Testimony of

NEIL E. HARL

Charles F. Curtiss Distinguished Professor in Agriculture

and Professor of Economics

Iowa State University

Ames, Iowa

United States Senate

September 15, 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 conditions necessary to obtain higher farm commodity prices; (2) the nature of the adjustment process under current farm legislation; and (3) suggestions for Congressional action.

 

I. Necessary Conditions for Higher Commodity Prices

The low prices for many farm commodities in nominal terms are even lower in real terms in comparison to the low prices experienced in the 1990s and earlier years. The question uppermost in almost everyone's mind—when will better prices return and what factors can turn the situation around?

A year of low prices can be endured by most farm businesses if it is apparent that conditions will improve. However, if low prices continue for two, three or even more years, the damage to the sector in terms of failing firms will rise sharply. Unfortunately, there is little in current law to assure that a balance in supply and demand at a higher price will be achieved in that time period.

Higher crop prices can be expected if a change occurs in one or more of four factors—(1) domestic demand; (2) exports; (3) unfavorable weather in the major crop producing regions of the world; or (4) progress in forcing a shift in land use away from the commodities with low prices.

Domestic demand

U.S. demand for food products rises slightly faster than the population growth rate which has been increasing at less than one percent per year the past couple of decades. The gross birth rate, running as high as 26 per thousand in the 1950s, has dropped to less than 15 in recent years. Moreover, there is little hope for a significant increase in domestic demand for food products. Incentives in place to produce petroleum substitutes with crops, particularly corn, provide an important underpinning for the use of crops for non-food uses.

In short, increases in domestic demand are unlikely and cannot be expected to provide much increased price buoyancy.

Exports

As can be seen in Figure 1, agricultural exports peaked in 1995 and 1996 above $60 billion. Exports have declined since and could go lower. Agricultural exports for the current fiscal year are expected to total about $55 billion.

 

Figure 1.

 

As shown in Table 1, the U.S. market share of world feedgrain exports has dropped more than 13 percentage points in 1997-98 over the average of the three prior years. Moreover, the world export level in feedgrains has declined by about 184,000,000 bushels. Corn exports are a major factor in that decline, dropping from 2,067,000,000 bushels in 1994-1997 to 1,475,000,000 bushels in 1997-98. One reason for the decline in corn exports is that Argentina is exporting about double their level of corn exports in the mid-1990s.

 

Table 1. Feedgrain export analysis

 

3-year average

1994-95

to 1996-97

Estimated

1997-98

crop year

Projected

1998-99

crop year

 

(million bushels)*

World total feedgrain exports

3,664

3,480

3,483

U.S. corn exports

2,067

1,475

1,600

U.S. exports, other feedgrains

263

269

219

Exports by other countries

1,334

1,736

1,645

U.S. market share

63.6%

50.1%

52.5%

*Metric tons converted to 60-pound bushels.

Source: USDA and Doane Agricultural Services.

 

Table 2 shows the decline in U.S. wheat exports from 31.3 percent of the world total to 28.4 percent in the current fiscal year. World exports of wheat have increased modestly in the current fiscal year over the three year average.

 

Table 2. Wheat export analysis

 

3-year average

1994-95

to 1996-97

Estimated

1997-98

crop year

Projected

1998-99

crop year

 

(million bushels)*

World total wheat exports

3,647

3,666

3,589

U.S. wheat exports

1,143

1,040

1,050

Exports by other countries

2,504

2,626

2,539

U.S. market share

31.3%

28.4%

29.3%

Source: USDA and Doane Agricultural Services.

World soybean exports are shown in Figure 3. The U.S. market share has declined modestly, from 44.0 percent of the global export market in 1994-97 to 42.3 percent in 1997-98. World exports of soybeans have increased in 1997-98 over the three year average.

 

Table 3. Soybean export analysis

 

3-year average

1994-95

to 1996-97

Estimated

1997-98

crop year

Projected

1998-99

crop year

 

(million bushels)*

World total soybean exports and meal exports

2,447

2,792

2,787

U.S. exports soybeans & meal

1,076

1,182

1,162

Exports by other countries

1,370

1,611

1,626

U.S. market share

44.0%

42.3%

41.7%

Source: USDA and Doane Agricultural Services.

 

Table 2 shows a modest increase in projected U.S. exports in 1998-99 but against a decline in world exports in wheat. Table 3 shows an expected decline in the U.S. market share of world soybean exports in 1998-99 in the face of small decline in the world export market.

Global trade in agricultural economies could very well decline further if the weakness in economies of the Pacific Rim nations and Russia deepens.

It is important to note that 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 rose sharply in the worst of these years, as shown in Figure 2. While I am not predicting a 40 percent decline in agricultural exports this time, exports could well go lower than at present. The concern is that the economic effects of the export decline in the 1980s on producers were largely offset by the increase in government payments to the sector. The authority for such support of the sector is not available under the 1996 legislation.

 

 

Figure 2.

Source: USDA.

 

Weather

On the supply side, one factor that could produce improved crop prices is adverse weather in the major crop producing regions of the world. With the 1998 growing season largely concluded in the Northern Hemisphere, the next opportunity for weather problems is in the Southern Hemisphere in 1998-99 and in the Northern Hemisphere in the 1999 crop year. At the moment, one could not confidently predict other than normal weather.

Reduced supply from lower prices

If demand does not increase from domestic demand or exports, and supply is not reduced by bad weather, the market will adjust the level of supply. This can be painful, economically, for producers as discussed in the next section.

 

 

II. How the Market Adjusts Supply

The current low crop prices are sending a clear signal—too much is being produced to expect the price levels of recent years.

The 1996 farm bill

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.

The adjustment process doesn't necessarily reward efficiency and penalize the inefficient. The squeezing by the market is expected to lead to failure first by those with limited equity—mostly younger operators and others who have been weakened by crop or other losses in recent years. Those with ample equity will survive, even though not perhaps as efficient, and will likely take over the land and other assets of those failing. When this occurs on the most productive areas, no effect is expected on aggregate supply. The reduction in supply must be accomplished through land use shifts at the margin along with some reduction in output everywhere as lower crop prices result in lower levels of input usage.

Prior legislation

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.

Contrasting models of adjustment

The 1996 legislation introduced a vastly different adjustment model for balancing supply and demand. The market makes it clear that the "core" producing regions may be able to count on continued production of the crop and markets will signal, through higher prices, if production is needed in the "swing" zones at the periphery. Figure 3 illustrates for corn the "core" areas and the "swing" zones. When not needed, the market squeezes the swing zone areas back out of production.

 

Figure 3.

The model of government involvement took a different tack—the base was the historic production area for the crop. If supply needed to be reduced, land idling and commodity storage programs were utilized to cut back on output. This was a relatively painless process for producers.

One reason sometimes given for shifting to a market-based model for adjustment is that the government-involved model limited the upside price potential. But is it realistic to believe prices will remain high under the market model? That is most unlikely. Farmers have demonstrated for generations that, given price incentive, they increase production every time and drive down price and profitability. Moreover, under the market model, those on the sidelines at the periphery, will be waiting to get back into the production game at the first opportunity. Thus, the only period of better prices that can be expected is the brief period from an initial spike up in prices before producers respond with increased output.

Therefore, it appears that farmers in 1996 gave up a model with a relatively painless downside adjustment and limited upside potential for a model inflicting economic pain to accomplish the downside adjustment with limited upside potential.

It is a fundamental fact of economic life that, long-term, the prices for crops will never depart very far or for very long from the cost of production on marginal lands. As soon as they do, producers respond to boost output.

 

III. Suggestions for Congressional Action

Downside protection

The preceding section outlines two discrete models for adjusting supply with fluctuations in supply, primarily from weather, and fluctuations in demand, mostly from increases or decreases in exports. The two models are the government/market model, utilized from 1933 through 1996 and the market model which has been in place since 1996. The question is whether the market model can be modified to provide greater downside protection.

It should be noted that any effort to curb the downside runs counter to the basic nature of the market adjustment process. Any attempt to shield producers from low prices—(1) runs the risk of inducing more production, rather than what the market is prescribing—less production, which is perverse; and (2) slows down the adjustment process (by shielding those in line to shift their land use patterns from the full effects of low prices).

If low prices are believed to be a one or two year phenomenon, with adverse weather or a pick up in exports expected to produce higher prices, several steps would be feasible. A modestly higher loan rate is one possibility. Another alternative would be a farmer-held commodity reserve program to shield crop supplies from the market until prices have reached a higher level. I am not unmindful of the budgetary costs of an expanded loan and commodity storage program; however, the economic and social costs of doing nothing could be very significant.

In the event low prices continue for more than a couple of years, a farmer-held reserve program could result in a build up of stocks sufficient to suggest a return to land idling. Indeed, a continuation of prices at current levels will lead, almost certainly, to substantial support for more aggressive government intervention including some type of acreage reserve, possibly an expanded conservation reserve program. While that approach would concentrate the adjustment pressures in communities at the periphery of major producing regions, it would be more economically and environmentally rational from the standpoint of resource use than idling land over the entire subsector.

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 and Russian 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 and Russian crises 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.

 

* * *

 

I would be happy to answer questions from committee members.