Economic Reality and U.S. Government Farm Programs
JUNE 01, 1985 by E.C. PASOUR
Dr. Pasour is a Professor of Economics at North Carolina State University at Raleigh.
Farm bankruptcies are front-page news. Although the magnitude of the problem has undoubtedly been overstated by the media, there are no hard data on the precise number of farm businesses experiencing financial stress. According to a 1984 survey, less than 20 percent of all farm operators had debt/asset ratios of 40 percent or higher. While the USDA on the basis of a recent American Bankers Association survey of agricultural banks found the incidence of farm bankruptcies “relatively low,” pleas for government to “do something” are widespread throughout the land.
The paradoxical nature of the call for government action to alleviate the economic distress in U.S. agriculture is too little recognized. As shown in the following analysis, current farm problems are rooted in past government programs. As so often happens when government inter venes, government farm programs not only have failed to achieve their objectives but have created pressures for further intervention to deal with the unforeseen and unintended consequences of these policies.
Despite the fact that U.S. agriculture is often considered to be a bastion of free enterprise, farm programs today are remarkably similar to the protectionist Roosevelt New Deal policies instituted during the Great Depression of the 1930s. Moreover, it is ironic that government outlays for farm programs have increased greatly during the Reagan Administration. The tax payer cost of farm price support programs alone increased from $4 billion in 1980 to more than $20 billion in 1983—making these programs the most rapidly growing item in the deficit-plagued federal budget.
Although agriculture escaped the deregulation movement of the late 1970s and early 1980s that affected transportation, banking, and so on, it appears that major changes are likely to occur in U.S. farm policies within the next decade. The pressures for change are due to changing economic conditions and to an increasing public awareness of the effects of past government farm policies.
As the U.S. Congress debates a 1985 farm bill, agricultural policy is at a crossroads with only two choices. The choice is either to continue the existing network of costly programs involving government subsidies and government-sanctioned restrictions on competition that now affect about half the output of U.S. farms or, alternatively, to rely on the competitive market process to bring about appropriate adjustments in production and resource use. In making this choice, it is important to consider the objectives and results of current and past farm programs.
Government Intervention to Assist Low-Income Farmers
Price supports, marketing orders, and other restrictions on competition were instituted to increase farm prices and incomes during the Great Depression when economic conditions in agriculture were greatly different than they are today. While farm incomes, on average, historically have been lower than nonfarm incomes, this is no longer the case. If the half of the farms that are noncommercial rural residences are eliminated from the income statistics, the farm sector has higher family incomes, on average, than the nonfarm sector. Of course, there is no presumption that wages should be equal. And, if public policies are instituted to equalize wages in different sectors regardless of underlying economic trends, there is little incentive for labor to adjust in response to changing economic conditions.
Furthermore, government farm programs make the income distribution less equal within agriculture since most farm program benefits are related to farm size. Consequently, when farm product prices are increased by price supports, incomes of small farmers are affected relatively little. Economist William Lesher estimates that just 13 percent of the farms obtain 45 percent of direct government payments, while 71 percent of the farms receive only 22 percent of the payments. The result is that although farm programs are justified on the basis of helping low- income farmers, it is owners of large farms with incomes quite high relative to nonfarmers who receive most of the benefits.
Government Intervention to “Stabilize Agriculture”
Another goal of farm policy is to “stabilize” farm product prices and income. Despite this often stated goal, there is little doubt that past government policies have contributed to the current financial distress being experienced by substantial numbers of farmers. The record sug gests that government attempts to stabilize agricultural markets have been no more successful than similar attempts by government to “fine-tune” the overall level of economic activity during the past 15-20 years. Indeed, much of the current economic distress in U.S. agriculture can be traced directly to inflationary monetary and fiscal policies and to subsidized credit, which induced farmers to overinvest in land and capital facilities during the late 1970s.
Economic instability is often increased by government intervention as Washington political decision makers manipulate agricultural (and other) programs to affect upcoming elections. Prior to the 1976 election, for example, the Ford Administration raised the loan rate on wheat from $1.50 to $2.25 per bushel and tripled the tariff on imported sugar. Similarly, President Carter increased dairy price supports on the eve of the 1980 election. Again, in September 1984 President Reagan changed the rules of the Farmers Home Administration (FmHA) to postpone and reduce farm debt—thereby merely postponing the day of reckoning for many farmers.
The subsidized credit programs operated by the FmHA create an incentive to expand the size of farm operations through borrowing. The high ratio of capital to labor in U.S. agriculture makes farming particularly sensitive to changes in interest rates. When the cost of capital is sub sidized, farmers are induced to substitute capital for labor and land. Thus, easy government credit policies undoubtedly have contributed to the recent increase in farm bankruptcies.
The importance of the export market for U.S. farm products increased markedly during the early 1970s. Although the United States is the world’s largest exporter of agricultural products, government policies increase uncertainty and instability in export markets. The suspension of grain sales to the Soviet Union in 1980 by President Carter is a prime example. Uncertainty and instability inevitably increase when the demand and price of farm products hinge on unpredictable political factors.
However, it is not only trade restrictions directly affecting agricultural exports that are of importance to U.S. farmers. During the recent recession, the Reagan Administration tightened import restrictions on a range of products including autos, steel, textile products, and motorcycles. Since buyers of U.S. farm products must obtain dollars to make these purchases, such restrictions on imports, whether “voluntary” or involuntary, are especially damaging to U.S. agriculture. The conclusion is that much of the market instability for U.S. farm products during the past decade can be traced to government policies.
Indirect Effects of Farm Programs
Restrictions on competition inevitably reduce the efficiency of resource use. In current wheat, feed grain, and cotton programs, the government pays U.S. farmers not to till some of the world’s most productive farmland. The higher prices for bread, milk, sugar and other products resulting from price support programs are especially harmful to those with low incomes and create increased pressures for food stamps and other income transfer programs.
There is a cost of production “trap” associated with the operation of all agricultural price support programs. Any effective price support will increase cost of production as increases in product prices are capitalized into prices of land, production rights, and other specialized re sources. Thus, if the price of wheat were doubled or tripled to (say) $10 per bushel, prices of land and other specialized resources in wheat production would be bid up so that the expected cost of production, including the return to entrepreneurship, would tend to equal product price.
Since the benefits of farm programs are largely capitalized into higher prices of inputs (especially land), it is the owners of these inputs at that time who benefit. Producers who enter production later receive little benefit from such programs unless price support levels are further increased. Later entrants into production receive higher product prices, but they also have higher costs. Moreover, the increased prices of land and other inputs creates a trap that makes it difficult to abolish farm programs. If price support levels are reduced or abolished, prices of land and other specialized assets decrease—imposing huge losses on current farmers, particularly land owners. The windfall losses would not necessarily be incurred by those who received the gains since many farmers bought land and other farm assets after prices of these assets had already increased and, therefore, did not receive the original windfall.
There is a great deal of public concern about the viability of the small farm. Thus, it is ironic that interest rate subsidies of the FmHA and the CCC (Commodity Credit Corporation) promote the trend toward fewer and larger farms by encouraging the substitution of machinery and other capital inputs for labor. When credit is allocated on the basis of opportunity cost, credit is used by those producers who best accommodate consumer demands. If credit is subsidized, some less productive producers are kept in business, thereby increasing output with lower product prices. Thus, another indirect effect of subsidized credit is to harm those producers not receiving preferentialtreatment in capital markets.
Schizophrenic Nature of Programs
Farm programs are incredibly complex and there is no way to determine the net impact of the network of price supports, marketing orders, credit subsidies, conservation subsidies, food stamps, and other programs financed through the U.S. Department of Agriculture. However, the programs are often inconsistent, having opposite effects on farm product prices. For example, price support programs for milk, sugar, feed grains, wheat, cotton, and tobacco along with food stamp and other subsidized food assistance programs increase product prices. On the other hand, government-financed research activities and credit, land, and water subsidies tend to increase output and decrease farm product prices.
Expenditures to “stabilize farm prices and income” by reducing output totalled about $20 billion in fiscal 1983. During the same period, expenditures that increase output totalled about $15 billion. If the dollars spent on these programs were equally efficient in achieving their conflicting objectives, some $30 billion may have been spent in 1983 on activities having little (or no) net effect on food costs, farm prices, or farm incomes. That is, because of their opposite effects on product prices, a substantial part of farm program expenditures merely cancel out each other. However, there are important gainers and losers associated with the operation of farm programs as indicated below even if the expenditures, on average, are self-defeating.
The fundamental problem in agriculture, as in other areas, is to achieve the most productive pattern of resource use. There are only two ways of securing economic cooperation—the market system and central direction. There is, in general, a strong case for decentralized competitive markets as the most effective means of coping with constantly changing economic conditions. The competitive entrepreneurial market process is fully as applicable in agriculture as in other economic sectors. The market in agricultural production and marketing activities can do what central planning cannot do: it can utilize the detailed information in millions of minds that cannot be conveyed to any planning authority. In view of the record of past government farm programs, the burden of proof should be on those advocating continuation or expansion of programs that prohibit or inhibit the operation of the entrepreneurial market process.
The value of U.S. farm exports jumped from $8 billion in 1972 to about $44 billion in 1981—a dramatic increase in real terms. The increased dependence of U.S. agriculture on international trade has important implications for domestic agricultural policies since there is a fundamental incompatibility between domestic agricultural price support programs and free international trade. When domestic prices of dairy, tobacco, peanut, sugar, and other products are raised above the world price, imports must be restricted to prevent domestic consumers from purchasing lower priced imports. As the dependence of U.S. agriculture on exports increases, the liberalization of trade becomes increasingly important. However, the United States cannot be a credible proponent of free trade as long as U.S. farmers operate under an umbrella of protectionist domestic agricultural policies.
Implications and Conclusions
The effect of government-enforced restrictions on competition in agriculture is to increase income to wheat growers, sugar producers, dairy farmers, and other small groups at the expense of the public at large. Consumers and taxpayers bear the major costs of government farm programs. Price support programs mean that consumers face higher prices of milk, sugar, pea nuts, tobacco, oranges, and other products. Consumers are hit especially hard in the case of sugar and dairy products. In late 1984, the domestic price of sugar was four times the world price. Similarly, U.S. dairy product prices were two to three times the world price. The dairy program is also expensive to the taxpayer. In fiscal 1983, the treasury costs were $2.6 billion—or about $13,000 per commercial dairy farmer. The cost of price supports, subsidized credit, and other USDA outlays is now roughly $50 billion per year and increasing rapidly. Farm programs are not an unmixed blessing to farmers. Farmers who rent or buy land, production rights, or other specialized resources, also face increased production costs.
The notion of individual rights, including the ability of people to engage in voluntary exchange is central to questions concerning the appropriate role of government in agriculture (and in other sectors). In the decentralized market process, maximum scope is provided for individual choice. Only through this approach can the nation’s agricultural resources be used most economically serving the interests of farmers, consumers, and taxpayers alike. In agriculture, as in many other areas of economic activity, government might make its greatest contribution by attempting to do less. In the long run, noninflationary monetary and fiscal policies plus a more open economy would benefit agriculture far more than the network of costly action programs now in place.
3. Many of the points discussed below are elaborated upon in more detail in E. C. Pasour, Jr., “The High Cost of Farm Subsidies,” Back-grounder No. 388 (Wash., D.C.: Heritage Foundation, Oct. 22,1984) and E. C. Pasour, Jr., “The Free Market Answer to U.S. Farm Problems,” Backgrounder No. 389 (Wash., D.C.: Heritage Foundation, October 30, 1984).
4. David H. Harrington, “Income and Wealth Issues in Commercial Farm and Agricultural Policy,” pp. 145-153 in Increasing Understanding of Public Problems and Policies—1984 (Oak Brook, Ill.: Farm Foundation, 1984), p. 147.
5. William G. Lesher, at the Conference on Alternative Agricultural and Food Policies and the 1985 Farm Bill, sponsored by the Giannini Foundation and Resources for the Future, Berkeley, California, June 11, 1984.