AAEC 4305: Agricultural Policy

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AAEC 4305 Agricultural Policy

• Fall 2007
• Dr. Don Ethridge

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Course sections

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

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Key economic concepts for ag. policy

• Market
• Market demand
• Elasticities
• Relationship to incomes/expenditures
• Market supply
• Market equilibrium
• Producer and consumer surplus

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Definitions

• Marketall buyers and sellers of a defined good
  in a defined time and space.
• Market demandrelationship between quantity of a
  good that buyers will purchase per unit of time
  and the alternative prices of that good, other
  things constant.

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Definitions (cont.)

• Market supplythe relationship between the
  quantity of a good per unit of time that sellers
  will sell at alternative prices, other things
  constant.
• Market equilibriumthe market condition at which
  all of the good offered for sale is bought.

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Definitions (cont.)

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

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The Magic of Markets

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

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Efficiency

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

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Market failure

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

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Producer and Consumer Surplus in a Functioning
Market
S
Pareto Optimal allocation You cant make anyone
better off without making someone else worse off.
P
D
Q
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Example of govt. intervention-price floor
Supply
Domestic Price Floor
A
B
C
Producers gain A, B, and C
P
Consumers lose A, and B
Demand
Q
Qd
Qs
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Cost to Taxpayers if Surplus Dumped
S
Domestic Price Floor
Ps
A
B
C
If government can dump surplus it will recover I
and J
D
P
E
H
F
G
Price of Surplus dumped on World Market
Pw
D
I
J
Q
Qd
Qs
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Intro. to policy

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

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Policya guiding principle leading to a course of
action (programs) that is pursued by a government

• Economic policypursued in management of national
  economic affairs
• Agricultural policysectoral economic, natural
  rescource, and social policy

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Forces affecting agricultural policy

• Inherent instability
• Golbalization
• Technology
• Food safety
• Environmental concerns
• Industry structure/industrialization
• Politics/political system
• Individual events

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Why study policy?

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

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Policy problems

• Price income instability
• Political instability
• Poverty
• Food safety
• Market failures
• Note Problems often eminate from industry
  structure.

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Two Broad Categories Of Justification of
Government Market Intervention

• Market Failure
• For some reason markets fail to work
• Economics has a lot to say about when and why
• Redistributional
• Policy makers want to redistribute wealth
• Economics has relatively little to say

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Causes of Market Failure

• Common property (non-excludable) goods.
• Unfair market power.
• Asymmetric information.
• Externalities.

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Non-excludable goods

• Inherently cant be exclusively consumed or
  defined as a common good.
• National defense
• Ocean fishing grounds
• Government Responses.
• Public provision
• Regulate use of the common good
• Provide incentives to encourage cooperative use

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Unfair Market Power

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

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Asymmetric Information

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

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Externality

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

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Agriculture/food sector policy goals

• Market stability
• Food security, safety, health
• Sustainability
• International competitiveness

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How economists contribute

• Analyze policies and programs
• Educate and provide advice

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The policy process

• 3 main groups in the U.S.
• Diverse interests many misperceptions
• History of changing interests

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Influence groups

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

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Perceptions and Reality

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

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

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

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

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

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Four broad historical periods of U.S.
agricultural policy

• Pre-1930s
• Building the infrastructure
• 1930 to mid-1960s
• Depression war years
• Price supports and storage
• Mid-1960s to mid-1990s
• --Coupled direct payments
• Mid-1990s to present
• --Decoupled direct payments

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Policy prior to the 1930s

• General economic developmenttransportation
  (rail, roads, canals), postal (rural mail),
  Homestead Act (1862)
• Institution buildingUSDA (1862), Land Grant
  Colleges (1862), Hatch Exp. Sta. (1887, 1890),
  Fed. Land Banks (1916), Coops (1922), PCAs
  (1933), etc.
• Regulatory developmentICC (1887), Sherman
  Antiturst (1890), FDA (1906), meat inspection
  (1907), grain standards (1916), Pack.
  Stockyards (1921), Commodity Exc. Auth. (1922)

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Then came the 1930s

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

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1930s-1960s progression

• Ag. Marketing Act of 19291st Farm Bill
  revolving fund to buy surplus raise prices
  failed because money went quickly.
• AAA of 1933price supports for reducing acres in
  wheat, cotton, corn, hogs, rice, tobacco, milk
  financed by excise tax on processors.

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• Soil Conservation Domestic Allotment Act of
  1936income parity instead of price parity goal
  funding through Congress instead of processors
  shift acreage to soil conserving crops.
• AAA of 1938reenacted provisions of 1936 act
  created fed. crop ins. initiated non-recourse
  loans.
• WWIIstrong demand high prices Congress raised
  support prices (didnt cost much)

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Post World War II acts

• Extended high price supports based on parity
  concept
• Maintained rigid acreage allotments
• Agricultural Act of 1948 (90 of parity)
• Agricultural Act of 1949 (permanent law)
• Agricultural Act of 1954
• Agricultural Trade Development and Assistance Act
  of 1954 (PL-480)
• Agricultural Act of 1956 (Soil Bank)
• Agricultural Acts of 1958, 1962, and 1964

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1960s-1990s progression

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

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

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1965-1996 programs

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

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1996-present

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

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Some consequences of ag policies over time

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

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Trends in ag support policies 1970s to date

• Less market distorting and more market-oriented
• Less restrictive on producers
• More trade oriented
• More environmentally and consumer friendly
• Very expensive 15-25 billion/year
• Less popular public support

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Major components of U.S. commodity policy tools

• Price supports
• Production controls
• Direct payments
• Trade protection
• Subsidized crop insurance

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Price supports

• Create surpluses
• Handling of resulting surpluses
• Government purchase
• Non-recourse loan

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Production controls

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

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Direct payments

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

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Subsidized crop insurance

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

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Policy in a Global Setting

• Trade concepts and global equilibrium
• Restrictive trade policy impacts
• Domestic commodity impacts on other countries
• The World Trade Organization (WTO)

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Types of trade restrictions

• Import quotas
• Import tariffs
• Export subsidies
• Exchange rate manipulation
• Sanitary health restrictions
• State trading

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Domestic policies have impacts on world markets
and other countries

• Domestic price supports example, U.S.
• Input subsidies used by many developing countries

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• Countries trade policies have impacts on
  domestic industries
• Countries domestic policies have trade impacts
• Globalization (economic, market, and policy
  integration on a global scale) has benefits and
  costs

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Economic integration

• Remove barriers to commercial interaction
• Allows buying selling of goods services and
  the free flow of resources (labor, capital)
• It facilitates the coordination of economic
  policies

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Market integration

• Allows the flow of goods between countries on the
  same terms as within countries
• Main requirement is the absence of barriers to
  entry and exit of resources

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Policy integration

• Consists of a common set of policies, laws,
  regulations

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Current major globalization issues (observable in
WTO)

• Market access (lower import barriers)
• Export subsidies (reducing/eliminating)
• Trade distorting domestic policies
• Economic development, particularly in the LDCs

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WTO

• Internatl. Monetary Conference in 1944 created
  the IMF World Bank
• Failed effort for an international trade
  organization resulted in GATT in 1947bring more
  order to world trade
• GATTs strength came from Most Favored Nation
  principle
• GATTs offices (now WTO) in Geneva, Switzerland

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WTO (cont.)

• Over time, GATT had major impact on lowering
  trade barriers in manufactured goods
• Among industrialized countries, average tariffs
  on manufactured goods fell from 40 in 1964 to 5
  in 1979

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WTO (cont.)

• GATT Rounds
• Geneva (1947)
• Annecy (1949)
• Torquay (1951)
• Geneva (1956)
• Dilion (1960/61)
• Kennedy (1964-1967)
• Tokyo (1974-1979)
• Uruguay (1986-1993)
• Doha (2001--)

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WTO (cont.)

• GATT evolved into WTO during the Uruguay Round
  (1994)
• Included ag. trade for the first time
• Gave WTO Commission power to enforce agreements,
  resolve disputes

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WTO classifies programs into 4 categories

• Green boxminimally trade distorting no
  concern. (Research/extension, income support not
  tied to production)
• Blue boxminimally trade distorting because
  production constraints prevent farmers from
  increasing output in response to subsidies

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4 categories (cont.)

• Amber boxdomestic supports that distort market
  prices and trade (input subsidies, price supports
  w/o production controls, direct payments linked
  to production)
• Red boxstrictly prohibited (none specified yet)

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Food Policy

• Food safety/securitypolicies concerned with food
  that is safe from harmful contamination
• Nutrition and assistancepolicies concerned with
  availability of adequate, safe food for everyone

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Food safety/security includes (see Kinsey paper)

• Safety from chemical and biological substances
  that cause illness or death
• Safety from diseases related to food (diet)
• Safety from deliberate contamination in the food
  chain (bioterrorism)
• Policy goal is to achieve all three.

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• Examples of safety/security concerns
• Food additives (preservatives)
• Natural substances (cholesterol, GMOs)
• Chemical residues (pesticides, hormones)
• Pathogens (E coli, Salmonella)
• Diseases (BSE)

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Reasons for different acceptance of GMO food (see
Hebden et al.)

• Cultural acceptance of technology and attitudes
  about nature (what is natural)
• Scale structure of ag. sectorproxemity of ag.
  to population centers
• Who consumers trust for informationconsumer/envir
  onmental groups vs. scientific/academic sources
• How much of consumers information is obtained
  through media sources

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• Achieving food safety requires coordination/cooper
  ation across the entire food chainproducers,
  processors, transporters, etc.and usually
  requires government involvement.

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Food safety policy tools

• Food inspection programs
• Labeling
• Import restrictions
• Licensing (e.g., for chemicals /or applicators)
• Content regulations

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Food nutrition and aid

• Concerns are largely hunger, malnutrition, and
  safe food, both domestically and internationally
• Causes are related to
• Incomes and income distribution, related to cost
  of food (effective demand ability to purchase)
• Education (knowledge)
• Economic structure and infrastructure

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Food nutrition and assistance policy tools

• Food aid, both domestic and international
• Technical assistance for food self-sufficiency
  (mostly international)
• Education programs (domestic internatl.)
• Food price controls (mostly other countries)
• Support for infrastructure development (domestic
  internatl.)
• Research technology transfer (domestic
  internatl.)