Issue Position: Agriculture

Issue Position

Agriculture

Agriculture is extremely important to the U.S. in general and to this area in particular. Our farmers are the most productive in the world. Unfortunately, high agricultural production frequently exceeds demand and depresses agricultural prices and profitability. Furthermore, trade practices of other nations frequently subsidize their agricultural exports or restrict our agricultural producers' ability to export to them. Consequently, there often is international trade friction associated with agricultural products and with the direct and indirect subsidies directed at agricultural production. Those frictions pose political risks that are in addition to the ordinary risks of whether, disease, and market price fluctuations that agricultural producers ordinarily face.

Several years ago, the U.S. passed a farm bill that was badly needed by farmers in this area as cotton prices had plunged to roughly 30 cents per pound. The farm bill raised support prices for cotton and, in order to ensure its passage, for numerous other crops besides. In the short run, the farm bill helped local producers, but now it is beginning to cause problems. Brazil has won a case before the World Trade Organization that claims our cotton price support subsidies are excessive and hurt poor country cotton producers around the world. Furthermore, in order to proceed with the Doha round of international trade agreement talks, the U.S. has recently agreed to cut agricultural subsidies by 20%. In addition, because the recent farm bill set price supports so high for many commodities that no producers could take a loss, it has encouraged overproduction in many areas, thereby depressing market prices for those commodities and guaranteeing that U.S. price support payments will, in the long run, be higher than estimated initially, thereby adding to the U.S. budget deficit. Consequently, potential budget cutters may target the farm bill for cutbacks, and there now are fewer farm-state representatives in congress to protest such cutbacks.. Thus, despite what others may say, the recent farm bill is in trouble politically.

Our problem, then, becomes one of figuring out how to prevent the farm bill rug from being pulled out from under local producers. It may not be good enough to say it must be defended at all costs because the U.S. trade negotiator is likely to sacrifice some agricultural price supports in order to ensure that the Doha trade round will go forward. Thus, one must come up with additional rationales for protecting certain agricultural producers. There are three rationales I can think of.

First, while Libertarians support free market price mechanisms, in this case, because of past price supports, agricultural markets have been distorted and capital has been misallocated. Consequently, one can argue that we should move toward flexible support prices gradually so producers have time to adjust if they are not the low-cost producers and need to reallocate their capital over time. Thus, I suggest that one can argue that agricultural price support levels be set at average market price levels over the past ten years. Initially, the price supports would stay as they are, but each year, the average support level would be adjusted by taking 9/10 of the previous years price support level and adding 1/10 of the most recent year's average price for that commodity. In that way, price support levels would gradually adjust down for commodities that were being overproduced and the least efficient producers would be able to leave the industry gradually before their losses became financially crushing. This would incorporate the benefits of the free market system without crushing producers financially with rapid price changes.

A second rationale for continued agricultural price supports is that certain commodities might be deemed to be essential goods for the country to produce, in order to maintain self-sufficiency for national security reasons. If it were to be deemed desirable to maintain enough domestic capacity to produce 10 million bales of cotton each year, the government might run a Dutch auction each spring in which producers could offer to sell the government a certain amount of production (deliverable, with predetermined grade discounts, as called for by the cotton futures exchange) at a fixed price for December delivery. The government could accept bids for the predetermined amount at the price determined by the Dutch auction mechanism--in essence, issuing futures contracts to buy the predetermined amount at the Dutch auction determined price. All winning bidders in the auction, who had bid an amount equal to or below the final price, would, in essence, have sold a futures contract to the government guaranteeing the amount of cotton to be delivered and the price at which it would be delivered. Since these contracts with the government would be the same as futures contracts, they could be hedged in the futures markets, if necessary, and the government could pass its contracts on to the futures markets by selling futures there. That mechanism would allow prices to be hedged forward for a substantial amount of the year's crop, provided that the futures contracts had sufficient delivery flexibility with respect to location and grade discounts so that a wide variety of producers, exporters, and consumers would have access to the market. They also would ensure that a certain minimal amount of production could be grown and financed each crop year, depending upon national needs.

A third rationale for maintaining some price supports is that other countries have ganged up on the U.S. to inflate our dollar value and distort our exchange rate, with resulting effects on market prices of internationally traded goods. It is quite likely that the U.S. dollar is overvalued by 20% or more on a purchasing power parity basis. As a result, our exports sell for 20% or more higher in foreign currency terms than might be desirable. Consequently, domestic prices for our exported commodities may have to fall by 20% or more to make our exports attractive to foreigners. That could make the difference between 40 cent per pound and 50 cent per pound cotton. Temporary price supports could be defended on the grounds that they were needed to adjust for the fact that our currency was not being allowed, due to the intervention in our foreign exchange markets by other countries, to trade at its purchasing power parity. While this is true, I don't like this rationale because purchasing power parity is a slippery concept and, thus, there would be no single price level of support that could be justified, and the resulting price level would be a political football, encouraging retaliation from other countries in the world. Instead, I favor this argument as a theoretical argument for explaining why price supports for agricultural producers are justified--and thus why a flexible price support system can be maintained in the U.S.

If a flexible price support system were to be adopted, agricultural producers would have to assess whether they were among the low cost producers for a commodity or whether they should shift their production to other commodities. In this area, many producers are efficient cotton producers, and probably would be among the most efficient if water subsidies to California and Arizona producers were to be fully priced. However, other crops also do well in West Texas. Grapes, peanuts, onions, trees, and livestock, all can be profitably produced, and agricultural economists and researchers at Tech may have other helpful ideas. In addition, hunting rights can be sold and wind farms located on some lands. Overall, there are many areas where farmers can earn diverse sources of income from their land, so they do not have to be fully committed to growing only one crop. In fact, one of the most important principles of finance is that an investor (which is what a landowner is) should diversify because the future is uncertain.

One disadvantage to diversification, however, is that farmers incur considerable capital costs in gearing up to produce particular commodities. Unfortunately, after investing in and depreciating their specialized equipment, they might be hit with expensive tax burdens for the "recapture" of their depreciation expenses if they sold their equipment. I think this is inequitable and would like to see the tax laws changed so all agricultural equipment expenditures would be eligible for deduction as current expenses with no recapture required.

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