Bruce A. Babcock

Presented at the American Farm Bureau Federation’s convention and annual meeting, January 8, 2001

Center for Agricultural and Rural Development
Iowa State University
Ames, Iowa 50011-1070
www.card.iastate.edu

Bruce A. Babcock is a professor of economics, Department of Economics, and director of the Center for Agricultural and Rural Development at Iowa State University. Dr. Babcock may be contacted by e-mail at babcock@iastate.edu or by phone at 515-294-6785.

The Center for Agricultural and Rural Development is a public policy research center founded in 1958 at Iowa State University. CARD operates as a research and teaching unit within the College of Agriculture, Iowa State University, conducting and disseminating research in four primary areas: trade and agricultural policy, resource and environmental policy, food and nutrition policy, and agricultural risk management policy.

As many of you know, economists typically deliver one of two types of messages about farm policy. The first, from my more free market colleagues, focuses on the damage that government programs do to U.S. consumers and/or taxpayers. Free market economists advocate elimination of government intervention in the name of economic efficiency. The second type of message is from economists who look out for the financial interests of farmers. They use their expertise to develop policy proposals that will enhance farm income, with perhaps some attention paid to loss of economic efficiency. My more interventionist friends seem to pine for the good old days when USDA economists were at the helm of the agricultural economy, balancing farm income, budget costs, and exports.

Today I want to take on a different role, one of a good friend of and advisor to agriculture. And, like the best friend of someone in denial, friends are often the only people who can bring the reality of a situation into sharp focus. My view of today’s reality in agriculture is that Congress is wide open for new proposals, but the public is skeptical; and agriculture is developing a culture of dependency. After I present my good friend wake-up call, I will then take on the role of policy analyst and discuss if and how the growing demand for new counter-cyclical programs can be reconciled with our current crop insurance and marketing loan programs.

The first issue that I would like to address is what I see as agriculture’s real and growing public relations problem. This public relations problem is caused by two factors, only one of which can be controlled. The uncontrollable factor is caused by the continuing consolidation of production agriculture. Farms continue to get larger, and the long-running and resilient public support for a farm policy that helps small family farms continues to be less and less relevant. The changes are most evident with respect to modern livestock operations, but they are evident also in crop operations. For example, when Ann Veneman was being discussed as a possible secretary of agriculture in the new administration, some observers were quoted as saying that she would not understand "real" agriculture because she came from California, which, as everybody knows, is corporate agriculture. I grew up in California on a family farm in Tulare County, and went to school at the University of California-Davis. Most of the farmers I knew there farmed a large number of acres, but all operations were family run. But to many, "large" translates to "corporate." So as crop operations become larger, they inevitably invoke less sympathy than small farms.

The other, controllable, factor causing the public relations problem is the lack of a policy objective justifying the $70 billion that agriculture has received in direct payments since Fiscal Year 1998. What is causing the problem, in my view, is not necessarily the level of payments but rather that the payments have flowed to agriculture without any serious discussion of what the payments are supposed to accomplish, other than the idea that we should not lose any farmers. However, many realize that this publicly stated goal did not guide the dispersion of payments, because a large proportion of payments flowed to well-capitalized farms that were not in danger of failing.

Many in the public increasingly conclude that farm policy is nothing more than a simple raid on taxpayers by large, well-to-do farmers who owe the public nothing in return for the payments. This perception is strongly held by some taxpayer interest groups, most environmental groups, and all small-farm advocacy groups. But many in the mainstream of agriculture are also drawing this conclusion.

Here are some quotes from Secretary of Agriculture Dan Glickman taken from the New York Times: "Even as the amount of money paid to farm counties has soared, restrictions on who can get those funds and how they are supposed to be used do not form a consistent policy." ... "Essentially the government’s role in requiring the farmer to do something in return has largely been eliminated by Congress. And while I don’t like the large payments going to some farmers--that’s an outright embarrassment--many of these payments are keeping large sections of America from folding up and going down." Secretary Glickman concludes that "maybe it is time that we had some intellectual honesty in farm policy. Nobody talked about it during the presidential election. And you rarely hear about it spoken in Congress. But these farm payments have become truly rural support payments."

Secretary Glickman can find only one justification for the billions in farm aid: to prop up rural businesses (including farms). But when did Congress decide that farm policy is really a rural development policy in disguise? The short answer is that it didn’t. Congress has not made this declaration because Congress knows that income support for farmers is not an effective national rural development tool, primarily because, with the exception of some Great Plains counties, most rural counties are not "farm dependent" as defined by the USDA. Furthermore, most studies indicate that farm aid does not translate into a permanent increase in people, jobs and business in rural areas in the long run. But if we should not be using farm policy as a rural development tool, what broad public concern is being met by giving $70 billion in direct aid to farmers? Such a question is not asked of other federal programs. Generally, we know that education programs are supposed to increase our nation’s productivity. Defense programs are supposed to enhance our national security. Environmental programs are supposed to result in cleaner air and water. What are farm programs supposed to do? Here are some objectives that have been proposed.

• Maintenance of minimum income levels for farmers
  A recent USDA study showed that a negative income tax (earned income credit) would best meet this goal at a relatively low cost.
• Secure food supply
  Nobody suggests that we will ever have any trouble meeting U.S. needs for food.
• Provide cheap food
  There would be a small increase in the price of food if we eliminated current farm programs.
• Environmental protection, including landscape management
  If farming causes enough environmental damage or can provide enough scenery, then there is a role for government to play in enacting environmental or recreational programs.
• Lack of multi-year risk management tools
  Farmers who invest in land, machinery, and buildings could use multi-year financial contracts that presently do not exist.

So we are left with two possible justifications for broad public support for farm programs: environmental quality and to make up for the lack of multi-year risk management tools. As I mentioned earlier, an unwritten, but publicly stated, policy objective is to prevent any farmer from being forced out of business. But clearly this cannot guide farm policy without a complete rejection of our capitalistic society. After all, without the risk of failure, a business should not expect any long-term return on investment.

Again, I cannot overstress the importance of agriculture presenting to Congress and to the public an intellectually honest justification for taxpayer support. Without such an honest presentation, the public can only conclude that agriculture is just another interest group with its hand in the taxpayer’s pocket, which weakens agriculture’s position in Congress.

Personally, I have no problem with those of you who support the idea that, indeed, that is what agricultural policy should be about. But I believe that there is a price to pay for receiving government aid that flows without a stated purpose.

Before discussing what this price is, let’s talk about the way that most sectors of the economy have been run over the last 20 years. Over the last 10 to 20 years, American businesses have faced relentless competition, relentless technological change, unprecedented consolidation, and, for many products, falling prices. Faced with this competition, surviving companies are those that have cut costs and continuously introduced new products that have been accepted by the consumer. "Creative destruction" is a term that Joseph Schumpeter coined in the 1940s to describe the continuous process by which new technologies push out the old; new companies push out the old; and new products push out the old. The engine behind this creative destruction is the pursuit of profit.

The beneficiaries of this destruction and pursuit of profit are today’s consumers, tomorrow’s workers and consumers, and the successful companies. Who loses?--companies that cannot or choose not to keep up. U.S. companies that have survived the last 20 years are the world beaters.

What does this have to do with agriculture? Most of the world’s successful companies are those that have had to rely on the marketplace for their revenue. But Congress’s willingness to provide support over the years has shown agriculture that when times are tough, the first place to look for help is to the government coffers. Obviously agriculture is not unique in this regard. Chrysler and U.S. Steel are among the beneficiaries of federal help. But agriculture needs to recognize that there is a price to pay for this help. The price is the development of a culture of dependency instead of one of innovation and self-reliance.

With too much government assistance, there is the danger that U.S. agriculture will be transformed into something like European Union agriculture: a sector that until recently was insulated from market forces and that had lost the need to innovate and be the low-cost provider of high-quality products that the world’s consumers want to buy. Instead of having an incentive to look to the market for guidance about what to produce and how much to produce, if U.S. agriculture, like EU agriculture, only looks to government for solutions, it will lose out to world-beating sectors like those of New Zealand, Brazil, Australia, Chile, and Argentina.

Am I saying that it is in the long-run interest of U.S. agriculture to cut itself off from government aid? Not really. What I am saying is, to best position itself for future prosperity, U.S. agriculture needs to (1) make its best case as to why the public’s interests are being met with some sort of aid, (2) design the policy so that the aid package actually meets that broad public purpose, and (3) make sure that the policy does not hinder producers’ incentives and ability to compete in world markets.

The first two points will help solve agriculture’s public relations problem, and the third point will help U.S. agriculture move away from a culture of dependency.

I would now like to turn attention to a more focused discussion of the kinds of policies that are being proposed and how they might work with existing programs and policies. After all, new farm bills are never revolutionary in nature: they are always evolutionary.

With regard to meeting environmental objectives, I believe that an observation from Paul Johnson, past chief of the Natural Resources Conservation Service and now an Iowa farmer, serves as an excellent policy guide. In an interview with the Des Moines Register from his Christmas tree field, Paul observed that farmers receive revenue from their corn, their soybeans, their livestock, and even their Christmas trees, but they do not receive any revenue from the number of song birds on their land or the amount of soil and nutrients they keep out of our lakes and rivers. An economist could not have said it better: when something has a zero price, it generally receives zero value and zero attention. If we want to enhance environmental quality, we need to put a price on it, and the self-interested pursuit of profits will take care of environment quality. Thus we should develop markets for environmental attributes, much like we have with the current Conservation Reserve Program whereby farmers’ enrollment bids are ranked according to the environmental attributes they provide. Or Congress can adopt a policy of stewardship payments whereby farmers receive payments based on the practices they adopt. What this means for farmers is that they will have another product to sell in the marketplace. Profits from supplying environmental goods can enhance and diversify farm income.

The second type of program that I would like to discuss might meet the objective of providing long-term risk management tools. Such an objective is consistent with the proposal for a new type of counter-cyclical program. Under such a program, payments would increase when times are tough and would decrease when times are good.

In designing such a counter-cyclical farm policy we should try to ensure that the payments arrive when they are most needed. So how can we design a counter-cyclical policy? Two events can cause cash flow on a farm to be lower than anticipated. Price can be lower than average, or yields can be lower than average, or both. A low price affects all producers of a crop. Low yields typically affect many producers in a region.

Suppose Congress and the public accept the idea that the government should provide farmers with long-term cash flow protection. This leads at once to the conclusion that counter-cyclical payments should arrive when a farmer has cash flow difficulties caused by uncontrollable and unforeseeable circumstances.

Congressman Charles Stenholm’s Supplemental Income Payments for Producers (SIPP) proposal would provide payments to farmers when national farm revenue from a crop falls below a certain level. I have read press reports that the Commission on 21^st Century Production Agriculture is proposing a counter-cyclical policy whereby the objective is to stabilize national farm income generated from the eight program crops.

The problem with these national policies was discussed in a research paper that I wrote with Chad Hart ("Counter-Cyclical Agricultural Program Payments: Is It Time to Look at Revenue?" CARD Series 00-BP 28). We found that payments from a national program would largely flow when price is low, notably in 1986, 1998, and 1999. Thus they would not flow in some of the worst cash flow years in major production states. Iowa corn farmers would have received nothing from the SIPP program in 1993, and Texas cotton farmers would have received nothing in 1980. Furthermore, payments often would flow to farmers that have had good years. For example, Nebraska corn farmers in 1988 would have received large payments even though they enjoyed high yields and high prices. Our conclusion is that if a counter-cyclical payment is to arrive when a farmer needs it, then it must be triggered by events at the state or county level. That is, an effective program must be more finely tuned than a national program can ever be.

Before we even begin to talk about a new counter-cyclical program, though, we should recognize that we already have government and private counter-cyclical programs. We have the loan deficiency payment (LDPs) program, and the Chicago Board of Trade, the Kansas City Board of Trade, the Minneapolis Grain Exchange, and the Chicago Mercantile Exchange to cover price risks. And we have a newly reformed crop insurance program to cover yield and revenue risk. Wouldn’t a new counter-cyclical program duplicate existing public programs and private products? The answer is an unequivocal yes.

Commodity exchanges allow farmers to buy futures and options. These tools can effectively reduce price risk for one or two years into the future. If prices are low and stay low for more than one or two years, then they may not provide the type of long-run price protection sought by farmers. But that is where the LDP program comes in. It provides a long-run floor price for the eight program crops.

As Dr. Hart and I discovered, a national counter-cyclical policy would not make payments when regional or individual yield losses occurred. That is why a counter-cyclical program targeted at the state or county level would be better at providing true counter-cyclical protection. But such a targeted program would greatly reduce the need for crop insurance, because most crop insurance losses are the result of either price declines or yield declines that affect many farmers in a region. That is, the crop insurance industry already provides counter-cyclical yield and revenue payments.

Why then do we need a new program? The answer lies in part in the desire to take agricultural market transition assistance (AMTA) payments and make them counter-cyclical. But agriculture should be prepared to answer how to do this without duplicating existing programs. Justification for a new national counter-cyclical program would increase if marketing loans were eliminated. A national program would not significantly reduce the need for crop insurance because it would not cover individual or regional yield shortfalls. Justification for a county- or state-level counter-cyclical program would increase if marketing loans were eliminated and the crop insurance program were privatized to cover the residual individualized yield risk that would not be covered by the federal counter-cyclical program. The feasibility of a viable private crop insurance industry would be increased because this residual yield risk is an insurable risk that would not require federal reinsurance.

Of course, few are calling for the privatization of the crop insurance industry or the elimination of marketing loans. But keeping them makes it difficult to argue that we need to adopt a new counter-cyclical program.

I would like to turn now to a discussion of what to do about loan rates. Even though we probably are not going to eliminate marketing loans in favor of a national or targeted counter-cyclical program, many are still calling for adjustments to be made.

I have heard three arguments: (1) current loan rates need be raised because they do not provide enough protection; (2) current loan rates need "rebalancing" because farmers are choosing crops according to government incentives instead of market incentives; and, (3) current loan rates need to be reduced because they are depressing market prices as farmers keep land in production because of government incentives. In addition, we are in danger of not meeting our World Trade Organization (WTO) obligations to reduce supply-expanding expenditures.

Arguments (1) and (3) clearly are not reconcilable. It is true that current loan rates keep land in production that would otherwise have gone out of production, and it is true that this supply-expanding effect of loan rates runs counter to our WTO commitments. But we can let other countries make that argument.

Is it in agriculture’s interest to raise loan rates? Such a move would (1) transfer more money to agriculture, (2) make farmers even more dependent on government incentives, (3) depress market prices as farmers would expand production onto land that currently does not return enough to justify planting, and (4) raise land rents and land prices. If this is what agriculture wants then so be it, but it will be difficult to justify to taxpayers why farmers should receive even higher guaranteed prices for their crops when other sectors of the economy do not receive such guarantees. This justification problem is particularly relevant if agriculture also proposes a new counter-cyclical payment program that would provide duplicate protection.

Some say that we should offer higher loan rates only to producers who fallow some land. A recent study that I conducted for the Iowa soybean growers found that such a program would result in land being set aside--and in higher LDP payments--primarily in high-cost production areas. Justification for targeting payments and set-asides to high-cost areas could be to counter the acreage-expanding effects of the current marketing loans and crop insurance subsidies.

What about adjusting loan rates so that they are neutral with respect to planting decisions? To see how a rebalancing would take place, consider the case of Kansas. As shown in Table 1, a farmer who can choose between corn, soybeans, and wheat will tend to choose corn at current loan rates because the returns over variable cost for corn are higher than for the other two crops.

Now suppose we want to freeze the soybean loan rate at $5.09/bu and adjust the corn and wheat loan rates so that the returns over variable costs for each crop are equal. Corn loan rates would have to be decreased by $0.10 per bushel and wheat loan rates would have to be increased by $1.46/bu to equalize returns.

What would happen to returns over variable costs in Illinois if the Kansas loan rate adjustments were applied? Current Illinois loan rates tend to favor soybeans. If the $/bu adjustments that equalized returns in Kansas were applied to Illinois, then the bias toward soybeans would be even more pronounced.

This simple example illustrates that if Congress wants to rebalance loan rates, USDA would have to make regional adjustments that accounted for differences in yields and production costs. This exemplifies the general point that government intervention often causes unintended consequences that often lead to demands for more government intervention to fix the consequences of the initial intervention.

I set out in this talk to raise some issues that I believe should be addressed head on by agriculture as it presents its case to Congress and the new administration. Agriculture is going to have to compete with many popular programs if it is to expand its baseline budget. National defense, education, energy and environmental programs, tax cuts, and transportation will all be asking for more federal support. With an increasingly urban Congress, it is imperative for agriculture to present honestly what broad public purpose is being met by support for farmers and why particular policy alternatives will achieve that broad public purpose.

Furthermore, as the agricultural sector prepares to meet future opportunities, we should make sure that government support for farmers enhances the sector’s ability to capture those opportunities rather than diminishes the chances through continued development of a culture of dependency.