Lecture 2 -The Farm Problem.pptx

AGRB 4520/6520: AGRICULTURAL POLICY! Lecture 2: “The Farm Problem” Fall Question: Is tomato a fruit or a vegetable? Nix v. Hedden (1893) U.S. supreme court: Tomato should be classified as….. 2 Review What is policy analysis ?  Policy analysis is a means of synthesizing information includin...

AGRB 4520/6520: AGRICULTURAL POLICY! Lecture 2: “The Farm Problem” Fall Question: Is tomato a fruit or a vegetable? Nix v. Hedden (1893) U.S. supreme court: Tomato should be classified as….. 2 Review What is policy analysis ?  Policy analysis is a means of synthesizing information including research results to produce a format for policy decisions and of determining future needs for policy relevant information  Client oriented advice relevant to public decisions and informed by social values 3 Agenda:  Why do we need agricultural policies?  Is “the farm problem” the main reason?  Did the policies solve the problem? 4 What is Agricultural Policy? 5 What is Agricultural Policy  Is a complex web of interventions covering output markets, input markets, trade, renewable and exhaustible resources, regulation of externalities, education, marketing, and distribution of food products  Determines the present and future conditions in agriculture 6 What is Agricultural Policy  Alternatively: It is how governments influence agriculture and how agricultural sectors influence governments  It does not operate in a vacuum. Ag. policies must consider concerns of the World Trade Organization. 7 Why is it complex?  Rapid technological change In 1830 it took 250-300 man hours for 100 bushels of wheat on 5 acres Today, it could be less than 1 hour! 8 Why is it complex?  Basic Economics Supply, demand , elasticities, risk  Interaction between society and agriculture (changing consumer preferences) 9 History 10 When did Ag. Policies first appear?  Ancient Egypt: The Pharaoh took 20% of all food from the farmers as a form of taxation (Genesis 47:24)  Ancient Greece: Indirect taxes on hers, wine and hay among other things. 11 “Corn Laws” 1815 - 1846  Measures enforced in United Kingdom. The central theme was restrictions and tariffs on imported grain.  Prices did increase.  But! The “working class” had to spend most of their income on bread.  The law was eventually repealed. 12 What about U.S.?  1630s: Colonial authorities restricted the number of tobacco plants a settler could grow to 1500 because of overproduction, that lead to lower prices  This is among the first policy prescription for American farmers long before the U.S. became a sovereign nation 13 “The Navigation Acts”  1651: Required all goods traded between English colonies and England to be carried on English or colonial vessels The majority of the crew should be English by birth. Goal: Restrict ships from other nations (mainly Netherlands) to carry goods between the colonies and Europe the ships had to pay duties source: https://www.marinersmuseum.org/sites/micro/usnavy/02.htm, (https://www.ncpedia.org/navigation-acts-1651-1660). 14 “The Navigation Acts”  1660: The law identified goods (including tobacco, cotton, wool) that were to shipped only to England or an English province 15 “Staple Act” 1663  The Staple Act, required all European goods imported into the colonies must be shipped there only from England (goods had to unloaded, inspected, paid for in duties and repackaged for shipment). As a result, the prices paid by colonial consumers increased 16 Why we have Ag. Policies today? 17 Agricultural Policy - Criticisms Enormous budgetary costs: $428 billion (19-23) Huge surpluses of farm products Major disputes with other countries: Examples: i) Canada VS USA for corn subsidies, ii) Brazil VS USA for Cotton, iii) VS EU for poultry exports USA Support special interests   https://ustr.gov/about-us/policy-offices/press-office/press-releases/2009/january/us-files-wto-case-challenging-eu-restrictions-us-p https://www.wto.org/english/tratop_e/dispu_e/cases_e/ds357_e.htm 18 • HOWEVER! • The same programs, been part of an agricultural sector whose productivity over much of the past century has been spectacular 19 Today: “Developmental paradox” 20 Why the Paradox?  Structural changes in the economy  Impact on consumer welfare  “Rationally ignorant voter” 21 How do we enable policy change SET OBJECTIVES IDENTIFY INDICATORS  What are we trying to achieve?  How do we know if we are achieving it?  improve livelihood outcomes for people subject to poverty  Quality  Quantity  Time  improve livelihood outcomes for people in general IDENTIFY OUTPUTS  What needs to change  Policy & policy Instruments  Policy Processes  How do they need to change ?  New policy instruments  Change attitudes, skills, knowledge  People  improve service delivery 22 Step #1: Set Objectives  It is not an easy task (remember the definition – complex web).  Before we set objectives we need to clearly define the problem. 23 “The Farm Problem”  Glen Johnson and Quance (1972): “ Most people would agree that the U.S. has a farm problem – but there is disagreement… in defining the impact, and in prescribing policies”  Ronald Reagan: “ If money could have solved the farm problem, we would have solved it a long time ago” 24 The Farm Problem and Ag. Policies  Experts do not agree on what the “farm problem” is  “The farm problem is what the politicians want it to be”  Agricultural policy is often developed in the absence of well defined objectives. 25 “The Farm Problem”  Schultz (1945): “The low earnings of most farm people and the great instability of income from farming”  Tweeten (1971): “Low absolute net income and low rates of return on farm resources”  At the base, the farm problem must relate to farm household income and to the level of financial resources 26 “Old Farm Problem”  Agriculture is in a chronic disequilibrium. Science and industry continually impose technological advances in agriculture which cannot adjust rapidly enough to avoid excess production capacity and low returns.  Farm fundamentalism: Family farmers are an essential part of our heritage and thus must be preserved. 27 Seeds of the farm income problem  Inelastic supply (Cochrane, 1958)  Agricultural Output has a completely inelastic supply curve  Output expands because of new technology that shifts the supply curve.  This increases income for early adopters. BUT the average farmer is back where he/she started 28 Elasticities for various food products 29 Source: The Demand for Disaggregated Food-Away from Home and Food at Home Products in the US, Seeds of the farm income problem  Inelastic demand  Demand increases slowly over time. Supply increases more rapidly  Increasing productivity leads to commodity surpluses.  Implication: Farm product prices decline over time 30 The Farm Problem - Elasticities $ Market Equilibrium D S1 S2 P1 P2 ΔP Q 1 Q2 ΔQ Q Assume we have an inelastic demand for a particular crop Also assume that due to great weather conditions there is an increase in supply due to record yields  → A shift out of supply curve at every price Results in price falling relatively more than the market clearing quantity 31 The Farm Problem - Elasticities $ What happens to total D S1 S2  Total revenue under original equilibrium was area 0P1AQ1  Total revenue under the new equilibrium is 0P2BQ2 A P1 P2 farm revenue when you have an inelastic demand and an increase in supply? B ΔP We know that total 0 Q 1 Q2 ΔQ Q revenue to this sector has ↓, (i.e., 0P2BQ2< 0P1AQ1) 32 The Farm Problem Elasticities $ D1 P1 P3 P2 Q 1 Q2 Q3 In contrast, with a S1 S2 relatively elastic demand curve, D2  Shift in supply will result in price P3 instead of P2  Shift in supply will result in D2 quantity Q3 rather than Q2  Compared to inelastic demand, a larger impact on quantity and less of an Q impact on price 33 The Farm Problem – Price Fluctuations  Suppose we have a crop which takes a year to grow and is SA grown only once year (i.e. Hops for beer) P P1 a  Suppose now that demand were to rise but supply cannot respond immediately DA O Q1 Q 34 The Farm Problem – Price Fluctuations P Question: What will happen to Price SA P1 a DA O Q1 Q 35 The Farm Problem – Price Fluctuations P SA P2 Since supply is fixed, the price is determined by the available supply at Q1. P1 a So price rises to P2 DB DA O Q1 Q 36 What will happen next? • Farmers observe the high price Now they want to grow more crops At the new price what will the supply be? 37 The Farm Problem – Price Fluctuations P S A At P2, the following year supply increases to Q3 P2 P1 a DB DA O Q1 Q3 Q 38 The Farm Problem – Price Fluctuations S P A But now Supply exceeds demand so price must fall to P3 P2 P3 P1 a DB DA O Q1 Q3 Q 39 The Farm Problem – Price Fluctuations P S A But next period farmers see lower price and decide to supply less: Q4 P2 P3 P1 a DB DA O Q1 Q Q 4 3 Q 40 The Farm Problem – Price Fluctuations S P A Notice here that we are spiraling through time to an equilibrium P2 P3 P1 This is a stable Cobweb a DB DA O Q1 Q Q 4 3 Q 41 The Farm Problem – Price Fluctuations P SA P1 a Suppose instead that the supply curve was very flat DA O Q1 Q 42 The Farm Problem – Price Fluctuations P SA Now what will happen to Price? P1 a DA O Q1 Q 43 The Farm Problem – Price Fluctuations P SA P1 a Since supply is fixed, again the price must rise to P2 DA O Q1 DB Q 44 The Farm Problem – Price Fluctuations P SA P2 P1 a But! next period farmers observe that the price of hops was very high So now they want to grow hops DA O Q1 DB Q 45 The Farm Problem – Price Fluctuations P SA P2 P1 a Now Supply Increases to Q5 DB DA O Q1 Q5 Q 46 The Farm Problem – Price Fluctuations P SA P2 But again Supply exceeds demand so price must fall to P5 P1 a P5 DB DA O Q1 Q5 Q 47 The Farm Problem – Price Fluctuations P SA P2 But at P5 next period farmers decide to supply Q6 P1 a P5 DB DA O Q6 Q1 Q5 Q 48 P6 SA P2 But if only Q6 is supplied demand will exceed supply and price will rise to P6 P1 a P5 DB DA O Q6 Q1 Q5 Q 49 P6 SA P2 But Now the price and quantity are gradually spiraling away from equilibrium. This is an unstable cobweb. P1 a P5 DB DA O Q6 Q1 Q5 Q 50 Summary of Cobweb Effects • With a supply fixed yearly and a sudden rise in demand leads to a big increase in revenue. The lagged response next year can generate cyclical fluctuations in prices over the next few years. When Q goes up and P fall, revenue PxQ can also fluctuate. Not all cobwebs are stable. 51 Cobweb Model of Price Instability 52 Turkey Prices! 53 The Farm Problem – Asset Fixity • Asset Fixity refers to the difficulty farmers have in disposing of capital equipment when downsizing or shutting down the business. When commodity prices are low and farmers are downsizing the value of their assets (i.e. tractors, combines etc.) may be quite low relatively to the purchase price. 54 The Farm Problem – Asset Fixity • Resources get “trapped” in agriculture. During period of high prices expected returns from investment exceed acquisition cost, so new investments are made. However, demand begins to decrease again 5 5 The Farm Problem – Asset Fixity Limitations: Functions are for aggregate commodities. Model assumes isolated markets. Inconclusive evidence to either confirm or reject the asset fixity theory. 56 Policy Prescriptions  Supply control programs.  Payments tied to production base.  Food security through government.  Cost subsidies. 57 Did we solve the farm problem NO  Solving the farm problem was easier when farm families shared the same goals, faced the same challenges and opportunities, and the farm size was similar. Today, farming (especially in the developed countries) has been substantially transformed due to the technological changes and economic opportunities.  “One size fits all” solutions do not work. 58 Changing Perspectives  Today: Average farm income equals or exceeds the average income of non-farm families.  Recognize that commodity markets work and agriculture is a a nearly long term equilibrium 59 Changing Perspectives  The inelastic demand for farm products becomes irrelevant in an open economy  Larger elasticity -> Production control approach to increase income is less efficient 60 New Farm Problem  Contemporary Ag. policy extends beyond just price and income supports. It includes: Trade, environmental conservation, food safety etc.  Involves a more diverse farm structure  Emphasis on externalities 61 62 Who is a farmer ?  The profile of agriculture depends on what definition is used for the term farmer. If so-called “hobby farmers” are included in the definition, US average farm household income will equal or exceed the national average household income of non-farm families.  Do not forget the off-farm income!  Should the policy be “targeted” ? 63 64 65 66 67 Farm Consolidation  Farms have become fewer in number and larger in size.  However, small family farmers are the large majority of farmers 68 Who Owns Farmland?  Land ownership has been changing.  Ownership of farmland has become increasingly separated from the farm operator.  This is one of the major stumbling blocks for policymakers when they try to design farm policy. 69 The Farm Problem and Ag. Policies  Who should be the target of agricultural policy? Should the policy be targeted at all?  Should the policy facilitate the exit of low- income farmers?  Important distinction: Farm income vs. farm wealth! 70 Questions? 71