Agriculture - event - 8/31/2006

Prospects for Reform of U.S. Agricultural Policy – With or Without Doha*

Remarks by Robert L. Thompson**

I am honored to be asked to address prospects for change in U.S. agricultural policy on the same platform with Secretary of Agriculture Mike Johanns and former Congressman Cal Dooley. I am particularly pleased for this event to be here at the Cato Institute as Bill Niskanen, Cato's Chairman, was my boss at the Council of Economic Advisers back in the mid-1980s.

Today I will begin by reviewing several of the usual stated objectives for our farm programs and show how our current programs fail to contribute to achievement of these objectives. Then I will turn to some of the forces working to preserve the status quo in the 2007 Farm Bill, followed by forces that are working to change U.S. agricultural policy significantly in that farm bill.

Objectives of Farm Policy

There are five commonly cited objectives of farm policy which I will review in turn.  These objectives include:

• Low farm family income
• Variability of farm income
• Competitiveness
• Food security
• Rural development

In the 1930s when U.S. farm programs began, we were in the depths of the Great Depression and the dust bowl. Average farm family incomes were below those in the rest of the American economy. Most attempts in farm policy to lift farm family income have involved measures to lift prices received by farmers above the levels the market would provide. This has been done variously through government purchases at guaranteed prices, restrictions of how much a farmer could produce, and restrictions on imports. As a result, the largest farmers, who sell the most and are rarely those in greatest financial need, receive the largest benefits. The lowest income farmers, who sell little, receive few benefits from the program. When direct payments have been used instead of price supports, they are distributed on historical production bases, not on a needs basis, so again the largest producers receive the largest benefits.

Farming is a risky business. One of the inputs in farm production, weather, is a random variable not under the farmer's control. Moreover, commodity market prices, usually determined in spot markets, are highly volatile. Modern farming is a highly capital intensive industry that uses very specialized equipment and facilities that have few alternative uses beyond producing the product they were designed to produce.

The second frequently stated objective of farm policy is to reduce the variability of farm income. Farmers do have several instruments available to this end. They can use cash accounting which provides significant flexibility in shifting receipts and expenses between two tax years. In addition, farming is the only business that is still allowed to use income averaging (over four years) when filing federal income taxes. The United States has well developed commodity futures and options markets on which farmers can buy price insurance, as well as heavily subsidized crop insurance to insure against yield losses. When one penetrates most income stabilization arguments for farm programs, what is sought is stabilization around a higher mean.  While larger than average farmers receive the bulk of farm program payments, ultimately the benefits are capitalized into the price of farmland, increasing the wealth of the largest land owners.

The third commonly stated argument for farm programs is to increase competitiveness. Exports are extremely important to the profitability of American agriculture, which produces significantly more than U.S. residents consume. Ninety-six percent of the world's population lives outside the United States. U.S. agricultural competitiveness depends principally on our fertile soils and favorable climate, low unit-costs of production that have resulted from productivity enhancing agricultural research, and low cost transportation associated with our well-developed infrastructure and much lower-priced energy than our competitors. Because farm program payments get capitalized into the price of farmland, they raise the long-run cost of production, undercutting our competitiveness. This has also become a significant barrier to entry to the next generation of farmers.

Food security is frequently cited as an objective of farm policy, however, when one recognizes that U.S. farmers produce a quarter to a third more than Americans consume, there is little merit to this argument.

Rural development is also advanced as an argument for farm programs. Farm programs which distribute the benefits in proportion to sales provide liquidity that facilitates larger farmers to buy up their smaller neighbors, accelerating consolidation of farms and loss of jobs in agriculture. Rural economic development is about creating non-farm employment in rural America. In fact, most of the small farmers who have escaped poverty have done so not as a result of farm programs, but by becoming part-time farmers, with at least one full-time source of income from off the farm. If the objective of farm policy is to facilitate rural development, we need measures that improve rural infrastructure, education, health services delivery, amenities, and the investment climate, not farm programs that distribute the bulk of the benefits to the largest producers.

Current farm programs fail to contribute much to achievement of these five frequently cited objectives of U.S. agricultural policy. The one objective with the most credibility is the objective of reducing farm income variability, but even there, one needs to ask where the presently available policy instruments and market mechanisms fall short.

Factors that Impede Change in Farm Policy

Farm policy changes tend to be evolutionary, not revolutionary. Inertia is the first factor likely to impede any large change between the 2002 Farm Bill and the 2007 Farm Bill. Moreover, most producers of the five commodities that receive 93 percent of all farm program payments are very happy with the 2002 Farm Bill and would like nothing better than for it to be extended unchanged. The commodity groups and farm organizations that represent the producers of these commodities tend to be significant contributors to Presidential and Congressional campaigns. Four of the most highly supported commodities, sugar, rice, cotton and milk, are the four largest campaign contributors from the agricultural sector. This ensures at least that get they their positions heard when policy is made.

Politics will also impede change in the next farm bill. You are all familiar with the red and blue state map that shows which party's candidate for President received the largest number of votes in each state. You may be less familiar with the red and blue county map, but I can tell you that rural America is very red. In the last election, President Bush gained votes in rural America and lost votes in urban areas. I can imagine that Karl Rove is not enthusiastic about any change in farm policy that might precipitate loss of Republican votes in rural America. Similarly, Democratic Party strategists are surely also intent upon picking up some of those red votes, so they will not be enthusiastic about getting out in front with any farm policy change that might cost them rural votes. Finally, don't forget that Iowa has one of the earliest Presidential primaries, and no aspirant to the Presidency is likely to utter a word against farm programs in Iowa for fear of becoming an early casualty in primary season.

There is another factor that might impede reduction in the amount of farm support, if not the mechanism by which it is transferred to farmers. There is significant capitalized value of farm program benefits in the price of farmland. In the early 1980s the price of farmland in the corn and wheat growing areas of the United States dropped an average of 60 percent in less than five years. This precipitated the highest rate of farm and rural bank bankruptcies since the 1930s. When that was over, farm land prices had fallen to a level at which farming could generate a reasonable return on investment in land.

 

In the last 20 years the price of farmland has been bid back up to probably twice what it could possibly cash flow under any reasonable expectations of future world commodity prices. While not the only factor, farm program benefits have contributed to this run-up in farmland prices. A significant reduction in farm program payments could precipitate a drop in farmland prices in parts of the country away from urban development potential. When one recognizes that the investment in farmland represents most farmers' retirement savings, no Congressman wants to do anything that might precipitate a drop in farmland values.

 

The Doha Round of WTO trade negotiations were suspended indefinitely this summer. Much progress had been made in the negotiations on agriculture, including commitments of increases in market access for agricultural products, with the highest tariffs being cut the most; reductions in trade-distorting domestic agricultural support, with those with the highest trade-distorting supports making the deepest cuts; and complete elimination of agricultural export subsidies. The negotiations broke down over inability of the negotiating parties to agree on the percentages by which the cuts should be made and how many exceptions should be allowed for products that are politically powerful ("sensitive") or important to developing countries' food security or rural livelihoods.

U.S. farm organizations had never been very enthusiastic about the Doha Round of trade negotiations. They strongly supported the U.S. Administration in the Uruguay Round of GATT negotiations, and the Uruguay Round Agreement on Agriculture included many conceptual advances. Non-tariff barriers to trade were converted into tariffs and, for the first time, both trade-distorting domestic support and agricultural export subsidies were capped and bound. Nevertheless, the agreement was rife with loopholes, and little real trade liberalisation occurred. American farmers, who had expected significant increases in exports, became frustrated as they watched Brazil capture most of the growth in the world market. They also viewed it as unfair that both the EU and Japan had negotiated much higher caps on their trade-distorting domestic support.

US farm organisations, remembering their dashed hopes for larger exports following the Uruguay Round, made it very clear to the Administration that they would support a Doha Round agreement on agriculture only if it included significant increases in foreign market access to compensate for any reductions in domestic support that the US negotiators might accept. The official policy position of many farm organizations is to support extension of the 2002 Farm Bill until a Doha Round agreement on agriculture is reached. It appears unlikely that an agreement will be reached before the 2007 Farm Bill is written.

Factors Favoring Change in Farm Policy in 2007

An unprecedented level of transparency has been brought to the farm policy debate. It is becoming widely known that farm programs do not measure up well relative to their most frequently cited objectives. There has been widespread editorial comment in newspapers across the country against farm programs. The Environmental Working Group has secured through Freedom of Information requests the annual farm program payments received by each individual farmer and posted them on its website for the last several years. These and data published by the USDA's Economic Research Service have demonstrated for all to see how skewed is the distribution of farm program benefits towards the largest producers of only five commodities.

Farms that produce "non-program commodities" are not noticeably less profitable than those producing commodities which receive benefits. And the fruit and vegetable industry, whose value of production now exceeds that of all program commodities combined, is not subject to less risk than production of cotton, rice or corn.  As a result of this increased transparency, more non-agricultural groups have joined the debate over future farm policy than ever before.

The Federal budget deficit is frequently cited as a factor that will force change in agricultural policy in the next farm bill. There is no question that the United States needs to do something about reducing the deficit, but I, for one, do not expect the deficit to have much influence a on the 2007 Farm Bill. First, there is little evidence that Congress or the President is all that concerned about the deficit. But, more importantly there never has been a binding budget constraint on U.S. farm programs. The last time Congress got serious about doing something about the budget deficit was 1985 when it passed the Gramm-Rudman-Hollings Bill that mandated across the board cuts in all federal government programs. Within months after passing that bill, Congress passed a farm bill which authorized the then largest farm program payments in history. While the budget deficit will get a lot of rhetoric, I do not expect it to significantly affect the content of the next farm bill. 

Historically there has been great solidarity among the general farm organizations and the various commodity groups when farm bills have been written. Without a binding budget constraint, the organizations representing different commodities and the general farm organizations were willing to ignore the fact that certain commodities and regions of the country consistently got proportionately larger benefits than others did. Farm organization leaders anticipate that there will be a tighter budget constraint this time, and there are signs that the historical solidarity among groups is beginning to fracture, creating a greater likelihood that change is possible.

Southern states have historically received significantly more benefits per acre and per farmer than other states from farm programs, particularly for rice, cotton and sugar. One observes widening differences in policy positions between regions, in particular between the South (rice and cotton) and the Midwest (corn and soybeans). Perhaps fragmentation is nowhere more evident than within the largest general farm organization, the American Farm Bureau Federation (AFBF). The AFBF's state membership-weighted voting gives six Southeastern states control of the national organization's policy positions. The Southeast pushed through a policy position to support extension of the 2002 Farm Bill while other regions of the country were exploring less production- and trade-distorting alternatives, such as farm revenue insurance.

Fragmentation is also occurring between program commodities and fruits and vegetables, which have no support programs. The fruit and vegetable industry is acknowledging that it has received some benefit from a prohibition on growing fruits and vegetables on land for which producers of program commodities are receiving direct payments. The WTO has found this prohibition to be inconsistent with international trade rules if the United States wants to avoid having to count these direct payments under its cap on trade-distorting support to agriculture. In exchange for giving up this prohibition, the fruit and vegetable industry is seeking support for research and promotion for its commodities.

The most visible split arose when the sugar lobby actively opposed Congressional passage of the CAFTA-DR free trade agreement[1], when most of the rest of American agriculture supported it. The sugar lobby will not get as much support or forbearance from other commodities as in previous farm bills. While the sugar lobby has successfully kept greater access to the U.S. market for foreign sugar out of almost all of the free trade agreements signed to date, they failed in their protectionist efforts on one, the North American Free Trade Agreement (NAFTA). On January 1, 2008, when the NAFTA agreement is fully implemented, there will be free access to the U.S. market for Mexican sugar. The present sugar program will become unsustainable at that time, and it will have to be reformed before then, most likely in the 2007 Farm Bill.[2]

In 2003, Brazil took a case to the WTO against the U.S. cotton support program. Brazil alleged that several features of the U.S. cotton program stimulated larger production of cotton in the United States than would otherwise have occurred and that this larger production was pushed out into the international market by means of both direct and indirect export subsidies, with the effect that the world price of cotton was depressed below the level at which it would have resided. Because Brazil's cotton growers receive their entire income from the world market price, Brazil argued that this was unfair and that the U.S. should change this policy and/or pay it compensation. The WTO panel and Appellate Body found in Brazil's favor on most of its allegations. Congress has repealed the direct export subsidies ("Step 2 payments"), and the USDA has administratively changed the indirect export subsidy, export credit guarantees.

The WTO panel and Appellate Body found that marketing loans, loan deficiency payments, and counter-cyclical payments had contributed to "suppression" of the international price of cotton by stimulating larger production of cotton in the U.S. than it would otherwise have produced. Congress has done nothing yet to bring the cotton program into alignment with WTO rules. If it does not, Brazil has the right to demand compensation for the losses suffered by its cotton growers.

These same policy instruments are also central elements of the U.S. support programs for rice, wheat, corn, soybeans and other grains. If these programs are not changed in the 2007 Farm Bill, there is a high probability that a series of WTO cases will be brought against the United States for other commodities whose support programmes are similar to those for cotton. With the precedents set by the Brazil cotton case, it is hard to see how the US would win those cases. The U.S. could have given up marketing loans, loan deficiency payments and counter-cyclical payments in the Doha Round and got something in exchange if those negotiations had been brought successfully to closure.

If our commodity support instruments are not changed so that they become less trade-distorting, the U.S. is likely to lose them through litigation and perhaps have to pay a fine, too. The threat of a series of WTO cases being filed against the U.S. is perhaps the most likely force that might cause the Senate and House agriculture committees to consider seriously alternative mechanisms for supporting U.S. agriculture.

Every farm bill is influenced disproportionately by the current economic condition in the farm sector at the time the farm bill is written. Expectations tend to be very myopic. While no one can predict how crop conditions here and around the world will evolve between now and mid-2007, we can predict with some assurance that whatever they are will affect the content of the next farm bill.

There is one market development that already looks likely to affect the upcoming farm bill debate. With massive subsidies and high import protection, biofuels production, particularly corn-based ethanol, is growing rapidly in the United States. The growing demand for corn by ethanol plants has lifted its price sufficiently that it appears unlikely that corn growers will receive much future benefit from the present corn support programs. The National Corn Growers Association's policy committee has recently gone on record supporting a change from the present marketing loan-- deficiency payment -- counter-cyclical payment structure to a federally-subsidized WTO-compliant revenue insurance program. Such a program might also obviate the need for the federal crop insurance program and ad hoc disaster payments.

Conclusions

There are three basic issues that are likely to dominate the 2007 Farm Bill debate. The first is to what extent federal farm policy will continue to provide income transfers to individual farmers as opposed to investing in public goods for the greater good of American agriculture and rural America. The second it to what extent payments that are made to individual farmers are linked to the production and/or price of specific commodities as opposed to payments that are fully decoupled from the production of any specific commodity (or even whether the farmer produces anything). The third is the threat of WTO litigation dismantling our present farm programs piecemeal as opposed to putting in place a well-thought out alternative when the farm bill is written.

If I were a betting person, I would wager that the 2007 Farm Bill will look a lot like the 2002 Farm Bill. However, there are just enough forces for change that one should not rule out a bigger change than one would normally expect from one farm bill to the next. The strongest forces for change seem to be the growing public perception that current farm programs are not achieving their objectives, pressure for agriculture to participate in federal budget deficit reduction, and the threat of WTO litigation, if not progress in the Doha Round of WTO negotiations.

The most discussed alternatives to the present structure of trade-distorting supports include: investments in public goods including agricultural research, rural infrastructure and conservation; direct payments that are decoupled from the production and/or prices of any specific commodities but which might require adherence to stiff environmental regulations, and/or some form of subsidized farm revenue insurance, an approach to farm policy used by Canada.

** Professor Robert L. Thompson holds the Gardner Chair in Agricultural Policy at the University of Illinois at Urbana-Champaign. He served formerly as Assistant Secretary for Economics at USDA and as Senior Staff Economist for Food & Agriculture at the President's Council of Economic Advisers.