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«Bruce A. Babcock Working Paper 00-WP 263 December 2000 Center for Agricultural and Rural Development Iowa State University Ames, Iowa 50011-1070 ...»

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The Regional Distribution of Farm-Level Impacts

from Acreage Set-Asides

Bruce A. Babcock

Working Paper 00-WP 263

December 2000

Center for Agricultural and Rural Development

Iowa State University

Ames, Iowa 50011-1070

www.card.iastate.edu

Bruce A. Babcock is a professor of economics and director of the Center for Agricultural and

Rural Development, Iowa State University.

This publication is available online on the CARD website: www.card.iastate.edu. Permission is

granted to reproduce this information with appropriate attribution to the author and the Center for Agricultural and Rural Development, Iowa State University, Ames, Iowa 50011-1070.

For questions or comments about the contents of this paper, please contact Bruce Babcock, 578F Heady Hall, Iowa State University, Ames, Iowa 50011-1070; Ph: 515-294-6785; Fax: 515e-mail: babcock@iastate.edu.

Iowa State University does not discriminate on the basis of race, color, age, religion, national origin, sexual orientation, sex, marital status, disability, or status as a U.S. Vietnam Era Veteran. Any persons having inquiries concerning this may contact the Director of Affirmative Action, 318 Beardshear Hall, 515-294-7612.

Executive Summary The question of whether the United States should once again authorize acreage setasides will be addressed now that Congress has decided to hold hearings about a possible early rewrite of farm policy. Questions about the impact of acreage set-asides on farm income and national policy goals will need to be answered. This paper takes an initial look at three pertinent questions: (1) What impact will acreage set-asides have on the prices of corn, soybeans, and wheat? (2) What would be the differential farm-level impacts of set-asides across regions? And (3) How might acreage controls work with existing marketing loans?

A 10 percent reduction in corn, soybeans, and wheat would significantly raise prices in a one-year time frame. Over a three-year period, production in other countries would increase, and processors and livestock feeders would adjust their demands, so the price impact would be much less significant. Thus the major benefits from a permanent reduction in supply would be relatively short-lived and not shared equally across crops.

For example, soybean producers would benefit much less than corn producers because the soybean buyers have a greater ability to find alternative supplies and ingredients than do corn buyers.

The attractiveness of supply control programs, either voluntary or mandatory, also would not be equal across farmers of the same crop in different production regions.

Those producers that reside in areas that have low per-acre land rents relative to per-acre crop revenue would receive a disproportionate share of program benefits. Corn Belt farmers with their high cash rents and high per-acre yields should be much less enthusiastic about a program that ties payments to land set-asides than irrigated corn farmers in Oklahoma with relatively high yields, high costs, and low land rents.

Supply control would have to increase prices above loan rates before any farmer would see a benefit if marketing loans were continued. Thus, maintaining current eligibility requirements for marketing loans would make the attractiveness of voluntary set-asides quite low. Some additional inducement, such as a higher loan rate for participating farmers, would have to be enacted before a voluntary program would become feasible.

Set-aside programs would tend to target subsidies and would tend to reduce production in regions that would otherwise go out of production first when prices were low. One possible justification for this type of program would be to counteract the acreage-expanding impacts of the U.S. marketing loan and crop insurance programs.

THE REGIONAL DISTRIBUTION OF FARM-LEVEL IMPACTS

FROM ACREAGE SET-ASIDES

Larry Combest, chairman of the U.S. House Committee on Agriculture, has announced that his committee will be holding farm bill hearings with a possible objective of an early rewrite of the Federal Agriculture Improvement and Reform (FAIR) Act.

Without a rewrite, the Act will expire with the 2002 crop. One of the key questions that his committee will have to address is whether to bring back acreage set-asides. In past farm bills, the secretary of agriculture could limit eligibility for program payments to those farmers who set aside a certain percentage of their normal planted acreage. Set-asides were used to control total production and increase price—which reduced per-bushel payments—and to limit the acres that qualified for payments, thus reducing program costs.

Under the FAIR Act, all farmers are eligible for marketing loan payments and there are no government controls on what can be planted. Rather than planting their “base” acres to protect program payments, farmers began to make planting decisions guided more by the relative profitability of different crops. The result has been a dramatic change in farmers’ planting decisions across the United States. As shown in Table 1, soybean acreage has dramatically increased in many states. Wheat acreage has decreased significantly in most states, and corn acreage has expanded in most states, with the largest percentage increases occurring outside the Corn Belt.





The surge in corn and soybean acreage comes despite weak prices for both crops.

And wheat prices remain depressed despite the drop in wheat acreage. Some feel that U.S. farmers are planting too many acres for their own good, and that the FAIR Act should be abandoned in favor of a farm bill that would allow the U.S. Department of Agriculture (USDA) to reinstate acreage controls. For example, Professor Darryl Ray at the University of Tennessee, in a series of policy papers and presentations, argues that U.S. farmers would be better off if U.S. crop acreage could be constrained by USDA when price is low. He argues that low crop prices indicate that the United States has 2 / Babcock

–  –  –

excess supplies of crops. Furthermore, he argues that these low prices and excess supplies are not self-correcting because U.S. farmers will not let their land go idle.

Given this policy context, it will be useful to examine the economic impacts of acreage controls. This paper gives insights into three questions: (a) What would be the market price effects if crop acreage were reduced? (b) Who would be the winners and losers from acreage controls? and (c) How might acreage controls work with existing marketing loans? While these questions have been studied previously, they have not been adequately addressed in the context of the FAIR Act. Answers to these three questions should help guide interests groups and policy makers in their current farm policy deliberations. Before addressing these three questions, it will be useful to first examine the economic forces that influence farmers’ acreage decisions to determine if we are indeed in an “oversupply” situation.

Farmers’ Acreage Decisions A useful framework to examine farmers’ decisions is to make the simplifying, yet straightforward, assumption that farmers take actions that make them financially better The Regional Distribution of Farm-Level Impacts from Acreage Set-Asides / 3 off. This leads to the conclusion that farmers will not plant an acre if revenue (price times yield) from the acre will not cover the additional costs that vary with the planting decision. Variable costs include the cost of seed, chemicals, fertilizer, labor, fuel, and repairs. Costs that do not change, such as fixed land expenses and depreciation, are not considered in the planting decision. To maximize their financial well-being, farmers will tend to plant the crop that achieves the highest excess of revenue over variable expenses.

Clearly, farmers can lose money in a crop year by following this decision rule if the excess of revenue over variable cost fails to cover all fixed expenses. But if the land is not planted, both revenue and variable costs are zero, which means that none of the fixed costs are covered.

When land rental markets are functioning, the best measure of the difference between expected revenue and variable cost for a parcel of land is its rental rate. The maximum a farmer would be willing to pay to farm an extra acre is the excess of revenue over variable expenses. If there are many potential renters, then we should expect land rents to be bid to this difference.

This simple decision rule can be used to explain why we might not see large acreage decreases when price declines. Consider an Iowa farmer who has the opportunity to plant corn, soybeans, or nothing. Assume that fixed costs for this farmer are $150, expected yields are 150 bu/ac for corn and 40 bu/ac for soybeans, and variable expenses are $120/acre for corn and $90/acre for soybeans. Suppose the farmer expects to receive $1.50/bu for corn and $4.10/bu for soybeans at harvest sales. At these low prices, revenue less variable costs is $100/acre for corn and $94.50/acre for soybeans, so the farmer would tend to want to plant more corn and less soybeans. With corn planted, expected farm profit for the year would be -$50/acre for corn, compared to -$150/acre if nothing is planted, so the land will not be left idle. In fact, as long as the expected price of corn is greater than $0.83, the land will be planted.

What would happen if the expected soybean price rose to $5.00/bu and the corn price was held constant? Now soybean net revenue (expected revenue less variable costs) would be $35/acre greater than with corn. This increase in soybean price would result in a fairly dramatic increase in soybean acreage with a resulting decrease in corn acreage.

4 / Babcock However, if corn prices were to increase by the same proportion (to $1.83/bu), then the farmer would still tend to choose corn, and not soybeans.

This simple example illustrates that we should expect to see acreage shift between crops only if relative prices change. If all prices rise or fall together, then we should expect only modest changes in crop acreage decisions. What will change is land rental rates, rising as crop prices rise, and falling as prices fall.

This example also illustrates that when all prices fall together, total crop supplies may not decrease significantly in the short run (one year). Crop supply will not fall at all in the most profitable areas (where land rents are highest) if the price decline is less than that required to drive land rents to zero. Only in those locations where land rents are already low will a general drop in prices result in land being taken out of production.

Over time, however, the drop in crop supply due to low prices will increase as farmers have more flexibility to change fixed expenses into variable expenses. When this occurs, variable expenses increase, and it makes more sense not to plant land when prices are low.

Effect of AMTA Payments Before leaving this discussion of land use decisions, consider what would happen to our corn-soybean farmer if the government announced a doubling of Agricultural Market Transition Act (AMTA) payments (also known as transition payments and freedom to farm payments). Because AMTA payments flow to farmers regardless of which crop is grown, such a doubling would have no effect on the relative profitability of the two crops, so a doubling of AMTA payments would not affect acreage decisions. Of course, the increased payments would help the farmer cover fixed expenses, but they would not influence the choice of crop.

Effect of Loan Rates Now, suppose the farmer was guaranteed $5.16/bu for soybeans and $1.76/bu for corn through the government loan deficiency payment (LDP) program. Net revenue from soybeans is now $142.20/acre compared to $139/acre for corn. The availability of LDPs increases the relative profitability of soybeans, so LDPs should be expected to increase The Regional Distribution of Farm-Level Impacts from Acreage Set-Asides / 5 acreage devoted to soybeans. Marketing loan programs will only be acreage neutral when loan rates do not affect relative profitability of competing crops. Many argue that the large expansion in soybean acreage shown in Table 1 can be attributed to soybean profitability enhanced by the soybean loan rate. Furthermore, marketing loan programs will tend to keep acreage in production in some higher cost areas because they prevent land rents from being driven to zero.

Do We Have Excess Supplies?

Many argue that we need to adopt acreage set-asides because modern agriculture will always generate surplus supplies, unless crop yields fall short due to adverse weather (for example, see Schnittker and Harl). To an economist, a surplus or excess supply exists when more is produced than is consumed in a market. Using this definition, the FAIR Act cannot generate excess supplies because the policy is designed to make sure that all that is produced in a crop year is consumed in the following marketing year. The LDP and marketing loan programs have taken government out of the business of multi-year crop storage, and market prices are allowed to adjust freely to guarantee that all that is produced will be consumed or purchased and stored privately.

How then, can advocates of acreage set-asides argue that we have excess supplies?

Because current policy guarantees a price to producers and allows market prices to adjust below this price guarantee, there can exist a wedge between the loan rate price that producers receive and the price that consumers pay. In this regard there is indeed an excess supply—but it is caused by acreage being planted in response to the governmentguaranteed loan rate.

Thus, supply is larger than what would be produced without government intervention.

One solution to this oversupply situation is to eliminate the price guarantee. This would drive production out of the highest-cost regions and reduce the overall supply of crops.

But this policy prescription is not what advocates of acreage set-asides have in mind.

Rather, they believe that even without federal price guarantees, farmers’ own free actions will lead to crop supplies too high to sustain a price level that they would like to achieve in the marketplace. Instead of $1.40 corn at harvest, advocates would prefer that market 6 / Babcock prices were $2.20. But a 10-billion-bushel corn crop is too large to support a $2.20 price.



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