheat were below the loan rate. Deficiency payments rose sharply. Rigid price floors were again creating stock piles as U.S. commodities were priced out of the market.
PIK, the largest acreage reduction program in the history of farm programs, was introduced in 1983. A total of 82 million acres wase enrolled under the PIK program with payment at 80 percent of production for all crops but wheat and at 90 percent of production for wheat. A combination of PIK and drought in 1983 cut stocks sharply and prices rose much more than anticipated. The bins were refilled in 1984.
The Food Security Act of 1985 introduced a general realization that world markets are a controlling factor in U.S. agriculture. Price supports were reduced from levels projected in the 1981 Bill and farmer incomes have been upheld by direct government payments. Export enhancement programs along with the declining value of the dollar and a modest recovery in world market have resulted in a turn around in exports. Acreage reduction programs and payments in CERTs have reduced stocks. Marketing loans for rice and cotton have made us competitive at world prices.
The evolution of programs has been conditioned by short-term economic and political conditions. Emergency measures once enacted have evolved into long-term programs that often had different objectives and impacts than those intended in the original legislation. Throughout most of the history of the programs the importance of market pricing has been stressed on a bipartisan basis. Yet, political expediency has resulted in a 55 year history of price support programs. A full recognition that income support through ridged prices is unfeasible over the long term is required in order to move to a market oriened program.
Multilateral efforts to bring about rationality in world markets by removing domestic and export market programs that interfere with prices and distort trade are essential to remove the excess capacity problem.
