On Agricultural Subsidies by Rich Countries-BECKER

A report due out at end of July on agricultural policies in countries that belong to the Organization for Economic Cooperation and development (OECD) quantifies the extensive government subsidies farmers receive in these countries. These subsidies amount overall to about 29% of their farm revenues. This per cent varies considerably: from highs of 68% in Switzerland, 64% in Norway, and 56 % in Japan, to "only" 16% in the US, and a relatively low 5% in Australia. The beautiful views of cows and sheep on the very green Swiss mountains are courtesy of the Swiss government that pays farmers generously to keep these animals grazing on the mountains. Developing nations object to the farm subsidies by rich countries because they make it difficult for farmers in their own countries to compete in the world markets for agricultural goods. The European Union has high tariffs against farm imports from countries outside the Union, while the US gives significant export subsidies to its agricultural products. Most rich nations have direct payments to farmers when agricultural production increases, and they also help subsidize the cost of water, seed, machinery, and other farm inputs. Farm subsidies are the main complaint lodged by developing nations against the trade policies of developed nations in the ongoing Doha talks on more open international trade. Richer nations in turn complain about the many barriers to imports of Western and Japanese goods erected by poorer nations. Both sides are right, but the US and other rich nations should greatly liberalize their farm policies irrespective of whether developing nations lower their trade barriers. The reason is not mainly to help poorer nations, although it would do that in a way that adds to world economic efficiency and trade. Freeing agriculture would also help consumers and even many farmers in rich nations. Whether subsidies to agriculture raise or lower prices to domestic consumers depends on the form the subsidies take. Restrictions on imports of farm goods clearly raise domestic farm prices by cutting back access to farm products from more efficient producers in poorer nations. Subsidies to farm exports also raise domestic prices by artificially diverting production from the domestic to the export market. Subsidies to farm inputs like water encourage excessive use of water compared to other inputs. This is partly through inducing farmers to shift production toward crops that use a lot of water, such as rice, and away from crops that use little water. The result is lower prices for water-intensive crops, and higher prices for water-sparing crops. The OECD report estimates that more than half of the farm subsidies in member nations are through policies that raise domestic prices of agricultural goods. The argument is sometimes made that farm subsidies are desirable to encourage small farms, and the way of life on these farms. Yet this claim is contradicted by the evidence available for many decades, and confirmed again in the OECD report, that the vast majority of subsidies go to the largest farms. In many cases they are given to people who own but do not farm their land. Another argument in defense of farm subsidies is that they contribute to a better environment. Some of the subsidies may do this by reducing population density and pollution, but many others add to environmental damage. For example, subsidies to irrigation and other water use by farmers is one of the major ways that fresh water is wasted. Environmental and geopolitical arguments are used to justify the large subsidies to ethanol production from corn in the US. Ethanol helps reduce the West's dependence on oil because ethanol is a substitute for gasoline. GM and other companies are beginning to promote E85, which means 85% ethanol and 15% gasoline. Automobile fuel tanks can easily be modified to take this combination, but the US still has only a small number of gas stations that have the expensive equipment to dispense highly ethanol-intensive fuel. Ethanol not only reduces dependence on oil imports, but also ethanol based fuel cause less pollution than gasoline does. Ethanol probably also uses less energy, although that is debated since both the plants that produce ethanol, and the fertilizers that help to grow corn, use considerable quantities of natural gas. The US has subsidized ethanol production from corn primarily to help corn growers rather than to reduce energy use since it is combined with a steep tariff on imports of ethanol from elsewhere. These imports would come mainly from Brazil that produces ethanol from sugar cane at a much lower cost than the US production from corn. Instead of subsidizing domestic production of ethanol, a much wiser policy for the US would be to eliminate these tariffs and import ethanol from democratic and friendly countries like Brazil that can produce ethanol more cheaply. The economic case for eliminating farm subsidies by rich countries is a compelling one since these subsidies are inefficient, generally raise food prices to consumers in these countries, and anger developing countries that see their natural markets blocked. Yet while economists have been rather united in their criticisms of agricultural policies, the farm lobby has been powerful, especially in Japan and many European nations. This is despite the fact that farmers in most rich countries constitute no more than a tiny percentage of the labor force. It may seem paradoxical that farmers are typically rather heavily taxed in poor countries, like India and China, where they constitute a large fraction of the population, and are subsidized in rich countries dominated by cities and towns. But the economic analysis of interest group politics demonstrates that small groups are often much more powerful politically than large groups, even in democracies where large groups would seem to command more votes. The explanation is that small groups may be organized more easily-although farmers tend to be spread out geographically- and the per capita tax on others to finance the subsidy to small groups tends to be smaller than the per capita cost of subsidizing large groups. Whatever the explanation, experience has shown that it is difficult to eliminate, or even greatly cut back, farm subsidies in richer nations. There is more hope for being able to change the subsidies to ways that are less discouraging to agricultural imports from poorer nations, that do not mainly help richer farmers, and that do not raise food prices to consumers. Possibilities include the equivalent of an earned income tax credit to fulltime farmers who make low incomes, lump sum income payments to farmers, and possibly greater support for education in farm areas. While the best politically feasible alternatives to present policies are not so clear, it is obvious that the present system of farm subsidies in rich nations is a lightening rod for conflict in trade talks with third world countries, while they help their own farmers in highly inefficient ways.

Comments

[N.E.Hatfield]

Harris, If you take a look at UDNations acreage yield vs. manpower input they have no comparative advantage. Where their advantage lies is in their methods devoid of herbicides, pesticides, fertilizers, and lower yielding seeds. No cost inputs here. This places their acreage yields far below the U.S. and most other developed nations. In fact, it makes most of them into subsistence farmers.

So where is the excess product coming from? Out of their mouths, taken by their governments to cover their debt to the international banking community. UDN's definitley require a radical rethink of their basic agronomy policies.

[Leighton]

In response to Ben and Jack, thank you for the remarks. I'll reply in order to the remarks made above.

to the issue of whether farmers are and would be willing to "give something up" - surely they do, to the extent that they have other options in employment. I think here, though, it's not a matter of giving something up that is discretionary in light of the fact that many farmers are facing bankrupcy (more than they can give up and continue to eat, etc.). If they had some vehicle by which to survive when operating a "failing" business, perhaps they might.

as to whether farms make small communities possible - I should have been more clear. Certainly, I don't mean to suggest that only farms make all small communities possible, but I do think that it is fair to say that the small communities of which they are a part (which is a majority of the midwest in this country) rely upon them. for example, where I grew up, towns previously populated at rates of 2 to 5 thousand are struggling to keep their own schools, etc.

As to the issue of whether small towns do "produce" some sort of "output" for which the end consumer does not pay, I disagree that the answer is clearly "no." I know that as a "midwestern boy" who grew up "on the farm," employers (for one) deeply value the "work ethic" that is so common in small towns. With that said, I do not have such a clear view on the issue myself. As a young person studying economics, I often found myself arguing to my father that what happened to shoe makers, barbers, restaurants and grocery stores in these same places "must" at some point happen to farmers. To my mind, though, this goes to the question of valuing whatever is "produced" in these situations, which the end consumer or "market" may not be able to do. To take my above example, if law firms want to continue to be able to hire persons of a certain "sort" (midwesterners from small towns), in what way could they indicate as much? Further, couldn't it be the case that imperfect information prevents the end user of this "product" from appropriately valuing it (even by their own terms)?

and, as for the suggestion that rural areas benefit more from roads and traintracks laid down through them, you may be right. It seems to me, though, that you are receiving some benefit from the products leaving Iowa through those same roads and tracks.

As I had tried to indicate earlier, I am sympathetic to the notion that the market can be trusted. Explanations for why not in specific instances need not fall outside of free-market terms. Although my suggestions may seem tenuous, is it not possible that unaccounted-for costs and benefits exist here? More to the point, if we were to assume that this was the case (as some people do), what mechanisms would YOU suggest policy makers use to account for these benefits?

L

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[Haris]

NE:
I'll agree that most countries' agriculture policies probably need some adjustment. And I think everyone will agree that most developing countries' agricultural industries are less productive, on a per acre basis, than their American and European counterparts. However, the developing countries are much, much less efficient when it comes to building hybrid engines and putting together airplanes. This difference in productivity is what gives them a comparative advantage. [Not an absolute advantage: a country can be less efficient at producing every good and still have a comparative advantage in at least one.] The reason that many of these countries don't produce a surplus is because they cannot sell it. The world is flooded with cheap subsidized Western agricultural products because, thanks to subsidies, producers can sell below cost. Remove the subsidies and let developing countries compete fairly, and their production will rise because the price they receive on the world market will rise.

Leighton:
You are right, there are probably many uncaptured costs and benefits here. On the costs side, subsidizing agriculture reduces the labor pool available for places where it would be more beneficial in the long run, it increases pollution from farm runoffs, skews dietary preferences to match prices rather than nutritional requirements, not to mention costs the West billions in foreign loans and grants to countries that would be able to survive without them if there were no subsidies. On the benefits side, as you said, agricultural work fosters work ethic, reduces unemployment and probably crime in rural areas, makes the nation more self-sufficient, and, last but not least, provides some sort of psychic rewards in preserving tradition.
As you can see, the uncaptured costs and benefits are many and complex, and it is by no means clear that there should be a subsidy or a tax, or what its magnitude should be. While a subsidy would be a good way to encourage more of the product to capture its positive externalities, in the absence of clear evidence that this is the case I say let the market do its thing.

[ben]

To All, "Subsidies raise the cost of product." Do they now?

Yes. Lost-cost means of production don't need a subsidy to be employed. Production must be increased in ways that are especially costly, otherwise that means of production would have employed without the subsidy.

Because subsidy increases output, it reduces market price - but price is not the same as cost.

[ben]

Haris

Good response to Leighton.

Leighton

In contrast to Haris, I'm not convinced anything you mentioned qualifies as an externality, and that is what you need in economics to justify a subsidy (the political threshold for subsidies is different and lower). My reading of your list of small town benefits is that they are privately enjoyed, leaving no room for government to improve things.

[N.E.Hatfield]

Harris, Once again we are up against the hard wall of cheap bread and circuses. The fact is we live in a world of hard economic and political realities that colors all thought and action at every level; which will not change. ;)

[Slade]

As a Farm Bureau county board member in Minnesota, I find the usual supply of myths -- e.g. near poverty of smaller farm operators -- and other forms of under-information not to be surprising.

I was surprised by Prof. B's comment:

"For example, subsidies to irrigation and other water use by farmers is one of the major ways that fresh water is wasted."

This unfelicitous expression -- he could have said "inefficiently allocated" -- implies that the user of the water is callously disregarding all sorts of social values. (Certainly the Israelis' irrigation is socially monitored, for example.) I will not argue that ethanol tariffs or sugar quotas are anything but protection. I will argue that city folk do benefit from the children of agricultural towns who arrive in the urban workforce with decent educations are underappreciated.

I admire the reforms in ag policy in New Zealand and Australia that have succeeded.

[Drossos Stamboulakis]

The welfare and inherent efficiency costs of protection are huge: not only for the 'protected' country itself, but for the world at large. However, it is likely that the marginal political cost of moving towards freer trade and policy heavily outweights the benefit.

Take sugar as an example: A proposed aspect of the Australian-USA FTA was the 'opening up' of the protected American sugar market to Australian producers of sugar. Ultimately, this proposition failed (undoubtebly due to the political influence wielded by those who receive protection in the sugar-farming states).

However, this example allows us to illustrate the economic cost due to the restrictions or 'protection' on trade. The USA suffers from:

(1) A higher price for sugar (estimated to be almost 4 times higher than the market price); estimated to cost over $2billion anually for US consumers.
(2) An estimated 7,500 to 10,000 jobs lost since 1997 because of artificially high sugar prices.

The gains in moving towards a freerer agricultural policy are self evident in this instance. Abolition of the sugar program would result in a net annual welfare gain to the US economy of more than $1 billion (US International Trade Commission, June 2002).

The US sugar program is almost a textbook case of concentrated benefits and diffused costs. A very small number of sugar growers receive enormous benefits, while the costs of this protection and subsidies are spread across the entire economy (thus it can be said that the MPB exceeds the MPC and it is likely that protection will remain until they are equal, or the MPC of removing the trade distortion becomes less than the MPB accrued in keeping it).

Consequently, US sugar producers have a very strong incentive to lobby and fund campaigns of US policymakers who in turn support their industry. Thus, whilst the economically rational solution would appear to be a simple one (remove the protection), many difficulties are encountered in the political sphere.

Sugar stands as a good example of the inherent inefficiences of high marginal political costs and their conflict with minimising opportunity cost. The sugar industry is indicative of more widespread problems with freeing up agricultural policy within rich nations.

It is unlikely (in the short to mid-term, at least) that much progress will be made. However, as pressure continues to mount, perhaps breakthoughs on a bilateral level may presage a wider multilateral policy push (something of the Doha-round ilk, but hopefully more succesful). This remains to be seen.

[Vivered]

So much discussion - with so little impact in the real world.

It is basic microeconomics which points out that subsidies are almost always inefficient. But since subsidies (like earmarks) are based on politics, the fact that the subsidies hurt farmers in 3rd world countries in rarely on the minds of the congressmen of the worlds lone superpower.

3rd world countries would be stupid if they buy the 'free markets' story and open up their markets. What is good in theory (or at U-Chicago) is rarely what happens in real life due to real world factors like politics.

[ben]

The US sugar program is almost a textbook case of concentrated benefits and diffused costs. A very small number of sugar growers receive enormous benefits

This comment got me thinking. If subsidies are available to any sugar producer, then won't subsidies, which temporarily raise profits, induce entry until profits are returned to zero? If so, the net effect is: sugar farmers achieve no long term benefit from subsidy, you just get more sugar producers, and a vested interest in maintaining or raising protection. The many costs of subsidies are not, of course, dissipated over time.

Given free entry and access to subsidies by all producers, subsidies cannot assist farmers - though marginal farmers need them to survive!

[Haris]

Two comments:
1. US sugar producers are actually protected by import quotas rather than direct transfers, so once the import quotas are filled, the price rises because high cost domestic producers make up the difference between import quota and demand.

2. If my knowledge of econ serves me correctly, subsidies do in fact encourage entry [to the extent that agriculture allows for that - there is only so much arable land], and profits do return to zero. However, zero in this context includes industry-normal accounting profits, which are significantly higher than they would be without the subsidy. In fact, many of these businesses would lose money and shut down without subsidies. With subsidies, they live, and the taxpayer pays for it. This does result, as you pointed out, in a vested interest in maintaining protection.

[Drossos Stamboulakis]

ben,
You are right in that subsidies do distort the market. They act to alter the way in which the 'invisible hand' of the market operates, leading to overproduction beyond what the market warrants (which in some instances: e.g. positive externalites - think, education. Can be beneficial).

The problems with subsidies (or import quotas or tariffs or any other market-distorting policy) is both this inefficiency cost, and the cost of rent-seeking involved: a cost, which is often hidden to the economy.

The rent-seeking costs (i.e. the costs involved in gaining tariff/quota/restriction, or the maintenance thereof) which includes things such as lobbying costs, political payments, etc. have been found (especially in the case of monopolies) to entirely dissapate the supposed benefit (and in extreme cases, to exceed it).

Secondly, as Haris responded, the effects of subsidies boost uncompetitive suppliers in the domestic market, who operate less efficiently than those internationally. Similarly, there are significant barriers to entry (both natural and legal), meaning that new sellers are less able to be induced to enter the market (and the subsidies tend to go to the established, larger agricultural projects).

The results of this are not just the domestic costs, but have wider global implications: producers of agriculture in poor nations are, due to the subsidy, unable to sell their own goods (this is most pertinent in the case of staple goods such as rice, maize and other crops) on the world market (as the subsidy-induced cost in a large economy such as the US lowers the world price).

As a result, poor farmers not only cannot sell their produce, but often find it cheaper (in dollar terms) for them to purchase what they would otherwise have produced from the more inefficient US producers, who are bolstered by subsidies.

[ben]

Haris

However, zero in this context includes industry-normal accounting profits, which are significantly higher than they would be without the subsidy.

If there is entry, I don't see how this can be true. If with-subsidy normal profits are higher in sugar than they are in, say, wheat production, then won't wheat farmers switch to sugar until returns across different crops are equalized?

Indeed, won't producers in unsubsidised industries switch to farming until returns across industries are equalized?

This all turns on free entry, and Drossos has indicated there are barriers to entry, which desn't surprise me. In the case of farming subsidies, it may be the case that these barriers are actually welfare-enhancing, by limiting over-production, and creating competition among farmers for rents. To the extent this competition favors the most efficient producer, rather than the most effective lobbier, these barriers may be efficient. A case of one distortion partly offsetting another.

[Haris]

ben
while you're right that with free entry, the hypothetical wheat farmers would switch to sugar until profits equalized across those two industries. But even the equalized profits are higher than they would be without the subsidy, since with the subsidy the price producers receive [price they sell for plus the subsidy] is higher than they could get without subsidies and the world market price. The more important distortion, however, is that the subsidized good is overproduced and crowds out other goods that might be more useful but aren't produced.

[Zathras]

Although what Haris says above is true, keep in mind, first, that both sugar and wheat are subsidized, by programs that work very differently, so comparing them is difficult. As well, an important consideration for farmers able to grow both wheat and sugar (that is, sugar beets) is not just the expected price of these two commodities but their expected price volatility. Largely because of the way the sugar progam works to control the supply of sugar to the domestic market, sugar has much less price volatility than wheat. Farmers requiring steady income to service debt will place greater value on commodities the price of which they can predict accurately well in advance.

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