Posted on 05/01/2004 3:18:07 AM PDT by Remember_Salamis
U.S. Agricultural Policy: Ensuring Taxpayers Shell Out a Bushel NTUF Policy Paper 149 by Kathryn Landuyt
Mar 29, 2004
The economic condition of farmers has engaged the attention of public policy- makers for over sixty years. During this time span agricultural policy has vacillated amongst a variety of mechanisms with the "underlying assumption that farm policy can and should reduce the risks farmers face by stabilizing prices and incomes."[1]
Since government first pursued an active role in agricultural public policy, it appears as though the economic problems of farmers have exacerbated over time. The unprecedented amount of money spent, the number of claims made, and the sheer amount of government time spent dealing with farm-related issues seems to indicate that farmers are facing greater challenges today than ever before, but is this in fact true? While the efforts made to combat the economic problems appear evident, the reasons justifying these efforts do not seem quite as clear.
One component of the farm sector's economic circumstance that is not considered in designing agricultural public policy is the issue of "moral hazard" -- whereby individuals, in this case farmers, make inappropriate decisions in the absence of supervision that would otherwise compel them to act appropriately. Therefore, under the idea of moral hazard, farmers induce economic problems for themselves with the knowledge that government will cure these problems.
More often than not, solutions offered by the government render farmers better off economically than if farmers acted appropriately, making the choice of government assistance all the more enticing. A cyclical effect develops as farmers take advantage of this situation and government keeps running to the rescue, forcing agricultural public policy efforts to multiply in intensity as well as cost.
Current emphasis on the use of government-sponsored crop insurance programs highlights the problem of moral hazard infesting agricultural public policy today. Ironically though, crop insurance was initially perceived as an alternative for historically utilized policy tools, one that would lower costs associated with assisting farm problems. Instead, the moral hazard influence has exerted precisely the opposite effect.
Amidst all the rhetoric, the failure to acknowledge the ramifications surrounding this waste of government (and therefore taxpayers') money regrettably continues. Even worse though, the scenario is actually multifold since taxpayers are affected on several levels repeatedly. Taxpayers first come under the policy spell by way of dishing out money to support the program from the beginning. The "opportunity cost" of keeping this money or actually seeing the money put to use for something self-beneficial is forgone.
Taxpayers next fall victim at the consumer level, as government price control efforts compel taxpayers to buy agricultural commodities at prices artificially propped up by tax dollars (and thus their own incomes). Hence, Americans essentially pay twice for a commodity -- first through taxes and secondly through artificially high prices, slowly eroding disposable income.
History of Agricultural Public Policy
Wholesale government intervention within the agricultural marketplace first began during the Great Depression of the 1930s, when farmers underwent a significant period of financial stress. The Agricultural Adjustment Act of 1933, along with succeeding farm bills during this dramatic time, marked the beginning of a formal federal role in agriculture. At this point, the primary goal was to assist farms in just managing to survive. Farm prices had dropped by 56 percent, making way for the successive decline in farm income by 70 percent.[2]
By 1954, farm policy shifted towards a focus on flexible price supports. Under this policy the government could ensure farm prices and farm incomes simultaneously. Instead of attempting to hold the price of goods fixed, the government established a range of movement (minimum mandated prices) for the floor price of commodities. Agricultural products could not be sold for less than a designated range of movement in price, thus guaranteeing at least some income level for farmers. Products could, however, be sold for above the minimum range.[3]
The 1970s brought about a policy of market orientation. By separating farm price practices from farm income practices, policymakers hoped to restore competitiveness in the world market and take advantage of strong foreign demand -- both would allow a substantial increase in exports. Policy objectives for farm prices and farm incomes were pursued by means of two tools. Farm prices were taken care of by price targets, which "provided for direct payments, called deficiency payments, to producers of the difference between the target price and the average market price whenever the average market price for a specified period of time falls below a target price."[4] The U.S. could export competitively and at the same time support farmers if the competition drove down prices to a level that threatened farm income.
When the 1980s came, agricultural policy shifted gears again. Rampant inflation during this time prompted then-President Ronald Reagan to initially pursue a tight monetary policy. Assistance to farmers came in the form of "nonrecourse" loans supplied by the Commodity Credit Corporation (CCC).
A nonrecourse loan works by providing farms with a loan equal to the government-established price of a crop multiplied by the amount of that crop in possession by the farmer. The farmer can then choose to sell the crop if the market price is higher than the government-established price and return the loan (plus interest). Or, if the market price is lower than the government-established price of a crop, the farmer can refrain from selling, keep the loan as income, and turn over all crops to the government as payment for the loan.
Unfortunately, the federal government was not the only one attempting to operate on a tighter budget during the early 1980s; so too were consumers, the result being that the majority of loans granted by the CCC were never recovered and crop storages overflowed.[5]
Agricultural Policy Today
The farm policies that had begun during the Great Depression and evolved in the decades afterwards proved so costly that serious reconsiderations of farm policy came into play during the 1990s. The 1996 Farm Bill, and most recently the 2002 Farm Bill, seemingly (but not actually) offered the most promise to enact a budget-conscious policy.[6] Besides doing away with most of the previous policy tools, except the nonrecourse loans provided by the CCC, one of the major changes in the agricultural public policy realm was the growing insistence of the government to share the responsibility of economic problems facing farmers with farmers themselves. [7]
The agricultural insurance program became a cornerstone of the new farm policies and provided a way for farmers to take on the burden of their own price and income assistance programs. "Under the old program if price went down, deficiency payment went up," or government price supports increased, but now "farmers will need to substitute other risk management tools in place."[8] Crop insurance comes in several forms. First is private crop insurance, in which farmers pay a premium to collect on if the crop insured fails for some reason. The amount paid to cover damages depends on the crop insurance level chosen and the corresponding premium.
All other crop insurance programs are government-sponsored and fall into three categories. Federal Multiple Peril Crop Insurance works on the individual farm level and helps farmers internalize the cost of purchasing crop insurance as part of their business expenses (under a private crop insurance purchase this cost is not counted as a business expense). Farmers must accept a minimum level of insurance, but have the option to buy up to 75 percent of the value of their crop if the crop is destroyed or the price falls below the government-established market price.
The second type of government-backed crop insurance plan is called the Group Risk Plan, whereby everyone in the large, nationwide, pre-defined group who wishes to participate pays the same premium rates for a specified coverage level.
A third insurance program is revenue insurance, which guarantees a farmer a certain level of revenue from a crop. This is similar to an income protection plan, whereby income is guaranteed based on the harvest futures market at planting time.[9]
It is obvious that farmers have not been completely left to fend for themselves under the new policy goals, since crop insurance has a federally-sponsored cushion. Despite the strategy of shifting towards a balance of responsibility in agricultural public policy, farmers now have yet one more option: harvesting insurance policies.
The Backfire and Its Causes
The United States government-run subsidy program has cultivated the seed of moral hazard, from which sprouts agricultural malaise. As one national newspaper noted, "The Agricultural Department occasionally endorses insurance offerings that practically invite farmers to fail. One deal in Texas in 1999 insured fall-planted watermelons. But weather stacks the odds against melons planted at that time of the year. South Texas farmers planted lots of melons, lost much of the crop, and reaped a total of $21 million in insurance payouts."[10]
In addition, President Bush signed a $3.1 billion ad hoc disaster relief bill in February 2003 for drought and other recent losses. This bill will provide even more assistance to farmers who bought crop insurance, and for those who didn't it provides substantial help in exchange for the sole promise to buy crop insurance for the two years following the bill's enactment.[11] In the 1991 to 1992 period, farmers paid $7.8 billion in premiums while receiving $14.7 billion in indemnity payments, which together yields a net benefit of $6.9 billion.[12]
The basic economic model for understanding any type of producer behavior is rooted in the "expected utility theory." Here, producers are assumed to maximize expected utility of wealth when making production decisions. In other words, a producer will choose production methods that are expected to achieve the most lucrative end results.[13] Applying this same theory to the realm of agriculture, we see that a farmer picks a system that expects the most profitable crop yield. However, this model of behavior is somewhat oversimplified -- in the case of agriculture the word "production" hardly exists and is eclipsed by the word "decision."
The production process whereby farmers attempt to secure a money-making harvest could more aptly be called a decision process. Over the years, with the advent of extensive government-supported agriculture programs (including the most recently taxpayer-funded crop insurance plan), farm production mechanisms have given way to decision mechanisms as the agriculture sector seeks to make the federal government its number one customer. Forget planting, irrigation, and plowing systems -- farmers have been engaging in a complex coordination of government programs supporting their incomes. It is not natural hazards, foreign tariffs, or changes in consumer preferences that have changed the profits of farmers. The real culprit lies in moral hazard.
Moral hazard arises when government policies give farmers a chance to opt for programs not necessarily justified by market economics. The problem "occurs because the [agent/farmer] can take actions which affect the probability of losses and cannot be observed by the [principle] . . . In general, these input choices differ from socially optimal choices. For example, inputs which reduce the probability of low yield might be used less intensively than is socially optimal."[14]
To observe the issue in another way, "if Congress in 2002 passes a law that preserves the $17 billion Freedom to Farm and loan program payment of the last two crop years . . . farmers will assume this policy will continue indefinitely."[15] On the other hand, an "alternative approach is to model farmers as disbelieving the permanence of new laws or regulations, and assuming they will go away after a few years or depreciate in value."[16]
The difference between these two paths is that in the former, government programs are encouraging farmers to remain in a state of false need in order to collect support payments, whereas the latter program is creating a sense of randomness in that farmers might get some support but at the same time act to ensure that with or without the support they may still subsist successfully.
Now a major distinction comes to light -- if farmers expect the bailout, the bailout continues because farmers are making decisions that perpetuate a cycle of need that is met time and time again. However, if farmers can only hope for assistance then they are more inclined to take measures to be successful, with or without government handouts. Money is needed constantly to fund an ongoing bailout, but a helping hand in hard times is less costly because it only happens at the greatest necessity. Even then, it is not as expensive as it probably could be, since the farmers have been taking significant strides to avoid this dismal state from the beginning.
Detrimental Spillover Effects
The government is not the only one taking a hit on this policy though. Private firms that provide similar services to those of government-sponsored agricultural programs, such as crop insurance, lose out too. The discounted government program has driven insurance business out of the private sector and into the public sector. The situation has become so bad that private crop insurance companies like Independent Agents & Brokers of America, "[say they] will go to court if necessary to block the expansion of a federal program that slices members' commissions on crop insurance."[17]
The federal program in question is the federally-approved Premium Discount Plan, underwritten by Converium Insurance North American, Inc., formerly Zurich Re, and sold through Crop I Insurance Direct, a general managing agent.[18] Under this plan, associated companies can sell insurance at discounted rates.
Currently, the discount is exacerbated by the USDA's recent move to sell insurance for the 2003 growing season at rates discounted up to 10 percent from the government's standard crop insurance rates.[19] According to Bob Skow, Chief Executive Officer of the Independent Insurance Agents of Iowa, "The bottom line is this: We feel that this particular premium discount program is leading to some unfair competitionÉ. If it were to become successful, agents would see their nominal commission rate on policies of 15 percent cut by 5 to 10 percent," he said.[20]
The subsidy tool of farm policy creates "the subsidy incentive [where] the difference between the actual premium and the actuarially fair premium as determined from FCIC [Federal Crop Insurance Corporation] information (it includes subsidies and other rate adjustments for nonactuarial purposes)" is skewed such that the actual premium is below the actuarially fair premium.[21] "Beginning with the Federal Crop Insurance Act of 1980, crop insurance premiums were subsidized."[22] With subsidies, the insurance premiums reduce the amount of money farmers pay to be eligible for indemnity payments.
Thus, if subsidization is figured into premiums that are set equal to expected indemnities, there is a situation where indemnities are provided at a level lower than cost, forcing the program to enter the red zone. Furthermore, the presence of this added benefit (getting more than paid for) prompts others to capitalize on the savings unnecessarily, adding more costs. Ideally, premiums for government crop insurance should equal expected indemnities so that the program breaks even. In the private crop insurance segment, premiums must be more than indemnities in order to compensate the insurance underwriter for carrying risk.[23]
The chart on the page that follows was featured in The Wall Street Journal on May 5, 2003 and shows just how large the discrepancy between the amount of money collected in premiums and the amount of money paid through indemnities has grown.
Big Harvest
Farmers as a group get more for crop insurance claims than they pay in premiums. The difference, in billions.
Note: Figures are for the year in which crops were harvested. Source: The Wall Street Journal, May 5, 2003, United States Department of Agriculture.[24]
The USDA has defended this program by saying that funding crop insurance at a lower rate than private means is "intended to increase competition in the crop insurance industry" and ultimately make crop insurance cheaper.[25] In actuality, this theory is not cheaper, nor does it prompt competition. Reduced costs for farmers are paid for by taxes and private companies cannot compete since they do not have anyone else to swallow their costs (like crop insurance has taxpayers). What has essentially taken place is a government-sanctioned monopoly.
The bottom line is indefensible: for taxpayers, "crop insurance hasn't been such a sweet deal. The government estimates its costs for crops that failed in 2002 hit $3.9 billion, up 75 percent from what the program cost in 2000."[26] During the previous fiscal year, for the 2002 droughts, farms are collecting about $3.75 for every $1 they spent on crop insurance.[27] Compared to this 375 percent gain, the historical return on the stock market is only 10 percent and even less in bad times. If this is the case, then people could just convert their backyards into farms in order to collect government subsidies. No real effort is needed to farm, only a plot of land upon which to make a claim.
An Example to Emulate
Agriculture sectors in New Zealand and the United States are comparably similar with the exception of one characteristic: New Zealand does not support a government-sponsored agricultural program of the size and scale found in the United States.[28] A comparison between the United States and New Zealand shows that indeed there is a level of moral hazard because the farm business of New Zealand has thrived for years and even set new records of success.
Furthermore, New Zealand once featured a large government-supported agriculture program to assist farmers, but then scrapped the program. Prior to reforms New Zealand subsidized farmers at about 30 percent of the value of production, whereas the United States currently maintains a 17 percent level of subsidization.[29] One might think that reforming New Zealand's agricultural policy was a nearly unattainable goal, especially when considering the high level of subsidization New Zealand farmers enjoyed and the fact that the New Zealand economy is five times more dependent on the farming sector than the United States.[30]
Yet that conclusion would be wrong -- in 1984 New Zealand bluntly ended all farm subsidies. The result has been new levels of success in the profitability of the farm sector. Improvements since ending subsidies include an increase of 40 percent in the value of farm output and productivity growth averaging 6 percent each year; meanwhile, output has risen by 3 percent, yet only 1 percent of farms have gone out of business since the reforms began.[31] New Zealand's farming sector is thriving under free market conditions. Without the government standing as the single largest surefire customer, farmers had a clear incentive to make their operations profitable or else risk lost income.
Conclusion
The essential point of contention driving agricultural public policy rests on whether government or free markets will perform best in allocating goods and services. The four most frequently mentioned reasons for government involvement include preventing low farm incomes, stabilizing farm prices, preserving an adequate food supply, and protecting the capacity of agriculture to produce in the future (conservation programs).[32] While all these concerns are real, what about the overlooked group of taxpayers, who must foot the bill to prop up agricultural America and at the same time purchase the very same products they are buttressing?
A survey of attitudes of United States adults concerning agriculture, farming, and farmers indicates that 76.8 percent believe that "farming should be an occupation where farmers can make their economic decisions independently," not in conjunction with the government.[33] Moreover, only 25 percent of these same adults say that they would be willing to have food prices raised to help preserve farms.[34] A whopping majority of those surveyed favor more independence between farmers and the government, yet these adults, taxpayers, and constituents obviously have not been duly represented in Congress, as more bills are passed to unite farmers and government closer together than perhaps ever before. With Gross Farm Product encompassing a smaller and smaller share of Gross Domestic Product and farm employment dropping, how can farm expenditures that continue to grow be justified, especially in the wake of New Zealand demonstrating a successful free market system?
There is no justification for the current path of agricultural public policy. The government needs to get out of farming and let farmers just farm.
About the Author
Kathryn Landuyt served as an Associate Policy Analyst for the National Taxpayers Union Foundation in 2003.
Notes
[1] Gardner, Bruce L., "Risk Created by U.S. Policy in Agriculture," in Just, R.E. and Pope, R.D., Eds., A Comprehensive Assessment of the Role of Risk in U.S. Agriculture, (Boston: Kluwer Academic Publishers, 2001), p. 489.
[2] Knutson, Robert et al., Agricultural & Food Policy, (New Jersey: Prentice-Hall, 1998), p. 246.
[3] Ibid., p. 260.
[4] Ibid., p. 262.
[5] Ibid., p. 271.
[6] Ibid., p. 274.
[7] "Farm Security and Rural Investment Act of 2002," Public Law 107-171, 107th Congress, 2nd Session, May 13, 2002.
[8] Knutson, Robert et al., Agricultural & Food Policy, p. 275.
[9] Ibid., pp. 286-90.
[10] Kilman, Scott, "Abuses Plague Program to Insure Farmers' Crops," The Wall Street Journal, May 5, 2003, p. A1.
[11] Ibid.
[12] Young, Edwin Y., Vandeveer Monte L., and Schnepf, Randall D., "Production and Price Impacts of U.S. Crop Insurance Programs," American Journal of Agricultural Economics, 2001, Volume 83, Issue 5,
p. 1196.
[13] Meyer, Jack, "Expected Utility as a Paradigm for Decision Making in Agriculture," in Just, R.E. and Pope, R.D., Eds., A Comprehensive Assessment of the Role of Risk in U.S. Agriculture, (Boston: Kluwer Academic Publishers, 2001), pp. 3-19.
[14] Nelson, Carl H., and Loehman, Edna T., "Further Toward a Theory of Agricultural Insurance," American Journal of Agricultural Economics, 1987, Volume 69, p. 527.
[15] Gardner, Bruce L., "Risk Created by U.S. Policy in Agriculture," p. 499.
[16] Ibid.
[17] Ruquet, Mark E., "Agents Threaten Suit on Crop Insurance," National Underwriter, April, 28, 2003. Volume 107, Issue 17, pp. 28-30.
[18] Ibid.
[19] "Federal Crop Insurance Rates Discounted," Farm Industry News, Mid-February 2003.
[20] Ruquet, Mark E., "Agents Threaten Suit on Crop Insurance."
[21] Just, Richard E., Calvin, Linda, and Quiggin, John, "Adverse Selection in Crop Insurance: Actuarial and Asymmetric Information Incentives," American Journal of Agricultural Economics, 1999, Volume 81, Issue 4, p. 834.
[22] Ibid.
[23] Ibid.
[24] Kilman, Scott, "Abuses Plague Program to Insure Farmers' Crops."
[25] "Federal Crop Insurance Rates Discounted," Farm Industry News.
[26] Kilman, Scott, "Abuses Plague Program to Insure Farmers' Crops."
[27] Ibid.
[28] "Life After Subsidies: The New Zealand Farming Experience, 15 Years Later," Federated Farmers of New Zealand, revised November 1999.
[29] Chris Edwards and Tad DeHaven, "Save the Farms -- End the Subsidies," The Washington Post,
March 3, 2002, p. B7.
[30] Ibid.
[31] Ibid.
[32] Knutson, Robert et al., Agricultural & Food Policy, p. 16.
[33] Ibid., p. 11.
[34] Ibid.
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