Testimony of

 

Neil E. Harl

Charles F. Curtiss Distinguished Professor in Agriculture

and

Professor of Economics

Iowa State University

Ames, Iowa

 

Before the

 

Committee on Agriculture, U.S. House of Representatives

 

July 30, 1998

 

 

 

 

Thank you, Mr. Chairman, for the opportunity to appear today and testify on problems in the agricultural sector in this country.

My testimony is divided into three parts—(1) thoughts on longer-term farm policy; (2) commentary on the export picture; and (3) concerns about short-run economic and financial stress in the sector.

 

I. Thoughts on Longer Term Farm Policy

Concerns about the 1996 legislation

The 1996 farm bill represented a significant departure from federal farm legislation since 1933. While the transition away from government programs will likely produce a more rational system of resource allocation, several important implications of the shift deserve mention.

• The loss of the so-called "safety net" as protection against low prices is proving to be a serious problem, as we had feared. While some sectors of U.S. agriculture have enjoyed favorable prices until quite recently, low prices have returned. U.S. farmers are the world’s best economic citizens--give them half an economic incentive and they increase output. The result is a disproportionate drop in price--and in profitability. That means consumers are in a very favorable position, assured of an ample supply of food and fiber at a relatively low cost, long-term. But, it means also that producers periodically endure periods of low prices.

The agricultural sector, in terms of policy, is characterized by two important featues:

—First, the number of producers is so great that no single producer can influence price with their output decisions and so they may not cut back on production until price drops below variable costs or they are able to shift to a more profitable alternative crop. This feature makes it difficult for the sector to reduce supply without government assistance.

—Second, although we have become very clever in developing more effective chemicals, better seed varieties, larger and more efficient equipment and improved management, our cleverness still hasn't given us much influence with weather. Year-over-year, weather is the big factor influencing supply of the major crops in this country. Given the enormous capacity to produce, a series of years with favorable weather puts pressure on price. It was to be expected that farm commodity prices will be more volatile than during the era of farm programs. This is important to consumers as well as producers.

• Elimination of the federal farm programs will mean less economic buoyancy from government. While the proportion of farm income coming from government programs has dropped from the relatively high levels of the mid 80s, as shown in Figure 3, elimination of the farm programs will, of course, remove whatever buoyancy comes from government benefits.

After a period of adjustment, the economic returns to labor and capital will likely return to an equilibrium level.

• Another significant feature of the elimination of federal farm programs is the shift in land use patterns that will occur over time. Shifts in land use will be dramatic and will be felt across the agricultural sector, but the greatest shift will occur in areas of marginal land.

Under the farm programs from 1933 to 1996, government farm programs attempted to help balance demand and supply by idling land. Depending upon the year, the amount of idled land ranged from none to 70 to 80 million acres. The land was idled in checkerboard fashion, some of the very best land was idled and some of the poorest. This was not economically rational but it spread the burden of adjustment over the entire country and it did not squeeze producers economically as adjustments were made in the productive base.

Under the 1996 legislation, production decisions are left to the market. And the market doesn't adjust production in the same way as government programs. The market squeezes out the thinner soils and steeper slopes, the higher per-unit cost of production areas. With no land idled, production increases, crop prices fall, and land values come under pressure until there is less profitability for crop production on the least productive land than for the next most profitable use for that land. The least productive land then transitions out of intertilled crops to a less intensive use, to another crop or to grazing land. Depending upon the area, some might transition to wasteland. At least, the increase in supply of grazing land would assure that the less productive grazing land would decline in value.

Rather than having 70 to 80 million acres of farm land out of production on a checkerboard-pattern, there could be close to that many acres which would transition to a lower-valued use unless exports are maintained at high levels. However, the more productive land would not be among those acres moving to a lower-valued use. The transition would tend to be concentrated in areas with highly erodible, lower productivity land that has thinner soils and lower rainfall.

This movement of land to a less intensive use would spell economic pain for producers everywhere. Adjustment pain is felt not just by those at the periphery of the core producing areas, but by producers everywhere. Beyond that, those geared up to sell inputs to or purchase outputs from a crop-based agriculture also would have to adjust. Indeed, the transition for farmers is expected to be shielded in part by the Conservation Reserve Program. Little or no adjustment assistance is expected for those who dry, store or ship grain or oilseeds or who sell seed, fertilizer, chemicals and equipment for a row crop-based agriculture as the area transitions to grazing.

Figure 1 illustrates the fact that, for each major crop, there will be a "core" area of production and a "swing zone" at the periphery.

That zone of thinner soils and steeper slopes at the periphery of major crop producing areas becomes a swing factor in production. In times of good prices, it swings back into intensive production; when prices fall, it’s squeezed out again. This is the reason now why the most intensive resistance to the 1996 farm bill is in those swing areas where the next best use represents an economic jolt for producers and others involved. And it means another dimension of instability for those areas.

So, while the market is doing its job, the squeeze is felt even by those on the best, most productive, soils as the production of the major crops shrinks into a more compact area with 100 percent of the best land in production.

These land use shifts aren't likely to be one-time events. As exports rise (or fall), domestic demand rises (or falls) and changes in supply from technology and weather occur, the zone of swing acreage at the periphery of the core areas will see shifts in land use occur.

All of this is rational, economically, but it adds enormous uncertainty for producers; those who supply inputs; and those who store, ship, dry or process outputs.

 

II. Exports

Export trends

The 1996 farm bill was enacted in a time of optimism in U.S. agriculture. As can be seen in Figure 2, agricultural exports peaked in 1995 and 1996 above $60 billion. Exports have declined since and could go lower.

As can be seen from Figure 2, U.S. agricultural exports declined about 40 percent from 1981 to 1986. During that time, corn, soybeans and wheat piled up in storage, in barges on the Mississippi river and up and down main street. Government payments shot above $25 billion in the worst of these years. While I am not predicting a 40 percent decline in agricultural exports this time, exports could well go lower than at present.

Figure 1.

Figure 2.

 

Figure 3.

Source: USDA.

 

What impact will the Asian crisis have on world food demand and on U.S. farm exports? For the better income countries, where credit isn’t a major problem, commodity demand for food purposes is likely to decline modestly. But for low income areas—especially where credit is a problem—the impact is likely to be much greater.

Until the slide in Asian economies bottoms out, it’s difficult to say how much food demand will suffer. So far, increases in demand elsewhere in the world have offset some—but not all—of the decline in Asia.

An important point to note is that authority for such payments (which, nationally, totaled well over one-third of net farm income in the mid 1980s and in some states exceeded 80 percent of net farm income) isn't in the 1996 farm bill.

Optimism in export projections

Exports may well fall short of projections for several reasons.

▪ Increases in output in Argentina and Brazil, in particular, have been substantial and may well go higher.

▪ In countries with higher per-unit costs of production, as trade barriers fall, producers are unlikely to fold their tents and abandon their land. The more likely scenario is that land values will fall in those countries and producers will continue producing so long as they can more than cover their variable costs with the most profitable crop.

After all, land values are price determined, not price determining. Land has value as expected profitability is capitalized into the value of land. Some areas of the world can realistically expect significant declines in land values as trade barriers are demolished.

Low income countries

The last frontier for increasing food demand is the Third World. While only a modest fraction of each additional dollar of income in the U.S. goes for food, the figure in Third World countries is nearly four times as great. The key is per capita income. An accelerated pace of economic development, with higher per capita incomes, is the long-term solution to assure increased food demand. It is in the interests of low cost producers of food to the world to be supportive of efforts to boost economic development in the struggling economies of the world.

We wish we had a costless, painless solution for lagging countries to the queuing problem headed by countries such as Korea, Taiwan, Indonesia and others which have learned that the route to prosperity is to use their ample supply of low wage labor to produce labor-intensive products the rest of the world wants.

Consequences of trade liberalization

Over the next several years, food consumption patterns are likely to change worldwide—

• Diets will be improved, allowing for more caloric intake per person.

• Consumers will gradually shift to a more protein-rich diet. For many that means a shift away from a cereal-based diet.

• The per capita utilization of grains will likely double or even triple as dietary patterns converge toward the U.S. model of protein-rich but increasingly health-conscious consumption.

In general, in a world of no trade barriers, countries are expected to export those goods that utilize intensively the resources with which the country is relatively well endowed. Thus, countries with large populations relative to the supply of arable land can be expected to produce labor-intensive products and to import products requiring arable land such as feed grains. Likewise, countries with a heavy endowment of arable land and a favorable climate for crop production are expected to produce for export those products requiring arable land. Thus, meats, feed grains and other processed food products requiring feed and food grains should be produced by countries such as the United States, Ukraine, Canada, Brazil and Argentina.

What will this mean for wages, land values and the level of prosperity in agriculture? A compelling case has been made that so long as capital, technology and goods can move freely across international boundaries, wages and land rents should be the same in every country. Note that this theorem does not require the free movement of people, only the free movement of capital, technology and goods.

The consequences of completely free trade should be— (1) a gradual increase in grain prices, (2) higher farm incomes in the short-run in the countries with a favorable land endowment and (3) higher land values in the long-run in the low-cost of production countries as farmers bid the higher prices and incomes into land values. At the same time, it could mean lower farm incomes and lower land values in countries with less productive land that have protected their agricultural sectors with barriers to imports.

The rate of progress toward completely free and open trade will be determined by political considerations. Trade barriers will be reduced as consumers in a country communicate to their governments that they want to eat better and live better. Until that happens, trade barriers in food products will continue.

 

III. Short-Run Problems

Several problems should be addressed in the short-term.

IMF funding

In my view, it is critically important, not only for farm exports but also for economic stability worldwide, for the International Monetary Fund (IMF) to be funded adequately. IMF-led efforts to stabilize the Asian economies and bring about structural reforms will pay off in generous dividends, long-term.

Without IMF intervention, worldwide agricultural exports will decline significantly and the effects of the Asian crisis generally will have a much greater impact on the U.S. economy.

Disaster assistance

In my view, the severity of conditions in the Great Plains states from unusually adverse weather conditions justifies legislative attention. Both crop producers and livestock producers have experienced unusual economic trauma in those areas. Extending crop insurance benefits, providing compensation for flood assistance and targeting help to livestock producers would be in keeping with the well-established tradition in this country of easing the burdens resulting from physical disasters. Figure 4 shows the loss ratio for acres insured under FCIC policies in 1997; Figure 5 reflects the percentage of total crop acreage insured in 1997, both for the top 20 states.

 

Improved crop storage programs

While it is important, long-term, not to distort resource allocation unduly, the low crop prices today (which could go lower) suggest that short-term programs to encourage farmer-held reserves may be justified. As noted, in the face of favorable weather and declining exports, producers (and others in rural communities) are vulnerable. A supply-demand balance could well be achieved only at very low price levels. That condition could continue for some time.

I am not unmindful of the budgetary costs of an expanded loan and commodity storage program; however, the social costs of doing nothing could be very significant.

* * * * *

I would be happy to answer questions from committee members.

 

Figure 4.

 

 

 

 

 

 

 

 

 

 

 

 

 

Figure 5.