Farm program considerations

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Farm Forum

Part 1

With low prices facing farmers as they harvest their 2016 crop, it is becoming clear that the counter-cyclical policies contained in the 2014 Farm Bill will not provide much protection for most producers. As a result, farm groups are beginning to look toward the next farm bill and the types of policies that might best protect farmers against low prices.

In a recent column, we argued against direct payments, subsidized revenue insurance when crop prices are above the cost of production, and loan deficiency payments. We promised future columns that would lay out some policy instruments we support. To start with, we want to identify a couple of principles that we keep uppermost in our minds as we identify program instruments that make sense to us.

We believe that farm policies ought to be designed so as to treat the cause of farm problems, not the symptoms. Our concern about the current array of crop programs is that they are designed to treat the symptoms, price variability while prices are at or above the cost of production, while ignoring the possibility of prices that are well below the cost of production and likely to remain there for extended periods of time.

There is the old saying: “an ounce of prevention is worth a pound of cure.” That is certainly true of the cost of current farm programs which are slated to be higher than projected when the 2014 legislation was scored by the Congressional Budget Office.

The opposition to policies that could provide that “ounce of prevention” is based on two things. First, lulled into complacency by a decade of high prices that was brought on by annual increases in the amount of corn needed by the ethanol industry, they believed that crop prices were on a new plateau and would not drop below the cost of production for an extended period of time. With the assumption of prices that were, on average, profitable, they were more interested in providing shallow-loss revenue protection than providing support during long periods of low prices.

Second, and more importantly, they did not want to admit that aggregate food markets, in general, and agricultural commodity markets, in particular, do not behave like the neat supply and demand graphs they saw in their high school and college economics textbooks. Or more cynically, they know that, in the face of low prices neither quantities supplied nor quantities demanded respond sufficiently in the short-to-medium run to restore profitability, they just don’t like the policy implications of such an admission.

We also believe that the loan rate for each crop ought to be set at a level, between the variable cost of production and the full cost of production, that will allow farmers to remain in production. This does not guarantee any but the most efficient to earn a profit while enabling most to put in a crop next year. To us it does not make sense to have a loan rate set at one level and a target price set at a higher price and thus two programs. We only need one program—one that works.

Another belief that we have is the idea that it does not make sense to design a program that requires the government to make a payment on every bushel or pound that is produced by US farmers. As economists, we believe that it makes sense to pay only for the bushels of supply that are in excess of those demanded by the market at acceptable prices, including normal pipeline supplies.

Our criteria for a credible farm program are:

• We ought to treat causes not symptoms of the farm price and income problem,

• We ought to establish reasonable loan rates that change over time, and

• We should not make payments on most every bushel and pound of production.

• By now, most of our regular readers know what the program would look like.

Such a program would allow farmers to take out a short-term, nonrecourse loan on their crop or a portion of their crop. The loan would be made at the loan rate times the amount of production put under loan and the crop would be the collateral for the loan. Farmers would be able to pay off the loan plus interest at any time up to the term of the loan, say 9 months. If the price in the marketplace were to be lower than the loan rate, they could then forfeit the covered commodity as full payment of the loan. The government would have no recourse to collect the difference between the amount owed and the value of the crop at the settlement of the loan.

When we have done this in the past, the season average price paid to farmers has remained above the loan rate and only a small portion of the crop has been forfeited.

In Part 2 we will flesh out the details of our vision for such a program.

Part 2

In Part 1 we said that a supply management program for the crop sector makes more sense to us than the current combination of revenue insurance with farmers choosing either ARC or PLC as counter-cyclical programs. We called for a supply management program because it meets our criteria.

A supply management program sets a loan rate that is between the variable cost of production and the full cost of production and uses a non-recourse loan and storage program to take enough of the crop off the commercial market to cause the price to rise above the loan rate. As a result, the immediate cost to the government is only for the amount of the crop taken off the market plus storage costs for that portion of the crop.

This type of program meets two of our criteria for a defensible crop sector farm program. First, it treats the cause of low prices rather than treating the symptoms by taking a portion of the crop off the commercial market, causing prices to rise above the loan rate. Second, a supply management program pays only for a portion of the annual production rather than shelling out money for every bushel, pound, or bale produced or a large percentage thereof.

Supply management programs have come under criticism and we will address them in coming columns, but first we need to take a further look various elements of the program design we are proposing.

A supply management program works by setting a loan rate (the price at which the commodity is taken into storage) and a release price (the price at which the commodity is made available to the commercial market). By setting these two prices, the program establishes a band within which the commercial market and the forces of supply and demand establish the price that allocates the commodity among various competing uses.

The loan rate serves to establish a floor price that protects farmers from long periods of low prices while the release price protects consumers when supplies are tight as the result of decreased supply or increased demand. Thus the government’s investment in the program serves the needs of both the producer and the ultimate consumer by moderating prices at both ends.

In addition, if the loan rate were to be set properly, then the program would be a true Blue Box program under current trade agreements. It would mean that US farmers could not be accused of dumping surplus grain on the world market at prices that are below the cost of production. In addition, particularly for farmers in the least developed countries, this program would put a floor under their prices and provide them with some stability as well.

To establish how the program works we want to limit our immediate consideration to a program design in which the government holds the stocks through a federal government organization called the Commodity Credit Corporation (CCC).

When the commodity, say corn, is sold by the CCC at the release price the government recoups the acquisition costs at the loan rate, interest, and most, if not all, of the storage costs, which is not true or the programs we currently have.

As the crop is received by the CCC, it is put into storage which serves as a crop reserve. History has shown that without setting a ceiling on the amount of the crop held in reserve, the reserve can become unwieldy. In setting that limit, policy makers need to look at the historical variability in supply and set the maximum size of the reserve so that it can meet the needs of the market in tight supply situations.

To keep the reserve from exceeding the maximum size, production will have to be reduced which means reducing acreage. In the past, acreage was set crop by crop which led to distortions as the relative usage and prices of the various row crops changed. Any future program would have to allow for planting flexibility and instead take a certain amount of acres out of production, allowing farmers to choose their own crop mixture.

We will discuss additional details of and issues surrounding a sound supply management program in future columns.

Harwood D. Schaffer is research assistant professor, retired; University of Tennessee; and director of the Agricultural Policy Analysis Center (APAC). Daryll E. Ray is professor emeritus, University of Tennessee, and is the former director of APAC.