fedgazette

A fair price for whom?

Fair-price programs might be popular with farmers and lawmakers, but they carry with them a wheelbarrow full of both obvious and subtle ill effects

Ronald A. Wirtz - Editor, fedgazette

Published March 1, 2002  |  March 2002 issue

Grant most farmers just one wish to get out of today's farm economy quagmire, and you'd get a pretty predictable answer: a fair price.

The private market, said one Minnesota farmer, often fails to "establish fair pricing for the those who produce product. Fair value should be established at the [farmer's] production level in order to assure a constant and quality supply."

But what exactly is a "fair" price—and fair for whom?

In the current farm debate, a fair price implies one that is higher than the prevailing low prices of the past several years, one that allows farmers to cover their costs plus a little something extra for the effort. However, it all but ignores the issue of efficiency and the fact that some farms are profitable even at today's prices.

"The farms that produce most of the food and fiber in the United States cover their variable costs and would continue to cover their variable costs at crop prices that are even lower than they are now," according to Jeffrey Hopkins, an economist with the Economic Research Service (ERS) of the U.S. Department of Agriculture (USDA).

Fair-price programs might be popular with farmers and lawmakers, but they carry with them a wheelbarrow full of both obvious and subtle ill effects. For starters, much of the public resources end up subsidizing large, highly efficient farms that often don't need the subsidy to be competitive and profitable. But in an odd sense of equity, such programs also prop up inefficient operations that, in any other industry, would be pushed out of business with nary a teardrop.

Created equal?

That there are efficiency differences among farmers shouldn't be surprising—it occurs in any industry—particularly given the sheer number of operations and the variety of scale. When farm prices are high, efficiency gaps become the yawning concerns of economists and policy wonks, because virtually all farmers are whistling to the bank, some with bigger deposits than others. But big price swings—corn went from a record $3.25 a bushel in 1995 to less than $1.80 in three years—coupled with an efficiency gap mean that some farmers make deposits while others try to stay out of foreclosure.

Among a sample of more than 1,800 Minnesota corn farmers tracked by a University of Minnesota farm management database, the bottom 40 percent (by income) barely earned enough sales revenue to cover their direct costs in 2000, and lost $65 dollars an acre—after government payments—once long-term overhead costs were considered.

In contrast, the top 40 percent of these farmers saw an average $70-per-acre profit over their direct costs and a full-cost net return (including government payments) of more than $22 an acre. Each group harvested about the same number of acres, and although slightly higher yields helped, about 80 percent of the profit differential resulted from per-acre costs that were almost 25 percent lower for the high-performance group.

An ERS report last summer found that the average cost of producing corn nationwide ranged from $1.19 per bushel to $3.67. Analyzing 1996 corn production data, the report found that better than half of farmers—who produce somewhere on the order of 90 percent of all corn—grew it for less (sometimes much less) than $2 a bushel, which included both immediate operating and longer-term ownership costs. The study found that low costs were related to farm size and higher average yields, as well as full-time farmer status, lower farmer age and college education.

The most efficient quartile of farmers in this study harvested corn at an average cost of $1.43 a bushel. Even factoring in 3 percent annual increases for inputs, the subsequent average cost of $1.65 for this quartile is below today's market price and well below the government loan rate of $1.89. Neither does it factor in lump-sum payments to corn growers (planned and emergency) for past production that averaged about 65 cents a bushel from 1998 to 2000, according to the USDA.

By comparison, the bottom quartile of the nation's corn farmers controlled 16 percent of all corn acres and produced just 8 percent of US corn at an average cost of $2.50 a bushel, and even they break even on paper as a group thanks to government subsidies.

Geography can play a big role in efficiency. The ERS report found low-cost corn farms were generally located in the Heartland (Iowa to Indiana) and the Prairie Gateway (Nebraska to Texas), while high-cost farms were found in the Southeast and also in Northern states from Minnesota through Maine, where farms were generally smaller and faced poorer growing conditions.

A November ERS report on cow-calf operations found that ranches in the West and Southern Plains "have significant cost advantages in other regions" because of a longer grazing season that requires less supplemental forage in the winter. Harsher climates in Northern Plains states, the report said, require ranchers to "spend significantly more to maintain herds."

"The farms that produce most of the food and fiber in the United States cover their variable costs and would continue to cover their variable costs at crop prices that are even lower than they are now." —Jeffrey Hopkins Economic Research Service

And while public opinion shuns the large farm, these are the farms and farmers that can exist even in periods of low prices. Among North Dakota farms, "a strong relationship" exists between gross sales and profits; median rates of return on both assets and equity grew as sales increased for every year from 1991 to 2000, according to a North Dakota State University report last October.

Legislating fairness

While fair-price programs usually target the struggling farmer, current price programs favor large, efficient farms, at least in terms of where most of the public money lands. Large, low-cost wheat farms make up a small minority of all wheat producers but harvested about 54 percent of the total wheat crop in 1999. They also took home 50 percent of all federal payments to wheat farms, according to the ERS, despite the fact that "for most of them, market revenue alone was sufficient to cover all costs."

But attempting to limit who receives government support based on profitability and efficiency is fraught with the wrong kind of incentives—it would reward the least efficient and competitive farmers and penalize the most efficient farmers. The hard reality of policymaking is that the best designs on legislative paper to help farmers get better prices can and do backfire.

Just such a conundrum exists over the marketing assistance loan program. The 1996 farm law did away with formal price supports and replaced them with a program designed to provide short-term financing to principal crop farmers, so they could pay their bills after harvest but hold onto crops and sell them throughout the year rather than immediately after harvest, when prices are normally low. Farmers would then repay the government loan and keep whatever was left over.

But the program has had an unexpected—and for farmers, detrimental—effect on prices because it has bolstered year-round supplies (more farmers were bringing crops to market at different times), which in turn flattened out the price peaks. "Farmers no longer have seasonal rises in prices" because the program "smoothed out the supply-demand flow," according to Leland "Judge" Barth, a marketing specialist with the North Dakota Wheat Commission. While supplies remain strong, much of the program's benefits accrue to grain buyers who have better supply assurances and can pay lower prices year-round.

The program has since morphed into a de facto price-floor program because market prices have been below the government's loan rate since 1998. When this happens, farmers can take the government "price," pocket the loan and default their crop over to the government. The program also includes a very popular "loan deficiency" component whereby farmers get the same pricing benefits year-round without having to actually take out the loan. Here a farmer sells product at the going market rate and then receives a government payment making up the difference between the price and the higher government rate. In all, the marketing assistance loan program put about $7 billion into farmers' pockets in 2000. A Congressional Research Service report noted that "the persistence of very low commodity prices has transformed the loan program into a major vehicle of farm income support."

To the chagrin of many farmers, the loan "price" for eligible commodities is scheduled to go down according to the existing formula, which uses five-year price averages. Agriculture Secretary Ann Veneman announced that she would wait and set marketing loan rates after Congress showed its hand and passed a farm spending bill.

Many larger operations—which produce most of the nation's food—likely could still make a go of it at lower loan rates, especially when additional government subsidies are considered. But farm groups are pushing hard on Congress to increase the loan rates, and the Senate's farm proposal boosts loan rates almost across the board for major commodities, some as high as 20 percent, which would add several billion dollars annually to both tax bills and farm income.

Government: the low price leader

Economists also point out that farm prices are not likely to rebound very much until food and fiber supplies are brought more in line with demand. But the irony is that farm-income support programs—particularly subsidized crop insurance and market loan programs—are at least partly responsible for extensive surplus crop stocks, which in turn keep a lid on prices.

Government: The Low Price Leader

Subsidies remove a farmer's disincentive to stop producing crops that would not otherwise be profitable. Production that is artificially high helps keep prices low, which in turn triggers government aid. It's just such a policy spiral that gets farmers wishing for natural catastrophes (on other farmers) to break the cycle of overproduction and low prices.

Many farmers harbor nostalgic notions of agriculture as a way of life, when instead "agriculture needs to be viewed as a business and managed that way as well."
—Jim Halstead
President, Sibley County Farm Bureau

Neither is it clear that government payments provide net social benefits, at least beyond farmers. David Orden, a professor of economics at Virginia Tech, estimates that the government safety net increases total farm output by somewhere between 1 percent and 6 percent. The subsequent oversupply has kept prices artificially low and reduced gross farm revenue from 1998 to 2000 from what the market would have otherwise provided. Government then fills the income gap, but net farm income rises less than 80 cents for every dollar of public support—something Orden called "a vicious not virtuous cycle."

Image-Marketing Assistance Loan or De Facto Price-Floor Program

Biting the hand that feeds

Not all farmers believe government programs are necessary for farmers to receive fair prices.

Many farmers harbor nostalgic notions of agriculture as a way of life, when instead "agriculture needs to be viewed as a business and managed that way as well," said Jim Halstead, the president of the Sibley County Farm Bureau and owner of PrairieLand Alfalfa Co., a commercial hay farm "in the heart of Minnesota corn and soybean country."

Many farm issues are in need of attention, Halstead said, including an overhaul of the farm marketing infrastructure (how crops and livestock are bought and sold) in the United States and abroad. But lawmakers "continue to worry about the bottom line of farmers who refuse to adjust their focus to products that can generate a profit without a USDA handout," Halstead said. "Our industry appears to be the same from one farmer to the next. But there are definite differences in management approaches."

"We allow people to lose businesses and industries every day in this country because they are producing something that is outdated or is no longer in demand. ... Yet, in agriculture we strive to maintain ourselves just as we are."
—Perry Olson
Minnesota Elk Farmer

"The short-term solutions offered by our governmental agencies are not going to cure any of the long-term problems. We need to address the fact that government subsidies have inflated land values to a level beyond its current productive value," Halstead said.

Perry Olson is a Minnesota elk farmer with 100 head, who also grows about 100 acres of alfalfa, rents about 50 acres to local soybean growers and has about 150 acres in various conservation programs.

Olson said area farmers "seem to make a go of it whether corn is selling for $1.25 or $5 a bushel." Most of this was due to government subsidies that don't lend themselves "to natural supply-demand characteristics that are important to our culture. We allow people to lose businesses and industries every day in this country because they are producing something that is outdated or is no longer in demand," he said. "Yet, in agriculture we strive to maintain ourselves just as we are."

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