Farm Subsidies and Risk Management

November 10, 2011

There has been much written recently about the so-called shallow loss proposals to provide subsidies for farms in cases when farm revenues fall slightly below the record high levels of the past few years. 

The proposals come from a bi-partisan collection of influential farm state legislators, such as Rep. Collin Peterson (D., MN) and Senator Richard Lugar (R, IN) et al., and commodity groups such as the National Cotton Council. (The Congressional Research Service has prepared a helpful summary of the proposals). All suggest that new and expanded subsidy programs are needed to help farmers manage untoward risks of farming.  These ideas have even gotten support from some long time advocates for farm policy reform such as the distinguished former Agriculture Secretary and U.S. Trade Representative Clayton Yeutter.

Let us take a step back and put these proposed programs in context.  First, since the middle of the last decade farm prices for the major grains, oil seeds and cotton have doubled or more than doubled and are expected to remain elevated.  This has meant that the long-standing support programs with their fixed congressionally mandated support prices no longer trigger payments.  Projections for the next decade suggest that prices are unlikely to drop back to below the established support prices.  Since there is no support for simply raising the government set minimum prices, and simply paying farmers and farmland owners based on their history of having political clout (as was established in 1996) now seems infeasible, commodity groups needed another formulation to continue to receive significant government payments.

One way to ratchet up supports and lock in high revenues is to tie payments not to price per se, but to revenue.  Hence the new proposals each include variants of the idea that when revenue declines by 5 or ten percent below what farmers of a particular commodity have come to expect, the taxpayer would make payments to fill the gap.  Thus, this year, with harvest time price of soybeans about 10 percent below the futures price established last winter, government payments would kick in under some proposals.  Even now under subsidized crop insurance programs, farms or county yields as little as 5 percent below average would be enough to trigger crop insurance payments in some cases. Notice this would happen with a price of soybeans of more than $12 per bushel when the average farm price from 2004 to 2006 (not a particularly low-price period) was below $6.00 per bushel. In other words, historically high prices have become the new “benchmark” for support. Talk about a ratchet effect.

We can use insurance information to get a sense of how much the proposed programs are designed to satisfy farmers latent demand for “risk management.” Under the current crop insurance program with more than 50% premium subsidies, additional subsidies for program delivery, and subsidies to cover losses of insurance companies, relatively few farmers buy insurance to cover losses above 20 percent.  And, as premium subsidies decline farmers abandon insurance altogether. Farmers employ many risk management strategies from diversification and crop rotation to storage and use of forward contracts. Given these options, they do not choose to buy more risk management when asked to pay a major share of the costs. The opportunity to lock in high revenues with expected payoffs likely to be in the billions of dollars is not about risk but about higher returns, and no operation can afford to turn down higher returns with little or no risk.

Finally, there are two further problems with the argument that farming is especially risky and therefore taxpayers must continue to provide payments whenever revenue targets are not met.

First, notice that this idea only seems to apply to that subset of farm commodities that have received the traditional farm subsidies since the 1930s. There are no proposals for massive “shallow loss” subsidies for industries such as fruits, vegetables, tree nuts, broilers, hay, hogs, beef cattle, greenhouse and nursery products, eggs or seeds. These industries are at least as risky as corn and soybeans, but they have not traditionally been subsidized to the degree to which some crops have become accustomed. (As an aside, there is no evidence that the long term prosperity or productivity of the heavily subsidized industries is higher than the less subsidized farm commodity industries.)

Second, the debt to equity ratio of the subsidized farm sectors does not make them particularly vulnerable. In fact farm debt is well below 15 percent of equity. Moreover, most farms have substantial non-farm income and most farmers work off the farm or get retirement income from non-farm occupations. The farmers that are least likely to work off the farm operate the largest farms and practice a number of risk management strategies. Thus, relatively few farms are in danger going under. Farming is a risky business, but, given how they are organized, there is nothing particularly risky about farming compared to other businesses.

Under the new “risk management” proposals, any individual farm would gain from access to government payments when market revenue falls below some recent average or pre-set target. That said, there is simply no evidence or consistent reasoning for subsidies whether rationalized by “risk management” or one of the other dozen or so common claims (see page 12 of this book by Stanford University’s Woods Institute). Furthermore, there is no evidence that the long term prosperity of agriculture is enhanced by government subsidies or that U.S. farming is more productive or that Americans eat better because we have spent trillions of dollars on farm subsidies over the past seven decades. The best argument for farm subsidies is that we have always had them and change is hard. But, that argument has been stretched a bit thin and this period of record farm profits and record government budget deficits is an ideal time to finally cut the cord.

(Other papers critical of recent “risk management” proposals and well worth your time are a piece written by Bruce Babcock for the Environmental Working Group and one by Barry Goodwin and Vince Smith for AEI. For a recent broader evaluation of farm subsidies visit my paper written jointly with Barry and Vince and published by AEI).


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